Prospect Capital Corp (PSEC) 2013 Q4 法說會逐字稿

Good morning, and welcome to the Prospect Capital Corporation fourth fiscal (sic) and fiscal year earnings 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 John Barry, Chairman and CEO. Please go ahead

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 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, our 10-K, and our corporate presentation, filed previously and available on the Investor Relations tab of our website, prospectstreet.com.

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

Thanks, Brian.

To provide new and even continuing investors more information on our Company, than we can fit into a short August earnings call, we are holding a separate webinar overview of Prospect at 2 PM Eastern Time today. Investors can access the webinar through the Investor Relations tab on our website, prospectstreet.com. During that event, Grier will be taking investors through our overview corporate presentation that is also available on our website.

In the same location on our website, investors can also access our more detailed, archived Analyst and Investor Day presentation from July 10 in New York. That is a five-hour webinar that includes senior members of the Prospect team presenting our multiple origination strategies and in-depth case studies to provide investors deep dive information about Prospect's business. You might think of it as, all you wanted to know about Prospect, but forgot to ask.

Now, onto our financial results for the quarter and fiscal year. Our net investment income, or NII, in the June 2013 quarter, was $92.1 million, or $0.38 per weighted average share, exceeding our prior guidance of $0.31 to $0.35. Net investment income for the quarter increased 43% year over year. $0.38 of net investment income per share for the quarter exceeded $0.33 of paid dividends by $0.05, or 15%. Our net investment income for the June 2013 fiscal year was $324.9 million, up 74% year-over-year. Our $1.57 of net investment income for the year exceeded $1.28 of paid dividends by $0.29, or 23%.

We just announced three more shareholder distributions, extending through March 2014, giving investors eight months of visibility on future dividends. The March 2014 dividend will be our 68th shareholder distribution, and the 45th consecutive per-share monthly increase. Our August 20 closing stock price of $11.07 represents an 11.9% dividend yield. I see our stock price is up since then. Our net investment income has substantially exceeded dividends, demonstrating robust dividend coverage for the June 2013 fiscal year, the last quarter, the prior nine months, and the cumulative history of the Company.

For the June 2013 fiscal year, our net investment income exceeded dividends by $53.4 million and $0.22 per share. Since our IPO nine years ago, through March 2014, distribution at the current share count, we will have paid out $12.27 per share to initial shareholders and $991 million in cumulative distributions to all shareholders. Our NAV stood at $10.72 on June 30, up $0.01 from March 31. We have delivered solid NII while keeping leverage modest. Net of cash and equivalents, our debt to equity ratio was 55% in June.

We estimate our net investment income per weighted average share in the current September quarter will be $0.30 to $0.36. We have substantial debt capacity and liquidity to drive future earnings through prudent levels of matched book funding. Our Company has locked in a ladder of fixed-rate liabilities extending 30 years into the future, while most of our loans flow with LIBOR, providing potential upside to shareholders as interest rates rise.

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

Thanks, John.

Our business continues to grow at a solid and prudent pace. As of today, we've now reached approximately $4.9 billion of assets and undrawn credit. Our team has increased to more to 80 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 nonsponsored lending, Prospect-sponsored operating buyouts, Prospect-sponsored financial buyouts, structure credit, real estate yield investing, and club and syndicated lending. 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 evaluates thousands of opportunities annually, and invests in a disciplined manner, in a low single-digit percentage of such opportunities.

Prospect's originations in recent months have been well-diversified across our seven origination strategies. 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. Prospect's approach is one that generates attractive risk-adjusted yields, and our debt investments were generating an annualized yield of 13.6% as of June 30. 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 June quarter were a record $799 million, representing the fourth quarter in a row with originations of approximately $750 million to $800 million. Originations have exceeded $3 billion in the past 12 months. We also experienced $322 million of repayments in the June quarter, as a nice validation of our capital preservation objective. As of June 30, we were up to 124 portfolio companies, a 46% year-over-year increase, and demonstrating both an increase in diversity as well as a migration toward 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. Our originations in the June quarter were weighted toward the last month of the quarter, resulting in only a partial-quarter positive income impact from such originations. We expect such originations to generate full-quarter positive impact in the current September quarter.

