Prospect Capital Corp (PSEC) 2012 Q4 法說會逐字稿

Good day, and welcome to the Prospect Capital fiscal year earnings release and conference call. All participants will be in listen-only mode.

(Operator Instructions)

After today's presentation, there will be an opportunity to ask questions.

(Operator Instructions)

Please note, this event is being recorded. I would now like to turn the conference over to Mr. John F. Barry III, Chairman and CEO. Mr. Barry, the floor is yours, sir.

Well, thank you, Mike. Joining me on the call today are Grier Eliasek, our President and Chief Operating Officer, and Brian Oswald, our Chief Financial Officer. Brian?

Thanks, John. This call is the property of Prospect Capital Corporation. Unauthorized use is prohibited. This call contains Forward-looking statements within the meaning of the securities laws that are intended to be a Safe Harbor protection. Actual outcomes and results could differ materially from those forecast due to the impact of many factors. We do not undertake to update our Forward-looking statements unless required by law. For additional disclosure, see our earnings press release and our 10-K filed previously.

Now, I'll turn the call back over to John.

Thanks, Brian. Over the past year, your management delivered record Prospect net investment income and record Prospect year-over-year growth in your June 2012 quarter as well as in the 2012 fiscal year. Your management also delivered $0.47 per share growth in net asset value per share over the course of the last year. Net investment income for 2012 was $187 million, up 98% from the prior year. On a per-share basis, net investment income for the year was $1.63, up 48% from 2011. Net investment income for the quarter was $64 million, up 113% from the prior year. On a per-share basis, net investment income for the quarter was $0.51, up 66% from the prior year.

Your management delivered strong net investment income growth while keeping leverage low. Net of cash and equivalents, our debt to equity ratio was less than 36% in June. We have substantial unused debt capacity and liquidity to drive future earnings. We estimate our net investment income per share in the current September quarter will be $0.41 to $0.46. We just announced more shareholder distributions through October, which will be Prospect's 51st shareholder distribution and 28th consecutive per share monthly increase. Our net investment income has exceeded distributions, demonstrating substantial distribution coverage for the current tax year, the prior fiscal year, the last three quarters, and the cumulative history of the company. That excess coverage is more than $50 million in the current tax year, demonstrating our conservative approach to distribution payouts and coverages. Prospect has now paid out more than $10 per share and more than $500 million in distributions since 2004.

I will now turn the call over to Grier.

Thanks, John. Our business continues to grow at a prudent pace. As of today, we have now reached more than $3 billion of assets and undrawn credit. Our team has increased to nearly 60 professionals, representing one of the largest dedicated middle market credit groups in the industry. With our scale, longevity, experience and deep bench, we continue to focus on a diversified investment strategy that includes third party, private equity sponsor related lending, direct non-sponsor lending, Prospect sponsored transactions, and structured credit. Our team typically originates thousands of opportunities per annum and invests in a disciplined manner in a single digit percentage of such opportunities. Our non-bank structure gives us the flexibility to invest in multiple levels of the corporate capital stack with a preference for secured lending and senior loans.

Our approach is one that generates attractive risk-adjusted yields. In our debt investments, we're generating an annualized yield of 13.6% as of June 30. We also hold equity positions and many transactions that can act as yield enhancer's, or capital gains contributors, as such positions generate distributions. Originations in the 2012 fiscal year were $1.12 billion, up 17% from the prior fiscal year. We also experienced $501 million of repayments as a nice validation of our capital preservation objective. As of June, we are up to 82 portfolio companies, a 14% increase from the prior year, and demonstrating both an increase in diversity as well as a migration towards both larger positions and larger portfolio companies. We also continued to invest in a diversified fashion across many different portfolio company industries, with no significant industry concentration.

The June quarter was particularly active, with $573 million of originations, and $146 million of repayments. Exits for SonicWALL, Copernicus, BMJ, and sports helmets generated realized IRRs of 16%, 35%, 36%, and 41%, respectively. We closed the First Tower acquisition in the June quarter, and we are expecting to receive annualized yields in excess of 18% from this investment. ESHI paid us $33 million in dividends in the June quarter as a significant income contributor. We don't know precisely what dividends ESHI will pay us in the future, but we hope to see solid dividends in the next two quarters.

The current September quarter is off to a strong start with $400 million of originations and $45 million of repayments. Pinnacle and US Health Works exited with realized IRRs of 15% each. Our credit quality continues to be robust. None of our loans originated in nearly five years has gone on nonaccrual status. Non-accruals, as a percentage of total assets, stood at 1.9% in June, down from 3.5% in the prior year. Our advanced investment pipeline aggregates more than $600 million of potential opportunities, boding well for the coming months.

Thank you, I'll now turn the call over to Brian.

Thanks, Grier. As John discussed, we've grown our business at low leverage. Net of cash and equivalents, our debt-to-equity ratio stood at less than 36% in June. We believe our low leverage and diversified access to funding demonstrate both balance sheet strength as well as substantial liquidity to capitalize on attractive opportunities. We're a leader and innovator in our marketplace. We were the first company in our industry to issue a convertible bond, conduct an ATM program, develop a retail notes program, and acquire a competitor as we did with Patriot Capital. Shareholders and unsecured creditors alike should appreciate the thoughtful approach, differentiated in our industry, that we have taken toward construction of the right-hand of our balance sheet.

As of June, we held approximately $1.5 billion of our nearly $2.3 billion in total assets as unencumbered assets. The remaining assets are pledged to Prospect Capital Funding, which has a AA rated $507.5 million revolver with 15 banks and with a $650 million total size accordion feature at our option. The revolver is priced at LIBOR plus 275 basis points, and revolves for three years followed by two years of amortization with interest distributions allowed. We started the June quarter with a $410 million revolver in 10 banks, so we've seen significant lender interest as we've grown the revolver. Outside of our revolver and benefiting from our unencumbered assets, we've issued at Prospect Capital Corporation multiple types of triple B rated unsecured debt including convertible bonds, a baby bonds, and retail notes program. All of these types of unsecured debt have no financial covenants, no asset restrictions, and no-cost defaults with our revolver. We've now tapped the five-year, 7-year, 10-year and greater unsecured term debt market to extend our liability duration. We have no debt maturities until December, 2015, with debt maturities extending through 2022. With so many banks and debt investors across so many debt tranches, we've substantially reduced our counter party risk over the years.

