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American Capital Ltd. (NASDAQ:ACAS)

Q4 2008 Earnings Call Transcript

March 2, 2009 11:00 am ET

Executives

Amanda Cuthbertson – Director, IR

Malon Wilkus – Chairman and CEO

John Erickson – President, Structured Finance and CFO

Sam Flax – EVP and General Counsel

Analysts

James Shanahan – Wachovia Securities

Vernon Plack – BB&T Capital Markets

Troy Ward – Stifel Nicolaus

Faye Elliott – Banc of America

Harold Sirkin [ph] – Sirkin Capital Investments [ph]

Sanjay Sakhrani – KBW

David Jordan – Axiom Capital Management

Matthew Howlett – Fox-Pitt Kelton

Jeffrey Talbert – Wesley Capital

Angelo Guarino [ph] – PRI [ph]

Larry Ring – Dwight Asset Management

Nick Cayano [ph] – Paulson

John Hempstead – Hempstead & Co.

Thomas Tarantino [ph]

Jerry Johnson [ph]

Andrew Shaw [ph]

Eric Hamilton [ph]

Philip Low [ph]

Operator

Ladies and gentlemen, thank you for standing by and welcome to the American Capital Shareholders Call. At this time, all participants are in a listen-only mode and later we will conduct a question and answer session with instructions being given at that time. (Operator instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to your host Ms. Amanda Cuthbertson. Please go ahead.

Amanda Cuthbertson

Thank you for joining American Capital's fourth 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 Securities and Exchange Commission. 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 March 16th by dialing 800-475-6701. The replay pass code is 982334. To view the slide presentation for this call, please turn to our website americancapital.com, click on the Q4 2008 Shareholder Presentation link in the upper right corner. Fill-up the conference call option to view the streaming slide presentation or the webcast option for both slides and audio. Participating on today’s call are Malon Wilkus, Chairman and CEO, John Erickson, President and CFO, Ira Wagner, President, European Private Finance, Steve Burge, President, North American Private Finance, Gordon O'Brien, President, Specialty Finance and Operations, Sam Flax, General Counsel, Tom McHale, Senior Vice President of Finance and Rich Konzmann, SVP of Accounting.

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

Malon Wilkus

Thank you, Amanda, and thank you all for joining American Capital’s shareholder call. Today we will briefly review our Q4 and year-end 2008 results. So, we like to spend the majority of this call discussing the issues most pressing to our investors and go right to Q&A. Our stock price has been hard hit in the current market as everyone knows and every employee at American Capital is a shareholder, so we are all disappointed in the share performance. And like so many co-operations and families American Capital is facing challenges in this unprecedented economic environment. But it is important during these – to most of the times to reiterate the underlying value of American Capital. Our portfolio of cash generating investments and the global platform we build over the course of the last 23 years to originate, manage, and exit these investments. Today we will discuss our Q4 and year-end results, the challenges we are currently facing, our strategy going forward and as always take your questions at the end of our formal remarks. As is always the case on these calls, it is our goal to provide you with as much information so that you can make an inform decision regarding your investment in American Capital.

With that in mind let us turn to slide 1. Actually it is slide 4, I should say and as you can imagine American Capital is faced with a series of challenges. Like so many other corporations in the work today, the first however is the one that we are most focused on and win your face with the recession of unknown dimensions. It is the portfolio that counts and in our case we of course take responsibility for our portfolio, we have control to a certain extent over it. We are able to act upon it and we believe as you will see, we have a very fine portfolio relative to the fact that we have been in a 13-month recession. The other three challenges beginning with our mark-to-market valuation of hold maturity investments are quite out of our control, these are the mark-to-market valuation process it to a great extent judging the liquidity of markets as opposed to the value associated with actual credit impairment and unfortunately that has had a cascade effect on our company in a couple of ways, first that it is contributed to the breach of our covenants and our credit agreements and that of course has then contributed to receiving – and have both have a qualified audit opinion, but with an explanatory going concern paragraph.

So, let’s talk about these going to slide 5, starting with our portfolio in the performance during this severe recession. We had approximately $440 million in the fourth quarter depreciation based on performance, which is only 29% or 26% of the $1.9 billion of depreciation in Q4. And only 2.9% of our loans are non-accrual of fair value and in all of the way we were able to realize $2.2 billion of realizations, tremendous amount of realizations and the proceeds that was within 1.7% slightly lower then our prior quarter’s valuation. So, I think our portfolio is performing and we will talk a lot more about portfolio in a couple of minutes here. Going to slide 6, then we were faced of course with the mark-to-market valuation of what really are hold maturity investments. The mark-to-market procedures value our investments using a hypothetical market reflecting to a great extent illiquid distress trades. And so $1.2 billion of depreciation in the fourth quarter was due to widened spreads. A portion of which reflects illiquid distress trade and we are – but we are really a long-term patient investor and depreciation doesn’t necessarily represent permanent loss of value. I think we will show you that was the case in the last recession. Values declined during the last recession, but we recouped them in the static pools prior to the last recession performs quite admirably.

Third, our assets are valued at fair value, but our liabilities are valued at face value. So, we are – I think rather bought bizarre kind of reporting environment, where we used the hypothetical markets in the stressed trade environments to reflect the value of our assets, but our liabilities are at face. Our network would increase 1.2 billion if we could fair value our liabilities under FAS 159. And the adoption of Window for FAS 159 closed prior to the impact of FAS 157 became clear and so I believe that non BDC that had a fiscal year-end – calendar fiscal year-end adopted 159, I believe virtually all ADC’s would adopt it today if they could have done that if they were given the chance once again. Let’s turn it to slide 7 then, so these fair value approaches, the depreciation we are experiencing under the mark-to-market regime that we operate under has caused in part the breach of our covenants due to asset value declines. Those covenants were initially set prior to the adoption of 157 and FAS 159. And we expect 2009 interest coverage however to exceed over two times. So, through are in breach, we are performing very well under our credit agreements, we will talk about those in a minute here and finally due to the fact that we breached these credit agreements and in fact we understand there will be a number of co-operations that are public – that will be experiencing the same thing even if they just have debt that is coming due in 2009 and that is, we didn’t receive an high qualified audit opinion, so there is an explanatory going concern paragraph within that opinion.

So, let’s turn to slide 8 and get to our portfolio, we did produce $0.21 of net operating income in the fourth quarter, which is a $0.72 – I am sorry, 72% decline from the third quarter of ’08, but prior to one-time charges, we produced $0.41 per share and I think that kind of decline is kind of consistent with what we are seeing public companies the world over. On a realized basis we have $0.01 loss, we had $246 million of realizations in the four quarter and we had $32 million of net realized losses on portfolio companies in the fourth quarter. But please note, we are in one of the worst quarters in M&A history in the middle market, we still produce 246 million of realizations, which is think is quite admirable. On the bottom line, we have an $8.13 loss that is in great part as a result of the 1.7 billion of net unrealized depreciation and I should point out that approximately $440 million of that depreciation is related to performance. The balance is all upon yield and market-multiple effects. In the fourth quarter, we produced $144 million of cash flow from operations and we ended up with a $15.41 NAV per share when you use our realizable value and base the NAV after that we would have $20.63 per share. And we ended the quarter at $209 million of cash.

Turning to slide 9, you could see the impact of various items on our income between – spreading between Q3 net operating income to our pro forma Q4 NOI and then our finally Q4 NOI. And $0.15 of the decline was indeed due to non-accruing loans, this is of course where we take full responsibility and we are of course concerned about that kind of underperformance in the portfolio, so we have our operations team, our investment teams, our legal apartment, our human resources apartment working very hard with our portfolio companies providing managerial systems and trying to help turn companies around that are broken and then of course help maintain the performance of companies that are performing well. And of course the great proportion of our portfolio is performing well. We also had elimination of the ECAP dividends, so just as American Capital choose not to pay a dividend for the fourth quarter, European capital has done the same thing and then there were some other dividend income that we had received in the third quarter that we are not receiving in the fourth. There was a decrease in financing fees relative to the third quarter and an increase in interest expense relative to the third quarter and that was due to the refinancing that occurred on September 29th. Then we’ve had some other reversals and that would bring us to a pro forma Q4 NOI of $0.41 a share and that is before the non- recurring items mostly related to taxes and then the reversal of bonuses, we paid as you will see very little bonuses in 2008. So, $0.41 of share, we think that is a good indicator of our performance for the fourth quarter.

