Prospect Capital Corp (PSEC) 2017 Q3 法說會逐字稿

Good day, and welcome to the Prospect's Capital Corporation third fiscal quarter earnings release conference call and webcast. (Operator Instructions) Please also note that this event is being recorded.

I would now like to turn the conference over to Mr. John Barry, Chairman and CEO. Please go ahead.

Thank you, Andrea. Joining me on the call today are, as usual, Grier Eliasek, our President and Chief Operating Officer; and Brian Oswald, our Chief Financial Officer. Brian?

Thanks, John. This call is the property of Prospect Capital Corporation. Unauthorized use is prohibited. This call contains forward-looking statements within the meaning of the securities laws that are intended to be subject to safe harbor protection. Actual outcomes and results could differ materially from those forecast due to the impact of many factors.

We do not undertake to update our forward-looking statements unless required by law. For additional disclosure, see our earnings press release, our 10-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. For the March 2017 fiscal quarter, our net investment income or NII was $73.1 million or $0.20 per share, down $0.04 from the prior quarter. This decrease was driven primarily by a decline in interest income due to lower prepayment fees, a lower coupon First Tower refinancing and reduced yields from certain structured credit investments close to expected call dates, partially offset by a decrease in management fees. Our net income was $19.5 million or $0.05 per share, down $0.23 from the prior quarter. This decrease was driven primarily by the factors above and unrealized depreciation in the energy, financial and structured credit sectors.

For the 9 months ended March 2017, our NII was $236.4 million or $0.56 per share, down $0.13 from the prior year. Our net income was $201.7 million or $0.56 per share, up $0.54 from the prior year. In addition to deploying capital in new originations, we are also seeking to increase income through extensions, refinancings and calls in our structured credit portfolio; realizations in our multifamily real estate portfolio; securitizations and refinancings in our online lending business; revolver draws to retire more expensive term debt; divestitures of lower-yielding assets; improvements in controlled investment, operating performance and enhanced asset yields from LIBOR, potentially increasing beyond 4 levels.

We previously announced monthly cash dividends to shareholders of $0.08333 per share for May, June, July and August 2017, representing 109 consecutive shareholder distributions. We plan on announcing our next series of shareholder distributions in August.

Since our IPO 13.5 years ago, through our August 2017 distribution at the current share count, we will have paid out $15.96 per share to initial continuing shareholders. Continuing $2.3 billion -- excuse me, exceeding $2.3 billion in cumulative distributions to all shareholders. Our NAV stood at $9.43 per share in March 2017, down $0.19 from the prior quarter. Our debt to equity ratio was 78.9% in March 2017, slightly up from 78.8% in March 2016.

Our balance sheet, as of March 31, 2017, consisted of 90.7% floating rate interest earning assets and 99.9% fixed rate liabilities, positioning us to benefit from rate increases. Our recurring income, as measured by our percentage of total investment income from interest income, was 95% in the March 2017 quarter. We believe there is no greater alignment between management and shareholders than from management to purchase a significant amount of stock, particularly when management has purchased that stock in the open market, paying the same prices as other shareholders. Prospect Management is the largest shareholder in Prospect and has never sold a share. Management on a combined basis has purchased at cost over $175 million of stock in Prospect, including over $100 million since December 2015.

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

Thanks, John. Our scale of business was over $6 billion of assets and undrawn credit continues to deliver solid performance. Our team consists of approximately 100 professionals, representing one of the largest middle-market credit groups in the industry. With our scale, longevity, experience and deep bench, we continue to focus on the diversified investment strategy that covers third-party private equity sponsor related and direct nonsponsored lending, Prospect-sponsored operating and financial buyouts, structured credit, real estate yield investing and online lending.

As of March 2017, our controlled investments at fair value stood at 31.5% of our portfolio. This diversity allows us to source a broad range and high volume of opportunities, then select at a disciplined bottom-ups 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. Our nonbank structure gives us the flexibility to invest in multiple levels of the corporate capital stack with a preference for secured lending and senior loans.

