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American Capital Ltd. (NASDAQ:ACAS)

Q3 2008 Earnings Call

November 10, 2008 11:00 am ET

Executives

Amanda Cuthbertson - IR

Malon Wilkus - Chairman and CEO

John Erickson - CFO

Sam Flax - General Counsel

Analysts

Jim Shanahan - Wachovia

Steven Kwok - KBW

Troy Ward - Stifel Nicolaus

Faye Elliott - Merrill Lynch

Vernon Plack - BB&T Capital Markets

John Neff - William Blair

Arnold Giba - Merrill Lynch

Jeffrey Talbert - Wesley Capital

Matthew Howlett - Fox-Pitt Kelton

Amy Dumon - FBR Capital Markets

Sean Jackson - Avondale Partners

John Wood - BlackRock Capital

William Heitz - Heitz & Company

David Jordan - Axiom Capital Management

Operator

Ladies and gentlemen, thank you for standing by and welcome to the American Capital Shareholders Call. At this time, all lines are in a listen-only mode. Later there will be an opportunity for questions and instructions will be given at that time. (Operator Instructions) As a reminder, this conference is being recorded.

I will now turn the conference over to Amanda Cuthbertson, Investor Relations. Please go ahead ma’am.

Amanda Cuthbertson

Thanks, Cathy, and thank you for joining American Capital's third quarter 2008 earnings call.

Before we begin, I would like to review the Safe Harbor statement. This conference call and corresponding slide presentation contains statements that to the extent they are not recitations of historical facts, constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

All such forward-looking statements are intended to be subject to the Safe Harbor protection provided by the Reform Act. Actual outcomes and results could differ materially from those forecast due to the impact of many factors beyond the control of American Capital.

Certain factors that could cause actual results to differ materially are included in the risk factors section of American Capital's most recent 10-K and 10-Q and periodic reports filed with the SEC. Copies are available on the SEC's website at www.sec.gov. We disclaim any obligation to update our forward-looking statements.

An archive of this presentation will be available on our website and the telephone recording can be accessed through November 24th by dialing 800-475-6701. The passcode for the replay is 963704.

To view the Q3 slide presentation, please turn to our website www.americancapital.com and click on the Q3 2008 Shareholder Presentation link in the upper right corner.

Joining us today on the conference call are Malon Wilkus, Chairman and CEO of American Capital, John Erickson, CFO, Steve Burge, President, North American Private Finance, Gordon O'Brien, President, Specialty Finance and Operations, Sam Flax, General Counsel, Tom McHale, SVP of Finance and Rich Konzmann, SVP of Accounting.

With that, I will turn the call over to Malon Wilkus. Malon?

Malon Wilkus

Thank you, Amanda. Thanks everyone for joining us for third quarter 2008 conference call. We had very good performance on our portfolio in the third quarter, but because of developments certainly that were made evident the week of October 10th, we were focusing on capital preservation.

Our portfolio generated strong cash flows and gains in the third quarter. In fact, $0.72 of realized earnings per diluted share and that would be $0.98 before taxes on the retained capital gains. And as you know, we will discuss later, we did choose to retain our capital gains through deemed distribution, and as a result incurred the capital gains tax.

We also had $520 million in the third quarter of realizations from exited repayments, that is quite robust. We amended our secured and unsecured credit facilities in the third quarter that lowers our tangible net worth covenant down to $4.5 billion and it reduced however our combined capacity on our credit facilities by about $956 million.

Despite the fact that our portfolios has performed well, it is our belief that we are in a severe recession. As we will talk further about, we are experiencing extreme financial market volatility and that has required us to take certain very important strategic initiatives to focus and build our capital base.

We are doing that by overall reducing our leverage and reducing our dividend and revising our dividend policy. And certainly that is disappointing, but it is a prudent thing to do in this environment.

So if you move to, I am actually going to go to slide six real quickly here, to point out the unprecedented volatility in the market. We have shown on this slide six, the VIX index, which had been running on average for the last 15 years at around 20. At the end of September it was at 40.

For the week ending on the 10th of October, at that week it ended at 70. So, a dramatic increase in volatility and that is causing extreme volatility on asset pricing. So, for the week ending October 10th, spreads widened catastrophically in the credit markets and there was virtually no liquidity and that is irrespective of credit quality. Firms that had to mark-to-market, experienced tremendous depreciation as a result regardless of the asset quality.

Now as you know through this quarter, American Capital has depreciated our assets $731 million below what we believe is realizable value. That is required under GAAP and yet we are faced with a fixed tangible net worth requirement under our credit facilities. So, we have determined that though our cash flows are doing well, our portfolio is doing well even despite the recession, we think we have to focus on conservation and growth of capital.

So, we have taken a number of actions that include the retention of our capital gains. We have revised our dividend policy, which I will speak to in a minute. We are focusing on operational efficiencies. We have acquired the public vote of European Capital with by using American Capital stock and that also will increase our book value, our tangible net worth, and we have terminated our share repurchase plan.

So let's move to slide seven and I would like to discuss our revised dividend policy. Again, the purpose of this is to preserve our capital base. Our policy is revised so that we can manage our capital base proactively in this highly volatile markets and what we have done is retained our net long-term capital gains and treat them as deemed distributions.

We will talk about that specific development on the next slide. Our Board will also evaluate declaring dividends after the financial results are determined each quarter. As you know, in the BDC community and I think also in the REIT community, gains often or dividends often have been declared before the end of the quarter.

Instead we will go through our quarter, we will prepare our financial results and then we will determine the amount of any dividends and so the Board can more precisely assess the taxable income, cash flow and changes in fair value to better manage our tangible net worth in the current volatile markets. In addition, the Board has decided not to pay the dividend in the remainder of 2008.

Now, we intend to declare dividends of our spillover amount of $300 million. We will have to declare that by June 15th, 2009 and we will have to pay it out by September 30th, 2009. So, as of now we are currently forecasting that we will pay a dividend of $300 million and declare it by June 15th of '09.

If you move to slide nine, we wanted to talk about the 2008 deemed distribution. What we have done is retained our long-term capital gains, that is $155 million of net long-term capital gains for the 2008 tax year. We have retained it through what is called a deemed distribution.

