Oaktree Specialty Lending Corp (OCSL) 2013 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth-quarter 2013 Fifth Street financial earnings conference call. My name is Celia, and I'll be your operator for today. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Dean Choksi, Senior Vice President of Finance and Head of Investor Relations. Please proceed, sir.

Thank you, Celia. Good morning, and welcome to Fifth Street Finance Corp.'s fiscal fourth quarter and yearend 2013 earnings call. I'm joined this morning by Leonard Tannenbaum, Chief Executive Officer, Bernard Berman, President, and Alexander Frank, Chief Financial Officer.

Before we begin, I would like to note that this call is being recorded. Replay information is included in our October 24, 2013, press release and is posted on the investor relations section of Fifth Street Finance Corp.'s website, which can be found at www.fifthstreetfinance.com.

Please note that this call is the 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. 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 provide high level commentary on the BBC sector. Then, we will open the line for Q&A. I will now turn the call over to our CEO, Len Tannenbaum.

Thank you, Dean. US equity and credit markets continued to be impacted by the Federal Reserve's quantitative easing program. While the middle market was initially insulated, it has now experienced yield compression and elevated prepayments for some time. The net effects of these trends are lower yields and in returns in FSC's portfolio and across our BDC peers.

An example of our weighted average yield on debt investments declined from 12.3% in the December 2011 quarter to about 11.1% in the September 2013 quarter. During the same period, the annualized current yield on the iShares US dollar high yield corporate bond ETF declined from approximately 7.2% at the end of December 2011 to approximately 5.8% as of mid-November 2013.

In this market, most fixed income investors have two basic choices. They can either take imprudent risk and reach for higher yields or accept lower average returns. At Fifth Street, we source, structure, and manage the majority of our investments. We use our platforms to scale relationships and investment expertise to find niches where there is less competition, where we can ultimately earn attractive risk adjusted returns. Over 90% of our deals come directly from private equity sponsor relationships that we have built over the years.

We outlined several initiatives on our last earnings call to improve net investment income per share, including the acquisition of HFG as a portfolio company of FSC, expansion into metric debt lending; three, growing our capital market's presence; and, four, better utilization and the reduction in cost of our bank credit facilities.

We continue to source deals from our key sponsor relationships, where a partnership approach is valued more than lower yields, and we differentiate ourselves from many other middle market lenders by being the leader in the financing solution in larger hold sizes in the unitranche. Offering larger hold and commitment sizes enables us to generate incremental alpha, because there are fewer competitors able to commit to funding larger unitranche transactions.

By utilizing our platform and expertise, we have been able to keep our asset yields from compressing more than the broader fixed income credit indices. We've also reduced our funding cost by renegotiating lower pricing on our revolving bank facilities. Nonetheless, net interest margin compression has pushed net investment income per share below our former dividend, and some of our initiatives are taking longer than initially expected to offset that pressure.

Our Board of Directors, therefore, decided to reset the dividend to a level consistent with current net investment income per share, since dividend distributions have been in excess of net investment income for the last several quarters. The Board of Directors declared monthly dividends for the quarter ending December 31, 2013, totaling slightly over $0.24 per share, which is representative of net investment income per share of $0.24 earned for the quarter ended September 30, 2013.

As we believe we will earn our dividend, our Board of Directors declared monthly dividends for January through May of 2014 of $0.0833 per share per month, which is a $0.25 per share quarterly dividend and $1.00 per share annual dividend rate. The new annualized dividend provides an approximate 10% dividend yield at the current share price, which is still above our peers, who have current annualized dividend yields between 7% and 9%.

We believe this is an attractive yield, considering approximately 80% of our portfolio consists of relatively safe senior secured loans, and there are no loans on nonaccrual at the end of September quarter. NAV per share has been stable for several quarters, despite earnings not matching the dividend.

We understand that setting a dividend consistent with net investment income is important to our equity investors, our debt investors, as well as the rating agencies to maintain and perhaps improve our investment grade rating. We believe our net investment income per share in fiscal-year 2014 should meet or exceed $1.00 per share annual dividend rate.

