Oaktree Specialty Lending Corp (OCSL) 2010 Q1 法說會逐字稿

Good day, everyone, and welcome to today's Fifth Street Finance Corp's first-quarter 2010 earnings release conference call. As a reminder, today's conference is being recorded. Now I'd like to turn the conference over to Ms. Stacey Thorne, Head of Investor Relations. Please go ahead.

Good morning and welcome, everyone. My name is Stacey Thorne and I am the Head of Investor Relations. This is a conference call to discuss the results for Fifth Street Finance Corp's quarter ended December 31, 2009. I have with me this morning Leonard Tannenbaum, CEO and President; Bernard Berman, Chief Compliance Officer, Executive VP and Secretary; and William Craig, Chief Financial Officer.

Before I begin, I would like to point out that this call is being recorded. Replay information is included in our press release released yesterday and is posted on our website. Please note that this call is the property of Fifth Street Finance Corp. Any unauthorized rebroadcast of this call of any form is strictly prohibited.

Before we go into our earnings, I'd like to call your attention to the customary safe harbor disclosure in our press release sent yesterday, February 9, 2010, regarding forward-looking information. These conference calls include forward-looking statements and projections, and we ask that you refer to our most recent filings with the SEC for important factors that would cause actual results to differ materially from these projections. We do not undertake to update our forward-looking statements unless required by law. To obtain copies of our latest SEC filings, please visit our website or call Investor Relations at 914-286-6811.

The format for today's call is as follows. Len will provide an overview, Bernie will provide an update on the SBA and other lending facilities, Bill will summarize the financials, and then we will open the line for Q&A.

I am now going to turn it over to our CEO, Leonard Tannenbaum.

Thanks, Stacey. From an economic standpoint, we continue to see stability. We also see the prospect for a continued ramp in mergers and acquisitions activity. As both strategic investors and private equity firms increase their activity, we expect loan demand in the middle market to accelerate.

Fortunately for our business, there continues to be a limited amount of our competitors that can complete a transaction for the private equity sponsors without any syndication risk. This provides us with some additional pricing power and the ability to capture market share.

Increased mergers and acquisitions activity has also allowed us and our private equity partners to sell a division of one of our portfolio companies, Best Vinyl, to a strategic investor. In addition, another portfolio company, TBA, was able to sell a division that was breakeven in EBITDA to another competitor, to a different competitor.

In the case of TBA, in the last few days we received a paydown of $2.5 million on our second-lien loan, with another $500,000 expected in the near future. It has been pro active portfolio management and a partnership approach with our private equity firms that allowed us to successfully navigate a very challenging environment.

I am pleased to report that category 3, 4 and 5 rated securities account for less than 7% of the portfolio. The first fiscal quarter of 2010, that ending December 31, 2009, was very robust from an origination standpoint. During the December quarter, we originated $144 million worth of deals. 100% of those were first-lien and about 50% of those were floating-rate loans.

Recently, our SBIC subsidiary received its SBA license, which Bernie will talk more about later. On average, these new investments have about 50% sponsor equity and rollover equity, IRRs in the mid teens, and just under 50% of the loan amounts are floating with a LIBOR floor of approximately 3%.

On average, debt to EBITDA of the recent deals that we have closed is about 3.3 times deep. The increase in floating-rate loans with floors will begin to serve as a hedge against a substantial increase in interest rates over the coming years. Our SBA leverage will also serve as a hedge against rising inflation and interest rates, as the interest rate on that piece of debt is fixed for 10 years.

Although Fifth Street originates 100% of our securities, we have partnered with Aries Capital on one of the loans, and we have syndicated $7 million of our largest exposure to our partners at [Unitrend]. We continue to use -- we will continue to use financing partners to provide diversification in the portfolio. Our pipeline of loans remains strong at over $1.3 billion.

We continue to expect a high conversion of our pipeline and to sign term sheets, due to our ability to commit to the entire loan without syndication risk, by utilizing both our credit lines and the SBA facility, and the desire for sellers to close by the end of the year due to the increase in the tax rates next year.

