Oaktree Specialty Lending Corp (OCSL) 2012 Q4 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Q4 2012 Fifth Street Financial Corp. earnings call. My name is Alex, and I will be your event manager today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference.

(Operator Instructions)

As a reminder, this call is been recorded for replay purposes. Now, I would like to hand the call over to Dean Choksi, Senior Vice President of Finance and Head of Investor Relations. Go ahead, please.

Good morning, and welcome to Fifth Street Corp.'s fiscal fourth-quarter and 2012 fiscal year-end earnings call. I'm Dean Choksi, Senior Vice President of Finance and Head of Investor Relations at Fifth Street. I am joined this morning by Leonard Tannenbaum, Chief Executive Officer; Bernard Berman, President; and Alexander Frank, Chief Financial Officer.

Before I begin, I would like to point out that this call is being recorded. Replay information is included in October 22, 2012 press release and is posted on our website, www.fifthstreetfinance.com. Please note that this call is property of Fifth Street Finance Corp. Any unauthorized rebroadcast of this call in any form is strictly prohibited.

Today's conference call includes forward-looking statements and projections, and we ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these forward-looking statements and 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 914-286-6855.

The format for today's call is as follows -- Len will provide an overview of our results and outlook, Bernie will provide an update on our capital structure, Alex will summarize the financials, and I will add a new section to our earnings call by providing some commentary on the BDC industry. Then, we will open the line for Q&A.

I will now turn the call to our CEO, Len Tannenbaum.

Thank you, Dean.

The US election results seemed to be the catalyst for investors to reduce risk. Some of the selling earlier in the month of better performing high-dividend yield stocks may have been prompted by the potential for higher tax rates in 2013, as Congress and the White House work on a solution for domestic fiscal imbalances and the upcoming fiscal cliff. The potential for lower government spending and higher tax revenues in the future could be headwinds to economic growth in the short run. However, monetary policy should remain a significant tailwind for markets and offset some of the impact from tighter fiscal policy and higher tax revenues.

The massive amounts of liquidity that are being pumped into the financial system through quantitative using pogroms have left investors expecting low interest rates for the foreseeable future. As a result, investors are reaching further out in the risk spectrum in search of incremental yield, which is helping to reduce the cost of borrowing for large companies.

At Fifth Street, we are positioning our balance sheet and maintaining capacity to be opportunistic in 2013. We currently have approximately $500 million of available capital, after taking into account an amendment to upsize our ING-led credit facility, which is currently at $230 million. We anticipate expanding the line to over $350 million in commitments from at least 10 lenders, including at least five new banks, with more flexible terms and a lower cost than the existing facility.

We are pleased to report strong September quarter results to end our fiscal year 2012. And, we have a solid start to the December quarter and fiscal year 2013. For the fourth quarter, we delivered $0.27 per share of net investment income, which is consistent with last quarter and in-line with consensus.

For fiscal year 2012, we reported NII of $1.11 per share, our third-consecutive year of increased earnings. Our earnings power continues to improve, and we remain on a path, we expect, will enable us to cover our dividend with NII. We achieved consistent growth in NII over the last three years, from $0.95 per share in fiscal year 2010, to $1.05 per share in fiscal year 2011, to $1.11 per share in fiscal year 2012. We are confident in our ability to maintain our dividend, with the possibility of an increase, as we continue to focus on earning our dividend with NII in fiscal year 2013. As a result, we estimate net investment income should increase again to at least $1.15 per share in fiscal 2013.

Our portfolio credit quality is the best it has ever been. At September 30, 2012, we now have only one security on PIK nonaccrual, and that one is Coll Materials Group. We have now put the problems associated with our 2007 vintage loans behind us. Our credit outlook is positive, with over 99% of the portfolio now ranked one and two. Our net asset value has been relatively stable for the last several quarters and this quarter increased $0.07 to $9.92 per share as of September 30, 2012.

The December quarter is starting off strong, with over $179 million of originations closed as of November 27 and a robust pipeline heading into the end of the year. We are on track to meet or exceed the high end of our target range of $100 million to $300 million in gross originations for the December quarter. The momentum in the March-quarter pipeline is also starting to build. The election results catalyze certain sponsors' desire to close deals by year end, leading to an increase in our pipeline. This new deals are larger, higher quality, and many are with existing sponsor relationships. We appreciate that sponsors want to close by December 31 and have been flexible in providing unitranche or mezzanine financing options for them.

