Prospect Capital Corp (PSEC) 2013 Q2 法說會逐字稿

Good morning, everyone. Welcome to the Prospect Capital Corporation second fiscal quarter earnings release and conference call. All participants will be in a listen-only mode.

(Operator Instructions)

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

(Operator Instructions)

Please note today's event is being recorded. I would now like to turn the conference call over to Mr. John Barry, Chairman and CEO of Prospect Capital. Mr. Barry, please go ahead.

Thank you, Jamie. This is Grier Eliasek, President and COO. Joining us on the call today are John Barry, Chairman and CEO; and Brian Oswald, our CFO. Brian?

(technical difficulty) 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 subject to 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-Q filed previously. Now I'll turn the call back to John.

Thank you, Brian. In the December 2012 quarter, we achieved record net investment income and origination volumes. We also delivered $0.12 of growth in net asset value per share for the year-over-year period. NAV stood at $10.81 on December 31, 2012. Net investment income for the quarter was $99 million, up 172% from the prior year. On a weighted average per share basis, net investment income for the quarter was $0.51, up 55% from the prior year. We have delivered strong net investment income growth while keeping leverage low. Net of cash and equivalents, our debt-to-equity ratio was 29% in December. We have substantial debt capacity and liquidity to drive future earnings.

We estimate our net investment income per weighted average share in the current March quarter will be $0.27 to $0.31. We just announced more shareholder distributions through April, which will be our 57th shareholder distribution and 34th consecutive per share monthly increase. Our net investment income has exceeded distributions, demonstrating substantial distribution coverage for the current fiscal year, the prior fiscal year, the last five quarters, and the cumulative history of the Company. We have now paid out more than $11 per share and $675 million in distributions over the life of the Company. I will now turn the call over to Grier.

Thanks, John. Our business continues to grow at a solid and prudent pace. As of today, we have now reached more than $4 billion of assets in undrawn credit. Our team has increased to more than 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 covers third-party, private equity sponsor-related lending, direct non-sponsored lending, club and syndicated lending, prospect-sponsored transactions, real estate yield investing and structured credit.

This diversity allows us to source a broad range and high volume of opportunities, then select in a disciplined bottoms up manner the opportunities we deem to be the most attractive on a risk-adjusted basis. Our team typically originates thousands of opportunities annually 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 and our debt investments were generating an annualized yield of 14.7% as of December 31. We also hold equity positions in many transactions that can act as yield enhancers or capital gains contributors as such positions generate distributions.

Originations in the December 2012 quarter were a record $772 million, up approximately 5 times our originations in the prior year, December 2011 quarter. We also experienced $349 million of repayments, as a nice validation of our capital preservation objective. As of December, we are up to 106 portfolio companies, a 41% year-over-year increase, demonstrating both an increase in diversity as well as a migration towards both larger positions and larger portfolio companies.

We also continue to invest in a diversified fashion across many different portfolio company industries with no significant industry concentration. In the December quarter, we enjoyed exits for Northwestern, Blue Coat, Hi-Tech, Wilson, Mood Media, Shearer's, Potters, Renaissance, VanDeMark, Hudson Products, Safe-Guard, and STP. Our financial services' controlled investments are performing well, with annualized cash yields in excess of 18%. Our CLOs are currently yielding approximately 25% annualized.

During calendar year 2012, we received significant dividend and interest income from our ESHI investment. We expect our income from ESHI in calendar year 2013, to be significantly less than such income in calendar year 2012. We are looking to offset this decrease by utilizing existing liquidity and prudent leverage to finance our growth through new originations, including attractive yielding investments in the financial services and other sectors.

The current March quarter is off to a strong start, with $141 million of originations and a growing pipeline. Our credit quality continues to be robust. None of our loans originated in more than five years has gone on non-accruals status. Non-accruals, as a percentage of total assets, stood at only 1.1% in December, down from 1.9% in June 2012 and 3.5% in June 2011. Our advanced investment pipeline aggregates more than $400 million in potential opportunities, boding well for the coming months. Thank you. I will now turn the call over to Brian.

Thanks, Grier. As John discussed, we've grown our business with low leverage. Net of cash and equivalents, our debt-to-equity ratio stood at 29% at December 31. 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, which we have taken toward construction of the right hand of our balance sheet. As of December 31, we held approximately $2.9 billion of our assets as unencumbered assets. The remaining assets are pledged to Prospect Capital funding, which has AA-rated $552.5 million revolver with 17 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 -- excuse me, 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 Corp., multiple types of BBB-rated unsecured debt, including convertible bonds, a baby bond and the retail notes program. All of these types of unsecured debt have no financial covenants, no asset restrictions, and no cross defaults with our revolver. We've now tapped the 5-year to 30-year unsecured term debt market to extend our liability duration. We have no debt maturities until December 2015, with debt maturities extending through 2043. With so many banks and debt investors across so many debt tranches, we substantially reduced our counterparty risk over the years.