As of March 2017, our portfolio at fair value comprised 48.8% secured first lien, 20.5% secured second lien, 17.8% structured credit with underlying secured first lien collateral, 0.2% small business whole loan, 0.7% unsecured debt and 12% equity investments, resulting in 87% of our investments being assets with underlying secured debt benefiting from borrower pledged collateral.

Our secured first lien mix increased by 290 basis points from the prior quarter. Prospect's approach is one that generates attractive risk-adjusted yields, and our debt investments were generating an annualized yield of 12.3% as of March 2017, down 0.9% from the prior quarter due to the factors previously described. We also hold equity positions in certain investments that can act as yield enhancers or capital gains contributors, as such positions generate distributions. 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.

As of March 2017, we hold 125 portfolio companies with a fair value of $6.02 billion. We also continue to invest in a diversified fashion across many different portfolio company industries with no significant industry concentration. The largest is 9.6%. As of March 2017, our asset concentration in the energy industry stood at 2.6%, including our first lien senior secured loans where third parties bear first loss capital risk. Nonaccruals as a percentage of total assets stood at approximately 1.4% in March 2017, down 0.1% from the prior quarter with approximately 0.3% residing in the energy industry.

Our weighted average portfolio net leverage stood at 4.15x EBITDA, down from the prior quarter. Our weighted average EBITDA per portfolio company stood at $49.4 million in March 2017. The majority of our portfolio consists of sole-agented and self-originated middle market loans. In recent years, we have perceived the risk-adjusted reward to be higher for agented, self-originated and anchor investor opportunities compared to the nonanchor broadly syndicated market, causing us to prioritize our proactive sourcing efforts.

Our differentiated call center initiative continues to drive proprietary deal flow for our business. Originations in the March 2017 quarter aggregated $450 million, down $20 million from the prior quarter. We also experienced $303 million of repayments and exits as a validation of our capital preservation objective, down $342 million from the prior quarter, resulting in net originations of $147 million, up $323 million from the prior quarter.

During the March 2017 quarter, our originations comprised 66% third-party sponsored deals; 12% syndicated debt, including early look anchoring investments and club investments; 10% real estate; 6% online leading; 4% operating buyouts; and 2% structured credit.

To date, we've made multiple investments in the real estate arena through our private REITs, largely focused on multifamily stabilized yield acquisitions with attractive 10-year financing. In the June 2016 quarter, we consolidated our REITs into NPRC. NPRC's real estate portfolio has benefited from rising rents and strong occupancies and our cash yields have increased.

In the past year, NPRC has recapitalized many of its properties with attractive financing and exited completely certain properties, including Vista, Abbington and Bexley, so we can redeploy capital into other return-enhancing avenues. We expect both recapitalizations and exits to continue. NPRC also recently closed its first portfolio investment in student housing, an attractive segment similar to multifamily residential where we have analyzed many opportunities for several years.

In addition to NPRC's $2.06 billion of real estate assets, over the past few years NPRC and we have grown our online lending portfolio with a focus on super-prime, prime and near-prime consumer and small business borrowers. NPRC and we, as of March 2017, had exposure to approximately $786 million of fair value online loans directly and through securitization interests across multiple origination and underwriting platforms.

Our online business, which includes attractive advance-rate financing for certain assets, is currently delivering a more than 12% annualized return net of all costs and expected losses. In the past 4 years, we and NPRC have closed 5 bank credit facilities and 2 securitizations, including in the December 2016 quarter, our first consumer securitization to support our online business with more securitizations expected in the future.

Our structured credit business performance has exceeded our underwriting expectations, demonstrating the benefits of pursuing majority stakes, working with world-class management teams, providing strong collateral underwriting through primary issuance and focusing on attractive risk- adjusted opportunities.

As of March 2017, we held $1.1 billion across 41 nonrecourse structured credit investments. The underlying structured credit portfolios comprise over 2,500 loans and a total asset base of nearly $20 billion. As of March 2017, our structured credit portfolio experienced a trailing 12-month default rate of 1.05%, a decline of 11 basis points from the prior quarter and 44 basis points less than the broadly syndicated market default rate of 1.49%.