We believe that these events, coupled with our strong brand and relationships, have allowed us to capture premium pricing over the market. We believe the opportunities in the middle market are large and growing, as lenders still have not returned to the middle market with substantial capital and, in fact, several have exited. We plan on continuing to take advantage of this environment to gain market share with top quartile private equity sponsors, as well as capture strong risk adjusted returns.

I am pleased to announce that we've achieved our goal that we set out last year of having 65% of the portfolio in first-lien loans. We currently have about 66% of the portfolio in first-lien loans, taking December 31, 2009 fair value and adding our recent transactions.

We believe that first-lien loans are substantially safer than second-lien and unsecured loans, and we are pleased that the portfolio is well-positioned to sustain an economic decline as well as benefit from an economic expansion.

As our pipeline consists predominantly of first-lien loans, I expect this percentage to increase to about 75% by the end of 2010. This strong first-lien position, coupled with further diversification and expansion of assets, should position Fifth Straight favorably to reduce its cost of capital over time.

Another advantage for us is that our investment portfolio has the vast majority of loans generated in the recent credit dislocation, thus providing strong risk-adjusted return characteristics.

Our board of directors declared an 11% increase in the dividend this quarter to $0.30, which was up from $0.27 in the previous quarter and $0.25 in the quarter before that. Due to the increased pace of originations just noted, coupled with the use of leverage, we anticipate the dividend should continue to increase during 2010.

As a RIC/BDC, we target a payout of between 90% and 100% of distributable income. Our distributable income per share for the quarter ended December 31, 2009 was $0.35. As the velocity of deals begins to return to normal, we expect to be able to realize some of our $7.8 million in negative fees.

We also have begun to accrete exit fees into income as appropriate. Our substantial prepayment penalties should allow us to retain many of our good loans as the credit market continues to recover. Over the coming monthly newsletters, I look forward to highlighting what I will expect will be several key hires to complement our team.

We are continuing our hiring process to add to our underwriting, portfolio management and marketing divisions, and look forward to continue to deliver a strong product offering to the private equity community, along with growing returns to our shareholders.

I want to thank our investors for their strong response to our recent offering. The board and I are very pleased with Fifth Street's ability to issue stock at a premium to NAV. Unlike many other BDCs, we are not seeking approval to sell shares below NAV at the next shareholder meeting. I believe that it takes a very accretive opportunity to warrant asking the investors to allow a BDC to issue shares below book.

As one of the leading firms of capital to deploy in the middle market, both through use of our credit lines and SBA leverage, we look forward to levering our assets modestly to enhance investors' returns.

I want to thank my partner, Bernie Berman, who has successfully navigated the important SBA process that we began in November 2008. To talk about where we are with the SBA licensing process and the deployment of our SBA equity capital, I would like to hand the call over to Bernie.

Thanks, Len. We are very pleased to announce that our SBIC subsidiaries license was approved as of February 1. We are now waiting for our capital commitment, which we expect to receive in the next few weeks. Once we receive a capital commitment, we will be able to begin accessing SBA leverage.

We expect that we will be able to access up to $37.5 million in leverage upon the receipt of a capital commitment, and the balance of the commitment upon the completion of our first examination by the SBA. We are in the process of requesting an early examination in order to expedite our ability to access the full capital commitment.

Our SBIC subsidiary has invested $73 million of its $75 million in regulatory capital, with the other $2 million held in cash. Over time, we expect to be able to access $150 million in leverage, which is the maximum permitted by current law. We are excited to be part of the SBIC program and look forward to a long partnership with the SBA.

We are also working on a new credit facility which will provide us with leverage against our existing portfolio, including our second-lien loans. We expect to make a formal announcement in the near future.

I am now going to turn it over to our CFO, Bill Craig.

Thanks, Bernie. With respect to our balance sheet, as of December 31, 2009, total assets were $453.2 million, which included total investments of $436.7 million at fair value, and cash and cash equivalents of $11.8 million. Liabilities were $42.9 million, which included a loan payable of $38 million, and stockholders' equity was $410.3 million.

With our offering in January, we have since paid down that loan payable and are now unlevered. Our net asset value per share at December 31, 2009 was $10.82.

With respect to our operations, total investment income for the three months ended December 31, 2009 was approximately $13.2 million, which included approximately $2 million of PIK interest and $0.9 million of fee income, which included approximately $27,000 of income from accrued exit fees.

