Prospect Capital Corporation (PSEC) Q2 2013 Earnings Report, Transcript and Summary

Good morning, everyone, and welcome to the Prospect Capital Corporation's Second Fiscal Quarter Earnings Release and Conference Call. [Operator Instructions] Please note today's event is being recorded. I would now like to turn the conference call over to Mr. John Barry, Chairman and CEO of Prospect Capital. Mr. Barry, please go ahead.

Thank you, Jamie. This is Grier Eliasek, President and COO. Joining us on the call today are John Barry, Chairman and CEO; and Brian Oswald, our CFO. Brian?

This call is the property of Prospect Capital Corporation. Unauthorized use is prohibited. This call contains forward-looking statements within the meaning of the securities laws that are intended to be subject to Safe Harbor protection. Actual outcomes and results could differ materially from those forecasts due to the impact of many factors. We do not undertake to update our forward-looking statements, unless required by law. For additional disclosure, see our earnings press release and our 10-Q filed previously. Now I'll turn the call back to John.

Thank you, Brian. In the December 2012 quarter, we achieved record net investment income and origination volumes. We also delivered $0.12 of growth in net asset value per share for the year-over-year period. NAV stood at $10.81 on December 31, 2012. Net investment income for the quarter was $99 million, up 172% from the prior year. On a weighted average per share basis, net investment income for the quarter was $0.51, up 55% from the prior year. We've delivered strong net investment income growth while keeping leverage low. Net of cash and equivalents, our debt-to-equity ratio was 29% in December. We have substantial debt capacity and liquidity to drive future earnings. We estimate our net investment income per weighted average share in the current March quarter will be $0.27 to $0.31. We've just announced more shareholder distributions through April to be our 57th shareholder distribution and 34th consecutive per share increase. Our net investment income has exceeded distributions, demonstrating substantial distribution coverage for the current fiscal year -- the prior fiscal year, the last 5 quarters and the cumulative history of the company. We've now paid out more than $11 per share and $675 million in distributions over the life of the company. I'll now turn the call over to Grier.

Thanks, John. Our business continues to grow at a solid and prudent pace. As of today, we've now reached more than $4 billion of assets and undrawn credit. Our team has increased to more than 60 professionals, representing one of the largest dedicated middle-market credit groups in the industry. With our scale, longevity, experience and deep bench, we continue to focus on a diversified investment strategy that covers third-party private equity sponsor-related lending, direct non-sponsored lending, club and syndicated lending, prospect-sponsored transactions, real estate yield investing and structured credit. This diversity allows us to source a broad range and a high volume of opportunities, then select in a disciplined, bottoms-up manner the opportunities we deem to be the most attractive on a risk-adjusted basis. Our team typically originates thousands of opportunities annually and invests in a disciplined manner and a single-digit percentage of such opportunities. Our non-bank structure gives us the flexibility to invest in multiple levels of the corporate capital stack, with a preference for secured lending and senior loans. Our approach is one that generates attractive risk-adjusted yields, and our debt investments were generating an annualized yield of 14.7% as of December 31. We also hold equity positions in many transactions that can act as yield enhancers or capital gains contributors as such positions generate distributions. Originations in the December 2012 quarter were a record $772 million, up approximately 5x our originations in the prior year December 2011 quarter. We also experienced $349 million of repayments as a nice validation of our capital preservation objective. As of December, we're up to 106 portfolio of companies, a 41% year-over-year increase and demonstrating both an increase in diversity, as well as the migration towards both larger positions and larger portfolio of companies. We also continue to invest in a diversified fashion across many different portfolio of company industries, with no significant industry concentration. In the December quarter, we enjoyed exits for Northwestern, Blue Coat, Hi-Tech, Wilson, Mood Media, Shearer's, Potters, Renaissance, VanDeMark, Hudson Products, Safeguard and STP. Our financial services-controlled investments are performing well, with annualized cash yields in excess of 18%, and our CLOs are currently yielding approximately 25% annualized. During calendar year 2012, we received significant dividend and interest income from our ESHI investment. We expect our income from ESHI in calendar year 2013 to be significantly less than such income in calendar year 2012. We are looking to offset this decrease by utilizing existing liquidity and prudent leverage to finance our growth through new originations, including attractive yielding investments in the financial services and other sectors. The current March quarter is off to a strong start, with $141 million of originations and a growing pipeline. Our credit quality continues to be robust. None of our loans originated in more than 5 years has gone on non-accrual status. Non-accruals as a percentage of total assets stood at only 1.1% in December, down from 1.9% in June 2012 and 3.5% in June 2011. Our advanced investment pipeline aggregates more than $400 million in potential opportunities, boding well for the coming months. Thank you. I'll now turn the call over to Brian.