As of today, we have issued four tranches of convertible bonds with staggered maturities that aggregate $647.5 million of interest rates ranging from 5.375% to 6.25%. And, have conversion prices ranging from $11.35 to $12.76 per share. We have issued a $100 million 6.95% baby bond due in 2022 and traded on the New York Stock Exchange with the ticker PRY. We have issued $59.1 million of retail notes, with staggered maturities and a weighted average interest rate of 6.4%. From March 31 to today, in addition to our revolver expansion, retail notes program issuance and two convertible bonds issuances, one in April and one recently in August, we have issued equity twice, both times at a premium to net asset value. In an ATM program in June and July we raised $59.2 million. And, in an underwritten offering in July, we raised $269.3 million. We currently have no borrowings under our revolver. Assuming sufficient assets are pledged to the revolver and that we are in compliance with all revolver terms and taking into account our cash balances on hand, we have over $600 million of new investment capacity.

Now, I'll turn the call back over to John.

Excuse me, this is the conference operator. I apologize, gentlemen, it looks like we have just lost Mr. Barry's location.

That's okay, Mike. We're on to answering any questions from the group.

Okay, I do apologize, sir. Thank you.

(Operator Instructions)

This is John Barry, am I on the call?

Mr. Barry, you are back on the call, sir.

Okay, I wanted to -- I want to do the first question, okay?

Yes, sir.

When it's time to answer questions, then I'll just -- .

We're just about to take our first question, sir. Arren Cyganovich, Evercore.

Thanks. The thing that I guess is getting a little bit more difficult to model is the dividend income from Energy Solutions. And I guess the benefits that you are continuing to have from the sale of Gas Solutions. So, I was wondering if you could talk a little bit about the -- I would assume that some of that is in your next quarter's guidance of $0.41 to $0.46. Can you put any parameters about how much of the carryover -- I know you had earnouts of $28 million. How much of that has been already in that? And how much of the remaining benefit is there from that sale of Gas Solutions that you said, I guess, is going to come over through over the next couple of quarters?

Grier, could you ask the person to repeat the question, please? I lost my connection briefly.

Sure, I was just asking about the potential of the Gas Solutions dividend income that's been high relative to -- I think $33 million, I guess, from Energy Solutions overall this quarter. How much of that was from Gas Solutions? How much is remaining? And how much should we expect over the next two quarters?

Okay, good. Before we do that question, this is John Barry back on the call. I did lose my connection. But as a substantial shareholder, I have an important question for the team. One thing the team left out is that the total return in the last year is 29%. But with that said, this call to-date seems quite retro to me. What is the team going to do for me as a substantial shareholder in the upcoming year, Grier?

Well, predictions on the future are just that. We think we've got a good pipeline and attractive liquidity profile. Maybe we should migrate to answering the question instead.

Okay, Grier, why don't you go ahead and take the -- .

Okay, so, the question was about Energy Solutions holding. There's a $28 million earnout. And that's a longer dated earnout. And we wouldn't necessarily expect to receive any proceeds from that this year. It's related to what the future realization looks like to the purchaser, which is owned by a private equity related institution. We did have, I believe it's $10 million of escrowed funds, that is due to be released in two stages. We got $5 million of that in July, and the second tranche and final tranche would be released in early January, I believe.

Relating to the question about what future distributions dividends might look like -- yes, some of that is included in our guidance for the September quarter. Our hope and expectation is that we will continue to reap substantial dividends. As I said in my prepared remarks, we don't know precisely how much, but we expect at least for the next two quarters to have substantial dividends. And then, we will see about 2013.

Energy Solutions today is a business focused on energy and energy-related services including the offshore supply vessel industry, with an operating business called Freedom Marine Holdings where we continue to make additional investments to grow that business. So, we're looking at add-on acquisitions, we're looking at organic growth opportunities, and it's difficult to predict exactly where, especially 2013 will play out, but we expect 2012 to still have substantial distributions.

Thanks, that's helpful. But maybe if you could maybe take a step back and let me understand the dividend contribution from the sold portion of the midstream business? Or is that the remaining businesses, I imagine, can't provide that level of dividend, that $33 million that are part of Energy Solutions? I just want to get an idea of what is more recurring and nonrecurring in that business?

Sure. Well, we reaped a substantial gain on sale as the purchaser, as is typical. We talked a little bit about this on the last quarter, as is typical with especially energy-related transactions, there's a lot of partnership asset-related M&A that occurs, especially in the MLP space, and this is an MLP-able asset, as a midstream asset. So, the buyers tend to want assets and not C-Corps. So, as a result, we had a substantial gain on sale at the corp level. And as we bring back cash for Prospect Capital Corporation, we reap significant earnings out of -- dividends out of earnings and profits. We had somewhere around, what, Brian, $160 million of cash a few months ago at ESHI.

Today, post the distribution that we made in June, that's down to more like in the $125 million-ish level. And so, that gives you a sense of how much cash we have that could be distributed. I suspect we wouldn't distribute all of that by the end of 2012. And it really does depend upon what opportunities we see out of the business.

Okay, that's helpful. And then, following up on the First Tower acquisition, it's a relatively large, relative to your portfolio, I think about 14% of the fair value of the portfolio. And so, maybe you could just talk about your comfort in that business, and having such a large proportion of your portfolio in one company?

And then, the other question would be on the -- it's listed as a debt facility, and it is at L plus 18.5%, which seems very high. So, if you could just talk about the pricing on that yield of that investment?

Sure. So, we're very excited about the Tower acquisition. This is a transaction that we worked on for almost a year, from inception to finality. Building upon a multi-year experience in the consumer installment lending business, having previously been a lender to a company called Regional Management that actually went public in the Spring time. Around the time we announced the Tower acquisition, actually. We have many years of experience in this industry, and built upon that for this deal.

