Prospect Capital Corp (PSEC) 2014 Q1 法說會逐字稿

Good morning and welcome to the Prospect Capital Corporation first fiscal quarter earnings release and conference call. All participants will be in listen-only mode. (Operator Instructions). After today's presentation there will be an opportunity to ask questions. 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.

Thank you, Andrew.

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

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

Thanks, Brian.

Because we have so many new investors interested in our company and owning our stock, we invite new investors to review our recently-recorded webinars as an introduction to Prospect. Investors can access our webinars through the Investor Relations tab on our website, prospectstreet.com. During those events we walk through our overview corporate presentation that is also available on our website.

In the same location on our website investors can also access our archived Analyst and Investor Day that we held on July 10th in New York City. This is a five-hour webinar that includes senior members of the Prospect team presenting our multiple origination strategies and in-depth case studies intended to education investors about Prospect's business.

Now, on to our financial results for the quarter.

Our net investment income, or NII, in the September 2013 quarter was $82.3 million or $0.32 per weighted average share. NII for the quarter increased 11% year over year. Our net income for the September 2013 quarter was $79.9 million, up 69% on a dollars basis and up 7% on a per-share basis year over year.

We just announced more shareholder distributions through June 2014, giving investors eight months of visibility on future dividends. The June 2014 dividend will be our 71st shareholder distribution and the 48th consecutive per-share monthly increase. Our November 1st closing stock price of $11.34 provides an 11.7% dividend yield.

Our NII has exceeded dividends, demonstrating substantial dividend coverage for both the June 2013 fiscal year and the cumulative history of the Company. For the June 2013 fiscal year, our NII exceeded dividends by $53.4 million and $0.22 per share. We utilized a penny of that excess in the September quarter.

Since our IPO nine years ago, through our June, 2014 distribution at the current share count we will have paid out $12.60 per share to initial shareholders and $1.1 billion in cumulative distributions to all shareholders.

Our NAV stood at $10.72 on September 30, stable from June 30. We have delivered solid NII while keeping leverage modest. Net of cash and equivalents, our debt-to-equity ratio was 53.7% in September, down from 55.7% in June. We estimate our NII per weighted average share in the current September quarter will be $0.28 to $0.33.

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 float with LIBOR, providing potential upside to shareholders should 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 more than $5.3 billion of assets and undrawn credit. Our team has increased to more to 90 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-sponsor 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 12.5% 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.

While the market has experienced yield compression in recent months, which may have moderated in the current December quarter due to an uptick in deal activity, we have continue to prioritize first lien senior and secured debt with our originations to protect against downside risk, while still achieving above-market yields through credit selection discipline and a differentiated origination approach.

Originations in the September quarter were $557 million. Originations have come in at exceeded $3 billion in the past 12 months. We also experienced $164 million of repayments in the September quarter as a nice validation of our capital preservation objectives. As of September 30, we were up to 129 portfolio companies, 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 September quarter were weighted towards the last month of the quarter, resulting in only a partial-quarter positive income benefit from such originations. We expect such originations to generate full-quarter positive benefit in the current December quarter.

Our financial services-controlled investments and structured credit investments are performing well with typical annualized cash yields ranging from 15% to 30%. To date we have 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 10-year financing. We hope to increase that activity with more transactions in the months to come.

We closed our acquisition of CP Energy last quarter and currently have other acquisitions under LOI at attractive multiples of cash flow, with both double-digit yield generation and upside expectations. We are also exploring other yield-generating, risk-adjusted origination strategies, including in the online prime consumer lending and 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 differentiated call center initiative continues to drive proprietary deal flow for our business.

Our credit quality continues to be robust. None of the loans originated in over six years has gone on non-accrual status. Non-accruals as a percentage of total assets declined only 0.3% in September 2013 from 1.9% in June 2012 and were stable from June 2013.

Credit discipline is a key theme of the past quarter. Origination channels other than sponsor and syndicated businesses, which are more subject to spread compression and leverage increases in ebullient markets, increased from 45% in the four quarters ended September 2013 to 66% in the September 2013 quarter. This diversified origination that allows for greater credit discipline is a highly-differentiated aspect of the Prospect platform.

We have booked $106 million of originations so far in the current December quarter. Our advanced investment pipeline aggregates more than $1 billion in potential opportunities, boding well for the coming months. We expect a significant pick up in deal closings over the next several weeks.

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 53.7% in September, down from 55.7% in June. We believe our low leverage, diversified across to matched-book funding, substantial majority of assets unencumbered and weighting towards unsecured fixed-rate debt demonstrate both balance sheet strength and 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 are 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 side of our balance sheet. As of September 2013 we held more than $3.9 billion of our assets as unencumbered assets.