For the three months ended December 31, 2009, we recorded net unrealized appreciation of $1 million. This consisted of $1.2 million of net unrealized appreciation on debt investments, partially offset by $0.2 million of net unrealized depreciation on equity investments. We also recorded $0.1 million of realized gain.

As Len mentioned earlier, we are actively moving towards larger, more secure first-lien transactions as evidenced by the following. Our weighted average yield on investments was 15.7% at September 30, 2009, which included a cash component of 12.9%.

Our average portfolio company investment at September 30, 2009 was $11.5 million. This compares to the current quarter. Our weighted average yield on investments was 14.9% at December 31, 2009, which included a cash component of 12.7%.

Our average portfolio company investment at December 31, 2009 was $14.6 million. At December 31, 2009, our portfolio consisted of investments in 32 companies. At fair value, 64.3% were first-lien loans, 34.9% were second-lien loans, and 0.8% were equity investments.

At December 31, 2009, approximately 19% of our debt investment portfolio at fair value bore interest at floating rates. All of our floating-rate loans carry a minimum interest floor of a at least 9%, which protects our return in a low rate environment and also serves as a hedge.

During the quarter ended December 31, 2009, we invested $144.2 million across four new and three existing portfolio companies. With respect to the portfolio, it's holding steady. As of December 31, 2009, we had stopped accruing PIK interest and original issue discount on five investments, including two investments that had not paid their scheduled monthly cash interest payments.

With respect to our ratings at December 31, 2009, the distribution of our debt investments on the 1 to 5 rating scale at fair value was as follows. The percentage of 1 and 2 rated securities for the quarter ended December 31, 2009, was 93.3% in comparison to 92.6% as of September 30, 2009. We are closely monitoring all of our investments and continue to provide managerial assistance as proactively as possible.

With that, let me turn it back over to Stacey.

Thanks, Bill. As a reminder for the month, Fifth Street does not report quarterly earnings. We release a monthly newsletter. If you would like to be added to our mailing list and receive these communications directly, please either call me at 914-286-6811 or send a request e-mail to IR at FifthStreetCap.com. Alternatively, e-mail alerts can be sent through the Shareholder Tools link under the Investor Relations tab on our website, www.FifthStreetFinance.com.

Thank you for participating on the call. I will now turn it over to Anthony to open the line for questions.

(Operator Instructions) Greg Mason, Stifel Nicolaus.

Good morning, this is John filling in for Greg. Len, you mentioned in your remarks that distributable income was $0.35 versus the $0.30 dividend. Could you tell us what your options are with that excess distributable income?

We did carry over some income year-over-year and did pay some excise tax, because many of the deals closed at the end of December and there is really no way to declare a dividend in time to sort of moderate that. Clearly, the dividend has to go higher during 2010 to flow towards our target of 90% to 100%.

We probably will have to carry over income again year-over-year from this year into next year. A lot of the dividend growth depends on continued origination and portfolio continuing to be stable or slightly increasing, which is what we are currently seeing.

(multiple speakers) You'll offset realized losses against that distributable income, perhaps retain the capital?

Will we do more chargeoffs; is that the question?

Yes.

We don't anticipate doing any more chargeoffs. To do a chargeoff takes a very high degree of certainty on a tax -- in order to exclude it from taxable income. The threshold for taxable income and PIK nonaccruals are two different thresholds. The PIK nonaccrual threshold is much lower as my finance team is nodding towards me.

So just because everything is on PIK nonaccrual does not mean everything is out of taxable distributable income. Though we try to lower taxable distributable income by as much as we can, it's a different threshold.

Okay. Turning to leverage, could you maybe give us some color on what you believe the appropriate leverage level is for your model?

I don't think we ever want to get towards the 1 to 1 leverage that the BDCs can max out at, because what it does unfortunately is make it difficult to write down assets when you have credit lines outstanding, because that would cause the 1 to 1 to get violated.

My ideal leverage, excluding our SBA leverage, which we do anticipate we are going to get a relief from the SEC as many of the other BDCs, the SBA leverage has gotten relied from the SEC to exclude both -- to exclude that subsidiary from leverage requirement.