From a diversification standpoint, as we -- pro forma for recent issuance and deploying capital, I think you see Tower declined to sub-10% of our asset mix. But it's a highly, highly diversified business, diversified across multiple states, literally hundreds of thousands of loans. And, in itself, running at a fairly low level of leverage with a multi-bank, multi-year facility. This is also a business that performed quite well during the last recession, with very little of a downdraft that you might see in, say, industrial businesses that occurred in the last recession.

You asked about pricing of our HoldCo debt. And it seems like that's a higher rate. We've been able to achieve pretty attractive prices on debt instruments, closed another deal in the space in a non-control sense called SMC. And have an attractive rate as well. So, we think that it's attractive, not just on a return basis, but on a risk-adjusted basis.

Is there anything, John, you would add to that?

Thank you, Grier. Two things for me. If you remove the regulatory risk and you look at this company over the past decade, and even decades, you observe a company that seems to be somewhat insulated from the economic cycle, which maybe is counterintuitive, but leading to why, at length, maybe at another time, what you see in economic downturns is a small, a modest uptick in non-payments and associated defaults. But not anything significant that impairs the value of the investment.

So, the primary risk is regulatory. And people fear that there will be some regulatory interference, which never seems to come because in the states where these types of businesses operate, they are contributors to the community. And as a result, each time there is a head of steam from some regulatory direction to try to restrict what these businesses do, the steam peters out before anything happens.

A third point is on the regulatory front. The business that we own is, as Grier says, there's many fish between us and the shark swimming out there. Were regulators to interfere, they would first interfere with so-called payday lending, where people take their -- hand a blank check to the lender, and the lender cashes the check the day the money is deposited from payroll into the person's account. And similar, very expensive forms of, I guess what I would call, super subprime personal lending.

Our loans are generally in the thousands of dollars. And they are made to more substantial credits. And as a result, we have a much less -- a lower default rate. And we are farther from the center of attention for regulators. So, for those reasons, we believe that this, in addition to the main point that Grier mentioned that there are so many thousands of loans there, that we are buying a diversified portfolio, in effect, with very minimal single variable risk.

Thanks for the color. Appreciate it.

Mickey Schleien, Ladenburg.

Yes, good morning, and thank you for taking my call. Just briefly on First Tower, you closed in the middle of June. Did you accrue any investment income in the current quarter -- in the quarter you just reported for First Tower?

Grier?

We did about -- we closed, what was it, Brian, June 15, so, about two weeks worth?

Okay. Now, I want to talk a little bit about the spillover income. I calculate about $0.53 -- I'm sorry, $0.43 of spillover income available for potential dividends. Any thoughts on whether you're going to -- are you more interested in retaining that for funding your business? Or perhaps declaring a special dividend to avoid the excise tax?

Sure, I'll start with this one. So, we view the excise tax as relatively cheap financing. It's a 4% excise tax on undistributed capital, that relates to not hitting a 98% distribution in a particular year. The more important payout requirement is the 90% related to preservation of RIC status, which, of course, is very important, and our intention is to continue being a non-tax-paying RIC from that standpoint.

And, as you mentioned, spillover is something we can utilize where we can count distributions over the next several quarters towards the prior tax year distribution requirement. We're actually on an August tax year slight offset from our fiscal, which ends in about a week. And we would have to distribute by, I think it's May, somewhere in that timeframe, Brian, in order to meet our distribution requirement for the August tax year. So, we have plenty of time to meet that requirement.

We're being very, very careful to make sure investors are seeing the dividend as a rock solid proposition. We're not making guarantees about the future. But by keeping our dividend adjustments in the highly modest increase category, we think we're enhancing our ability to do that for the long-term. And I think in our industry, we probably have the highest coverage by a country mile as any of our peers in the past 12 months of net investment income versus distribution payout.

Okay, fair enough. I just wanted to also understand the nature of the "other income" that you reported in the fourth fiscal quarter.

I'm going to ask Brian to handle that one. Brian?

Yes. It's going to be substantially structuring fees and other fees that we've charged on new loan origination.

Okay. And you reversed accruals for legal fees in the quarter. Can you explain that, please?

We actually didn't reverse. We actually got reimbursement for some of our legal fees from our insurance carrier. And we applied the proceeds from that to reduce our legal fees.

Okay. And lastly, could you update us on the status of H&M and new Meat Company?

I'm going to push that back to Grier.

Sure. H&M, what we've done there is we struck a deal with the current owner, for that current owner to inject more capital into the business, junior to our secured position, to drill more wells. Recall, this is a crude oil producer in west Texas, still an attractive economic proposition given where crude oil prices are, given the nature of how drilling has unfolded in the Permian basin to drill wells. And a lot of the drilling in our country in the last year has been focused on liquids-rich gases and liquids crude oil itself. So, that's happening in real time. A number of wells are going to be drilled in the upcoming weeks. And our hope is that continues to enhance value towards a future exit.

John, is there anything you would add to that?

Yes. We're really very happy that when we moved to foreclose, that the equity owner felt that taking the company into bankruptcy was a method of avoiding any obligations, because what the equity owner discovered was that the property belonged to us unless he started writing checks, something he hadn't done in years and years. So, he's now writing checks for millions of dollars, otherwise the asset goes to us. And we're happy to see that drilling has revived. And the asset values are being protected and enhanced. For me, speaking to Chip, who I'm sure is -- Greenblatt, is on the line, Scattered Corporation, look him up. I'm glad to see you finally writing checks, Chip.

And new Meat Co?

John, do you want to take that one? It's Meat Co.

On Meaco?

No, Meat Co.

Meat Co.

Oh, Grier, why don't you address that, sure.

Meat Co is a meat distribution business based in -- on the West Coast that, over the last 6 to 12 months, has been in the course of transitioning to a much larger distribution facility. And they just now, in real time, have been expanding and opening up their new facility.