The remaining assets are pledged to Prospect Capital Funding LLC, which has a AA-rated $587.5 million revolver with 20 banks, and which can be increased to $650 million under an 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 during the amortization period. 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 a BBB-plus rating from Kroll.

We have now tapped the unsecured term debt market to extend our liability duration up to 30 years. 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'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 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 the ticker PRY. On March 15, 2013 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 $519 million of program notes, with staggered maturities between 2016 and 2043, at a weighted average interest rate of 5.6%. During and since the September 2013 quarter, in addition to our revolver expansion and program notes issuance, we have issued equity at a premium to net asset value and therefore accretive. From July 1 through November 4 we sold approximately 34 million shares of our common stock in our ATM program at an average price of $11.20 per share and raised $379.8 million of gross proceeds.

We currently have no borrowings under our revolver. Assuming sufficient assets are pledged to the revolver and that we are in compliance with all the revolver terms, and taking into account our cash balances on hand, we have over $869 million of new investment capacity.

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

Okay, time for questions.

We will now begin the question-and-answer session. (Operator Instructions). Greg Mason, KBW.

I wanted to talk a little bit about the CLO income. You mentioned it in the Q, but it fell a little bit this quarter, I believe, to $26 million from $28 million last quarter. Could you talk about what's going on in the CLO equity in your portfolio, as well as the CLO market in general?

Sure, Greg. This is Grier. We did have a decline in income in our CLO book related to how we do income recognition, which involves a number of factors including reinvestment spread. There was a decline of reinvestment spreads that occurred during the June quarter that showed up in the recently-completed September quarter. But, we see those spreads as having stabilized and, in fact, maybe moving up a little bit.

In terms of the book itself within CLOs, we -- and that yield, by the way, is north of 15%. And in terms of the credit quality of the CLO book, I would describe that as sterling. At the end of September we were, I believe, below 0.2% in terms of our default rate within the CLO business compared to a market average of over 2%. That's 0.001, less than 0.001 of the overall market. And that's a direct reflection of only working with the top 15% collateral managers in the industry, working on primary deals where we scrub out -- remove CCC assets, and controlling the call which allows us to maximize a return and protect against risk both on an ongoing basis and at the end of the deal.

And we saw a very nice consummation on a full turn from -- as deals roll off the non-call period. Typically, that's two years. We're now in our third year of that business that we've been ramping since the middle of 2011 and we just realized Apidos VIII with a 30% IRR. We're not guiding folks to expect getting 30% in every single deal within the book, but we think that's a positive reflection.

And we have the option value. We can either call the deal, cash our chips and then put capital into other origination strategies if we don't like the risk/reward in the primary market, or we can do a new deal with the proceeds, as we elected to do with the excellent team at CVC Apidos.

Does that help, Greg?

Yes, great. And then on the CLO fair value, you mentioned in the Q that you had an increase in the fair value of CLO equity. We calculate about $21 million. Could you talk about the causes of that, particularly given you've got interest -- or reinvestment spread compression. Can you talk about the moving parts to get the fair values that went higher?

Yes, Greg. It's Brian. The most important piece in that is the taking into account the ability to call the deal. If you value the assets out to maturity, they would be -- they would probably come in lower because the expected cash flows in the periods further out tend to come down as the leverage starts to go away. So, because we control the call, we're able to value the assets to the call date and that allows us to value most of these assets at a value above par.

Great. And then finally one last question. As you look at new CLO equity, what kind of rate are you modeling out for those? I know previously, I think it was upper teens. Is that coming in a little bit with the reinvestment issues going on?

Well, our CLO business, which by the way is only about 15% of our business. It's been kind of in a stable band. It hasn't necessarily been growing within our book. We actually underwrite to a low to mid-teens return, but we use much more conservative assumptions than what the rest of the marketplace uses. We'll use much higher default rates, much lower recovery rates, much lower and declining reinvestment spreads, etc. And so a return -- the modeled number you spit out is obviously a function of whatever you put into it.

And then what's occurred is the election returns, so to speak, have come in much stronger than our underwriting assumptions on all of these deals, which is what we like to see. You want to beat your budget, beat expectations, so to speak. And as a result, we've been really more in the mid-teens; in some cases higher teens from a yield perspective.

And you expect that to continue on the new investments you're making?

Yes. In fact, we've seen a little bit of a yield uptick recently.

Jonathan Bock, Wells Fargo Securities.

Maybe staying on the CLO subject really quickly, Grier, you mentioned the removal of the CCC bucket as well as very important items as to controlling the call as part of the deals. As a result, do you really believe that gives you some enhanced ability to effectively let's say drive material outcome for a majority of our CLO equity, similar to what you had with the Apidos CLO that we just saw recently?