Our financial services-controlled investments and structured credit investments are performing well, with annualized cash yields in excess of 18%. To date, we've made multiple investments in the real estate arena, with our private REIT, American Property Holdings, largely focused on multi-family stabilized yield acquisitions, with attractive ten-year financing. We hope to increase that activity with more transactions in the months to come. We closed our acquisition of CP Energy earlier this month, and currently have multiple other acquisitions under LOI at attractive multiples of cash flow, with both double-digit yield generation and upside expectations.

We're also on the lookout for other yield-generating, risk-adjusted origination strategies, including in the aircraft and container leasing sectors. The majority of our portfolio consists of agented and self-originated middle-market loans. In general, we perceive the risk-adjusted reward in the current environment to be superior for agented and self-originated opportunities compared to the syndicated market, causing us to prioritize our proactive sourcing efforts.

Our credit quality continues to be robust. None of our loans originated in nearly six years has gone on non-accrual status. Non-accruals, as a percentage of total assets, declined to only 0.3% in June 2013, from 1.9% in June 2012. The current September quarter is off to a solid start, with $262 million of originations and a growing pipeline. Our advanced investment pipeline aggregates more than $600 million in 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 with low leverage. Net of cash and equivalents, our debt to equity ratio stood at 55.7% in June. We believe our low leverage, diversified access to match book funding, substantial majority of unencumbered assets, and waiting towards unsecured fixed rate debt demonstrates both balance sheet strength as well as substantial liquidity to capitalize on attractive opportunities.

Our Company has locked in a ladder of fixed-rate liabilities, extending 30 years into the future, while most of our loans float with LIBOR, providing potential upside to shareholders as interest rates rise. 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 notes program, issue an institutional bond, 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 June 2013, we held more than $3.6 billion of our assets as unencumbered assets. The remaining assets are pledged to Prospect Capital Funding, which has a AA rated, $567.5 million revolver, with 18 banks, and with $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 2012 quarter with a $410 million revolver, and 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 investment-grade, unsecured debt, including convertible bonds, a baby bond, an institutional bond, and program notes. All of these types of unsecured debt have no financial covenants, no asset restrictions, and no cross defaults with our revolver. We enjoy a BBB rating from S&P, and recently received the BBB+ rating from Kroll.

We have now capped 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 many banks and debt investors across many debt tranches, we've substantially reduced our counterparty risk over the years.

As of today, we have issued five tranches of convertible bonds, with staggered maturities that aggregate $847.5 million, at interest rates ranging from 5.375% to 6.25%; and had conversion prices ranging from $11.35 to $12.76 per share. In the past, we have repurchased such bonds when we deem such purchases to be attractive for us. We have issued $100 million, 6.95% baby bond due in 2022, which is traded on the New York Stock Exchange under the ticker PRY. On March 15 of this year, we issued $250 million in aggregate principal amount of 5.875% senior unsecured notes due March 2023. This was the first institutional bond issued in our sector in the last six years.

We have issued $430 million of program notes, with staggered maturities between 2018 and 2043, at a weighted average interest rate of 5.6%. During the June 2013 fiscal year, in addition to our revolver expansion, program notes issuance, institutional bond issuance, and two convertible bond issuances, we have issued equity at a premium to net asset value and therefore accretive. From May 8 through August 21, we sold approximately 14.2 million shares of our common stock in our ATM program, at an average price of $10.95 per share, and raised $155.3 million of gross proceeds.

We currently have no borrowings under the 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 $660 million in new investment capacity.

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

Thank you, Brian. I think we're ready for questions, if there are any.

(Operator Instructions)

Troy Ward, KBW

Can you give us some color on the H&M and the Wolf transaction? Just some background? It looks like in April, you transferred all the assets of H& M to Wolf Energy, which is 100% controlled by you. But the fair value assigned to the assets was $44 million. So we took a loss of about $19 million. And then one month later, after you have had this investment for six years, one month later somebody approaches you and pays $66 million, which was basically the original cost basis plus or minus a couple, for assets that you just valued at $44 million. So now that $66 million of repayment looks like a $20 million gain, because we just took a $20 million loss, but it's really just shareholders getting their original principal back. Can you give us some color on why these assets were transferred to Wolf? And why were they valued at $44 million when they were sold a month later for $66 million?

First, you have the big picture correct. There are some technicalities with respect to accounting for this transaction which could take maybe 20 minutes to discuss here. So why don't I ask Brian to give a brief precis right now, and then maybe you can discuss this at greater length with Brian off-line. Because I suspect there will be follow-up questions and technical discussions that may not be of equal interest to everyone here. Go ahead, Brian.

