Prospect Capital Corporation (PSEC) Q3 2012 Earnings Report, Transcript and Summary

Good day, and welcome to the Prospect Capital Corporation Third Fiscal Quarter of 2012 Earnings Release Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mr. John Barry, Chairman and CEO. Mr. Barry, please go ahead.

Thank you, Sue. Joining me on the call today are Grier Eliasek, our President and COO; and Brian Oswald, our CFO. 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 and our 10-Q filed previously. Now I'll turn the call back over to John.

Thank you, Brian. For the 3 months ended March 31, 2012, our net income was $50.2 million or $0.44 per share. For the 3 months ended March 31, 2011, our net income was $33.8 million or $0.38 per share. For the 9 months ended March 31, 2012, our net income was $154.6 million or $1.39 per share. For the 9 months ended March 31, 2011, our net income was $91.3 million or $1.11 per share. Our net income increased 49%, and our net income per share increased 16% from the March 2011 quarter to the March 2012 quarter. These increases are primarily due to growing interest income from additional investments, a loan prepayment premium received from NRG, higher dividend income from our investments in Energy Solutions and NRG and fees recognized in connection with the sale of our stock in NRG and the sale of Energy Solutions of its gas processing assets. Our net investment income was $58.1 million or $0.51 per share for the March 2012 quarter and $24 million or $0.27 per share for the March 2011 quarter. Our net investment income was $122.5 million or $1.10 per share for the 9 months ended March 31, 2012, and $64 million or $0.78 per share for the 9 months ended March 31, 2011. Our net investment income was $36.5 million for the December 2011 quarter or $0.33 per share. Our net investment income per share in the March 2012 quarter represented an increase of 55% from the December 2011 quarter and an increase of 89% from the March 2011 quarter. We are targeting continued growth in net investment income per share as we utilize prudent leverage to finance our growth through new originations, given our debt-to-equity ratio stood at less than 34% as of March 31. We estimate that our net investment income for the current fourth fiscal quarter ended June 30 will be $0.38 to $0.43 per share. Our net asset value per share on March 31 stood at $10.82 per share, an increase of $0.13 per share from December 31. This growth represents our sixth consecutive quarterly increase in net asset value per share. Our portfolio continued to perform during the quarter. None of our loans originated in 4 years -- over 4 years have gone on non-accrual status. We have generated cumulative net investment income in excess of cumulative distributions to shareholders for both, one, the current August 2012 tax year, $98.2 million of net investment income from September 1, 2011 through March 31, 2012 compared to shareholder distributions of $80.3 million during the same period; and two, since Prospect's Initial Public Offering almost 8 years ago, $435.1 million of net investment income from July 27, 2004 to March 31, 2012 compared to shareholder distributions of $423.7 million during the same period. Depending on future distributions to shareholders, spillback dividend classifications, differences between net investment income and investment company taxable income and other factors, we may retain significantly all or a portion of recent realizations and reinvest them in additional income-producing investments. I am looking forward to the day when we can report that we have made distributions exceeding $0.5 billion, and after that, $1 billion to our shareholders. We recently declared our 46th, 47th, 48th and 49th consecutive cash distributions to shareholders, including 26 consecutive per share monthly cash distribution increases. I'll now turn the call over to Grier.