Yes, Jonathan. And thank you for your question. We have a role -- a significant voice both up front and on an ongoing basis. These really are almost joint ventures that we put together with our collateral manager partners who put up significant equity and so-called skin in the game; in some cases personally and in some cases institutionally or both, alongside our significant capital. And our team, that numbers almost 100 people strong now, works and pours through individual credits on a bottoms-up basis using our industry experts. So we work hand-in-hand with the collateral manager on that up-front selection.

A huge amount of modeling goes in on the front end as well. Sometimes you feel like you make your money on the buy in this business and that's true with this asset class; no less than making sure you're keeping the leverage appropriate on the loan or keeping the purchase multiple appropriate on an acquisition. So, we do have the ability to drive outcomes up front. And then, on an ongoing basis, that call right is a powerful one.

It's interesting; if you don't own a majority of the equity in a CLO, you oftentimes don't know who the other holders are and it certainly isn't published in a place and the trustee doesn't even know. So, you end up having to call around or piece it together and figure it out. Sometimes people never actually get there and, as a result, they're not able to call things at the optimal time period, especially if there's a manager that has different incentives involved.

We avoid all of that by holding the unilateral right to call the deal when it's in our best interests. It also acts as a liquidity protection and enhancement, which is always a good thing to have, and our strategy continues to be sound.

I want to emphasize since we've spent a lot of time on CLOs here, this is only about 15% of our business. We do -- we are optimistic in what we're seeing in the current market. But, a very small percentage of the time do things come together where it's our partner collateral manager and the right numbers that come together to make the so-called [artwork] on the front end, where the asset spread is rich enough and the liability spread is low enough that we're dialing in to an appropriate return. Sometimes it's hard for the outside world to see that we're saying no 99 times before we say 1 yes; and that's true in this business as well.

I appreciate that and appreciate your comments on this is one of the many businesses. I guess the question is -- so let's say for example if you own let's say 95% of the equity in ING's 2012 CLO, there were several there, one would probably say that that's -- you're the primary beneficiary. And I'm curious. How does this look relative to an accounting rule like ASC 810 that would say if you're the true primary beneficiary of an off-balance sheet levered investment, that you would then need to consolidate that for purposes of the regulatory one-to-one test?

Brian, have you received any questions on this as you start to think about whether or not this is going to need to be consolidated?

No. We have not gotten any questions on this. To clear the air on that, we actually had a conversation with the SEC before we started this strategy in which we cleared the accounting treatment in advance. So, the bottom line is that because we do not do the day-to-day control of this investment, we are not required to consolidate it. The only right that we have is the right to call the deal.

Which is a pretty powerful right, as you stated recently. I guess the only question, though, is as I look at commentary that the Commission likely had with Apollo, which is out there publicly, they are already asking you, as it appears, is to evaluate whether or not consolidation under 810 -- this is the group broadly, is something that should be considered. So, I appreciate your comments on that.

Moving to one other vehicle that I do find unique, this is the REIT. And maybe -- help me understand this broadly as it relates to the amount of PIK that you're collecting. I just noticed that that changed a bit in here. I've got -- you have your debt investments and then that debt investment in APH gives a yield of 6% cash, 5.5% PIK. Can you walk through, considering you control the entity, why you would elect a 5.5% PIK component?

Jonathan, that PIK is actually being paid in cash.

Okay. But then why does it have a PIK component in the statement? I'm just curious.

Because there's sometimes seasonality associated with different real estate assets. The summer months might be slower as people are moving in and out of multi-family apartments. An apartments vacant for two weeks or four weeks as a result. So it's really to ride out seasonality, but always been paid in cash.

Okay. That's good. Then if I look at the investments that you make within your REIT, so let's take Pembroke Pines for example, you had a purchase price of the property at $225 million versus mortgage debt of $157.5 million, 70% LTV, and that's a $67.5 million we'll call it effective equity into the property, right? That's what you would be putting up. Yet as I look at your investment into APH, I see a total of $76 million into the actual REIT itself. So, I'm curious. If you only paid $67.5 million for Pembroke Pines on an equity basis after leveraging with GSE debt, why put in $76 million?

I'm sorry, what was the last sentence there? The $76 million?

Yes. So, if you look at your -- and you make a point after each one of your acquisitions in the REIT to announce how much debt you're going to apply to APH and how much equity you're going to apply to APH to effectively facilitate the transaction. I was just adding those up and it seemed a little -- it seemed different, particularly in that the total debt attached to APH is $63 million and $13 million for equity -- this is just related to Pembroke Pines, was $76 million, yet the effective equity in the property was only $67.5 million. So, it's about $9 million more than what you've announced you paid in your financials. I'm just curious what accounted for that delta.