We have done this in the past. This one is the largest amount by far. It totals $0.72 per share and that is after paying the $54 million in taxes on behalf of our shareholders. Now all the shareholders of record on September 30th are entitled to receive two components, a $0.25 per share tax credit and that is available whether you hold your American capital stocks in a taxable or nontaxable account. You can work with your brokers, your brokerage firm or your bank to work through the process of getting that credit.

In addition, you receive as a shareholder $0.49 per share increase of your cost basis. Immediately you can increase your cost basis by $0.49. So, the deemed distribution though you do not get a cash dividend you are getting two very important valuable assets or attributes in this arrangement.

Now on slide nine. We also wanted to point out that at the end of September, we had forecasted over $500 million of taxable income will be rolled over from '08 to pay 2009 dividends. The actual amount has developed to $455 million of taxable income that would be rolled over from 2008 to pay 2009 dividends.

However we are doing $155 million of that amount in the form of the deemed distribution, we just discussed, other long-term capital gains and therefore reduced the rollover down to $300 million. So, let me just go over that again. We thought we would be doing $500 million due to several transactions that did not occur or that we found no longer expect to occur, we have brought that down by $45 million to $455 million.

Of that amount, we are paying out the $155 million of deemed distribution and that remains the $300 million that we expect to rollover into next year. Then keep in mind we will also be making income next year as well.

Now in addition today, we announced that we are acquiring the remaining $34.5 million shares or the 32% interest in European Capital that we still we do not own. We currently own $72 million shares or 68% of the company and we will be acquiring those remaining shares by exchanging $11.5 million for the American Capital shares.

The value of this represents about $158 million based upon the American Capital share price of $13.77 at the end of last week. The exchange ratio or this exchange or this acquisition is a fixed ratio of 0.333 shares of ACAS common stocks per share of European Capital and the timing we anticipate that it will close upon sometime in the first quarter of '09.

We will need approval for our shareholders to do this transaction. American Capital shareholders have to approve. European Capital shareholders must approve and then we also need certain other regulatory approvals.

Now the rational for doing this is that European Capital is a strong franchise representing a core platform for American Capital. European Capital has $1. 9 billion in assets and seventy portfolio companies. We have about 100 people located in four offices in Europe and I think we have an excellent franchise doing outstanding business in Europe and this is a very nice diversification for our overall assets to be deployed around the world.

European Capital has experienced off late what we consider mispricing in the marketplace. And the fundamental value of European Capital was not really being accurately reflected. There is a significant discount to its book value even though the investment portfolio continues to perform.

This transaction is expected to decrease American Capital's earnings volatility because as you know, we have had this sizable asset on our balance sheet, our 78% investment in European Capital and that is traded in the public market. It has been trading down.

It is also been highly volatile and that impacted our tangible net worth. So by doing this acquisition, we expect approximately and actually we wanted to update that approximately $300 million increase in our tangible net worth as a result.

Now, let's move to slide 14. We had $0.74 in net operating income per share that versus the $0.68 to $0.75 guidance that we provided. It is highly consistent with the first and second quarter of the year and our assets continue to perform. We actually produced a 10% return on equity on our net operating income.

We had $0.72 of realized earnings and as I said earlier it is actually $0.98 before tax and then $0.72 after tax. The tax associated with capital gains and that is versus the guidance of $1.05, and as I mentioned earlier, we missed the $1.05 due to a few transactions not being executed. That is a 12% return on equity, which is really quite good performance and they total $73 million in net realized gains.

Now, we also have on the bottom line, $2.63 loss that as a result of $700 million of net realized loss and net depreciation, the bulk of that is the depreciation, which we will talk about. Bringing our NAV to $24.43, that is a $2.58 decrease in our NAV since the second quarter of '08.

On slide 15, you can see in the first section, the net realized gains and losses, $92 million of gains came of our private finance portfolio. We had $19 million of structured products of realized losses and $13 million of realized losses on foreign currency and another $14 million in interest rate derivatives. Then in this section, you also are required to put our taxes on the retained capital gains of $54 million. So, our net realized loss comes out to be $3 million.

With respect to unrealized depreciation and appreciation, first of all we have a $67 million of reversal associated with the gains. We had $183 million of private finance portfolio depreciation and $262 million of managed funds depreciation.

Private finance portfolio, some of that is associated with declines in multiples; some of it is associated with the FAS 157 mark-to-market bond yield analysis approach and then some of it is associated with a decline in performance of EBITDA for these portfolio companies.

On the managed funds, as I mentioned, a large part of the $262 million is associated with just the trading down of European Capital in the public market and the depreciation that results from that on our books.

We also had $90 million foreign currency translation depreciation and $85 million of depreciation associated with our structured products and virtually all of that is due to market yield and bond yield analysis, the widening of spreads that we just discussed.

If you turn to the next page, 17, you can see that we do show the difference between our GAAP fair value and what we believe would be our realizable value upon the exiting or the settlement or maturity of our investments in these companies. And that total is $730 million, which we think we will experience. Once we conclude with the acquisition of the remaining shares of European Capital, we would also expect then a significant appreciation there, where we would be booking that at NAV.

Now, if you turn to slide 18, this also gives you a flavor of the mark-to-market issues, this is just by quarter. You can see the fair value of our structured products and the cash flows on an annualized basis flowing off of them. In this third quarter we had $134 million of cash flow, the assets were being valued at $386 million.

I do want to point out there is a decline from the second quarter to the third quarter but that is really due to timing differences of receipt of cash flows and not due to troubles or losses in the portfolio. Actually the portfolios are performing extremely well and experiencing virtually no losses.

If you go to slide 20, you can see that we had $440 million of new investments for the quarter. If you go to slide 21, we had $520 million of realizations and you can see the details there. On slide 22, we just helped to catalog since our IPO that we have continued to have a 17% weighted average IRR on our exits and repayments, that is $245 million in total on $11 billion or 47% of all capital that has comeback to us.

Once again, the proceeds since our IPO have exceeded our prior quarter’s valuations by less than 1%. The IRR on our equity exits alone, it is 31%. So, really quite outstanding. So, the assets continue to perform.

On slide 24 and actually easier to see on slide 25, you can see our past due and non-accruing loans are at 2.4% of their fair value. Then on slide 27, we just wanted to point out we continue to have our syndications department doing a great job of syndicating senior debt. All of this is associated with our exit.

When we do staple financings to help a buyer purchase some of our companies by providing senior debt and sub-debt and then as you all know, we turn around and syndicate out the senior and we continue to have very good success. In the third quarter, we syndicated $114 million of senior debt.