Moving to slide 10, in all of 2008 we produced $2.42 in NOI that’s a 28% decline from ’07. We had – it would be $2.62, if we backed out the one-time charges I just mentioned. We had realized earnings of $2.58 and a total of $132 million in net realized gains on portfolio companies in 2008 that causes, really would be a $15.29 loss as a result of $3.6 billion of net unrealized appreciation, approximately a billion of that related – and only a billion of that is related to performance of portfolio companies. The balance is associated with bond yield analysis and multiple contractions. We paid up $3.09 in dividends for all of ’08 and we also had an additional $0.72 in deemed distribution of dividends per share associated with our capital gains in the past year ’08. And we produced $383 million of cash flow from operations. If you turn to slide 11, you again get a sense of the difference between performance of companies and the bond yield or credit yield analysis that is being done relying on really hypothetical markets that are driven in great part by looking at trades in highly distressed markets. And so as a result our structured products, which are currently valued at a $122 million is valued at I should say, which currently is producing a $122 million in cash is currently valued at a $186 million or 1.5 times cash flow. And those products are performing, we think they are performing well considering the recession and we expect them to continue to produce income for a long-time to come.

Going to slide 12, just to get further into the statistics on the portfolio, we have $7.4 billion of investment based on GAAP, $8.5 billion based on realizable value and we are producing just shy of 11% weighted average yield on the debt investments for the fourth quarter. So, the assets continue to perform and produce a substantial amount of income. And in fact the revenues from our portfolio investments totaled $218 million for the fourth quarter and $1.1 billion for all of ’08. So, we have a lot to work with in terms of being able to produce performance for our shareholders. Indeed it is a case that 2.9% of our non-accruing loans at fair value are – or our loans are non-accruing and that is a 50 basis point increase over the third quarter of ’08. It is a $150 million of $5.1 billion total loans at fair value. So we have taken our hits with respect to the loans that are not-performing and we have already written those down and what remains is a $150 million of value for loans that we still have on our crew, out of $5.1 billion. Now our average debt to EBITDA is 5.9 on our portfolio, but this is a misleading statistic and we are trying to come up with a better was to represent this, but we weren’t able to get it together for this presentation. That number is really reflecting the maximum average, for the average maximum I think would be better to say, the average maximum debt to EBITDA that we are exposed at, at our portfolio companies.

It doesn’t represent the average exposure. And as you know, a third of our balance sheet is in senior debt often with no other debt above it. Therefore our exposure varies all the way from zero to some higher number of which the maximum average is 5.9, but the average for our exposure I would guess is somewhere around four times debt to EBITDA and just to make a little bit clear, we could have some of our portfolio companies performance decline and continue to declines and as long as they have positive create interest income, we would still show performance on that portfolio through some of our exposure in that company. The interest coverage ratio was two times and actually this compares all of these statistics compare well relative to the last quarter, they have been quite consistent in terms of performance and they on average have a debt service coverage of 1.7 times. Now our unfunded portfolio commitments at the end of the year was $1.2 billion that is now down to $660 million as of February the 23rd, and out of that $660 million realized that, if this represents the maximum amount they could draw if they had the collateral base indeed many of them would not have nearly enough collateral to be able to draw the maximum and many portfolio companies would also be in covenant to fall and they would be really up to us whether we would advance them under our line commitments to them and of course we are constantly getting some repayments back off of revolvers that we have the portfolio companies, as well as it is having to go out so there is cash flows going both directions.

Let’s move to slide 13 and I mentioned earlier that we – it is all about when you are in recession, you don’t know how deep or long it might be. It is all about the performance of the portfolio and the quality of the portfolio. In the last – entering into the last recession, we thought we’ve had a good portfolio, not merely the quality that we have today, but back then we thought we had a good portfolio, but we depreciated that portfolio quarter after quarter, I think 14 quarters in a row, so we were experiencing substantial depreciation and at the time the portfolio’s on a statistical basis is a pre-2000 and 2000 static pools would not have shown very good performance in the middle of 2001. Those would have been negative IRRs, but yet because we are loan sort of patient [ph] investor, we can elect when to exit that’s why marking our assets market doesn’t make a lot of sense because we can chose to hold to sometimes sell those [ph] maturity at a future date when it makes far more sense to exit. You know our view of course is like every investor, we buy low, we sell high and we have kind of capital base and be able to do that and as a result our pre-2000 and our 2000 static pools performed remarkably well relative to the rest of the investment community back in those years. This was an exceptional performance. So, we had a 10% or 8% and an 8% for pre-2000 and 2000 IRRs. Now you look at 2005, 2006, and 2007 static pools they are performing on a whole investment basis, ’06 at a 5% IRR, ’05 – I should have said ’05 is at 5%, ’06 is at 10%, and ’07 has a 1% IRR.

Now we are not happy with those kinds of returns, but we know that we are valuing them today, but that’s the kind of result that you are likely to get when you are in the middle of a difficult recession. You can see that we are able to exit and get outstanding returns, because we can be very thoughtful about it and so our exited portfolio statistics looking at ’05 is showing a 29% IRR, a 21% IRR on ’06 and a 9% IRR on ’07. Those are outstanding IRRs in this environment, simply outstanding. And a lot of those exits occurred in the last two years and a lot of it 2.2 billion of those exits occurred in 2008. So, we are proud that how the portfolio is performing, we are confident that we are exiting both good companies as well as – in end as well, we are exiting some underperforming companies or our portfolio continues to be of the similar quality and I think our non-accruing static makes that evident. So, as a long-term patient investor, we will be very careful about exiting when it makes sense to exit the investment and reap excellent returns for our shareholders.

Moving to slide 14, credit agreements, we have $4.4 billion of total debt outstanding and we in fact reduced our debt $943 million from the peak in Q2 2007. In addition, we repaid and we are actually terminating our secured revolving facility. So, we have done a lot to bring down our exposure to our creditors, we anticipated this troubled environment and we worked very hard to bring our exposure down and that has helped, I think our position quite well in terms of were we stand today. Our portfolio is doing its job as well. So, our interest coverage in 2009 is expected to exceed two times. For 2008, I think it was 3.7 times, so we are doing very well in maintaining performance in terms of interest and debt service coverage. And we do have $2.1 billion of debt in securitized and non-recourse structured vehicles. There are no covered breaches or cross defaults with our unsecured debt. So, these $2.1 billion in the debt is securitized is continuing to perform. We do however – we have covenant breaches on $2.3 billion of unsecured debt. Now the covenants were initially set prior to the adoption of the current fair value standards and we expect our lenders and note holders indeed to declare a default that may very well happen this week and to charge default interest. And is the case if the lenders and note holders could indeed choose to accelerate, but we certainly don’t think that would make any sense or would be to their advantage in anyway. As a result of these breaches our auditors initially they are unqualified opinion include an explanatory going concerned paragraph.

Let’s move to slide 15, our negotiation with our unsecured creditors are ongoing and again back in ’08 and we have offered both secured and unsecured proposals and the creditors responded with secured proposals requiring from our point of view really unacceptable amounts of scheduled amortizations. And we simply are not willing to risk becoming a forced seller in these kinds of terrible markets. So from our point of view, we must maintain our ability to refuse unacceptable offers on our assets and that means we simply can’t agree to schedule amortizations that would just be too severe for us to be able to forecast whether we can achieve them or not. So, we are having ongoing negotiations, we certainly hope we can achieve and come to an agreement, we will keep the market informed of that certainly, but it is important to note that our unsecured creditors did not have a right to foreclose on assets. No such rights exist. On slide 16, you can see how we performed in terms of interest coverage on our debt in ’06 we had a 3.5 interest coverage ration of 7.2 and in ’08 it is 3.6, I think I gave a higher number moment ago. But really outstanding interest coverage performance we continue to do that.

On slide 17, we just want to give you the sense of the – our view of the outlook, we do believe we are operating in the severe recession that we anticipate will go through 2009, I think there is little doubt about that and so we are focused on providing operational managerial financial support to our portfolio companies, we are doing what business development company act requires in providing managerial assistance and are working very hard at it and having some very fine results. There indeed has been a dramatic decline in middle market M&A volume in the fourth quarter. Multiples also declined and that those declines both in terms of volume and in multiples appeared to continue in the first quarter of ’09. But as I mentioned we are a long-term patient investor and then I also mentioned that in the fourth quarter, we had about $250 million of exits in prepayments and amortization, so we continue to produce a fair amount of liquidity of the portfolio even in what would be considered one of the most extraordinarily bad middle-market M&A environment. We also remain focused on operating efficiencies and so we’ve reduced our headcount by 32% and our offices by 29% in 2008 that also resulted about a $50 million estimated annualized headcount cost savings and we had a 93% reduction in bonuses in 2008 versus 2007. And then certainly we have implemented and provided other operating efficiencies.