Yes. Pembroke is a highly-prized asset. I think it's the largest -- I'm told it's the largest garden-style multi-family trade in the state of Florida and very attractive for the GSE's to finance. They were sort of stumbling all over to finance that asset. So, we were able to get more attractive financing.

The asset itself is penned in by the everglades and there really is no new land available for folks that spend any amount of time in South Florida. So, asset values are rising substantially and we see significant upside from our equity position and not just the debt side of things.

So, it's sometimes certain assets will have a little bit of a higher leverage ratio associated with them because of the scale and the location and barriers to entry. In other cases that might be a little bit lower. But, we sort of call back the return by paying a higher cap rate, i.e. lower multiple, for the business.

Okay. So I guess you needed $67.5 million to finance the business or you have equity in that property. You paid $76 million for a $9 million kind of delta above it. Maybe turning to the GSE debt itself, my guess is it was for something like CapEx. Can you give us a sense as to the interest-only term on the GSE debt? I'd imagine that this is interest only for a certain period of time?

Yes. Our multi-family deals are typically interest only for three to four years. We've seen lender terms get more attractive over time. In some cases we've been pitched five years. We like a longer interest-only period before amortization kicks in because, obviously, it's very low cost -- when you're talking about 3.5% to 5% funding on a non-recourse basis against a single asset that's very attractive. And I want to emphasize that none of those deals are cross-collateralized with one another. When we get pitched those deals, we turn and walk the other way. Then typically the financing term is 10 years with a 30-year amort when that kicks in.

If you had to pay interest today, would you be earning your stated yield that you expect on the property today, right? Or is there some amount of expected growth in rental income that would need to come alongside the fact when interest payments are going to be required once the GSE debt stops its interest-only period?

Right. So we basically underwrite these deals such that if nothing else happens and you're looking at the run rate profitability of the business, we're dialing into a double-digit yield. And then you're right that if zero change over a three-year period and amortization kicked in, you'd have some compression. But, the reality is you've had income growth. There is inflation which works to your advantage, albeit modest. 2% inflation is still going to inflate rents and inflate your returns. There's a little bit of an inflation hedge, by the way, built in with this real estate business that's another benefit of it. And--.

So I guess the-- oh, go ahead. Sorry.

And our models show that we believe that yields will grow through not only that inflation, but also most of these properties are kind of 10 to 20-year-old properties, sort of A-minus, B-plus properties. And there's typically upside through a capital expenditure program that's been proven out the property. So say 25% to 45%, give or take, of the units have already been upgraded to nicer amenities; cabinets, appliances, etc. And there's typically a rent bump. And the IRR associated with that incremental investment, depending upon the deal, we've seen anywhere between 15% and 30%.

So, that bump would also add to rent growth and be upside, not reflected in the run rate purchase price that -- our hope is it would levitate the yield and cause it to grow even through the financing going from interest only to interest plus amort in the years out.

Okay. So I guess -- I mean, this is one that any logical investor would ask, is that given that we're near peak rental occupancies and somewhat peak rental rates, your view is that it's possible to take a much older property that competes with newer ones, fix it up and then be able to effectively pay for the interest expense that will come on GSE debt of 70% LTV in this deal that will then allow you, on top of that, after making those additional interest payments, to earn a respectable IRR.

Yes, because we're looking at replacement costs for new construction in these areas. And our purchase -- our all-in cost is somewhere in the order of 60% to 75% of replacement costs. And so it's just not economically feasible in many cases because the construction costs for a new property to be competitive with what we have going on. That's one piece.

The second piece is, in many cases these properties are advantageously located and that can't be easily replicated. And I mentioned the Pembroke Pines arena. There really is no location, no land to build a property like that in South Florida anymore. So, that creates a barrier to entry that's highly beneficial to us as the owner.

Appreciate it.

Jon Bock, when you -- and thank you for these questions. They are good ones. When you buy in an area where there's lots of land available and lots of available supply of new housing available to come on stream, the thesis of buying a somewhat older building and upgrading it will not be as effective as it will be in an area where, as Grier just mentioned, the available supply is constricted.

If you're upgrading in an area where somebody can build a brand new building across the street or down the road, you will need to upgrade in order to just keep up; in order to just maintain your rents in the worse case. Well, obviously in the worse case rents can go down. In an area of constricted supply, where you're not seeing new supply coming on stream and there are not alternatives for people to move into new buildings out of yours, you have the ability to upgrade and earn these IRRs that Grier mentioned. And so we are targeting the latter case.

Secondly, we don't target it just on a pro forma basis or imaginary basis or looking at REITs data or conducting market surveys, we focus on buildings where in fact the owner has already done those renovations on some of the apartments. So, rather than guessing, we can see exactly what -- not exactly, but with some precision what the expected IRR will be per dollar of upgrade.

Robert Dodd, Raymond James.