I believe excluding that, the optimal balance is about 0.5 times levered. I think that has to fluctuate between 0.3 and 0.7, as you do small offerings to pay it down. Obviously, the best use of capital for any offering is to pay down debt.

Okay. So given the $100 million facility you are currently working on in the Wells, can you maybe give us a roadmap of how you would plan to come up with the additional leverage near to medium-term to come up to that 0.5 target?

I think if you assume that we can achieve an expansion of the Wells facility during the year up to the $100 million, which we've already funded the subsidiary to accomplish, and you assume a new $100 million facility which we should have the assets to be able to draw against; and we know eventually we're going to get through this $150 million of SBA leverage which be we've been approved for, or we are about to get our leverage approval for; and we have some cash on the balance sheet, it gets you to -- we will be able to deploy between $300 million and $400 million this year without doing any additional offerings. And that gets us to a little bit south, I think, of 0.5, but it gets us towards our target if we max deploy.

Thank you very much.

Chris Harris, Wells Fargo Securities.

Great, thank you. Good morning, everyone. Obviously, origination is very strong here, and your pipeline also looks great. Just wondering, a lot of your competitors seem to be having difficulty generating primary opportunities, and some of them have mentioned that that's probably a latter half 2010 event.

And just wondering how you guys are differentiating yourselves here and how you are seeing so many opportunities, while some of your other competitors seem to be kind of standing still from an originations perspective?

We are seeing that because a lot of our competitors are calling us asking to take pieces of the securities that we just originated. So I think one of the big differentials in this market is the syndication market has not come back yet, and the COO market is starting to open but really has not come back yet.

And there's basically two firms in our space that can take down a deal from an equity sponsor without any syndication risk. And the equity sponsors know that there is syndication risk, and there is a lot of also battling back and forth between syndicate partners that we have seen.

So they really want to just know their transaction is done and committed to, and they are going to get their capital. And the two firms that can do it are us and Aries. And I look forward to partnering on more things with them. They are a great shop. But right now, that competitive advantage is not only gaining us a little bit pricing power, but it's winning us deals.

Okay, that makes sense. You've had a little bit of activity here since the end of the quarter. What kind of origination pace should we expect maybe for the balance of the quarter and maybe over the next couple of quarters?

I think this quarter -- look, the last quarter was clearly a lot of deals being pulled in from this year into last year to close by December 31, as the administration potentially was raising some different taxes on this healthcare plan which got watered down. And I think that caused a lot of sellers to say we want to close by December 31. So we took that opportunity to capture a lot of great transactions at great pricing.

I think this quarter will be slower. I know this quarter will be slower. The pipeline is pretty good. I think what you are hearing from the market in that M&A activity will increase as the year goes on is right, because again, you're going to have a capital gains increase from 15% to 20% and a top income tax increase, I don't know, from 36% to 39% or 40%.

And I think those two things will drive additional M&A activity in the second half of the year, barring no economic increase. We are basically looking at a flat year or budgeting our firm for a flat economic year. It could be better or worse, but that's pretty much where we think the world is going this year. And therefore, this quarter is going to be a bit slower. I think you'll see an increase in the next quarter and increases each quarter after that.

Okay. Then on the new $100 million facility, can you provide us with kind of is there a price talk range that you can kind of guide us toward, or is it still too early to disclose any of that information?

No, I think the pricing -- you saw the Aries transactions being announced where Wells I think did a $400 million facility, and there was another very large facility that was done. I think [Mike Arigetty] is very smart in what he's doing, and we are following a little bit in his path as we have some of the same partners. I wish I had all of the same partners.

The Wells Fargo, we are going to hopefully expand like he does, which is a separate facility, which we are hoping to expand just to their $100 million dollar line. And the new facility should be, I think, around that same pricing, maybe a little bit higher. But the good thing about the new facility, as Bernie said -- maybe it wasn't highlighted enough -- is it will give us leverage against second-lien.

So that's -- as you know, we still have about one-third of the portfolio in second-lien. None of those are in the Wells -- Wells Fargo typically doesn't lend against second-lien.

With the expansion of the Wells line, could we potentially see a better rate, a better rate on that facility, or is the pricing going to stay the same?

