Prospect Capital Corp (PSEC) 2014 Q2 法說會逐字稿

Good day, and welcome to the Prospect Capital Corporation Second Fiscal Quarter Earnings Conference Call. All participants will be in a listen-only mode. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Mr. John F. Barry III, Chairman and CEO. Mr. Barry, the floor is yours, sir.

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

Thanks, John. This call is the property of Prospect Capital Corporation. Unauthorized use is prohibited. This call contains forward-looking statements within the meaning of the securities laws that are intended to be subject to Safe Harbor protection.

Actual outcomes and results could differ materially from those forecasts 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-Q 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.

Thank you, Brian. Because we have so many new investors interested in our Company, we invite such investors to review separate and recently recorded webinars as an introduction to Prospect. Investors can access such webinars through the Investor Relations tab on our website prospectstreet.com. During those events, we talk to 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 10 in New York. This is a five hour webinar that includes senior members of the Prospect team presenting our multiple origination strategies and in-depth case studies to educate investors about Prospect's business.

Now, on to our financial results for the quarter. Our net investment income or NII in the December 2013 quarter was $92.2 million or $0.32 per weighted average share. Our net income for the December 2013 quarter was $85.4 million, up 84% on a dollars basis and up 25% on a per share basis year-over-year.

We just announced more shareholder distributions through September 2014, giving investors seven months of visibility on future dividends. The September 2014 dividend will be our 74th shareholder distribution and the 51st consecutive per share monthly increase. Our January 31 closing stock price of $10.87 provides a dividend yield of 12.2%.

Our net investment income has exceeded dividends demonstrating substantial dividend coverage for the cumulative history of the Company. For the June 2013 fiscal year, our NII exceeded dividends by $53.4 million and $0.26 per share. We utilized $0.03 of that excess in the past six months.

Since our IPO ten years ago through our September 2014 distribution at the current share count, we will have paid out $12.93 per share to initial shareholders and $1.2 billion in cumulative distributions to all shareholders. Our NAV stood at $10.73 on December 31, up $0.01 from September 30. We have delivered solid net investment income, while keeping leverage modest. Net of cash and equivalents, our debt-to-equity ratio was 48% in December, down from 55.7% in June.

We estimate our net investment income per weighted average share in the current March 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 is 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.

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 nearly $6 billion of assets and undrawn credit. Our team has increased to approximately 100 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; structured 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 12.9% as of December 31.

We also hold equity positions in many transactions that can act as yield enhancers or capital gains contributors as such positions generate distributions. While the market has experienced yield compression in recent months, we have continued 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 December quarter were $608 million. Originations have come in at approximately $2.7 billion in the past 12 months. We also experienced $255 million of repayments in the December quarter as a validation of our capital preservation objective.

As of December 31, we're up to 130 portfolio companies, demonstrating both an increase in diversity as well as the migration towards 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 December quarter were weighted towards the last two months 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 March 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've made multiple investments in the real estate arena with our private REITs, 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.

Real estate represented 29% of our originations in the December quarter. We closed our platform acquisition of CP Energy in the September quarter, and closed multiple follow-on acquisitions in the December quarter. We currently have other acquisitions under LOI or near LOI at attractive multiples of cash flow, with both double-digit yield generation and upside expectations.

In December, we announced our entering into a definitive agreement for the $326 million acquisition of Nicholas Financial, a 15-state, 65-branch, 28-year old automobile finance company which purchases loans originated by more than 1,600 car dealerships. In the past year, NICK financed the purchase of nearly 15,000 automobiles. NICK's loan portfolio is in excess of $290 million.

We expect to generate returns from this transaction in the same range as our other investments in financial services companies. Subject to certain conditions, we hope to close the transaction in March or April. This past quarter, we made initial investments in the online prime consumer lending business. We are also exploring other yield-generating, risk-adjusted origination strategies, including any online small business lending, aircraft leasing, equipment leasing and reinsurance 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 stable. None of the loans in our portfolio originated in over six years has gone on non-accrual status. Non-accruals, as a percentage of total assets, declined to 0.3% in December 2013, down from 1.9% in June 2012 and were stable from June and September 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 48% in the four quarters ended December 2013 to 62% in the December 2013 quarter. This diversified origination that allows for greater credit discipline is a highly differentiated aspect of the Prospect platform.

We have booked $181 million of originations so far in the current quarter. Our advanced investment pipeline aggregates more than $800 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 48% in December, down from 55.7% in June. We believe our low leverage diversified access to matched-book funding, substantial majority of unencumbered assets and weighting towards unsecured fixed-rate debt demonstrate 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 December 2013, we held more than $4.1 billion of our assets as unencumbered assets. The remaining assets are pledged to Prospect Capital Funding LLC, which has a AA-rated $712.5 million revolver with 22 banks, and with $1 billion 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 ten 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've 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 counter-party 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 seven years. We have issued $647 million of program notes, with staggered maturities between 2016 and 2014 (sic - see Press Release "2043") at a weighted average interest rate of 5.5%.