On slide 18, we want to point out that we are proactively managing our balance sheet, so we are working with the creditors to be structured credit facilities as I just said. We are focused on capital preservation and that is why there will not be a dividend associated with fourth quarter of ’08 and there is so far to date there has been no dividend declared to Q1 ’09 and I don’t want to give anybody any expectations for that. We continue to forecast that we would pay up – we will declare by June 15th and pay by September 30 $296 million of dividend. That is sweeping out all our – the balance of our 2008 taxable income. And the IRS, I should point out has recently announced that ruling that temporarily permits up to 90% of dividends to be paid in stock. And though we have not made any decisions about that in this environment where we are husbanding capital as best we can that something that I know our board will very seriously consider. So, we continue to be focused on liquidity, but only at reasonable prices and we are exceeding I should say a result of this fair value determinations, we are exceeding our 1 to 1 debt equity, currently at 1.4 to 1 as you have probably have known by now that BDC rules generally did not allow for additional debt until we were below 1 to 1 except to pay executing indebtedness, but I want to make it clear with a company that pays it, we can turn around, we can take those proceeds if they are not required to be used to pay down our structured finance facilities than the additional proceeds can be used to reinvest to help our portfolio companies with working capital needs or whatever. Certainly, we can use it to invest in new companies. That’s not our intention in this environment; our intention is to help repay down our credit facilities so we get our lenders in a comfortable position.

And finally I want to say here that our Board of Directors, our management, our employees remain highly aligned with our shareholders. We have in total 11 million shares owned by employees and directors and of course those values are severely dramatically down, it has been terrible not only for our shareholders, but for our employees and we have 34 million of underwater options held by employees and board of director and those are deeply, deeply underwater. So, we are feeling the pain just like our shareholders and we are single mindedly devoted and passionately committed to turning our share price around. So, let me end by giving you a couple of key takeaways. Our portfolios generated $144 million in fourth quarter of cash flow from operations. Our portfolio is continuing to perform and though not as well as the quarters passed or in years passed nonetheless that the portfolio performs and produces a great deal of income. We are focused on providing operational managerial and financial support to our portfolio companies, we will do that in the ordinary course and we are not going to take any kind of extreme actions that would wreck havoc on values of our portfolio. And we are proactively managing our balance sheet, working with creditors to restructure credit agreements, preserving capital by deferring dividends, and achieving portfolio liquidity at good prices. So, our portfolio and platform vastly exceed the value of our stock. And – so consistent throughout American Capital’s history is our ability to be an inventive flexible and to adjust the changing market conditions. And we are facing challenges in finding opportunities to utilize our investing expertise in this world of challenges. And as in other recession it won’t be easy and inevitably we will have to make adjustments to our business, but we are an entrepreneurial company and we remain focused on the long-term values with and with that I would like to open it up for questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question will come from the line of James Shanahan of Wachovia. Please go ahead.

James Shanahan – Wachovia Securities

Thank you very much and good morning. Couple of quick ones, there was a $43 million tax provision in the quarter and given the operating and GAAP losses, and perhaps you could just expand on that please?

John Erickson

That was basically a reversal of our tax asset. So, with where we stand we had to basically write-off the tax asset because as you evaluate the tax asset you need to look at the light because that you can recovered in the near-term and so that was something we weren’t able to do (inaudible).

James Shanahan – Wachovia Securities

Okay. Another quick one, if you choose to pay dividend with stock assuming of course that you elect to do maybe the 90%, would you actually have to get additional shareholder approval for that or could you do that without shareholder approval?

Malon Wilkus

Sam, would you take that?

Sam Flax

Yes we could without shareholder approval.

James Shanahan – Wachovia Securities

Should we anticipate and in our modeling that you will do that then get for liquidity purposes?

Malon Wilkus

You know as I said earlier this is something for our board to decide and we – and the board hasn’t even began any consideration of it at this time.

Sam Flax

And then, you would be permitted to do variations of 19.10 as well, which would be you could nothing over 18.20 or whatever, so I think it is something we will exert the board that there is no – no decision at this point of time.

James Shanahan – Wachovia Securities

Okay and I would like to ask one more and then I would get back in the queue out of respect for my peers here, but, you breached the covenants under your credit agreements this quarter, which many investors expected, but why was there no 8-K issued at any point during the first two months of ’09, was it not deems to be material or what was your view on why that won’t have been necessary?

Malon Wilkus

Sam would you?

Sam Flax

Sure. A breach of the covenant is not in and of itself an 8-K event only if acceleration is.

John Erickson

The other thing to keep in mind that you know our evaluation process is linked the – you know – and it is probably even as you have seen, I mean, I will use, you know the allies have probably been blended they announced a revision December 31st and 30 days later you know probably their valuation process is, he will review that they can no longer live in the covenant, I think it would – evaluating this illiquid assets it does take a lot of time and obviously this environment takes more time than normal, so even the timeframe determining that is pretty lengthy.

James Shanahan – Wachovia Securities

Okay thank you.

Malon Wilkus

You are welcome.

Operator

Thank you. Next we will go to the line of Vernon Plack of BB&T Capital Markets. Please go ahead.

Vernon Plack – BB&T Capital Markets

Thanks very much. There was a comment in the press release this morning about we have been working with other leading business development companies on legislator regulatory text and accounting solutions to address challenges that the industry is facing. You know, if you had anymore color on that comment on not?

Malon Wilkus

Well there is not lot we can say about it, but we – look I think all the obvious concerns with our shareholders have been coming to in the market in general and the analyst I think general does well. Our – it is obvious to the BDC community in the – in – as it is to the market and so we have been trying to address some of these concerns with the appropriate organizational body and it is something that we have been working on for quite a long while and I think we’ve – it is fair to say we’ve had some success and I also think our profile in front of these organizations have improved quite substantially, I think we’ve had a lot more face time as it were the never before and certainly they know that the BDC virtually all of the entities we are dealing with, I think are becoming more appreciative, but how important the business development community has been to the middle market in providing funding to companies that are growing and developing in the middle market. In fact by our calculations about 50% of old mezzanine financing in the middle market was done by business development companies in 2007. So, we were trying to get our points across and help them understand our situation and I think it is having some positive effect, but I don’t accept any miracles as well.

Vernon Plack – BB&T Capital Markets

Thanks. Given the covenant breaches on your unsecured debt, could that in the way of you paying the $296 million in dividend.

John Erickson

You know I think that the lenders and we are aligned to minimize our tax burden. I think that, you know certainly they would prefer that we do the 90.10 or some derivative of that and I think the capital preservation benefits all stake holders in American Capital.

Malon Wilkus

Note that the amount of our dividend equates to the – very close to the same amount of taxes that we would owe on 2008 taxable income. So, one-way or the other there is going to be, in one case there will be an obligation to pay the taxes in cash and in the other case there would be the payment of the dividend, which the IRS is now allowing to be 90% paid with the stock.

Vernon Plack – BB&T Capital Markets

Okay. So the answer is, the unsecured lenders could in fact, perhaps prevent that, but it certainly wouldn’t seem like they will –

John Erickson

No, they can’t.

Malon Wilkus

No. They don’t they are unsecured they don’t have they really have no right that would give them a voice on this.

John Erickson

I notice. No covenant in any of the agreements that prevent the payment of the dividend.

Vernon Plack – BB&T Capital Markets

Okay. And just one final quick question, I know that past due to non-accruals is a percentage of face are now around 15% that was a level that you hit back in 2001, obviously anyone’s guess, but where do you expect that number to go?

Malon Erickson

I think you will – you would first have to tell me what’s happening with the economy and I think certainly am not counting on the economy to turn around in any magical way, starting next quarter. As we said earlier, our view is the recession will continue throughout ’09 at least and – but I can’t tell you, I honestly we just can’t give you forecast of where this 14.5% will go. If you look back at the last recession, there was a huge jump from one quarter to the next. From 6% to 15% and the next quarter it reversed dramatically down to 11.7%. So, this can happen rather quickly, it is the case in most markets turning. You look like you are heading down, down, and down and all of a sudden you start heading up, up, up and that could be the case for this 14.5%. All I can tell you is we believe that the portfolio is a very good one and we particularly invested in the companies that we now own with a eye towards their ability to survive and do well during recession and some cases be kind of cyclical to recession. So, I think we have flushed through a number of other companies that didn’t fit that category and we will have to see whether the balance part portfolio will perform at better levels or at existing levels.

Vernon Plack – BB&T Capital Markets

Thanks a lot.

John Erickson

Thank you, Vernon.

Operator

Thank you. And next we will go to the line of Troy Ward of Stifel Nicolaus. Please go ahead.