Thanks, Grier. As John discussed, we've grown our business with low leverage. Net of cash and equivalents, our debt-to-equity ratio stood at 29% at December 31. We believe our low leverage and diversified access to funding demonstrate both balance sheet strength, as well as substantial liquidity to capitalize on attractive opportunities. We're a leader and innovator in our marketplace. We were the first company in our industry to issue a convertible bond, conduct an ATM program, develop a retail notes program and acquire competitors, as we did with Patriot Capital. Shareholders and unsecured creditors alike should appreciate the thoughtful approach differentiated in our industry, which we have taken toward construction of the right-hand of our balance sheet. As of December 31, we held approximately $2.9 billion of our assets as unencumbered assets. The remaining assets are pledged to Prospect Capital Funding, which has a AA-rated $552.5 million revolver, with 17 banks and with a $650 million total size accordion feature at our option. The revolver is priced at LIBOR plus 275 basis points and revolves for 3 years followed by 2 years of amortization with interest distributions allowed. We started the June quarter with a $410 million revolver in 10 banks. So we've seen significant lender interest as we've grown the revolver. Outside of our revolver and benefiting from our unencumbered assets, we've issued at Prospect Capital Corp. multiple types of BBB-rated unsecured debt, including convertible bonds, a baby bond and the retail notes program. All of these types of unsecured debt have no financial covenants, no asset restrictions and no cross the bolts [ph] with our revolver. We've now tapped the 5-year to 30-year unsecured term debt market to extend our liability duration. We have no debt maturities until December 2015, with debt of maturities extending through 2043. With so many banks and debt investors across so many debt tranches, we substantially reduced our counterparty risk over the years. As of today, we have issued 5 tranches of convertible bonds with staggered maturities that aggregate $847.5 million, have interest rates ranging from 3.75% to 6.25% and have conversion prices ranging from $11.35 to $12.76 per share. In the past, we repurchased such bonds or we deem such purchases to be attractive to us. We have issued a $100 million, 6.95% baby bond due in 2022, and traded on the New York Stock Exchange with ticker, PRY. We have issued $183 million of retail program notes with staggered maturities between 2019 and 2043 and a weighted average interest rate of 5.9%. From March 31 to today, in addition to our revolver expansion, retail program notes issuance at 3 convertible bond issues, one in April, one in August and one in December, we have issued equities 6 times, each at a time -- each time at a premium to net asset value. In 3 ATM programs, we raised gross proceeds of $268.8 million. In an underwritten offering in July, we raised gross proceeds of $269.3 million. And in our underwriting written offering in November, we raised gross proceeds of $388.5 million. We currently have no borrowings under our revolver. Assuming sufficient assets are pledged to the revolver and that we are in compliance with all the revolver terms and taking into account our cash balances on hand, we have approximately $740 million of new investment capacity. Now I'll turn the call back over to John.

Thank you, Brian. How about some questions?

[Operator Instructions] And our first question comes from Greg Mason from Stifel. Greg M. Mason - Stifel, Nicolaus & Co., Inc., Research Division: I wanted to -- if you could discuss your new REIT strategy. You've started it in December, looks like you've added to it here in the new year. Can you just talk about what you're trying to do in that REIT strategy, how big it could be and also the return potential. I know that debt has a 12.5% return, what should we expect for equity returns on that potential strategy?

So our business continues to grow and expand and diversify. We think that sets us up well, not just from a reward opportunity standpoint but also from a risk management standpoint. We view diversity as a good thing, and we view a big part of our job is to manage risk even though it seems like a good part of the world out there seems to have forgotten about risk on the current quarter. We haven't. But we're not just diversifying for diversity's sake. One component of our real estate strategy is significant tax efficiency. Real estate investments, to be set up for private REIT in our structure, is a BDC have a nice and almost a rarified nexus of being both a 70% basket industry under our BDC rules, as well as one that we can hold without a C corporate tax paying block or in between. So that's one aspect of it. It's obviously contracted cash flow, recurring revenue, diversified, a lot of things we look for on the credit side. To date, our investments had been in the industrial sale-leaseback side, which is really very closely aligned with corporate credit analysis anyway. And also on the multifamily front, where you can get government-supported financing from the GSEs on a 10-year basis. So you've got a yield compression going out there across many different asset classes, and real estate is not immune to that. But if you can lock in an attractive spread for 10 years and deliver that spread to the investor in a sort of a low-double digit and potentially even better basis, we view that as fairly attractive. You asked about average returns, and I would say the low to mid teens is what we would expect on covenant all-in blended basis in that strategy. In terms about how big it could be, we've made about a fairly modest as of 12/31 investments in that area about $50 million or so. We expect it could grow to be significant. What is significant? A little low to put precise projections out there because we don't really think about our business that way. We look at everything bottoms up. Every deal stands alone and has to pass muster. But what I can tell you is we've got a very robust pipeline of opportunities, many of which singular opportunities are in the $15-million-plus range. So we think it can grow perhaps significantly, and we like having that diversification, the diversification of real estate, the diversification of our buyout strategy, the diversification of structured credit. Maybe 90%, 95% of our peers sort of do one thing, their long and strong sponsor's finance. Don't get me wrong. That's a good business. It's big part of our business. We continue to address it, but it can be a frustrating and yield compressing and more commoditized business from time-to-time. So when you've got lots of different choices, we can afford to be very disciplined and choosy. So that's part of the component as well. Did I answer your questions, Greg? Greg M. Mason - Stifel, Nicolaus & Co., Inc., Research Division: Yes, that's great. And just one follow-up on the new multifamily property in Florida. You talked about GSE debt. So is there GSE debt in front of your $30 million investment that you make in those properties?