During and since the December 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 October 1 through January 31, we sold approximately 27.3 million shares of our common stock in our ATM program and raised approximately $307 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 revolver terms, and taking into account our cash balances on hand, we have over $800 million of new investment capacity.

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

Thank you, Mr. Oswald. We can now answer any questions.

(Operator Instructions) Terry Ma, Barclays Capital.

Hello, thanks for taking my questions. Can you just give us some high level color on what you're seeing in the consumer lending space with respect to net charge-offs and delinquency trends, just given that auto finance and installment lending will be such a large portion of your portfolio?

Sure. Well, we have multiple consumer finance strategies in our portfolio. The largest by far is in the installment space through our First Tower and Credit Central investments, Tower being much larger than Credit Central. In the installment space, which is the bulk of our book today, there has been an increase in charge-offs, not necessarily delinquencies, in the tail end of 2012 and early part of 2013.

And that increase appears to be not only stabilizing but now on its way down over the last several months. So we're pleased with that and the increase wasn't really that large anyway a year and a half ago. So they've been kind of in the modest category. But we're seeing stability, modest decreases. And we're very pleased with how the business is performing, which is why we have been focused on organic growth in those companies.

First Tower, for example, expanded in the last year to two additional states. I think they're in five states now. Credit Central, which is a B loan lender, Tower is an A loan lender, has been focused on its own expansion as well, most recently in Texas for example. So we're seeing good trends overall.

In the auto space, we have a pretty small investment right now in one company called Nationwide, and we're making a much larger investment now with the take-private of Nicholas Financial that we hope to close in the next couple of months. In general, in the auto finance arena there has been an increase in charge-offs over the last 18 months but sort of like what's happening in Installment arena, not of an increase that would cause us anxiety. And we certainly factor that into our valuation and future expectations of the performance of the sector and are comfortable with it.

And then thirdly, within consumer finance, we've been recently expanding in the online channel, which we're excited about. We think there's a huge, huge trend, a disruptive trend that's going to be occurring in our economy. We've been participating in the online direct prime based consumer arena, which is -- it's not a binary world. Sometimes people think about it prime versus subprime, it's obviously on the spectrum of credit quality. But we've been growing that kind of north of 700 FICO Score business. It's a very small investment currently and hope to see that increase here in calendar year 2014.

Okay. And how are you participating in the prime space, is it through First Tower or is it through another investment?

Through another investment, and it's very small. Well, I'm sure I have more to say about it in future quarters. We're also looking at the small business online direct lending as well.

Okay. Thanks. I appreciate the color.

Christopher Knowland, MLV and Company.

Hi, thanks for taking my question. A quick question, for the pipeline mentioned in the comments, you indicated $800 million, which is a little bit below the $1 billion level you had mentioned in the previous quarter. What sort of range should we anticipate in terms of the pipeline, is it seasonal or is there a some sort of range just fluctuates in between?

Sure. It's tended to range between $500 million and $1 billion. I wouldn't read too much into changes within that range because it can be lumpy with additions, and we're pretty careful about that pipeline, we call it, category A pipeline and we generally don't add deals to that classification unless the certainty factor and likelihood has ratcheted up significantly typically as expressed in a signed work letter or LOI or something of that nature.

And then we used to account it up in the Category B just because we put term sheets out then we decided that wasn't such a great use of time because we're always active doing that day in and day out. But there is a significant amount of activity behind that which we're hoping to add to category A in

the not-too-distant future.

Great. Grier, a follow-up question on the increase in investment yields relative to the prior quarter. Is that mostly reflecting higher level of prepayments?

Brian, you want to comment on that?

No, it's primarily the result of new business and changes in our yields on CLO investments.

Great, thank you. I'll get back in line.

Thanks so much.

Merrill Ross, Wunderlich Securities.

Good morning. I wanted to ask of the logic behind dividing your American Property Holdings into [three] REITs. I assume it was a different property manager of the different portfolios?

Yes, you are absolutely right. We have now multiple relationships with different property managers and so we've divided those into separate investments. Our desire, of course, as we expand relationships with those property managers and that they perform as managers that we would do follow-on acquisitions with the same managers and in the same REITs.

Thank you.

Andrew Kerai, National Securities.

Yes, good morning. Thank you for taking my questions. The first thing I have -- you look at the end of the quarter here and your growth leverage is 0.56, net, I believe, it's 0.48. Just kind of looking, you know, that there is no utilization under your credit facility right now, and given that that's LIBOR plus 275, if you guys sort of taken a look at -- if you took -- basically if you took your leverage ratio up to about 0.7, roughly 20% or so of your debt funding mix will come from that credit facility. So it will lower your overall cost of debt by about 70 basis points. You would also lower the unused commitments fees as well too and you probably add about $0.08 or $0.10 or so annually to that investment income. Just kind of given that you're a little bit --you're sort of modestly below sort of the dividend payout per quarter, is that kind of sort of something you guys are looking at possibly taking up the leverage as well as utilizing that credit facility to drive down the cost of debt a little bit further?