Thanks, John. Our origination efforts during the March quarter and current quarter continue to prioritize secured lending, with an emphasis on first-lien loans, though we also seek to close selected subordinated debt and equity investments. In addition to targeting investments senior in corporate capital structures with our new originations, we have also increased our new investments in third-party private equity sponsor-owned companies, which tend to have more third-party equity capital supporting our debt investments than in non-sponsor transactions, while still maintaining flexibility to pursue attractive non-sponsor investments. With our scale team of more than 50 professionals, one of the largest dedicated middle-market credit groups in the industry, we believe we are well positioned to select, in a disciplined manner, a small number of investments out of thousands of investment opportunities sourced per annum. At March 31, our portfolio consisted of 78 long-term investments with a fair value of $1.69 billion, compared to 72 long-term investments with a fair value of $1.46 billion at June 2011 and compared to 58 long-term investments with a fair value of $749 million at June 2010. During the March 2012 quarter, we completed new and follow-on investments aggregating approximately $170 million. Our repayments in the March 2012 quarter were approximately $188 million. On January 4, Energy Solutions sold its gathering and processing assets for a sale price of just under $200 million, adjusted for the final working capital settlement, including a potential earnout of $28 million that can be paid to us based on the future performance of Gas Solutions. So far, after expenses, including structuring fees of $10 million paid to PSEC, Energy Solutions has received approximately $149 million in cash and an additional $10 million remains held in escrow. Our loans to Energy Solutions remain outstanding and are collateralized by the cash held by Energy Solutions after the sale transaction. The sale of Gas Solutions' assets by Energy Solutions has resulted in significant calendar year of 2012 earnings and profits for Energy Solutions. As a result, dividend distributions from Energy Solutions to Prospect will be required to be recognized by Prospect as investment income to the extent there are current year earnings and profits sufficient to support such recognition. Energy Solutions currently has approximately $148 million of cash available for future debt service, distributions, operating investments and the add-on acquisitions it is seeking and reviewing. Together with prior cash flows, but excluding both escrow and earnout, the exit price for Gas Solutions produced a 57% internal rate of return and 5.5x cash-on-cash multiple for Energy Solutions on its Gas Solutions investment. On January 9, Arrowhead repaid our $27 million loan. On January 12, we made a follow-on investment of $16.5 million to purchase secured notes issued by CIFC CLO. On January 17, we provided $18.3 million of secured second-lien financing to National Bankruptcy Services, a financial services processing company being acquired by a leading private equity sponsor. On January 31, Aircraft Fasteners repaid our $7.4 million loan. On February 2, Prospect sold NRG to a strategic buyer for $123.3 million. In conjunction with the sale, our outstanding $37.2 million loan was repaid. We received a $26.9 million make-whole fee for early repayment of the outstanding debt, which was recorded as interest income for the March quarter. PSEC earned a $3.8 million advisory fee in connection with the transaction, which was recorded as other income in the March quarter. After expenses, we received for sale of our equity net proceeds of $26 million and recognized a realized gain of $24.8 million in our March quarter. In addition, there is $11.1 million being held in escrow, of which at least 80% is due to us upon release of the escrowed amounts. Monies released from escrow will be recognized as additional gains if and when received. Including all cash flows over the life of the investment, but not including escrowed amounts, Prospect has realized a 58% annualized internal rate of return on our NRG investment. On February 10, we provided $15 million of secured financing to Rocket Software, a leading global infrastructure software company. On February 15, we provided $25 million of secured financing to Blue Coat Systems, a leading provider of Web security and wide area network optimization solutions. On February 24, we made a follow-on investment of $7.9 million to purchase subordinated notes in Apidos CLO. On February 28, we made a secured follow-on investment of $9.5 million in Clearwater Seafoods. On February 29, we provided $15 million of secured second-lien financing to Focus Brands, a leading franchisor and operator of restaurants, cafés, ice cream stores and retail bakeries. On March 1, we made a secured follow-on investment of $27.5 million in Safe-Guard. On March 14, we made an investment of $26.6 million to purchase subordinated notes in the Babson CLO. On March 16, VPSI repaid our $16.6 million loan. On March 23, Anchor Hocking repaid our $20.4 million loan. On March 27, we provided $12.5 million of secured financing to IDQ, a manufacture of refrigerant refill kits for automobile air conditioners. And on March 30, ROM repaid our $31.6 million loan. Since March 31, in the current quarter, we have completed 3 new investments, aggregating approximately $80 million, and received repayment on one loan. On April 2, we made an investment of $22 million to purchase subordinated notes in the PineBridge CLO. On April 16, we made a secured debt investment of $15 million to support the acquisition of Nixon, a designer and distributor of watches and accessories. On April 20, we made an investment of $43.2 million to purchase subordinated notes in the Symphony CLO IX. And on May 8, SonicWALL repaid our $23 million loan. On March 19, we entered into a definitive agreement to provide debt and equity for the acquisition of the businesses of First Tower, a private, multiline, specialty finance company headquartered in Mississippi with over 150 branch offices. We are acquiring 80.1% the First Tower for $110.2 million of cash and approximately 14.5 million shares of our common stock. We have the option, at our sole discretion, to substitute up to 100% cash in lieu of such 14.5 million shares of our common stock at a price per share based on average trading prices prior to the closing date. Completion of the First Tower acquisition is subject to regulatory approvals and is expected to close late in the current quarter. We are pleased with the overall credit quality of our portfolio, with many of our companies generating year-over-year and sequential growth in top line revenues and bottom line profits. None of our loans originated in over 4 years have gone on non-accrual status. The fair market value of our loan assets on non-accrual as a percentage of total assets stood at approximately 2.2% on March 31, down from 3.5% on June 30, 2011. Because of the performance of several controlled positions in our portfolio, we have selectively monetized certain such companies and may monetize other positions if we identify attractive opportunities for exit. As such exits materialize, we expect to reinvest such proceeds into new income-producing opportunities. We are pleased with the performance of our controlled portfolio companies and are actually exploring other new investment opportunities at attractive multiples of cash flow. Our advanced investment pipeline aggregates more than $500 million of potential opportunities, a significant increase and nearly doubling from our prior quarter earnings release as we observe a significant uptick in market activity this quarter compared to last quarter. These investment opportunities are primarily secured investments with double-digit coupons, sometimes coupled with equity upsides through additional investments, and diversified across multiple sectors. Thank you. I will now turn the call over to Brian.