As of today, we have issued five tranches of convertible bonds with staggering maturities that aggregate $847.5 million at interest rates ranging from 3.75% to 6.25% and have conversion prices ranging from $11.35 to $12.76 per share. In the past, we have repurchased such bonds when we deemed such purchases to be attractive to us. We have issued a $100 million, 6.95% baby bond due in 2022 and traded on the New York Stock Exchange with ticker PRY. We have issued $183 million of retail program notes with staggering maturities between 2019 and 2043 and a weighted average interest rate of 5.9%. From March 31 to today, in addition to our revolver expansion, retail program notes issuance and three convertible bond issues, one in April, one in August and one in December, we have issued equity 6 times each time at a premium-to-net asset value.

In three ATM programs, we raised gross proceeds of $268.8 million. In an underwritten offering in July, we raised gross proceeds of $269.3 million and in our underwritten offering in November, we raised gross proceeds of $388.5 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 of the revolver terms, and taking into account our cash balances on hand, we have approximately $740 million of new investment capacity. Now I'll turn the call back over to John.

Thank you, Brian. How about some questions?

Ladies and gentlemen, at this time, we will begin the question-and-answer session.

(Operator Instructions)

Greg Mason from Stifel.

I wanted to -- if you could discuss your new REIT strategy? You started it in December. It looks like you've added to it here in the new year. Could you talk just about what you're trying to do in that REIT strategy? How big it could be? Also the return potential -- I know the debt has a 12.5% return. What should we expect for equity returns on that potential strategy?

Thanks, Greg. So our business continues to grow and expand and diversify. We think that sets us up well, not just from a reward opportunity standpoint but also from a risk management standpoint. We view diversity as a good thing. We view -- a big part of our job is to manage risk. Even though it seems like a good part of the world out there seems to have forgotten about risk in the current quarter, we haven't.

But we are not just diversified for diversity sake. One component of our real estate strategy is a significant tax-efficiency; real estate investment to be set up a private REIT in our structure as a BDC, have a nice and almost rarefied nexus of being both a 70% basket industry under our BDC rules as well as one that we can hold without a C Corporate tax paying block or in between. So that's one aspect of it.

It's obviously contracted cash flow, recurring revenue, diversified -- a lot of things we look for on the credit side. To date, our investments have been in the industrial sale leaseback side, which is really very closely aligned with corporate credit analysis, anyway. And also on the multifamily front, where you can get government-supported financing from the GSEs on a 10-year basis.

So you've got a yield compression going out there across many different asset classes, and real estate is not immune to that. But if you can lock in an attractive spread for 10 years, and deliver that spread to the investor in a low double-digit and potentially even better basis, we view that as fairly attractive. You asked about average returns, and I would say the low- to mid-teens is what we would expect on an all-in blended basis in that strategy.

In terms of how big it could be, we maybe -- we've made about, fairly modest, as of December 31, investments in that area, about $15 million or so. We expect it could grow to be significant. What it significant? A little low to put precise projections out there because we don't really think about our business that way. We look at everything bottoms-up; every deal stands alone and has to pass muster. But what I can tell you is, we've got a very robust pipeline of opportunities, many of which -- singular opportunities are in the $50 million plus range. So we think it can grow, perhaps significantly; and we like having that diversification.

The diversification of real estate, the diversification of our buy-out strategy, the diversification of structured credit -- maybe 90%, 95% of our peers do one thing, they're long and strong, sponsored finance. Don't get me wrong, that's a good business. It's a big part of our business. We continue to address it. But it can be a frustrating and yield-compressing and more commoditized business from time to time. So when you've got lots of different choices, we can afford to be very disciplined and choosy, so that's part of the component as well.

Did I answer your questions, Greg?

Yes, that's great.

Just one follow-up on the new multifamily property in Florida. You talked about GSE debt. So is there GSE debt in front of your $30 million investment that you make in those properties?

There is. That type of debt comes, I think, at about a 3% to 4% fixed interest rate.

Okay, great. Then one final question and I will hop back in the queue.

You've also been focusing on the installment lender area with the First Tower, and then you did Credit Central in the fourth quarter, and then subsequent Nationwide subprime auto lender. Could you talk about these subprime borrower focus? What you see in that business? Why you like that? And more importantly, give us comfort with how those businesses perform through the downturn as the potential risks in those areas?