We are also using market liquidity to our advantage. In the last few months we exited several smaller more liquid credits to lock in gains above par. We also have expanded our emphasis on capital markets transactions where our sponsor relationships, underwriting expertise, and market reputation create opportunities for us to agent and syndicate deals with attractive risk reward characteristics. As we grow this effort, we should generate incremental fee income through syndication and also generate additional assets with attractive risk reward characteristics for our balance sheet.

Our investment-grade credit rating is also helping us to increase the duration, flexibility, and diversity in our capital structure. We issued $75 million of baby bonds, consisting of unsecured 12-year debt at 5.875%. E-securities trade with a $25 par amount and are listed on the NYSE under the symbol FSCE. Baby bonds complement our secured bank debt because their maturity is substantially longer than other sources of debt funding. Baby bonds are attractive sources of long-term capital, and we may issue additional unsecured debt, if market conditions warrant, with different maturities to diversify our debt structure.

We are focused on continuing to increase the average duration of our liabilities which totals, today, approximately 5.6 years. We continue to work on closing an amendment to our credit facility was our ING-led syndicate, which should provide a lower cost and more flexible source of debt to fund growth. We have had a positive reception from new and existing lenders, due to our investment grade rating, improving asset quality, and established institutional lending platform. We look forward to announcing more details shortly.

In September 2012, we raised $91 million of equity which was deployed later in October, when we closed a record $120 million in gross originations. Our September offering was accretive to NAV, well received by investors, and will help us fund a very strong pipeline through the end of the year. We believe our earnings outlook continues to improve, as we head into the next fiscal year, as a direct result of the steps we took in fiscal 2012. Book value is stable to increasing, our portfolio credit quality is the best it has ever been, and we continue to reduce the cost and risk in our diversified liability structure.

Our extensive investment in our origination platform is generating high-quality yield flow, leading sponsors, and providing us with new capabilities that were not available to Fifth Street at its size two years ago. In addition to our strong franchise, with low and middle-market sponsors, we have expanded our platform to invest in larger portfolio companies. To support these efforts, we are in the process of hiring two experienced employees, focusing on originating larger deals with bigger private equity sponsors. We are pleased with our performance over the last fiscal year and look forward to delivering a fourth consecutive year in growth in net II -- in net investment income.

I will now turn the call over to our President, Bernie Berman.

Thank you, Len.

Although there have been no changes to our existing credit facilities since the last earnings call, we are working on a material amendment to our ING-led credit facility and expect it will close shortly. Under the amended facility, we anticipate significant improvements, which include -- a substantial increase in commitments; a lower interest rate; higher advanced rates across multiple classes of securities; and greater flexibility on eligible collateral, concentration limits, and financial covenants. The changes we expect to make are a reflection of the growth in the size of Fifth Street's platform and the quality of our portfolio. We are pleased that five new banks will join the lending syndicate group.

The progress we made the last several years growing the platform, originating a diversified portfolio of high-quality senior assets, and diversifying the liability structure, has been noticed by lenders to the sector. Having an investment-grade credit rating is also helpful. We believe these changes will increase the size and flexibility of our capital base, while helping us reach our internal target leverage limit of between 0.6 times to 0.7 times debt to equity, excluding SBA debentures. As of today, our leverage is approximately 0.4 times debt to equity, excluding SBA ventures.

With respect to our $75 million leverage commitment received in connection with our second SBIC license, we have invested substantially all our regulatory capital and expect to begin drawing leverage this week. SBA debentures continue to be an attractive source of low-cost, long-term funding with the last interest rate lock for SBA debentures at approximately 2.8% in September. If interest rates remain low, the next lock in March 2013 should also be at very attractive rates.

I am now going to turn it over to our CFO, Alex Frank.

Thank you, Bernie.

We ended the 2012 fiscal year with total assets of $1.4 billion, an increase of $179 million, or 15% of the year-ago period, reflecting continued growth in net new originations and the strength of our business platform. Investments were $1.3 billion at fair value, and we had available cash on hand of $74 million.

Net asset value per share increased from $9.85 to $9.92 during the September quarter. For the three months ended September 30, 2012, total investment income was $42.5 million. Payment-in-kind interest remained a low percentage of total income at $3.6 million for the quarter, or 8.4% of total investment income, as compared to 9.3% for the year-ago period. Net investment income increased 12% to $22.3 million for the quarter, as compared to $20 million in the same quarter the previous year.