This asset -- first of all, we didn't -- we haven't owned it for six years. We had a loan on this asset. And what actually happens that generated the loss was that we foreclosed on the assets. When the foreclosure came through, we were forced to follow the accounting literature for a troubled debt re-structurings, which, when you have a foreclosure, you have to. And we had valued this asset back in March at $44 million. So that forced us to take about a $19 million loss at that point in time. I'd say about two or three weeks later, someone who had bid $44 million of the foreclosure sale, came back with an offer at $66 million.

There was a lot of substantial evidence to point to the $44 million when we valued it that, but this -- the person who actually came in to buy the asset has substantial assets in the region already, and this filled in some gaps that they had between their properties. So that's why it was advantageous for them to buy the properties from us. So they bought it at $66 million. We received repayment of the $44 million that we had booked as an asset when we transferred the assets. And then we had also recognized a gain for the payment on a net profit interest that was also assigned to that property. So I think the important thing here, Troy, is that both the realized loss and the realized gain both happened in the same quarter, so it really was a net about $7 million.

I'd add to that, Troy, that the sale came together very quickly. We had been determined to give [ball] control of that asset for a while. The wheels of justice can move slowly in the court system, but eventually they did work in the right direction, and we obtained ball control. And we knew these assets would be priced in the marketplace. West Texas has a lot of drilling going on focused on crude oil, and going to the other working interest parties, which ended up being the buyer, was just a natural to do, which was not going to happen until we had control. So a deal came together very quickly once we had control

Okay. Brian, can you talk about -- it said in the release there was -- obviously if you just look at the raw numbers, it looks like roughly a $20 million over your cost basis, but the capital gain you took was $11 million and change. Did the other $9 million or so go through the income statement, and is it baked into NII this quarter?

No. The rest -- this asset is resident in an operating Company that has other operations. So the proceeds that we -- Prospect didn't receive the proceeds. Wolf Energies received the proceeds. The -- I guess it's about $57 million or so is what we have received so far. There are still assets down at H&M. They still have -- we only sold certain of the assets. They were not all of the assets. There are still assets down there that are being operated that will generate future income and may be sold in the near future.

So, were the proceeds similar to Gas Solutions? Are the proceeds just now sitting in an entity controlled by you that are going to be dividended up through the income statement in the future?

A little bit differently at this Company, because this Company has not generated sufficient earnings and profits that, if they were to declare a dividend, it would be a dividend rather than a return of capital. So no, I don't believe that there will be dividends declared from Wolf. So it's not the same. At Gas Solutions, they generated sufficient earnings and profits where they had -- where there was a need for them to record them as dividend income. So it's not the same, no

So what came through the income statement this quarter related to this transaction?

There was some advisory fees -- about $4 million of structuring and advisory fees, and $991,000 of net profit interest from the amount that was due prior to the foreclosure

Right. Okay. And then moving on --

That's it.

Can we look at -- in the 10-K, it said you had a $24 million and change dividend from R-V Industries for the year, but it didn't say how much was in this quarter. I think some came in the fourth quarter last year. Can you tell us how much came in from R-V Industries in this quarter? Just trying to figure out where our core number is here. And then what was the genesis of that dividend?

R-V is a profitable company, so they are generating earnings and profits all the time. We generally get a dividend from them every quarter. The -- I believe the dividend in the fourth quarter was about $11 million.

And how much of that was generated in the quarter? And how much of it was from the -- you put additional debt down there. Was it additional free cash?

This is all generated from earnings

(multiple speakers) generate (multiple speakers) --

We just put additional cash down so they would have sufficient cash to make the distribution. They had already generated the earnings. They been using the earnings to actually pay off other debt that they had outside of our system. So they had third-party debt that they had used the cash to pay off.

So how much debt did you put down at R-V this quarter?

I believe $14 million

You put $14 million down and you dividend $11 million back up?

Yes.

Okay.

Out of -- which is out of earnings and profits. And R-V is looking at a series of potential add-on acquisitions, and we're still determining whether or not we'll use third-party bank debt, term debt, revolving debt, and our own debt, or what combination of those three sources we'll use for add-on acquisitions.

Okay. I'll stop here and get back in the queue.

Troy, it's John. Just to add, we see R-V being a profitable Company and generating net income and E&P on a sustained basis, so that we take regular people at our Company even call them recurring dividends, which I think is a number you're looking for. Brian, is there a -- in effect, what Troy asked for, a core dividend amount, base case sustainable, that is independent of paying down debt. Prospect replacing M&T debt with our debt. It is a sustainable level of dividends. I think that's what Troy is looking for.