Troy Ward – Stifel Nicolaus

Great thank you. John Malon, just a quick comment before I have a couple of questions, I would just request that maybe this Q&A process could go on least as long as your shareholders have relevant questions and you are not repeating yourself. Just moving on the question, first of all, what is the dollar amount of unencumbered assets that you have on the balance sheet that aren’t pledged due to securitizations?

John Erickson

Let me see if I can calculate that number.

Malon Wilkus

We will get you that answer; do you have a second one?

Troy Ward – Stifel Nicolaus

Yes. In kind of relationship to that I know the unsecured creditors don’t have a call on your assets, but obviously as people would know you, if you get that call you would go to the court and probably receive a judgment, what is the ability to – with the on balance sheet securitizations I am assuming the covenants related to those are credit quality driven. If those unencumbered assets get – I get pledged and lack of the better were to your unsecured creditors, what is your ability to continue to replace credit stressed assets in your securitizations?

John Erickson

Well within the securitizations most of the revolving periods have ended or I think, there maybe one or two more that are ending, but we are not really offering any assumption that we replaced credits within the BLT’s [ph] at this point.

Troy Ward – Stifel Nicolaus

Okay good. And then quickly on ECAS, can you give us a little bit of commentary, maybe I missed it on the ECAS transaction and whether or not that fixed exchange ratio is still in place and if you expect to use that fixed number of shares?

Malon Erickson

Yes.

Troy Ward – Stifel Nicolaus

Okay. And then John, several quarters back and I apologies that I don’t have all the details, but in your quarterly release you talked about a CLL equity that you guys felt was really miss-marked and if I remember right it was marked like $11 million fair value and you said a cash flowed 6 or 8 or something, can you give an update on that particular investment just to give us some type of feel on how the assets have – and that one instance maybe has performed versus your expectation at the time?

John Erickson

It is still producing very similar income that it has produced when we said that back last three quarter ago.

Troy Ward – Stifel Nicolaus

Great. So, potentially it is actually cash flow to higher than the fair value that the first mark was marked down to?

Sam Flax

Yes we would have generated more than 11 million in cash flow. We made that statement.

Malon Erickson

Actually if your turn to slide 11 Rich if you would –

John Erickson

Hang on, so this is 4.6 billion of unencumbered assets.

Troy Ward – Stifel Nicolaus

Okay and then just going back to the debt, if you have the have the number yet, but can you just walk through the process of the unsecured debt, you know like you said you assume they are going to give you the issue default not necessarily an acceleration, but default if it goes to a – will the next step be called for the unsecured if that is the route they would go?

John Erickson

I would well. Yes. Arguably that could be the next step. If you remember we’ve worked with these lenders for five and ten years and you know certainly everyone is trying to get the best deal for themselves at this point in time. You know we understand the lenders have their own needs and concerns and so they want to create and cut the best deal for the lenders, we obviously want to cut the best deals for the shareholders and we very much view this as the continuing negotiation. You know, and one other thing that’s up until now because we were in a quite period, we really couldn’t deal the public bonds now that we have got this announcement that we deal public bonds and that certainly was one of the challenges we are putting any sort of deal in place ahead of this announcement, but I would expect this to continue negotiating I think that the past year that was probably not in anyone’s best interest and I think that you know there is certainly reasonable deals that we are willing to cut, I think that I would hope that people we have partnered with for ten years and five years that you know will also end up with the other day cutting a reasonable deal.

Troy Ward – Stifel Nicolaus

Okay. And then we will listen for that update on the dollar amount of unencumbered assets –

John Erickson

It is 4.6 billion.

Troy Ward – Stifel Nicolaus

4.6 of unencumbered?

John Erickson

Yes.

Troy Ward – Stifel Nicolaus

And that would be against approximately $2.2 billion of unsecured debt?

John Erickson

Correct.

Troy Ward – Stifel Nicolaus

Alright, thank you.

Malon Wilkus

Troy?

Troy Ward – Stifel Nicolaus

Yes.

Malon Wilkus

Let me just give you some interesting statistics, on our structured product, we had 206 million of depreciation this quarter or of the fourth quarter, of which 55 million is due to performance and those assets, those structured products have a cost basis of $956 million and a current GAAP value of $186 million.

Troy Ward – Stifel Nicolaus

How do you look at your structured products, I guess structured products in general in this market, if you see you know, another caller already mentioned that you know, the – your credit card, your non-accruals have peak, have already hit it where you peak last time, and if you only equity tranches in these structured products what are the chances that those products were not built to withstand this environment? I mean that is just getting price in the market right now correct?

Malon Wilkus

Yes, okay. On slide 11 and you will see that we are valuing all those assets of a $186 million and they are producing a $122 million of cash flow. So, yet – look, again asking a forecast which is, will it break someday, you can keep in mind there is a lot of investments here there is not just one. There is a dozen and so could a whole of bunch of these structured investments break and we not burn income that impossible, it doesn’t happen in one fell soup, it can – will decline as the portfolio underperforms,. But currently in the fourth quarter it produced $122 million of cash flows. So, –-

Troy Ward – Stifel Nicolaus

And you had a markdown to $186 million?

John Erickson

That’s correct.

Troy Ward – Stifel Nicolaus

Okay.

John Erickson

I will say we have made some changes to our credit estimate. So, you know obviously in – we are doing the modeling for these, some of the depreciation is credit related, but the vast majority of it is spread related and I think that you maybe kind of alluding to me with the markets facing in the right levels of defaults and losses and you know it is best we can tell, we don’t believe that we think the marks are way more severe then where we think the defaults and losses are going to be an I think it is still just a reflection of a lot of distressed sellers. I mean people that own these assets that don’t have to sell are not selling to date. I think they see huge value in these assets and even when we run our models with more severe default and loss levels the value of the assets today are way below those sorts of stress runs.

Troy Ward – Stifel Nicolaus

Alight great, thanks guys.

John Erickson

Alright.

Operator

Thank you. Next we will go to the line of Faye Elliott of Banc of America. Please go ahead.

Faye Elliott – Banc of America

Hi thanks. Should we read a decline in your off balance sheet as any indication of weakness in the portfolio companies and then could you comment on just EBITDA and revenue trends in your portfolio companies?

John Erickson

The reduction of the undrawn commitments of the proactive part on us to try and reduce undrawn commitments, I mean obviously when you are in a type of good environment, you want to try and reduce the amount of undrawn commitments you have. So, we have been working actively to do that and we are continuing trying to do more of that just that we don’t have potential funding requirements sitting out there that we need to come up with cash to fund.

Faye Elliott – Banc of America

How do you go about reducing them in your negotiations with whoever had that commitment?

John Erickson

Well for one for example, we have a bunch of revolving credit facilities that we have worked with a number of portfolio companies to refinance a part of those and have somebody else come in to it. So, that is one example of how you would reduce un-funding commitments and in some other cases we had way in excess the capital that was needed in this environment committed to the companies that we just negotiate to change some of those agreements and reduce the amount of capital later [ph].

Faye Elliott – Banc of America

So, it wasn’t related to the performance of the companies.

Malon Wilkus

That’s right. I can’t think of any that is related to the performance of the companies.

John Erickson

And then in some cases we actually funded some, which reduced them so –.

Faye Elliott – Banc of America

Okay and then could you – the second part of question, just comment on the revenue and EBITDA trends, some of your competitors are doing that this morning within their portfolios and I will note if your can provide an update?

Malon Wilkus

Yes. As you know we get monthly statistics off of our portfolio as to their overall performance in debt – I am sorry in revenue and EBITDA and this is a trailing set of data however and so we don’t we are – as far as statistics that is very hard to reconcile and be certain of, but generally speaking in the fourth quarter, a portfolio was performing well in the aggregate in weighted by the amount of our investment in the portfolio, so revenues were up and EBITDA was up on a trailing 12 month basis and we are pretty pleased by that. In fact, on an OPM basis revenue is up around 4% and EBITDA around 7%. And then on a one month basis, just taking a snap shot for November is off about just 1.6% and 8% for EBITDA.

Faye Elliott – Banc of America

That said (inaudible) ticket?

Malon Wilkus

Well that is really year – either month-over-month, year-over-year or LTM over LTM year-over-year.

Faye Elliott – Banc of America

Okay. And then, have you been able to share with your lenders all of this information. I thought I have mine and said that it was – you had not given your lenders access to your books and I was wondering if that was in fact not true? It sounds like it is not?

Malon Wilkus

No. That is indeed not true. I can tell you that I think American Capital is the most due-diligent firm in the world. I can’t say and as you know, we did 31 common equity offerings and we’ve done enumerable debt offerings and so forth over the years and so our bank crew knows American Capital probably better than they could know almost anyone. I mean they have just, they have not only lent to us, but they helped underwrite a variety of offerings themselves. So, they’ve had tremendous access and actually we continue to get acolytes from them for providing data to them.