Thanks, Grier. Our modestly leveraged balance sheet is a source of significant strength. Our debt-to-equity ratio stood at less than 34% at March 31. Our equitized balance sheet also gives us the potential for future earnings upside as we prudently look to utilize and grow our existing revolving credit facility, as well as potentially add additional secured and unsecured term facilities, made more attractive by our investment-grade ratings at corporate -- at the corporate, revolving facility and term debt levels. On March 27, we renegotiated our credit facility and closed on an expanded 5-year revolving credit facility for Prospect Capital Funding. As of March 31, 10 original lenders had extended commitments of $410 million under the facility. We increased the facility size to $482.5 million in April with commitments from 4 additional lenders, thereby bringing our total number of lenders to 14. The facility includes an accordion feature, which also allows commitments to be increased up to $650 million without the need for re-approval from the existing lenders or the rating agency. As we make additional investments, we generate additional availability to the extent such investments are eligible to be placed into the borrowing base. The revolving period of the facility extends through March 2015, with an additional 2-year amortization period with distributions allowed after completion of the revolving period. Interest on borrowings under the facility is one-month LIBOR plus 275 basis points, with no minimum LIBOR floor. The facility continues to carry a high-investment-grade Moody's rating of Aa3. Investments in the new -- improvements in the new 5-year facility from the prior 3-year facility include longer tenor, increases in advance rates under certain conditions, decreases in drawn interest cost, decreases in unused line fees, increases in maximum eligible loan sizes and increases in baskets for longer-dated and quarterly pay loans. Based on current LIBOR, we achieved a 125 basis point reduction in the annual drawn interest coupon compared to the previous 3-year facility. We have also significantly diversified our counterparty risk. We currently have 14 institutional lenders to our facility, up from 5 lenders at June 2010, 2 lenders at June 2009 and 1 lender at June 2008. In addition, our repeat issuance in the past 3 calendar years in the 5-year and greater, as well as 10-year and greater, unsecured term debt market has extended our liability duration, thereby better matching our assets and liabilities for balance sheet risk management. All of our term debt offerings are unsecured, have fixed interest rates and have no asset restrictions, have no financial covenants, have no technical cross-default provisions and have no payment cross-default provisions to our revolving credit facility. In the March and current quarters, we have also diversified our term debt beyond the convertible debt into the program registered bond and listed registered bond markets, thereby expanding our access to capital across multiple capital markets. All of our term debt has an investment-grade S&P rating of BBB. On February 16, we entered into a selling agent agreement for the issuance and sale from time to time of an unsecured program registered bond series. These program notes have a fixed interest rate and a 10-year maturity. During the March quarter, we issued $5.5 million of such program notes at an average interest rate of 6.97%. Since March 31, we have issued an additional $8.5 million of such program notes. On April 16, we issued $130 million of 5.5-year unsecured [Audio Gap] due 2017. This coupon represents the lowest coupon of any term debt we have issued to date. These 2017 notes are convertible into shares of common stock at a conversion price of approximately $11.65 per share of common stock, subject to an adjustment in certain circumstances. On May 1, we issued $100 million in aggregate principal amount of 10.5-year unsecured 6.95% notes due 2022 in the form of a listed registered note. These 2022 notes represented the longest dated notes issued in the prior 18 months by any business development company. In December 2010, we issued $150 million of 5-year unsecured 6.25% convertible notes due 2015. These 2015 notes are convertible into shares of common stock at a conversion price of approximately $11.35 per share. In February 2011, we issued $172.5 million of 5.5-year unsecured 5.5% convertible notes due 2016. These 2016 notes are convertible into shares of common stock at a conversion price of approximately $12.76 per share. Between January 30 and February 2 of this year, we repurchased $5 million of our 2016 notes at 97.5% of par, including commissions. We may look to make additional repurchases of debt if attractive opportunities become available. We currently have no borrowings under the credit facility. Assuming sufficient assets are pledged to the facility and that we are in compliance with all the facility terms and taking into account our current cash balance, we have over $600 million of new investment capacity at this time. Any principal repayments or other monetizations of assets would further increase our new investment capacity. Any increase in our facility size or issuance of other debt, including additional term debt, would also further increase our investment capacity. Now I'll turn the call back over to John.

Gee, I hesitate to speak up here since I've been informed that I am sounding wooden, unprepared and slow, understated, not good. I apologize to everybody. Maybe I can liven this up a bit. I'd like to hear from anyone on this call who appreciates our rereading our press release every time we have an earnings call. Is there anyone who's not able to get the press release and likes to hear it read out loud, likes to take notes? If people could speak up, I'd like to re-examine why we do this each time. Who thinks it's a good idea? Who thinks that we should just go right into the Q&A and assume people have read the press release. We spent 25 minutes on it here. No one has an opinion, I guess. Oh, okay, why don't we queue up a couple of people and get some feedback on both whether I'm wooden and unprepared and slow and whether we should be rereading out loud our press release.

[Operator Instructions] Our first question comes from Mickey Schleien of Ladenburg.

Let me start by saying I don't think you're wooden and slow, but I really would appreciate it if you didn't read the press release because I'm perfectly capable of reading it. What we do enjoy is the color that you can add in terms of the dynamics and the portfolio during the quarter, given that we don't have a lot of time to necessarily go through the Q in detail since multiple companies are reporting. That being said, what I would like to know is where you see the sweet spot in terms of risk-adjusted returns in the investments that you're making at the moment.

Okay. Just before we go to that. I think what we might do is shorten the presentation that we read, going forward. And in terms of the sweet spot, what I would say to you is -- was that your whole question, Mickey?

I'm sorry?

You didn't get a chance to finish the question.