Pricing is LIBOR 400 with no floor, and that's better than a lot of people. And I think that's probably where it's going to be for the foreseeable future.

Okay, last question here then, Len. I appreciate your comments about the hiring goals for the near term. I guess a few months ago, there was a lot of talent seeking employment based on what happens on Wall Street. And I'm just curious to get your thoughts; are you still seeing a solid inflow of applications there? Maybe if you could just give us a little color on what's happening.

Our hiring process -- and actually, we use something called the Top Grading System -- but our hiring process is very robust, and anyone who's been through it will attest to that. It takes us two to four months to hire someone as they go through competency interviews, tandem interviews, background searches, phone screens, all sorts of things. We are very careful to hire within our culture. We have a tight culture, and we're also very careful about mis-hires.

Having said that, there has been a pipeline -- you just saw the hiring pipeline -- which is, I don't know, almost 1000 people that have come through this pipeline at various positions. And as that has gotten funneled down, we are ending with some really great candidates, and I feel confident in the next 30 days we will announce some of them.

And we are also looking for another key hire which is going to be Chief Risk Officer and Chief Underwriting Officer, as we continue to grow and have multiple credit lines and build the very detailed -- we have the detailed process and procedure, but we are building the formats that our credit line providers want to see.

We are going to hire this absolutely key hire. It's going to take a while for it, but we are definitely out there recruiting for it. And everyone on the call, if they know this great Chief Risk Officer or Underwriting Officer, you can definitely send them our way. But we feel really good about hires, both in the portfolio management division, in the recruiting division, along with HR. So we are close on a number of really good hires.

Great, thanks, Len.

Robert Dodd, Morgan Keegan.

Hi, guys. This is Bo in for Robert. A few questions here. Could you give us an update on the five investments that are currently not accruing on PIK?

Can we give you an update how?

Just -- well, it looks like some of those assets have gone from Tier 3 into 4 and 5. I was wondering if you could just give a little more color just in general on how they are doing?

So no assets went -- not that I know of -- went from 1 or 2. We view the two different baskets, and I probably should say this on every call. We view 1s and 2 together as assets that are performing well and that we don't -- they're not in the portfolio management division's hands in terms of working out or restructuring anything.

And we view assets in three baskets -- 3, 4 and 5 all together. They fluctuate between 3, 4 and 5 quite often, and I don't know that I would take -- I would take with a grain of salt any moving between those three categories until it gets back to a category 2, which means it's no longer on our watch list.

Every security in baskets 3, 4 and 5 with the exception of 1, which is [Rost Harlow], is on PIK nonaccrual. [Rost Harlow] is not on PIK non-accrual. Actually, it's doing just fine. It's a basket 3. But we like to also see things perform for an extended period of time before they would get back to basket 2, so they stay on watch lists.

One of the ones I want to say that's in 3, 4 and 5 is our wholly-owned -- not wholly-owned but 95% owned company, which is Lighting by Gregory. And just because it's in that basket doesn't mean it's not doing well. Lightning by Gregory continues to actually perform very well and a little bit ahead of our plan, except when you own something, we could pay ourselves, we can not pay ourselves, we can pay ourselves all PIK like some people do and say it's income.

We determined not to do things like that. We are recognizing cash sweep payments from Lighting by Gregory, so when they pay us cash, we do recognize that. We recognize no PIK income from Lighting by Gregory. I do expect somewhere, if it continues to improve, that we should be able to continue to get payments from them.

So actually baskets 3, 4 and 5 are pretty stable. The portfolio management team now has the time to visit all of our two-rated securities to determine and really go through all that analysis, and that's what they're in the process of doing.

Got you, thank you. Another question, on the accruing of exit fee income happening in this quarter and then going forward, is that going to be -- how material is that going to be going forward and could you give us ball park figure for this fiscal year?

I'm not sure. I know that -- I think it will increase. I think it's safe to say that from $27,000, it's got to increase since we have $7.8 million of exit fees. And as a number of them -- we don't have a history -- the issue is we don't have a history of collecting exit fees. We wouldn't get an exit fee unless we thought it had some value.