John Erickson

More in fact, the revolving credit suite providers have always done periodic inspections and come in and review assets review all the evaluation work. So, it is not – as though they don’t know anything about us and now we have recently come they are trying to give a much of information, we need to work with us for a long-time and then you know send for other inspectors into review our valuation work in our assets.

Faye Elliott – Banc of America

Alright thank you.

Malon Wilkus

When you have a chance please send us the notice where you saw that because that’s pretty strange.

Faye Elliott – Banc of America

Sure. Mostly I think of Reuters head line, but I will find it and send it over.

Malon Wilkus

Reuters, unbelievable.

Operator

Thank you.

John Erickson

Just to caution everyone, don’t believe everything that you hear in this environment. Obviously there is a lot’s of rumors that go around.

Operator

Thank you. Next we will go to the line of Harold Sirkin [ph] of Sirkin Capital Investments [ph]. Please go ahead.

Harold Sirkin – Sirkin Capital Investments

Thank you. Two quick questions. Number one, you described it with the credit line as the credit and default that there is going to be default interest, could you identify the number of the default interest?

Malon Wilkus

It’s 2% I think.

Harold Sirkin – Sirkin Capital Investments

2%?

Malon Wilkus

I think it can be – the parts of it or – could be impacted in other ways to go up the 3%, so with a range of 2% to 3%.

Harold Sirkin – Sirkin Capital Investments

Okay and then in the press release you said that you have had four realizations from portfolio companies in 2009. Could you define the amount of the proceeds and whether or not it was a gain or loss over the carrying value as of December 31, ’08?

Malon Wilkus

We had $2.2 billion of realizations of the portfolio in 2008. Were you asking about ’08 or ‘09?

Harold Sirkin – Sirkin Capital Investments

’09. It says you have had four realizations from portfolio companies in 2009.

Malon Wilkus

I hear it. We don’t – actually we don’t have that statistics and it is not a lot. I can tell you that. But relative to the prior quarter’s evaluation I could continue to be performing very well on that statistics. And as we have made it I hope is clear as we can we just don’t view ourselves as in meaning to do any kind of sell that substantially discount to what we think is the liable value.

Harold Sirkin – Sirkin Capital Investments

Thank you.

Malon Wilkus

You are welcome. And I should point out that in all of – I guess the statistics I have is in ’04 as the Q4, we estimated 1.7% lower than the prior quarters evaluation. And for all of ’08, I think we exited within 1.9% of the prior quarter’s valuation. So, that actually brings down our IPO to date statistics to 0.5% higher than the prior quarters valuation starting from our IPO through the fourth quarter. So, we continue to be very proud about our balance sheet bookings that those valuation relative to actually our realizations. Next question please?

Operator

Thank you. We’ll go to the line of Sanjay Sakhrani of KBW. Please go ahead.

Sanjay Sakhrani – KBW

Hi thanks. I have a couple of clarification questions. I just want to make sure I got the commentary on the unsecured debt outstanding correctly. The lenders can’t foreclose up on the assets, but they can ask for accelerated repayment, is that correct?

Malon Wilkus

Yes they have a right to ask for accelerated repayment and that has not happened.

Sanjay Sakhrani – KBW

And then as far as the priority stack is concerned, I mean the secured investors and the assets encumbered in the securitization yet paid first, right, and then the unsecured or kind of the low all of that?

Malon Wilkus

You know keep in mind the assets with respect to the securitizations are in their entities and those assets are completely distinct and separate from the assets that anyone else would have a right to get value off of anytime.

Sanjay Sakhrani – KBW

Okay so the 4.6 in unencumbered assets that’s what would be used potentially for the unsecured and secured lenders?

John Erickson

For the unsecured lenders as Malon mentioned the BLT’s has a business loan trust that we have are actually separate and they need consolidate for accounting purposes, but those are distinct pools of assets that you know are outside the unsecured lenders reach?

Sanjay Sakhrani – KBW

Well of course if there is a residual value left in those entities after the securitizations – the liabilities of the securitizations have been entirely repaid then those values and those assets would come to the part of our total pool of unencumbered assets?

John Erickson

Right. So, the securitizations are wholly depended upon the value the assets that secure them and so if those assets went to zero tomorrow they could not come after our encumbered assets for any value.

Sanjay Sakhrani – KBW

Okay and you guys don’t have any like retained interest in the securitization or anything like that right?

John Erickson

Well on the business loan trust, yes. We retain all of the non-investment grade bonds, so we do have retained interest in those.

Malon Wilkus

So that’s what I was meaning, the residual values after repaying all the liabilities of the securitization, all the residual value goes to the benefit of our shareholders.

Sanjay Sakhrani – KBW

Alright.

Malon Wilkus

Those that we believe that – that could simple amount of values. So, over and above the put in is –

John Erickson

It is effectively non-recourse financing to American Capital.

Sanjay Sakhrani – KBW

Now I understand. So, what is the value of those residual values, are they marked at cost or –?

John Erickson

It is consolidated so you wouldn’t see it like that.

Sanjay Sakhrani – KBW

Okay.

Malon Wilkus

But because it is consolidated it means that any – our book value is truly reflecting those amounts and then of course that is on a GAAP basis and then we believe that there is additional value associated with realizable value.

Sanjay Sakhrani – KBW

Okay I will take it after that call. Just have some follow-ups on that. But Malon then just on your negotiations with lenders or kind of other broader strategic changes being discussed and is there any consideration of kind of shipping away from the BDC model?

Malon Wilkus

No, there hasn’t been any discussion to that and the earlier or later last year, I think we have conveyed that we have to evaluate everything here at American Capital in light of the environment that we in, so that we can operate in the most effective manner and most importantly preserve capital. The BDC structure continues to require the payout of our taxable income. The IRS has this temporary allowance to payout up to 90% of that taxable income as a stock dividend. But that is not a permanent decision by the IRS. So, we continue to need to look at how we are structured and how we operate so that we can be performing for our shareholders for a good long while to come.

John Erickson

Yes, I would just say that this environment is difficult enough negotiating with the lenders over what they know to sit there and try and explain to them something like that would be pretty challenging.

Sanjay Sakhrani – KBW

Okay. And I mean maybe one final one, just is there any consideration being made to buy back some this debt that had a steep discount out there, I mean can you monetize on any of your investments and kind of do that?

Malon Wilkus

We can’t comment on that.

Sanjay Sakhrani – KBW

Okay, great thank you.

Malon Wilkus

You are welcome.

Operator

Thank you. And next we will go to the line of David Jordan of Axiom. Please go ahead.

David Jordan – Axiom Capital Management

Thank you very much. The debt coverage ratio, did you say it was like 1.8 or 2 to 1?

Malon Wilkus

In ‘08 – the interest coverage?

David Jordan – Axiom Capital Management

Yes.

Malon Wilkus

Our interest coverage was around 3.7.

David Jordan – Axiom Capital Management

3.7. So, where was, I mean this might be early –

Malon Wilkus

I should say 3.6 in 2008.

David Jordan – Axiom Capital Management

3.6 to 1?

Malon Wilkus

Yes.

David Jordan – Axiom Capital Management

Okay, so if the debt service coverage declined, that would mean that some point in time your net operating income would disappear is that correct? That’s a theoretical question, but is that correct or not?

Malon Wilkus

Well the calculation we were using is really EBITDA interest coverage ratio.

David Jordan – Axiom Capital Management

Okay.

Malon Wilkus

So, and our EBITDA is the larger component of course is our – essentially net operating income, but got adjustments to it.

John Erickson

You know we got down to a 1 to 1 coverage and the net operating income would be –

David Jordan – Axiom Capital Management

Negative.

Johns Erickson

Negative, yes.

David Jordan – Axiom Capital Management

I am saying it, what point would it be –

John Erickson

Breakeven.

Malon Wilkus

Basically our net operating income is our net interest margin puts it on expenses so it is not – it is a chicken on the egg, it is not long for the other there effectively getting back to the same number.

David Jordan – Axiom Capital Management

Okay you know when the write-down of the assets the $8.5 a month, whatever it was, do you think you adequately compensated for that. I know you did through the end of the year, but you think you were conservative enough to include what was happening during the first quarter or so or is it likely we are going to see more write-downs in the value of the equity and take the book value down further?

Malon Wilkus

Look it just entirely depends what happens to spreads. I can just tell you that if the spreads ended up last year let’s just say for one particular asset was at 20% spread over some index rate and at the end of this quarter it ends up at 25% well there will be more depreciation. If on the other hand it goes from 20% down to 15% then there will be appreciation on that asset. And we don’t know, I don’t think anybody on this call knows what is going to happen on the last day of this quarter.

