Dec 10, 2008
Executives
William Craig – Chief Financial Officer, Chief Compliance Officer Leonard Tannenbaum – Chief Executive Officer, President Bernard Berman – Executive Vice President, Secretary Stacey Thorne – Vice President, Investor Relations
Analysts
Greg Mason - Stifel Nicolaus & Company, Inc. David Chiavarini – BMO Capital Markets Chris Harris – Wachovia Roger Brown – Brown and Brown Brian [Gunig] – [Sunvest] Brian [Noveling] – DRW Investments [Yaz] – [Hugo News] David [Roser] – Tedco Inc.
Dr. Eugene Stricker – Fifth Avenue Capital Ron Silverton - Asgard John Ellis – Private Investor
Operator
Welcome to the Fifth Street Finance Corp. fourth quarter 2008 earnings conference call.
Today’s conference is being recorded. At this time I’d like to turn the conference over to Mr.
William Craig, Chief Financial Officer.
William Craig
Thank you. Good afternoon and welcome everyone.
This is the conference call to discuss the results for Fifth Street Finance Corp. for the year ended September 30, 2008.
My name is Bill Craig and I am the CFO and CCO of Fifth Street. I have with me this afternoon Len Tannenbaum, CEO and President; Stacey Thorne, VP Investor Relations and Bernard Berman, Executive VP and Secretary.
Before I begin I would like to reiterate this call is being recorded. Replay information is included in our press release today and is posted on our website.
Please note that this call is the property of Fifth Street Finance Corp. Any unauthorized rebroadcast of this call of any form is strictly prohibited.
I would also like to call your attention to the customary Safe Harbor disclosure in our press release today regarding forward-looking information. Today’s conference call includes forward-looking statements and projections and we ask that you refer to our most recent filings with the SEC for important factors that would cause actual results to differ materially from these projections.
We do not undertake to update our forward-looking statements unless required by law. To obtain copies of our latest SEC filings please visit our website or call Investor Relations at (914) 286-6811.
The format for today’s call is as follows: Len will provide an overview. I will summarize the financials.
Len will recap and then we will open the line for Q&A. With that I’ll turn it over to Len.
Leonard Tannenbaum
Thanks Bill. Welcome everyone to our year-end conference call and thank you for participating.
It has been a very volatile year but a successful one for Fifth Street Finance Corp. We were able to complete our IPO at book value and deploy the proceeds in the best market for lending in decades.
We were able to enhance our terrific relationships with private equity sponsors and demonstrate our strong value by sticking to our turn sheets while the competition re-traded or disappeared altogether. We continued to build on our great team by adding key members and growing our bi-coastal presence.
We met and exceeded expectations for growth, dividend and credit quality. Most importantly we held our very disciplined approach which had delivered strong returns for Fifth Street for the past ten years.
The approach is as follows: Only doing deals in conjunction with private equity sponsors, only completing first and second lien originations with the second liens having strong inter-creditors and liens, originating 100% of our securities in-house (we did not buy syndicate paper), setting strong covenants and terms and most importantly only originating deals which our scoring system showed us at high rewards relative to a low risk profile. Discipline, trust and shareholder focus is what you will hear from us over and over again.
We have historically operated in an LP environment in our previous fund where we had to deliver strong returns to our investors without the benefits of leverage. We have proven over time that we do not need leverage to generate high returns.
In this economic environment we will be very disciplined with adding any leverage to our currently un-levered portfolio. From a valuation standpoint we currently have written down almost $17 million of assets yet all of our loans are performing.
Since we get paid monthly by our portfolio companies we view nonperforming loans as any that have not paid within 30 days. These write downs as of September 30 value the portfolio appropriately at that point in time.
If the economy and/or any specific company performances deteriorates from that point we will have future mark downs. If they get better we will have mark ups.
What you will receive from our team and will learn to trust over time is that we appropriately value our securities. I look forward to calling the bottom in the decline in values but we have not gotten there yet.
The good news is that our sponsors are being very proactive in this environment and are in general supportive of companies with additional equity. This is one of the reasons we believe that sponsor-backed lending has substantially lower risk than unsponsored lending and therefore will have lower default rates.
Pricing in our market is truly exceptional. We believe many of the securities originated today will lead to enhanced returns in the market recovery.
We are also adjusting price upwards in any security that has a technical default or may have a technical default. Exit fees are also being added or enhanced to many securities as we endeavor to add potential upside to our investment returns when we eventually have an economic recovery.
We are not seeking permission in the upcoming proxy to sell stock below book value as almost all of our peers have done. While reduced capital availability will constrain our growth in the near-term, we have recently applied for SBIC leverage which will provide long-term, low interest, government supported funding for our deals.
We believe that if we receive an SBIC charter it will be very accretive to earnings. We also believe we can help small businesses grow as a result of this charter.
This is right in line with the government’s desire to stimulate credit to small businesses which account for more than 80% of the United States employment and economic growth. The lower middle market lending environment is picking up again in volume as sellers begin to adjust their expectations to the new macro economic backdrop.
There are very few competitors in this space that are actually lending. Competitors are going out of business from over-levering their assets and under pricing their previous deals.
This phenomenon creates opportunities for us. We are excited about our market positioning and appreciate the trust that you, our shareholders, have placed in our team.
We look forward to rewarding that trust with strong relative returns, a low relative default rate and increasing dividends. Now I will turn the meeting back over to Bill, our CFO, to discuss the details of our financial statement.