In the March 2017 quarter, this portfolio generated an annualized cash yield of 17.9%, down 3.6% from the prior quarter and a GAAP yield of 13.6%, down 1.2% from the prior quarter. As of March 2017, our existing structured credit portfolio has generated $857 million in cumulative cash distributions to us, representing 65% of our original investment. To date, we've also exited 7 investments, totaling $154 million with an average realized IRR of 16.8% and cash-on-cash multiple of 1.42x.

Our structured credit portfolio consists entirely of majority-owned positions. Such positions can enjoy significant benefits compared to minority holdings in the same tranche. In many cases, we receive fee rebates because of our majority position. As a majority holder, we control the ability to call a transaction in our sole discretion in the future, and we believe such options add substantial value to our portfolio. We have the option of waiting years to call a transaction in an optimal fashion rather than when loan asset valuations might be temporarily low. We, as majority investor, can refinance liabilities on more advantageous terms, remove bond baskets in exchange for better terms from debt investors in the deal and extend or reset the investment period to enhance value.

Our structured credit equity portfolio has paid us an average 22.6% cash yield in the 12 months ended March 31, 2017. So far in the current June 2017 quarter, we've booked $109 million in originations and received repayments of $75 million, resulting in net originations of $34 million. Our originations have comprised 60% third-party sponsor deals, 18% structured credit, 16% syndicated and club debt, 4% online lending and 2% real estate.

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

Thanks, Grier. We believe our prudent leverage, diversified access to matched-book funding, substantial majority of unencumbered assets and waiting 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 over 25 years into the future, while the significant majority 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, develop a notes program, issue an institutional bond, acquire another BDC and many other firsts. Shareholders and unsecured creditors alike should appreciate the thoughtful approach differentiated in our industry, which we have taken towards construction at the right-hand side of our balance sheet.

As of March 2017, we held approximately $4.6 billion of our assets as unencumbered assets, representing approximately 75% of the portfolio. The remaining assets are pledged to Prospect Capital funding, which has a AA-rated $885 million revolver with 21 banks and with a $1.5 billion total size accordion feature at our option. The revolver is priced at LIBOR plus 225 basis points and revolves until March 2019, followed by a 1-year amortization with interest distributions continued to be allowed to us.

Outside of our revolver and benefiting from our unencumbered assets, we've issued at Prospect Capital multiple types of investment-grade unsecured debt, including convertible bonds, institutional bonds, baby bonds and Program Notes. All of these types of unsecured debt have no financial covenants, no asset restrictions, no cross defaults with our revolver.

We enjoy an investment-grade BBB+ rating from Kroll and investment-grade BBB minus rating from S&P. We've now tapped the unsecured term debt market on multiple occasions to ladder our maturities and to extend our liability duration more than 25 years. Our debt maturities extend through 2043. With so many banks and debt investors across so many debt tranches, we substantially reduced our counterparty risk over the years.

We have refinanced 3 nonprogram term debt maturities in the past 2 years, including our $100 million Baby Bond in May 2015, our $150 million convertible note in December 2015 and our $167 million convertible note in August 2016. We recently issued a 4.95% $225 million convertible bond, using a substantial amount of the proceeds to repurchase bonds maturing in the upcoming year. For the remainder of calendar year 2017, we have liability maturities of $67 million. Our $885 million revolver is currently undrawn. If the need should arise to decrease our leverage ratio, we believe we could slow originations and repayments and exits to come in during the ordinary course as we demonstrated in the first half of calendar year 2016.

We now have 8 separate unsecured debt issuances aggregating $1.7 billion, not including our Program Note, with maturities ranging from October 2017 to June 2024. As of March 31, 2017, we had $1.01 billion of Program Notes outstanding with staggered maturities through October 2043.

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

Okay. Thank you, Brian. We can now answer any questions.

(Operator Instructions) Our first question comes from Christopher Nolan of FBR & Co.

Grier, what was the reason for the lower yields in the CLO portfolio, please?