On slide 28, you continue to see the kind of liquidity coming off the portfolio. We had $3.4 billion of amortizations, prepayments and exits since over the last 12 months ending the third quarter and that is a 31% turnover or liquidity rate.

So, just to summarize folks and then we will open up for questions. We had good performance on our assets, but because of this incredibly volatile market that we are in, we are focusing on capital preservation. So our portfolio is generating strong cash flow and gains.

We had defined realized earnings for the quarter. We had defined exits and prepayments and therefore liquidity. We also, we did something very tough in this market today, which was amend our secured and unsecured credit facilities in the quarter. You know, quite to our satisfaction, it does require that we de-lever some. With the degree of liquidity coming off of our portfolio, we feel like we can handle that.

But we are in a severe recession. We think this is going to be a tough one. So, we are doing everything that we think is necessary to preserve and protect our capital base and to build it. In doing so, we are going to de-lever and part of that effort will involve reducing the size of our dividend, revising our dividend policy and though that is disappointing and I understand that with respect to so many people that are our shareholders.

Nonetheless, it is a prudent thing and I just want you to know that we are working very hard for you. To the extent that we do not payout dividends, we are retaining earnings and most corporations in the world retain earnings and buildup their company and perform well and their stock price reflects it. So, we expect the same thing through our efforts and we hope that you can continue to support us with your interest as a shareholder.

So, with that let me open up for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) First question will come from Jim Shanahan with Wachovia. Go ahead, please.

Jim Shanahan - Wachovia

Thank you. Good morning.

Malon Wilkus

Good morning.

Jim Shanahan - Wachovia

What portion of the value of American Capital LLC is associated with European Capital Financial Services? It was $323 million investment at June 30 and but it was only written down modestly. I'm assuming here, Malon and John, that is going to be written, if European Financial Service goes away and that would negatively impact the value of American Capital, LLC, is that correct?

Malon Wilkus

That's correct. When we look at the valuation; we actually combine the European manager with the fund. On a combined basis we've had that at a discount to NAV. So I think the $260 million pickup, we were talking about would be net of a reduction of the manager.

But I think that for accounting purposes we may actually end up having the European Capital treated as a portfolio company. So you wouldn't actually have the manager go down in value because those two separate components would still be there.

But in any event, we valued it on a combined basis; the value of the manager plus the value of our stock has been at a discount to NAV and we would expect that we own 100% of it. We will then value it at about NAV and that is the $260 million or so pickup that we have talked about.

Jim Shanahan - Wachovia

260 on a net basis?

Malon Wilkus

Right.

Jim Shanahan - Wachovia

Because I guess, by my math you had costs exceeding fair value by $109 million at June 30, then with an additional $264 million impairment that's 372. And you are saying you will get $260 net back after, if you go back to NAV on European Capital. Do I have that correct?

Malon Wilkus

Yeah. I think probably, there is probably some currency swings down there as well.

Jim Shanahan - Wachovia

Okay.

Malon Wilkus

Could have to change those numbers.

Jim Shanahan - Wachovia

Okay. I will …

Malon Wilkus

We are just giving you kind of what we expect the net tangible net worth right now to change.

Jim Shanahan - Wachovia

Okay. One more, quick one please. Given the effects of early October, do you think that American Capital would have been in violation of the minimum tangible net worth covenants at any point, let’s say even on October 31st?

Malon Wilkus

Let me respond to that. I don't think there's a company in the world if they had to have used the GAAP valuation and bond yield and market spread analysis that we do, would not have seen their assets depreciated dramatically. That includes banks and investment companies, and regular C-corps, REITs, anything.

The spreads that occurred or the developments that occurred the week of the 10th was unprecedented. Even the highest quality credits in the world could not trade. And so, we of course don't do our valuations other than on at the end of each quarter. So we can't really specifically respond to that question. But I can just say that it would have been an unprecedented event for every company in the world with respect to their asset valuation, if they had to use bond yield analysis.

John Erickson

I mean certainly, it would be a concern for us. And we just come off September 29th amending our facilities picking up $1 billion worth of cushion and you can see that already for the third quarter that the mark-to-market has eaten up a chunk of that.

So I think today, we have got maybe about $450 million prior to buying in ECAS. But then with ECAS it will get us back up to about $700 million of cushion. So, that’s why we've had to take the measures we are taking. And the tangible net worth covenant has really become one of the things that you have got to focus on and manage.

Jim Shanahan - Wachovia

Thank you, gentlemen.

Malon Wilkus

Yep.

Operator

Thank you. Next we have Sanjay Sakhrani with KBW. Go ahead, please.

Steven Kwok - KBW

This is actually Steven Kwok filling in for Sanjay I was wondering if you could talk about what is the core run rate of net operating income going forward and perhaps you can also touch on what you think is a reasonable amount of internally generated liquidity? Thank you.

John Erickson

I think for the net operating income, I think we have got tons of history out there. So, you could do your own models and project the run rate. I think that there's lots of data out there and you can see where it has been running for the past couple of quarters.

In terms of liquidity, I think Malon went through a couple of slides already that we have had good internal generated liquidity. We continue to experience exits and prepayments and syndications of assets.

And with the broad diverse portfolio of ours we have been generating very nice liquidity. I think in the third quarter, we had $114 million of loans that were syndicated for example. And then we had, I guess, $520 million of realizations in total. So that demonstrates the liquidity.

Steven Kwok - KBW

Right. And then one final question is that, if you can provide an update on your thoughts on credit quality trends this cycle relative to the last cycle? Thanks.

John Erickson

I wouldn't call the last cycle a severe recession. The last cycle was a recession and I think we are not going to provide projections right now on where a severe recession can go. I just think that up until now the portfolio has performed very well. We feel like it is well positioned. But what ends up happening in a severe recession, we are going to working like crazy and we will have to see how bad it gets.

Steven Kwok - KBW

Thank you.

Malon Wilkus

I have to say overall, we have an outstanding portfolio. We have been very thoughtful in the last couple of few years. Very specifically, we always have, but we have upgraded that to a higher level of standard about investing in non-cyclical companies.

Now, that's not to say we haven’t made our mistakes, and I think we have. But I think overall, we have really an outstanding portfolio one that can handle a very tough recession and continue to produce very nice income for us and our shareholders.