Yes, we expect to see $3 million to $4 million of dividends a quarter

Great. That's helpful.

So Troy, does not fully answer --

It does.

Okay. And obviously, for more deep dive background, you have Brian's number.

Okay.

Robert Dodd, Raymond James.

A couple of follow-ons on the numbers, and then a math question. Just following up on that R-V question. My math says about $13 million in dividends in the quarter comparing that the prior Q at $23 million in terms of follow-on from the follow-on additions. Can you clarify that's right? And then also, on the question -- previously retained earnings that dividended up, why -- and obviously, it's not consolidated, exactly, but why did the equity value of R-V only drop $700,000 when you dividended up $13 million of previously retained earnings?

Go ahead, Brian.

I'm going to pass it over to Grier to talk about their -- R-V's operations.

The business is doing well, is the answer. RV posted another strong quarter. TTM EBITDA and profitability continue to ramp from March to June. So the third-party evaluation process determined that the enterprise value of the business had grown

Okay. Great. On the next -- on fee income, other income, as you call it. $21 million in the quarter, I know, and formally that's Wolf, so the $17 million from other sources. High origination number, obviously, in the quarter. But, was there anything in that number? Because it looks somewhat larger than I would've expected, even for ballpark $800 million in originations in the quarter. So beyond Wolf, were there any other large structuring fees tied to any of these -- any of the new originations or anything else you can call out?

Nothing out of the ordinary beyond business as usual and an active origination quarter, Robert.

Okay, perfect. Just finally, on the market that you're seeing out there in terms of, obviously, demand -- you saw -- we've seen a lot of numbers from, obviously, other competitors where repayments have essentially been running in line, or in some cases higher, on a variability with origination, so to speak. You had a lot of repayments, but you also had a large number of origination. Are you seeing any appetite for other of your portfolio companies to repay early? Or -- you gave us some pipeline numbers, but color wise, what are you expecting to see out of the market in the second half of the year, in terms of general activity? Any color there would be helpful

Sure, Robert. We would expect for repayments to pick up in a bull market, and we're currently in a credit bull market. And you saw an uptick in repayments in the June quarter compared to the March quarter. The March quarter, I think everyone is taking a little bit of a breather from a hyperactive tax-driven December quarter. Generally, our loans are five years in length, and they tend to pay off in 2.5 to 4 years. And so the earlier end during bull market activity and at the later end on average, during more of a downturn. Repayments, though, can happen in a lumpy fashion. Having said that, just like originations can be lumpy. It's almost remarkable our originations have been in the $750 million to $800 million category -- or range, in each of the last four quarters, given how bottoms-up lumpy they can be. And the same truly goes for repayment. Sometimes we get visibility further advanced, sometimes not so much. And it can depend upon exit activity of the owner related to selling the Company.

For re-financings, we fight hard to stay in quality credits. Obviously, if we have concerns, we're happy to get paid off. But for quality credits, we look for ways to stay in the credit. The best new customer is an existing customer, and a credit, you know, especially that's seasoned, is -- can be a very powerful origination process for us. So we work hard to stay in quality credit. Doesn't mean we meet every ask for recapitalization activity, enhanced leverage, et cetera. But you've seen us support our existing book, deals like Capstone, Progrexion, which are $200 million-plus holds, just to pick two of those, are great examples of that. Where we have kept up with tremendous growth and profitability for each of those businesses, staying in the credit, meeting the objectives and needs of the business owners to support them along the way. I hope that helps, Robert. I can't give you a perfect conveyor belt answer on repayment

Okay, I appreciate it. Thanks for the color.

Jonathan Bock, Wells Fargo securities.

John, just one big picture question first, looking at the stock price, obviously now sub a 12% yield. Is it fair to say -- we heard you speak this at the Investor Day, that the stock is somewhat, I'd say, undervalued or under-appreciated at these current price levels?

(laughter) Jon, I love the question. I'm wondering if there is a CEO in America who does not believe his stock price is lower than it really fairly should be. So I'm going to join that crowd. Why that's the case, I'm not exactly sure. I happen to think it's an excellent value where it is. I'm sure you already knew that. I believe that the main thing that we need to do as a Management team is spend more time communicating the fundamentals of the Company to the investment community, starting with people like you and Troy and Greg and Dr. Robert. We're trying to do that, as you know. And we hope that, over time, as people understand our Company more thoroughly, that the stock price will reflect that information.