Sure. We have spent many, many years analyzing consumer finance businesses, starting with and especially the installment space. We're -- obviously, we made our First Tower investment last June. That diligence deep dive goes all the way back to 2007, when we made a junior debt investment in a company called Regional Management, which is now a publicly traded company. I remember with that transaction we analyzed the financials, I think, going back to the 1980s.

So we looked at multiple economic cycles, multiple recessions, analyzing delinquencies and charge-offs. We're quite intrigued that in that business and businesses like that -- yes, there is an impact during economic recessions, but not as severe as one might surmise without doing further investigation and analysis. So we like the steadiness of the business. We like the attractive cash yields; there's a ready stable of lenders, primarily banks who give you ABL-type of financing, generally in the 60% to 85% range for these types of businesses. That enables you to enhance your yield attractively.

But given the unlevered yields are the mid-teens, so push came to shove, and you had to pay off the senior debt, you'd still do pretty well in our mind. We're looking at the possibility of securitizing some of that debt. It's a little trickier; we have decentralized servicing in the case in installment. It's a little easier to do in the areas of auto finance.

Tower is an A loan installment lender; we purchased it in June. Credit Central, B Loan, a little bit higher than the APR scale; a little bit shorter loans, a great track record, a team that we're backing there as well. A smaller transaction, we would like to see it grow, probably as a separate independent platform, separate management team, separate capitalization, financing, et cetera.

Nationwide, which we just closed in the auto finance space. Not a huge investment for us, about $25 million, but an area in which we've spent, again, going back to careful diligence and underwriting, we spent about 18 months exploring, understanding the auto finance sector. And thinking about risk at a macro level and at a micro level.

So we made this investment; we were actually looking for other investments in that sector. So don't be surprised if we see future announcements. We may close nothing if we don't find the right team platform and value, or we may close something interesting.

There's a little bit more volatility in auto finance than on the installment side of things. So, careful underwriting is required there, and there's lots of different models, there's branch-based models, there's more centralized models. There's different parts in which people play geographically, different parts on the credit quality of customers. A key for us is to work with teams that have an excellent track record of careful underwriting. The longer the team company has been around, the more data there is to analyze over a long periods of time.

Does that help answer your question, Greg?

Very good, thank you.

Greg, this is John.

These businesses have been around for a very long period of time. They're highly diversified; they provide steady returns; and they suffer from always being out of favor. The result is that people who are prudently investing in this area -- and we passed on some and we've gone after others -- I think, can outperform. I remember Joe Steinberg, back in 1985, talking to me about Leucadia being -- investing in one of these businesses and saying, John, this is the best investment we've ever made. These people always repay their loans for the car or the boat or the TV or the sofa or whatever it is.

So we've been looking at this area, as Grier said, for a long time, and we feel we have significant expertise in the area. We've had good results to date. As a result, we are very happy to continue investing in that area.

Just to underscore the diversity, Tower has hundreds of thousands of loans. Significant diversity for Nationwide, Credit Central; we like the granularity of the customer base. We're also not running these businesses with a huge amount of leverage. We're not maxing our leverage; we're leaving ourselves a significant [position] on the borrowing base. So this is not a leverage at the portfolio company-type strategy.

We're getting attractive unlevered returns and boosting that prudently as well, with the end result being, we are able, in this part of our portfolio, generate 20%, in some cases more than that. I think we're collecting more than 30% in one of those deals, which is a very nice piece of our portfolio when you have yield compression that is confronting the more corporate finance, including sponsor finance side of things. So it's nice to have other yield contributors when you have that phenomenon occurring elsewhere.

People worry about Richard Cordray and what he is going to do. Well, we have two responses to that. One is that there is many actions contemplated, threatened, considered, and organized, but many fewer negative ones occur. We underwrite in any event these credits, assuming various negative occurrences, yield compression, recessions and so forth. Even with those adverse cases, we do very nicely. So this is going to be a stable, and we hope, growing part of our portfolio.

Robert Dodd from Raymond James.

I've got a couple. Just to follow-on, on what Greg asked on the REIT side. I understand this is an attractive area for diversification, et cetera, but what's your edge versus the REITs that are out there that have structurally, for whatever reason, lower cost of capital? So you've got to have an edge on underwriting and finding the right property where their cost of capital doesn't price you out the market. Can you talk about that a little bit?

Absolutely, Robert, thanks for your question. I would say our cost of capital is not higher, it is equal to the public REITs, because we pay no taxes at the portfolio company private REIT level and we pay no taxes upstairs. So it's just measured on an efficiency basis, I would say, where we've got a match. Look, there's a lot of inefficiencies embedded in the, quote-unquote, middle market, private deal market of real estate, too, not unlike on the corporate side of things.