John Erickson

I think we have talked before about several of our large buyouts, we specifically invested because we felt like they were non-cyclical. And we are talking about companies like SMG and Will Research, we think those are extremely well positioned for recession.

Operator

Okay. Thank you.

Malon Wilkus

Do you have another question, Sanjay?

Operator

He has left the line. So, we will move on to Troy Ward with Stifel Nicolaus. Go ahead please.

Troy Ward - Stifel Nicolaus

Great. Thank you. Just a follow-up here on Jim's question on ECAS. Did the ECAS’s RBS credit facility get extended and if not are you going to step up and provide that going forward?

Malon Wilkus

There should be a press release out right now on that subject that will give you the information you need.

Troy Ward - Stifel Nicolaus

Well, okay. And then, quickly on the balance sheet, the accrued dividends payable line was 0 this quarter, but yet you paid an early October dividend. Can you explain us what happened there?

Malon Wilkus

We record our dividends based on the record date, or actually the ex-dividend date, I’m sorry. The ex-dividend date was in October.

Troy Ward - Stifel Nicolaus

Yes.

John Erickson

We should clarify. We weren't sure, we were wanting to double check with Sam Flax, our General Counsel. But we are not quite sure whether that release has gone out yet. But it’s very positively renewed the facility and we just wanted to make sure that it was conveyed in a proper way and to regularly update.

Troy Ward - Stifel Nicolaus

Great. I appreciate it. I will follow up. Real quickly back on the accrued dividend. If you paid it in October, shouldn't you have had some accrued liability on the balance sheet at the end of September?

John Erickson

We recorded it on the ex-dividend date, that’s how an investment company records the dividends.

Troy Ward - Stifel Nicolaus

Is that just any different from every other quarter?

John Erickson

Pardon me.

Troy Ward - Stifel Nicolaus

I mean, every other quarter, you have an accrued liability.

Malon Wilkus

Troy, the quarter is the dividend, that we obtained is during the quarter. This quarter the ex-date was actually in October.

Troy Ward - Stifel Nicolaus

So, there was a difference in just in the amount of the dates. Okay. All right. Thanks for that.

Operator

Thank you. Next we’ll go to Faye Elliott with Merrill Lynch. Please go ahead.

Faye Elliott - Merrill Lynch

Hi. Thanks. On the liquidity question, can you just comment on the pick levels from this quarter and how you see them trending?

Malon Wilkus

You referring to pick?

Faye Elliott - Merrill Lynch

Yeah.

Malon Wilkus

Well. They wouldn't have changed much from prior quarters.

Faye Elliott - Merrill Lynch

So, do you see it trending up at this point? Was it in the 40% range?

Malon Wilkus

No.

Faye Elliott - Merrill Lynch

What level do you --

Malon Wilkus

We will try to look it up, what those levels are. But let me just say that keep in mind, the new investments that we are making are in the staple financing of the mezzanine debt that we are funding with respect to companies that we are exiting. And in those investments, the pick level effect you can see our pricing charts.

Let me ask if you would turn to our chart showing the pricing from in the current period versus future periods or versus the prior periods. That’s slide 36. You can see that for mezzanine financing in the LTM period ending the third quarter, it was on average our pricing was at 15.7%. I’d guess maybe 2 (inaudible) points of that is pick.

Faye Elliott - Merrill Lynch

Okay. But that's pretty typical. Are you seeing any investments that typically had paid cash interests now moving into a higher percentage of pick?

John Erickson

No, in fact we record any conversion of debt instruments into equity and I don't think we had any conversion in the third quarter.

Malon Wilkus

We don't have any pick toggles, we don't really have any pick in this quarter.

Faye Elliott - Merrill Lynch

You didn't have any toggles at this quarter.

Malon Wilkus

No. We did not do pick toggles and I think our pick percentage has been fairly consistent for ‘07 and ‘08 rank about 20% of our income coming from pick.

Faye Elliott - Merrill Lynch

Okay.

John Erickson

The financial statements that were actually in our earnings release, we have the financial tables and in there we do show any conversions of debt to equity.

Faye Elliott - Merrill Lynch

Okay, terrific. Thank you.

Malon Wilkus

In case were interest in not being paid because can’t pay it and you convert it to pick, Now there is a chance you would wouldn’t accrue it anyway, so your non accrual would probably kick in, you might charge the company pick but you wouldn't accrue it, so you would never see it.

Faye Elliott - Merrill Lynch

Great, thanks so much.

Malon Wilkus

Faye, you’re welcome.

Operator

We will go to Vernon Plack with BB&T Capital Markets. Please go ahead.

Vernon Plack - BB&T Capital Markets

Thanks very much. I know your debt to equity ratio at the end the quarter was 0.9. Where would you like to manage that number to?

Malon Wilkus

In this environment I think you want to manage it lower. I think that you saw, going back to last year, we prepared for this environment by taking down about .7 to 1. And so you want to manage it down because you would expect in this environment to have some depreciation. So that's one of the reasons for the dividend policy change, is we are going to retain the capital and we are going to use excess to pay down debt.

Vernon Plack - BB&T Capital Markets

As it relates to the dividend, I know there is a minimum pay out related to be in BDC, is the thought would it be a reasonable assumption to assume that the dividend may approximate net operating income next year?

John Erickson

Well, keep in mind, we can retain our net long-term capital gains and pay the deemed distribution. And that’s what we have done for third quarter and that is going to be now our standing policy. Then we have to pay out 90% of our ordinary taxable income, and we have till June 15th of each year to declare paying all of that out and paying it out by September 30th.

What we have said for 2009 is that we are rolling over 300 million, we expect, intend to declare it by June 15th and pay it out by September 30th. What we then do in subsequent years, the board has set a policy that it will evaluate its dividend payments every quarter, and for that matter, the board is intending to evaluate each quarter starting in this fourth quarter, but they will be evaluating the cash flow, the earnings, tangible net worth and so forth as soon as the financial statements are reviewed and in. So, for each quarter there would be a lag but then they would evaluate it and then determine the dividend for that quarter.

Vernon Plack - BB&T Capital Markets

So, is it safe to assume that we should not really expect anything more from a dividend perspective in '09 than say $1.44 at $300 million on $207 million

John Erickson

There would not be a requirement for meeting our rick test to do anything else in '09. So, and then we go out to 2010 by June 15th.