Sometimes I also think that there is a conglomerate discount, which I'm sure many of the people on the phone call are aware of, and I think what we need to explain to people is, we're not a conglomerate. We have multiple allied, parallel, yield-driven value investor strategies, all of which work out of the same wheelhouse, and all of which benefit from the significant deal flow that PSEC has, and that leverage, the expertise of the team. So communication, better communication, more constant, continuous communication, is going to be an additional strategy that we are going to employ. I hope you felt the Analyst Day with a step in the right direction.

Absolutely. And the question is, as you've looked at the stock, perhaps undervalued, seeing a dividend yield of 12%, the one thing that gets hard to reconcile, if it is such a good value, why sell more shares via an ATM program when you have either available cash or available liquidity on a credit facility?

What happens is, we have a big origination team that is constantly originating. There is always a large book of incoming originations at a significant spread to even the 12%. Remember, the 12% is our marginal cost of capital. We have this large book of originations coming in on a continuing flow, telling our origination people, stop, start, stop, start, is not, we believe, the best strategy for the Company, for its market presence, for the ability of our origination people to compete. So, while we tap the gas pedal a little bit sometimes, push it a little harder than at other times, we might look more carefully, for example, at a lower-yielding, senior secured first lien opportunity, when we are awash in liquidity. We might look at it harder than when we're not. We believe in what I would call smaller adjustments to our path and our strategy. And we also recognize that, while we like having the dividend yield be much lower than it is, our marginal cost of capital, when you take into account our revolver, which is very inexpensive. And when you take into account the cost of the other debt instruments that we have, our marginal cost of capital does enable us to do transactions, sub 10%, which are accretive to earnings and potentially accretive to the NAV and the stock price.

Got it

Instead, we look at each deal on a deal-by-deal basis and only do transactions that are additive. Lastly, were we to turn off the ATM for an extended period of time, it would be 60, 90 days, in general, before we would observe that we need -- we either need to shut down or slow down originations or we need to put the ATM back on. And what we see is that, from time to time, there are dislocations in the marketplace where the entire credit markets get repriced. Those are coincident with repricing of our stock. So it's like the moment you get a call from Filene's Basement, we're marking everything down 75%, is right at the same moment your credit card company calls you and says, by the way, we just cut off your credit line. So we want to be able to be there when the bargains surface in connection with market dislocations, even if our ATM shuts down. And by the way, it doesn't have to shut down. We just choose not to sell stock below NAV. I don't believe we have for years now. Is that helpful, Jonathan?

Yes. I appreciate. It's just a general question that lots of people ask in a tighter spread environment, as it relates to essentially raising the equity book at a point when, at least we would hear it's rather difficult to originate quality credit. So no, John, I appreciate your candor in that regard. But maybe --

(multiple speakers) Jon, a couple other things. The amount of stock that actually gets sold to this ATM is very modest amount, on a daily or almost daily basis. Every sale is accretive to the NAV, and we believe that we can make a profit off of each share that we sell. As well, this is an inducement to these credit providers to provide credit. So there are a number of other less immediately apparent reasons for keeping it in place. But I would tell you that we do restrain the amount that is sold that way on any given day, week, month. So I think it's now, at this point, a fairly low -- I don't have the exact percentage of our equity capitalization that is augmented on a monthly basis that way, but it's not -- Brian, do you have it? Is fairly modest nowadays.

Yes, we issued about $140 million, $150 million over the last quarter. Let me add some items, too, to try to help answer the question, Jon Bock, and I appreciate it very much. Year-to-date, in the calendar 2013 year, we started the year in an under-levered situation, because we wanted to make sure we had lots and lots of dry powder to meet origination requirements in the December quarter, given all the tax-driven activity. People calling up needing to close by 12.30, 1.00, et cetera. Year-to-date, we've issued a pace of about 1.5 times to 2 times debt versus equity, so I think we've been prudent to walk up that leverage while still keeping it overall in the modest category. And on a daily basis, the ATM has been in the range of 10% to 15% above book, as John mentioned. We use that as a way to reward credit providers to our Company, and as that's a major de-risker to have 18 banks in our credit facility. We have more than any other BDC by a country mile. And this program helps to attract significant credit to our Company, acting as an anchoring point when we hit the next recession.