No, no. My question was where's the sweet spot in terms of risk and reward in the leverage-low market at the moment for you?

Okay. Why don't we gave you 2 wildly varying answers, one from me and one I can't quite predict from Grier. In my case, it's always moving around. And on any given day, it might be different from where it was in the prior day. The first thing that we want to look to is preservation of capital. We want leverageability. We want a higher-rated assets. So we're looking most carefully at senior assets where we see there's adequate collateral, good rating, good investment by the sponsor, a good track record by the management, audited historical financials going back 5 years and we'd like to get into the low-double digits on those loans. I'd say that those types of opportunities get our attention quite quickly. Another set of opportunities that do are opportunities to invest in the equity of CLOs. We believe that there's been a wholesale abandonment of that asset class. And so occasionally, we take equity participations. Usually, it's junior notes in CLOs where we feel we're richly rewarded for taking risk. It has not eventuated with respect to the managers that we work with. The managers we work with have not had any loss of capital with respect to the equity and their CLOs. So those are 2 good areas. One is viewed by all people as being very safe, lower returning. The other area, if you're wondering where can you get higher returns, we find that the CLO is an area where occasionally we can dip our toe and then get some nice returns. Grier?

Mickey, it's an interesting question to ask us as dour credit-oriented lenders about sweet spots because mostly we look at -- we deem to be sour since we only invest in 1% or 2% approximately in what we see. So we usually don't like what we see out there at any markets, bull market or bear. I guess you can see that's discipline. And we don't really think about kind of tops down sweet spots either. This is a credit shop where things have to go through a rigorous and almost vicious wringer, where something like 18 or 20 blooming signatures are required before something funds. And finding something that everybody likes is almost a miracle, it feels like sometimes. So it's all an incredibly bottoms-up process that ends up resulting in a naturally diversified portfolio, and we're quite differentiated from our peers because we have a more diversified business. We have a sponsor finance business. We have a non-sponsor we call direct lending business. Within sponsor finance, we -- both agent deals, sole-lead deals, club deals and anchor deals on upper-middle-market-type transactions. And then we have our one-stop business, which almost none of our peers were in, just like the direct lending business. And within the one-stop, we also look for other types of one-stop financings and buyouts where especially finance models are intriguing to us. So our mission in life is to drive yield, to drive dividend, to drive earnings growth for our company in a diversified risk-adjusted fashion and also a tax-efficient fashion. I think the Tower deal that we announced in March is an excellent example of that. That's extremely tax-efficient. No taxes at the downstairs level. No taxes at the upstairs level as a nontax-paying rig with all those cash flows being swept into Prospect shareholders' hands in the form of dividend distributions. I wish I could give you a better answer, but sweet spot really depends on whatever credit memo I'm reading at that particular moment in time.

There you go, 2 very different answers. And let me point out that we believe one of the very strongest things in our company is the fact that people are expected to do their own work, their own analysis, reach their own conclusions and defend them in a room with other people that will be opposing them. For example, we have a loyal opposition who is required to shoot down whatever position is being presented by someone concerning a credit. And the result is that, in fact, whether it's at the lower end of the return scale where we ought to be getting a lot more collateral and a lot more security and safety, or whether it's an area where we're seeking higher return, there is a rigorous process, and that process tends to weed out surprises, which is the main thing that we want to avoid here.

The next question comes from Arren Cyganovich of Evercore.

Could you talk a little bit more about the First Tower acquisition, about the company itself? It's going to be, I guess, a relatively large company, looks like about 14% pro forma for the total investment portfolio. And then maybe some of the -- your expectations in terms of dividend returns from that investment?

Sure. We're very excited about the Tower deal. I talked about the tax efficiency a few minutes ago. We think this is a world-class management team led by Mr. Frank Lee. The company is based in Mississippi. It's diversified in several states with future growth anticipated in new markets as well. The company has performed well for many years with consistent earnings growth across multiple cycles. We think it's an attractive part of the consumer finance industry. This is not a payday lender. This is not 400% APR-type business. This is much lower on the APR level, focusing on "larger loan segment of installment lenders." There's a couple of comps, a publicly-traded one, that went public more recently that you can look at as well to get a sense of the industry. We announced that inverting our purchase multiple on a cash flow basis results in about a 20-ish percent return on a trailing 12-month basis. Obviously, we're not predicting the future. But our intention is to distribute the vast bulk of such cash flows upstairs to Prospect Capital Corporation. We're also pleased that the management team has made a significant co-investment alongside our capital to widen incentives. Where are we looking at potential tuck-in acquisition opportunities even though we haven't even closed the deal yet? We're hoping to sometime next month. And we think it's an excellent specialty finance model. It's a model that is run with a recently low leverage downstairs as we referenced less than 50% debt to total cap. So this is not a highly leveraged specialty finance model. With supportive lender bank group supporting the transaction, we were looking for future optimization from that standpoint as well.

Can you tell if you're leaning towards closing in cash or if you're still anticipating paying for the transaction partially in shares?