Yes. You're absolutely right in everything you said. We are for sure under-levered currently. And our leverage decreased from September 30 to December 31, under-levered versus where we like to take the business and versus many of our peers. So, our plan, which didn't pan out in this particular quarter but over let's say the medium term is to lose that leverage still in a highly prudent category in that 0.7, 0.75 range by utilizing our existing facility and then taking that with term funding which we've proven out in a pretty diversified fashion across institutional high net worth and program notes markets.

And that's why we've been expanding our access to secured funding by adding additional relationships to our credit facility. With that in mind, we think having a larger revolving facility is important. Given the size of our business, we're up to over $700 million now. So the access to such dry powder in our revolver and that should serve us well given we've been in the $0.5 billion to $1 billion pace of originations per quarter.

It also affords us flexibility. Of course, we go through a sharp dislocation in the financial markets or the economy overall that we can pivot and capitalize on that by having such committed funding in hand. But you are right about the numbers you've quoted and that's absolutely our game plan to carry out --.

I'd like to give Andrew an A+ for power listening. We love power listeners, Andrew. The one thing I would add to what Grier said is that as the credit facility gets larger, it's easier and more prudent for us to be accessing it more deeply and more often. Right?

If you have a $100 million credit facility, you probably want it there for a rainy day unutilized. When you get to $1 billion, it's more prudent to be into the leverage of the credit facility in larger amounts and for larger periods of time which I think is a point of your question and that's exactly the direction we wish to go.

Great. Thank you so much for the color. John and Grier certainly appreciate it. Just wanted to turn to the CLO investments as well too. So it looks like the yields on your CLO equity has stabilized a little bit in the current quarter. I know last time on the call you had said that you had kind of lowered your reinvestment rate assumptions a little bit. You could just kind of talk about maybe the yields kind of you're seeing in that market and if you've seen it gets a little bit of stabilization in terms of what you're modeling out from just a spread perspective in the CLO equity investments?

Sure. Our yield went up a little bit this past quarter, right, Brian, how many basis points? In the range of 30, 40 basis points and of course our cash yield that we received is significantly greater than our GAAP recognized yield because we are assuming future potential losses that have not actually materialized in the book.

And in fact the default rate of our CLO book, and we're very proud of this statistic just like the overall PSEC default rate, is only somewhere in the order of 12 basis points on an annualized basis compared to 240 basis points for the overall S&P/LSTA industry average. So we're running at 120th of the default rate of the overall -- we think that's real outperformance in conjunction with our collateral managers.

In terms of the assumptions that underpin that income recognition, reinvestment spread is an important assumption, but there are things that and in general, reinvestment spreads have been on the decline in the last year. Sometimes you have moments where it will increase, but generally been on the decline. We're hoping there is stabilization there because there is stickiness that's been occurring with new CLO formation on AAA spreads. They seem to be quite sticky at about 150 basis points. So you're not seeing the same dynamic that you saw in 2006 and 2007 where AAA spreads marched down to 30 basis points and then took asset spreads with them.

You're really not seeing that dynamic occur. CLO managers will tell you that the reason for the decline in reinvestment spread is not new CLO formation but rather unlevered retail mutual funds with fund flows going from bonds to loans. In reality, both are probably a driver there.

The great thing about the way we've constructed our business is we have control over all of these deals. So if reinvestment spread should drop more than desired, that means our loans are becoming increasingly more valuable and we can just call these deals and our book is now seasoned. We started this program of CLO 2.0 in August of 2011 and now we've built up to, what Brian, close to 30 deals in that book.

And generally the two-year non-call and new formation and we're seasoned on average in the book of more than a year. So we can call many of these deals -- we already -- in fact called [that bit A] we talked about this in the call last quarter and captured I think we're up to a 33% IRR on that deal which puts us as one of the top ten CLOs in history for realized returns.

And then we've got other deals passing their call periods as well where we'll do the cost benefit analysis on whether we keep going or whether we call or -- into a new deal or refinance. We've got tremendous optionality. Then of course the debt tranche does not enjoy because they're stuck with the same spread no matter what -- without the optionality we have as a control equity. So, does that help a little bit on our CLO book?

Yes. That's great. Thank you, Grier. And then I just had one last question. So just kind of turning to that sponsor business. I know you guys have been focusing more on the non-sponsored direct deals given sort of the better risk-adjusted returns in that market and some of the sloppiness that's kind of -- that we've seen in sponsored lending recently. But I mean what -- kind of from where I'm sitting that the mix sort of a refinancing -- of refinancings has abated somewhat in that market? If you had kind of any indication from the private equity sponsors, what their level of appetite is for new loan funding here, if M&A activity might pick up here as 2014 kind of moves along?

We're seeing an increase in activity here [sending in] the first week of February 2014 versus a year ago for M&A. We're involved in a lot of processes right now supporting many of our relationships. We'll see how many of those pan out. But in terms of competitiveness, we see a bifurcation where smaller deals they might require funding checks from cash flow lenders, let's say, $15 million, $30 million checks, there seems to be a wall of money available for those deals.