William Craig
Thanks Len. Before I begin to get into the numbers I’d like to recap some history so we are all on the same page.
I will remind you that the inception of Fifth Street was as a fund on February 15, 2007. So some of the comparable discussions that might typically take place on a call such as this may be omitted if it is not meaningful.
On January 2, 2008 the fund converted to a business development corporation which then went public in mid-June and our fiscal year-end is September 30. With respect to the IPO we received net proceeds of approximately $129.5 million.
We used approximately $15.2 million to redeem our preferred stock and approximately $27 million to pay down our revolving credit. The balance is largely to be invested.
With respect to our balance sheet ending September 30, 2008 total assets are $299.1 million which includes investments of $273.8 million net of $5.2 million of unearned fee income and cash of $22.9 million. Debt is at zero and stockholder equity is $294.3 million.
Our weighted average yield on investments was 16.2% at September 30, 2008 versus 16.8% at September 30, 2007. The weighted average yield on debt investments includes a cash component of 13.3% at September 30, 2008 and 13.9% at September 30, 2007.
Our net asset value per share at September 30, 2008 was 13.02. For the year-end total investment income was $33.2 million.
Total expenses were $13.1 million. Net investment income was $20.1 million.
Total unrealized depreciation was $16.9 million and earnings per common share, basic and diluted, was $0.29. With regard to the dividend, our board approved first fiscal quarter of 2009 and second fiscal quarter 2009 dividends on December 9 of $0.32 per share and $0.33 per share respectively.
The first quarter dividend is payable on December 29 for stockholders of record on December 19. The second quarter dividend is payable on January 29 for stockholders of record at December 30.
For the 2009 fiscal year we plan to pay a third quarter dividend in May and a fourth quarter dividend in August. At September 30, 2008 93% or almost $256 million of our interest bearing investment portfolio consists of fixed rate loans and 7% or nearly $18 million consists of floating rate loans.
All of our floating rate loans carry a minimum interest rate floor of at least 9% which protects our return in a declining rate environment. With respect to the portfolio, during the three months ended September 30, 2008 we invested $65.1 million across four new and two existing portfolio companies.
At September 30, 2008 our portfolio consisted of investments in 24 companies. All of these investments were in connection with an investment by a private equity sponsor and these investments consisted of 40% first lien loans and 59% second lien loans.
The balance is equity investments. As of September 30, 2008 no investments were in non-accrual status.
We did, however, mark three securities down as part of the valuation process for a total unrealized loss for the quarter of $3.6 million. The mark downs resulted from a decline in economic performance relative to expectations and declining comparables through the same period.
For the year unrealized losses totaled $16.9 million. With respect to our rating at September 30, 2008, the distribution of our debt investments on the 1-5 investment rating scale at fair value was as follows: Our overall portfolio credit is strong.
Investment rating one investments totaled $7.7 million or 2.8% of the portfolio. Investment rating two investments totaled $249 million or 89.2% of the portfolio.
Investment rating three investments totaled $17.7 million or 6.4% of the total portfolio. Investment rating four investments totaled $4.6 million or 1.6% of the total portfolio.
At September 30 we had one investment with an investment rating of one. It had an average debt to EBITDA multiple of 4.0 times.
Nineteen investments had an investment rating of two which had an average debt to EBITDA multiple of 4.23 times. Three investments had an investment rating of three with an average debt to EBITDA multiple of 5.86 times and one investment with an investment rating of four with an average debt to EBITDA multiple of 9.8 times.
Again, none of these investments are on non-accrual status. We are closely monitoring the status of securities with an investment rating of three and four and continue to provide managerial assistance as needed to help the companies navigate through the current economic downturn.
We continue to see the validation of our dual underwriting methodology as private equity sponsors are committing additional funds to support their portfolio companies. Regarding our valuation process, we believe that our securities should be marked up or down on a quarterly basis including debt and equities to a level where they would sell with a willing buyer and a willing seller.
Our valuation process is straight forward. Our internal team assembles all the necessary data from the portfolio companies and initiates their process which includes valuating the companies based on market comps, transaction comps and discounted cash flow.
At the same time they deliver the exact same data to our outside third-party who commences their process. Both groups produce a report that is reviewed by the valuation committee of the board which makes the ultimate determination.
We like the process because it is rigorous and arm’s length. We also like the fact that we typically value over 90% of the securities in a given quarter.
As to recent developments we have invested $23.3 million in three transactions since September 30. One of these investments was in a new company.
In addition, Rose Tarlow, an existing portfolio company made a $350,000 draw on its previously undrawn revolver. On November 28, 2008 Bank of Montreal approved a renewal of our $50 million credit facility subject only to satisfactory documentation.
The terms included a 50 basis point commitment fee and an interest rate of libor plus 3.25% and a term of 364 days. Starting in the first fiscal quarter of 2009 we will be FAS157 compliant.
With that let me give it back to Len.
Leonard Tannenbaum
Thanks Bill. In last quarter’s conference call we touched on several key points and deliverables and I’d like to update you on the progress.
Shareholder focus, to reiterate last quarter’s statement we believe that performance will ultimately drive the price of our stock. We believe a ramp in consistent yield is an essential part of the equation.
We have increased our dividend as we have now deployed substantially all of the cash from the IPO. Our dividends have gone during this fiscal year from 30 to 31 and we announced today increases to $0.32 and $0.33 for the first and second quarters of fiscal 2009.
We continue to expect dividends to increase over the course of the year. Creating Excess Returns.