Our hope and expectation, along with the sponsor owner, is that that will -- should cause a meaningful uptick in profitability. We've been careful on the valuation there. As you've seen, there was a bad debt write-off associated with one of their customers, which we hope and think was a one-time event late last year. And so, by getting past that, as that rolls off of TTM profitability, and having the new facility open up, we're seeing liquidity improve at the company, we're seeing profitability improve. And our hope and expectation is that the company will continue to grow its profits in the coming quarters.

Thank you for your time this morning.

Thank you.

Robert Dodd, Raymond James.

Hi, guys, a few questions. If I can go back to Energy Solutions real quick, the fair value at the end of last quarter was $166 million. That's gone to $126 million, down about $39 million. Obviously, $33 million of that is the dividend. Can you give us some color on what the other $6 million markdown was? I assume that's the other assets embedded in that portfolio.

And then, tied to that, obviously the common equity, which is my proxy for cash at Energy Solutions went from $122 million to $70 million. $80 million if we include the escrow payable. That's down about $40 million. That leaves you about maybe $80 million in cash left to dividend up or buy other assets. You expect substantial dividends the next couple quarters, but how are you going to allocate that between bringing assets in to keep ESI going long-term as a dividend to you, versus upstreaming that dividend or that cash short-term to boost NII?

Thanks, Robert. I'll take the second part of the question, and then refer the valuation one to Brian. On the second part of the question, the answer is -- we don't know exactly how capital will be allocated between distributions and additional investments within ESHI related to acquisitions and related to organic growth. We do have some investments planned in the Freedom Marine business, the offshore supply vessel business, we acquired a new vessel some months ago. And we're looking at updating the technology of some of the existing fleet for a more modern GPS-related technology. Those should not be large investments for the latter.

Recall, as we take capital up to Prospect Capital Corporation, and we've been, we think, prudent and conservative on our Prospect Capital Corporation dividends. That cash, which was sitting in a, effectively, a money market type account earning very little, we can now utilize in a productive capacity at Prospect Capital Corporation where we have a weighted average yield on debt instruments of 13.6% as of June. So, let's not forget that as well.

On the valuation side, I'll ask Brian to tackle that. Brian?

Hello, Robert. The valuation -- there's several components to it, but one of the components is that these escrow receivables and contingent payments need to be valued also. And there were some changes in the assumptions on the collectibility of the contingent payment that drove the change in the fair value.

Okay, got it. I appreciate that. Next one, if I can. On First Tower, the covenant you made about it shrinking as a percentage of the portfolio from the current size. That, to me, would tend to imply that you're not looking to make substantial, at least, add-on acquisitions in the installment-lending space. Is that right? Are you expecting to keep First Tower? Grow it modestly, but leave it as is? Or add-on a likely road to growth there?

Sure. Well, I was doing calculations based on the existing business of Tower remaining reasonably stable in size, or only growing modestly. And then, the rest of the book growing. We do expect to be making organic investments to drive growth in Tower. There's plans in place to expand to different geographies, which we think is great from a diversification standpoint. And consumer demand continues to be robust across their businesses.

In terms of add-on acquisitions, we're always looking at add-on acquisitions across all of our controlled book. And we're looking actively at new deals. As we look at the lifespan of our Company and some of the most move-the-needle transactions you can point to, such as Patriot Capital or Gas Solutions or NRG, those were obviously all control in nature.

And differentiating, I think, as Prospect Capital Corporation is as a BDC for shareholders, since nearly all of our peers do not do controlled deals or choose to house those in separate funds that are only available to -- on a private basis, to institutional investors. So, that's available to folks here. And we're actively looking at other deals, but diversified by industry, not necessarily limited to specialty finance and consumer installment lending. But we do have a lot of expertise in this industry. And we are looking at deals. It's just hard to predict and model out because, as I said earlier in my remarks, we close in a single-digit percent of the deals we look at.

John, is there anything you would add to that?

No, that's pretty complete.

If I can keep going then, the next question I've got is [for priority] allocation. You've emphasized you want to move to senior secure, and I understand that given the economic environment, et cetera. But it looks like the fastest-growing portion of the portfolio right now is CLOs, with the majority of that actually being residual interest. And post the end of the quarter with $400 million in deployments, $60 million of that in the ING and Halcyon CLO's. That is continuing to grow. My estimate may be 13% of assets at this point. What's your target, if you have a target, allocation for that? And how do you reconcile -- if I was going to put CLO residual interest on a risk profile, it pretty much would be at the opposite end from senior secured.

Sure. Well, actually, to correct one thing you said, we're not really moving towards senior secured. We've been senior secured. And we've had a majority of our assets in senior secured loans for quite some time. On a comparative basis, we've had the highest mix of income through first link senior secured loans of almost all of our larger peers you might comp ourselves to. By the way, I would point out that I've seen in the past, some of our peers use the words senior loan. And then, they forget to leave out that it is a last-out first lien, which is, in our definition, junior debt. Or it's a second lien, so, there's not really an apples -- it's not easy to do apples-and-apples comparisons without clear labeling. We try to be as crystal clear as we can be in our 10-K, and break things out actually multiple ways.

On your question about CLOs -- actually before answering that, I just want to comment, having a diversified book is very, very important to us. And we're up to, what now, Brian, 85-ish or so portfolio companies here today, in the last week of August. Maybe we'll be above 100 by this time next year. We will see. Having a significant diversification by industry -- we have 30 industries now in the company. So, we think that builds a significant risk management for the future.

CLOs are a modest percentage of our book at Prospect Capital Corporation. And will always be a modest percentage. Not just because of diversification requirement, but also because they fall into the so-called 30% basket for BDCs. That picks up -- and we talked a little bit about this last quarter, but I think it's helpful to understand in terms of natural caps on assets. It picks up -- really most financials, which is what Tower's a part of as well, it picks up offshore entities and CLOs for tax purposes are almost entirely housed in the Caymans, in that $300 billion marketplace. Even though these are US loans as the underlying. It picks up public companies with a market cap of more than $250 million. That part is very little of our focus, as we are focused on the [less efficient] part of the marketplace. So, that 10% to 15%-ish range of assets, I think, is a place where it will be difficult to go beyond, given that 30% basket.