Small is not beautiful there. You think maybe the opposite of it'd be less efficient for smaller deals and in fact there is more people who can write smaller checks. What we really enjoy is writing a $200 million check and there's only -- if I count on one hand, the other folks that can do that in this business and we're one of them. So there's just a lot less competition. Once you get larger, you get too larger, of course you get into the syndicated market and competing there.

And a lot of times our terms get compared to that market, and we'll win business because of speed, flexibility, maybe a management team doesn't want to stop talking to customers and running their business for a couple of months to run a road show, lots of different reasons for that. But it's quite competitive.

I don't want to give you the sense that we dislike or detest to sponsor business, that would not be an accurate rendition because it is about half of our installed base book. What happens as we talk to investors and analysts et cetera is we end up spending a lot of time talking about our non-sponsor business in part because it's -- what is -- part of what's very different about our business compared to other BDCs that are nearly 100% sponsor focused. So we're talking about the parts that are different as opposed to the parts that look a little bit more similar.

Andrew, I don't know if you're a sailor but if you're a sailor and you're in a monohull and the waves get rough, you're going to be rocking around. If you're in a catamaran, it's a little smoother. If you're in a trimaran, it's much smoother. We remember going back to 2006 and 2007 when there was a frenzy of bubble lending in the sponsor channel. We stepped back from that and the syndicated channel to focus on other verticals and we're very happy that we did because when the bubble popped we were less exposed than some other people to that particular channel.

Nowadays, we have many more verticals that allow us to compare channel A, channel B, channel B, channel C and we allocate our capital towards the verticals where we see the best risk reward at any particular point in the market cycle. So, currently I think sponsor lending is a little less of a percentage of our new originations than it has been in the past for that reason.

Great. Thanks so much for taking my questions and the color as always guys.

Thank you.

Casey Alexander, Gilford Securities.

Hi, good morning. Can you -- I know because of the multi-platform deal origination that you're following, this might be a little troublesome but can you give me a breakdown of the fixed to floating rate portion of your portfolio and kind of what your underwriting philosophy is towards that?

Sure. Well, our underwriting -- I'll talk about the philosophy first, then Brian will give you the specific numbers. From an underwriting philosophy standpoint, we really endeavor to have put all of our assets be floating rate and we like to have our cake and eat it too. Even back in 2006, when LIBOR was at 5%, we put 5% floors into the majority of our deals and there of course the risk was -- floating was not so good because you'll be floating down as opposed to up.

So we wanted to have both the ability to float up and have a minimum return. Here the floors worked again for the borrower of course because LIBOR continues to be near zero and the borrower gets the first benefit as rates go up which isn't necessarily a bad thing to protect on debt service for a particular company. But our philosophy is to be almost entirely floating rate and we're at -- in September quarter 89%.

Yes, I think we're right around 90%.

90% Brian is saying on our assets are floating as of December 31. And then on the fixed side, we -- well, with no revolver drawn, we're basically a 100% fixed this second in time, and you have to probably be crazy running a business like ours in the next couple of years if you didn't go out and fix long-term debt given where treasuries are.

When treasuries start [scooting up] a bit in the middle part of the year, we shifted a little bit of our issuance, which is primarily last year been in the weekly program notes. What's great about that is we can shape our needs literally every week. We can price discriminate all parts of the curve, we can tweak our pricing, we can run test, we can sort of nudge the investor base in the direction of where we wanted to go. And we've been focused more on the five to seven year -- really four to seven year range with that issuance which is nice because that's matched-book funding. We're not having to pay more than we would necessarily need to for financing. So that's been our philosophy and if the economy goes in a tare and LIBOR gets ratcheted up and rates go skyrocketing up, we will benefit from having all that fixed rate financing.

Great. Okay. Thanks. Thanks very much for taking my question.

Sure. Thank you, Casey.

Robert Dodd, Raymond James.

Hi guys. Just following up on a couple of the other questions. On particularly the leverage question, because this has come up as a theme before. Can you give us an indication of -- your target 0.7, 0.75, can you give us any color on kind of the timeline because looking at January, what you've told us in the release, $180 million in deployments, $120 million in gross proceeds from equity raises. So at least at the end of January the leverage is going to be down again. So can you give us some more color on what part of your strategy on capital raising you're actually going to adjust and when in order to get that leverage up to the target range and cover the dividend?

Sure. I think what you'll see, it really is more asset origination driven Robert as we -- we're very focused on not doing these large chunky gap down equity raises. We talked about that in prior calls and we do think our approach is superior to protect investors.

So, really as originations increase as we hope to see happen this quarter and to next, we'll be utilizing our secured funding. We have more firepower there, more than $700 million. If that alone utilizing that gets you in the range of what we're talking about. And of course we'd be doing a bond takeout of that and we have lots of different options.

We were the first in the space a 11 months ago to do an institutional bond. Others have followed that in the last few months, which is a good thing because it makes it a deeper market and reduces the cost of capital and now we have prints out there in not just the ten-year range where we've print it but also the five-year range.