We have not decided that yet. But we are seeing a pretty big uptick in our investment pipeline anticipated cash needs. Tower would be about $270-ish million or so, give or take, depending upon our stock price should we choose shares this quarter. And then we referenced a more than $500 million pipeline's probably more than $600 million at this point versus our liquidity of about that amount of capital. So we'll decide, and we don't have to decide today or this second in time. We're going to start in the next few weeks and it really will depend upon other competing capital needs and a number of factors.

Okay. And then lastly, the new guidance for the upcoming quarter, $0.38 to $0.42, is a bit above what you're recurring income would be, what's included in that, that would be, I guess, from maybe the NRG or Gas Solutions that would be elevating that to a higher level?

Well, there's nothing from NRG included in that figure. We sold that company and had a very strong record quarter in this most recent completed March 2012 quarter. It does include some expected distributions and continued servicing of interest from Energy Solutions Holding, which is not just Gas Solutions, it has multiple energy companies within it.

You can't detail any specifics about -- I think my run rate of recurring income is somewhere around $0.25 for your portfolio, so it's pretty elevated.

At this point in time, where we are in the quarter, I think we're comfortable with the level of prediction, which is what guidance is embedded in the June outlook. And I don't think we'd want to break that out at this point in time. But I will say one other thing about this recurring income aspect. As I said before, we have a very -- a highly diversified business that we think gives us the opportunity to participate in markets and to look at a far wider range of attractive opportunities and peers who are just kind of long and strong sponsor financed at any and all moments in time. That's a good business for us, mind you, but it's just one of multiple businesses that a company like ours can participate in. And so recurring is an interesting concept. When you make double-digit coupon loans in the marketplace, arguably all capital is bridge capital that people want to repay as quickly as possible. So what's recurring when you're charging points upfront, when your capital's outstanding for 1 year or 2 or you repaid and maybe you're getting a back-end prepayment and/or some type of equity like participation kick or the purchased or got as part of additional consideration. We've had several attractive deals. You're buying Patriot Capital for about 60-ish cents on the dollar and reaping 40% plus IRRs in a realized basis of loans from that, monetizing Energy, monetizing Gas Solutions. We think when you look at a team, you look at the track record and performance, and you have multiple "nonrecurring items." You have to ask yourself at what point do they become recurring. So I'll leave you with that thought.

Our next question comes from Robert Dodd of Raymond James.

This is actually Bo Ladyman in for Robert. The follow-up on guidance, and I apologize if you already covered it, is the First Tower acquisition included in any way in that guidance?

Partially. I mean, we're putting out guidance that we feel comfortable with. If you added up every last dollar in our pipeline and included interest and structuring fees from that and Tower and the existing book, I think you would find with some back-of-the-envelope calculations that we put out some pretty careful numbers.

Okay, that helps. And then in 10-Q, I saw that you did not recognize or didn't have any dividend income in the quarter from Energy Solutions. What type of run rate should we be expecting on the dividend side from that entity going forward?

We don't really have numbers to put out for on -- when you say run rate, that's implying, "Hey, tell me not just June, tell me September, tell me December and so on and so forth." We don't typically put out guidance that far in advance and haven't in our 8 years as a public company. And if we did so, it would be kind of arrow extraction, not very useful information. We just haven't decided yet. It's going to depend also on what type of opportunities we see. We've done add-on acquisitions at Energy Solutions and Gas Solutions for 3x cash flow, just thinking about one add-on we did in the last 18 months. If those deals come along, you'd rather put capital out for acquisitions. If they don't, maybe you put the money upstairs and pay out a distribution to yourself. So there's lots of potential sources of -- potential uses of the, about $150 million we have downstairs at Energy Solutions Holdings. We didn't drive the structure, by the way, of that particular transaction purchased by a private partnership that needed to do a tax-efficient purchase, and we happened to have a C corp down there. So it ended up being an asset sale, which puts us in a position where if we do take back distributions up to the level of earnings and profits of which we have a pretty sizable earnings and profits anticipated for tax in calendar year 2012 because we sold that business for well over the basis, what was it, Brian, of about $130 million over to tax basis of the assets. So that's not our choice of the character situation, that's just how the accounting would work.

Okay. In deploying some of the capital -- some of the cash out of Energy Solutions, would you only be looking at energy-type assets or would that be not restricted?

Well, it's an energy-focused company and the expertise of the management team is really in the energy sphere. If we were to do another industry, more likely than not, it will be in a different platform, in a different portfolio company altogether.

Okay. Last then one from me. On First Tower, obviously, deals like that can be lumpy. But was that sort of a one-off? Are you seeing some more opportunities for that type of transaction and more buy-out transactions going forward?

Well, we first started working on that deal last summer, and I think that shows how things can appear lumpy on the origination front, and that's true in our business. But what isn't always appreciated, I think, from outside world, is the gestation period of the number of things we're working on. It takes months, if not years. Deals that will probably close next quarter and the quarter after that, that we start working on last year, for example. We've been examining this marketplace for a long time. We're not examining -- we've been an investor in it. We used to be a second-lien, senior second-lien lender to a company called Regional Management, which actually just went public, excellent company, well run. And we're refinancing and paying off out of that company about 1.5 years ago. And we don't necessarily love it when a good credit pay off because we've got to go find another one to go put capital into. And that was one of those deals we said ourselves, "Wow, we love this company. We'd love to own a business like this if one comes along." And in fact, it did in the form of Tower. But our hit rate on one-stop types of deals on portfolio types of deals, Patriot Capital types of deals, is also very low. Having said that, we continue to scour the planet for similar types of opportunities.