I would also say that, in calendar year 2012, we experienced significant growth. We've about doubled our business. We do not expect to double our business every year, ad infinitum. Mathematically, that becomes impossible after a while, as the dollar sizes get larger and larger. And we do expect to continue to grow, but we expect the rate of growth to decline. And so the need for equity at the same level should decline as well. So I think these are positive signals for equity investors.

On the point of the stock price, and where we're trading, and -- there are lots of different catalysts we can talk about for business monetizing, existing controlled investments, rotating towards higher-yielding investments, new strategies that are ramping like real estate, et cetera. But we think pure awareness generation, and focusing on that, and building that, is maybe the most important catalyst of all. Because we've been so laser-beam focused on performing, and less on communicating about what we're doing, that we're now playing catch-up to that respect.

We just hired a Head of Investor Relations, [Colin Finn,] who's starting in the next couple of weeks. We're doing a webinar this afternoon for new investors. This forum right now is more for people already familiar with the Company who want to know what the earnings are, and ask detailed questions. But a lot of people who are new investors might have more basic questions. What is a BDC? There's a lot of awareness to be generated about, what is a BDC? For an industry with a combined market cap of only $20 billion to $25 billion, we are where MLPs were ten years ago. We're going to more conferences. We're doing more outreach. So we would argue that awareness generation is very good for existing and prospective investors, who are looking for a catalyst any time they buy a stock

Appreciate that. And then I've got a few more, so I'll pepper them quite quickly. Guys, with APH, the amount of structuring fees that came in from APH this quarter, do you happen to have that number? I noticed it was $4 million for the year. What was it this quarter?

Probably at least one-half, because we've closed the REM deal, Pembroke Pines deal, which is our largest multi-family investment in the June quarter, which represents -- that's about half of our real estate book, right? So I would say, probably about one-half in the June quarter

Okay. Appreciate that, Grier. And then one question that we pose to a lot of CEOs as it relates to risk in the space today. Obviously, a number of people talk about risk, and as it has increased in general, just in sponsored back-out lending. I understand that you have many multiple ways to skin a cat and earn return. But wanted to turn maybe a few of your specific transactions that you originated this past quarter. And I just wanted to take a look at one in particular, Arctic Glacier. So this would have been a deal that you provided sub debt financing at a 15% coupon, about 5 times leveraged through the sub debt. Now today, HIG dividend recaps roughly one-half their equity investment. You step up your second lien senior position and a covenant light loan at L plus 1,000 with a $1.25 floor, and leverage is in an excess of 6 times. So how would people choose to say that -- one, that the all-in return is lower, leverage is likely higher, and the sponsor's taking money off the table. How do you view that in light of the fact that you're getting a lower return at what some people would say is that the risk in this loan has increased?

Sure. And I remember you asked about Arctic when we closed that a year ago, as well, Jonathan. Obviously, the hot summer is on your mind, right? Arctic is a company which the sponsor has managed well over the past year. They've optimized operations. They've taken a lot of cost out of the system. They are also looking at a pretty robust pipeline of add-on acquisition opportunities. You're right. Getting paid 15% sounds good at a high level at a lower attachment point. But you missed a piece that we did trade into a secured position, which we were lacking before in the mezzanine context, so we have a true --

(multiple speakers) I'm sorry. I was always under the impression that loss rates on second lien senior collateral is generally the same as mezzanine, just per a Moody's report. So are you saying the second lien position provides --

I think that needs to be dissected, because -- and I'm glad you're asking this, because there's a lot of confusion, I think, when people look at deals and how they are announced in BDC books. For example, sometimes people reported a first lien, but it's really a last-out first lien that's -- we would, class-wise, a similar credit profile to a true second lien, that the senior second lien without a subordination. So we do not have payment subordination in this deal. That means the first lien cannot block us. And that's a major de-risker as opposed to the prior situation, where you had a payment block possibility if there's a downturn. So I think, on this scale, there's some positives, there are some negatives, overall. The bottom line is, we evaluate each such deal as a brand-new credit, a brand-new situation. And if we're not comfortable, we'll take the payout, which of course happened to [June] about $322 million in the past quarter.

I appreciate that, Grier. And again, at the end of the day, it's just a function of the market. But I appreciate your discussion. And last question, as it relates to CLOs. Looking at your -- looking at the recent deals that you've done, what is the weighted average spread, in general, that you are modeling those deals towards? Or the weighted-average coupon that you are modeling those deals towards today?