It becomes interesting given what's happened to treasury. So that would be a likely place to look for us, but of course we have other areas that we're constantly looking at, the convert market. Our program notes get decent volumes, we've been kind of that $10 million to $15 million range per week. And we raised -- what we raised last year, Brian, in the program notes? About $500 million?

[Four some, $400 million].

Just under $500 million. So we've got the ability to raise a decent amount of financing. We like those because they tend to have one or two years of call protection and we think that's great flexibility to have, to be able to repay debt at any time should you wish to delever. I know we're talking about the opposite, but cycles happen and flexibility is a good thing.

I can't give you right now, Robert, I know you'd like to have it a more precise answer on when exactly we'll hit 0.7, because I think it's going to be more asset origination driven using the levers I've talked about. But I will point out that we've been able to put on the books decent origination numbers in relatively short order. And that would enable us to get to that target.

Probably I'd like to see that happen. Let's put it this way, I'd like to see that happen this year, Robert, not at the end of the year, have you say, what happened to hitting 0.7? I'm still waiting for that.

Okay, I appreciate that color. On --.

Robert I want to underscore something very important from my point of view, and that is maintaining financial flexibility, having the capital available, the resources, the manpower to deal with spikes in investment activity, which do come from time to time, big chunky deals and the like. It's very important to me.

Number two, what I very much want to avoid and we've been successful avoiding this now for quite some time is one of these underwritten stock offerings where your stock gaps down 3%, 4%, 5%, 7% depending on whether it's a bought deal or a marketed deal. We feel that those are not shareholder friendly. In fact our shareholders don't like them, and I'm not surprised, I don't like them being a shareholder. So that's an important objective for us and if the result is that we end up having more unutilized credit, that's not the worst thing in my mind.

Number two, if getting there is achieved by using an ATM and not large underwritten offerings, it gap our stock down and leave it punished and pummeled down for weeks on end. I think that's also a good thing. So those two objectives are more important to me than attaining some theoretical [70.67, 70.61] leverage ratio.

Okay, appreciate those comments, John. Following on the consumer finance side, obviously, you've got a lot of exposure there. I mean non-qualified assets, obviously assets, the CLOs. You've got -- your 30% bucket there, I mean how much of that bucket because right now I think after the Nicholas deal you'll be using about half of that on consumer finance and half on CLOs ballpark. Is that a target to kind of breaking non-qualified 50/50 between consumer and CLO exposure or is there -- do you expect that proportion of the mix to shrink and add other non-qualified vehicles as well over time in terms of shifting away potentially from the consumer finance focus and your potential exposure to consumer cycles?

Sure. The consumer book, even pro forma for NICK will be -- I don't think it will be 10%, it will be closer to 10 than the 15 number that you've quoted there. CLO structured credit, which of course is the senior secured business model as well, like the rest of our business, is in the range -- in the range of 15% to 18%, kind of fluctuating in that band.

So, we've been using somewhere between 25% and -- I guess 23% and 28%. We do have capacity in the 30% basket and of course, it's helped every time you close a 70% basket deal. We'll see if the law changes on that. I'm not going to spend too much time speculating on legislation, but there will be some relief at least for the financial services part of that should that occur, but we'll see. We're certainly not planning our business around that. But I think that helps -- give folks a sense of what those two in the aggregate would be because they can't be more than 30%.

Got it. Appreciate that. Just one follow-up on the CLO yield question. And the valuation, the CLOs, I mean you gave a lot of color already, but just looking at the notes in the K, the valuation parameters, six months ago the discount rate was [15%] on your CLOs, and you talked about the value increasing given the call option, the way the spreads have moved et cetera, your discount rate is now 17%, moved up implicitly, devalued with obviously a lot of other variables in there. But can you give us an idea, is that a risk premium -- what's the reason that you've taken up the discount rate implicitly down the valuation given the color you gave which was all positive on the potential value of the residuals?

Yes, the discount first and foremost for our valuations, we actually have a third party valuation agent called Gifford Fong that actually does the valuations. And they are the ones suggesting the changes in the discount rates.

I understand. They still have to justify them to you.

Yes, they do. And the moving of the discount rates is basically entirely based on market conditions. So the market conditions for our CLOs show that. If you look at the valuations, you already see that our CLOs are valued about in excess of $40 million above our cost basis.

So I don't think that we want to move them up more. I think that all you're doing by doing that is leveraging the future because at some point they have to come back to somewhere around par if you let them run out. So that's kind of our thinking on that is that we really don't want our -- we don't want to value our CLOs at 125% or 130% at par. So that's where we're coming at it from.

Understood. Thank you.

David Chiaverini, BMO Capital Markets.

Thanks. Good morning. Couple of questions for you. First, are you able to comment on the interest coverage at First Tower?

You're talking about the interest coverage on the bank facility?

No, on the -- well, for both, the bank facility and then the subordinated debt to Prospect.

I don't have that in my fingertips, Dave. We can see if we can track that down later.

It's nicely covered, Dave.

Yes, it's pretty significant. Well, the leverage is only about one to one at Tower. So the installment businesses are not very levered. The auto finance businesses can typically get more financing because of the hard asset collateral nature of the securitization markets and the bank market likes even more.