Sure. It really was specific, Chris, to 4 deals that we're in the process of calling right now and how our constant-yield method works for -- we're updating assumptions each quarter and uses a levelized-yield methodology. So for those 4 deals and as the deal get much closer to call and those are past the reinvestment period where you can really only reinvest within certain weighted average life restrictions where if you have repayments in those particular deals that exacerbate the situation. So really we've recognized, we think, the income that we will out of those transactions. But the good news is as we take those transactions and call them, we take the capital from those and then reinvest those in other income-producing properties. So we see it more as a timing issue, if anything else. If you take out those 4 deals, our yields were actually reasonably steady. And our CLO book from quarter-to-quarter, which reflects an offsetting effect -- and I'm talking about GAAP yields here, which reflects an offsetting effect of -- on the negative side, assets spread compression and liabilities costs increasing due to the fed hike in December. On the positive side, we've been very aggressive and proactive on refinancing deals and/or extending deals with lower cost future liabilities. So as those offset, we've been able to maintain more of a -- a reasonably steady, we think, GAAP or economic yield correcting for those 4 that we expect to call and reinvest and enhance income. Does that help, Chris?

Yes. No, it's good detail. And I guess, as a follow-up. In your comments talking about NPRC, you sort of indicated that you're expecting 12% leverage yields. This is a little bit down than the mid-teens, I think, you guys were talking about earlier. Is this a reflection of expectations of rising funding costs with rising interest rates? Or what's the detail there?

It's more of a timing aspect. We'd like to see those numbers go up to more the mid-teens level. What we're doing is we're repositioning our marketplace online book, and we're focusing on certain platforms that have -- really have the best results for us from a charge-off perspective and where we've demonstrated a vibrant -- we and others, a vibrant securitization market that can help enhance our returns. What we've been doing with some of the other platforms is reducing our exposure, declining to reinvest, let alone grow those portfolios and manage to a prudent exit, so we can redeploy in other areas. So the 12% reflects some other platforms that kind of dragged down that weighted average. But as we exit those areas and then reinvest into what's worked best, we expect for those numbers to go up.

Our next question comes from Merrill Ross of Wunderlich.

When we look at the level of income at quarter end on the current portfolio, it just looks like it's getting tight to cover the dividend next quarter. Would you agree with that?

Well, yes, in sense that our net investment income came in below the current dividend rate. We look at the dividend a little bit longer term than that as a board. Some of these factors we hope -- we can't guarantee, but we hope are temporary in nature that we can improve. And I talked in reasonable detail about the structured credit book and how reinvesting some of those deals we hope will enhance income. We talked in our earnings release about 3 significant drivers for the reduction in net investment income on a sequential quarter basis, that was one of those. The second one pertained to a reduction coupon in our controlled consumer finance business, First Tower. And what we're seeing there is there's been an increase in charge-offs in the last year, really last few months, in particular, with the biggest driver of that relating to some natural disaster activities and severe flooding, and folks recall that, that happened in Louisiana, which is one of the biggest states for First Tower in the second half of 2016. So I think there were tens of thousands of people displaced from their homes, et cetera, which as you can imagine, pressures charge-offs. We're hoping that's not a recurring type of activity and that we'll see improvement there in that business, maybe not instantly but over time. And then the third item pertains to prepayment income. Our prepayments and exits were substantially reduced in the March quarter compared to December. Part of that is uncontrollable in the sense of counterparties that own companies pay you off or refinance you. And we have some ability to influence that to the extent that we can stay invested in credit, sometimes that's not an option. On the control side, we do look to optimize value. Then the real estate business, in particular, we have been exiting certain properties on a prudent basis, and we're looking to do that. We're looking to both buy properties as well as exit properties and kind of recycle and optimize that book. So those are 3 drivers there, some of which we hope to correct in the future.