David Jordan – Axiom Capital Management

Okay, so let’s not go to the last day of the quarter, let’s go to today’s conference call, how much have the spreads widened to today from – just at anyone point in time, today’s point in time, how much did they –?

John Erickson

That’s a good question. I don’t – we haven’t done any kind of comprehensive analysis of that. We don’t do that till we ended the quarter, but kind of an eyeballing of it is that spreads have been fairly flat fairly flat quarter to date and we will have to see of course the market has been down quarter to date, so multiples might be lower quarter to date but debt-related spreads probably are more flat.

Okay, and then just one last thing; and I am sure everybody wants to know this, I'm sure everybody knows you are working very hard. I think personally you have done a great job in dealing with the world being so upside down. I think you have done a great job doing that, so we're not – we're still alive and kicking. But when would you suggest that we might hear something about dealing with the bank? I know you must be frustrated that you weren’t able to announce it today. So do you have any idea or could you hold our hand and give us an idea what you could – what one could hope for, possibly expect in terms of dealing with the banks so we are going to know are going to be there for a longer period of time, assuming the spreads don't widen and give us some more difficulty? Is that a fair question or not?

Malon Wilkus

Yes, David I really can't say one way or the other. We really can tell you only what we have accomplished or not in that regard and at the moment we don't have an agreement.

David Jordan – Axiom Capital Management

Okay, thank you very much for your time.

Operator

Thank you. And next we will go to the line of Matthew Howlett of Fox-Pitt Kelton. Please go ahead.

Matthew Howlett – Fox-Pitt Kelton

Thank you for taking my question. Just a follow-up on the business loan trust again. I understand the normal beneficial impact it would have if you could mark those liabilities to mark it on the FAS 159. But just getting back to more of the covenant, I know you are not in breach of any of those covenants inside those deals to date, but my question is have the rating agencies reviewed it or updated their review on those business loan trusts, do they do it quarterly, do they do it monthly, and I'm really targeting on that triple fee bucket test, whether or not they pun it or shadow rate it or whatever they do on those deals.

Malon Wilkus

Keep in mind that doesn't have an impact on us. It will have possibly an impact on the bond holders of those securitizations.

Matthew Howlett – Fox-Pitt Kelton

Would it redirect cash flows if you – it is my understanding that if one of those breaches are hit, it would triple pay the structure and redirect cash away from the residual owner to the senior holder and now that wouldn’t impact GAAP EPS but it would impact cash. That is my understanding.

Malon Wilkus

Yes. The rating agencies work with us on ongoing basis to monitor them. We don't have ratings figures inside there. It is actually like delinquency in default traders. And some of the BLTs are trapping cash but that is not a bad thing. We went through this in 2000 with our first BLT where we also – right after we did the December 2000 BLT we did the 01, 02 recession. It came – really trapped cash it amortized down and we ended up with assets coming out of it, which was not a bad thing; it worked fine.

Matthew Howlett – Fox-Pitt Kelton

Okay, so in other words, it is just building up again and you will expect to be recouped at when these fields are collapsed at some point.

Malon Wilkus

Absolutely.

Matthew Howlett – Fox-Pitt Kelton

Okay, fair enough. And then just one other thing on potential cap rating; I know you recently got approval for the rights offering. You mentioned you would only want to generate liquidity at the right price and can you give us comment anything on raising additional capital here, equity capital?

Malon Wilkus

You know, we did get approval from our shareholders to be able to issue 20% of our shares associated with the acquisition of the remaining piece of eCap that we don’t own, European Capital. That additional 20% is about 42 million shares, so we do have the approval to issue those shares below book, but I can tell you at prices that we are currently trading at 42 million shares times our current trading is a level of proceeds which is rather insignificant to our business; and therefore it is just something that we are very, very unlikely to do.

Matthew Howlett – Fox-Pitt Kelton

Fair enough. I just wanted to clarify that. And this last question if I may. Out of the four deals that were pushed in December or the fourth quarter, have any of those deals been a part of what you have done so far and that you are projected to sell or earn in the process? I just wanted to see if – cash flow might come back a little bit in the quarter and we are just trying to sense of maybe think or a little bit better year for selling.

Malon Wilkus

During the fourth quarter we did have a number of sell processes where we engaged investment banks. We went through relatively broad auctions, both strategic and financial buyers and interestingly initially received indications that we are in line with our expectations, but as the quarter wore on and as time passed in the quarter, it became increasingly obvious to us and our advisers that the remaining bidders were adjusting their bids lower to take advantage of what they perceived to be a motivated seller. But since we are a long-term investor, we elected to pull those transactions rather than sell what we found were artificially low prices. So keep in mind we continue to own those companies, they continue to perform for us and they could be available for sale at a later date. In the current quarter, I think we have about eight companies that are for sale and as you know we have a large and diverse portfolio and we are really concentrated on selling companies that we think are recession resistant and/or would have significant strategic interest and therefore would be a value, really an end market including the environment that we are in right now. So we believe that we will be able to sell these assets at reasonable values even in this market. And as you say, I think we are seeing some improvement there, there have been some high-yield deals that have been done recently and they are showing some additional capital available to the market. So we are hopeful that we will be able to achieve reasonable values on the sales of assets.

John Erickson

We have a portfolio full of very high quality assets and we are in various stages of negotiations with different buyers and we're optimistic that in any market, there is demand for high-quality assets and we continue to use that in various stages along those eight companies we are discussing.

Matthew Howlett – Fox-Pitt Kelton

Great. Thanks for the color.

Operator

Thank you. Next, we will go to the line of Jeffrey Talbert of Wesley Capital. Please go ahead.

Jeffrey Talbert – Wesley Capital

Hi, good afternoon and thanks for taking my question. I have a question please in the press release evaluation of portfolio investments in the second paragraph. You talk about a change in the way you will be using outside consultants to evaluate the portfolio from I guess what was a rolling quarterly process to as requested. Could you tell us exactly how that is going to work and what the background for that decision was?

Malon Wilkus

We felt that one thing that we were not getting from the – and this is really the audit committee felt that the thing that we are not getting from our consultants over the last many years now is data from them that they were conducting their analysis and making presentations to us that came to individual or aggregate conclusions without actually sharing with us their data and they felt that the procedures that we had I guess they concluded that they could not both provide the data and their results. And we were undermined and our audit committee came to the conclusion that they really wanted not only their advice but their data and so we have restructured it so they continue to participate in the same manner they have in the past, in very expensive reviews of every portfolio company together with us in our valuation meetings. They continue to review our whole analysis of it, but they also provide us data that we could use to improve the quality of our valuation process and then they report to the audit committee both with respect to our procedures as well as with respect to individual investments that the audit committee engages them to conclude on. So we think frankly this works somewhat more smoothly. We were also finding that we were having trouble in the way that they were doing in the past to get our reporting done on time, because we had so many parties involved and this probably helped save some time in the process.

Jeffrey Talbert – Wesley Capital

Got it. Okay. Let me just put a follow-up question to make sure I understand the process, because it is not something that I am an expert on. It is my understanding, and please correct me if I'm wrong, that the issue of whether a default occurs is really as of today don't you think you have actually not published financials? I just want to try to understand the process and your discussions with the lenders that technically speaking, the fact that they haven't sent you a default letter of some acceleration notices is as much a product that they are not having, a definitive set of financials if anything, is that an accurate valuation of that?

Malon Wilkus

Very much along that line. You have a reporting requirement under the agreement. In our case, that reporting requirement includes coming to conclusions about the asset value so that we can come to conclusions about our tangible net worth. And as you know, it is just an enormous process for us to come to conclusions about all of our assets. It goes through multiple steps and we have, as you know over 50 CPAs and financial professionals on staff that works on this. And ultimately, it is not a decision made by our management, it is a decision made by our Board of Directors after getting recommendations from our audit committee, and after our audit committee gets recommendations from the consultants and management, and in addition, it requires a process that we go through with Ernst & Young, our auditors, who ultimately apply in on our balance sheets on an annual basis. So we really – until we reported or until our Board came to conclusions about our asset values and therefore about our tangible net worth; until that occurred, we weren’t in a position to report under our loan agreements. Now there is a certain time period you have to do that within and of course we fulfilled and now that the reporting has been done, we have understood that it is likely that we would get a default notice.

Jeffrey Talbert – Wesley Capital

Got it. And just so I understand what the process it took, so I understand what might happen. (inaudible) issue a notice of default, however ill advised that it might have been with that acceleration. If they do that, they could conceivably force an involuntary bankruptcy. Is that, however remote, that is a possibility. That is what I'm trying to say what could happen.