It's not they don't like installment, they just give a higher advance rate on that. So with only one to one leverage and forget the cost of that funding, it's like [L+ 275], somewhere in that range for Tower. The interest covered is pretty significant. I just don't have the number right at my fingertips.

Right. And I was curious about after that -- after that's covered the facility within First Tower, just the coverage of that excess earnings to cover the interest that's paid from First Tower to Prospect. But if you don't have it at your fingertips, that's fine. And then --.

Well, I will say that facility is sized to really sponge up as much as the excess cash flow. I don't think -- we didn't have any dividends to the equity. So, in fact, there is a variable interest component to that hold-co interest as well, which can increase or decrease based on the revenues, the underlying operating business. So there is a variable piece built into that, but that piece of it you can call it as essentially covered.

Got it. Okay, thanks for that. And then the other question was on the pipeline, the $800 million pipeline. Can you comment on the yields you're seeing in the pipeline and compare that to what they were say six months to a year ago?

We've seen yields come down on first lien paper, first lien senior paper which people use the term stretch senior, unitranche one stop, they all kind of mean the same thing. And you're seeing yields that are in the -- if you're careful and disciplined, 9% to 10% range and sometimes competitors are stretching down to [8%] on deals too. But it's generally tough to get too much above that.

It would have to be a smaller deal or something funky is happening with the situation. And then -- and that's for not -- I'm not talking about last out, I'm not talking about subordinating anybody. I'm talking about a true first lien, because that term also gets thrown around. It sometimes doesn't mean too much. We've announced with peers and now they report. And then as you move into a second lien or a last out, you can march up to another 100, 200 basis points above the numbers I just quoted in the middle market.

We don't do a whole lot of true mezz. We like to be [as high in] balance sheet as possible. So even our CLOs, yes, they are more levered by nature of the securitizations but 95% first lien senior secured paper. So in general we'd rather take a quality piece of paper and lever it prudently than to dive into a singular corporate credit risk at a high sort of mezz like attachment point.

And our data, our underwriting history shows that avoiding being in the tween or squeeze play is a -- it's a smart strategy to avoid that. And so on CLOs we're getting our returns. We've been pretty disciplined about that and interestingly, as a control investor, we can throw our weight around with the rangers, with collateral managers, pick our spots. We underwrite to a 13%, 13.5% IRR with fairly draconian assumptions and then we end up getting several hundred basis points above that, because the world ends up coming in a lot better than expected.

And our [GAAP] yield has been running at 15.5%, 16%, somewhere in that range as you see reported. That's been pretty stable the last couple of quarters. It's been higher than that earlier in 2013. We're seeing stability in that book and our financials are very stable as well, running kind of the installments are closer to 20%, the autos are closer to 30% because you can get more of financing.

And so it's a little bit of a barbell strategy in how we have yield contributions but in general, we're happy with how the market is going. The yield compression has been the most significant as syndicated market. I didn't mean to lump agented, sponsored and syndicated together. They, of course, are quite different. But the syndicated market, we've slowed that activity substantially. It never was a huge part of our business but it's really de-minimus now. Does that help?

It does. So as you kind of march your leverage up towards that 0.7, whether it's 0.6 or 0.7 or what have you, would it be unexpected or unreasonable to expect your portfolio yield of 12.9 to kind of come down as you progress towards that upper end of the leverage?

Well, it depends on business mix and if we are able to manage our business mix appropriately and part of the business mix too is what you're doing with operating buyouts and what you're doing with direct lending where we can also capture higher returns. We've had an uptick in our control activity, not just financials but operating companies in the last 18 months or so. So if we manage our mix appropriately then you wouldn't necessarily see a decline in yield even if there is a lot of desperate lenders throwing their capital in the sponsor deals out there.

Got it. Thanks a lot.

Thanks Dave.

Greg Mason, KBW.

First, I had a couple of questions on the NICK acquisition. Grier, based on your comments you said you expect returns similar to other specialty finance. When I think of those investments, I think, upper teens types of returns. Am I thinking broadly in the right range there based on your comments?

Look, we'd hope to be 20 but time will tell.

Okay great. And then on -- I would expect that there are going to be some additional transaction fees that come into the income statement as usual with these events. I know that's supposed to close in April but could go early or later based on your commentary. Do you have any kind of ballpark of what those fees could be and does the current guidance range, the upper end include potentially this coming in the first quarter?

I don't know if you're including that, Brian. Are you, this quarter?

(multiple speakers). Not happening this quarter.

Not happening. He is assuming it being an April event. We'll see if it's March or April. It's always nice to be aspirational in managing a project to get it done earlier. But Brian's comments would suggest April perhaps to may be more likely, we'll see.

Our upfront structuring fees tend to be 150 basis points to 300 basis points, somewhere in that range. And I expect that will be the case here. We have not finished the financing documents with all parties.

Great, perfect. And then I know last summer when the markets had their downturn, you guys halted your ATM program when the stock went down. Hopefully, we won't see any more down movements in the market this time, but if the stock and the markets were to go down further and you go down below book value, what's your thought with the ATM program at this point if that were to occur?

