Oaktree Specialty Lending Corp (OCSL) 2015 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2015 Fifth Street Finance Corporation earnings conference call. My name is Denise and I will be your operator for today. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I will now turn the conference over to Robyn Friedman, Vice President of Investor Relations. Please proceed.

Thank you, Denise. Good morning and welcome to Fifth Street Finance Corp.'s second-quarter 2015 earnings conference call. I am joined today by Todd Owens, Chief Executive Officer; Ivelin Dimitrov, President and Chief Investment Officer; and Richard Petrocelli, Chief Financial Officer.

Before we begin, I would like to note that this call is being recorded. Replay information is included in our April 6, 2015, press release and is posted on the Investor Relations section of Fifth Street Finance Corp.'s website which can be found at FSC. 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 may include forward looking statements and projections that reflect the Company's current views with respect to, among other things, future events and financial performance. Words such as believes, expects, will, estimates, projects, anticipates, and future or similar expressions are intended to identify forward-looking statements. These forward-looking statements are subject to the inherent uncertainties in predicting future results and conditions.

Certain factors could cause actual results to differ materially from those projected in the forward-looking statements. New risks and uncertainties arise over time, and it is not possible for the Company to predict those events or how they may affect us. Therefore you should not place undue reliance on these forward-looking statements. 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. To obtain copies of our latest SEC filings please visit our website or call Investor Relations at 203-681-3720. We undertake no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events, or otherwise except as required by law.

The format for today's call is as follows: Todd will provide an overview of our results and outlook; Ivelin will discuss the market; and Rich will summarize the financials. Then we will open the line for Q&A. I will now turn the call over to our CEO, Todd Owens.

Thank you, Robyn. For the quarter ended March 31, 2015, FSC generated $0.19 of net investment income per share which covers our quarterly run rate dividend of $0.18 per share. As expected, our March quarterly net investment income per share was lower than the $0.23 of net investment income per share we generated in the December quarter.

As we said on our last call, our December quarterly earnings were well above steady-state due to seasonally high originations and above target leverage levels. In contrast, during the March quarter we took advantage of the seasonally low origination environment to manage our leverage to 0.7 times, within our target range of 0.6 to 0.8 times debt to equity.

Additionally, we were pleased to report that the credit profile of our portfolio was stable this quarter. There are no additional loans that have been placed on nonaccrual with the exception of Edmentum, which we previously stated would move to nonaccrual in the March quarter. Since the end of this quarter Edmentum has signed a restructuring loan agreement, and we are comfortable with the carrying value on this asset.

We are pleased that we both reduced our leverage and covered our dividend this quarter. As I stated in February, we have set our dividend at a level that we believe should consistently be covered by our sustainable net investment income. We feel comfortable with our current dividend level, and we continue to believe that last quarter's dividend reduction was an important step in putting FSC on a sustainable path into the future. Additionally, as we stated last quarter, we hope that over time we can use earnings in excess of our regular dividend for a variety of purposes including special dividends and buybacks.

During the March quarter we continued FSC's strategic review and realignment to focus on driving strong, sustainable performance for our shareholders. As a result of the ongoing strategic review, we have taken additional steps to optimize performance at FSC. These steps include reducing our regulatory leverage from 0.83 times to 0.75 times debt to equity and addressing the proposed amendment to our investment advisory agreement with Fifth Street Asset Management's board, which would have the effect of reducing management fees on prospective equity capital raises.

As part of our strategic review, the FSC management team and Board of Directors has proposed to our external manager that our investment advisory agreement be amended to reduce management fees related to future growth. By reducing fees on prospective equity capital raises, we are creating operating leverage and allowing our shareholders to benefit from economies of scale as FSC grows. Under the proposed framework all investors whether new or existing shareholders share would equally in the benefit of the fee reduction regardless of when they invested. We continue to work through the details of the amendment to our advisory agreement, and we expect to provide additional information to shareholders with final details before the end of the June quarter.

The initiatives we mentioned today, as well as others that we continue to evaluate, are part of the broader plan initiated earlier this year to deliver improved returns to FSC shareholders over the long-term. Although we've made progress on our strategic review, the process is ongoing and we anticipate announcing other findings from the strategic review over the balance of this year.

I would now like to turn the call over to our President and Chief Investment Officer, Ivelin Dimitrov, to discuss the portfolio and market dynamics.