Merrill, this is John Barry. I appreciate your question and I have a bit to add. I think about these results on 3 levels. First, we're seeing spread compression everywhere we look. It can be aircraft leasing, it can be real estate, it can be sponsor loans, it can be online lending. Everywhere we look, there is spread compression. We do our best to avoid having that spread compression impact our book, but there's a limit to what we can do. For example, in our CLO book, we see quite a bit of refinancings and repricings. So the market is enabling borrowers across the board to reduce their borrowing costs and as a result, income to lenders. That's the macro. Will that change? Well, we can't predict the future, but what we've noticed over the last 16 -- really, in my case, 30 years in this business, is you seem to have a downward trend in asset spread until something happens. I just heard yesterday morning, I think the volatility in excess was the lowest it's been in 28 years. That normally is a sign that it's not going to stay that way. We'll just have to see. So that's the macro. And everyone on this phone call has an equal ability to predict the future, which in my case is 0. Then the next level I look at is what I would call timing differences in our portfolio. Sometimes they're mark-to-market where there is some volatility around the mean and -- there I look at our CLO book. There are timing differences. I look at -- I think that's the main area that I would -- that I think of the book as having a timing difference's income that we would expect it in this quarter -- not in this quarter, but in the future quarter. So as far as I'm concerned, the timing difference is just -- is a timing difference, at least we get the money eventually. The third level, which is the most frustrating to me, is operating problems because that's where I feel that we have a rule and can always do more. In our case, there's 2 areas of operating problems. One is the energy business. We're just amazed at how long this U -- sometimes it's a drop and then you expect regression to the mean in most markets. This is not -- has not been -- at least in our part of the energy market where we are, largely services, has not regressed to the mean, anywhere near what we would have expected based on past history. So that has been very frustrating, very disappointing. We spent a lot of time on that. It's not that easy to fix problems in an industry where revenue is collapsing and where people are pricing down and desperately trying -- your competitors are trying to desperately stay in business really by pricing below their marginal cost. So that is very frustrating. Looking backwards, we wish we had never invested in energy. Well, we don't get that opportunity. We are invested in energy. It's only -- what is it? 2.3% of our book. Thank goodness it's not more. But it's been extremely, extremely, extremely frustrating and upsetting for all of us. Then another part of the operating problem is other companies that are not in the energy business. And while our nonaccruals are low relative to the industry, they really should be a lot lower in my view. And I think we should be doing a lot better, dealing with not just energy but nonenergy companies. And that has my attention, believe me, and has everyone's attention. So those are really the strands I think that have fed into a very, very disappointing quarter for me. Typically, you'll have -- I don't know, 1 or 2 or 3 things that are problems and 7 or 8 things that are going well and then they tend to offset each other. This is one of those quarters where it's like you got a baseball team and your 3 batters just went up and they all 3 struck out, you say, "Gosh, thank goodness, the last inning wasn't like this, and we hope the next inning will not be." But I appreciate your question. And as far as the dividend goes, we examine the dividend at least a million times a quarter and we try to size it in relationship to what we think is the long-term sustainable earning power of the company, but we also have to be aware of these macro forces. And where interests rates are going in the future, as [Keynes] said, there's 2 opinions, right? Those from people who don't know where they're going and those opinions from people who don't know that they don't know where they're going. So we kept our dividend where it is and we're focused right now on resolving these operating questions, which is the one area where we really can do something, and I hope you find that helpful.

One other piece to add, Merrill. I think useful to quickly articulate some of the catalysts for what we hope could be earnings drivers on a going forward basis to enhance net investment income. I talked about the CLO business, calling deals and reinvesting is one of those, more within our control that we're actively doing now -- have done already this quarter and are doing more we think in the balance of the quarter. LIBOR going up is not within our control, the Fed determines that, but that would be a positive catalyst now that the floors are finally being exceeded. And on top of that, the floor aspect in the syndicated market, the borrower has the ability to elect 1-month or 3-month LIBOR in assets, so many have elected 1 month, which has kept the floors from coming to play even longer, whereas the liabilities are pegged up for 3 months and they never had a floor to begin with. So catalyst 1 is in our structured credit book, catalyst 2 in the online book. We see the securitization market as a potentially key driver. We've already printed one deal in our consumer finance portfolio within NPRC, and we're working hard on other transactions. A recent print in that space was, I think, 3x oversubscribed with lenders who view this as an attractive real market and growing market. Number 3, within real estate, we're in the money on a lot of deals and we do have foregone IRR calculations deciding when it's optimal to sell properties. So you'll see us continue to do that. We view that as a potentially positive earnings driver. Number 4, we talked about our controlled book, particularly on the financial side with companies like First Tower and improving the charge-off profile there. So we cover that. Number 5, as John mentioned, within energy, we're working hard in recovering collateral where there is a liquidation in play and then reinvesting in essentially dead, nonincome-producing money into income-producing properties and enhancing operations for the balance. Number 6, liabilities. We'll likely be using our lower-cost revolver more to retire near term -- more expensive term debt over the next couple of years. You'll also see us thoughtful and constructive on the term side. We repurchased some -- a higher coupon liabilities recently and issued a new convertible term bond on more advantageous coupon, for example, just a few weeks ago. And then in our middle market book, LIBOR going up. Again, not within our control, could be a positive driver as those floors start to get exceeded. So those are some of the catalysts to potentially look to for the future that we're focused on, Merrill.