Our thought is to be disciplined and to focus on raising capital above book. We would have to have a very good reason indeed to dip below. What we've concluded watching behavior and reactions is, even if you can show someone you are buying something for steeper discount than where you're issuing, the criticism factor ratchets up to a high level so much so that it may not be worth it.

It's an unfortunate byproduct because the math suggests otherwise. So just saying you're only going to focus on issuing above book no matter what is a good approach, but you also want to maintain flexibility. Look, if another Patriot came along like we did four years ago, and I think what we reaped on that Brian, over 40% IRRs unlevered buying a credit book? It's fabulous. So we'd have to analyze this really hard, but there is certainly a cacophony on the choice to dip below to do a net accretive deal.

Well, I don't remember the last time we sold a share below NAV.

It's been a long time. (multiple speakers) has been five years. So I think watch what we do, not what we say, and you did not see us issue below book last year.

Same thing with doing (inaudible) stock down. We haven't done that in almost two years now.

A year and a half.

Year and a half, okay, fine.

That's great color. And then one last question. It looks like you had some kind of debt to equity conversions in Ajax, Gulf Coast and NMB this quarter. Can you talk about just kind of the thought process behind those? And I didn't see any yields on the preferred equity, are they getting any income at this point in the cycle?

Sure. We talked a little bit about that in November. The forging space has faced a difficult time especially with the slowdown in the mining sector. Basically -- I think I said we see how cat is doing, you'll see how the forging space is doing, the companies in our book. And you saw a huge drop off in calendar year 2013.

Until here in 2014 you're now seeing improvement, but we're really getting de-minimus income out of those two deals at the present time. And the cycles -- those are highly cyclical companies -- and as the cycle rebounds and as companies rebound, then you can look at appropriate levels of debt. But having inappropriate levels of debt against a company going through a deep industry cycle doesn't strike us as a very prudent thing.

Great. Thank you guys.

Thank you.

Jon Bock, Wells Fargo.

Good afternoon, and thank you for taking my questions. Grier, very unique that the peer to peer, just a little more color on those assets. Could you give us a sense on the yields that perhaps one could get, you mentioned on prime, what's the kind of yield or expected return one could look at in that space?

Sure. And people use the term peer to peer for kind of historical reasons. It's obviously a misnomer when an institution like ourselves is making the loan which is why we call them online direct consumer lending. I guess peer-to-peer is less than a mouthful. But we're getting yields generally in the mid-teens, pre-losses and then you can layer in your loss assumptions based on historical averages.

I think our weighted average yield in that book is somewhere around 13% net to us and we're assuming losses of about 5% to talking about a net 8% and then we can lever that three to one with the secured funding, which we haven't done yet. But as that book grows, we'll look at potentially doing that. Now that's in the prime based consumer space.

Then you also have small business that we're looking at and those characteristics look much more similar to subprime B loan lenders like our Credit Central business. You're underwriting a business but you're also underwriting the business owner that tends to be more of a subprime business owner.

So there is different dynamics going on. The great thing is we have so much expertise in what we're doing there, having been a lender of this space for many years of regional management and an owner for last several years with Tower and Credit Central. It gives us a great perspective on what's going on there.

Okay. And I think you went ahead and answered my next question, but one reason these would make sense to be inside the REIT is the fact that you can leverage those returns higher than if you were to have them on the balance sheet of the BDC?

Correct.

And are those now also, even though they could perhaps be business loan or consumer loans going to be considered qualified assets?

Yes.

Okay. Now moving on, John, you talked about and I also saw this in the release being the largest -- one of the largest providers of credit in the middle market with one of the largest workforces. And I think in the release you mentioned you had about 100 individuals. Would you mind being able to break that out between how many you have working on investments and how many you have working in a non-investment capacity which would be just as important?

Well, we actually don't sit around and count, so I'm going to have to just estimate that we have maybe 50 people in investments. We have probably ten in legal, we have 15 in finance and accounting, we have five in tax and we probably have another ten in admin.

That's a pretty good estimate and I'd add to that that a lot of the lawyers and admin and certainly tax, and CPA professionals support our new originations and existing portfolio companies. We certainly have people that manage the public side of things, securities filings et cetera. But the majority actually of that 50 is geared towards the portfolio and that's a significant part of our competitive advantage because we -- talking about confidentiality agreements, we process thousands of those every year.

Just being able to turn those as its own process and subdivision within our business. Huge amounts of tax work that occur with our consumer finance companies, with buying our operating businesses. A lot of middle market companies lack that expertise and in other areas. So we can support them in a huge way which really was the original attempt of business development company, law being enacted in 1980.

And most of our peers don't really do much, they just lend money and that's it. We do a lot to support our companies and the staffing that we have, even including that back office, is a big contributor to the front end and the portfolio as well.

Just as an example, we probably have more tax lawyers and tax accountants than any other BDC. Just brought on another tax lawyer recently a few weeks ago. And that enables us to assist portfolio companies in their tax claims and then it creates greater efficiency and greater productivity throughout the system.