Vernon Plack - BB&T Capital Markets

Okay.

John Erickson

Is what we would have to absolutely you have to deal with next, and hopefully that environment is a lot better.

Vernon Plack - BB&T Capital Markets

Got it.

Malon Wilkus

Of course, look the market has changed so dramatically in such a short time. I think it is worth pointing out, we establish a stock purchase program at the beginning of this year. We did that because of the price that our stock is trading at. We were looking at the beginning of the year it traded already below book. Our cash flows were tremendous. Our stock, our assets were performing wonderfully well. It wasn't but 61 days later that we were trading above book that we actually issued equity.

Now, the reverse has happened again. Our stock has come down again, and the market has gone into an incredible dislocation. So these things are happening very quickly. It has gotten to the point where our belief is that we just have to hunker down. We have to focus on what the market considers the most important thing of all and that is preserving your capital base.

Frankly, if we could de-lever entirely, if we could generate and move entirely to cash, that probably would be the best received outcome for the market. It’s understandable considering the tremendous volatility and the concerns that people have about the market and the actual financial markets as well as the main stream.

John Erickson

Well just to highlight Malon’s point, on September 29th through September 30th we were trading virtually at our 9/30 NAV. I mean we were about $25 a share right then. So, these markets are volatile. Things are changing quickly and we need to just stay ahead of it and it is just difficult to know what we will do in terms of dividend for 2010 at this point in time.

Vernon Plack - BB&T Capital Markets

Just one final question, if I could in terms of on the operations side in this type of environment you have quite a bit in terms of people. What type of operational efficiencies could we expect going forward. I would think that you would be making staff adjustments.

Malon Wilkus

We will look at that very closely. As you know earlier this year, we let about 80 people go. That's always very tough because we have some outstanding people and I could tell you today we have a tremendous team of people throughout our entire organizations and there's not one of them that I would feel happy about letting go.

But we will take a hard look at that. It’s the only appropriate thing to do under these circumstances certainly the volume of new investments is down dramatically and we still have a very sizable portfolio. It’s a tremendous portfolio. It takes a lot of work to manage it.

So, there is a certain limitation as to what we can do in downsizing. But we will look at that and my guess is by the time we talk again we will have an opportunity to discuss the degree and the amounts and the kind of changes that we might put into place.

Vernon Plack - BB&T Capital Markets

Thank you.

Operator

Thank you. We will go next to John Neff with William Blair. Please go ahead.

John Neff - William Blair

Just a couple of questions. Is this, given the dividend policy revision, is this an opportunity to revisit the BDC structure in its entirety for American Capital?

Malon Wilkus

Well I was thinking about this today. Just think for a second, would it be better to be an investment bank or how about a bank? Or how about a REIT? Or a hedge fund? Or Ford Motor Company as a C-corporation. I mean there's not a investment platform that I know of that is not experiencing extraordinary distress right now.

Now the BDC format has worked extremely well for 11 years. It does require two fundamental things, that is quite unique. It requires the payout of 90% of your ordinary income. You can keep your gains, but you have got to payout at least that amount of ordinary income.

It does require us to mark-to-market our assets in ways that other corporations, other structures don't require. If we make a $10 million loan to a $100 million revenue company and a bank makes a similar loan, we have to mark-to-market that using bond yield analysis and a bank doesn't.

A C-corp that has a portfolio company somewhere, they don't have to mark-to-market the performance of that subsidiary, while we have to using quite possibly bond yield analysis and subject to changes in multiples and marketplace or discount rate.

So those are the two things that we are subject that are quite different and demanding. Nonetheless despite that, we have performed extremely well and if you compare our stock price together with our dividends over the last 11 years since we went public,c there's hardly a corporation in the world or an index in the world that has out performed us.

So, it does give me pause, when I think about any changes. Nonetheless when it comes to these topics, we spend a huge amount of thinking about it. It’s only the right thing to, right now having to payout our income at a time when everybody else, all they seem to care about is preservation of capital, in the building of your capital base that's a tough environment to have to payout our ordinary taxable income.

And in a time, where there is such tremendous volatility that’s completely out of our control on the spread in the bond market, its a tough time to have to be marking to market our balance sheet, when virtually all of our assets would be impacted by that valuation technique.

Even though the underlying performance of our assets have been outstanding and continue to perform well. And so, it's irrespective of credit quality. So I know you asked a short question, I gave you a long answer and I am not going to give you the definitive one.

All I can tell you is that we will always try to figure out what's best for our shareholders. And if staying BDC, and paying out 90% of our taxable income is the best thing for our shareholders, that's what we intend to do.

But, on the other hand, if it's better for us to do things such as retaining all of our income and being a taxable BDC, that's a possibility as well. That doesn't solve the mark-to-market but becoming a C-corp possibly would and I think all of those are possibilities and you can count on us to be looking and trying to figure out what's the best thing is for our shareholders.

John Neff - William Blair

Thanks for that color.

Malon Wilkus

I want to make further comments, that obviously, this environment was bad for over a year, but what we're talking about now is a shock that's really been over the last 30 or 40 days. So, I think this month that we would be very thoughtful and you certainly can't let what might be a short-term shock color your long term strategy.

John Neff - William Blair

Last question, looking forward. Could you comment on what you envision the competitive landscape looking like coming out of all of this recessionary period? Thanks very much.

Malon Wilkus

Well, look, the private equity and mezzanine fund industry, as you know has had a tremendous 35 year period. and in the last several years it raised record breaking levels of capital. Access to that capital has declined precipitously in the last six months and year and it is quite possible in our view that there will be hundreds of private equity firms that will never be able to raise another round of capital.

That would be very good for us, keep in mind we compete with 1,000 firms. So eliminating 100 or eliminating hundreds might start to have an impact on the competitive environment. But probably not a huge amount. This is an incredibly competitive industry. I expect it to stay that way for a long time.

But we have huge competitive advantages, and so this will be a time this period, I have said it many times in the past, when we're structured that is rationalizing this industry. And I think this is the time when that occurs, in these difficult times when other firms can't raise capital or they lose the capital they had raised in the past and we continue to have our capital and continue to perform and we will be the survivor. I think that is exactly the process that we are in the middle of right now.

Is there a next question?

Operator

Yes. Thank you. We will go to Arnold Giba with Merrill Lynch. Go ahead, please.