There is, and that type of debt comes, I think, at about a 3% to 4% fixed interest rate. Greg M. Mason - Stifel, Nicolaus & Co., Inc., Research Division: Okay. Great. And then one final question, I'll hop back in the queue. You've also been kind of focusing on the installment lender area with the First Tower and then you did Credit Central in the fourth quarter and then subsequent nationwide subprime auto lender. Could you talk about kind of these subprime borrower focus, what you see in that business, why you like that and kind of more importantly, give us comfort with how those businesses perform through the downturn as kind of the potential risks in those areas.

Sure. We spent many, many years analyzing Consumer Finance businesses starting with and especially the installment space, where obviously we made our First Tower investment last June. That diligence deep dive goes all the way back to 2007 when we made a junior debt Investment in a company called Regional Management, which is now a publicly traded company. I remember, with that transaction, we analyzed the financials, I think, going back to the 1980s. So we looked at multiple economic cycles, multiple recessions, analyzing delinquencies and charge-offs. And we're quite intrigued that in that business and businesses like that, yes, there's an impact during economic recessions but not as severe as one might surmise without doing further investigation analysis. So we like the steadiness of the business. We like the attractive cash yields. There's a ready stable of lenders, primarily banks, who give you ABL-type of financing, generally in the 60% to 85% range for these types of businesses. That enables you to enhance your yield attractively. But given the unlevered yields are sort of in the mid teens, so push came to shove, and you had to pass the senior debt, you still do pretty well in their mind. We're looking at the possibility of securitizing some of that debt. It's a little trickier. We have decentralized servicing the case of installment, a little easier to do in the area of auto finance. Tower is sort of an A loan installment lender that we purchased in June. Credit Central, B loan, a little bit higher in the APR scale, a little bit shorter loans, a great track record. A team that we're backing there as well. Smaller transaction, we'd like to see it grow, probably as a separate independent platform, separate management teams, separate capitalization, financing, et cetera. Nationwide, which we just closed in the auto finance space, not a huge investment for us, about $25 million, but an area in which we've spent, again, going back to careful diligence and underwriting, we spent about 18 months exploring, understanding the auto finance sector and thinking about risk at a macro level and at a micro level. So we made this investment. We are actually looking for other investments in that sector. So don't be surprised if we see future announcements that we may close now, I think, if we don't find the right team, platform and value, or we may close something interesting. There's a little bit more volatility in auto finance than on the installment side of things. So careful underwriting is required there, and there's lots of different models. There's branch-based models. There's more centralized models. There's different parts in which people play geographically, different parts in the credit qualities of customers. And key for us is to work with teams that have been excellent track record of careful underwriting. And the longer the team or company has been around, the more data there is to analyze over long periods of time. Does that help answer your question, Greg?

Greg, this is John. These businesses have been around for very a long period of time. They're highly diversified. They provide steady returns, and they suffer from always being out-of-favor. The result is that people who are prudently investing in this area, and we've passed on some, and we've gone after others I think can outperform. I remember Joe Steinberg back in 1985 talking to me about Leucadia being investing in one of these businesses and saying, John, this is the best investment we've ever made. These people always repay their loans for the car or the boat or the TV or the sofa or whatever it is. So we've been looking at this area [indiscernible] for a long time, and we feel we have significant expertise in the area. We've had good results to date, and as a result, we're very happy to continue investing in that area.

And just to underscore the diversity, Tower is hundreds of thousands of loans. Significant diversity for Nationwide, Credit Central. We like the granularity of the customer base. We're also not running these businesses with a huge amount of leverage. We're not maxing out leverage. We're leaving ourselves a significant cushion on the borrowing base front. So this is not a leverage at the portfolio of company-type strategy. We're getting attractive unlevered returns, and boosting that prudently as well. With the end result being we're able, in this part of our portfolio, generate 20%, some cases more than that. I think we're collecting more than 30% in one of those deals, which is a very nice piece of our portfolio when you have yield compression that is confronting the more corporate-financed, including sponsor-financed side of things. So it's nice to have other yield contributors when you have that phenomenon occurring elsewhere.