Malon Wilkus

Upon acceleration, we would be likely contest that and it would take some months in court procedures for that to occur and then at the time that ultimately – if they were to get a order that would allow them to get a claim on assets, then at that time, we would almost certainly want to seek the protections and events to reorganize under Chapter 11. But we think that all that is quite unlikely and keep in mind to out that process and even if we were to go to that extent, they would be unsecured and until we gave them security, they would be unsecured and their rights as an unsecured claimant is far less than really those rights of a secured lender.

Jeffrey Talbert – Wesley Capital

Okay, that is very helpful and I appreciate it very much, thank you.

Malon Wilkus

And I should point out that we worked very hard over the last 18 months to retire all of our recourse secured loans. And we have been successful in doing that and therefore all of – outside of our securitizations, we have no secured facilities.

Jeffrey Talbert – Wesley Capital

But I guess if you come full circle, although they are unsecured, obviously, as equity holders, they are ahead of us.

Malon Wilkus

Yes.

Jeffrey Talbert – Wesley Capital

Okay, just wanted to make sure I understood the process. Thanks again.

Operator

Next we go to the line of Angelo Guarino [ph] of PRI [ph]. Please go ahead.

Angelo Guarino – PRI

Hi. Can you talk a little bit about the 159 election and the arguments that the regulators are giving you in the feedback of why the bifurcated balance sheet valuation approach makes sense and if you get a window to re-elect, would your lenders be obligated to accept that accounting change?

Malon Wilkus

Yes. The requirement under 159 is that you had a one-time election for existing liabilities and that was on January 1, 2008 and unfortunately, we were – not only American Capital but I think many DDCs were struggling with trying to understand the implications of FAS 157 in valuing the asset size of the balance sheet. And up through January and February of 2008, through January and through parts of February, it was entirely uncertain from our auditors as how the FAS 157 would be implemented with respect to our third tier assets. And as a result, neither American Capital nor any other DDC that had the end of the year financials elected to implement FAS 159. Now you can’t apply FAS 159 – and therefore by the time we did understand the impact of FAS 157, it was too late and you couldn't go back and implement it. You could, under 159, apply at any time you enter into a new loan agreement, but that really doesn’t help the situation in this case. So, now the – the regulators are not – the FAS 159 was implemented by FASB and it is questionable to what extent a regulator could have an impact on that. But it does seem pretty odd for us, because if we were able to retroactively implement 159, we would have $1.2 billion of additional book value.

Angelo Guarino – PRI

So you are saying FASB is the one who is telling you with the open window, it is not the regulators that are saying whether or not you can elect at this time?

Malon Wilkus

That is right. This is accounting and GAAP requirement and FASB set this standard for implementation. And then finally I will say that even if we were to – if FASB were to come out and say we could elect one more time, had one more chance at electing, that would improve our balance sheet by $1.2 billion, but we would still have already breached the covenant and there is not a retroactive re-fixing of that.

John Erickson

And at this point, frankly, we are looking to try and develop a covenant package that gets away from your spread lining and mark to market accounting and I think that one of the points that we have been reviewing as a bank is our desire certainly to try and develop a covenant package that measures credit impairment. That is what we can manage, that is what we feel like we should be penalized for is if we have four performing assets and yes, the banks should have a hammer, but just the way it is spread, it has been what is really recounted with us and so, as we are working on the covenant packages, that is one of the areas of negotiation with the bank and our strong preference would be to have a covenant package that didn’t have tangible net worth and didn’t get tied to mark to market accounting and that certainly is what we have been offering and the banks have their opinions and we will work with one.

Angelo Guarino – PRI

So if you get a renegotiation or refinancing of this loan, as part of your whole package, you could elect the 159 mark to market on that renegotiated version?

Malon Wilkus

Yes, but you can imagine that that probably doesn't change any value because that would set a standard for the current fair value. So spread would have to change from there for there to be any impact or any changes of depreciation or appreciation associated with 159.

Angelo Guarino – PRI

So it is a fun academic procedure to account that, but it really is not going to –

Malon Wilkus

Except that if we could implement it today, particularly all of our structured financing would immediately have a different valuation assigned to those liabilities on our balance sheet. And then to some degree, there would be a change to the credit agreement that we entered into on September 29 and then with respect to our bonds and our notes outstanding, those would also be significantly impacted by – or the booking of those liabilities would be significantly impacted by 159 if we could elect with.

Angelo Guarino – PRI

Is this something that your little group is lobbying as one of the items that you are trying to make progress on?

Malon Wilkus

Well I am not going to get into details about everything we are doing, but all the issues that are obvious to you are obvious to us and we are doing our best to try to help people realize that it is not necessarily the best business climate to be doing some of these things and our objective has always been what will help our shareholders understand us the best. And we do think that FASB has kind of veered from that premise. We don’t think it is easy to understand our balance sheet as it used to be.

Angelo Guarino – PRI

Thank you.

Operator

Thank you. Next we will go to the line of Larry Ring of Dwight Asset Management.

Larry Ring – Dwight Asset Management

Thanks very much. I just want to ask a couple of quick questions. To the breach of covenants, the default event under the outstanding public bonds?

Malon Wilkus

No there is no cross default in the public bonds for covenants in the other debt facilities.

Larry Ring – Dwight Asset Management

Alright. So the public bonds also then don’t enjoy the additional 200 to 300 basis points of additional payment?

Malon Wilkus

There is no default. There is no event of default at this time on the public bonds and thus any default interest rate in the public bonds would not be affected.

Larry Ring – Dwight Asset Management

Anything that would trigger, there is a few things that trigger, but basically missing principal on the interest payments, is that correct? Breaching a covenant is not an event of default.

Malon Wilkus

It is an event of default but that event of default has not occurred under the public bonds.

Larry Ring – Dwight Asset Management

Okay. Also have you heard anything – have you heard anything from the rating agencies, have they opined upon whether if you do get a default notice from your creditors, they would then have to move the rating in accordance with that?

Malon Wilkus

We have spoken to the rating agencies but they have not commented publicly on that.

John Erickson

Yes, you have to wait for them to make their own comments.

Larry Ring – Dwight Asset Management

Okay, great. Thanks very much.

Operator

Thank you. Next we go to the line of Nick Cayano [ph] of Paulson. Please go ahead.

Nick Cayano – Paulson

Hi. Correct me if I am wrong, but if we had the ability to elect FAS 159 and the environment improved so that spreads narrowed both on our investments and on our underlying debt, we would then – the gain on this additional $1.2 billion of equity that would be gained from being able to mark liabilities and for our market would reverse and so is FAS 159 really that helpful?

John Erickson

It would have given a better matching between the assets and liabilities, because in that environment, we would've seen less volatility in the depreciation and appreciation line because what has happened is our assets have depreciated, but our liabilities didn't depreciate with them. If we had depreciated with them, then you are right. If both things are appreciating, it just takes volatility out of the equity and the unrealized appreciation/depreciation line.

Malon Wilkus

So they would have moved more together than just having the assets go down and liabilities staying fixed.

John Erickson

And therefore the book value would reflect more credit impairments as opposed to spreads widening or contracting.

Malon Wilkus

Right.

Nick Cayano – Paulson

Okay. Thank you.

Operator

Thank you. And next, we will go to the line of John Hempstead of Hempstead & Co. Please go ahead.

John Hempstead – Hempstead & Co.

Thank you. My question is about the shareholder lawsuit that was filed last fall. Could you give us kind of an update on that situation?

Malon Wilkus

Yes. There is no update. There was a deadline for filing additional suits and the matter is now pending before the Federal court.

John Erickson

Is there another question, John?

John Hempstead – Hempstead & Co.

No, that was it.

Operator

Thank you. And next, we will go to the line of Thomas Tarantino [ph], a private investor. Please go ahead.

Thomas Tarantino

Yes, hello gentlemen. This question may have already been answered and if it has I apologize, but is there any chance that FAS could lose its (inaudible) status or choose to abandon so and what is the date by which ACS would have to secure it?

Malon Wilkus

I think you are referring to (inaudible). I think as you have seen the IRS has issued the 90/10 dividend, where we pay 90% stock and 10% cash to try and provide relief to both in this environment and so certainly they are trying to be helpful so that in this liquidity crisis, (inaudible) themselves of the ability to maintain their status. As we have discussed, we must declare the 2008 dividend of about $300 million by June 15 of this year, so that is really our deadline for dealing for dealing with issue would be June 15 declaration.