The Board of Directors' decision to realign the dividend at the current level is a reflection of the market environment and the high quality of the portfolio. In short, we believe the realignment to the dividend is the right thing for our shareholders in the short and long-term, and here at Fifth Street, we are committed to ensuring FSC's long-term success, which will, in turn, be beneficial to our shareholders.

We are hopeful as the Fifth Street platform expands and our recent initiatives are successful in improving that investment income per share that our dividend can return to a higher level. In addition, by matching our dividend distributions with net investment income, we may report modest NAV per share accretion in future quarters.

September quarter net investment income per share was below our expectations, due to higher prepayments early in the quarter and originations weighted towards the end of the quarter. We did close $307.4 million in gross originations in the September quarter of which $294.4 million were funded. However, several deals slipped into October. Our net originations for the quarter were only $120 million, which resulted in lower net investment income per share.

The December quarter is historically our strongest quarter, as sponsors are motivated to complete deals before year end. This quarter is shaping up to be consistent with historical trends. We have already funded a record $425.5 million as of November 25, 2013. We still have an active pipeline of deals through calendar year end and maintain plenty of financing capacity. We do not have permission to sell shares below book value and do not intend to do so.

HFG is performing above original underwriting plan and benefiting from its affiliation with Fifth Street as a portfolio company of FSC. Healthcare Finance Group is currently in the market with a $475 million syndication of a revolver and term loan for a large hospital system.

Our capital markets team, led by Fred Buffone, should be a significant driver of earnings over time as we originate and syndicate loans to our other investors, as well as source assets for our own balance sheet. The ability to originate loans and syndicate them to leading financial institutions is an indication of the strength and quality of our middle market lending platform.

Syndication capabilities are important, because we may earn incremental fee income, better manage our liquidity, and potentially earn premium yields by committing to larger deals, which can partially be sold after funding. For example, we syndicated a $20 million portion of our unitranche loan to Adventure Interactive Corp after the end of the September quarter. This reduced our debt exposure of approximately $113 million, as of September 30, 2013, to a current level of around $93 million. We intend to actively use our capital market's best to add additional liquidity in the calendar fourth quarter. We are in active discussions with other institutions regarding additional syndications and first add opportunities.

Our flexible and low-cost liability structure benefits shareholders by enabling us to retain assets across the debt capital structure and finance them in an efficient manner. We are working on expanding our access to funding, lowering our funding costs, and improving the terms and flexibility of our debt capital, which Bernie will discuss in more detail.

Management and the Board of Directors understand the importance to our investors of paying dividends, supported by net investment income per share, and we believe that this should, over time, lead to more attractive valuation for our share price, as well as NAV accretion. Our Board of Directors also expressed their confidence in our portfolio by increasing our share repurchase program to 100 million from 50 million, which we intend to use if the shares trade at a meaningful discount to book value per share.

I will now turn the call over to our President, Bernie Berman, to discuss our capital structure in more detail.

Thank you, Len. The current frothy market enables us to improve the terms of our debt capital by reducing the cost of revolving bank debt, increasing our access to debt financing, and extending the weight of the average maturity of our liabilities.

Since the end of September quarter, we announced an increase in our syndicated credit facility led by ING and a reduction in our Sumitomo credit facility. We added three new lenders to our ING facility and increased the existing commitment from Sumitomo, raising the total amount of commitments to $605 million. We remain in discussions with additional lenders about joining the ING facility.

The reduction in our Sumitomo facility to $125 million from $200 million is reflective of the yields compression in the market for first lien loans. We initially entered into the Sumitomo facility to finance first lien senior loans. At the time, the facility was our lowest cost revolving bank debt and had attractive advance rates. However, as yields for first lien loans compressed, they became a less attractive investment, given our return requirements, so the facility was never fully utilized as intended.

Sumitomo remains an important lender and partner to FSC and increased its commitment to our syndicated credit facility, led by ING, making them one of the largest lenders in the facility. I'm now going to turn the call over to our CFO, Alex Frank.

Thank you, Bernie. We ended our fourth quarter of fiscal 2013 with total assets of $2.1 billion, including portfolio investments of $1.9 billion at fair value, and we had available cash on hand of $147.4 million. Net asset value per share was $9.85 at quarter end.