Thank you, Todd. From an overall marketing standpoint, the March quarter was characterized by softer M&A activity as private equity firms exhibited greater deal selectivity which has widened the bid-and-ask spread. As a result, middle-market issuance was off to a slower start during 2015 with sponsored loan volume at $9 billion through March 31, 2015, which is the lowest quarterly figure in five years.

Specifically in regards to the Fifth Street pipeline, we did not have any deals slip from the December to the March quarter, which contributed to lower-than-expected origination volume. Since the end of the March quarter we have seen our deal pipeline grow and middle-market loan activity increase.

Additionally, as a sponsor-backed middle middle-market origination platform, we have seen several benefits since news broke that GE capital will be selling most of its assets including a $16 billion sponsored finance portfolio. GE Capital is a low-cost strong competitor within the middle-market sponsored-backed landscape, and its exit should provide additional opportunities for us and our peers. GE Capital's announcement has created substantial uncertainty within the market. As a result, sponsors and clients are less willing to award mandates to GE Capital and are more willing to pay other lenders such as Fifth Street a higher yield for certainty of closing. In addition to new transactions, we are receiving inbound calls from companies in our existing book of business who are looking to refinance in order to decrease their exposure to GE Capital. Lastly, we are receiving resumes and interviewing very talented individuals who may leave GE Capital. This dynamic and the exit of one of our largest competitors provides Fifth Street with an opportunity to take market share.

In regards to our own portfolio, we feel comfortable with the credit quality and believe that FSC maintains a strong and diversified portfolio of investments. We feel good about our portfolios conservative positioning as we have continued to migrate the portfolio to more senior secured instruments and limit our exposure to cyclical industries. At March 31, 2015, investments in the energy sector accounted for 1.8% of total investments at fair value spread across three portfolio companies.

We ended the March quarter invested in a diverse group of loans across 137 portfolio companies. During our most recent portfolio review process, as we predicted on our last earnings call, we placed Edmentum on nonaccrual. The four investments that are nonaccrual comprised 2% of our total portfolio at fair value as of March 31, 2015.

Additionally, FSC's joint venture with an affiliate of Kemper Corporation continues to perform well, generating a 16% weighted average annualized return on FSC's investment during the March quarter. As of March 31, 2015, the joint venture had $308 million of assets including investments in the range of one-stop and senior secured loans to 27 portfolio companies, an increase from $265 million of assets at the end of the December. To match the previous increase in FSC and Kemper's equity commitment from $100 million to $200 million, we are in the process of expanding our existing credit line for the joint venture and expect to increase it from $200 million to $400 million.

I would now like to turn the call over to our Chief Financial Officer, Rich Petrocelli, to discuss our financials in more detail.

Thank you, Ivelin. We ended the second quarter of fiscal year 2015 with total assets of $2.7 billion, a decrease of $64 million from the second quarter of fiscal year 2014. Portfolio investments totaled $2.5 billion at fair value which were spread across 137 companies at March 31, 2015. At the end of the March quarter we had $115 million of cash on our balance sheet. Net asset value per share was $9.18 at the end of the March quarter compared to $9.17 at the end of the December quarter. The increase in NAV was driven by net investment income in excess of dividend distributions and spread compression partially offset by modest additional fair value markdowns.

For the three months ended March 31, 2015, total investment income was $68.2 million. Net PIK, PIK accruals recorded in excess of PIK payments received, represented only 4.6% of total investment income. Net investment income was $29.5 million for the quarter. We believe we are conservatively positioned relative to our peers with over 94% of the portfolio at fair value consisting of debt investments, 80% of the portfolio invested in senior secured loans, 74% of the debt portfolio consisting of floating-rate securities, and no CLO equity at quarter end.

The credit profile of the investment portfolio continues to be solid as 98% of the portfolio at fair value was ranked at the highest one and two categories. The weighted average yield on our debt investments has increased quarter over quarter from 10.4% to 10.7%, including the joint venture return with the cash component of the yield making up 10.0%. The average size of a portfolio debt investment was $21.4 million and the average portfolio company EBITDA was $32 million at March 31, 2015. Our top 10 portfolio company investments represent 29.2% of total assets.

I will now turn it back over to Robyn.