And people about worry about Richard Kudrow [ph] and what he's going to do. Well we have 2 responses to that. One is that there's many actions contemplated, threatened, considered and organized, but many fewer negative ones occur. And we underwrite, in any event, these credits, assuming various negative occurrences, yield compressions, recessions and so forth. And even with those adverse cases, we do very nicely. So this is going to be a stable, and we hope, growing part of our portfolio.

Your next question comes from Robert Dodd from Raymond James. Robert J. Dodd - Raymond James & Associates, Inc., Research Division: I've got a couple. One, just a follow-on on one of Greg's on the REIT side. I mean, I understand this is an attractive area, diversification, et cetera, but what's your, potentially, your edge versus the REITs that are out there that have a structurally, for whatever reason, lower cost of capital. So you're going to have an edge on underwriting and finding the right property where their cost of capital doesn't price you at the market. Can you talk about that a little bit?

Absolutely, Robert. Thanks for your question. I would say our cost of capital is not higher, it's equal to the public REITs because we pay no taxes at the portfolio of company private REIT level and we pay no taxes upstairs. so it's just measured on a efficiency basis, I would say, where we've got a match. Look, there's a lot of inefficiencies embedded in the "middle market", private deal market of real estate too, not unlike on the corporate side of things. And of course, there are many deals that don't make sense to do. There are properties with low cap rates. There are properties that need significant capital expenditures attached to them. Ones where there's too much of an overbuild happening in a particular geography. There's lots of analysis that go into it. And I want to emphasize that our book-to-look ratio is very low in terms of conversion rate, what we see versus what we do in that area. Just like the rest of our business, that's run for many years, really since the beginning of this organization, at a single-digit percentage, in typically a low-single digit percentage conversion rate on deals. So as with a lot of things, it's bottoms up not tops down. It's ever deal stands alone, and you win attractive risk reward. That's the proverbial dollar bill on the sidewalk that the economist doesn't believe can ever exist by outhustling the competition, by working with strong operating partners who can find less auctions transaction flow, where you can get compelling value. Not that different from how we're able to do attractive deals in the control front. Some would say, "Hey, tops down, there's lots of private equity firms, you can hire any number of efficient auctioneers of businesses, and they're going to find the highest bidder. And if you win, you must have a way of repay it, and that's winner's curse. Well that's a tops down view. Bottoms up, we see lots of dollar bills when we hustle for them, when we go after them. And where recreate, as is with property manager, operating partners, who can source propriety deal flows. So we have one such relationship, which we work with on the multi-family side. Of course you need to have property manager there any way on the back end. And that same relationship is we're looking with multiple other very interesting transactions with. And there'll be other relationships like that in other sectors within the real estate. So -- but every deal is a standalone, which is why I was cautious in the earlier question about saying it'll definitely be a $500 million or $5 billion or whatever x number of months and years from now. We're optimistic. We're excited on what we're seeing, but cautious as always. Robert J. Dodd - Raymond James & Associates, Inc., Research Division: Got it, appreciate that. Another one, on the nonqualified bucket. Obviously, the REITs qualify in the structure you have. But on the nonqualified side, with First Tower and your Consumer Finance and then your diversified finance for CLOs, I mean, it seems like you've got quite a lot of concentration within the nonqualified bucket, and a couple of -- one is clearly the Consumer Finance that's clearly a niche sector, it's not a -- so there's quite a lot concentration. What are your thoughts on adding more diversification within the nonqualified assets?

Sure. We are looking at other sectors. I mean, broadly speaking, it's financial services types of companies that go into nonqualified, as you put it. Others refer to it as the 30% basket for BDCs. I would suggest we have a lot of diversity there already. Structured credit, what are we up to, Brian? 12 deals, 14 deals, 12? As of 12/31 we are making other investments. And that's somewhere the 10% to 15% range of our asset base. Consumer finance is maybe the 5% to 10% range, probably about 10%. So we have capacity with the 30%. We do joke about whether or not we face capacity issues. We have an arm wrestling match between our structured credit team and our sort of big buyout team. But we've been growing the denominator, if you will. So we haven't really faced an issue. We monitor that basket everyday. We've got plenty of capacity there, and we're looking at investments. And so we have -- within Consumer Finance, we've got different parts of the installment spectrum. We've got auto finance well diversified within structured credit. We're looking other types of assets that would fall within the 30% basket that are quite diversified, and we'll see if we end up making investments in those arena. Look, we view -- you asked the question about adds earlier. We view ourselves as having significant edge when it comes to analyzing specialty financed business models, maybe because we are a specialty financed company. So we know a thing or 2 about our own business, we should be able to apply that to outside platforms and synergistic areas. So we've attempted to do just that and tried to analyze things very carefully over a multiyear period and looked at lots and lots and lots of deals before pulling the trigger on the ones that we have. So does that help? Robert J. Dodd - Raymond James & Associates, Inc., Research Division: Yes, absolutely, that's helpful. And then just one last one, just kind of a general question. Obviously, you talked about the market, as you said, in the middle market sponsor finance that we're getting what has gone -- has been that way for a little while now. I mean, are you seeing any signs of that continuing to get worse, getting better? Are you seeing changes in structures either on covenant fee structures? I mean, are fees that would normally be paid upfront, not getting paid upfront? I mean or what's -- what are you seeing in the market?