For the three months ended September 30, 2013, total investment income was $57.1 million. Net payment in-kind interest, or PIK, accruals recorded in excess of PIK payments received, which is a key indicator of earnings quality, was a low $2 million for the quarter, or only 3.4% of total investment income. Net investment income increased 28.6% to $28.7 million for the quarter, as compared to $22.3 million in the same quarter the previous year.

We exited six portfolio companies in the quarter, all of which were exited at or above par and in line with previous fair value marks. The credit quality of the portfolio was excellent, as net realized and unrealized losses were $2.6 million, or only .1% of the investment portfolio.

The weighted average yield on our debt investments remains steady at 11.1%, with the cash component of the yield making up 10%. The average size of a portfolio debt investment was $22.1 million at September 30, 2013, an increase from $19.7 million at the prior year end. We had gross originations of over $307.4 million in the quarter in ten new and seven existing portfolio companies, bringing the total companies in our portfolio to 99 at September 30, 2013.

During the quarter, we also received $176.5 million in connection with the exits of six of our debt investments. Approximately 95% of the portfolio by fair value consisted of debt investments, with 78% of the portfolio invested in senior secured loans and 67% of the debt portfolio consisting of floating rate securities.

The investment portfolio continues to be very well diversified by industry sponsor and individual company. Our largest single exposure continues to be healthcare, including pharmaceuticals at 21% of the total portfolio. Our investment in HFG, our Healthcare Finance portfolio company and largest single exposure, represents 5.6% of total assets, and our top ten investments represent 32% of total assets, down from 35% at June 30, 2013.

The credit profile of the investment portfolio is as strong as ever. 100% of the portfolio was ranked in the highest one and two category, which is favorable versus previous quarter and year ago period. During the quarter ended September 30, 2013, we had no investments in the portfolio on which we had stopped accruing income, as compared to one at September 30, 2012.

Now, I will turn it back to Dean.

Thank you, Alex. In Len's remarks, he talked about our ability to generate attractive risk adjusted returns in unitranche loans, particularly for larger borrowers. I will take a few minutes to expand on his comments and explain why we believe we generate alpha in this type of loan.

A unitranche loan is where there is only one intercreditor agreement. In contrast, a more traditional debt structure with first lien debt provided by a bank, and second lien and/or mezzanine debt provided by another lender normally includes at least two sets of intercreditor agreements detailing the rights among the different lenders.

When Fifth Street offers a sponsor or unitranche solution, we are generally the only provider of debt. This type of financing solution offers several benefits to borrowers, which is why unitranche loan pricing may command a premium over a combination of senior and mezzanine debt.

One, streamlined negotiations because there is typically one lender and no intercreditor agreement among the separate lending groups, the time and legal costs incurred to negotiate the documents are less than a traditional senior and mezzanine debt solution.

Two, certainty of close with only one lender, the sponsor has a higher degree of certainty to close within a specified timeframe at previously agreed upon terms. This is not always the case when dealing with a syndicate or a club, where certainty of close and terms can change throughout the process. This is an advantage for a sponsor, particularly when they are bidding for an acquisition

Three, flexibility with only one lender involved, it is easier to customize loan terms regarding amortization, covenants, and prepayments at origination and to make changes over the life of the loan. The flexibility enables the borrower to customize a loan specifically for the business and strategy.

At Fifth Street, we take a partnership approach to lending by providing customized financing solutions appropriately priced for risk. After 15 years of lending to middle market companies, we focus on lending to borrowers that value a partnership approach, not the cheapest source of capital. Over time, we believe lending to these sponsors should minimize losses while generating attractive returns.

Thank you for joining us on today's call. Celia, please open the line for questions.

Thank you. (Operator Instructions) Greg Mason, KBW.

Good morning. Thank you. Len, I'm a little surprised. Last quarter, you laid out your five-point plan to grow earnings -- get earnings back up to covering the dividend. This quarter, the earnings fell, and the dividend was cut. I'm just surprised of that kind of move after outlining that five-point plan last quarter. Could you just give us kind of the thought process behind that and why, at least, the five-point plan hasn't started kicking in yet?

Sure. It's been extremely frustrating. The five-point plan, including capital. Capital markets takes time to syndicate down transactions, win deals to syndicate -- actually get [skim] income. Venture capital takes time to ramp and get out there as a venture capital lender. I mean, the ramp time could be six to 12 months on both. I think capital markets will play a big part in this quarter.