Arnold Giba - Merrill Lynch

Just a quick question on the ECAS field. In terms of the approval, what sort of approval rate from other shareholders and American Capital are required? And same question for the American approval, the ACAS approval?

Malon Wilkus

Let me ask our Sam Flax, our general counsel to answer that question.

Sam Flax

The ACAS approval is a majority of outstanding shares and the ECAS approval is 50 % plus of the holders representing 75% of the shares, not counting American Capital. That is those ECAS rates are minority shareholders.

Arnold Giba - Merrill Lynch

Okay. Thank you.

Malon Wilkus

We will also say that the vast majority of those, the float that we don’t hold, is held by institutions and it's fairly concentrated.

Operator

Thank you. Next we have Jeffrey Talbert with Wesley Capital. Go ahead, please.

Jeffrey Talbert - Wesley Capital

Two things, I just wanted to touch on. One, I am confused about the answer with respect to the dividend, and when you actually would show that as a payable on the balance sheet.

My understanding from talking to our securities lawyers that if your Delaware corporation, which I believe you are that it becomes a legally bonding obligation and should be on the books as a payable irrespective of whether you are 40 Act company or not as of 9/30. Could you clarify your interpretation of that, please?

John Erickson

Well, it is an accounting interpretation, not a legal interpretation, and you just have to go through the investment company guide and you will see when you would….

Jeffrey Talbert - Wesley Capital

You are saying that supersedes Delaware corporate law?

John Erickson

From an accounting perspective investment companies are like typical corporations required accruing their dividends on the ex-dividend day. So, it's a something to remain to the investment companies.

Jeffrey Talbert - Wesley Capital

Okay. And your position is that, I am just trying to go be clear, because I have got a pretty smart securities lawyer on the other side and he's telling me something very different.

Malon Wilkus

Is there two sides to this? I didn't know.

Jeffrey Talbert - Wesley Capital

What I am trying to understand is, I just want to make sure for our purposes at looking at the stock I understand as of 9/30, what the balance sheet looks like and the two pieces, I am just trying to get in place.

One of them is should there have been an offsetting liability for dividends payable, a couple of hundred million dollars, not a substantial? Then the other piece goes back to an early questions and that's the RBS loan. I still don't see a press release on anyones site, I have been unable to get a straight answer, if you had to pay that off with another $200 million bucks what happens?

John Erickson

Let me back up. The answer is if you want a pro forma the financials and put in a liability for the two dividend payables you are welcome to do that, that's your assessment. But the other fact is, it wouldn't have impacted our tangible net worth at 9/30.

We revised it at $1 billion of cushion sheet and certainly go back and put it in and knock the tangible net worth down for that payment and it doesn't have an impact anyway, if that's what you are getting at.

Jeffrey Talbert - Wesley Capital

Well it’s just a combination, again not trying to be contentious at all, I am just trying to understand, not for the net worth covenant, but when I see $300 million of cash, the way I would look at it was just to understand from a liquidity perspective whether there's an immediately offsetting liability and that I think, we have answered that.

Malon Wilkus

The answer is that under GAAP you don't do that. Secondarily even if we had to do it, we would not have been in breach of anything. Thirdly, you're welcome to go and do a pro forma yourself if you want to and trade our stock on that basis. It’s entirely up to you.

John Erickson

And it’s already paid now.

Jeffrey Talbert - Wesley Capital

I understand completely. Could you try though, rather than telling us to look at the press release, I still don't see it. I have been asking for a while, what happened with the RBS fund?

John Erickson

It is online and it’s just posted and just cleared the wire. The press release says that European Capital renews their multicurrency credit facility. They will renew at it was $150 million euro facility.

Jeffrey Talbert - Wesley Capital

Got it. And it’s a $100 million and it’s due and payable when, please in terms of the term loan?

John Erickson

August of next year.

Jeffrey Talbert - Wesley Capital

Perfect. That's all really I needed to know. Thank you all a lot. I appreciate it very much.

John Erickson

You're very welcome.

Operator

Thank you. Our next question is from Matthew Howlett with Fox-Pitt Kelton. Please go ahead.

Matthew Howlett - Fox-Pitt Kelton

Thanks for taking my question. Could you maybe update us on conversations you are having with Washington in terms of maybe getting the onetime restriction taken off temporarily, being able to maybe issue preferred stock and having it not count as debt and then maybe even participating in the TARP?

Malon Wilkus

I can't say that we are having conversations with Washington, I’m not sure, I have that kind of in. But I will say that we understand that there is a number of efforts going on to allow a freer interpretation of how to pay a dividend or whether you could use shares as well as cash to pay the dividend.

We understand there is some efforts trying to get some exemptions so you can issue shares below book under certain circumstances so that perhaps maybe we can participate in the TARP plan. These things would be interesting and if we in any way can be helpful in pursuing them or moving them forward, we would be trying to do that thoughtfully.

But we are not going to count on any of those things. What we are going to count on is performing with respect to the things that we can control and we are working hard on all of those things and that is most specifically right now, what we are extremely focused on is preserving and building our capital base.

With all the liquidity we have in our portfolio, with the outstanding relationships we have with our lenders and with the performance of the portfolio, even despite this recession, we feel very good about our position.

Matthew Howlett - Fox-Pitt Kelton

Okay. A follow-up on that one of your peers mentioned that they would issue preferred stock, if they could get it treated as equity and they thought that it was demand for it out there. Have you sort of tested the waters on that front at all?

Malon Wilkus

Well it would require that the preferreds not to be treated as debt in calculating the debt to equity ratio that a BDC is subject too. Until that happens, it’s really not worth speculating on whether you can raise it. We have said all along that we are not interested in raising dilutive capital and we will work very hard to avoid that. So far, I think we are on a path to doing a very good of managing our business without it.

John Erickson

Well, as you see, like in the European Capital transaction for example, we were able to basically use our shares to buy other assets at a discount. So it ends up really, in this case being accretive to book value for us.

Matthew Howlett - Fox-Pitt Kelton

Right. Okay. Fair enough. Most of the questions around your funding have been centered on the revolver and you guys have done a good job of managing that covenant.

My question is on the $2 billion or so of CLO or business loan trust debt out there. I know, there are triggers inside of those, rating agency driven triggers, based on that netting downgrades and interest coverage.