But let me comment about risk and risk adjusted -- you used the term opposite spectrum. I would not use that language, Robert. We think the, call it, leverage associated with CLOs is arguably the best leverage you can get. It's naturally matched book funding, it's multi-year funding. You have no real covenants, and then a bank can come bulldoze over you and foreclose on your property type risk that exists. We have zero defaults in our CLO book, which now stands about a dozen or so deals. And maybe 1,000 loans. There's extreme diversity across name and industry. And we think very attractive risk-adjusted yields.

So, we've carved out a market leadership position in that marketplace. We're very comfortable with that. We continue to see attractive flow from our investment partners. And it will continue to be an important part of our business, but a minority part of our business. As we have lots and lots of horses that pull the dividend wagon for our Company.

John, is there anything you'd add to that?

Well, Robert, just to link your questions, obviously, we appreciate your excellent questions on FT and CLOs -- we are bottoms-up investors. So, we don't start at the beginning of the year -- okay, we need to hit this allocation, that allocation, this percentage of our assets, let's go look for things that will fill those buckets. We look at everything that comes in. And when we think we see an excellent risk-reward, we are going to go for it. That was true with Gas Solutions, which, at the time, was a significant percentage of our assets. It was true of Patriot. It was true of FT. And it's true with these CLOs.

So, when people ask -- what's the grand scheme here? And I [hadn't] asked that, what's the grand plan? What's the total strategy? The total strategy is to keep doing bottoms-up investing with a very sharp eye on risk. And we believe that that's the reason why -- I think our IRR in our controlled book is above 60%. From 2004 to-date we haven't placed -- we've seen nothing go on non-accrual in over five years. The item that went on nonaccrual went on nonaccrual for a very specific -- we made the investment and it went on non-accrual shortly -- not shortly, years later, for specific reasons, which we can go into.

When you look at the CLOs, for a variety of reasons, we think that the market substantially overestimates the risk there. If you look at our portfolio, a risk portfolio like ours, which is running at a high IRR, 13% and change current return in this environment, where treasuries are yielding, I don't know what, 25 basis points, you have to ask yourself -- how are these people doing this with no non-accruals in five years? We're doing it by focusing very carefully on risk.

And I submit that the number-one risk in our business is single point of failure risk. So, when you invest in one single company, what if they lose a contract? What if there's a regulatory issue? What if a gigantic competitor decides to devote huge resources to taking market share? What if a unique CEO dies? So, those are single point of failure risks that we have every time we make an individual loan. We don't have those in the CLO book. The main risk in the CLO book is the macro risk of a significant economic downturn.

Now, you might say -- yes, that's what you were thinking about. Our CLO investments are structured so that the mark to market that occurs will not be a problem for us because none of ours are mark to market investments in the CLO book. Number two, we are investing only with managers on a fund-to-funds basis, where we have various control call rights. And only with people that we have determined to be the best of the best. By analyzing their track record, by analyzing their performance, by analyzing their systems, by analyzing the capacity of the teams that are there. Overseen by us.

And in every case, I think the lowest IRR of any of our managers going through the credit crisis of '06-'07 -- '07 and '08 was, I think, 9.4%. Meaning that when it was really ugly out there, these managers managed to write through it and made money for the equity with no defaults. As Grier said, no defaults since -- in any of our CLO book. And when you look at that, you ask yourself -- why does this type of investment have -- it frightens so many people? Well, because there were other people that did not structure their deals so carefully; the result of their lack of care was that there were problems.

I don't know that there were any defaults or loss of capital with those mark to market. I just don't have the data because we don't invest in those. But the result of the mistakes that people made doing mark to market CLOs is that many people won't look at them. Many people have this visceral view, CLO, alphabet soup, I'm not going near that. And that's great for us. Because the result is -- the entire market appears to be mispriced. I don't know how long that will continue. And we are able to invest on a very risk-controlled basis. And our results to-date have been above our base case.

So, the concern is some significant economic downturn. But we saw the same structures, the same managers, the same types of portfolios in '07 and '08 perform just fine. So, that's why we believe that we have identified and structured away much, not all -- you can't structure it all away, but much of the risk in those CLOs.

Okay, I appreciate that. That's very helpful. If I can have one more, not on CLOs, just one last question -- easy one, hopefully. If we take out the [struction] fees from First Tower from other income, it was about $5 million left over -- $5 million on $520 million in gross originations. Is that indicative that currently the origination income you're generating is about 100 BPS on origination?

Brian, do you want to take that? Grier?

Sure. That's pretty accurate. It ranges between 0 and 200 basis points. So, yes, I think that's a pretty good estimate.

I'd just add to that. In some cases, Robert, if we have a refinancing situation or a change of control situation where we're in a credit and a new buyer for the equity is coming in, you have a built-in advantage as the incumbent with superior credit knowledge having lived with the credit for a while. And we may offer a more modest 100 basis points in that situation. More typically on a new credit, we'd be higher than that, probably closer to 200 basis points. A little below that on some of our first lien stuff, and a little bit above that on, typically on some of our junior debt.

Okay, appreciate it. Thanks, guys.

Thanks, Robert.

Greg Mason, Stifel Nicholas.

Great, thank you. A quick follow-up on Rob's question on the CLOs. As we think about modeling purposes, what are you generating in terms of returns on your CLO equity income?

Thanks for your question, Greg. I think, Brian, we're north of 18% right now. And low 20%s in some of our deals. But that's probably a pretty good number to utilize for modeling purposes.

Would you add anything to that, Brian?

I'd say 18% to 22%.

Okay, great. And then, my next question is actually a follow up on John's first question about shareholder returns. Is there a point where the growth in the equity base has diminishing returns for shareholders, where you get to you are too big and you're competing in a much more competitive environment in the larger scale? Can you talk about your views on growth and returns for shareholders?

Greg, I would like to respond, and Grier will have a lot to add, I'm sure. That is a challenge. There's no doubt about it. As you grow, your ability, at least theoretically, your ability to put money to work at high returns diminishes. If you are running a hedge fund and you go from small cap stocks to large caps, and you enter more and more efficient markets, you have more difficulty. No doubt about it. Is that true here? Well, as a theoretical matter, it is.