But I think the most frustrating part is earlier in the quarter, we actually thought we were going to earn a lot more money. And by having early prepayments early in the quarter, which means we had lower average balance during the quarter and therefore, higher unused fees, and then we closed deals at the end of the quarter. We had a lousy net origination number of $120 million, because deals slipped into October, and as the originator that backs private equity, we just have no control over when these deals close. It's up to the private equity sponsors. As you can see, the ones that closed in the October quarter, they closed right? $400 something million dollars of gross originations already this quarter.

So we had an earnings push, and at $0.24, the Board looked at $0.24 versus our dividend level and said, all right, we just have not earned our dividend for several quarters, and we have to put it, at least, temporarily in line with the current earnings level, and if we earn more than the dividend, we can change that.

I think the other major part of this is the rating agencies have written consistently about the importance of having dividends in line with earnings. And we are focused -- we think we are a differentiated triple-B minus Company with S&P and Fitch, and we are very focused on trying to do everything we can to improve our ratings, and we think this is a key factor that's necessary to do that.

So, as you -- obviously, you've put out your dividend well in advance now of what you're going to be doing, and you've done that in the past. As you've been thinking about the dividend planning, did you know that you were going to be reducing this dividend when you did your offering at the end of September, less than two months ago?

Absolutely not. We -- as I said, we actually thought we were having a much better quarter at that time, and it's just amazing how things change. This is why we don't give guidance anymore until we really do know. It's very, very volatile, and deals that you think are closing between September 15 -- everything closes end of quarters.

Except, magically, we had a big quarter this quarter in October, because things were supposed to close the end of the quarter and got pushed into October. So -- I mean, to put it into perspective, right, $100 million in deals, at a 2% OID, is $2 million. And so, it materially affects the quarter for every $100 millions of deals that push from one quarter to the other.

Okay. And then, I think Alex talked about, and you've talked about this in the past, that you've moved to more first lien safer yielding assets in this environment. When the Board meets in January, do you think there's going to be any discussions around maybe [2 and 20] isn't the appropriate fee structure for these lower yielding assets?

Obviously, you've got a much lower fee structure in Fifth Street floating rate. Not that's -- not that that's where these yields are, but clearly focusing more on the first lien is difficult to making yields. So, any thoughts around the fee structure with this lower-yielding, high-quality focus?

Apollo and us have dealt with the fee structure at different ways. We -- we're focused on reducing our G&A expense -- our total costs. I think what you should see this year is an improvement in the G&A as a percentage of assets, and we're really focused on it. As has not been highlighted, we actually returned $3 million in fees during the year. So we actually did charge, effectively, less than 2 and 20.

We are focused on lowering the cost structure, but what I will say is we do -- we really don't want any more yield degradation, and there's some ways around that. By back levering deals, by having higher capital markets business, which is fee income without a management fee attached to it, it should generate a better ROE and ROA.

So I know my scorecard, and I know we're going to have an analyst day next year, and I know what I have to achieve. And I am going to use our December and March financials for your scorecard, but as you've seen there's been numerous other dividend cuts in our industry. There should be probably more and some people are not earning their dividend or using other vehicles to dividend up income that was saved up from previous years to maintain their dividend, and that'll have to end at some point.

So, I think all of us are facing the same thing. Look, it's a competitive environment. We're all up against each other.

Okay. Thanks. Appreciate it, Len.

Douglas Harter, Credit Suisse.

Thanks. Just wanted to touch -- you've mentioned, now, several times it's a very competitive environment. Sort of wanted to understand why you've raised so much capital, why you're sitting on so much, sort of, excess liquidity. If you view the environment as so competitive, why not be running with less liquidity, less capital, and look to maximize ROE in that environment?

Well, look, I've always had the idea first of all, we're going to run this quarter, it looks like we're going to run very close to our target leverage by the end of the quarter. And I know that we've never hit target leverage before, and we're going to try to get rid of those naysayers.

And we understood the stock would trade down with the dividend cut. That's fine. We don't sell stock at a discount to book, either. So, you don't have to worry about any offerings this quarter probably and that's fine, too, because we -- what we're going to be able to do is we've started having this great liquidity basket. So we've actually prepared for the environment by having a lot of deals that we could either sell or syndicate and generate income that way and rotate.