If anybody listening to this call is aware of any specialty finance companies, any portfolios, any hedge funds that need to lighten up, we are a highly motivated buyer. It is true that we will not pay the highest price, but we can be relied upon to be fair and to move forward expeditiously. So we're always on the lookout. We have to kiss a lot of frogs. We're happy to pay fees. I believe there's someone on this call who maybe is earning a fee for -- Sam, I hope you're there. And we're very happy to pay these fees out and enable people to liquefy and monetize investments, whether it's in financial services or not. By the way, we expect to see quite a lot of that activity between now and the end of the year. Whenever we see a deal prune away that we didn't get to look at, we find it to be very frustrating. So I know many of you work with investment banks, foreign investment banks, commercial banks, M&A advisers, please send us those deals.

And just to add one other point on Tower. We are looking at other potential add-on opportunities. but our core focus is on working with the excellent regulators to get formal approval at the state level for both the finance and insurance-related businesses, close that transaction on a timely basis in June and continue to have responsible stewardship company with consistent management that's done really an outstanding job running that company for a long time continuing.

Yes. And one of the other things about that company, that particular company that is attractive to us is that the credit profile is materially different from the leverage loan sponsor market, the cyclicality to the extent there is any is different. It's a different sine wave. And so as a result, it's a hedge for our business. It's a diversification of our business, and it enables us to spread the systems that we have in place here across other entities, and hopefully, improve their operations not that, that operation -- Frank, we're not saying your operation needs to be improved. But we do think that there are synergies between what we do and a number of specialty finance companies that are out there. And we would like the opportunity to bid on them.

And that business will be about pro forma for additional originations by June 30, maybe 10% of our asset base. So it's an important transaction. It's a meaningful one, but part of a significant diversified pool that continues to grow and grow and grow as we approach 80 and perhaps it'll be at 100 portfolio company by the end of calendar year 2012.

The next question comes from Joel Houck of Wells Fargo.

Forgive me if you disclosed this already, but did you talk about the multiple on EBITDA you paid on a trailing 12-month basis for First Tower?

We have not disclosed that. We did basically disclose what our multiple would be of pretax income, which is effectively distributable income of approximately 5x, and converting that, it's about 20%. You can probably back into multiple of EBITDA with a good desk work because I know you can do, Joel, based on the leverage that we also disclosed of the company.

This is how we look at it here. When we're talking to the seller, we can't believe you're forcing us to pay top dollar. There's no more money here. We're not paying $0.01 more. This is very richly priced. We can't discuss any -- even $0.01. Then when we're talking to our friends, we tell them what a great bargain we got, right?

Yes, I understand.

Joel, let me just add to that. That company went public in the sector I referenced, you could look it up, and we felt pretty good when that went public a week or 2 later.

Well, yes. Let me put it differently. I think the sellers got one amazing tremendous deal. And I think we also got a pretty good deal, too.

Well, they certainly invested alongside you, so it makes sense. One other...

You know what else I would say though? It's a very well-run company in an under -- in an industry that's not well understood. There's some prejudice. And if you look at the many, many years of stability and historic earnings and growth, Frank and his management team have done a great job there. I think they serve the community. There's a very constructive regulatory regime. And we're very happy to see if we can support the company in continuing to provide to the community the valuable service they provide.

Yes, we can have a conversation off-line. I've covered this industry for 10 years, and we cover all the public companies under my name, so I'm very familiar with the sector. What are you guys, in terms of the regulatory risk -- I mean, how did you get comfortable with what may or may not come out at CFPB given -- I know this isn't a payday lender, it's an installment lender; however, the comments, if you read from Cordray, have been very negative on this space, and most of the companies we cover have been running away, 100% running away from U.S. exposure, whether it's payday or installment lending. They've been making all their investments outside the U.S. and I'd be curious to see what you guys think about the regulatory risk of those transactions.

Sure, Joel. Happy to comment on that. And we spend a lot of time from the diligence standpoint of that topic. As I said, we first started looking at the deal last summer. I think we had it under exclusivity at the end of September, early October, and we didn't sign an agreement till March. So 5, 6 months of intense diligence of not just regulatory risk but all aspects of the business, financial accounting, legal, everything you can imagine. On the regulatory front, we examined risk at both the state level, as well as the federal level. Obviously, Cordray had his out of resort -- out of recess appointment that surprised a few people in December, and we studied that carefully. We feel like we're in pretty good ground focusing on the lower APR, higher ticket installment lending part of the business. And it's the higher APR that acts as really a bit of a red flag for regulators. And I think it's not really the right analysis to lump together every consumer finance business together from pawnshops, to payday, to large installment, to small installment. I mean, you compare Tower to even small installment lenders who have an average 70% APR, 9 months average loan and a $700 average loan where 75% of the core originations are just refis of existing book. A quasi treadmill perhaps, all the way to the payday lenders and the treadmill allegations that get made there. I won't really comment on that. But on the large installment side of things, you're talking about more like a 30% to 40% APR, $2,000 loans, 2-year loans. You're naturally, therefore, going to have somewhat more creditworthy borrowers. Tower's mix is a much lower percentage of refis as opposed to new "originations," and significant diversity across multiple markets, multiple states, and hopefully, new anticipated future markets. So I know their comments in January that had kind of a payday industry and gun [ph] sites. I consider 40% versus 400% to be different APR risk profiles, and we do a lot more analysis on that.