I have little more to add to that. Merrill, we -- from my vantage point, we just have to keep doing the best job we can each day. Reminds me of my friend, John (inaudible), years and years ago, ran a publicly-traded mutual fund trust. And I think in 1989, he was the worst-performing mutual fund manager in the country, but I guess he was the best in '89 and then the worst in '90 and then the best in '91. People said, "Well, John, what did you change?" He said, "I didn't change anything. I just keep doing the same job I've always been doing and I've always been trained to do." So sometimes there are market forces that are very strong. We are going to focus on what we can do, which is improving the operating performance in these portfolio companies and even in these -- in the ones we control. And even in the ones where we don't control. Another question that you didn't ask, but that I would like to address, which relates to your overall question is our taxable income. In the past, we have estimated our taxable income based on what we know to be the case in our book. But also based on estimates coming out of our CLO book, which come to us through the trustees for these various CLOs. And these trustees are providing information which are themselves estimates. And what we have learned is that these estimates are just estimates. And until we get the complete year-end information, we should not be distributing or cumulating, aggregating these estimates and distributing them as if we have reason to believe that they are doing 1% or 2% of what the final number would be. Could you elaborate on that Brian, or did I state it fairly?

You stated it fairly. The issue really comes down to -- there is so much activity that's happening inside of each individual CLO portfolio that the managers just aren't able to calculate the taxable effects of that on a regular basis. So we have just decided that we would wait and see what the actual results are when we get the reports from the trustees at the end of the year.

So Merrill, for example, when I mentioned the timing differences and I said, we have some of those in the CLOs, I understand, for example, when a CLO manager has a security trade from, say, purchases at, say, 99 and it trades down to 90, and that manager sells that security and buys another security at, say, 90. Did the manager have more confidence in rebounding? What we have is -- we then -- in that book we realize a taxable loss. Even though it's not clear that, that much has happened if you sell energy company A for 90 and buy energy company B for 90 that you think is going to do better. But we booked the taxable loss right then and there, realized it. And then if we believe there will be a regression to the mean in the energy book, which is more likely to happen in the CLO book than in the PSEC book. Why? Because it's more syndicated large-cap loans which have more resources to, in fact, regress to the mean, then you may have some feeling, "Oh, well, as the energy markets reflate or at least at that level, then the security that was purchased is likely to trade back up." So right now, we show a taxable loss causing our taxable income to drop. And just from my vantage point, as I said, I can't predict the future, but from my vantage point, we're booking a loss that we would not have booked had the manager in that particular CLO book sat still with that particular security. So these are some of these timing things that affect us.

There is one other timing impact to what John just described. There's a lot of 2016 and we talked about some of that on the last call, these sort of swap trades. The other aspect that's come into play more recently is extending deals and refinancing them, where there is an upfront time ["0" investment] required, generally a placement cost with an investment bank to place the liability some legal as well. And then a pretty significant return on that upfront cost through a significantly lower liability spread going forward. In many cases, these refinancings can have embedded IRRs of 200% to 400%. So they're very good investments to be done. But they do create a time 0 hit to taxable income. So in addition to the difficulties of estimation, there's also a lot of swing factor noise that's appearing for at least 2 significant reasons in recent weeks, months and quarters.

Anyway, Merrill, I don't want to sugarcoat any aspect of this last quarter, which was profoundly frustrating and disappointing to me. But what we do want you to know is there's many levers, meters, gauges that we constantly watch, measure, look at and attempt to optimize. And we're hopeful that we will be able to optimize more of them next quarter.