And I think the model is to support sponsors through the cycle. Look, I've spent 15 years developing sponsor relationships, and we are the menu of choice to our sponsors, and we'll continue supporting our sponsors in any part of the cycle. Having said that, we're going to make sure the risk adjusted returns are there. That the equity in each deal is 30% to 50%. And as we think the market gets frothy, and it goes to ten times, we're just not going to lend past 5 times or 4.5 times.

So, we understand that FSC has been viewed as a low beta player, a safer bet, a lower leveraged bet, a higher credit-quality thing, and sometimes our investors are frustrating that we're not reaching for yields or all PIK securities to drum up the dividend or drum up an investment income. We're just not going to do that.

We're happy in our positioning. We're happy the way we run the Company. We're happy providing this stuff to our sponsors. We're really targeting almost a zero nonaccrual rate, and I think that's much more important to me than earning incremental dollar.

Great. Thank you.

Robert Dodd, Raymond James.

Hi, guys. Just to kind of extend on Greg's comment a little bit about the five-point plan. Because you illustrated the reasons why, essentially, you'd run out of patience on that or the board had run out of patience and cut it.

But that seems to be, frankly, a bit of an accident of timing in terms of a couple of deals were late and for that reason a plan that had been laid out very carefully last quarter with a lot of detail, etcetera, was set aside because of a couple of things that didn't go coincidentally -- unfortunate timing by a couple weeks. I mean, that seems a rather rapid reaction.

So, I mean, is there any more color in terms of do you expect more of these repayments, etcetera. In terms of how much of the activity that you're seeing in December is refis and, obviously, you're going to syndicate and do some back levering, if you can. But are we just going to see extremely elevated repayments even in the first fiscal quarter of this year?

So, I think spread compression is greater than expected, no question about it. Because, instead of going six times deep or seven times deep, like some lenders are doing, we're just not doing it. We rather be cheaper and stay high in the structure and stay safer.

Having said that, I think you're right. This quarter should benefit from the deals being pushed early into the quarter, but, even at $0.26 or $0.27 or whatever number -- I mean, we had a $0.28 dividend, right? And the board, in the medium term -- the quarter -- it's not a quarter result.

We had not earned our dividend the past several quarters. There has to come a time where you earn or exceed your dividend, you [accrete] any deeper share. If you continue to lose any deeper share, which is the differential of earning your dividend every quarter, you're losing your earnings assets. If the shareholders ever want stock appreciation, we have to increase our asset base per share. And the only way to do that is by earning your dividend, and because -- and that's really the base way.

And we may have some equity gains, we may have some other things, but the goal is to actually stop the NAV slide, which I think we've done. But the actual idea is [to accrete] NAV over time, even if it's slightly, so that we can start getting a better share price and a better return on equity and return on assets.

Okay. If -- one follow-up, okay? On the expectations that you're going to earn $1.00 --rate on that, $1.00 of NII in 2014. What's -- obviously, as you said, maybe you'll hit target leverage by the end of the year. It's not something that's been sustained, generally. What's the implicit average leverage, if you will, for 2014, to get to that number that you're using in your estimations?

To earn more than $1.00?

Yes.

I think we could actually run lower than target leverage and earn our $1.00, but the idea is not to cut the dividend twice, right. The idea is to get the dividend to a number that you can meet or exceed, and so, whether -- I think most analysts had $1.04-ish as an estimate for next year. So I don't think that's that far off from where we are today.

I mean, could it be $1.00, could it be more than that? Sure. But at $1.04, and you're $1.15 dividend rate, you know you have a disconnect. And what we didn't want is the constant writing by every analyst and the constant comments of, boy, it's another quarter they didn't earn the dividend, and it's net asset value pressure down. It has to end.

And I think we're also really paying attention to -- as investment grade credit, we really are paying attention to our credit ratings. This will cycle again at some point, and I would like to be higher -- a little bit higher rated than we even are, even though we're double investment grade. Because I think it's very important to be positioned into the next cycle, and I've always had that attitude. I can't tell you when the cycle's going to come, otherwise, I'd be in a different business.

Thank you.