While we generate alpha in all environments the current environment is the best environment I have seen in our 10 years as lenders. We have generated the vast majority of our investments in this very favorable environment and we expect our shareholders to benefit from that over the next few years.
Transparency. We continue to disclose debt to EBITDA of the rating trenches.
There is no doubt that EBITDA has deteriorated somewhat in this past quarter. The vast majority of the portfolio is not in danger of payment default.
You should continue to monitor our disclosure reports and monthly shareholder updates for return in the lower middle market. We believe our focus on transparency will deliver a higher multiple of book value over time.
Ultimately our goal is to generate strong returns. Let me reiterate our target of 15% net yield to NAV.
We are making progress towards that goal as we have achieved about a 10% yield on an annualized basis to NAV. We believe we will achieve our goal of 15% over the next 12-24 months.
Last quarter I said I would look forward to the call where I could proudly say we could trade at a premium to NAV and a premium to our peers. I know that to achieve these goals we need to continue to prove to you, our shareholders that we can deliver consistently over time.
We are now trading in line or better than many of our peers but are at a substantial discount to NAV. We believe by consistent, disciplined performance we will prove to be one of the beneficiaries of this credit dislocation.
Thank you for your support.
Operator
(Operator Instructions) The first question comes from the line of Greg Mason - Stifel Nicolaus & Company, Inc.
Greg Mason - Stifel Nicolaus & Company, Inc.
I wonder if you could talk a little bit about the dividend and 11 days in between the two record dates. Why are both of those record dates in December?
William Craig
As you know, we have an interesting history becoming a BBC in January of last year and then going public in June.
Greg Mason - Stifel Nicolaus & Company, Inc.
January this year.
William Craig
Right. We wanted to be in compliance as much as possible with the taxable distributable income rates.
So it has to be record date in 2008.
Leonard Tannenbaum
We should have announced this quarter’s dividend earlier and we waited until the board meeting and next year we won’t make the same mistake. We will announce it four weeks earlier than we just did.
Greg Mason - Stifel Nicolaus & Company, Inc.
Could you also talk about the good news on the BMO facility? You stated in the past you wouldn’t mind being levered in the 0.4 or 0.5 to 1.0 range.
That would imply another $100 million of potential credit facilities you could get beyond the BMO facility. Any thoughts with any additional credit facilities beyond BMO at this time?
Leonard Tannenbaum
No.
Greg Mason - Stifel Nicolaus & Company, Inc.
Is that due to a market function or are you just comfortable with running very low leverage at this point?
Leonard Tannenbaum
We have heard from and talked to many of our shareholders and gone around the country doing so. In doing so right now in this volatile environment being un-levered is definitely a benefit and our shareholders view it as that.
I think as you see the economy stabilize and/or improve additional leverage is not only prudent but will enhance general the return. So right now we feel pretty comfortable with a very low level of leverage.
That may change as the economy does.
Greg Mason - Stifel Nicolaus & Company, Inc.
Can you tell us how many of your portfolio companies you received additional funding from sponsors? You talked about pretty positively about getting sponsors to put in more money.
How much of your portfolio are your sponsors doing that with?
Leonard Tannenbaum
In anything that had a technical default, every sponsor with the exception of one has supported their companies. In our 10-year history as you watch the performance of all our other funds was a very strong credit enhancement.
I think Bill talked a lot about that on the road show about why sponsor backed transactions enhance the credit quality of the portfolio. The one that has not come to the plate and has not delivered on expectation is HIG and that deal is American Hardwoods.
We will not be doing any transactions with HIG at any time in the future.
Greg Mason - Stifel Nicolaus & Company, Inc.
Can you talk a little bit, you mentioned Martini Park in your press release, you quoted the unfunded commitment on November 4 and we saw an article on November 24 that the Dallas location has closed. Are you willing to give any kind of commentary on Martini Park at this time?
Leonard Tannenbaum
Sure. We are happy to give commentary on anything our shareholders want to know about.
Martini Park was initially a $15 million deal. In fact we got paid points on $15 million.
We have restructured Martini Park after a number of discussions given the economic environment, cancelled the additional $11 million of additional draw they could have had so our maximum liability is what we put out which is $4 million and restructured it to a cash pay and pick pay component. The close of Dallas, it was a money losing operation so we are pretty happy that was closed.
The equity sponsor is being extremely active and intelligent about the way he is handling the company and is looking for additional capital to open other investments sort of at the franchise idea. So with that, Chicago which is the primary operation we are secured by is actually doing okay.
Especially in light of the given economic environment. They are definitely cash flow positive and EBITDA positive.
Greg Mason - Stifel Nicolaus & Company, Inc.
You talked about this was a fantastic market for new investments. Can you talk about what you are seeing in terms of pricing on new investments, cash and pick yields, up front fees and really how many sponsors are out there doing deals and willing to take those kinds of rates at this time?
Leonard Tannenbaum
I think the choice, first of all we are only working with our equity sponsor partners at this time. We are reserving the capital for them.
We have built terrific partnerships over the past 10 years and it is our goal to maintain them. You can look at our subsequent events section and you can see some of the recent deals we have done.
I think we are looking at a 17-17.5% interest rate and that is not necessarily the total amount of earnings we are getting from those securities. I would say the IRR’s we are projecting in new deals are over 20.
In this environment that is really what our targets are.
Operator
The next question comes from David Chiavarini – BMO Capital Markets.
David Chiavarini – BMO Capital Markets
First off, what is the average EBITDA of your portfolio at this point?