Turning over to the investment portfolio's performance, we had net realized and unrealized gains of $4.8 million, or 0.4% of the portfolio. We had two portfolio company refinancings during the quarter, both of which were exited at or above par at an average price of 103% of par. We also exited our investments in four portfolio companies -- Best Vinyl, Lighting by Gregory, Repechage, and Rail, at a loss, but at a price that materially approximated our previous fair-value marks. Thus, there was no material net effect on the statement of operations, or NAV, for the four portfolio company exits.

We also completed the successful restructuring of Traffic Control & Safety Corporation, now Statewide Holdings, through a 363 bankruptcy court process in which we had the winning bid for the company. Through this restructuring, the Company has relieved its once overly burdensome capital structure. We are optimistic on the future of Statewide, as its operating performance has been tracking well this year; and given our large equity investment, we have meaningful exposure to the upside if it continues to show strong performance.

The weighted average yield on our debt investments decreased slightly to 12% at September 30, 2012, versus 12.1% in the prior quarter. The cash component of the yield increased 0.1% in the quarter to 11%. The average size of a portfolio investment increased from $19.3 million at the prior quarter to $20.4 million at fiscal year end. We originated $129.1 million of investments in the quarter in six new and four existing portfolio companies, bringing the total companies in our portfolio to 78 at September 30, 2012, versus 65 one year ago. We also received $30.4 million in connection with the exits of six of our portfolio companies.

We did experience a continued decrease in the level of early repayments for the second-straight quarter to a more normalized level, which ranges from $25 million to $75 million per quarter, again, allowing us to reach a record-high portfolio size. Approximately 96% of the portfolio by fair value consisted of debt investments, 70% of the total was in first-lien loans, and 70% of the debt portfolio was at floating interest rates. The investment portfolio continues to be well diversified by industry, sponsor, and individual company. Our largest single industry exposure is to healthcare, including pharmaceuticals at 23% of the total portfolio. The largest single individual company exposure is only 3.7% of total assets, and our top 10 investments represent 29% of total assets.

The overall credit quality of our investment portfolio increased from the prior quarter, as we exited the remainder of our poorly performing 2007 vintage loans. We rank our investments on one-to-five ranking scale, and the highest performing one and two-ranked securities were 99.5% of our portfolio, versus 98.3% in the previous quarter, and 98.5% as of September 30, 2011. During the quarter ended September 30, 2012, we had one investment in the portfolio, Coll Materials Group, on which we had stopped accruing income, which is down from four at June 30, 2012 and at September 30, 2011. As of September 30, 2012, the fair value of Coll Materials was $3.2 million, or only 0.23% of assets.

The Board declared five months of dividends in order to better align the monthly payment dates of our, then current, income estimates. Due to these five months of declarations, the Board did not declare monthly dividends last week at its November 2012 Board meeting. However, we anticipate that the Board will return to a schedule of declaring dividends for the following three months at its scheduled January 2013 Board meeting. The Board plans to continue to target an annual dividend rate of $1.15 per share, and we expect that our net investment income will cover the dividend going forward.

Before I turn the call over to Dean, I want to highlight a new section we will be adding to our earnings calls. As some of you know, we recently hired Dean as our Senior Vice President of Finance and Head of Investor Relations. Prior to joining Fifth Street, he covered BDCs and mortgage REITs, including Fifth Street, at UBS and has an extensive background in equity research. Before opening up the call for Q&A, he will provide a high-level overview of certain issues impacting BDCs.

Thank you, Alex.

As Alex mentioned, I will be adding a new section to the earnings call before opening the line for Q&A. Today, I will talk about how the increase in regulation for the financial services industry should positively impact business development companies, mainly by reducing the competitiveness of traditional lenders.

Banks should, over time, be less active in middle-market lending as they adopt Basel III, which increases the risk weighting on loans to unrated borrowers. This should cause banks to increase interest rates on loans to maintain a similar return profile, all else being equal. This also means that BDCs with an investment-grade credit rating, like Fifth Street, will have a cost of debt funding advantage over BDCs without an investment-grade credit rating. The long-term trend of bank consolidation also reduces the efficiency for larger banks to serve as smaller borrowers, as their overall loan portfolios increase in size. This long-term trend should cause banks to cede market share in middle-market lending to specialty finance companies focused on the middle market, like business development companies.