Of course there are many deals that don't make sense to do. There are properties with low cap rates. There are properties that need significant capital expenditures attached to them, ones where there's too much of an over-build happening in a particular geography. There's lots of analogies that go into it. I want to emphasize that our book-to-look ratio is very low in terms of conversion rate of what we see versus what we do in that area, just like the rest of our business, that's run for many years, really, since the beginning of this organization at a single-digit percentage, and typically, low single-digit percentage conversion rate on deals.

So as with a lot of things, it is bottoms-up, not tops-down. It's every deal stands alone, and you win attractive risk rewards; it's a proverbial dollar bill on the sidewalk that the economist doesn't believe can ever exist, by out-hustling the competition, by working with strong operating partners who can find less auctions, transaction flow, where you can get compelling value. Not that different from how we are able to do attractive deals on the control front.

So when we say, tops-down, there's lots of private equity firms, you can hire any number of efficient auctioneers of businesses, and they're going to find the highest bidder. If you win, you must have way overpaid and that a winner's curse. Well, that's a tops-down view; bottoms-up, we see lots of dollar bills when we hustle for them, when we go after them. And where we create edge is with property manager, operating partners who can source proprietary deal flows.

So we have one such relationship which we worked with on the multifamily side. Of course, you need to have a property manager there, anyway on the back-end. That same relationship is -- we're looking with multiple other very interesting transactions with, and there will be other relationships like that in other sectors within real estate.

But every deal has to stand alone which is why I was cautious in the earlier question about saying it will definitely be $500 million or $5 billion or whatever X number of months and years from now. We are optimistic; we are excited about what we are seeing, but cautious as always.

Okay, got it. I appreciate that.

Another one, on the non-qualified bucket -- obviously, the REITs qualify in the structure you have -- but on the non-qualified side, your first [time] in your consumer finance, and then you diversified as finance the sellers -- it seems like you've got quite a lot of concentration within the non-qualified bucket and a couple of -- one is clearly the consumer finance, so it's clearly a niche sector, as well as -- so this is quite a lot of concentration. What are your thoughts on adding more diversification within the non-qualified assets?

Sure. (multiple speakers) We are looking at other sectors. Broadly speaking, it's financial services-types of companies that go into non-qualified, as you put it, others referred to as the 30% basket for BDCs. I would suggest we have a lot of diversity there already.

Structured credit -- what are we up to, Brian? 12 deals? 14 deals? 12, as of December 31; we're making other investments, and that's somewhere in the 10% to 15% range of our asset base. Consumer finance is maybe in the 5% to 10% range, probably about 10%. So we have capacity with the 30%. We do joke about whether or not we face capacity issues; we have an arm wrestling match between our structured credit team and our [sig] buyout team. But we've been growing the denominator, if you will, so we haven't really faced an issue.

We monitor that basket every day. We've got plenty of capacity there, and we're looking at investments. So we have, within consumer finance, we've got different parts of the installment spectrum, we've got auto finance, a lot of diversified within structured credit. We're looking at other types of assets that would fall within the 30% basket that are quite diversified. We'll see if we end up making investments in those arenas.

Look, we view -- you asked a question about edge earlier. We view ourselves as having significant edge when it comes to analyzing specialty finance business models, maybe because we are a specialty finance Company. So if we know a thing or two about our own business, we should in theory be able to apply that to outside platforms in synergistic areas. So we've attempted to do just that, and tried to analyze things very carefully over multi-year period and looked at lots and lots of deals before pulling the trigger on the ones that we have, so --

Does that help, Robert?

Yes, absolutely. That's helpful. Then just one last one.

Just a general question, --obviously, you talk about the market, as you said, in the middle market, sponsored finance, especially as getting -- has gotten -- well, it's been that way for a little while now. Are you seeing any signs of that continuing to get worse, getting better, or are you seeing changes in structures either on covenant fee structures? Are fees that would normally be paid up front not getting paid up front? What are you seeing in the marketplace?

Well, first, it's helpful with that discussion to segment the market and how we define it. Of course, all this is caveated by saying, on a bottoms-up basis, every deal can be different. But we tend to address $5 million to $100 million EBITDA companies, quote, the middle market; $5 million to, say, $10 million of EBITDA, you might say is the lower middle market; $10 million to $40 million, the traditional middle market, classic middle market, middle of middle market, however you want to call it; $40 million of EBITDA, the upper middle market, quasi-syndicated market.