Thomas Tarantino

7/15, okay I understand that coincides with the dividend declaration – the dividend and you will pay that in September?

Malon Wilkus

Correct.

Thomas Tarantino

Okay, very good. Thank you very much.

Operator

Thank you. And next we will go to the line of Jerry Johnson [ph], a private investor. Please go ahead.

Jerry Johnson

Hi, gentlemen. Most of my questions have been answered just a question about if you do pay the 90% as stock would you be – would you have a treasury stock already or would you be buying that on the open market with the depressed prices that are out there right now?

Malon Wilkus

It would be the issuance of new shares.

Jerry Johnson

Why not just buy – you have got that money that is going to have to go out anyway. I understand – you would in essence be saving that, preserving that cash. Okay, that that makes sense. My only other doubt would be – there seems to be a lot of lack of communication. I have heard some professional investors on this call who weren’t necessarily clear on the rights of these unsecured debt holders. It seems like there is a lot of panic out there with people largely assuming that these unsecured debt holders really could just foreclose at any moment and I wonder if you had a comment about the communication strategy.

Malon Wilkus

Yes, there is a lot of confusion about this particular topic. As you know, we are in the business of investing and lending to the hundreds and hundreds of companies and further down the capital structure than most banks do and so we are in the middle of the capital of hundreds of portfolio companies over the years and so we are pretty well read and experienced upon the rights of the secured lender versus an unsecured lender and the market I think is not. And I think it is important that we do our best to try to help the market understand some of the differences in rights between those two lender classes. The main point being is that they do not have a right to foreclose on assets and the protections that are offered under Chapter 11 to reorganize still provides a great feel of protection to shareholders if indeed your underlying net worth is sufficient and you are in a position to repay your creditors to repay those unsecured creditors over time in full. And if you can do that, then you can preserve value, you have an opportunity to preserve value and quite possibly 100% of value for your shareholders and you are not even compelled to provide collateral to the unsecureds.

Jerry Johnson

But the stock is trading like it is the end of the world –

Malon Wilkus

That is right. It is – I don’t know, I believe this organization has done its very best to help the market understand as best we can that we think we have tremendously greater value in our book value than you see in our stock price. Not only is it about $15 a share in book value on a GAAP basis, but on a realizable value basis, the basis by which we operated for the first ten years of us being public and we’d had great degree of accuracy if you can just look at our exits with respect to realizable value being accurate with respect to actual realization. When you use that calculation where we would be at over $20 per share in realizable book value.

Jerry Johnson

Alright. Just one last question, you had said that the authorization to sell more shares below net asset value was going to be – those funds are going to be used to acquire their portion of European capital that you didn’t already have. Now you said the current stock price would result in pretty inconsequential amount of money, so how are you going to suspending your plans to buy the remaining portion of European Capital or have you found another way to finance them.

Malon Wilkus

No. Keep in mind the original agreement was that the – there was fixed ratio between our arrangement for the purchase of the remaining shares that we didn’t already own. So, the amount that we – the number of shares that we have issued for that purpose is determined and it should – if you – we don’t have European capital’s Q4 numbers, but if you just look back at Q3, it would actually be accretive based on the numbers that their book value per share back them.

John Erickson

Much because their stock is also trading significantly below their NAV per share. So, in essence the NAV you are picking up for the stock price is still attractive and though both stock prices are depressed.

Jerry Johnson

So, would you just be issuing stock to buy the European Capital?

Sam Flax

It was set up for stock for stock exchange.

Jerry Johnson

Okay, gotcha. Thank you.

Operator

Thank you. And next we will go to the line of Andrew Shaw [ph], he is a private investor. Please go ahead.

Andrew Shaw

Yes actually the previous caller answered my question.

John Erickson

Okay thanks.

Malon Wilkus

Thanks.

Andrew Shaw

Thank you.

Operator

Thank you. And next, we will go to the line of Eric Hamilton [ph], private investor. Please go ahead.

Eric Hamilton

In February AGNC, which is part of your company as I understand, pay announced the cash dividend. Now why – is that a decision that was okayed by your management because why are you paying – letting them pay a cash dividend that cash is so tight?

Malon Wilkus

Keep in mind, American Capital agency is a separate company that we are managing. It does have an independent board. I am one of the members of the board and it is the board that declares its dividend. And American Capital performed extremely well producing a great deal of income and the board chose to payout a portion of that income to the share holders. Now American Capital is a shareholder, we own a third of the company and so we were the recipients of the third of that dividend and we are very pleased about it, as if just think of it like any other portfolio company, we have an investment in it and in this case the portfolio company is performing extremely well and it has up streamed the dividend up to us very nice.

John Erickson

And also (inaudible) pointed out an agency as a REIT and therefore has similar requirements of distributing income to its stock holders in order to preserve its cash balance.

Eric Hamilton

I understand. Well it seems like 90% of this conference call is being dedicated to your refinancing unsecured debt and this doesn’t with the performance you keep on saying your portfolio is experiencing and currently experiencing. The two plus two don’t equal four here.

Malon Wilkus

Well we can appreciate that. Thank you so much Eric.

Eric Hamilton

Still that’s not an answer I suspect you can’t see into a crystal when it is so clouded, but this is a very clouded situation here and all these analysts that get on the phone and ask you questions they even really get to the harder matters and although their interest is within the unsecured debt and not the real portfolio because I looked at the portfolio when it was given up to me three months ago and I have noticed all the nice companies you have in health care and all the other things. Then I go to the bottom of the portfolio list and then there was a bunch of staff with Citi and Morgan Stanley, or whoever these other banks are they are still affiliated with, it looks like the bulk of the money is tied up in investments with them. Now I am not a genius, but I am not a financial analyst, and I don’t run your company, I ran my own company for 25 years, but I don’t get any of this. I am sure I am making you laugh, but I don’t think this is a laughing matter.

Malon Wilkus

No, no. I don’t feel that way at all. It could be some of your comments we share completely. Well as I said in the press release it is all about the portfolio. If the portfolio performs well and we will have a good outcome in every respect and if the portfolio doesn’t, no one could have a good out come. And right now the portfolio is not performing as well as it has, but it is still performing very well and I appreciate the fact that you point that out and maybe we rather go to the next questioner if we could, thank you.

Operator

Anything further, Mr. Hamilton?

Eric Hamilton

No, there isn’t.

Operator

Thank you. Next, we will go to the line of Philip Low [ph], a shareholder. Please go ahead.

Philip Low

Thank you for picking the questions. For the European capital buyback would that increase the net asset value more closer to the realizable net asset value?

Malon Wilkus

That is a very good question and for sometime we have been having a discussion with our auditors as to the proper treatment, if we end up owning a 100%, I will be honest with you, we thought our conclusion about that has not been made in final and so I can’t be certain yet whether it will be substantially higher as a result of implementing the transaction or not.

Philip Low

Thank you.

John Erickson

Probably there is a lot of factors in the decision we guess have to review all the factors though.

Philip Low

Yes. When can the American Capital get back to the business of lending for M&A, and I believe that the share prices would rise as you get back to business and at this time from the news release there does not appear to be a market with the buyer and sellers and is there a market now and also if there are funds and credit line available to fund this say new businesses?

Malon Wilkus

Of course we are constrained right now with the fact that there is not an opportunity in today’s market to issue additional equity or to raise additional debt and actually we are now precluded from additional debt. So, we are going to have to wait till the markets come back around, we will have to wait until we can bring our debt-to-equity back down below 1 to 1 before we can have the ability to actually grow our balance sheet. Right now all we are doing is recycling our balance sheet and of course we get a lot of capital coming back to us, which we can turn around and invest. In our existing portfolio, we could – if we wanted to invest in new companies, but we would rather just keep our capital devoted to our existing portfolio and also very thoughtful [ph] being pay down our creditors and delever somewhat.

So with that I appreciate your questions and these have been excellent questions all morning and we’ve gone for now quite some time, so I am going to just end by saying that we very much appreciate everyone joining us and participating on this call, there has been some excellent questions, this recession as we said earlier won’t be easy, but inevitably will make adjustments to our business and we are focused on a long-term and as a long-term patient investor I am confident we will produce good results for our shareholders in the end and with that I appreciate it, look forward to talking to you again in a quarter from now.

Operator

Thank you. And ladies and gentlemen, this conference will be available for replay after 3:00 p.m. Eastern Time today until March 16th at midnight. You may access the AT&T Executive Playback service at anytime by dialing 1-800-475-6701 and entering the access code 982334. International participants may dial 320-365-3844. Thank you for your participation today and for using the AT&T Executive Teleconference Service. You may now disconnect.

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Source: American Capital Ltd. Q4 2008 Earnings Call Transcript
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