Our next question comes from Christopher Testa of National Securities Corporation.

I was just wondering just on the structured credit side. Just wondering if you could give some more detail in terms of how many refinances you're getting? And if you could give us an indication of where you're getting the AAAs in your CLOs priced, a lot of them are going in the 120s, sometimes in the teens? And also just wondering if you're getting any resets and getting -- and being able to extend the reinvestment period by a year or so in any of these structures?

We're doing all the above. Folks with access to Intex can look up all the deals in our book and see the exact pricing, deal -- tranche by tranche. I mean, this -- we've done quite a lot of these at this point, well over a dozen [right, Brian?] Of refis. And -- so it would be laborious to try to do that through all the deals right now, talk about the pricing of each tranche. But if you want to talk about some of that offline that would be fine. In general, we're seeing some pretty significant liability spread compression, which is very good news to offset, which has been fairly significant asset spread compression. And the liability spread is also going to be a function of [tenure]. So if we're giving -- doing a full reset for, say, 4 years to a deal, of course, that's going to be a wider spread than if we're just extending a deal for, say, 2 years on a yield curve spread basis. So -- but it's very hard to answer generically because every deal is different, and we look at on an incremental basis. What is our upfront cost, which is mainly going to be placement and legal and what's our expected incremental return? So each is considered on individual investment basis, and we drive hard to get the best deal we possibly can.

Chris, I have a little bit to add to that. And first, of course, what Grier is pointing out, each time we do one of these transactions, there are upfront friction costs, fees, legal and accounting that drag down for us the immediate benefit, nothing new there. So I look at our CLO book, and I'm thinking as we go through the quarter, "Wow, this is great. We have refied and repriced our liabilities." There's a third word that we're now using, I forget, what's that one?

We're resetting.

Resetting. Okay. Three types of transactions: refinanced, replace, reset. Basically lowering the cost of our liabilities in our CLO book. And incidentally, I think it's fair to point out that it's our CLO team as majority owner of these CLOs that goes to the managers in most of the cases and proposes a transaction to lower the liabilities. We do discounting work, we do the analysis, we do the model and our team lines this up, brings it to the manager, persuades the manager and then we go. So I'm thinking, "Wow." So all across our CLO book, we are lowering our cost of capital. That's great. A dozen deals. So you would think, "Oh, our net return on equity in our CLO book should be going up." Well, wait a second, wait a second, we need to calculate in a number of items. First, we can only do one deal at a time because of market capacity. So the 12 are not all done on one day, Jan 1, but they're done sequentially over the last -- roughly a year. That's one item. Meanwhile, on the -- plus you have all the upfront cost, which Grier mentioned. Meanwhile, let's take a look over at the asset side. Number 1, we see all those borrowers repricing -- the entire universe is looking to refi, reprice, just like we're doing with one big difference. They can all do it on their own schedule. They are not waiting in a queue to get through the capital markets with major CLO liability books to be repriced. And typically, they don't have to go talk to a few dozen lenders, bondholders, item one. Item two, so the asset side of the book moves downward more quickly than the liability side, okay? I didn't anticipate that. Number 2, people -- borrowers are largely moving from a 3-month LIBOR to 1-month LIBOR. That was the first easy, low-hanging fruit they all see and they can all grab. Our numbers suggest that it would be about 75% will do that. I think last I ask -- we're 5/9 through that process. So hopefully, that process -- I'm going to call it asset spread compression through 5/9, maybe 6/9 through that process. And there were some other -- I'm trying to think of what the other -- there were a few other elements relating to the borrowers that we hope will have run its course, maybe we're 2/3 of the way through that and this asset suppression in a CLO book will have run its course. Grier, you had something to add?

Yes. Just to give you a flavor, Chris. I'm looking at a deal we just refinanced that was 160 basis point spread originally for AAAs and we refied it at 120. We're seeing AAA spreads really come down substantially 30, 40 basis points from where they were before. In most of our deals, we refinanced the AAAs, the AAs and the single As. We haven't touched as much the BBBs and BBs on deals because of the embedded discount margin for those and just haven't seen as much liability compression in those so-called mezzanine tranches for deals. So it's really been more of the super senior, most senior tranches of deals that make sense to refinance, and we've got the ability -- and we make sure our [dentures] give us tranche by tranche refi rights. Much older generation deals didn't get that flexibility and that's something that our team has insisted upon for all of our deals that we've been involved in for years.