William Craig
I would have to get back to you on that. The average EBITDA of all the companies?
David Chiavarini – BMO Capital Markets
Yes.
Leonard Tannenbaum
You certainly could take the average debt to EBITDA and you add debt and then you could figure out average EBITDA. We just haven’t done that calculation.
William Craig
We haven’t done it in the aggregate.
David Chiavarini – BMO Capital Markets
Can you talk a little about how you think lower middle market companies will perform given this recession versus larger middle market companies?
Leonard Tannenbaum
I think on a company specific basis a lot of our companies are niche industries. Companies like PPT, like Health Drive and others are performing very well.
Even the Burger King franchise the Gold Coast is performing well. So I think the smaller companies because they can hide from the overall economic cycle somewhat by a differentiated product or a mixed product are going to do better.
Having said that you have a different type of risk in small companies, right? They are normally one or two product companies while normally the bigger companies are multi-product companies.
So I think it is a different type of risk profile but I don’t see the smaller companies faring any worse than the economy as a whole if not better in some circumstances.
David Chiavarini – BMO Capital Markets
Given the current environment are you considering with new investments going forward moving up and looking at bigger companies than you have looked at in the past?
Leonard Tannenbaum
No actually I think we like our space a lot. We understand our space of the lower middle market and we think a disciplined approach, because we made it through the 01 cycle last time and we did it making money every single year and we plan on doing it through this cycle.
We want to stay with what we know and we know the lower middle market. We are moving up the capital structure however and you can notice by watching the changes in our mix that we have more first lien assets than I ever remember us having and far more than we have had in the past ten years with 40% first lien assets.
I think you can see that trend continue because even though we reach for higher pricing really more importantly in this environment is to reach for safety.
David Chiavarini – BMO Capital Markets
The three investments that were written down in the quarter were they in the consumer related industry?
Leonard Tannenbaum
Yes, all three investments were in the consumer related industry to an extent. Of the portfolio they are probably the most consumer focused.
William Craig
Other than restaurants.
David Chiavarini – BMO Capital Markets
Do you have at your fingertips your total exposure to consumer on a fair value basis?
Leonard Tannenbaum
I think it was 17% last time I looked.
William Craig
That is a ballpark figure not at our fingertips but it will be coming out in the K.
David Chiavarini – BMO Capital Markets
Then you mentioned in the press release you increased interest rates where you thought the risk reward of the investment began to get out of line. I had assumed once you make a loan the rate was locked in until it matured.
Are your terms unique? Could you talk a little bit about that?
Leonard Tannenbaum
One thing that was done in the previous environment was covenant light idea or loose covenants because nobody liked covenant violations. We have never really played that game.
We like covenant violations. We like tight covenants that allow us to come back to the table and really underwrite and think about how the equity sponsor is acting in each company, how the companies are acting and how the industries are acting.
When you set tight covenants and you have an economic decline as we just did you will get technical defaults even though the company may not be in any danger of a payment default. You can then use that opportunity to reprice the security.
So we are using that opportunity to reprice the security and by the way this is not unique to us. I’m hearing from a lot of our peers they are doing the same thing.
Operator
The next question comes from Chris Harris – Wachovia.
Chris Harris – Wachovia
I was wondering if you could comment a little bit more about this SBIC leverage that you talked about in your prepared remarks. What is it and how does it work?
William Craig
The SBA has the ability for a licensing program a small business investment company and we applied for the license. I think you will see some other BBC’s actually have or are affiliated with SBIC’s already.
We like it because it is in this environment fairly low cost capital and it would be attractive as capital for investing.
Leonard Tannenbaum
To be more specific the cost of a lot of the capital is 10-year treasury plus a spread. Bernie do you want to talk a little bit more about the structure?
Bernard Berman
Hopefully we will be forming a subsidiary that will be wholly owned by Fifth Street. If approved it will give leverage to the one from the SBA at very attractive rates.
As Dan said a six spread at the treasury which is fixed for 10 years so it is long-term leverage at very attractive rates if we are able to get it which we are hopeful of.
Chris Harris – Wachovia
Shifting to the write downs for the quarter, you guys had about $4 million and by my math that was about 2% of the beginning of the period portfolio. Does that seem to be a lot lighter than what a lot of your other peers have taken at least in the quarter ending in September?
I am just wondering if you can comment about what makes your portfolio different in regards to the write downs?
William Craig
It is hard for me to comment on what makes us different from the other guys. I don’t track them exhaustively or intensively.
I know we have a really rigorous process and to be flip about it we let the chips fall where they may by running our value process and let it come out. I guess the other thing to keep in mind is it is $16 million down in the aggregate for the year.
So it might be that we have been fairly straight forward about this from the beginning. So I don’t know if that is a comparable that holds up but we thought the number was about right.
I do know there are some people that are heavily discounting and honestly I don’t know why they are and I do know what we do though and we are pretty comfortable with the number.
Operator
The next question comes from Roger Brown – Brown and Brown.
Roger Brown – Brown and Brown
How do you account for paying such a big dividend when you only earned $0.21?
William Craig
The earnings are based on book income and the dividend is based on taxable income so there is a fairly significant cash component there. We feel we have it pretty well covered in terms of by the end of the year our tax distributable income will net out to the dividends we have scheduled which is what makes us a rich BBC and allows for this kind of treatment.
Roger Brown – Brown and Brown
Are you saying you are required to pay that out?