Well, first, it's helpful with that discussion to segment the market and how we define it. And of course, all this is caveat by saying on the bottoms up basis, every deal can be different. But we tend to address $5 million to $100 million EBITDA companies that quote middle-market $5 million to say, $10 million of EBITDA. You might say that's the lower middle-market. $10 million to $40 million, the traditional middle-market, classic middle-market, middle middle-market, whatever you want to call it. $40 million to $100 million of EBITDA, the upper middle market, quasi-syndicated market. And where you're seeing the most impact is probably in the upper bands, the upper middle-market, quasi-syndicated market. When the deal goes to Wall Street desk, it just flies off the shelves 2, 5, 10x oversubscribed to a lot of different buyers. We have dialed back our -- it never was a huge part of our business, but we have dialed back our activity there substantially. And we see leverage popping up. We see yield compressing. And the vast, vast bulk of our business is age in the business, prospect age in the business. So in the other parts of our business, there's definitely competition out there, and we certainly do lose deals over pricing. I would say that in general, there is yield compression going on across the board, whether it's senior paper or sub-debt paper alike in that space. So that is occurring. And how do you fight against that? And you asked a question about upfront. On the upfront point, whether it's the structuring fee or OID, which is more of a syndicated-type aspect, we're still getting say an average of 60 points upfront, Brian. That hasn't changed too much, Robert. It's in more on the yield side of things. But we differentiate ourselves as an agent with other factors. Yes, it's about basis points, but it's also about the relationship. It's about the repeat business. It's about the "reliability". Reliability, not meaning you say yes in every deal, but you try to assess out fatal flaws early and not have too many surprises that you generated on the back end. And we do a lot of repeat business with the same relationships, where we're not necessarily the lowest cost of capital. But it's an important deal for a counterparty, an important deal for us. And I think people that have the long view as counterparties realize that there is the initial spread or yield you start with, and you're going to go maybe through an economic cycle or 2 or say 1 deal, 1 cycle during the life of a particular loan. And you want to have a lender that, a, is financially strong. And because you pick the lowest-cost person from a weak lender, well, they're going to be the first one not giving you the amendment, not giving you relief, not being thoughtful on the back end if there's a problem and really hampering your business. And I think the really -- the smart-money counterparties know that. Maybe we call them smart just because they're willing to pay us a little bit more, Robert.

Our next question comes from Jonathan Bock from Wells Fargo Securities.

Broadly speaking, I was just curious, I noticed there is quite a bit of money market cash on hand in addition to the credit facility capacity. So perhaps walk us through the reasoning of an ATM or a new ATM being established at a point when it really seems that new equity likely would not be needed for a while?

Yes, great question, Jonathan. Putting aside the aspect of issuing above book and addressing just the purer -- because we have an issuing of our book. But addressing this liquidity question, we mentioned that our advance pipeline, we call it category A, is in excess of $400 million right now. That's one piece of it, but the team is working on some pretty significant transactions. And our hope and desire is that, that could actually change fairly quickly. So our desire is not to build a cash hoard. We know there've been other companies this week in other industries criticized for building cash wards. Our objective is to put that capital to work productively, and we think we will. And we're seeing a lot of deal flow right now. And January was a digestion month in which a lot of people in the industry collapsed and maybe got some sleep after a frenetic December. What did we close right in December? 24 deals in that month alone, something like that, including multiple transactions on the New Year's Eve, obviously, before the tax bogeyman got people. There was a huge surge related to that. But January's a bit of a rebuild. I think it always, is no matter what the year. And now, as we're going into February and then March, then we're seeing a rebuild. And we also pointed out the ATM, we really like for equity issuance because it doesn't cause kind of sort of gyrations as much with our stock price. It's also very efficient from a cost standpoint 100 basis points versus 500, 600, 700 bps give or take for an underwritten deal.