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

(Operator Instructions)

Terry Ma, Barclays.

So we've heard several BDCs talk about how the exit of GE Capital would benefit their business. Can you maybe give some incremental color on how FSC could benefit, whether it's from wider investment spreads from such a large lender exiting middle-market or just gaining in certain verticals that GE may have been strong in historically?

Thanks. It's Ivelin Dimitrov. So a couple of things, and I think we mentioned in our prepared remarks, but one thing we are definitely seeing in our business right now is when we are competing against GE we are able to win incremental business at spreads higher than what GE has proposed. And the color we are getting from our clients it is at this point they are not sure what's going to happen with the GE book and the people there and they just don't want to take that risk, so they are willing to pay us a premium. They don't need us to get to the same place where GE is; they know we are not going to have the same cost of capital. But as long as we can provide the certainty of close and get the deal done for them that resonates in the marketplace.

And the flipside, we've lost deals to GE over the last few years -- you know they represent a huge portion of the middle market. And so, a lot of those companies that finance their deal with the help of GE or the GE-Ares partnership, they are coming back to us and saying, we are doing and add-on acquisition or we have some transaction in the works. It would be great if you guys would consider proposing something here just to help us remove the uncertainty risks with whatever happens with GE. So we are seeing on a number of levels -- we are seeing with increased spreads on our deals and we are seeing it in additional deal volume.

Got it. And I think in your prepared remarks you mentioned you are seeing more activity in the middle markets since the end of the quarter. Can you maybe just remind us how you are thinking about capital from new investments, given your leverage ratio is, I think, pretty close to the high-end of your range?

So we managed our leverage ratio down in the March quarter and are at 0.75 debt to equity on a regulatory capital basis. Our stated range -- our target range is your 0.6 to 0.8, so we are within the range, although closer to the top and the bottom of the range. We'd like to maintain those regulatory capital ratios within those ranges. And that's our intention. I think the December quarter in some ways was anomalous because so many of our transactions actually closed in December as opposed to historically some of those slipping into the March quarter. But as a general matter we are trying to manage the leverage of levels to the 0.6 to 0.8 times. And given where we trade today and the inability to raise incremental equity capital -- what that means is that we are recycling dollars that are coming out of the portfolio in the normal course in terms of refinances, redemptions, and so forth. And that's what we did this quarter while managing the leverage levels down, and that's what we will do going forward is well.

Okay. Got it. Thank you. And that's it for me.

Doug Harter, Credit Suisse.

Thanks. Can you talk about the difference between what a PIK nonaccrual and a cash nonaccrual would be and what led the changes there in the quarter?

Sure. This is Rich. Certain loans have PIK interest as well as cash interest, and if we are currently receiving cash interest we will accrue the cash interest. It's that simple. And as far as the PIK are concerned we have to make a decision when we go through our evaluation process and review our portfolio; depending on how we view the ultimate collectability of that PIK, we will either accrue it or not accrue it.

Got it. So the fact that they went to cash nonaccrual meant that the loans were not paying in the quarter?

Yes. So Edmentum, for example, we received cash interest in the December quarter so we accrued it. In the March quarter we did not, so we did not accrue it.

Got it. And then you mentioned that Edmentum, that they have restructured post quarter end?

That has since been restructured, and we'll reevaluate the new security and whether to accrue the interest or not in the June quarter.

Got it. Should we expect any gain or loss on that restructuring?

At this point, we don't see it coming out much different than where it's currently valued.

It's Todd. As we said in the script, we feel good about the carrying value today of Edmentum.

Okay. Thank you, guys.

Troy Ward, KBW.

Great. Thanks. A quick question on the SLF, just looking at the portfolio which was included in the queue, obviously the loans you took off that you shared with the SLF from the Fifth Street balance sheet has considerably higher yields in it. So as the new loans get put on, it looks like they are around 5.5 to 6 and the loans from the Fifth Street balance sheet are, call it, 8.5, somewhere in there. What should we expect from the yield going forward on the overall SLF? Should we expect those yields to continue to come down as you continue to add new assets?