Leonard Tannenbaum
The unrealized losses do not impact the distributable income.
Roger Brown – Brown and Brown
Are you required to pay out the net income before the losses?
William Craig
Yes. There are some reconciling items there but simplistically yes that is correct.
Roger Brown – Brown and Brown
Then if you have capital gains you don’t have to pay those out either or if you have mark ups you don’t pay those out either?
William Craig
Unrealized gains that is correct. They don’t go into the distribution.
Roger Brown – Brown and Brown
With the rule 157 we happen to be holders of your earlier partnership. I notice you are selling at half of book value.
So should we be marking our holdings in that partnership at half of net asset value you declare?
Leonard Tannenbaum
I think you have to mark your partnership at the stock price wherever it may be since it is a liquid stock on the New York Stock Exchange.
Roger Brown – Brown and Brown
I’m talking about your previous partnership, not…
William Craig
Fund [two].
Leonard Tannenbaum
We can’t address Fund [two] on this call but we can certainly address it.
Roger Brown – Brown and Brown
Why can’t you address Fund [two] on this call?
Leonard Tannenbaum
This is a public BBC.
Roger Brown – Brown and Brown
Then you can call me back.
Leonard Tannenbaum
We can call you back.
Operator
The next question comes from Brian [Gunig] – [Sunvest].
Brian [Gunig] – [Sunvest]
Can you quantify the sponsor support that has been going on last quarter and maybe November, December and October in dollar terms?
Leonard Tannenbaum
You mean how much do sponsors put in additional equity to support the companies?
Brian [Gunig] – [Sunvest]
Yes.
William Craig
Actually after the first question I was thinking about that and we don’t have a total or a subtotal there. We can certainly approach it but here is the other side.
Oftentimes it is not strictly writing of a check. It might be hiring a consultant to come in and do inventory management.
It could be deferral on fees. There are a lot of ways they are actively supporting things.
And I don’t have a direct sense of what the…
Leonard Tannenbaum
It is a few million dollars per quarter at least. But it is not like they are writing $10-15 million checks.
It is not even necessary. The companies in general, when we underwrite a company we underwrite it with substantial opening availability and we underwrite based upon a strong cash flow and we stress test it for our providence.
When a company has issues we often encourage the sponsor and sponsors just often do it themselves of putting in half a million or million to million and a half dollars to support the company while it has liquidity needs and/or when we feel that we want a little bit more cushion in the economic cycle. I think we have found over the last ten years it is except for two cases the sponsors always supported their deals.
Brian [Gunig] – [Sunvest]
Based on the investment you made since the end of the quarter your cash balance is probably close to zero now?
William Craig
That is correct.
Brian [Gunig] – [Sunvest]
You were talking about being more prudent with putting on more debt and also taking that in context of where the economy is going. So are you saying you would pull down the line and use leverage ahead of seeing sort of a definitive turn in the economy?
The economy could be terrible for next year into 2010. We don’t know.
How early are you going to pull down the line in judging where things are in the economy?
Leonard Tannenbaum
We are a $300 million asset firm with potential to leverage $300 million of leverage on the BBC format. We are not going to do that or anything close to that.
We are going to pull down very small amounts of leverage. We probably will pull down on the $50 million line and we may expand to $100 million at some point but we certainly are not going to take our goal which was 0.5 or 0.6 times levered any time soon or at least until we see an economic turn.
Now, if the economy stays poor and our EBITDA continues to decline we are just going to support our existing sponsors. We are just not going to do any other additional deals.
Operator
The next question comes from Brian [Noveling] – DRW Investments.
Brian [Noveling] – DRW Investments
Just a follow-up on the SBIC loan. When exactly did you file that application?
William Craig
The exact dates are in the K which is going to be filed imminently.
Leonard Tannenbaum
It was in November.
Brian [Noveling] – DRW Investments
So is that a calendar year 2009 event would you guess?
William Craig
It is subject to the government approving our application and that is a little bit of a gray area. It certainly will not be calendar year 2008.
We are hoping it will be calendar year 2009.
Brian [Noveling] – DRW Investments
What is the potential size of that?
William Craig
Of the leverage, approximately $130 million.
Brian [Noveling] – DRW Investments
So that is sort of a maximum. Could it be you will get something and it might be just smaller?
William Craig
Yes that is possible.
Brian [Noveling] – DRW Investments
Just thinking about your putting the share repurchase authorization, it looks like roughly almost 1.5 million shares have traded below 50% of your book value but you did not take steps to buy any shares. How should we think of that share repurchase and looking at new…I understand supporting sponsors but putting new money to work when your shares are trading at below half of book value?
I’m just trying to figure that out.
William Craig
That is the essential question right now. We do have a share buyback plan in place and we are trying to be again, I think the watch word right now is being judicious in the use of leverage and the buyback.
As it gets down in the six range we might be buyers. We don’t want to be bidding against ourselves but we think we need to support the stock and it is an attractive return opportunity.
So we are just trying to be, as I said judicious in whether it is a stock buyback or putting it into an investment. We aren’t necessarily here to buy back the stock.
We would like to make good investments but sometimes that is the best investment we see.
Leonard Tannenbaum
I don’t know where you got the information that we did not buy back shares. We didn’t say whether we did or did not buy back shares yet.
We may have bought back shares in the past.
Brian [Noveling] – DRW Investments
I was just looking at the initial, there is nothing subsequent to the quarter or anything. I didn’t see anything here that indicated…
William Craig
We are trying not to be too effusive about what we are doing in terms of buying the stock. We want to be supportive but we don’t want to be stupid about it.