CLOs have traditionally been large buyers of senior loans in the broadly syndicated and upper-middle markets. The risk-retention rules imposed by Dodd-Frank has the potential to reduce future demand for loans from CLO managers. Furthermore, the government does support middle-market lenders, like BDCs, through the Small Business Investment Company, or SBIC, program of the Small Business Administration. BDCs with SBIC licenses, like Fifth Street, benefit from being able to issue government subsidized debt at a fixed spread over long-term US Treasuries for 10 years. Legislation currently in Congress may potentially allow managers of SBIC funds to increase debt issued under the program to $350 million from the current level of $225 million per manager.

Before we open the lines for Q&A, I would like to remind everyone that for the months Fifth Street does not report quarterly earnings, we generally release a newsletter. If you like to be added to our email list and receive these communications directly, please call us at 914-286-6855, or send a request email to ir@fifthstreetfinance.com.

Thank you for participating in today's call. Alex, please open the line for questions.

Thank you, Dean.

(Operator Instructions)

Jonathan Bock, Wells Fargo

Dean, I also appreciate your comments on the regulatory environment. That is very helpful, thank you. Len, one question starting with an industry one. Could you perhaps speak to where the best risk-adjusted returns really lie across both senior and subordinated, or second lien, kind of in the upper end of the middle market, where you are really looking?

We are actually looking all through the market. Today, we found a deal that was an $11 million deal that fits well in our SBA. And, we won another deal where we had to take $10 million of senior in order to win $5 million of very attractive mezzanine with a new sponsor that we have been trying to work with.

While we definitely are focusing and able to focus on the upper-middle market, we have not left the lower-middle market or middle market. We are actually able, at our size, to do all three, so we are finding attractive opportunities everywhere. I think the added advantage of having the flexibility to participate in the senior and having the Sumitomo line, the Wells Fargo line to be able to put that against, to efficiently leverage that capital, is really allowing us a competitive advantage.

Okay. Maybe across the space, is there one particular asset that one would favor? Only reason we ask is we have been seeing some additional competition, particularly in the mezzanine or maybe the second-lien category, as yield or demand for yields causing spreads to come in, and that perhaps there might be an increase in relative value in the senior assets. Are you seeing similar trends, or it just depends deal by deal?

I see both. It really depends -- it depends deal by deal, but in the mezzanine sector, or second-lien sector, we were fortunate enough through our sponsor relationship to get into one deal, and we talked a little bit about in the call -- or, in our notes, about selling some of our loans at above par. In that case, we were fortunate enough to get in at a relatively large hold size at 98%, and we sold out at 100% or 101% -- I think 101.5% and 101.25%. So, there really is a competitive advantage when you have the direct relationships with the sponsor, and you build an origination platform to allow you to capture that alpha. So, we're feeling like as long as we're sticking with our sponsors and supporting them in a good way, we're going to be able to generate alpha for our shareholders.

I completely agree. I know you mentioned originations -- maybe talking about the ones that were made this quarter, could you give us a sense as to how many loans were truly directly originated versus those loans that were part of a much larger first lien or unitranche bank syndicate?

About 80% of our loans were, what I call, sole originated, where there -- it was either us, or we sell down 5 million or 10 million to one other player. While 20% -- we're usually an agent, and you'll see us climb in agent rankings nicely, but they are probably broader in terms of 5 to 10 players. We definitely have a liquidity basket we did not have before.

Having said that, we are winning our allocations and winning our agencies based upon the sponsor relationships. So even though, I think Credit Suisse is terrific and Jefferies is terrific at leading some of these processes, we also have a good relationship with a lot of the different sponsors, at $1 billion-plus, where we work with them on our allocation, and they direct their agent to put people in that are going to act well in terms of knowing how credits move and how cycles move.

Great. Now, I did appreciate your comments on the last earnings call that highlighted your intention to increase leverage up to 0.6 and also the priority of optimizing the capital structure over raising additional equity. I think that was in August 6, yet in September there was an equity raise, which you announced. Maybe walk through the dynamic of delivering leverage because you obviously were well capitalized then and still raised, versus raising equity capital and being ready to fund deals that -- deal activity that might likely have increased as a result of the election outcome?

When we raised our last offering, we had the opportunity to raise almost any amount of money we wanted; and instead, we raised amount to not jeopardize our dividend stability and earnings growth. And, we were able to deploy that money within 30 days of raising it.