Okay, that's helpful. And another broad question, it's clear that there is substantial return upside in the nonqualified or the, we'll call it the CLOs/Structured Finance/Consumer Finance bucket. Yet you did mention on the call that in order for that to grow, and I think right now your non-qualified asset's around the 25% level, let's say thereabouts. But in order to grow that bucket, you also have to grow the denominator, which would imply additional equity issuance, which would affect, probably dilute a lot of the return upside over time given now that, that bucket is very close to approaching its 30% maximum, which you'll likely not want to exceed. So walk us through kind of the return dynamics in a post-gas solutions world where it seems perhaps the critical mass has already been received, that growth in that bucket is permanently established, it's already paying. But it would be harder to grow and receive even stronger marginal rates of return now that you have to issue additional equity in order to grow the assets in that bucket.

You mean, other than legislation taking away the 30% basket?

Well, I'm sure that would be up for debate, but yes, I do believe that is -- that would be one way for it to increase, but let's imagine for a moment that it does not.

Right, of course. Yes, and I was quoting ranges on -- I think we've got more cushion than 5%, if you will. I think we're less than 25% that you quoted. So we actually have some cushion built in right now to get to 30%. Longer-term steady-state, real estate is one area where we think we can achieve diversity and some nice returns. We're also looking at leasing businesses. Leasing is, I talked about, I forgot the exact words I used, the rarefied air maybe where you can find a flow-through that's not a 30%-er. And leasing companies, you can craft those to actually have that happy marriage of 70% basket deals that where you don't need blockers, or at least there's not a tax drag. So that's somewhere the real estate from that standpoint some attractive returns. We're looking at equipment leasing deals and aircraft leasing deals, lots of different possibilities there. And I would also say our buyout business. So we have closed what, Brian, 4 buyouts in the last 2 months? At this point, CCPI, CCI, Nationwide and Valley?

Yes.

So we've closed 4 buyouts. We've been on a pace in any given year of closing maybe 1 or 2. We've closed 4 in the last couple of months. Our hope and desire will see several fine net compelling value is to do more deals like that. And if we buy them right and buy them attractively and find value and yes, you can find value, even this -- everyone's lost their head, credit bubble risk on the world that we're in at the present time, you can find the dollars in the sidewalk. Then, there are -- I guess, your problems there are more Gas Solutions-type deals we'd hope and like to find. So we've got that potential. We've got that upside in our business model unlike, I don't know, 90% of our peers where it's a credit book or sponsor deals and that you got direction that go down through the bulk. We like to have upside.

Appreciate that. And perhaps talking about dollars on the sidewalk in the CLO business. Obviously, great returns. Could you give me a sense of how long it takes for, I mean, it's post-investment to receive your first cash distribution. Is there normally a 6-month lag?

Normally, the way we structure these deals, they've been all primary issuance deals working with a very high-quality group of collateral manager partners. And we've structured those deals such that we get initial payments, and there is a -- we insist upon having a significant percentage of rent at closing to enhance IRR. That's why there's just a lot of upfront work, a lot of work attached to that strategy more than I think people would suspect. And the accounting treatment, and Brian can add to what I'm saying here, and correct me if I'm wrong, is it's a level-yield analysis based on modeled input that get heavily scrutinized, as I'm sure you would suspect. And then a true-up and an adjustment to that model on a quarterly basis. Brian, anything you'd add to that?

No, that's pretty accurate. Basically, we project what the IRR is going to be for the life of the investment, and we recognize that on an accrual basis.

Okay. So one question then. On the type of collateral that sits in this, would you kind of assume this to be more of your BSL type of general collateral that your traditional kind of large CLOs are out there buying in the market today?

Yes. So it's all liquid broadly thinking, and we want that because your call right is worth something if you can sell the assets. We have looked at called some kind of middle-market CLOs with others, and we had to be at others to avoid consolidation under the rules. And it's tricky to make that work because you're not necessarily getting a illiquidity premium that you really should be getting. And a call right's a heck of a lot less valuable if you can't just be with the thing and be out in 2 days.

Okay, very interesting. And then I guess one last question is that to the extent that the income received here are based on modeled inputs heavily scrutinized, of course, in the event that the BSL market spreads contract, which they have, I would imagine that NIMs to your equity decline. So long as there is actually reinvestments that occur in the CLOs themselves. Given the fact that spreads have tightened and tightened hard in various loan repricings and BSL collateral, would it be fair to assume that there is a potential for decline in the value of CLO equity if the spread compression continues?