Where you've seen the most impact is probably in the upper bands, the upper middle market, the quasi-syndicated market. When a deal goes to a Wall Street desk, it just flies off the shelves -- 2, 5, 10 times oversubscribed to a lot of different buyers. We have dialed back our -- it never was a huge part of our business but we have dialed back our activity there substantially. We see leverage popping up, we see yields compressing and the vast bulk of our business is agented business, a prospect agented business.

So in the other parts of our business, there's definitely competition out there, and we certainly do lose deals over pricing. I would say that, in general, there is yield compression going on across the board, whether it is senior paper or sub-debt paper, alike, in that space. So that is occurring. How do you fight against that?

You asked a question about up-front. On the up-front point, whether it's a structuring fee or OID, which is more of a syndicated-type aspect, we're still getting, say, on average we'd say 2 points up-front, Brian -- that hasn't changed too much, Robert. It's more on the yield side of things. But we differentiate ourselves as an agent with other factors. Yes, it's about basis points. But it's also about the relationship; it's about the repeat business. It's about the, quote-unquote, reliability -- reliability not meaning you say yes on every deal, but you try to suss out fatal flaws early and not have too many surprises that you've generated on the back end.

We do a lot of repeat business with the same relationships, where we're not necessarily the lowest cost of capital, but it's an important deal for a counterparty and important deal for us. I think people that have a long view as counterparties realize that there is the initial spread or yield you start with, and you're going to go maybe through an economic cycle or two, or say one deal, one cycle, during the life of a particular loan. And you want to have a lender that, A, is financially strong, and because you pick the lowest cost person from a weak lender, well, they're going to be the first one not giving you the amendment, not giving you relief, not being thoughtful on the back end if there is a problem and really hampering your business. I think the really, the smart money counterparties know that. Maybe we call them smart just because they're willing to pay us a little bit more, Robert. (laughter)

Jonathan Bock from Wells Fargo Securities.

Broadly speaking, I was just curious -- I noticed there is quite a bit of money market cash on hand in addition to credit facility capacity. So perhaps walk us through the reasoning of an ATM or a new ATM being established at a point when it really seems that new equity likely would not be needed for a while?

Yes, great question Jonathan.

Putting aside the aspect of issuing above book, and addressing just the pure -- because we have been issuing above book -- but addressing just the liquidity question. We mentioned that our advanced pipeline, we call it category A, is in excess of $400 million right now. That is one piece of it, but the team is working on some pretty significant transactions, and our hope and desire is that, that could actually change fairly quickly.

So our desire is not to build a cash hoard; we know there have been other companies this week and other industries criticized for building cash hoards. Our objective is to put that capital to work productively, and we think we will. We're seeing a lot of deal flow right now. January was a digestion month in which a lot of people in the industry collapsed and maybe got some sleep after a frenetic December. What did we close, Brian, in December? 24 deals in that month alone? Something like that, including multiple transactions on New Year's Eve, obviously, before the tax bogeyman got people. There was a huge surge related to that.

So January is a bit of a rebuild. I think it always is, no matter what the year. Now as we're going in February and March, then we are seeing a rebuild. We'd also point out -- the ATM, we really like it for equity issuance because it doesn't cause gyrations as much with our stock prices. It's also very efficient from a cost standpoint. 100 basis points versus 500, 600, 700 bps, give or take, for an underwritten deal.

Okay, thank you. That is helpful.

Then another broad question. It's clear that there's substantial return upside in the non-qualified or the, we'll call it the CLO/structured finance/consumer finance bucket. Yet you did mention on the call that in order for that to grow -- and I think right now your non-qualified assets are around the 25% level, let's say, or thereabouts -- but in order to grow that bucket, you also have to grow the denominator, which would imply additional equity issuance, which would effectively dilute a lot of the return upside over time, given now that, that bucket is very close to approaching its 30% maximum, which you'll likely not want to exceed.

So walk us through the return dynamics in a post-gas solutions world, where it seems perhaps the critical mass has already been received. That growth in that bucket is permanently established, it's already paying, but it would be harder to grow and receive even stronger marginal rates of return now that you have to issue additional equity in order to grow the assets in that bucket.

You mean other than legislation taking away the 30% basket?

Well, I'm sure that would be up for debate, but yes, I do believe that is -- that, that would be one way for it to increase; but let's imagine for a moment that it does not.

Right, of course. I was quoting ranges on the -- I think we've got more cushion than 5%, if you will. I think we're less than 25% that you quoted. So we actually have some cushion built in right now to get to 30%. Longer-term, steady-state -- real estate is one area where we think we can achieve diversity and some nice returns.