Troy, it's Ivelin. So the SLF -- the credit facility we have in place with Deutsche Bank is a structured facility that gets governed by a number of different metrics. And in order to optimize the leverage there to get the full benefit of the leverage we have to target a specific type of asset mix and sometimes that means we have industry baskets as you know and we have other requirements. So in terms of putting together the target mix we sometimes have to deploy assets that are a little bit lower yield but fit nicely within the metrics of the vehicle and allow us to optimize the leverage to combine them with some of the more originated assets for the platform to have a little bit higher yield.

So our goal is to keep pretty much the same mix going forward, recognizing that we have the benefit of some of the legacy assets there. The higher spreads that come off, we will have to replace that, but we are cognizant of that and making the necessary modifications to the loans we put in.

Frankly, the spreads we are seeing today are not -- the broader market is tight but in our middle-market we are getting the benefit of not as much competition these days for our target loans and getting the benefit of people paying for the certainty of close. Our one-stops are holding the yields that we've had in prior quarters. And we think we'll be able to replace it and drive to the same or similar dividend profile that we have so far.

So you think with the growth, despite having to add lower yielding assets, you think you can keep the yield to Fifth Street around 16%?

Yes, the vehicle right now is fully funded so we have a new equity commitment that we've allocated to the vehicle that we haven't drawn on yet because we are in the process of upside in upsizing the leverage. But the vehicle today is in a maintain-and-improve mode. Any new asset that comes in replaces something that comes off and we try to target a similar risk-reward profile. So far we've been successful and the market seems to be moving our direction with certain assets. So, so far so good.

Okay. And Ivelin in your prepared remarks and speaking about the GE opportunity -- and Terry followed up on it with a question as well -- two of the phrases you used is your ability to take market share and more senior investments. And clearly that's been the mantra for Fifth Street for several years as you continue to take market share, which means growth, and you continue to do more senior investments.

But the income as a shareholder just hasn't been there -- there's no two ways about it. It just hasn't been there. The growth has not translated to shareholder value. More senior assets has not translated to more income because of the high fees. So as you look forward, what can you do to increase the ROE and increase the return for shareholders going forward? You talked about lowering the overall leverage; you are at the high-end -- that doesn't help, but although I agree with that choice. Just speak broadly, how are you going to increase the ROEs for shareholders if you continue to focus on taking market share and doing more senior assets?

I think that's a very good question. It's something that we talk about in our management committees every single time. It's a twofold answer. On one hand, there's things we can do on the asset side and on the capital structure side. I think the folks on the SLF, on the JV -- I think you've seen that produce the results as we've promised. It took us a little bit longer than we expected, but that vehicle is becoming a meaningful driver to our earnings in the senior loan assets, in the assets that we are able to originate and really have a nice risk-adjusted return there. These days in the middle-market if you chase yield you in up with adverse selection, and those are the things that we've seen the last time around that caused people to go out of business. So while we try to be prudent on the front end and be conservative on the asset selection side and make sure that we have the vehicles internally to optimize those assets. But also we have initiatives on the capital side as well, and I think that's what Todd talked about earlier.

I would just -- at a high level -- it's Todd -- I think one of the big levers we have to pull is to increase the size of the JV which we are working on accomplishing, or to add additional JVs -- again, that's one of the things we are working on. I think we are trying to manage down our borrowing costs and we are looking to take advantage of some of the favorable market dynamics that we see to improve our yields without taking incremental risks. I think it's probably the wrong time to be adding a lot of risk into the portfolio given where we are in the credit cycle.

Okay. And then one last one -- the information in the release, and then you talked about changing the fee structure. It really feels like -- kind of like we've seen where folks talk about buying back stock and then never do it. The reality is the incremental fee waiver that you are willing to do or change the fees, it doesn't benefit the shareholder at all unless you are allowed to grow. And first of all, why with the shareholder allow you to grow, i.e. put your stock price above book value given the past performance? It's kind of a chicken and the egg. You have to do something for the shareholder to ever be allowed to grow in my opinion. And yet there is not going to be in the shareholder benefit, only on incremental growth. So how does the Board view that? How do you view that? There's no benefit for the shareholder in changing the fees on incremental growth?

It's Todd again -- I think there are two separate questions that you are addressing. I actually do think that there is a benefit to the shareholders to have a fee structure that enables us to share the benefits of scale going forward by reducing the management fees on incremental capital raises, and that's what we are talking about. I think, although we are a long way away from trading above NAV as you just pointed out, I think that this is the right thing to do and it's the right leverage to build into the model at this point in time.