Is there anything that in those deals that we should be made aware of. And how could you manage the triggers in those deals, if there are downgrades from the likes of S&P and Moody’s in 2008

John Erickson

I mean, our business loan trusts those are funding vehicles for us and they are not necessarily like some of the market CLOs out there. And so there really are no triggers on those deals. They are nicely managed funded with the assets and they just de levered the assets.

Matthew Howlett - Fox-Pitt Kelton

There are no triggers to protect a AAA holder because…?

John Erickson

Well no the AAA protection is that you amortize down. So if you had delinquent loans for example, the structures are set up where the cash traps and amortizes the loans down, which is fine from our perspective. It is just a natural de-leveraging.

So the triggers revolve around delinquencies and basically when they generate lots of cash flows and when there is delinquencies, you trap the cash for the delinquent loans and pay down the AAA holders.

Matthew Howlett - Fox-Pitt Kelton

But would that cut cash off to your subordinated holdings?

John Erickson

I mean exactly. The non-rated, you end up you know de-leveraging the AAAs, which is fine and that's exactly we did in 2000. We had, our first securitization we came through the 01, 02 timeframes. We de-levered when we had delinquencies which are non-accruasl and performed very well for both the investment grade holders and as well as us because ultimately we get the excess collateral. So it's really in this environment, it's the best form of financing out there. I'd rather had that when the tangible net-worth triggers in the unsecured stuff.

Matthew Howlett - Fox-Pitt Kelton

Okay, great. Fair enough, thank you.

Operator

Thank you. Next we have Scott Valentine with FBR Capital Markets. Please go ahead.

Amy Dumon - FBR Capital Markets

Hi. This is actually Amy Dumon filling in for Scott Valentine. Thanks for taking my question. Could you walk us through how you came up with the 459 purchase price for ECAS and what's the timing for getting shareholder approval?

Malon Wilkus

Well, it was a negotiation, there was an established independent committee of the Board of Directors of European capital which is an independent Board. The independent members established a committee and engaged their own council and their own investment bank and there was a number of rounds of negotiation. We expect it to close some times in the first quarter. We will have to do a proxy to facilitate shareholder approval.

Amy Dumon - FBR Capital Markets

Okay. And that will be for the ACAS shareholders .

John Erickson

Yes.

Amy Dumon - FBR Capital Markets

Okay. And what about ECAS shareholders?

Malon Wilkus

There will be a meeting scheduled at about the same time for the ECAS shareholders after the meeting there has been a two or three week court process in Guernsey where Guernsey Court needs to ratify the transaction. So the transaction assuming both groups approve it would probably close about three weeks after the meeting days.

Amy Dumon - FBR Capital Markets

Okay. Thank you very much.

Operator

And our next question comes from Sean Jackson, Avondale Partners. Please go ahead.

Sean Jackson - Avondale Partners

Going back to credit quality for a second. You said that back in the latest downturn which you could see it is not as severe as this one. The past due loan percentage went up to 15%, I mean is your portfolio improved that much from a quality perspective to not see those levels again?

Malon Wilkus

Well we don’t know the answer to that. It will all depend on the level of troubles in the economy. We happened to think this is a severe recession and it could be lengthy. The last recession was considered not that severe.

But, on the other hand, our assets, our people, our processes, our decision making, are just a world away from what we have the day before the last recession. Just to point several things out, we were heavily invested in the capital goods sector of the economy prior to last recession. And today we have a far more diversified portfolio.

We had, before the last recession, no operations team to help to turn these companies around and today we have 38 people, in those 14 exCEOs and about four exCOOs and about three CFOs. That team has done an extraordinary job since the last recession, but they didn't exist before it.

Now have them doing outstanding work on our portfolio. We didn't have our fact team, which keeps us out of a lot of trouble. Our fact team has 70 some CPAs and financial professionals on it that do up front do diligence working with our investment teams.

And the day before the last recession that team didn't exist. They have, I am sure, in the period since the last recession, saved us hundreds of millions of dollars of mistakes. And I think they will have helped us keep from having made bad mistakes with respect to our existing set of assets.

We also are in much bigger companies. They're more robust and capable of handling the trouble, so the day before the last recession, they had about a 12% EBITDA margin. Today our portfolio has about a 20% EBITDA margin. Before the last recession, it was maybe $50 million or $60 million of revenues, today it’s about $150 million of revenues.

So, we think we are prepared like never before to be able to handle whatever thrown at us with respect to this economy. As I have said before, I think, we should be viewed as a haven in troubled times.

We have a preferential stream of income coming off of our debt instruments in these companies, that is our interest payments and our portfolio companies will work like crazy to avoid any default because those that we don't control, they risk us gaining control in those circumstances.

Keep in mind, we start off with a 1.9 interest coverage ratio. We start off with a 1.9 interest coverage ratio today in our portfolio, that’s as of the end of September.

So, a lot can go wrong before we fail to get our interest payments made and though we might depreciate our equity there as market multiples come down and they haven’t come down that much in the middle market. But if they do, we might have to depreciate it, but we can always hold companies through the troubled times, build them, perhaps help them do acquisitions in their industry and they come out a stronger company on the other side.

Sean Jackson - Avondale Partners

Right. Thanks for the color.

Operator

Thank you. We will go to John Wood with BlackRock Capital. Please go ahead.

Malon Wilkus

Thank you. I think we will take just two more questions. We have been going for over an hour or so. If you would go ahead.

John Wood - BlackRock Capital

Yes. Thank you. Could you please comment as best as you can as to the NAV? Perhaps as we speak clearly the figure was much higher and you commented on the crazy volatility in October? Can you give us some idea where it is now? And quickly also you mentioned your Asian Hong Kong operations, anything happening there?

Malon Wilkus

Well, the NAV, do we have an answer.

John Erickson

Well, I think you are talking about real time; right.

John Wood - BlackRock Capital

Yes.

John Erickson

Unfortunately we really…

Malon Wilkus

The NAV as of today.

John Wood - BlackRock Capital

Yeah.

Malon Wilkus

We don’t have that. We go through a massive effort to determine our NAV every quarter. It involves literally hundreds of people and tremendous amount of due diligence and analysis of multiples and performance of our companies and so forth.

John Wood - BlackRock Capital

Sorry for interrupting you. I appreciate that, but have things settled down a little bit which would give you perhaps more accurate information?

Malon Wilkus

You mean is there less any volatility and spreads have come in.