A lot of my questions have already been answered, but on one of them could you give us a little bit of a rundown on AIRMALL with a $7 million dividend. Was that a dividend to be capped or is it now in a position to be -- pay a sustainable dividend, obviously at a lower number than $7 million, I would think. They've never paid a dividend before.

And then secondly, just on CP, which you closed essentially in the quarter and it's been knocked down a very small amount, but $2 million immediately following the close. Can you give us an update, if anything's changed there?

Okay. Thank you, Robert. On the first item for AIRMALL, that business has continued to perform well. Recall AIRMALL is a business that has four US airports where it operates the food concession and retail establishments. And the performance of that business is significantly driven by enplanements and passenger spend for enplanement, each of which overall are up. Anyone flying today notices not a lot of empty seats on their aircraft. Maybe not so great for passenger comfort, but good for the airport concession business.

And that's a business, AIRMALL, which does have capital expenditures that occur from time to time related to specific airport needs. There's also new business opportunities, other airport contracts that the company is pursuing. And sometimes capital needs to be held back in potential anticipation of those other needs. In this case, we had accumulated a significant amount of cash within the business, as well as earnings, and elected to take a dividend. We're still evaluating what the -- what potential recurring dividend would be possible out of the business and haven't decided that at this juncture.

And then what was your second question, Robert? Could you repeat that, please?

Yes, CP Holdings, which you closed essentially in the quarter. And the equity was marked down $2 million from cost when you closed it, which is obviously very, very small, but--.

Right.

Any particular driver for that given it was so close to when you made the investment?

Yes. I wouldn't read too much into that, Robert. And our independent valuation process does a bottoms-up, whether or not we closed the deal three seconds ago or three years ago.

We're very happy with the performance of CP and, in fact, have made additional investments into the business. I call them particularly smart money investments. When you buy an energy services company -- I know you've got a lot of expertise in that sector as well, Robert, the smart money goes in and buys equipment and tries to avoid paying someone else a big enterprise multiple and premium to book. So, we're doing some of those trades right now, which we think are going to set us up very well for the future.

This is a company -- by the way, I would also call it a try-before-you-buy deal in that we are a lender to the company first. Liked the company, liked the management team, and then reached a deal with the sponsor to acquire the business on a consensual basis with everything performing well. The sponsor needed realization. We viewed it as an attractive opportunity to buy the business at an attractive price. And shows again the strength of our diversified originations doing a control deal, which almost no other BDCs do in the past quarter.

Okay. A last one on the (inaudible). The [heeling of staff], other income of $5 million. I assume that was the legal reimbursement. Is there anything coming to a resolution with that company?

That was a -- yes, that was a legal reimbursement associated with a settlement. And when you ask about resolution with that company, there's a lot of different storehouses of value we've looked to over the years. There's a building, there's a D&O insurance claim, we have this other legal aspect and we're hopeful there may be other pieces of value out there in the future.

Andrew Kerai, National Securities.

The first question, if we could just kind of talk about the dividend income for a second as well, too. $7 million from AIRMALL and not much from RV during the quarter. I know you guys have kind of talked about this previously and it can be kind of lumpy if you look at it, but I mean what is kind of a fair number to assume if you had to kind of handicap it for that dividend income number? I mean, I know in the past you've said, I think, about $3 million to $4 million from RV Industries. That obviously didn't transpire in the quarter, but I mean is $7 million a little bit too high or do you think that's a fairly decent run rate to kind of expect on a quarterly basis?

Well, we'd have to look across the whole book and it wouldn't be fair, I think, to blurt out. And I don't have the specific answer to blurt out to you right now because every company has its own set of needs. We look at the capital expenditure needs of the business, what's happening with add-on acquisitions, a whole host of topics and issues that are highly customized and individual to each company.

I would say on the operating control side of things, you mentioned RV there and AIRMALL, there might be a little bit more variability. Our financial buyout side is much more predictable, which is probably foreseeable to you because those are loan instruments, credit instruments and therefore high contracted recurring cash flow types of businesses. And recall we have two installment businesses and an auto finance business in the book.

So, those have been fairly predicable. And we're looking at other businesses within the sort of consumer finance and other diversified specialty finance sector as well. We haven't been too active in recent months other than supporting our existing companies, but we're working on some other deals which look interesting in that sector.

Okay, sure. Thank you. And just to kind of talk about -- to talk about First Tower's royalty, you marked up the equity about -- a little under $15 million or so in the quarter. You had said in the Q that it was related to sort of an improvement in their operating results. Can you kind of, I guess, maybe give us some metrics or why you felt it was appropriate to kind of mark that up in the July through September quarter?