I think the separate question you ask really comes back to the question of how you drive ROEs, and I feel like we acknowledge the point. We think about it a lot and the levers that we are trying to pull are the ones that we just described.

Great. Thanks, Todd.

Christopher Nolan, MLV & Co.

A quick question -- do you have any outlook in terms of the rollout pace for the SLF in coming quarters?

This is Ivelin again. We are in the process of upsizing the leverage. Our current leverage line with Deutsche Bank is fully funded, and the SLF is fully invested at this point. As you know, we have an incremental equity commitment that we expect to fund as soon as we obtain additional leverage. We are in the process right now of obtaining that. And so, we expect to sign something expeditiously and get it going. It took us a little bit longer to deploy the first time around, but I think that the second time, given that we already have a ramped up pipeline of assets that should fit the SLF, we expect to move a little bit faster on that. But that's our main focus these days.

Okay. So it's really contingent on the pace of just increasing the credit facility size, correct?

Correct.

Follow-up question would be, Todd, I think in your prepared remarks you mentioned the possibility of using the excess spillover income for buybacks, if I understood you correctly. What your preference? What is the current thinking of management in terms of special dividend rather than buybacks?

Yes. So what we said was -- and we are cognizant of the fact that the excess was $0.01 this quarter, but notwithstanding that our attention is to return the excess earnings either in the form of a special dividend or a buyback. We continue to debate and discuss potential share buyback. I think a special dividend would be an end-of-the-year type of event if we go that direction, and we continue to evaluate the appropriate course of action on the share buyback front.

Great. Thank you for taking my questions.

Doug Mewhirter, SunTrust.

Just a question on the yield -- was the larger number of exits relative to originations this quarter -- how much of it was just sort of the natural flow of exits? Or did you also do some selected sell-downs to either maybe get out some lower yielding assets are just sort of hit that target?

This is Ivelin. We absolutely did that, and that's something we do on an ongoing basis. But in the March quarter when things were slow for everyone there weren't a lot of deals out there. We found out that other people liked some of our assets a lot better than we did, so we were able to proactively sell some of our -- certain of our exposures in certain assets in which the yield was substandard for us, and rotate those assets into higher yielding deals. So we do it on an ongoing basis, but the March quarter was very opportunistic in that regard.

Okay. Thanks for that. And regarding your fee income, it was a little light in the quarter. I assume it was a function of originations being so low, as I imagine a lot of that sort of syndication fees. So I would assume that to the extent -- your fee income going forward would tend to track the amount of originations or gross originations that you have in any given quarter? Or is there any other factors that are --?

No, you're right. The originations in the March quarter were seasonally low, and in fact, as Ivelin commented in his section, they were -- the March quarter was lower than it's been in past quarters. And as I commented in my section, the December quarter actually had very strong originations, and that's part of the reason why the earnings in that quarter were higher. So, yes, you are thinking about it the right way.

Okay. Thanks. That's all my questions.

Robert Dodd, Raymond James.

On leverage for a second, have you received -- obviously 0.75 is in the regulatory range you want us to look at but all in you are at 0.91. Have you had any feedback or discussions with your rating agencies? Because obviously you are talking about wanting to manage your cost of leverage down and from what we've heard obviously 91 is a bit above what S&P likes to see for example for a BDC at investment-grade. So is there an appetite for you to actually lower overall leverage so that you are all in? Is more along the lines of 0.85 or something like that?

Look, our stated our stated range from leverage is 0.6 to 0.8 debt to equity; that's a regulatory ratio as you pointed out in your question, and we are going to manage the business to those levels. You can go back and look at what Fitch and S&P said. And each case they expressed some concerns over the overall leverage levels, and we managed those down in the March quarter. And it's our hope that we'll continue to operate -- it's our intent to operate within those targeted ranges we described. And so that's how we think about it.

Got it. Thanks. On the other thing as well, between special and stock buybacks, can you clarify the thought there? Obviously a buyback, while it does return capital to shareholders, is not a distribution that fulfills the income distribution requirements for a RIC. So it doesn't reduce your spillover -- not that obviously there's a lot of spillover at this point. But strategically can you address that process that -- obviously buyback does return excess capital but does not return spillover income to shareholders. And obviously, that's a tax rule. And how you plan on balancing those two issues?