Andrew Kerai, National Securities.

Yes. Good morning. Thank you for taking my questions. First question -- just a housekeeping item. The administrator expense that was negative $369,000. If you strip that out, you guys get it to -- get to $0.23 NII for the quarter. Can you just tell me, I guess, what that was? I mean, was that just a onetime reversal, or what exactly was that [contra] expense item?

Sure, I can take that. We -- a significant portion of the compensation that we pay people is discretionary, and we determine that compensation at the end of the year. So we make accruals over the course of the year, and we true that up at the end of the year. And the compensation came out a little bit lower than we anticipated, in terms of what the -- what FSC was allocated.

Okay, thank you. That's helpful. And then, just two -- kind of looking at the SBA leverage, right? I mean, so, this is the fourth quarter in a row you guys have been under the $225 million allotted. I mean, this is clearly accretive capital. If you could just give us some sort of sense as to why it's been trending below the $225 million for so long and if you guys intended to take that up and get the remaining $44 million of that over the next quarter or two.

It's even more frustrating than what you just said, because what happened in Fund 1 -- so, there's two funds. There's one with $150 million leverage, another with $75 million. Earlier in the year -- unfortunately, for us, a lot of the repayments hit Fund 1.

We actually were holding -- earlier in the year, we were holding $60 million of cash. My CFO's raising his hand -- more than $60 million of cash in Fund 1. And to deploy these, remember, you can't just deploy it in one deal. They have to be spread out, because there's some limitation to how much you can put in each deal, and they have to qualify.

So, our first idea was to use the cash, right. We're paying 4% on cash earning zero. This cash is trapped there. We can't take it out of the [SPB], and so, we got that deployed, and this quarter, we're finally deploying into the second license. And we should -- but, even that, right, is $11 million maximum, at a time, and so, that takes time. But with the new venture lending initiative, and almost every venture lending deal sitting [in the] SBA, I feel good that we'll get there in the near future.

Okay, great. Thank you. That's helpful color. And then, just the last question I have -- sort of, this $660 million plus that you have sort of closed in calendar Q4, so far, can you just give us a sense of what the yields are on those deals, kind of, compared to your -- to kind of your current weighted average portfolio yield?

I think it's consistent with about 11%.

10.5%, 11%.

10.5%, 11%. Look the idea, it's $400 something million dollars funded, which is the more important number, but it's consistent with 10.5%, 11%. We really -- look, we didn't want yield degradation from 12%. Now we're at 11%. We really would like to stop this. And so, we can do that in a bunch of ways, and we're going to have to do it.

One way we actually earn extra money is sometimes when we do a 9% one-stop or an 8% one-stop, we'll just syndicate down enough of it to make the IRR go up, and so, that's another encaptured administrative fee. So, I mean, there's other ways we're using this environment to generate extra income for the shareholders.

Okay, sure. And then, I just had one last question as well. So, if you look at the leverage ratio on sort of your kind of investment category two, kind of your performing in live loans. I mean, that has crept up a little bit. I mean, if you look a year ago, it was about 4. We're at about 4.7 times or so, now.

I mean, certainly, there's been some pressure on deals structures, I think, across middle market lending. But can you kind of comment, as sort of that 4.7, maybe 5 range is kind of the -- kind of where you draw the line, in terms of sort of your appetite to -- when you're sort of looking at the underwriting on these new deals?

So, I think there's a couple of dynamics. First of all, the average portfolio is not 4.7 right, it's 4.57, which is the blend of the ones and twos, which is what we have.

Sure.

The ones -- when you think of our ones in the portfolio, those are the ones that are the most dangerous to repay. So you see those are leveraged at 2.67, and the reason they're 2.67 is they've had a lot of amortization. They've done well, so their leverage ratio has dropped. While new loans, right, have not started to amortize. In fact, in the first year, there's very light or any amortization on almost every one of our loans, but if they start amortizing in year two and/or start performing that leverage ratio drops.

So, a lot of why you see the leverage ratio increase is simply the fact that we've replaced unfortunately for us, right, a lot of the old loans with new loans, but we really have not been more aggressive in the market. We're really still on average coming in around at 4.5 to start. And at 4.5, we hope to get that number delevered over time by amortization and by the Company growing at least modestly.