Yes. Well, that's where careful underwriting and having assumptions that are on reinvestment spreads well below current market conditions is important. So from the deals that we've underwritten in the last 18-plus months, we viewed reinvestment spreads, and risk went through different peaks and valleys during that time period. But we said, "Look, we're at a higher spread world right now. We think spreads are going to be heading lower on the reinvest." They widen that, and that's just upside for you, all the things being equal. So we modeled in way lower reinvestment spreads than those market conditions at the time and continue that modeled spreads that are lower than current market conditions. And that has served us well because we want to make sure during the non-call period for the deals, which is typically 2 years, that we're going to get a requisite return. After 2 years, if you have continued tightening, which of course, goes hand-in-hand with loan prices going up, then we can just call the deal, bank the return and be done with it. You may not even get to the 4 years, which is the typical time period for the reinvestment period to be over. So we felt like we protected that pretty well. And when counterparty says, "Hey, your base case looks pretty darn draconian to us." Now we feel rewarded in having been careful.

We typically look at a case, which we believe should never happen where defaults go up and spreads continue to tighten, which of course, I think everyone on this phone call knows. That would be a very interesting occurrence if you got hammered from 2 directions. And even in those cases, we have a positive return. Obviously, it's significantly less than what we look at, but we do have preservation of capital.

Okay. And then I guess, this is my last follow-up, is that the structuring fees were meaningful in the quarter, say up I think just looking at the cash flow statement, so maybe $16 million. Maybe talk about how you're looking at bringing structuring fees, how you bring them into income? And perhaps maybe some of the more onetime elements of both structuring entities and how that impacts NOI going forward?

Well, it's a core part of our business, and it's a portfolio that turns over. Loans repay, we make new loans. And it is a recurring part of our business. That doesn't mean that's going to be precisely flat or the same from quarter-to-quarter, but it is a key part of the economic return of our business and business model that it's not going away. It's not disappearing. It's still very much there. And so, we charge structuring fees when we're the agent. When we're not the agent, which is the syndicated channels, a very small part of our books, I mentioned we're doing very little in that market right now. Or if we do anything, it's small, and that's more of a OID-type upfront. But on the structuring fees side, we expect that to continue. And in the last 2 quarters, we did about $750 million in originations each quarter. We'll see where this quarter ends up. But -- and we expect that to continue. On the exit side, prepayments vary. It's going to be a little bit less than senior debt, a little bit more on junior debt. Sometimes it's hard call protection as well junior debt side, but say, we've tended to be what, Brian, somewhere between 1 and 3 points on the exit side?

Early redemption.

Early redemption. If it's held longer than that, then no. So 2 points going in, 2 points going out double the deal in the middle, allows you into have mid-teens IRR.

Our next question comes from Terry Ma from Barclays.

This is Kannan. The one question I had was related to the cash balance, the $430 million which is there on the balance sheet. You had capital raises late in November. So what really happened in that last 1 month? I mean, is it that these repayments went up because of which the base which you could deploy the cash probably was lower or is there something else there?

Well, you've got about a 3-week period there where you can't really raise capital. The capital market's sort of shut down for large raises, whether it's equity or bond issuance or what have you. And yet the right-hand side of the balance sheet, and yet the left-and side of the balance sheet continues and deals are closing with counterparties with pretty significant expectations that you're going to get there. And of course, we want to as well have plenty of capital in hand. And then repayments can happen and sometimes you have 30-days notice, and sometimes you have less notice than that. So we want to err on the side of having more of liquidity. The last thing in the world you want to do is let down a counterparty, not get there. Oops, tell them the capital to close. You're going to be pretty much dead to that counterparty to ever do a deal with them again. And repeat business is a very important competitive advantage for us, with relationships that we built up over long periods of time. So as I mentioned to a prior question, we've got a decent amount of liquidity now, but we're very focused on deploying that profitably. And we're seeing a nice uptick in both category A and in term sheets going up.

Okay. And from a leverage perspective, I guess given that you have this cash on the balance sheet, should we expect leverage to be roughly where it is right now over the next couple of quarters?

It's hard to project with specificity. We are, I guess, under-leveraged by a lot of accounts analysis at about 29% net debt, net cash and cash equivalents to equity as of 12/31. We have been issuing bonds or medium-term notes program. We're looking to expand that program. We're adding other broker-dealers to the platform, some pretty meaningful ones. So we're excited about that. We're going to look at other types of issuance. So we think that, that should grow. But we don't have a specific target. So we've talked in the past about how long-term leverage could go as high as 0.5 to 0.7. We tend to be more in the 0.3 to 0.5 range probably because when you're growing, when you're looking at a lot of deals, again you want to err on the side of having sufficient liquidity. So at some point, that may dial into a little bit more predictable range. Brian, you want to add anything to that?

The only thing I would say is that as a percentage around 50% for the debt is probably a good estimate at least through this quarter.