Brian [Noveling] – DRW Investments
I understand that. I don’t think it makes sense to go out and run out there.
Clearly there are some shareholders that have not fared too well in the six months and I think it would be just a good signal as you drop below that. Maybe people are thinking gees October and November must look really bad if they are still not buying stock.
I’m just playing devil’s advocate. I’m wondering how you are thinking about that.
William Craig
We sort of concur with that thinking and we have a plan in place and we will be supporting the stock.
Brian [Noveling] – DRW Investments
Can you give any more color on October and November? I know you kind of talked a little bit about it stabilizing but just general commentary?
Leonard Tannenbaum
October and November?
Brian [Noveling] – DRW Investments
Just the portfolio.
Leonard Tannenbaum
Every month we are going to release a statement to the shareholders because I think shareholder contact is really important and transparency is really important. What I wrote about in November is the deteriorating economic environment.
We all know in October the world stopped. It stopped for about a week.
It is no surprise to anybody and you can watch and see the stock market did in October. There has been a recovery in November which shouldn’t be a surprise either.
Therefore our quarter certainly got worse than September but not falling off a cliff worse. I think it has continued to decline.
I think I said that in my comments. I hope I can signal the turn at some point.
We just haven’t gotten there yet.
Operator
The next question comes from [Yaz] – [Hugo News].
[Yaz] – [Hugo News]
In terms of the way you report debt to EBITDA number is that EBITDA based on a LTM on a metric?
Leonard Tannenbaum
Say that again?
[Yaz] – [Hugo News]
Is the debt to EBITDA metric you guys reported on an LTM basis?
William Craig
Yes.
[Yaz] – [Hugo News]
So, based on my calculations it looks like your debt EBITDA ratio looks about 4.42 versus last quarter of about 4.0 just a simple blended average based on your financials. Does that sound right to you?
William Craig
I think that sounds reasonable.
[Yaz] – [Hugo News]
So if that is the case it sounds like EBITDA has really fallen a lot quarter-to-quarter but your write downs based on your NAV of 13.02 and last year was 13.12 or something like that. You haven’t really taken that material of a write down relative to the hit your portfolio had.
I just wondered if you had any comment around that?
Leonard Tannenbaum
I think the stressed securities that were early stressed accretively if you look at the ones that are stressed which are CPAC and American Hardwoods they are both written to less than 50% of value. In fact I think in one case it is 40% or less.
I mean, so it is the stressed securities that are feeling a lot of that. Also the debt to EBITDA ratio we want to be transparent in releasing them but you have to realize when one’s EBITDA goes from 3 to 7 or 3 to 8 it changes the average number quite a bit.
I wouldn’t take it as the entire portfolio is rapidly deteriorating but there certainly are a couple of securities. We have our first rated four security in American Hardwoods and that company has rapidly deteriorated.
There is no question about it. That is why it is written at $4.2 million with an original cost of I don’t know $11 million.
[Yaz] – [Hugo News]
So you are doing things in an LTM basis and as far as aggregate for the portfolio I would disagree that any one investment could have that big of an impact right? It is a rolling period your EBITDA is getting calculated over.
I’m not sure I agree with that.
Leonard Tannenbaum
Okay.
[Yaz] – [Hugo News]
On your weighted average yield it seems at 16.2% now, I think last quarter it was 16.5% but you have a bunch of new investments that were done even north of your 16.5% range and I’m just wondering how that was possible.
Leonard Tannenbaum
I had the same question when I first read that in the K and when our team calculated the number. We can certainly walk you through the details offline.
We are not going to walk you through it online. It is a function of OID and how certain securities are accounted for.
Also a number of the first lien loans, as I said, we tilted towards safety and Health Driver is the lower interest bearing loans on average but it is probably one of the safest loans in the portfolio.
[Yaz] – [Hugo News]
You mentioned there has been some technical defaults in your portfolio and so forth which I understand is probably not such a bad thing because you can renegotiate terms. How many of your 24 portfolio companies had technical defaults?
Leonard Tannenbaum
I would say probably 1/3. My guess is 1/3.
[Yaz] – [Hugo News]
The leverage loan index, basically that thing that there is a S&P capital leverage loan index which I am sure you are aware has just gotten annihilated particularly a lot of it happened in the last couple of months but a fair amount of it happened from June to September. Any comments on whether you think about that with respect to your thoughts on valuating the portfolio?
Leonard Tannenbaum
It is funny. People have asked the question, the leveraged loan index or the B index is 20% rate.
Why won’t you just buy some of those securities? I will tell you those securities are originated far worse than anything we originate in-house in general.
With our tight covenants and our net free cash flow covenants, with our being high in the structure and sponsor supported with open liquidity and thinking to our scoring system it is very difficult for us to even consider buying another person’s paper or syndicate paper. By that same token we value our portfolio versus the B index, the BB index or any other index.
I don’t think it is an apples-to-apples comparison.
William Craig
No I think that is fair. It always sounds like bragging to say but 20% open market paper is probably less valuable than our 20% paper just because we have the ability to customize our financing around the specific credit and know the management team very, very well and have a fairly good control on the business…we don’t control the business but we control the debt on a day-to-day basis.
Leonard Tannenbaum
What I will say though as you look at the spreads widen we have a fixed rate portfolio. Our spreads over treasuries or whatever benchmark you are going to use are 15-16 points over.