Sure. It's interesting. We saw in consumer finance across a lot of different companies an uptick, not a huge uptick, but an uptick in charge-offs that occurred in the spring. And then over the summer months and moving here into the fall, we've seen that really level off. So we haven't seen increases, significant increases, really, in charge-offs. So, that moderated and I think that had a positive impact on valuations for the quarter.

Okay. Thank you. And just, I guess, to kind of get back, if we could, just kind of talk about the regulatory risk. I mean First Tower, kind of like you had mentioned before, is more focused on the installment lending. Is any of kind of what you're seeing from a valuation perspective with that company maybe -- some of the regulatory headwinds face, like, kind of some of the more short-term payday lenders and maybe that business is kind of I guess helping the sort of lower regulatory installment lending business a bit, which First Tower focuses on more.

Well, we think there's a -- we're a couple steps removed from payday with Tower because, remember, Tower is an A-loan installment lender. It's not even a B-loan installment lender like some other comps you'd see. World, RMC primarily, are B-loan installment lenders. You're going to see higher APRs with the B-loan crowd and a little bit more regulatory risk. We do own Credit Central, which has exposure to that, but that's a much smaller business than Tower. Tower's the most significant holding we have.

So, Tower's more of a 30%-ish APR business as an A-loan lender, as opposed to say 70% for a B-loan installment lender and, I don't know, 300% plus for payday. The higher you are on the APR level, the more the regulatory risk, by and large.

So, we feel very comfortable about that. And Tower's in compliance with all state and federal laws and is diversified across multiple states, having diversified from 3 states to 5 since we've purchased the business, about 16, 17 months ago and they're looking at other states as well. More state diversity reduces regulatory risk as well.

Right. So I mean, I guess kind of asked differently, I mean, if I were to say, well, to the extent that there's regulatory headwinds and kind of that sort of short-term payday or kind of more of the higher APR or sort of installment loans, I mean, so, to the extent that that's playing out in that market, do you think on the margin that's kind of benefiting First Tower, which could also be kind of driving kind of some of the improvement in their operating results? Kind of if you look at the data in terms of them trying to grow their loan book.

Yes, I'm not sure regulation is a significant driver other than enhanced regulation with banks creates opportunities for the non-bank sector, broadly speaking. I mean for our entire business; not just in consumer finance, but across all of our businesses, with rules promulgated by the Fed for cash flow loans and limitations on amortization, leverage and the like with the bank market.

But, the specifics on how Tower's doing day to day, week to week, it's much more driven by the blocking and tackling basics of the business with the managing, underwriting, people, processes, charge-offs. The same thing the company's been doing for the last 30 years of its existence.

Sure. Thank you. And just my last question is royalties. So if you look at the leverage ratio, the sort of gross debt to equity, I mean, it was 0.59 X. Still a little below you're trying a 0.7, 0.75 times target. I mean is there any reason to believe that you guys maybe increased that at least a little bit kind of towards that target, which -- I mean, at least, I don't know, from my point of view, you seem somewhat prudent given some of the yield compression within kind of the senior secured side of the market that you've been seeing.

Sure. We have run our business with low leverage and modest leverage for a long time, as you know. And we've also messaged that, hey, since we've got matched-book funding, since we've got access to so many different credit markets in a diversified fashion, then we should be able to walk up from ultra-low leverage to still prudent-leverage category. Not necessarily in a straight line, because there may be a quarter in which that'll fluctuate. For example, the last quarter our leverage actually declined a little bit, which was a function of originations being a little bit lighter. It's still healthy, but a little bit lighter. And that comes down to credit discipline. We pass on a lot of deals, especially in the sponsor and syndicated channel last quarter.

We do like to raise equity capital on a just-in-time basis. We think that's highly protective of our company and stock over time, as opposed to large offerings that knock down the stock. And we think that just-in-time capital benefits us and allows us to move quickly when there are opportunities to take advantage of in the marketplace. And right now we're seeing a big uptick in activity. Part of it may be seasonal. It feels like everyone wants to close a deal by year end, clean up the books or accomplish whatever goal they're trying to do. We seem to have a lot of deals in category A, more than $1 billion as I said earlier, and we anticipate a lot of activity between now and year end.

[Terry Ma], Barclays.

I think most of my questions have been answered, but can you give us a little color on what you're seeing in the market with respect to re-fis and recaps? It seems you guys financed a couple large dividend recaps this quarters.

Sure, Terry. Thank you for your question.

Yes, refinancings and recaps have been a significant percentage of activity in the last 12 months. I don't have at my fingertips exactly what the breakdown is between acquisitions, M&A and recaps, but it seems like there's been a significant amount of recaps.