Sure. We model out in the range of a low- to mid-teens IRR. That's an, as a model, underwritten deals. So call it 13% to 14% IRR range, but we use very conservative assumptions. We use default rates well in excess of what the market is experiencing. We model in recovery rates well below reinvestment spreads declining where they are today. Our base case, if you will, is -- it's more than others would say, is a downside case, in some cases, extreme downside case. But we're happy to do that. Then what happens is, reality comes in much better than what we model out, and so we end up with a higher return. And this book has season. We're entering our third year now on the CLO business, and we already have deals coming up which are -- the call period is expiring. And we're looking at calling deals and booking a gain, a substantial gain, substantial IRR, well above what we've modeled out. Or just straight out refinancing the AAAs, which are perhaps lower in certain deals and the current environment than the existing pricing of the AAAs. One of the maybe (multiple speakers). Go ahead.

Maybe I'll rephrase it is that, what is your expectation on the collateral pool of the [Sikes] deal as well as CISC deal today? What are you estimating in terms of the weighted-average coupon on the BSL loans in the book?

I would have to go back. Off the top of my head, I don't remember that particular deal. But we're modeling out reinvestment spreads that decline in the range of L plus 350. And basically, the way we look at it is, you have got a reinvestment period of four years. Typically, the liability stack has a two-year non-call attached to it. And when you think about it, when spreads are declining, that is a signal of a positive economic activity in which default rates are more benign. We model out increasing default rates and declining spreads, which typically are not going to go hand-in-hand. But those are the two risks you worry about, things being too bad, i.e. defaults and losses, or things being too good, i.e. decline in spread.

Right now, there's a little bit more risk on things being too good and a decline in spread. And we look at it -- and that's why we are -- have been insistent upon controlling the call. A lot of players in this market are smaller vehicles. They can't write $30 million, $40 million, $50 million checks on deals like we can. Other BDCs have very small 30% baskets to manage these types of assets. They can't write the larger checks. We can. So by controlling the call, we can optimize the exit. When things get too good, the decline in spreads, that's fine. We'll just refinance the AAAs, or just call the entire deal outright. And that's what we're evaluating on some of our more seasoned deals.

And with the tightening spreads in general -- these are the last two. One, I would imagine that -- are you modeling in LIBOR floors as part of your assumptions? And then two, I noticed that -- look, DSL collateral, obviously, is highly competitive in a rather frothy lending market today, which is essentially what the CLOs are buying. And more importantly, beyond that, I think that covenant light buckets within these securities could be between 40% to 50% to 60% of the entire portfolio. So how are you judging risk as it relates to the fact that we're -- relatively peaks in terms of spreads, I'll call it tight, and getting tighter, and the fact that leverage is high, and covenant light deals are extremely high relative to history. And these two in particular have rather significant buckets with which to own covenant light loan?

Right. Obviously, if we had our druthers, we'd prefer a loan to covenants, whether held directly on our own or through our collateral manager's CLO book. But when we look at the risk profile leverage stats, credit stats, of today's loans compared to seven years ago, in the 2006, 2007 arena, today's market still compares favorably. And here's the interesting thing about CLOs that's counterintuitive. You think about asset classes, you think about timing, you want to invest during a dip, you want to stay away during a rally. CLOs are much more about trying to print cheap AAAs and having option value for the future. It surprises many to know that the highest-returning CLOs were during the so-called credit bubble of '06 and '07. You might say, gosh, that doesn't make any sense to me. I would've thought these guys would have been [death] -- no, the exact opposite. Because you pointed cheap AAAs, you had option value for many years into the future, and you could enjoy the benefits of volatility in that option value as markets went through a wider spread environment.

So we're looking very carefully at -- the thing we watch very carefully is, when you're ramping a new CLO, we do all primary issuance. By the way, a lot of CLO equity is trading for some pretty hefty numbers in the secondary basis. We have steered clear from that. We like to underwrite collateral on a primary basis. We reduce risk by having no CCCs. Zero. Completely clean baskets, when you start. We're monitoring very carefully the mix between primary and secondary issuance. We don't like paying a premium for loans that obviously have limited prepayment attached to them. And -- whereas in a primary issuance, you can get a [VIG] and through OID of a point or two, or sometimes three, depending upon market conditions. So we obviously prefer that, all other things being equal. But then you've got to monitor the ramp. And you don't want to have money laying around while you're paying the liabilities, and cash sitting around ramping at too leisurely a pace. So all this goes down to a very, very detailed set of models that our team runs.