So as Libor has increased and treasuries have decreased spreads have increased but our earnings power has not decreased. That is different than almost all of our peers.
I don’t think anyone has as much of a fixed rate portfolio as we do. That has allowed us to really maintain our earnings power even in an un-levered environment while many of our peers with floating rate securities have [increased] earnings power.
Operator
The next question comes from David [Roser] – Tedco Inc.
David [Roser] – Tedco Inc.
How many of your companies, I don’t know if you covered this beforehand, are not paying current pay?
Leonard Tannenbaum
They are all paying current pay.
David [Roser] – Tedco Inc.
In the deals you have done, you guys do deals with companies that put into escrow interest payments to you for the first year. Are there prepaid interest payments at all in any of your deals?
Leonard Tannenbaum
No, we don’t do that. But in some securities we do have other forms of guarantees and asset coverage.
Operator
The next question comes from Dr. Eugene Stricker – Fifth Avenue Capital.
Dr. Eugene Stricker – Fifth Avenue Capital
Am I right to assume that since most insiders I believe purchased stock around $13 a share prior to the public offering that at the stock’s current low price the expiration of a lock up period which I understand was today is academic and should be of little or no concern to investors?
Leonard Tannenbaum
Actually I think the press reported incorrectly. The expiration of the lock up period was Monday.
So the old shareholders have been unlocked for a couple of days now.
Dr. Eugene Stricker – Fifth Avenue Capital
So things look good.
Operator
The next question comes from Ron Silverton – Asgard.
Ron Silverton - Asgard
Did you indicate what the current unfunded balance was?
William Craig
It is detailed in the K.
Ron Silverton - Asgard
And that K is going to be out later tonight before you open tomorrow?
William Craig
It is going to be out shortly.
Ron Silverton - Asgard
Can you give me a rough sense of what that looks like? $10 million?
$20 million? Zero?
William Craig
I think the unfunded commitment right now about $24 million. You’ll see about $24 million in the K.
Ron Silverton - Asgard
As of 09/30 it was $24 million?
William Craig
Right and then you have to adjust for our recent developments.
Leonard Tannenbaum
One of the recent developments, this is also public information, is the Martini Park coming down by $11 million.
Ron Silverton - Asgard
The investments that were made two of those were new investments so I assume that didn’t impact the unfunded commitment at all. So the third was a draw down on the unfunded commitment is that right?
William Craig
Right.
Ron Silverton - Asgard
So that $24 million drops down to $13 million and knock out another $5 million so around $8 million?
William Craig
The other draw down, I think the one you are talking about, was about $350,000.
Ron Silverton - Asgard
In terms of meeting commitments today that would require you to pull down the revolver in advance of the SBIC loan coming up or approval. Is that right?
William Craig
Yes, I know that is the math but we really based on our discussions with those folks I would say it is unlikely that any of them are going to draw down. I think it is unlikely that they are all going to draw down instantaneously in the next 3-6 months.
Most of them have their own business issues.
Ron Silverton - Asgard
The SBIC process, I don’t know if there is a typical but can you give us some sense? Would you expect to hear something in the spring or with the new administration coming in does that create a lot of turn over there as well and it probably gets pushed out until the fall?
Leonard Tannenbaum
We are hoping the new administration is a positive. Obama in general has said that he may enhance the SBIC program and certainly will focus on it.
We don’t know if that is true or not. We’ll find out when he becomes President but we are being hopeful.
Ron Silverton - Asgard
The funding on that the spread is fixed or the actual rate becomes fixed off of wherever the spread is when it gets approved?
Leonard Tannenbaum
The rate gets fixed on each investment as we are pretty much as each investment is done when you draw.
Ron Silverton - Asgard
Have you done any buybacks yet? You kind of danced around it with the prior caller.
It wasn’t disclosed in the press release.
Leonard Tannenbaum
Every quarter you will see in the quarterly releases any buybacks we do for the previous quarter.
Ron Silverton - Asgard
I just noticed that you certainly talked about a bunch of subsequent events but that wasn’t included so I would assume that given that would have been disclosed if you had done any?
William Craig
I’m not sure that is a fair assumption.
Ron Silverton - Asgard
The K will be out when?
William Craig
It is imminent. In the next 24 hours.
Operator
The next question comes from Greg Mason - Stifel Nicolaus & Company, Inc.
Greg Mason - Stifel Nicolaus & Company, Inc.
If we look at last quarter in buckets three and four you totaled $20.1 million. This quarter together they totaled $22.3 million.
I would assume roughly $3.6 million of the write down this quarter came from those in all likelihood. Can you tell us what investments moved into three and four this quarter versus last quarter?
Leonard Tannenbaum
I don’t think we talk about individual investments do we?
William Craig
No, typically not ones that have moved quarter to quarter.
Greg Mason - Stifel Nicolaus & Company, Inc.
Can you tell us if it is primarily from one investment or two investments? Can you give us a number on companies that moved in?
William Craig
Moved into category three or moved into four?
Greg Mason - Stifel Nicolaus & Company, Inc.
I would assume American Hardwood moved from three to four at 4.6. So it would appear that if we back out category three last quarter would have probably been around $15 million and now it is $17.7 million.
It would seem something moved in there either one or maybe a couple of investments. Is that a fair assumption?
Leonard Tannenbaum
Yes there are definitely investments that moved into category three.
Greg Mason - Stifel Nicolaus & Company, Inc.
Just one or a couple?