We're seeing a pickup in M&A in terms of kind of primary activity in the marketplace. And a healthy amount of our category A deal flow is related to change of control situations as opposed to re-fis and recaps. In both situations we're going to underwrite the credit in the same fashion. Of course, we'll give a bit of a nod to new money at risk from an owner or from a sponsor, as opposed to obviously money being cashed out in a dividend fashion. And we'll factor that into the overall underwriting mosaic of how we look at risk for a particular credit. We won't just look at that one particular item. We'll look at everything involved in the deal.

Okay, great. Thanks. And just one quick follow-up on First Tower. How should we think about the net revenue interest from First Tower that's sitting there?

In terms of its stability? Well, Tower has been sort of what, Brian, kind of an 18%-ish annualized yield range to us since we closed the investment? That's been reasonably stable. We'd like to see that grow over time, obviously, all things being equal, but we're very happy with 18%. And we're looking at add-on acquisitions for Tower. We're looking at additional states for expansion, as I mentioned, but probably won't see dramatic changes in product mix or underwriting.

Frank Lee's been running that business with his capable management team for a long time. They have a tried and true underwriting processes and procedures which has served the company well for decades and we're not too eager in a tops-down fashion to insist upon deviations from what's been working for a long, long time.

And Brian wants to add another piece here.

Yes. What -- the net revenue interest adds about an additional $1.3 million of income per year; at least it has over the last year.

Casey Alexander, Gilford Securities.

Hi. First, just a maintenance issue. Do you have the proportion of fixed to floating rate loans in your portfolio?

Let's look for that and continue if you have a second question.

Okay. My second question, in looking at your presentation that you offer along with the quarter on the website, I was -- I couldn't help but be drawn by the slide Outsized Potential Return. I was wondering if you have an opinion that perhaps the market caps your valuation because of the perception that you're always out there in the market with your at-the-market equity program and if you think that contributes to your undervaluation.

Okay. A couple things there. First of all, 89% floating rate.

Great.

For assets and liability is 96% fixed. So, we're very well poised to benefit, all other things being equal, of course, from an increase in rates.

On your question about equity issuance, we really think, based on our experience, that at-the-market issuance kept at a low volume is much more protective to a stock than a large kind of GAAP-down offering. Obviously, someone might not like to see capital raises at all. But when we look at, for example, an offering we did in -- about a year ago, almost a year ago in 2012, it took a significant amount of wind out of the sales from that deal. So, we're just not anxious to go back there and there would have to be an enormous justification to do so from our standpoint and it's just really not our preference.

And we like the efficiency -- at the sort of stock price perspective, but also a spread. I mean, you're going to pay several hundred basis points to the Street from a large offering, whereas if you do an ATM, we run that at 100 bps. So, we're saving the shareholders a ton of money using that approach instead.

Well, and do you think that--?

And we're trying (inaudible) and get -- I think part of it -- we're trying to really get the message out about that. I think the overall question about discount or premium, people can have a lot of different opinions.

We have really made a concerted effort in recent months to do a lot more communication about the how and the what of what we do everyday and to communicate more about origination strategies. We held our Analyst Day in July. Folks can see that. (Inaudible) learn much more about our seven origination strategies. We walked through case studies. We have the senior members of our team present, which gives folks a sense of the breadth and depth of the organization of almost 100 people now. And it's those sorts of things we think, from awareness building, from education, from greater communication that we hope and think will make a significant difference.

Just also on the--.

Okay, great. Thanks.

On the ATM, I'm glad that you asked about that. I believe it's been more than a year since we have done an underwritten or bought deal, or marketed or whatever you'd like to call it, common stock offering. And one of the reasons that we have avoided issuing stock that way in over a year is that, if I were a person looking to buy BDC stock, I would be concerned about any BDC doing an offering that way in any short period of time, or even interim period of time after I purchased my stock. Because for certain the underwriters need to be offering it for 2% or 3%, maybe 4% or more of a discount. And the stock will, as we all know on this call, immediately trade at this new lower floor created by the need to lower the price in order to cause the market to absorb huge supply at one time.

I mean, it's like anything in this world. If you have one bicycle to sell, maybe you can get a certain price for it. If you have to sell 100 bicycles this afternoon, you're going to need to mark them down. So for that reason, simple micro-economics, we have avoided that and have not done such an offering in over a year. We've avoided the gyrations in our stock price that occur as a result of those offerings. We have avoided the big GAAP-down that's very distressing to someone who bought the day before or the week before. And as a result, we think that we provide a better value proposition. Over the course of a year it's not clear to me that we end up offering any more stock than we would otherwise and probably less.

So, we feel that this is a very stockholder-friendly approach, just-in-time financing at the lowest possible cost.

Greg Mason, KBW.

Great. Thank you, guys, and thanks for all of your answers to the questions. You addressed the positives movements of First Tower and the CLO equity. I wondered if you could give us a little bit of color on the two negatives in the quarter, Ajax and Gulfco. And you've done a great job of having no nonaccruals for six years. What is potentially the risk of those going on nonaccrual as you analyze those two businesses?