We're now offering that as a value add when we speak to management teams and companies about doing transactions that gee it looks like our tax department can help you people structure this more intelligently than you've been able to figure out.

Appreciate that. And then Grier, real quick just with AIRMALL. We see money go in for liquidity purposes and then subsequently in the same quarter, obviously for liquidity purposes would imply they need the money but then we see a dividend out or liquidity being taken out of the Company in the exact same quarter. Can you walk us through the reasonings and that situation in particular?

Sure. AIRMALL, cash is obviously fungible, a lot of things happening at AIRMALL across its [four] airports. It's utilizing capital as well to bid on new contracts. For example, in Philadelphia, it's actually bidding on a contract there as we speak and then other airports across the country. There is various CapEx improvement programs going on which is probably the airport model. There is the management services only model and then there is the developer model, you put up risk capital, improve the terminal, retail and restaurants and eating establishments and then have a higher revenue split with the municipality.

So AIRMALL has tended to focus on the latter. So we -- AIRMALL has done quite well and claimants are up, EBITDA is up significantly since when we bought the business. We'd like to continue making growth investments in the business, but we had some extra liquidity on hand as well and had plenty of excess earnings and profits built in that business and elected to take a dividend this past quarter.

Okay, great. And then just two more ones, two more questions if I may. And I appreciate the time, Grier, on the originations that were made just in December, could you give us a sense of maybe your all-in either coupon or let's just say maybe may be expected return, what you're seeing kind of blended across the new investments that you made broad brush stroke just this past quarter?

What do you think, Brian, this past quarter is pretty similar to the prior quarter. Our overall weighted average yield went up this past quarter from, say, [12.5% to 12.9%, from 9.30% to 12.31%]. So I think we're right around that 13%-ish range, Jon, which again is a blend of low double digits on some of the first lien sponsor stuff and investments that we've made in our operating buyouts this past quarter which had a higher yield and in CLOs which have a higher yield. So that 13% is a blend across all of this.

Okay and then as I look at the equity that was raised just this past quarter, let's say roughly 331 and then just apply maybe a general set of assumptions since it was raised at 11.3 -- $11.30 that's about 11.7 yield, you leverage that about 0.6 to 0.7 times with debt at 5.8% and then you layer on an additional 400 basis points of fees, you start to look at a 13.7 and presumably higher required rate of return on assets that needs to be generated for the dividend to remain flat. And can you walk us through the reasonings of why grow if it doesn't necessarily fall to the bottom line yet. It's just a question many people have on the BDC space and I'd be interested in your opinion.

Well, there is a possibility for future higher leverage as I know you've written about, Jon with the legislation and so you might have some assets which appear to be a drag on yield currently on the balance sheet and we have the discussions all the time, do you sell this off or do you hold them? I'd tell you originating assets is a valued commodity and people are hungry for assets out there who do not have the ability to originate unlike we do. We get lots of calls from people wanting assets because they haven't necessarily made investments in their team and infrastructure to be able to bring in deals as we do.

But if you just give away your assets that away and then you got the ability to do something to finance those down the road, you've given away optionality. So we're not interested in doing that, we rather retain the assets and be able to benefit as the landscape adjusts. I would also add that our business unlike folks that just lend money and don't buy companies does have the ability to grow income, they grow value over time and we've been making investments -- let's talk about CP Energy, for example, which is led by a fine professional in our team, Mark Hall, who leads our efforts in Houston.

We bought a business, bought that business after being a lender to it last year and then we've done add-on acquisitions, [check out some] smart money deals we buy equipment and put in the fields. We're estimating that the enterprise multiple of those acquisitions is something like 2.5 times -- 2.5 to 3 times, [so again] worth that. That's a 40% to 50% yield off of deals like that. Other folks that don't buy companies have the expertise of no hope, no prayer of getting those types of returns, we do and to grow that income over time.

So we do get benefits from that, we do get benefits from scale and diversity afforded by how we're perceived the outside world, how we're perceived when we track credit. We are now to what Brian, 22 banks think you quoted with anyone else? These are real assets to us, Jon, and we think the long-term view around here, John talked before about financial flexibility. It's very important.

I don't know when the next cycle is going to hit, maybe 2016, 2017, nine, ten years spacing from the last cycle, a lot of people are telling like it's not going to happen, it will. It will be the ones with more capital, more scale, ready go to in offence to benefit from them, just like we did with Patriot. In fact, we have to do a lot more with a lot more capital, just go around. So, I know it's hard to think about that here in your -- middle of a raging credit bull market beginning in 2014. We're thinking about it for the long term.

Appreciate that. Thank you very much.

Thanks.

While at this time there are no further questions. We'll go ahead and conclude our question-and-answer session. I would now like to turn the conference back over to management for any closing remarks.

Okay, well, thank you all very much. Have a nice week. Thanks all.

And we thank you, sir and to the rest of the management team for your time. The conference call is now concluded. At this time, you may disconnect your lines. Thank you and take care everyone.