So, I think -- the key part of being at our size now at about $1.4 billion in assets, is when we raise capital -- A, it is to only pay down our credit lines, which is terrific. It doesn't ever pay down our permanent leverage, which is the SBA debentures, the convertible, the baby bond, so we always are going to have a degree of leverage. And, it is a much more efficient use of capital because we are originating between $100 million and $300 million. I think on the call we said that we feel pretty confident that we are going to meet or exceed the upper end of that target. So, we are going to be very prudent about raising capital, and we are not going to -- we understand that we have to cover our dividend with NII, and we understand it's been a focus of the analysts, and we are focused on that.

Great.

Alex, just a small question. The $7.5 million in fee income, could you maybe give a ballpark percentage of that number that was driven by syndication fees that you structured and sold off, perhaps, to other participants in the syndicate, where you were the leading agent. And then, maybe an accounting question, do you bring those syndication fees into income when earned, or is it possible to amortize those?

Syndication fees are recognized as income. They are nonrecurring and nonrefundable, so that is the appropriate accounting treatment for them. As Len said, our mix of self originated versus syndicated transactions, where we are generally the lead, is reflective of the mix of the fees that we earn associated with those transactions.

Okay, great. Thanks a lot, guys.

Troy Ward, Stifel Nicolas.

Jon asked the majority of the questions I had. Len, one thing I wanted to follow up on was, you mentioned you are in the process of hiring two experienced deal professionals, I believe you said, to go after larger deals with private equity sponsors. Can you give us more color on why you're emphasizing that part of the market?

I definitely emphasize -- thank you for emphasizing that in the statements because we definitely want referrals of good people. We have had a lot of success taking Sunny Khorana from CIT, and him building a terrific Chicago presence, which now accounts for over one-third of our revenues, up from zero two years ago. We had a lot of success having Casey Zmijeski as a partner, which we took out of Churchill Financial and CapitalSource in his background.

We need more high-level originators like them to continue to build these relationships. When you work with the $1 billion-plus funds, they really want people they trust and to work with for a long period of time, and you can't build those -- well, you can, but it takes a long time to build those relationships. It's much easier and efficient to find someone that they already trust and bring them to Fifth Street. So, we are looking for that calibers -- those types of caliber of individuals with those deep relationships with the upper-middle market. As you know, we really just began this past year doing upper-middle market deals, with the support of Sunny and Casey, by the way, our partners. We really are looking for some two very highly qualified individuals.

Okay. Then, as you think about -- you have mentioned numerous times how you are above $1 billion. Where do you see the eventual growth for Fifth Street stopping? In our opinion, the balance-sheet growth has to stop before shareholders can truly benefit in the form of higher earnings and dividend, and that's what you have talked about for quite a few quarters, and as Jon said, you raised new equity. When do you see the point of Fifth Street leveling off and delivering higher earnings and dividend to shareholders?

First of all, we delivered higher earnings to shareholders over the years, and we just showed you three years of earnings growth. Yes, the dividend probably three years ago was too high, relative to the NII, no question about it. One year ago, or a little over one year ago, we rectified that by putting it in line with our earnings power. As we get bigger, you are going to see in our next credit facility, our cost of capital is going to continue to go down.

Another area, which we really haven't pursued -- and I would have answered this differently probably six months to nine months ago -- but an area where two of our major competitors are in -- actually one of our major competitors and one friendly large firm, Ares, do, and we are definitely entering this space, is the back-levered senior loans, or the bigger senior loans where we syndicate them down. And, the opportunity in this market is absolutely huge. There's a huge demand for it. There's a huge need for it. And, as the banks start pulling back from their Basel restrictions, I think our industry leader, Ares, is definitely going to benefit from it, and we want to be a part of the benefit for what should be many billions of dollars of demand for alternative asset providers.

So, I can't -- we are just starting to really build this deal flow. It is part of the reason why we are talking about hiring these two high-quality originators to continue to build area of deal flow, but this could quickly add to assets. Having said that, I think it is very opportunistic, it is going to increase the earnings to the shareholders, and we are focused on a per-share basis of increasing NII. It is not just about increasing income, it's about increasing earnings per share.

All right. Thanks, guys.

Douglas Harter, Credit Suisse.

I was wondering if you could talk about the yields that you are seeing in your pipeline and whether we can expect to see some stabilization in the yields that you are reporting?