Sure. Both of those companies are in the forging business, the industrial forging business. And Ajax in particular does a lot of business with companies like Caterpillar. And there's been a significant slowdown in the end user markets in the mining industry related to a decline in certain mining related commodities. And anybody watching Caterpillar as a public company can see what's occurred there.

So, we look at that with Ajax, which is a well-run company. The CEO's been at the helm for a long time and is familiar with the volatility of the cycle. And our hope is that that's a temporary phenomenon and that the company will continue to develop more end user markets that add value and grow the business.

And Gulfco is more focused on some of the energy than necessarily mining related end markets, but also has a cyclical aspect associated with it.

When we make a loan or purchase a cyclical business, we try to correct for that with being as high up in the capital stack as possible, to be the senior secured lender, which is the case with both of these. We endeavor to have a prudent leverage as well that's typically significantly lower than a non-cyclical business.

And we also potentially look at investing equity and delevering the business if that's the right approach, even if we're having a third party do that if we're not in the control seat. And that can result in less interest burden on the Company, which could also be the right thing to do. It's still an accruing loan, but with a lower attachment point or a lower dollar amount of such leverage, which is good for all involved.

And then when the business recovers and grows again, we may look to either recapitalize the business or sell the business. We were the owner of a highly-cyclical company called NRG Manufacturing, for example, and we sold that business after a significant surge in profitability for a number we thought was attractive and monetized that deal. And that's upside that is available to us in our control book, which we'll look to capture, just probably not anytime soon within the forging sector.

Andrew Kerai, National Securities.

I just had a follow-up question, if I could. So, if you could just kind of comment on the kind of origination outlook you have for the current quarter, I mean, kind of consistent with what you've seen historically. I mean, certainly borrowers and sponsors looking to close deals towards the end of the year is a positive for you guys. I just wondered if you had, I guess, some initial commentary on -- in terms of kind of the yields that you're seeing as we kind of close out the year here. I guess to the extent if you're seeing kind of the pickup in loan demand, at least kind of supporting the yield as you kind of rotate your book into these new assets as the year closes.

Sure. We're seeing a real stabilization in yields right now, which I think is driven by supply and demand, that there's been an uptick in activity. So there's sort of more deals to go around right now in the marketplace than three months ago or even six months ago. And so desperate lender syndrome, as I like to call it, of people shoving money out the door on a -- in an imprudent basis, accepting higher leverage and a too high risk attachment point has moderated a bit because people have more to feast on.

So that's what we're seeing, generally speaking, in the current quarter. It's hard here on November 5th to say exactly what originations will be when the ball drops on New Year's Eve. That's just the deal business. But, we do have more than $1 billion in category A right now, which is close to a record high.

Got it. Thank you. And that -- sort of in that origination pipeline (inaudible) sort of the billing, I mean is that -- that's primarily new money, right? It's not sort of the re-fi volumes you're seeing out there, right?

That is primarily for -- yes, there's been a significant increase in change of control situations. And not that re-fis and recaps have gone to zero, there's just been a little bit of a mix adjustment, which I think is probably a good thing.

Got it. And I mean do you guys kind of feel it in your portfolio now? I mean kind of a lot of -- call it re-fi burnout kind of, if you will, but a lot of the re-fi activity that maybe is kind of already kind of -- that's already kind of played out or do you expect kind of the headwinds for maybe additional re-fis to kind of play on the yield a little bit here going forward?

Well, recall that only about half of our business in the last year is sponsor-related business. And in fact, in the quarter just ended it more like a quarter to a third of our business. So, a lot of the businesses' origination strategies that we focus on aren't part of that wall of money, efficient eBay-like auctioneer or the sponsor who gets lenders to knock heads together and bid out their capital at ever-higher leverage and ever-lower yields.

So, we resist that from a business mix standpoint to start with. But within the sponsor segment itself, because I don't want to give you a sense that that's completely unattractive because it's been a very good business for us for a long time, but it is subject to more competition. Within that business there will continue to be refinancings, recapitalizations that will occur, driven by a strong performance of underlying portfolio companies. But I do think there's a mix shift that's occurring, at least right now, with an uptick in M&A. and judging by the amount of auctions going on and pent-up capital, equity capital that's been on the sidelines looking for a home, a lot of people are saying that 2014 will be an uptick in M&A versus 2013. We'll see. We're not taking any -- many any such prediction. I'm just relaying what I've heard from others.

This concludes our question-and-answer session. I would like to turn the conference back over to John Barry for any closing remarks.

Well, thank you very much, all. Have wonderful lunchtime.

Thank you all.

Bye, now.

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