How about as a practical matter? Well, as a practical matter, having a very small asset base, which we had when we took the Company public; we had $97.5 million to invest. What you find is that your ability to drive deals, your ability to get the terms you want, your ability to be flexible, your ability to do larger deals, your ability to move quickly, how attractive you are to sponsors, how attractive you are to sellers of businesses, being small is not helpful in any of those. And many other categories.

How about your ability to attract what we feel are the best people in the business doing this? Not that many people want to go to work at a $97.5 million asset-based company. So, I would submit to you that as we grow -- as we have grown, our ability to earn better returns has increased.

It is true that the average yield on the portfolio has dropped as we've grown. But, of course, it was very high. For years, it was in 16%s -- I think it was above 17% for a year or two. And then, it dropped into the 16%s and then into the 15%s. We were fortunate in making some very good investments with our small little tiny pile of cash in '04, '05, and '06 when it was more what I would call venture/lending. And so, we were able to earn high returns.

Whether we could do that again or not, I don't know. I feel that our ability to earn high returns now with a substantial asset base is much better assured because we have reversed all the factors that I mentioned. Including, most importantly, the desirability of working at Prospect. And I'm sure you can well appreciate that if you're a person with a long track record in sponsor finance, you find coming to work at Prospect an attractive possibility that you might not have seen years ago.

And if you look at our website and see the people that have recently joined, I'm not going to embarrass them by naming them, you will see their resumes. And you will realize that attracting people of that extreme high-caliber, really the best in the business, was not so easy for us, even eight years ago. So, that's the biggest thing for me is the extreme high-caliber and quality of the people that we have here because that's the whole business, right? You take that out of the equation and you don't have any business.

The second thing I'd mentioned to you is that we find that with the capital base that we have now, we are able -- I guess what I would say is, we are able to do significant control transactions on terms that may not be a 60% IRR in every case, which is what I believe our cumulative IRR is above that. But where, in each case, we are able to earn a return above -- not in every single case, but so far in every single case, I think, a return above what we can earn on our debt portfolio.

The ability to put money to work in control transactions is much -- let's put it this way, our market share in that segment is significantly less than our market share in the debt and the sponsor financing, the direct lending segment. So, yes, if we were to continue to grow at 100% per year for the next five years, we would start to wonder -- how big is the sponsor finance segment? And do we have to go into larger and larger deals? Even into high yield, which we do some of right now, and earn lower returns. Well, there's an aspect of that happening.

But there's also an aspect of that being offset by our ability to do these significant control transactions. Where, for example, we see companies that are presented to us, good companies, one we are looking at now, 5 times recurring cash flow. Well, that's a 20% current return. And if we buy at a point in the cycle where values are lower, and we exit at a point in the cycle when values are higher, which we've done, fortunately been able to do in the past, then we should do better than 20%.

So, I look at our portfolio return of 13.8%. I'm not -- you would think all other things being equal over long periods of time, that would tend to decline. That would be my expectation. But we believe we are doing things to slow that decline, and maybe even reverse it.

Grier?

Thanks, John. Greg, putting aside the step down, we think in risk of our business over the years, which is a substantial step down as we've increased the name count, the industry count, we provide more diversified access to funding than just about any of our peers at this point, a lot of it unsecured funding.

Your question was one of reward. And I'd say a few things to build on what John was saying. First, because of our scale, we have the ability to not just participate, but lead and take down entire amounts of larger transactions, capturing fees along the way in the ongoing benefits of being in that control-the-tranche seat. That's a great driver of our business. And we saw that just in the last few weeks, as we put $400 million on the books.

We talked about the CLO portion, which was a small piece of that; we didn't talk about the other $340 million of originations that were available to us. In significant part through our scale of being able to -- we closed an $85 million deal, swallowed that all on our own; we closed $110 million deal. And most of our peers are very small and do not have the ability to hold those sizes in one place.

The other aspect too is -- and I know, Greg, you've focused on and written about the theme of -- gosh, as BDCs get larger, do they -- is it better to be small than large? We like both. We have not stopped working on $5 million to $15 million EBITDA sized companies. We're hard pressed to go below that. But that size is still very much in our strike zone, as is $15 million to $50 million EBITDA companies.

And we might have had a migration towards somewhat larger sizes of portfolio companies, but that doesn't mean we aren't working on smaller deals, less efficient markets, particularly on a control side of things. As John mentioned, we've got some deals in the shop right now at some pretty attractive multiples. So, it's not just a question of scale, but what do you do with it? What we've done is we've hired a lot of people. And we continue to hire a lot of people, and talented people at that, as John was saying.

And we're not 10 people sitting here picking off loans from a desk at price takers at ever-reducing yields. I don't think that's a very good business for the long-term. You may do a little bit of that as a portion of your book, but be selective about it. We are the agent and/or anchor lender and/or controlling shareholder in the vast, vast bulk of our deals, probably, what Brian, 80%-plus?

At least.

So, that's very differentiating. And I know there's a watch out, you've written about, Greg, associated with BDCs that do more of the pick loans off of syndicated desk routine, and that's 100% of their business. That's not our business, and that's not going to be our business.

Great. I appreciate the thoughts, guys.

Thank you.

[John Ellis], investor.

Hello?

Hi, John Ellis.

Hello, Mr. Barry -- John, if I may. I'm glad we're on the same side of the table, finally. I've been wondering.

Well, John, when I -- . (multiple speakers)

-- question, we've heard all these things that the Company has done in the last year.

Ho-hum.

It all sounds great, but what's in it for us? I mean -- .

Ho-hum. What are you going to do for me tomorrow, right, John?

I have a table of your dividend payments in front of me. There hasn't been anything meaningful since, really, '09. You cut the dividend in Summer of 2010. There's been nothing meaningful since then. What are you going to -- what's the Company going to do for us? I hear all this -- all these statements about more NII. When I hear, like you may pay a tax on some of them, put it back into investments. That chills my blood.