I think so. I think you will see stabilization in yields. If you look at us versus the other top competitors in the industry, whether it is between 11.7% and 12.3% or 12.4% weighted average yield, we have now fallen right into the middle of the range. Appropriately, as we have increased average EBITDA of our companies has increased over the past two or three years, our average EBITDA is now over $20 million for the companies we lend to. It is much safer; it is much more stable; it will weather an issue or a recession much better, should one occur. So, I think as that happened, of course you earn less, but our borrowing costs have dropped proportionately, too. Over the last three years, our borrowing costs have dropped from LIBOR plus 450, to now, when we redo the facility, all three facilities will be under LIBOR 300, and I think that's -- as low as LIBOR 225 with Sumitomo. And, I think that ability to capture spread, not necessarily gross yield, is what we're focused on. So, I feel really good that we are going to be stabilized around that 12% number, and we are watching it a the monthly basis and pro-forma basis. But I think, hopefully, our cost of borrowing will continue to decrease, which inevitably should yield for higher -- it should answer with higher returns.

I guess just to follow up on that, is there way to break down how much of your lower borrowing costs is the result of you moving -- of lending to larger companies, versus you guys becoming larger and more diversified? Is there any way to kind of break those two out?

Not easily. I think the easiest thing to do is you compare the investment-grade rated companies against the non-investment-grade rated companies and where they are doing debt deals. Our last baby bond deal was done right in line with the BBB-rated companies. And right afterwards, another one in our industry did a baby bond deal 0.5 point higher, and another one was even higher than that. So, that spread differential is really reflective.

Look at the credit lines, the same thing, right? We are at LIBOR 275-ish, with no floor, and a non-investment grade or smaller company could be LIBOR 350 or 400. That is just going to be direct alpha to the bottom line. But, it also allows us to drop assets. I think if you take a Sumitomo line, however, it is a little bit more towards what you just said, where we are doing higher-quality assets in there, but we also have a lower borrowing cost.

So, you basically just have to average through the assets. Remember, we are 70% first-lien assets and right in our middle of our target range, and that really reflects the safety and the portfolio that we like. So, we are not going to really deviate a lot from the that. While a number of other people could be 70% subordinated and mezzanine, and they take higher risks, but they may get a little bit higher weight average yield.

Got it, thank you.

Bo Ladyman, Raymond James.

Good quarter; thanks for taking my questions. First question, you talked about Coll Materials going on PIK non-accrual in the quarter. Looking at the investment, there was an $11 million markdown in the fair value from the prior quarter. Can you give us an idea of what changed so much in three months and possibly the outlook for the investment? I know you have changed the terms of this investment a few times.

We are extremely disappointed in the company, we are extremely disappointed in what we were being told by management, and it was a 2007 asset that, of course, went the way of the wind. We mark to market, and we mark to where we think it is at any given time, even if we have to take a huge writedown, we are going to do it. So, we have this marked now at almost -- a little less than $3 million. So, it is almost immaterial to our results, but we wanted to bring it there, even though it is only on PIK non-accrual, because we were just very disappointed. The plans weren't being met at all. We were misguided by the budgets, and that happens when you have these smaller companies, which we did in 2007. And fortunately, it's the last one of our problems that we just have to clean up, and we expect it to be cleaned up in the next six months, one way or another.

Okay, thanks. I appreciate that. You mentioned that you are looking to -- that you utilized all the regulatory capital in your second SBA license, and you are looking to draw leverage this week. Can you give us an idea of how pricing has held up in that specific lending market?

Yes. We are going to use our leverage -- in fact, I think we are drawing our leverage today or tomorrow, to start drawing into the March fixing. And, the leverage -- I don't know which the question was -- is what price we are going to fix at or what price we are doing the deals at?

The deals, specifically.

The deals, specifically, I think we are really focusing on balancing better the higher yielding assets in the SBA. When we first did the first license -- when we first drew into the first license, we put all first-lien assets at 10%-ish type yields. And, we said to the SBA, look, that is not what we are going to do going forward. We are definitely going to balance it with second-lien and mezzanine assets. The second-lien and mezzanine assets we are putting in there are 13%-ish percent, versus the 10%-ish that we have in there, and as we cycle through that and match those types of assets against the very attractive SBA liabilities, we think that will be an earnings generator over a two- or three-year period, where the will take us -- it takes time to recycle those assets, to get them back, to amortize them down, or to get repaid, and then redeploy. But, we think that we should be earning 200 basis points more in terms of spread over those SBA assets.

Then going up market a little bit, you mentioned that you would expect yields to stabilize where they are now around the 12% range. Are you seeing competition increase more in other areas of the way that loans are termed, maybe in covenants or anything like that?