But the issue is collectability, and until we have a history of it, I don't think you're going to see it materially -- I shouldn't say material but a large increase in the income from these exit fees.

I almost think of it like a retailer which has an uncollectible account against collecting their receivables. We just don't have a history to determine what that uncollectible account should be. I think once you start seeing us recognize exit fees and we start having a history of recognizing exit fees, us and our auditors are going to say, okay, we need to take this history into account and change the amount we are recognizing.

Got you. Thank you. Then you referred earlier -- I might've missed this -- to $300,000 to $400,000 in new investments -- sorry, $400 million of new investments this year. Is that calendar or is that fiscal?

I don't think know that I said $300 million to $400 million of new investments this year. I said we have the capacity to originate $300 million to $400 million of new investments this year. I think on a quarterly basis, maybe excluding this quarter which is a bit slower as some of the deals got pulled into last year, we think $50 million to $100 million is a good budget on origination per quarter.

And I think most of them are going to be, if not vastly predominately, will be first-lien one-stop transactions, because that's pretty much what's in our pipeline. I think maybe there will be us a sprinkling of second-line this year with sponsors that we've worked with before.

Got you. Thank you very much.

Jasper Birch, Macquarie Capital.

Good morning, gentlemen. Looking at your investment activity, it looks like you are still focusing in defensive industries. Can you just comment, is that more of our macro view on where we are on the cycle or is that more just the best securities that you are seeing at the right prices have been in particular sectors?

I think we are -- look, from a weighting standpoint, we are a healthcare overweight and always will be. I mean as a BDC, we really have deep expertise in healthcare. In our previous funds, my fund 2 and fund 1, we have lots of healthcare exposure. We are hiring probably more consultants than ever before to go state-by-state and tell us how regulatory changes are working within the state, and reimbursement rates in Medicare and Medicaid.

So we probably have more information today than we've ever had in the sector. So we feel really comfortable. We can expect that weighting to stay between 30% and 50%. I think currently, it's in the mid 30s%.

Beyond that, I am very cautious of diversifying among all the other industries, whether it's food, consumer, manufacturing, etc. You are right in saying that a lot of the recent deals and probably a lot of those in the pipeline have a recurring revenue nature to a lot of them.

In some of them, and I just do want to mention this on the call, we even have -- and we just don't have this -- we don't have this necessarily in the Q -- is we do have guarantees on some of our securities. I have said this before on calls, especially when we work with a new sponsor and we want to make sure that they are willing their willingness and ability to re-up when a problem is there.

Usually, with our longer relationships, there are less initial guarantees on that. These are usually [last out] guarantees from private equity funds. So I do want to mention that we do have these things. And we are very careful lenders. Look, as I am one of the largest shareholders of the Company and everybody here, at least at the table and all of my board, owns shares personally.

We're very conscious to make sure that in any cycle, we are going to do well and outperform. And that is why I -- my initial comment said we are positioned probably better today for any economic downturn, but we are also equally positioned for a nice economic upturn as we do have some substantial equity kickers and exit fees to capture.

Great, thank you for the color. Can you just remind us in terms of the SBA license and the evaluation, asking for an early evaluation, what is the normal timeline about how many more months would it be until an evaluation is complete? Under an early evaluation, when would you expect to be able to start drawing some of that leverage?

Okay, I'm going to ask Bernie Berman to answer that question.

When you are dealing with a government agency, I am always cautious on putting specific dates, because we've been told timelines before that have not always been met. But I expect that we will be able to get an early evaluation hopefully within the next few months, and thereafter we would be able to access the balance of our commitment.

Great, thank you. Then just one small question on the SBA again. If you get the exemption, which I am assuming you will, obviously the $150 million in borrowings won't be counted in your leverage on the debt bucket.

Just to clarify, the $75 million in equity in the subsidiary, that is still in your equity bucket for your overall leverage calculation?

No, you can't have it both ways. So effectively, the way you could look at it is you would pull the subsidiary out of the calculation and look at it without the subsidiary.

Excellent. Thank you guys very much.

Casey Alexander, Gilford Securities.

Good morning. Did you say exactly what the size of the portfolio pipeline is currently?

About $1.3 billion.