Yes, that's helpful. I agree with you, kind of, on the APR. I would just add, you asked for feedback regarding reading the presentation, I don't find it that helpful. In fact, I don't dial-in and queue up until 20 minutes past the hour. So if you change that, please let me know so I can dial in on the hour.

And Joel, we really appreciate your help on this year.

The next question comes from Troy Ward of Stifel, Nicolaus.

First of all, I'd also agree with Mickey and Joel about the press release. We don't probably argue that quite as much, but some may. Anyway, moving on, Grier, you talked about the pipeline and definitely $500 million, maybe $700 million is a record. It's definitely as high as we can remember it. Can you give a little bit of color, both John and you did, on what you're seeing. Can you speak a little bit to what you maybe expect for the second half of the year? We have some investment managers out there really getting pretty excited on what they believe is going to be a very big closing of the end of the year based on some tax changes and political information. So are you guys seeing anything where you feel like we're gearing up for that? Or what's your color on that?

Well, this is Grier. I'll go first. I'd love to make a prediction on this call, the kind of arrow extraction that everybody and their brother is terrified, that rates are going to go shooting up, dividend rates from 15% to 39.6% at the stroke of midnight on 12/31/2012. And therefore, every business owner in a panicky fashion is calling up their sell side M&A banker and saying, start the process now, so they don't get jammed. At the same time, we said to our people, stick around this year, around the holidays, some interesting deals could occur. We don't really know, Troy, how much of a driver that's going to be. There was a head fake 2 years prior and the politicians decided to focus on the FD elections and probably that will be the same case this year and a lot of back and forth angry political talk, and we'll see what happens at the end of the year. I see business owners making more rational decisions and maybe sometimes the tax tail wags the dog, maybe it doesn't. But in relevance, certainly, I'm not sure somebody would give away their company. At least on the control side where there's, by the way, a much longer lead time to actually get a transaction done. I mean, it takes 6 to 9 months on a typical process so, yes, you better get it started now on May 11 if you want to close by 12/31, and hopefully, you didn't give your exclusivity to a buyer who decided to jam you at the last second with new terms on December 30. But the recap size is a different matter. And I think it is possibly you'll see some quick dividends that occur in that last quarter if it's -- if there's a ratchet up in tax rates. I would be amazed if there weren't. But we're not really depending upon that. There's other drivers going on, I think, as part of the natural cyclicality of it. A lot of people got anxious, we noticed, in the industry in the March 2012 quarter. There's some seasonality in there where it traditionally is a little bit of a slower quarter for a lot of people and then we saw things really pick up come March. Sometimes, it feels like everything happens between March and June and then between September and November and everything else is slow there in the business. But we are seeing a big pickup kind of system-wide. We don't get that anxious about the ebb and flow of the dollars necessarily in category A. We do report that so folks have a sense. Originations can be a lumpy business. I mean, look at this quarter, Tower loan of $270-ish million, give or take, plus there are other ordinary course business, could be a $500 million plus origination quarter for us as a result. We'll see when that comes out. But it's very hard for me to sit here in May and tell you what we think activity in originations will be like in September and December. I can tell you we're supporting a lot of processes. We're getting mandated on a lot of deals. And that probably will mean that we're active second half. Certainly, if you annualized the first quarter, we'll see.

, Hey, Troy, it's John Barry. I noticed you didn't comment on whether I was a little too wooden here. You just commented on just the press release.

I would never refer to you as wooden, John. You're always...

Troy, I know I could count on you. By the way, my commentary, in addition to what Grier had -- and by the way, give my best to Greg as well. I'm sure he doesn't think I'm too wooden, either. I'm counting votes in my favor here. But I wanted to mention a couple of things. First, when people start these various M&A activities out of nervousness over tax rates or maybe just because the people are getting old and want to retire or want family succession or growth capital, we're there for them whatever happens. And so one of the things that works to our benefit is if people do start sale processes and for whatever reason it breaks down, they don't get the price they want, they need to close something by the end of the year, for example, maybe they want to draw down their basis before, Brian could certainly comment on that, before the end of the tax year at a lower rate, we're here for that. And so sometimes we see what happens is that after the election or even after Thanksgiving, people will call us up and say, "Whoa, this sale process isn't going well. We need to move quickly on the dividend." I want you to make sure everyone out there knows that we're ready, willing and able to jump to the ramparts and help those people out. And that, in fact, has been a significant source of business for us. The other thing I'd mentioned about a new business is I have sent an e-mail to your financial institutions group M&A head, advising that person to please show us deals, because we understand that your firm is quite prominent in middle market specialty finance M&A, so we'd love to hear from you. And then the last thing is while our predictions are -- they're very difficult, especially about the future, if you do look at our existing pipeline, it is around $500 million. Last I looked at it this morning, what's that, Grier?