About four or five months ago, you started seeing the return of [covy-lite] and no covenant and all sorts of weird stuff, and we stayed out of a lot of them. In fact, just so you analysts and investors can be absolutely secure that we are not going to do a lot, if any, of those loans, our credit facility, basically, it was a very small basket to be able to do them and leverage them. So, not only do I not want to do a lot of those loans, but we can't leverage a lot of them, so we are actually encouraged not to do them, and that's fine.

Similarly, even for equity and preferred and all-PIK securities, really we didn't ask for leverage on those things, and we are not getting leverage on those things. We are disciplined anyway, so when the credit provider said -- well, we will feel a lot better without these things -- we said, that's okay. We think that, right now, because a lot of these deals want to close by year end and because there is some questioning and dislocation whether this fiscal cliff gets decided, or not decided, and what the result of that is, we are actually seeing pricing firm a little bit and covenants from a little bit, so we feel good about the deals that we are doing into year end. I can't tell you that continues into next quarter, but there has been a nice uptick in quality, at least the last two weeks.

Okay, that's all for me. Thanks, guys.

Stephen Laws, Deutsche Bank.

I think all my questions have been answered, so I may ask one that you guys have hit on a slightly different way. Clearly, moving up market seems like a lot of attractive opportunities there, deal size gets a little bigger. Can you talk about what really pushed that to happen? Is it you just need larger deals given your equity base has grown? Is it we have seen more and more entrants into the lower end of the market that are, say $200 million to $300 million of capitalization, that's made some of the smaller loans more competitive? Is it simply where some of your partners are kind of moving towards, and that's really more of the flow you are seeing? Can you talk about all of the different reasons, or what the primary reasons were you have decided to move up market? I know you have hit on it a lot in the call, but have a rush of new competitors pushed that decision at all?

I think you said that actually pretty well. I think it's all three reasons definitely play into -- look, we have 78 portfolio holdings. We have $1.4 billion in assets. We are still doing, as I said, we just signed today a terrific deal for the SBA at about $10 million. But, we are also being able to take down $100 million hold sizes and syndicate them down, or [backlog] them. So, we can do a $10 million and a $100 million, but what you are seeing in volume -- right, let's say five $10 million deals and I do one $50 million deal, I put the same amount of assets in the lower-middle market and the upper-middle market, but I only do one deal in the upper-middle market. There is no question that most of our deals are still in the lower-middle market. Dollars wise, you are going to see it more in the upper-middle market.

But, I'll give you an example at the last point you just made, Riverside Partners, one of our favorite partners and terrific private equity firm, just raised their fund oversubscribed at $625 million. That is up from $400 million-something, which was up from $300 million-something the time before that. And as we have these relationships, and they grow, we grow with them. And, we are going to support them at the bigger size levels. If you look at our top portfolio holdings we localize, it is with Riverside. They are -- that is just one example of that kind of growth. Whether that is Chicago Growth Partners in Chicago, or a number of other firms that are raising the success of funds, they have been great private equity sponsors. They have delivered good returns through their LPs, and we need to support them at bigger levels with different types of borrowing. So, that is a lot of the growth too, it's just basic growth along with your partners.

Great. Then, obviously, we don't know the bank rules and where those are going to shake out over the next, goodness I don't know, one to however many years. But, it looks like financial institutions, there's a number of them out there down about 30%, especially in the lower end. Is that something that that kind of void in the market is where you guys are positioned now, or have you moved up past where the void is? Or, I guess, can you help me think about where you guys exactly fit in now on the competitive landscape? Clearly, above those with smaller platforms and less capital that are a lot more worried about concentration risk on a $25 million or $50 million investment. Are you guys below the high-end banks that are active? Or, help me figure out exactly where you fit in the spectrum, I guess.

That actually brings up another point, which I did not make on the call about Basel. For the first time, we are really hearing from the banks how focused they are on Basel and the weighted cost of capital. For example, Basel is really going to really hit the insurance industry badly, and these kinds of assets, it is going to be much tougher for the banks to lend to. For us, I think it is pretty much middle, it didn't really help them -- since we are investment grade and investment grade internally to them, it's okay. But, a difference between investment grade and non-investment grade and the way they could charge a capital charge, could be 4% capital charge for investment grade to 12% for non-investment grade.