Okay. Well, John, I really -- I was thinking of you when I said -- okay, we heard all the great things that happened in the last year. Ho-hum. What are you guys going to do for me tomorrow?

Remember, I supported you when you were criticized for paying high fees. I'm all for that. I think management -- .

No, actually, I appreciate that. But I also remember on this call last year, a very long discussion about why we were over-distributing, which I dissented from even the perception of over -- .

I did, too. I was never part of that. I didn't agree with it.

I appreciate that -- .

I'm a shareholder.

I know. Let me try to address your -- we would like to -- obviously, we would like to increase the dividend. What we are doing right now, John, is we are increasing it by very tiny amounts every single -- .

They don't count, really.

I know -- you can't buy that big house down in Palm Beach you want with those increases just yet.

I can hardly buy dinner.

Okay, John, okay. Well, so, John, what we're doing is we want to be sure that -- Grier will often say to me -- John, I view the dividend as not so different from a liability, like an interest -- an obligation to pay interest on a loan. And we do not want to have to reduce the dividend.

If you remember, in the "economic crisis," great recession, whatever you want to call it, it was a downturn, and it was really a financial downturn in '07 and '08. We wanted to be able to take advantage of opportunities in the marketplace. And needed to be sure that we had the cash to do that.

And also have the cash to repay our bank facility in full at any second. Because everybody was panicking in those days. And the person without cash ends up disappearing from the field, which is what happened to Patriot. As a result, we issued shares. It was not a great time price to be issuing shares. It was dilutive to the NAV, and it was dilutive to the dividend.

And ultimately, we thought we could catch up by making the good acquisitions. And finally we just said -- you know what, we can't seem to catch up, so, we're going to cut the dividend. We did. It was very painful for us as a management team to admit defeat there. It was really a tactical setback. Because, frankly, buying Patriot, being able to pay our bank loan facility off at any single time -- the latter was a risk control and the former was a great addition to the earnings capacity of the Company.

I didn't complain about it, either.

I know that. So, now here we are with our NAV back up substantially. With the stock price back up substantially. Now, looking at the dividend, we are over -- we are substantially under-distributing, but before we raise the dividend again, we feel that we want to see more visibility with respect to 2014, '15 and '16. And we have things in the works with respect to those years.

But we don't yet have the comfort level that we feel we would like to have to know that if as and when we were to increase the dividend, that we can sustain it through -- all the way out to the end of 2016 and beyond. But let me tell you, John, everybody at Prospect hearing your comments here and being thankful for your support of management, is quite determined to find ways to increase the dividend and increase overall shareholder return.

I feel special, then.

What's that? You should feel special. As every shareholder -- . What's that?

Pay a special dividend, don't just -- .

Trust me, we will look at that. We will -- bear in mind something here -- .

When I hear these dates, 2016, ' 17, and so, doesn't give me a lot of confidence.

John, remember -- .

I'm 83, I need my (inaudible) now.

You want the stock price to stay high, too, I believe.

Far less interested in that, but if you pay a higher dividend, the stock price will follow. I guarantee it.

That's true. Well, now, John, also bear in mind that between now and the end of the year, we are expecting a -- possibly a cornucopia of investment opportunities depending on taxes and whether people feel they need to get out of dodge before tax rates go up hugely. And if that's the case, we may see lots of companies in filings, bargain-basement, and being excellent opportunities for us. So, we don't want to be sitting here unable to take advantage of that opportunity. But we are mindful of your focus on the dividend. You are not the only person. I am, too.

Grier?

I'm all set.

Okay. John, do you have any -- yes?

Our next question -- .

Hold on. Is that all right, John? Did I fully respond?

I guess we are on to the next question. Okay.

[Steve Carlos], Investor.

Yes, hello. First of all, congratulations on the quarter. I met the management team back in December. It was my first annual meeting I ever attended, and I got a very good presentation. And I got a good feel of you guys. And I have a couple of questions. One of them was probably already -- was already asked by Mr. John Ellis. I just want to just reiterate that I feel the same way that there's a lot of great things being done with the Company and being said with the Company. But at the end of the day, as an individual shareholder, the only way that I can tangibly receive those benefits is either with an increase in share price and/or a dividend increase. And, as Mr. Barry had said, the dividend increases have been incremental.

So, I would hope that the management team is constantly talking about perhaps, at the very least, some form of special dividend that would keep us going and hold us off until 2016 or 2017. This way, you're not committed, an investor isn't actually spoiled, so to speak, in thinking they're going to get a dividend increase substantially every month. But perhaps if we thought that at the end of the year there might be some type of bonus, if you will, that would, I think, would alleviate -- I know it would alleviate my hesitation with regard to what's going on with the Company. But that's the first thing I wanted to say.

Second to that was getting back to the First Tower acquisition. I wanted to know if -- you said that originally your interest in the First Tower acquisition was that you had invested in another similar company that you had a very good experience with, that subsequent to that had gone public. So, my question is that if -- first of all, how is that First Tower acquisition doing? How is the business? And then, second to that, are you possibly contemplating down the road possibly spinning off First Tower if it continues to do well into its own separate IPO and a separate company from Prospect?

Okay, Grier, why don't I take this, because I think -- I appreciate your question, and did enjoy seeing you at the shareholder meeting. Number one, First Tower is doing at least as well as we expected. So, we're very -- it's just been fine. We have a great manager there. Frankly, no company's perfect every single second. But I can't think of anything there that has been a disappointment to-date. So, we're very happy with that acquisition. That's number one.

Number two, when it comes to spinning things off, separate IPO's, we do look at that. We do consider those options, structural possibilities. There are a number that we thought of, not just relating to First Tower, and we continue to refine our thoughts. Nothing is imminent. That is possible.

The default always is, when you own -- it's like when you own a great piece of real estate. I don't know how many people you know that bought, I don't know, a four-unit rental, four rental units in Dorchester in Boston or some place like that, and they paid, I don't know, $100,000 for it 20 years ago. And now it's generating $100,000 per year. And so, that can happen with FT. And if that's the case, that won't be the worst thing.