Yes. Certainly makes sense. Thank you for taking my questions.

Thank you.

Casey Alexander, Gilford Securities.

Hi. Good morning, and thank you for taking my questions. The 78% of the portfolio that is senior debt -- do you have the breakdown of first lien to second lien in that?

We don't -- we're not --

In the K.

It's in the 10-K. (multiple speakers) It's individually [for] investment.

Yes, individual.

We, like some of the other BDCs, are conforming to senior secured. And the other differential, as you know, Casey, is second lien loans in the upper market -- it's mostly personal loans, obviously, but second-lien loans in the upper market are very different than second-lien loans in the down market, which is very different than mezzanine anywhere. So, I think the more disclosure is senior secured, which a number of other BDCs follow that disclosure.

Okay. Now, as you said, a bunch of deals slipped over into the fourth quarter, as we can see, based upon what you've funded already. But usually, there is -- Fifth Street's past experience has been a big rush at year end. Do you see that happening again this year?

I think we've already had it. I mean, we had a lot of it. I think it's very spread out this year. There's no rush to December. There's no magic to December. So we've seen October extremely busy and November extremely busy, and we're seeing December extremely busy. So it's more spread out than years past. There's no magical tax change or any reason why deals have to close, and so, it's more spread out.

Okay. In relation to the new share repurchase plan, there's a calculus to when buying your stock is a better deal for shareholders than putting money in a new deal. What level of discount do you think that is?

I'm not giving a discount, because then I'm tipping my hand as to where I'm going to buy the stock. But we're one of the few BDCs, I believe, that's actually bought in things. When the convertible bond traded to 85, even 90, even 95, I bought it in, and I bought in $35 million back in 2008, 2009. I bought in stock -- I mean, I saw [SOLAR] buy it at a very small discount to book. I don't -- we haven't really decided what the appropriate discount to book is, and nor would I tip my hand even if I had decided.

Okay. All right. Thank you very much.

[Ron Jacisco], Wells Fargo Securities.

Yes, good morning, and thank you for taking my questions. On the Adventure deal that you syndicated a little bit post quarter end, could you give us a sense of kind of the yield enhancement and the yield the investor's receiving on that 20% slice?

On the 20 million that we sold?

Yes.

So, we sold a pari parsu slice.

Okay.

But we're actually working on back levering that same deal, but we'll back lever it to the benefit of the person that we -- the entity, sorry, that we sold it to. But we do receive skim income, right. We receive a portion of the points up front as a fee, and then, obviously, no risk attached to that. So it's positive for the shareholders in that they'll get more fees without risk.

Thanks. And then, just on the quarter to data originations, appreciate the yield color, but could you give us a sense of kind of the first lien, second lien, maybe venture on your aircraft breakout in that? Is it similar to this quarter or --?

Venture and aircraft -- everything takes time to ramp, right? Venture and aircraft are still a very, very small piece of the portfolio, and so, that's not really where the -- I mean, it's driving. It's all just basic unitranche originations from private equity sponsors. In fact, I would argue, it was a bigger first lien mix, probably, in this quarter. Steve is signaling me by a little bit. So it's our normal first lien mix in the quarter, but it's a normal mix from sponsors really that's driving the [scores] originations.

All right. Thanks for the color, and have a good one.

Thank you.

David Miyazaki, Confluence Investment Management.

Hi. Good morning. I'd like to just follow up a little bit on a comment that Bernie referenced with regard to return requirements, and it's sort of related to what Greg and Robert also asked about. When you look at the current environment and your business model, what do you think is a reasonable rate of return on the equity?

Yes, we've had that discussion over time. Look, we're not that far, right, from just saying no to everything and putting in a floor. And I've hit that floor a couple times over the 15 years I've been investing and five -- over five years, now, as a public entity. And we're going to say no at very near to where we are. And we have, we've held the line.

Fortunately, some of the sponsors -- one case, from even our competitive BDC, it was a LIBOR 6.50 deal at 100 floor, and we won it at LIBOR 7.25, 100 floor. So we got a premium even over that, because the private equity sponsor said, hey, we'd much rather work with Fifth Street. We've done three deals with you, and we just don't trust this other BDC.