That's a good question. I think the point that we are trying to make is as a general matter is that we want to over earn our dividend on a consistent basis and that we will find appropriate ways to return that profitability to our shareholders. I think, as you correctly point out, the most obvious and cleanest way to do that is through a special dividend. But there are degrees of flexibility around the tax laws and rollovers that would allow us some flexibility on the share buyback front as well. And if we head that direction, that's what we would rely upon.

Okay. Got it. Thank you.

Casey Alexander, Gilford Securities.

Two questions -- first of all, it looks like Trans-Trade and Phoenix are the ones that encompass bucket number three. And this is the first time I can remember that bucket three has a leverage ratio that can't be calculated or was not meaningful. Is there something different about those two securities that allow them to stay in bucket three rather than migrating down to bucket four, given their leverage ratios?

I don't think the underlying business has really changed significantly quarter over quarter at Trans-Trade and Phoenix, so they still meet our characteristics for category three.

Okay. Secondly -- and I know Troy asked this, but I'm going to ask this in a different way. The reduction of management fees on new equity raises -- it seems to be at least in part some admission that past raises haven't been as successful for shareholders as it has been for the management companies. So why not extend the fee reduction to the existing portfolio, which arguably would lead to better net investment income coverage of the dividend, improved dividends, and give you the opportunity again to improve dividends and or higher share repurchase programs which could then in turn leads to better stock performance and get FSC back to the point where they can raise new equity?

As I said before when Troy asked us a question in a similar way, we like the idea and are working toward this goal with our manager of reducing the fees on prospective capital raises for the reasons I stated before which is to improve operating leverage if and when we get into a position where we can raise capital. So that is really the goal of the announcement that we've made today. I think the levers that we have and are focused on, again, are the ones that we have enumerated earlier which we hope will lead to ROE improvements. And among them are some of the things we said before which is to grow the JV, to explore additional JVs, to drive additional operating income, to find ways to lower our funding and costs and therefore our operating performance going forward. So those are the levers that we are focused on today, but we think going forward from the scale that we are at today it makes a lot of sense prospectively to have a lower fee structure.

All right. Thank you for taking my questions.

Jonathan Bock, Wells Fargo Securities.

Good morning and thank you for taking my questions. Ivelin, quickly, just I know one vertical and part of the breadth and depth of this history platform was you are operating a number of different verticals, whether it's aircraft finance or HFG, etc. Just curious where you stand with the venture lending vertical today in that effort?

That's a very good question. We go through that analysis ourselves in the process of allocating capital at FSC. The venture space is pretty interesting. In this sense, primarily we are focused on technology venture deals. We haven't really been active in life sciences and cleantech -- it's not a space we understand very well. But in technology it was an interesting phenomenon the last six months of last year and some of it has spilled over into this year when venture capital firms -- some of them are in the early stages of their development -- they are able to raise equity at a price that is lower than the price of our venture debt. And when you see that happening, it's pretty interesting and just leads you to believe that this is a space that is getting overcrowded and too many people are chasing those deals.

We were looking at a deal recently that we liked and other people proposing on that deal just for the benefit of being able to buy equity in the next round. From our perspective, that's pretty crazy. So we've been very selective.

There's a couple of deals we are looking at opportunistically. It usually has to deal with a story that we support somewhere else around the platform. So for example, healthcare IT has been a sector that we've supported on the middle-market side and also on the venture side. We like some of the solutions that companies are putting together in that space. And so, we've been very selective. I think things will turn, and we'll get more active again but for the time being we've chosen to be a little bit more conservative there.

I appreciate that, Ivelin. So -- being more selective but I guess the next question would be, are the same folks that you hired to build out the venture lending platform at Fifth Street still employed at the external manager today?

We've had some volatility in the ranks there but substantially all of them are still employed -- I would say probably 90%. And we have an office in Palo Alto that is fully operational, and we are able to look at a lot more deals these days just because of being able to be in the market. We put a lot of tombstones, we put a lot of thought pieces, and we get a lot of things shown to us.