Now, we have shown that when things tick up, when there's a bubble, when everybody wants to buy, NRG, or everybody wants to buy Gas Solutions, we're here to sell it. Here you go. If you really want it that badly, you can have it. But our default generally is to keep these yield assets. Because what they do is they generate a big yield that goes directly to the shareholder without intervening taxation. And if you invest in most other companies, the vast bulk of other companies that you can invest in, publicly traded, before you get a dividend, the Company has already paid 36% of its income in taxes. So, then you pay.

Let's say you're at the 30% tax bracket, okay? Or let's say you're at the top margin in New York, 45%. So, actually, a dividend has been taxed at that point, what is it, 45% plus 36%, I can't even count -- it's 81%. So, that's why there is an important benefit to us holding onto these assets as a default. And when it gets even better than that, we're happy to sell.

Grier?

Sure. We reap, Steve, significant benefits in holding Tower as a partnership. It's not a C-Corp. And so, it's very tax efficient to hold this partnership. And then, to have Prospect Capital Corporation as a registered investment company on top. So, virtually no taxes downstairs, no taxes upstairs. And Prospect's shareholders benefit.

Were we to spin off Tower and take it public, unless the tax rules were to change, which is not foreseen in this particular area, most likely you'd have to convert it into a C-Corp, which is, in fact, what Regional Management is. And companies like World Acceptance that are already public.

Those companies have done very well over the years. But there's just one problem -- they pay a ton in taxes. And it's very hard to shield that. So, there's some ideas we might have pertaining to a partnership -- .

Well, as an investor, I'm not necessarily -- I was thinking about that as a possibility. But the end result as an investor with Prospect and its relation to First Tower is the same as if -- well, how is Prospect Capital going to monetize this ultimately for the individual investor? When I heard about this acquisition, I was like -- wow, this looks like it's going to make some serious yields, as Mr. Barry said. I bet you we're going to hopefully see some serious increase in our, either dividend payment or a special dividend. Something somewhere down the road with full understanding that, which I highly respect your management team, is that you're constantly looking at risk before you're looking at reward. And I really think that I believe that's the way I run my practice, and that's really the way you have to go. Because if you take care of the risk, usually the reward will take care of itself down the road.

But I think that as investors, we've been relatively patient. To make a press release that says that Prospect Capital's given out $10.40 in dividends since 2004 is great. But, how many of us, I know I'm not, how many of us have been investors with Prospect since 2004? It's like Mr. Barry said -- what have you done for me lately? I haven't been an investor for a month, but I have been an investor since 2008, 2009. And, as a result, I would like to now hopefully receive a little bit more remuneration than what I've been receiving with respect to either monthly dividend increases or a special dividend. Something down the road where, sooner rather than later, I can really feel a little better about the Company.

Steve, your points are being listened to carefully by this management team. And the points made by the prior caller. Just want to set things into context -- we've owned the Tower investment for barely 60 days.

Right, I understand.

Give it some time to make sure it continues to do well and -- .

I understand. (multiple speakers)

-- upstairs distributions. And then, we'll see in the future about what we are thinking about as a Board for dividends.

Okay. And I just want to say one thing before I go is that I don't want to portray my call as being disgusted. On the contrary, I'm extremely -- I am happy with the Company. I trust the management inherently. I can see that you're definitely steering this Company towards the long-term. I'm 50, I've got two kids, one in college and one on the way, and I'm in this for the long-term myself. So, I just want to leave that thought, leave the phone call with you guys knowing that, all in all, I'm extremely happy with the management team and with the Company. I just would love to see a little bit more of remuneration sooner rather than later.

Good. Well, thank you, Steve, we got the message.

Thanks, and have a good day. And you guys have a good lunch. Okay?

Thank you, Steve.

Take care, and bye-bye.

[Ren Cook], investor.

Good morning. I've been listening to everything with a great deal of interest. My question regards all the variety of ways that you have been raising funds over this last year. Wondering if you can expand a little, the difference between convertible bonds, retail amounts, and baby bonds.

Okay. Well, Ms. Cook, this is John speaking. This would maybe require an all-day or all-week seminar. I'm going to -- .

Okay. Well, I -- okay, I am -- .

But hold on. I can give you the very quick answer. And I'm asking Brian to send you some information. If you call Brian, he can give that to you. By the way, for -- . (multiple speakers)

Can we have [Sagar] call Brian off-line on this topic?

Hold on. I just realized -- Ms. Cook, actually, if you were to look in the 10-K, it actually does explain everything. But let me do a very quick explanation for you, okay?

Okay. Let's make it even briefer -- the convertible bonds -- can individuals by those?

Here's the answer. You would need to speak to your broker, and you need to ask your broker, who will explain these varying securities. Do you have a broker?

Yes. Okay.

John, let me answer that because I think there's -- the convertible bonds, when issued, are issued under rule 144 that only institutional investors with $100 million of assets can purchase. But after -- .

I understand.

But after, I believe, one year, they become free to purchase by any investor, including an individual. So, in that case, yes, you should talk to your broker and see about those. I would say that I'm not sure what the liquidity looks like for those types of vehicles. And an individual investor might be better served to look at something like our retail notes program, or our baby bond, which trades like a stock as ticker PRY on the New York Stock Exchange.

Yes. I've looked at that one.

But the main thing is -- your broker has an obligation to study these things. And he also has an obligation to provide suitable investments, right? He's familiar with your financial situation, and what is suitable and what's not. So, I would start there. And let's see how that goes. If for some reason your broker is not giving you information that creates confidence for you, you can call Brian. He's on our website, you can get his number there.

Okay. Thank you very much.

It appears that we have no further questions at this time. We will go ahead and conclude our question-and-answer session. I would now like to turn the conference back over to Mr. John Barry for any closing remarks. Sir?

Okay. Well, I want to thank everybody. And now we're going to start working on what we're going to try to do for our shareholders tomorrow and in the days and weeks and months and years ahead. Thank you all; bye.

Thanks, all.

Thank you, sir, and thank you to the rest of management for your time. The conference call is now concluded. We thank you all for attending today's presentation. At this time, you may disconnect your lines. Thank you, and have a good day.