$1.3 billion, terrific. The investment on January 29, that kind of slipped through. I assume that was kind of because of the quiet period from the offering. Was there any syndication attached to that offering, or did you guys do the entire deal yourselves?

We held the -- I think it was a $22 million investment, give or take $1 million or $2 million, and we held the entire deal ourselves.

So there was no syndication?

No.

Do you have any current term sheets under consideration right now?

That's a good question, especially as you are modeling. We have term sheets under -- yes, we have term sheets under consideration, but we don't have any signed term sheets, I don't believe, right now.

Okay. On the floaters, I know you have a 9% floor on them. What is the initial yield that those are going out at?

It is -- well, we've disclosed that. It's 7%; it's LIBOR plus 7% with a 3% floor. So it goes back to Bill's comments. We are at least 9% or 10% on all of our floating-rate securities.

Okay. All right, let me see, I had one question. On the SBA, when you start to lever into the SBA, if you do an offering can you use that to delever the SBA pool or can you only delever that when a portfolio company pays down?

We are not planning to delever the SBA pool ever. The idea of the SBA pool is a seven-year recyclable pool of capital. So as one pays down in that subsidiary, we can then redeploy that capital within seven years. And then -- the length of the SBA facility is 10 years, and it actually is extendable even beyond that, under certain circumstances.

Right. I see that G&A expenses are moving up, and I assume that's related to your hiring pace. Can we expect that to continue to move up during the year, and any idea at sort of what rate?

I think you are going to finally see some G&A levered -- actually as a percentage of assets, G&A should move down. And the reasoning is the management fee, which is a constant, on assets is paying for almost all of the new hires. Our base team which is very critical, which is part of G&A or the expenses that are part of G&A, will finally start getting leveraged over time as our assets grow.

All right, okay. Great, that's all I have, thanks.

Jim Ballan, Lazard Capital Markets.

Great, thanks a lot. One question I have is you mentioned the loan modifications in your press release. Can you discuss generally kind of the typical order of events that lead you to conclude that modifying the terms makes sense? And then maybe talk about how frequently when you do a loan modification does that eventually lead to a loss or how frequent is that?

Let's see, in the 13 years that we've done this, it really varies. The first step for us typically in loan modification where we are modifying the interest rate is obviously -- nobody really modifies a loan unless the loan is in distress. And there's various reasons to do it, though, because there's usually multi-parties in the loan.

The first thing for us, and I call it two bites of the apple way of playing, is you take your second-lien loan to [the extent it's second-lien], and you convert part of it to equity and you keep some of it in interest, and you encourage our equity sponsor partners to invest alongside that in the equity. And I think the most typical loan modification for us is that.

The good news about this -- of course, the bad news about it is over time you are reducing your interest income. But the good news about that is the debt that you still have on the Company is more stable, much more easily serviced, and now you are capturing equity upside.

So I expect, for example, Lighting by Gregory, obviously was a loan modification. In fact, we own 95% of the company. At one point, the EBITDA went to zero and we worked hard. And I think if you go visit our store in New York City down in the Bowery, you will see the store is really nice. It was all redone.

A lot of money was put into it, not even by us, but by the different vendors. And the sales have picked up and EBITDA is now sufficient, not only to grow the business and to fund all of it internally, but to pay us cash each quarter. So that is a loan modification, but it takes portfolio management.

That's why my first hire, my first partner I brought on right around the time of Bernie, was Marc Goodman, our CIO, with 10 years of bankruptcy law experience at Kramer Levin and 10, 15 years of turnaround experience. Because we knew that there would be a couple of companies that we'd have to have equity slices in and help them turn around and make money.

And I think we've been very successful doing it over time. Of course, we have had our losses too, and the difference is we take them right away. We write them down, and at one point we had to take chargeoffs in the truly distressed meltdown in '08 or early '09.

Okay, great, that's helpful. Also, this may be asking you to look a little far into the future. But as you -- on the SBA side, once you've fully levered that subsidiary and it's essentially -- and you are essentially rolling things through that as they pay back, would you have thoughts of creating a second SBIC subsidiary, or is this sort of -- do you think most of it will go just into the BDC?