We are also looking at leasing businesses. Leasing is -- I talked about -- I forget the exact words I used -- the rarefied air maybe where you can find a flow-through that is not a 30%er. Leasing companies -- you can craft those to actually have that happy marriage of 70% basket deals, where you don't need blockers, or at least there's not a tax drag. So that's similar to real estate from that standpoint; some attractive returns. We're looking at equipment leasing deals and aircraft leasing deals, lots of different possibilities there.

I would also say our buyout business. So we have closed -- what, Brian, four buyouts in the last two months? At this point, CCPI, CCI, Nationwide and Valley? So we have closed four buyouts. We have been on a pace, in any given year of closing maybe one or two. We've closed four in the last couple of months. Our hope and desire -- we will see -- that we'll find enough compelling value is to do more deals like that.

If we buy them right, and buy them attractively and find value and, yes, you can find value even in this -- everyone's lost their head, credit bubble risk on world that we're in this at the present time -- you can find the dollars on the sidewalk. Then there are -- your problem is there are more gas solutions-type deals we would hope and like to find. So we've got that potential, we've got that upside in our business model. Unlike, I don't know, 90% of our peers where it's a credit book of sponsor deals, and you've got one direction to go -- down, through default. We like to have upside.

I appreciate that. Perhaps talking about dollars on the sidewalk in the CLO business -- obviously, great returns. Could you give me a sense of how long it takes for this post-investment to receive your first cash distribution? Is there normally a six-month lag?

Normally, the way we structure those deals, they been all primary issuance deals, working with a very high-quality group of collateral manager partners. We've structured those deals such that we get initial payments, and there is a -- we insist upon having a significant percentage of [rent] at closing to enhance our IRR. That's why there's just a lot of up-front work, a lot of work attached to that strategy -- more than I think people would suspect.

The accounting treatment -- and Brian can add to what I'm saying here and correct me if I'm wrong -- it's a level yield analysis based on modeled input that gets heavily scrutinized, as I'm sure you would suspect. Then a true-up and an adjustment to that model on a quarterly basis.

Brian, anything you'd add to that?

No, that's pretty accurate. Basically we project what the IRR is going to be for the life of the investment, and we recognize that on an accrual basis.

Okay. So one question then, on the type of collateral that sits in this, would you assume this to be more of your BSL-type of general collateral that your traditional large CLOs are out there buying in the market today?

Yes. It's all liquid, broadly speaking, and we want that, because your call [write] is worth something if you can sell the asset. We have looked at, quote-unquote, middle market CLOs with others; it would have to be with others to avoid consolidation under the rules. It's tricky to make that work, because you're not necessarily getting an illiquidity premium that you really should be getting. A call [write] is a heck of a lot less valuable if you can't just be with the thing and be out in two days.

Very interesting.

Then one last question is, that to the extent that the income received here are based on modeled inputs, heavily scrutinized, of course. In the event that the BSL market spreads contract, which they have, I would imagine that NIMs to your equity decline, so long as there's actually reinvestments that occur in the CLOs themselves. Given the fact that spreads have tightened and tightened hard in various loan repricings and BSL collateral, would it be fair to assume that there is a potential for decline in the value of CLO equity if this spread compression continues?

Yes, well, that's where careful underwriting and having assumptions on reinvestment spreads well below current market conditions is important. So in the deals that we've underwritten in the last 18-plus months, we viewed reinvestment spreads, and risk went through different peaks and valleys during that time period. But we said, look -- we're at a higher-spread world right now. We think spreads are going to be heading lower on the reinvest. If they widen, then that is just upside for you, all other things being equal. So we modeled in way lower reinvestment spreads than those market conditions at the time, and continue to have modeled spreads that are lower than current market conditions.

That has served us well because we want to make sure during the non-call period for the deals, which is typically two years, that we're going to get a requisite return. After two years, if you have continued tightening, which, of course, goes hand in hand with loan prices going up, then we can just call the deal. Bank the return and be done with it. You may not even get to the four years, which is the typical time period for the reinvestment period to be over. So we felt like we protected that pretty well, and one counterparty said -- your base case looks pretty darn draconian to us. Now we feel rewarded in having been careful.

(multiple speakers) We typically look at a case which we believe should never happen, where defaults go up, and spreads continue to tighten, which, of course, I think everyone on this phone call knows that would be a very interesting occurrence if you got hammered from two directions. Even in those cases, we have a positive return. Obviously, it is significantly less than what we look at, but we do have preservation of capital.

Then this last follow-up is that there the structuring fees were meaningful in the quarter -- let's say, up -- just looking at the cash flow statement -- so maybe $16 million. Maybe talk about how you're looking at bringing structuring fees, how you bring them into income? And perhaps maybe some of the more one-time elements of both structuring add to fees and how that impacts NOI going forward?