So it's -- we're winning some really interesting deals, but we're holding a line. We said we're just not matching that price, and we're not coming anywhere close, and I think we're really at that stage. There has to be a minimum deal. There are -- unfortunately, I pushed down my credit facilities to [225], so that I have a little bit better leverage.

I think we've indicated we're going to hit -- we're going to attempt to hit the unsecured market. So that's going to be an interesting data point, in terms of our borrowing capacity and our leverage capacity, in terms of what yields we have. But there's no doubt about it, David, the yields are compressing in this type of entity that we are not going to be able to do much lower than what we're doing.

I think that it is certainly a challenge that every bond investor is going to be facing when rates decline and remain low for an extended period of time. If credit is available, there's going to be a lot of refinancing, a lot of natural deleveraging.

But if I distill what you've communicated today to some really basic points, that if you're -- if you think you're going to be able to earn next year a $1.00 in NII, then that indicates off of your current net asset value, just for round numbers, about a 10% return on the equity.

That's right.

And if you subtract out where your managerial fee, 2 and 20, is and if you take out your G&A expense, and you take out a loss assumption, it's just really hard to see how a LIBOR 6.5, with a 1% of floor is going to get up to that ROE level.

Well, we don't do that one, right, so that's below the threshold. We did it about 100 basis points higher, and then what we have to do is either back lever them, so it doesn't come into -- we have to reduce the amount of assets that hit the management fee is the idea. So, while we're not going to do a fee reduction, what we -- you're not wrong in saying at those yields, you can't charge a management fee on all assets and the way you do that is by back levering.

So, effectively, we're managing an asset with half of the asset hitting the management fee. You're syndicating down assets. It will hit the incentive fee, of course, but it will not hit the management fee. If you syndicate down assets, same idea -- you're collecting extra income from syndication fees or agency]fees, but you're not, by managing assets, but not having those assets on the books, therefore, not hitting the management fee.

You have to generate revenue in HFG, which, right, doesn't hit the management fee, compared to the amount of assets that they have, so that you can generate ROE that way.

So there's lots of different ways to do it and including the fact that we're going to focus on G&A leverage and some other ways to reduce -- to lower the fee structure. Having said that, that's what we're going to have to do. We'll have to do a 10% -- I think that's about right. We're going to have to do a 10% return on equity, and we're going to have to focus on doing that, and we're going to have to utilize all of those different tools to get there.

It does seem though that you sort of created a pretty steep uphill challenge for yourself, given that the amount of capital you have to put to work and even the leakage around things, like unused capacity on your credit facilities or just putting them in place and paying the fees to get them set.

Yes.

Or, as you referenced, the trapped cash in SBICs -- that all of these things are situations that are going to dilute your return on equity, because there's costs associated with it.

And then, from our perspective as shareholders, it's a little hard to get our arms around, really, what is a reasonable return on equity expectation. Because when you take things -- assets, and you're not applying a managerial fee to it, those are things that you might be able to see. But, as we look forward into 2014 and beyond, it's hard to know how you're moving those assets around in such a way to effectively lower your management fee when the explicit fee we see is at the 2 and 20 level.

I hear you. You're going to see that in overall cost structure and overall leverage and total cost versus leverage, and you're going to see those -- look, I agree with you. We've hit some real -- this year has been really frustrating from -- especially the $60 million of cash trapped. I never even thought I was going to face that. I didn't plan for facing it, and you learn these lessons, which -- I'm not saying it's a good thing.

But you're right. The unused fees -- remember, a lot of the unused fees, by the way, in the credit facilities are matched by the unused fees collected by the credit lines we have outstanding, because we collect on those, too, and those are not hitting the management fees.

So there's a lot of offsets to what you just said, but I agree with you -- better utilization of leverage, which we're now able to do, because you have a liquidity basket that you can manage liquidity with. Having SBA being fully functional, which I think we've gotten to that point.

I'm sure there'll be another -- as you point out, there'll probably be another problem that I'm not foreseeing, and I can't predict those things. But I think we've addressed the ones that we've actually learned lessons on.

Okay. Thank you.

At this time, we're going to turn the call back over to Mr. Dean Choksi for closing remarks. Please proceed, sir.

Thank you, Celia, and thank you for joining us on today's earnings call.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.