I note that many of the other BDCs with SBA subsidiaries have set up the second subsidiary. Currently, the way they do it is you set up -- I mean set up the second license. Currently, you can do that and then capture another $75 million of leverage.

There are different bills floating through Congress that are going to expand on BDC's ability to join with the SBA in doing loans to small companies. The timing of that is clearly uncertain. The timing of when we can benefit from that is clearly uncertain. But I expect over the next couple of years, this SBA subsidiary and license, or a second license, will definitely expand.

Okay, great, thanks a lot.

David Chiaverini, BMO Capital Markets.

Good morning, guys. Thanks for taking my question. Could you comment on the revenue and EBITDA trends just on the portfolio?

EBITDA trends is probably stable. I don't think it's getting a lot better or a lot worse. It got a bit better towards the end of last year, and now I would just characterize it as stable. And that along with revenue -- one thing that is getting better is liquidity, which is to a lender quite important.

And the reason liquidity is probably getting better and why the economy is not adding jobs faster than everybody would like is people are very cautious on whether we are going to double-dip, whether it's sustainable, what's the effect on increased tax rates.

So pretty much throughout the portfolio, we are seeing CEOs being very cautious with adding new costs, with adding new people, with adding new expenses. And because of that, even though you're seeing slight revenue increases, you're definitely seeing more liquidity. They are also managing inventory very tightly.

So we are experiencing better liquidity, probably stable revenue and stable EBITDA. And Marc's nodding his head to me, so that must be the right answer.

When you say better liquidity, are you talking about the portfolio company balance sheets where they have a bit more cash or they are paying down debt a little bit more? Is that what you're referring to?

I think you bring up a good point which I don't normally say on calls. A lot of our securities are amortizing down their debt, and this happens every month. We get monthly cash payments, monthly amortization, not quarterly as many of our competitors do. Sometimes we get quarterly amortization; we get monthly cash payments.

And we actually also, as we pay our dividends, I also want to point out that our amortization exceeds our PIK, and that's really key. Because when we pay out a dividend, we are paying out all cash that we are receiving. And that's contrary to some BDCs that have PIK that have to include that into their dividend and they pay it out, but they don't necessarily get the cash or have the realization.

So we are very closely monitoring cash, cash payments, and so liquidity is increasing a little bit. It's also because the debt is getting paid down, therefore, less interest expense; therefore, a little bit more liquidity.

Okay, that's helpful. Thank you for that. Second question is related to the SBIC. Now once that is fully ramped and fully levered, will that be consolidated or will that be accounted as like a portfolio company?

It's consolidated.

It's consolidated now; it's always consolidated.

Okay, Great, thanks a lot.

(Operator Instructions) Keith Rosenbloom, CARE Capital Group.

Hey, guys. Congratulations again, Bernie, terrific job on the SBA.

Thanks, Keith.

Hey, Lenny, as you talked about moving into first-liens, maybe you could speak a little bit about the equity kicker environment that you are seeing. Are you guys still able to get nice equity kickers on your loans, and how are you marking them in the portfolio?

So much of our equity isn't marked down, because unfortunately in some of the waterfall methods and valuation, equity goes first. And even as Bill said for this last quarter, we saw $1.2 million net unrealized increase, but a $0.2 million decrease due to further writedowns in equity. So it is what it is.

We are getting limited equity kickers. In fact, we are working on a deal that we are actually going to get another one. We typically take exit fees instead of equity kickers. The reasoning is exit fees are at the same well as the debt, or can be at the same level as the debt, and the equity kickers are uncertain when we ever get them. But there is certainly limited opportunities that we are going to get equity kickers.

So the environment is -- you are focused more on building your optionality with these exit fees as opposed to the equity kickers?

Yes.

And is that factored at all into your NAV calculation?

Exit fees are very limited, a couple hundred thousand dollars into our NAV of the $7.8 million. And the equity, of course, is marked at fair value, so that is in our NAV. But I would say that our equity is marked down substantially from where we started it.

Got it. Guys, again, great quarter and keep up the great work.

(Operator Instructions) With no further questions in the queue, that will conclude today's question-and-answer session, as well as today's conference call. We do thank everyone for their participation. You may disconnect your lines at any time.

Thanks, everyone.