Well, it's a core part of our business; it's a portfolio that turns over, loans repay, we make new loans. It is a recurring part of our business. That doesn't mean it's going to be precisely flat or the same from quarter to quarter. But it is a key part of the economic return of our business and business model, that it's not going away, it's not disappearing; it is still very much there.

So we charge structuring fees when we're the agent. When we are not the agent, which is the syndicated channel; it's very small part of our book. As I mentioned, we're doing very little in that market right now. Or if we do anything, it's small, and that's more of OID-type up-front. But on the structuring fee side, we expect that to continue. In the last two quarters, we did about $0.75 billion in originations each quarter. We will see where this quarter ends up. But we expect that to continue.

On the exit side, prepayments vary. They tend to be a little bit less than senior debt, a little bit more on junior debt. Sometimes with hard call protections as well on the junior debt side. But we have tended to be -- what, Brian, somewhere between 1 and 3 points on the exit side?

For early redemption.

For early redemption; if it's held longer than that, then no. So 2 points going in, 2 points going out, double the yields in the middle, [solves] you into mid-teens IRR.

Terry Ma from Barclays.

This is Kannan.

The one question I had was related to the cash balance. The $430 million which is that on the balance sheet -- you had capital raises late in November, so what really happened in that last one month? Is it that the pace of repayments went up because of which the -- pace at which you could deploy the cash probably was lower? Or is there something else there?

Well, you've got about a three-week period there where you can't really raise capital. The capital market is shut down for large raises, whether it's equity or bond issuance or what have you. Yet the left hand side of the balance sheet continues, and deals are closing, with counterparties with pretty significant expectations that you are going to get there. Of course, we want to, as well with plenty of capital in hand. Then repayments can happen and sometimes you have 30 days notice and sometimes you have less notice than that.

So we want to err on the side of having more liquidity. The last thing in the world you want to do is let down a counterparty, not get there -- oops, tell them the capital we're closed. You're going to be pretty much dead to that counterparty to ever do a deal with them again. Repeat business is a very important competitive advantage for us, with relationships that we've built up over long periods of time. So, as I mentioned to a prior question, we've got a decent amount of liquidity now. But we're very focused on deploying that profitably and we're seeing a nice uptick in both category A and then term sheets going out.

Okay, then from a leverage perspective, given that you have this cash on the balance sheet, should we expect leverage to be roughly where it is right now over the next couple of quarters?

It's hard to project with specificity. We are underleveraged by a lot of the accounts analyses at about 29% net debt, net of cash and cash equivalents to equity as of December 31. We have been issuing bonds for medium-term [notes] program. We're looking to expand that program. We're adding other broker-dealers to the platform; it's a pretty meaningful one.

So we are excited about that. We're going to look at other types of issuance. So we think that, that should grow, but we don't have specific targets. We have talked in the past about how long-term leverage could go as high as 0.5 to 0.7. We tend to be more in the 0.3 to 0.5 range, probably because when you're growing, when you're looking at a lot of deals -- again, you want to err on the side of having sufficient liquidity. So at some point, that may dial in to a little bit more predictable range.

Brian, do want to add anything to that?

The only thing I would say is that as a percentage, around 50% for the debt is probably a good estimate at least through this quarter.

Okay.

I don't want to say we're afraid of leverage, but -- and we have designed our balance sheet very carefully, as you know and as we have talked about, which I don't think always get to appreciate -- especially in the current environment where people aren't thinking about risk. We think about risk a lot, and when you've got a balance sheet with a lot of unencumbered assets and all your term issuances unsecured, that's a pretty nice place to be.

If your leverage isn't pushing the max, pushing the envelope, pushing against covenant levels, you also have a nice cushion place to be. During those downturn periods, we had challenge in raising capital and everybody is below book and there's lots of great opportunities in the market. Then we can move in swiftly, and maybe find another Patriot Capital acquisition or others like it. This time, we shove a lot more liquidity to bring to bear than last time. Did that help?

Jerry [Luther] who is a Private Investor.

I had a couple of different questions.

I wanted to know what impact do you see on the adjusting of the convertible notes from '12, 10-year that is upcoming here? I think They are at a 11.35%.

I'm sorry -- I --

You're talking about our December 2012 maturity converts and the adjustment pertaining to dividends on the conversion price?

Right. What impact do you see of having the --

Those impacts are almost negligible. They are very immaterial. That price will not move more than a $0.01.

Okay, great. The other thing was -- where do we stand on meeting the distribution requirements for the August tax year? And do you see a need for a special dividend?