Okay. That's great detail. And just curious -- I know you guys have spoken at large about the online lending and the consumer, and you guys are generally bullish on the space. I'm just curious given the soft guidance and poor results at Lending Club and OnDeck. Just wondering if any of that is changing your thinking on how much you're investing in that space? Or just how you're going to go about investing in that space?

Well, we're getting good results in our platforms -- both of the platforms that you just mentioned and have a good relationship with both companies. Their models, especially Lending Club, are very different from ours in terms of being a pure originator and servicer as opposed to a balance sheet credit taker of risk as well as beneficiary along the way. One great thing about this business is because you're writing relatively small checks per deal, maybe $5000 to $10,000 for consumer loans, $30,000 to $50,000 for a small business loan and because they run off reasonably quickly, you've got the ability to make -- to pivot, to adjust course and make real-time decisions. We've been proactive in seeking to enhance underwriting, to enhance pricing and APRs, so touching both the risk side as well as the reward side. We've also, in some cases, negotiated the economic relationship we have with some of these platforms as well. And then we've been aggressive about having attractive financing, which is really mature with every passing year. A few years ago, there was -- I mean, less than a handful of commercial banks who knew anything about this space you could go to get funding. Now it's a much deeper market of those relationships. And of course, the securitization market has more and more people interested in providing warehouse lines and the like given a much more ready takeout upon exit. So we've learned some things, still have others. We think we're improving and getting better and really optimizing that book with the types of portfolios that have performed best with the best finance.

Chris -- this is John Barry again. For me, I really would like to see Lending Club -- they're good friends of ours, OnDeck, they're good friends of ours, and we feel we have a good relationship. We love to see the companies do well and generate lots of net income and have their stock trade up and all those great things. Fortunately, that doesn't directly impact us. We are impacted by the volume of loans that they show us, the credit quality, our ability to discern and select good quality loans. And so while we wish the best, of course, for our friends, Lending Club, OnDeck and others, we are fortunate, I believe, to date, to be able to continue to buy loans from them and not see any impact from the CEO leaving or a stock price swoon or the latest article in The Wall Street Journal or whatever it might be. And we do hope that, that continues. At the same time, we are always looking at additional platforms and looking at new sources of loans. We do not want to be dependent on any 1, 2, 3, 4, 5 sources.

Chris, the other item that I think important is, we've also determined with this market price online business that it's important to have a reasonably scale position in any one platform. Initially, we were spreading out across fairly significant numbers, about half a dozen or so different platforms. And what we realize is that there is a certain fixed cost embedded in each platform -- and unless you're really going to grow each platform to a sufficient scale, 100 million, 200 million plus, that it was really hard to get the target ROEs. Those ROEs were not going to be achievable. And the fixed cost pertains to dealing with the credit facility provider, doing the accounting for every SPV, trustee cost, a number of different --

Valuation, administrator, custodian. The number of hands that are outstretched requiring payment is fairly -- let's just put it this way, it's way more than I think anyone would have anticipated. And all of these costs do significantly drag down the net return. So the antidote is to increase volumes and increase scale without increasing those costs, which we have been on track doing. Right, Grier?

Correct. We're focusing on fewer platforms and therefore, amortizing -- signing up for fewer fixed costs.

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

Okay. Well, I want to thank everyone for coming on the call. I thank the people here and our shareholders for our interest and support. I'm reminded of one of our directors explaining to me once, John -- Mr. William Gremp, "John, trees do not grow to the sky." We will have quarters in the future. We've had them in the past that disappoint us. This one is profoundly disappointing to me. It causes great frustration. But it also causes me to be introspective, all of us, to ask, "What can we be doing better?" We are very focused on that. We do believe that we have great quarters in front of us, and we just hope that we can make the percentage of great quarters to the percentage of disappointing quarters as high as possible. Again, I thank everyone for joining us on this call. Have a wonderful afternoon.

Thank you.

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