John Wood - BlackRock Capital

The VIX come down. So you were suggesting in your paragraph quite strongly that we didn't know what to use to some extent for valuations.

Malon Wilkus

No, no, no.

John Erickson

I never said that once. What I said was that there was great volatility of the market and that at the end of September it was less. That’s of course, when we valued our portfolio. But what we were saying is that it is incredibly volatile and it’s true that it makes doing valuations more difficult, but keep in mind that we use a variety of techniques and we do a lot of work to determine our value.

In times of high volatility, we do our very best and come out with our conclusions and you see that in great detail on our balance sheet, when we submit our Q. By the way I would like to say that's unlike any corporation I know in which they have facilities, hundreds of facilities around the world, that really don't use fair value techniques at all to value the streams of cash flow going to those subsidiaries.

We do with respect to our portfolio of companies and you see the results. So, I think, we are actually far more transparent than the typical corporation in that respect. But the spreads have come down since the extreme levels of October 10th. They have come down quite substantially and that's I think a good thing and we will see it they keep coming down through the rest of this quarter. Did that answer your question?

John Wood - BlackRock Capital

Yes, it does. And also would you comment on LIBOR?

John Erickson

Well it has come down as well. I think everyone saw that LIBOR was really getting a credit spread embedded in it and that credit spread is declining, which is I think very healthy. It was certainly the goal of the TARP program and all the central banks, both the US and internationally. That’s what they're working on is to take the credit spread out of LIBOR and it is improving. So, we hope that trend continues because overall it will speak towards liquidity and the functioning of the credit markets and we need the credit marks to be functioning.

John Wood - BlackRock Capital

That reduces your costs as well?

John Erickson

Sure.

Malon Wilkus

It does reduce our cost. But keep in mind, we have very little interest rate sensitivity in terms of our net operating income. So the cost of our debt goes up, so does our income on our assets. So, we have very little extremely little interest rate sensitivity in our portfolio.

John Wood - BlackRock Capital

Thank you.

Malon Wilkus

You're welcome.

Operator

Next we have William Heitz with Heitz & Company. Please go ahead.

William Heitz - Heitz & Company

Mr. Wilkus, you stated that after each quarter you were going to consider, the Board was going to consider the results of the quarter as to determining a possible dividend for that quarter. But are you stating later that even in January of this year, if you have a good quarter this fourth quarter you are not going to consider a dividend?

Malon Wilkus

I haven't said that. I know that probably is a little confusing. What we have said is, we are not going to pay a dividend for the rest of this year. We have paid out quite a large amount of dividends up until now as you know. But don’t plan to pay a dividend between now and December 31st.

We actually closed our books generally in early February and it will be immediately after that our Board will evaluate, whether we should pay a dividend. That dividend maybe associated with the fourth quarter, but it would then get paid some time in the first quarter.

That’s the plan that our Board is implementing really from here on after. What they might do, I can't say, they will take into account cash flow, they will take into account liquidity, and also pay attention to our tangible net worth because when we do pay a dividend, it doesn't allow us to build our tangible net worth.

At the end of the following quarter, that may very well get tested under our tangible net worth covenants of our loan agreements and that's why we are being extremely careful how we manage our capital base.

William Heitz - Heitz & Company

June 15th, the $300 million of carry-over from this year maybe declared, you stated under the 90% ordinary income market, that be about $1.44 per share. Is that not affected Board's decision to review each quarter or is that already built into.

John Erickson

Well, the point we were trying to convey is that we intend to pay out at least $300 million of dividends by declaring it by June 15th and paying it by September 30th that minimally is what we intend to do. The Board could choose to do more than that, certainly we will be producing income that will make doing more than that possible. But on the other hand as we made it clear, we are also focusing very hard on building our tangible net worth and de-levering.

We don't want to give anyone false hopes for having any additional dividends.The Board may do it, its the policy to review it and make a decision at the time. But we minimally will pay out the $300 million declaring it by June 15th and paying it by September 30th.

William Heitz - Heitz & Company

All right. I calculate out to about $1.44 per share.

Malon Wilkus

Yes, approximately.

John Erickson

Roughly.

Malon Wilkus

If we don't issue more shares in between time, which we don’t expect to do. Well actually Sam, our General Counsel is pointing out that we will have issued shares for the purchase of the remaining shares that we don't own at European Capital. And that would perhaps change that number somewhat, but it’s not too far off.

William Heitz - Heitz & Company

Thank you very much.

Malon Wilkus

You're very welcome. Thank you. I'm glad you asked the questions. I will take one more question. And then we will finish.

Operator

Okay. Thank you. That will come from David Jordan with Axiom Capital Management. Please go ahead.

David Jordan - Axiom Capital Management

Yes. Thank you very much. I've recently reviewed all the videos on your website and everything. But I wanted to ask you in terms of the fee structure when you own the balance of ECAS, will that reduce your fees that you are getting from ECAS and lower your net operating income from an on going basis?

Malon Wilkus

It really shouldn't have any impact.

David Jordan - Axiom Capital Management

Okay. So, based upon what you have now, you consider likely that the, I mean you suggested that the net operating income because of all your fee structures should remain similar to what it has been, is that correct?

Malon Wilkus

We are not giving guidance on that this quarter, but really --

John Erickson

The ECAS transaction doesn't impact what you have seen.

Malon Wilkus

Yes.

John Erickson

So, the history is not impacted by the purchase of ECAS.

David Jordan - Axiom Capital Management

Okay. Thank you very much.

John Erickson

Okay. You're very well.

Malon Wilkus

Thank you so much, folks. Now I just want to finally say that I understand and I completely sympathetic, we all are here at American Capital to those that are our shareholders and rely on and care a great deal about our dividends. We feel similarly to you all and we are working hard to make American Capital the very best company it can be in these very extraordinary times.

It caused us to change some of our views of how much of our income we should payout. Nonetheless, I think, we have an outstanding company. We very much appreciate you being our shareholders and we hope you will choose to remain and with that I thank you all and look forward to our next conference call a quarter from now.

Operator

Thank you. Ladies and gentlemen, this conference will be available for replay after 12:30 p.m. today through midnight Monday, November 24th. You may access the AT&T Executive Playback service at anytime by dialing 1-800-475-6701 and entering the access code 963704. International callers dial 320-365-3844 using the same access code 963704.

That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference.

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