The way that the dividend works is that you do not need to distribute by August 31 all of your earnings. You can use what they call a throwback. You can throw back almost a year's worth of earnings, or a year's worth of dividends back against your current year earnings; and you can continue to roll that way. I would expect that we would continue to do that, because the penalty for doing that, or the cost of doing that, is a 4% excise tax, which is a very low rate of borrowing for us. We'll probably continue to roll this forward as we can, because it gives us some insurance that we won't have to -- we would never have to lower our dividends.

I see. That's pretty good.

Because of the liquidity that we are showing on the books and stuff, do you think we're going to be launching another secondary offering in the near future? Or do you think we have it covered?

Are you -- you're asking about an equity offering?

Yes.

Well, we have been in the past month or two issuing our ATM programs, which we like for the aforementioned reasons of low-cost spread, less disruption to our stock price, and taking advantage of the fact -- I think we are the most liquid BDC; something like 4 million shares traded. We're top two or three market cap, depending on how you define it, but the most liquid. So we're trying to avail ourselves of that liquidity benefit.

In terms of the future, we have plenty of liquidity on hand between the ATM and cash on hand, available borrowings, and we can tap the bond markets on a larger basis on top of our medium-term notes program. It probably takes them very large surge of originations and pipelines to justify that at this point.

Say, Jerry, if we can't predict the future, we can't even predict what's going to happen in the next hour; but I can tell you that if an underwriter walked in here right now and said -- let's do 100 million shares or 50 million, we'd say no. We don't need it, and we don't know how far out that statement would continue to be true, but it's true right now. We need to -- we're quite aware that we need to put this money to work in order to protect net investment income and the dividends.

I appreciate that, and from looking at the books and everything and your talk about the ATM and stuff, it was coming across that some of the rumors that have been floating around about another offering really didn't have a basis at the present time. So I appreciate you taking the time with me.

Well, I don't know where -- what rumors you're reading but I'd have to say I don't think I've ever read a rumor about our Company that was true, or heard a rumor about our Company or any one here that, in fact, was true. As you'd probably know, people write these things on message boards thinking they're going to manipulate other people into doing things. So that is one item I caution you on.

Number two, the ATM is a steady -- small but steady non-disruptive equity support system. Turning it on, turning it off is not the smartest thing; you might be disrupting what is a very valuable long-term system. But it doesn't overequitize us and it removes the need to actually do these offerings from time to time that do gap down the stock. So we think we have a very nice balance with this ATM. Maybe we get a little behind; we've got to ramp the originations, they were slow in the first couple weeks of January, they are picking up now. We know we have to keep working to keep putting that money to work and earning a positive spread and that's what we're doing.

Great, thanks a lot. I appreciate it.

Jerry, are you an accountant or tax lawyer or a RIC expert? We're very impressed here by your knowledge of spillback dividends and things like that.

Well, no, I'm just -- actually, I am a retired ironworker and so --

Good for you.

I like your Company. I've done a lot of in-depth reading about it, and I'm -- I wonder about things. That's all, and you guys always answer my questions.

Well, come see us in New York. You don't even have to wait for the next shareholders' meeting.

I'd like that. That sounds good.

Jerry (multiple speakers) check out our CCP -- (laughter)

Jerry, we might want you to get us help us diligence in the next metal bender we look at.

That'd be fine. I know a lot about that, that's for sure.

I bet you do. Are you in Pittsburgh?

No, I'm out in Nebraska.

All right, good. Thank you, Jerry.

Jonathan Bock from Wells Fargo Securities.

Yes, sorry, one quick follow-up.

I know you mentioned the CLO income, obviously, can be modeled. I was just curious -- of the $23 million or so that came in income this quarter, how much of that was actual cash? Where is that in the cash flow statement?

Well, it all flows through the change in interest receivable, but I believe that the answer to that is that about $17 million of the $23 million came in, in cash.

All right, great. Thanks a lot.

And recognize, in some cases the payment is going to occur in January, just a couple of weeks thereafter. So there's the aspect I talked about, the ramp-up, but there's also the aspect of just the timing of payments.

Of course, thank you so much.

The supply of levelized yield as appropriate. Thanks.

Ladies and gentlemen, I'm showing no additional questions at this time. I'd like to turn the conference call back over to Mr. Barry for any closing remarks.

Okay, let's talk about the Super Bowl. Ready?

Brian, what do you have to say? Were you happy with the results?

I was.

Okay. (laughter) There we go. We'll close the question right there. When Brian is happy, we are all happy, right?

Thanks, all. Bye.

Ladies and gentlemen, with that we will conclude today's conference call. We thank you for attending. You may now disconnect your telephone lines.