So, there's definitely -- for the first time in this two-month period -- and maybe, it is just because I'm redoing the facility here -- but, we are hearing from every bank, we are talking to every bank, and every bank is very focused on how loans to Fifth Street, loans to others affect Basel, and where their tangible equity is going and where their risk-weighted capital charge is going. As that continues, the lower-middle market and middle market should be very attractive for alternative asset providers like us and the industry.

As for BDC competition, we really do not see competition at all from the smaller BDCs. They keep trying to go public, and some of them get public, and some of them don't; and look, we were one. That's not the type -- when you are $200 million, $300 million market-cap company, our sponsors at $600 million, $700 million, $800 million, $1 billion, $2 billion funds, don't want to deal with you. The reason is because they can't provide the amount of capital in certainty to them, and they can't provide growth capital when they want to grow their companies. Not because they're not good or bad, it's just you need a certain amount of capital and capacity to satisfy the middle-market private equity firms. So, they are relegated to lower-middle market or they are relegated to participating, and that's going to be for a while until they grow. Some of them grew very rapidly, and some of them don't deliver.

That all makes sense. And, I guess as I drop off, congratulations. You continue to do a solid job on the pipeline, but also on the other side of the equation, you continue to do an excellent job of renegotiating your financing costs lower, so congratulations on both of those things.

Thanks, it's not easy.

I can imagine. Thanks.

Casey Alexander, Gilford Securities.

We certainly appreciate the improvement in the credit quality of the portfolio, so I congratulate you for cleaning up some of that stuff. Let me ask you, what is the cost of the Sumitomo facility in terms of a non-use fee? Are we really looking at just a snapshot of a moving train? Because, it sure seems as though it has been highly underutilized since you took it down.

It has been more underutilized than we would like by far. Part of the reason why it has been so underutilized is we originated a bunch of assets in there, nice high-quality, great assets, and six months later we get our prepayment penalty and we get prepaid on those assets and then we've got to put them back out. And, when they're put out in Sumitomo, we are not doing $50 million deals, we are doing $10 million and $15 million. So, it's got to be diversified, and the problem with that is, it takes time to redo those assets, so it has definitely been growing slower. Having said that, the use fee -- what is it?

I think it averages about 50 basis points.

50 basis points? So, it is 50 basis point non-use fee, and Sumitomo has been a terrific partner and been very flexible about that. Going forward, it's 50 basis points, but in the past they have been very flexible and realizing that the ramp up took a little bit longer.

Okay. Secondly, and this is probably just a clean up issue, but there are a couple of lines on your expenses, the professional fees and the G&A expenses, that were significantly lower than they had been in last quarter's. Is that truing up prepayments earlier in the year because this is the fourth quarter, or was there something unusual to this quarter that caused them to be so low?

No, I don't think it is unusually low or high, but you bring up another good point. We do focus on G&A, as a percentage of assets and a percentage of equity, and one of the things a lot of analysts have written about years past -- and, I think they're totally mischaracterizing it -- is that we were too high, on a percentage basis, of G&A as a percentage of assets. The reason is because we were relatively under-levered during those years. We just didn't put on all those assets, and we also had -- I build infrastructure first. That's just how I live my life. I don't wait for assets to come to then hire people and build infrastructure, we have our infrastructure in place.

A little bit of that -- now, financial service companies like us are scalable, and what you saw this past year is much more a big step down in G&A as a percentage of assets. And, I think you are going to continue to see G&A leverage as we continue to grow because we have put that key infrastructure in place, hiring really great people like Alex; but also, putting in systems like Black Mountain, Wall Street Office. The systems are very, very expensive. A lot of it was (inaudible), but it's still very expensive and implementation was very expensive and well worth it. We get up-to-the-minute, any way you want to slice our portfolio, risk basis, and any way you want to slice the assets, and we utilize all of that new information to make better decisions.

I certainly do appreciate that, and we would like to see the expenses managed, but these are both $0.5 million below what they've been in the last four to six quarters. And, the difference is about $0.02 a share in NII a positive bump, so they do stand out a little bit.

Thank you. I don't think you are going to see it -- you are not going to get on the call six months from now and say -- oh wow, it came right back and now we are too high. I think you are going to continue to see G&A leverage, as a percentage of assets, as we grow.

Okay, thank you.

We have no further questions in the queue at this time. Now, I would like to hand back to Dean Choksi for closing remarks.

Thank you for joining us on the call today. Please follow up with us if you have any further questions.

Thank you for joining today's conference. This concludes your presentation. You may now disconnect. Good day.