I appreciate that. Second -- leverage. Todd, when you talk about the reduction of leverage to 0.75, obviously it lowers risk but also lowers ROE. Curious given that there is commentary coming out from the Securities and Exchange Commission on the desire of regulatory folks to have those unfunded commitments put in their regulatory debt to equity ratio. For a venture lender it would make sense to perhaps exclude them from such an item as it relates to the fact they have milestones that need to be achieved in order to draw down that capital. And that argument is being weighed -- but here at Fifth Street we noticed that you do have a sizable amount of unfunded commitments almost to the point where your debt to equity today would be at 0.98. So how do you think about growth even at this leverage point and the need to perhaps delever more, given the sizable amount of unfunded commitments you have to middle-market companies that may have less restrictive or less constraints on their ability to draw down in an environment, and with the commission taking a much harder look at unfunded commitments as your regulatory debt to equity ratio?

Jonathan, it's Todd. That's a very good question. We are aware of SEC focus on this issue. We think that it's appropriate to have these revolvers treated as they have been treated in the past, but we are watching those very closely. I think that this is a big issue for the industry as a whole. Right now, we are not anticipating any change there, and we are not adjusting our approach to regulatory leverage levels. But we are watching that closely, and I think that that's a good question to ask and I think it will be a focus of the industries as we go forward here.

And just trying to understand the ability of draw downs on your and Ivelin's revolvers -- are there constraints on companies ability to draw down that capital subject to milestones or obviously phase 1 drug gets to phase 2, etc.? What are the constraints placed on those companies' ability to draw down that capital in the event we hit a liquidity crisis?

So this is Ivelin again. I think it's two separate issues. On one hand we have a lot of our unfunded and naturally if you are referring to those -- but we have a lot of borrowing base type revolvers that we provide. As we provide loans to middle-market companies, those are either borrowing base or subject to some financial covenants the companies, frankly, use for their regular working capital needs. I think the issue that most people have been focusing on -- I think that's what you are referring to is the delayed-draw facilities provided to venture capital companies and the ways those work -- to be able to draw the next stage of financing you have to be able to provide meaningful growth in your business.

So you see the type -- for example, a software business, you tied to a certain number of monthly recurring revenue growth that you need to show quarter over quarter. So if you are not able -- if your business is struggling and you are not able to show that number you are not going to be able to draw incremental funding. We don't have that much of those type of facilities, though. We have many maybe two or three of them across the portfolio. Most of our unfundeds are borrowing base or leverage-based revolvers.

Appreciate that color. And then lastly, just following up on the distinguished Mr. Ward's question just as a relates to the fee reduction, obviously it's a first step and applaud you and recognizing that there can, Todd, be the benefit of scale shared with your shareholders as the Company grows. Of course, that's predicated on being able to grow in the future. So absent the ROE discussions that you've mentioned -- absent this, there is one outstanding item as a relates (technical difficulty) that restricts institutional and even retail capital flow into the shares of FSC, and that is the ability of your external manager to earn NOI incentive or we'll call them outperformance fees while you have realized losses. Just noting that -- I think September -- today I think we've got over $170 million worth of net realized losses on the balance sheet.

How do you think of true alignment in that sense? And do you believe that is an important item to rectify in order to bring the shares closer to NAV parity, because it just can't be about the earnings, right? The market is already telling you that today. It's something about a management team's ability to be truly aligned with their shareholders that creates that degree of institutional trust. So what is the view you and the Board take in rebuilding that institutional trust lost if you still maintain a performance that pays out performance fees regardless of whether credit losses persist?

Jonathan, it's Todd. You've covered a lot of ground with your question, and I appreciate the question. I would say a few things -- number one, we feel comfortable with our overall fee structure. We think it's consistent with many if not most of the others in the industry. But I think your broader points is one -- and again, I don't want to keep repeating myself. But your broader point is a good one, and we are continuing to think about and explore ways of creating better alignment of interests with our shareholder -- between our shareholders and our management company and between frankly the officers and employees -- the officers, I should say, of FSC. So there are a number of ways you can think about that, and we are discussing and debating many of them.

And you took a positive first step. I would argue the market sees it as a step forward, a bit incomplete without the true alignment being fixed but a positive step nonetheless. So thank you for taking my questions.

Thank you very much, Jonathan.

We have no additional questions. I will now turn the call back over to management for any closing remarks. Please proceed.

We just want to thank everybody for dialing in and your continuing interest in our Company. We appreciate your time.

This concludes today's conference. You may now disconnect. Have a great day, everyone.