Close to $600 million.

Close to $600 million, of which is only $100 million is First Tower. And so if you take First Tower out, it's still close to a record for us, I think, if not, in fact, a record. And that's coming off of a slow start at the beginning of the year. It seems as if the M&A and the sponsor community seemed to have been slow in warming up. But now they're moving along. A last factor that's very important for us and also like to ask you to help us get this message out, when we tell our deal leads, our sponsor coverage professionals, be sure that your accounts, we don't call them customers, right, they're borrowers, that your accounts are aware that we can write bigger checks now than we could the 3 years ago, 5 years ago. This is a message which needs to be delivered, because many of these sponsors believe that they need to go to the investment banks, do a syndicated loan or that they can only deal with, I don't know, some -- one of the 2 BDCs larger than we are. And we are getting that message out, and we are seeing these larger transactions. I'm sure you know they tend to be maybe not generating the yields that the smaller transactions do, but that's compensated by the fact that typically there's better management, there's more capital and more collateral and more equity beneath us. We feel that this ability to write bigger checks is going to help us, we hope, to stay on a higher sustained level of originations.

Great. And then a couple of other questions. One on First Tower and one on Gas Solutions on the big deal. So first on First Tower, Grier, you talked about the expected return. In the press release, it talks, I don't have it right here in front of me, at 21%, I think, was the number you put out there. Is that across your whole investment you're speaking of? Or is that just the equity piece of the investment? And if so, what type of return do you expect on the loan side of First Tower?

That's across all of our capital.

Okay. And then on Gas Solutions, and you answered it a little bit, but a little more color would be helpful. You talked about why it was structured the way it was. I mean, obviously, Gas Solutions was a part, a very successful part, of the portfolio for a lot of years and that unrealized gain was out there. And now it seems like that, that -- it's not going to come through as a realized gain. First of all, is that correct and explain to me again why that had to be done that way?

That is correct because it's an asset sale. As a tax-exempt, registered investment company, we had to set up so-called SECOR blockers in order to hold equity-type investments. And so that was the case when we first bought Gas Solutions back in 2004, we set up a blocker. In the energy midstream industry, a lot of the buyers are -- have 0 interest in buying corps and they have to buy assets/LLCs, partnerships and the like. So that was the case here with the buying community and the ultimate buyer.

So from -- almost from inception there with Gas Solutions, when you thought about or when you thought in the future about, okay, when we monetize this event, it was never going to come through as a realized gain. It always would have been something structured like this?

Well, we spent some time in various sales processes that we talked about over the years. I mean, look back, I don't know, 2008 we probably first started talking about that. And we always wanted to sell the corp. as a starting point and just a lot of the buyers, because they are either MLPs that aren't corps themselves or they are private partnerships that hope to become or sell to MLPs, just seem to have interest in focusing on partnership asset-type purchases.

Okay. And then -- so now as we have it today with the capital all residing down at Energy Solutions, what -- it's been asked a couple of times but I'll come at it at a different direction, how do we have any understanding of what could possibly be dividend of each quarter? Well, let me ask it in a different way. In the press release, it talks about you have required to be recognized by Prospect as investment income to the extent there are current earnings and profits sufficient to support such recognition. So does that mean you can only dividend up each quarter what profits or earnings there were down at Energy Solutions? Or can you just dividend up whatever you want at any given quarter?

The test on earnings and profits looks at an entire year of -- the entire tax year of expected earnings and profits and you're allowed to take up to distributions and recognize this as GAAP income, whatever goes up to that earnings and profits level from a tax standpoint. So GAAP actually looks at tax is the answer to that. So it's more of an annual look as opposed to a quarterly look. And we haven't decided, as we said earlier, how much that we might take out of the business as distributions. It'll depend upon what we find in the way of operational additional investment opportunities or hit on one of Energy Solutions' businesses. We bought a new supply vessel just a few months ago. We're looking at some additional potential investments in that business. And maybe another attractive opportunity we didn't add on for Gas Solutions I referenced earlier of about 3x cash flow that was a great deal for us that helped to enhance value on the exit as well. So we're looking at other deals.

Okay. Right. Just one final one then. Is -- will the income that comes up through that line be subject to the incentive fee calculation from the management agreement? Or will it be excluded because it is derived from the sale of an asset? Is it derived from a capital?

Well, let's see. If capital up to earnings and profits will become considered income, that will just feed into our overall net investment income that's part of the income incentive fee. Additional distributions, thereafter, will be considered, I guess, realized gains right, Brian? And will be below the line is subject to whatever waterfalls and accounts are for capital gains.

Okay. So to the extent that Energy Solutions has earnings, that much is still going to come through the capital gains -- or the, I'm sorry, the incentive fee?

Correct.

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

Okay. I feel like singing Wooden Ships from Crosby, Stills and Nash, but we're done. We're going to have a great lunch, and we hope you all do, too. Thank you.

Thank you all.

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