I guess, I won't say we're afraid of leverage but -- and we've designed our balance sheet very carefully as you know, as we've talked about, which I don't think always gets appreciate -- especially in the current environment, where people aren't thinking about risk. We think about risk a lot. And when you've got a balance sheet with a lot of unencumbered assets and all your term issuances unsecured, that's a pretty nice place to be. And your leverage is pushing the max, pushing the envelope, pushing against covenant levels. You also have a nice cushion in place to be. And during those downturn periods with challenging raise capital and everybody's below book and there's lots of great opportunities in the market, then we can move in swiftly and maybe find another Patriot Capital acquisition or others like it. At this time, we should have a lot more liquidity to bring to bear than last time.

Our next question comes from Gerry Luther [ph], who is a private investor.

I had a couple of different questions. I wanted to know what impact do you see on the adjusting of the convertible notes from 12/10 that is upcoming here? I think they're at 11.35?

I'm sorry?

You're talking about our December 2012 maturity converts and the adjustment pertaining to dividends on the conversion price?

Right. Well, what impact you see of having that?

Those impacts are almost negligible. I mean, they're very immaterial. So that price will not move more than $0.01.

Okay, great. The other thing was, where do we stand on meeting the distribution requirements for the August tax year? And do you see a need for special dividends?

The way that the dividend works is that you do not need to distribute by August 31 all of your earnings. You can use what they call a throwback, and you can throwback almost a year's worth of earnings or year worth of dividends backed against the current year earnings, and you can continue to roll that way. I would expect that we will continue to do that because the penalty for doing that or the cost of doing that is a 4% excise tax, which is a very low rate of borrowing for us. And we'll probably continue to roll this forward as we can because it gives us some insurance that we won't have to -- we would never have to lower our dividends.

I see, that's pretty good. Because of the liquidity that we are showing on the books and stuff, do you think we're going to be launching another secondary offering in the near future? Or do you think we have it covered?

You're asking about equity offering?

Yes.

Well, we have in the past a bunch or 2 issuing our ATM program, which we like for the aforementioned reasons of a low-cost spread, less disruption to our stock price and taking advantage of the fact. I think we are the most liquid BDC, something like 4 million shares traded. We're top 2 or 3 market cap to be, and how you define it, but the most liquid. So we're trying to avail ourselves of that liquidity benefit. In terms of the future, we have plenty of liquidity on hand between the ATM and cash on hand, available borrowings, and we can tap the bond markets on a larger basis on top of our medium-term notes program, and probably take some very large surge of originations and pipelines to justify that at this point.

Say, Gerry [ph], if we can't predict the future -- we can't even predict what's going to happen in the next hour, but I can tell you that if an underwriter walked in here right now and said, let's do 100 million shares for $50 million, we'd say no. We don't need it, and we don't know how far out that statement would continue to be true, but it's true right now. We need the -- we're quite aware that we need to put this money to work in order to protect net investment income and the dividend.

I appreciate that. And from looking at the books and everything, and your talk about the ATM and stuff, it was coming across that some of the rumors that have been floating around about another offer in really didn't have a basis at the present time. So I appreciate you taking the time with me.

Well, I don't know where -- what rumors you're reading, but I'd have to say I don't think I've ever read a rumor about our company that was true or heard a rumor about our company or anyone here that, in fact, was true. As you probably know, people write these things on message boards thinking they're going to manipulate other people into doing things. So that's 1 item I caution you on. Number two, the ATM is a steady, small but steady nondisruptive equity support system. Turning it on, turning off is not the smartest thing. You might be disrupting what is a very valuable long-term system. But it doesn't over-equitize us, and it removes the need to actually do these offerings from time-to-time that do gap down the stock. So we think we have a very nice balance with this ATM. Maybe we get a little behind. We've got to ramp the originations. They were kind of slow in the first couple of weeks of January. They're picking up now, and we know we have to keep working, to keep putting that money to work and earning a positive spread, and that's what we're doing.

And we have a follow-up question from Jonathan Bock from Wells Fargo Securities.

One quick follow-up. I know you mentioned the CLO income obviously can be modeled. I was just curious of the $23-or-so million that came in, in income this quarter, how much of that was actual cash? And where is that in the cash flow statement?

Well, it all flows through the change in interest receivables. But I believe that the answer to that is that about $17 million of the $23 million came in, in cash.

In recognizing some cases, the payment is going to occur in January, just a couple of weeks thereafter. So there's the aspect I talked about the ramp up, but there's also the aspect of just the timing of payments, with supply of levelized yields as appropriate.

And ladies and gentlemen, I'm showing no additional questions at this time. I'd like to turn the conference call back over to Mr. Barry for any closing remarks.

Okay, let's talk about the Super Bowl, ready? Brian, what do you have to say? Were you happy with the result?

I was.

Okay, there we go. We'll close the question right there. When Brian's happy, we're all happy, right? Thanks all, bye.

Thank you.

And ladies and gentlemen, with that, we'll conclude today's conference call. We thank you for attending. You may now disconnect your telephone lines.