At the end of the day, results are what matter, and we've been generating some pretty attractive results in the segment. CLOs, we haven't necessarily -- we didn't put a lot of deals on the books in the last quarter, as more competition has come into the equity tranche. And if we're not hitting commensurate return relative to the risk profile we see, we say no. And that's been happening quite a bit. Does that mean that we'll have a harder time growing CLOs in the future? Perhaps. We'll see. I can tell you we are not lessening our quality standards one bit, and a big part of the quality standard is who we work with as collateral managers. We only have about a dozen collateral managers on our so-called approved list. That's maybe 15% of the entire market. Collateral management makes a huge difference in performance. And there's some pretty big names managing a lot of AUM with some fairly mediocre track records that we say no to, and are not on our approved list.

All right. Guys, I appreciate it. Very insightful, and congrats on the earnings beat.

Troy Ward, KBW

Great. Brian, the 10-K -- I'm sorry, that was already asked by Jon on APH. In August, you re-capitalized CP Energy, $94 million, a press release was put out, and repaid, I'm assuming, your $18 million loan. A couple of questions. Are you now in control of CP, from an equity standpoint? And will there be any large one-time structuring fees or other fee income generated from that buyout in the quarter?

This is Grier, Troy. Yes, we have control. But just as importantly is, Management are co-investors in the deal, and have significant equity ownership. I think our fees are in line with typical fees charged in the 2% to 3% range, on structuring fees. We could bring -- 1.5% to 3% are typical up-front structuring fee. And there's nothing that's out of the historical norm on this particular deal

So, it would be the 3% on the $94 million?

I don't know if it's 3% or 2%. I don't know off the top of my head, but it's in the range of 2% to 3%, Troy.

Okay. And then a follow-up on Robert's question from earlier on the dividend fee income. If I look back over the past five, six quarters and back out the one-time income from Gas Solutions, and other chunky payments that hit the dividend and other income lines, you've really been in, call it, the $12 million to $17 million range. This quarter it's almost $36 million, and the only pieces I've outlined in my notes are Wolf Energy accounted for about $5 million, and the real estate property APH accounted for $2 million. That still leaves us, call it, $27 million, $28 million combined in those two lines. Can you let us know if that's a run rate? Or if there's other big chunky pieces in there that I'm just not accounting for at this point?

While Brian tracks that down, Troy, I'm confused why people are suddenly backing out APH as nonrecurring. That is a highly recurring model with our private REIT. And --

(multiple speakers) I wasn't backing that out.

Okay.

It was just -- it was part of the -- I understand why that part, $2 million of it is higher, absolutely. No, I was just trying to --

Right.

Trying to whittle it down to what -- the part I don't know. I figure maybe $15 million previously was recurring, and now maybe an extra $2 million to $2.5 million from the real estate. But again, there is still probably a -- at least a 10% bogie in there -- or $10 million in there that I can't account for, that I'm not sure is re-occurring.

I think you said dividend income at the beginning, but you really are talking about other income, right?

I'm actually -- yes, it's actually both.

Because dividend income was only $14 million for the quarter.

Right, and then in (multiple speakers) $21 million for others, so the combined was like $36 million?

Yes.

So it was really a combination of those two line items. I'm still $10 million over what it feels like should be a re-occurring number.

The recurring comes substantially from structuring fees, and we generally get structuring fees on most of our new originations. So that's where substantially all of the other income -- and that -- I think you need to model in based on originations, that we're going to have 1% to 2% on all of our originations.

Brian, is one way to think about it that, of the $21 million that Troy is asking about, we had $800 million roughly of originations. If you have an average fee of 2%, you've got $16 million there. And therefore, now whittling this down, the missing piece is $5 million, which may or may not be recurring. How far off base am I saying that?

The missing 5% is from H&M (multiple speakers) -- or $5 million is from H&M.

So you've got your $21 million right there, Troy. $16 million-ish from structuring fees, originations, and $5 million from H&M.

Okay

Troy, is that helpful?

Yes, it is.

Good. How about another question?

Casey Alexander, Gilford Securities. Sorry, I apologize. It looks like the party removed their self from the queue. At this time, I'd like to (multiple speakers) --

Looks like we're all set, here. John, do you want to wrap things up?

Okay. We want to thank everybody for coming on the call in the middle of August. Have a wonderful rest of the month, and we will see you three months from now. Thanks, all.

Thank you all. Take care.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.