Leonard Tannenbaum
I don’t want to play the game each quarter about who is in what category and how they are going because it goes down to figuring out debt to EBITDA for specific investments and we don’t really want to do that.
William Craig
Let me comment on it this way. Honestly our problem children haven’t changed radically quarter-over-quarter.
Leonard Tannenbaum
That’s right. I think using some of the best analysis out there that our problem children are written down the most.
So you can figure it out that way.
Greg Mason - Stifel Nicolaus & Company, Inc.
You talk about you hired several people. How many deal people do you have today and can you remind us what you had at the IPO?
Leonard Tannenbaum
I think we are up seven. One of the guys we hired was John Miller who was a former managing director of now defunct Bear Stearns.
He is a Wharton grad, 1988, and I have known him for awhile and he is now a director in the company.
Greg Mason - Stifel Nicolaus & Company, Inc.
I believe you have a new portfolio company Cenogenics. Can you just give us a little color on what that business is and what they do?
Leonard Tannenbaum
Cenogenics is an age management business and we are doing that in conjunction with [Silas] who we also did Caregiver Services. This is one of the few businesses where we ask for weekly results.
They give us daily results. It is truly an amazing cash business of 100% privatized.
It is teaming up with a number of doctors and providing as I said age management services. You are going to see from us probably in this economic cycle more healthcare related deals to the extent we are really looking at doing more deals and/or add on’s with existing sponsor relationships.
Greg Mason - Stifel Nicolaus & Company, Inc.
I’m not really sure what age management services are.
Leonard Tannenbaum
Through a combination of diet and exercise regimen and in certain cases maybe even human growth hormone or other supplements. They help people feel younger and get healthier all through doctors of course.
Operator
The next question comes from John Ellis – Private Investor.
John Ellis – Private Investor
I wonder if you can clarify your leverage statement to me? You say you are not going to be on any leverage but on the other hand you talk about this SBA facility with two for one leverage and then handling that through a separately owned portfolio and wholly owned facility.
Is that going to be counted in your leverage or are you going to be doing no, no, no leverage?
Leonard Tannenbaum
I appreciate the need to clarify. I didn’t say we are not going to take leverage.
In fact we will draw on our $50 million line when we find the appropriate deals to do that with and/or expand the lines slightly. What I think the statement better clarified is we are not going to take on a high degree of leverage in this environment.
I think it is a matter of degree, not zero leverage.
John Ellis – Private Investor
Should the SBA facility then just be viewed as another facility that has attractive terms?
William Craig
That would be fair. It is a potential source of capital that has repayment provisions.
So yes if that is the way…
Leonard Tannenbaum
Most likely this is a 6-9 month trip before we even get the facility and set it up which means it is probably 9-12 months before we invest with it.
John Ellis – Private Investor
If I understand it properly you don’t have to count that borrowing in the two for one BBC. Is that correct?
Leonard Tannenbaum
You are right.
John Ellis – Private Investor
So it is off the books to that extent?
Leonard Tannenbaum
That is normally correct.
John Ellis – Private Investor
Is that the reason why you were thinking about putting it in a separate subsidiary?
William Craig
No, it is in a separate subsidiary because that is the way the SBA requires you to set it up.
John Ellis – Private Investor
So they are all this way?
William Craig
To my knowledge that are all this way.
John Ellis – Private Investor
I don’t have a very good idea of your management team. Can you just give me a little color on that?
Numbers of people, where they are located, the whole thing? When I look at a lot of places it says you have no employees.
That of course means your management team is freestanding. I’d just like to know a little bit more about it.
Leonard Tannenbaum
There are 23 in total. There are three or four located in L.A.
and the rest are here. There are four investment team members, investment committee members.
Our CIO is Mark Goodman. Mark actually was brought on in the very, very beginning of starting our second fund and Mark was brought on because we had gotten through the 2001 history and we were clearly worried that would happen again.
Mark has ten years of bankruptcy law experience, has 15 years of turnaround experience as a CRO and he is our CIO. So we built this, and I’m glad you asked the question.
We built this management team not for the good times but for the troubled times. In 2005, 2006 and 2007 obviously they turned out to be good economic growth years but when we have this economic crisis over the past year Mark has been absolutely invaluable in leading a portfolio management team to address and actually be really proactive in anything that looked like it was going to be a problem.
John Ellis – Private Investor
The 23 does that include the seven new deal makers you have just taken on?
Leonard Tannenbaum
I’m sorry, we took on seven new people. We didn’t take seven new deal makers.
We only took on one new deal maker. We really actually from an origination standpoint I think the entire origination team is only four people.
John Ellis – Private Investor
But the 23 includes the seven?
Leonard Tannenbaum
Yes.
John Ellis – Private Investor
Are your intentions to grow from here and if so what do you have in mind?
Leonard Tannenbaum
I think this team can handle more than double the assets we currently have under management. We obviously didn’t think that the cycle was going to hit as hard as it did.
I don’t think a lot of people did. But when the cycle turns we will continue to grow.
We certainly are more than adequately staffed for the size and current portfolio growth.
John Ellis – Private Investor
And your people have a 10-year history in this area?
Leonard Tannenbaum
I started the firm in 1998.
Operator
That does conclude our question-and-answer session. At this time I’d like to turn the call back over to you Mr.
Tannenbaum for any additional or closing remarks.
Leonard Tannenbaum
Thanks everyone for attending. It looks like we had much better attendance than the previous call.
We look forward to continuing to reporting our good results in the future.
Operator
That does conclude today’s conference call. You may now disconnect.