Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

John Scheurer – President & CEO

Penni Roll – CFO

Rob Long – Head of Asset Management

Shelley Huchel – Director IR

Bill Walton – Chairman

Analysts

Vernon Plack - BB&T Capital Markets

Troy Ward - Stifel Nicolaus

Greg Hillman – First Wiltshire Securities

Faye Elliott – Banc of America/Merrill Lynch

Robert Dodd - Morgan Keegan

Matthew Howlett - Fox-Pitt Kelton

Maynard Lichterman – Smith, Barney

Allied Capital Corporation (ALD) Q1 2009 Earnings Call May 11, 2009 8:30 AM ET

Operator

Good morning ladies and gentlemen, and welcome to the first quarter 2009 Allied Capital Corporation earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today, Mr. Bill Walton, Chairman; please proceed.

Bill Walton

Good morning, everyone, and welcome to Allied Capital's first quarter 2009 conference call. I'm joined today by John Scheurer, Penni Roll, Rob Long, and Shelley Huchel.

Shelley, would you open the discussion today with required conference call information and discussion about forward-looking statements?

Shelley Huchel

Today's call is being recorded and webcast live through our website at www.AlliedCapital.com. An archive of today's webcast will also be available on our website, as will an audio replay of the conference call. Replay information is included in our press release today and is posted on our website.

Please note that this call is the property of Allied Capital. Any authorized rebroadcast of this call in any form is strictly prohibited. I'd also like to call your attention to the customary Safe Harbor disclosure in our press release today regarding forward-looking information.

Today's conference call includes forward-looking statements and projections, and we ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these projections.

We do not undertake to update our forward-looking statements unless required by law. To obtain copies of our latest SEC filings please visit our website or call Investor Relations toll free at 888-253-0512.

For today's conference call we have provided a companion slide deck that complements our discussion and lays out many of the numbers we will discuss. These slides are available in the Presentations and Reports section of the Investor Resources portion of our website. We will make reference to the data included in the slides throughout today's call.

Finally, as always, there will be a Q&A session after the presentation.

With that, I'll turn it over to Bill.

Bill Walton

Thank you Shelley, we continue to operate as a company and as a nation in troubled economic times. The first quarter of 2009 not much changed in the fundamental freeze that still grips lenders and buyouts in our market.

Middle market leverage lending and buyout activity were essentially non-existent in the first quarter of 2009. As we have communicated to you previously our strategy to weather these difficult economic times has been focused on four basic elements; reducing costs and streamlining organization is the first one.

Building liquidity through selected access sales, retaining capital by limiting new investment activity and suspending dividend payments, and working with portfolio companies to help them position for growth as the economy recovers.

As we move through our discussion today you will see that we’ve made progress in all of these fronts but we still need to remain keenly focused on the strategy until the markets and economy improves. Of course John and his team are also working with their lenders to restructure our capital base and he’ll provide an update on these efforts.

For business introduction, let me turn the call over to John Scheurer.

John Scheurer

Thanks Bill, I think it makes sense to begin with the topic that is most important to all of you, where we are in our capital structure negotiation. As you know we reopened discussions with our lenders in late January in an effort to achieve a comprehensive restructuring of our revolving line of credit and private notes.

All parties to the discussions have engaged financial advisors and the discussions are progressing. But in a market like this one, financial restructures take some time to complete so we are not done yet and cannot discuss details but we continue to be optimistic that we will arrive at an acceptable outcome for all parties.

While we have been working on the restructuring we have made significant progress in selling some of our assets to generate liquidity. From year-end through today we have sold or had repayments on portfolio investments for about $320 million of cash proceeds, the bulk of which was from the sale of our Advantage sales and marketing note which netted $132 million.

The balance represented approximately 20 other securities and 11 portfolio companies. The assets sales have been completed under distress conditions in a very difficult market, yet our proceeds from the assets sold represented about 90% of the aggregate fair value of these assets as of December 31, 2008.

So we are pleased with our progress on the liquidity front. Primarily as a result of the sales and repayments, at March 31 we had cash totaling $290 million and at May 8 we had cash of about $360 million. We plan to complete additional asset sales and various refinancings throughout the course of the year but only if we believe the prices for the assets sold is prudent.

In other efforts to improve our leverage position we have also purchased 59 million of our publically issued notes that have discounted par in the secondary market. Most of these purchases were completed in April and the total gains associated with the purchases have been $41 million.

To the extent we purchase debt at a discount our asset coverage improves from both the extinguishment of debt and the benefit of the discount. At March 31 we continued to remain below our regulatory threshold of 200% asset coverage required for new borrowing activities and as required by the current covenants in our line of credit and private notes.

In the first quarter we continued to see multiple compression, decreases in market leverage levels and increases in market yields for subordinated debt instruments. In addition we saw some declines in operating performance. All of these factors contributed to the decline in fair values of our assets.

In the first quarter of 2009 we experienced an additional $350 million of net unrealized depreciation in the portfolio and at March 31, 2009 our asset coverage was 171%. On a pro forma basis assuming that our cash on hand at March 31 was used to retire debt, our asset coverage ratio would have been approximately 183%. If on a pro forma basis you also effect for the public note purchases that occurred in April, as if they happened on March 31, our asset coverage ratio would improve to approximately 187%.

Note that this does not capture all activities including asset sales which have occurred or value changes which may have occurred after quarter end. As you can see from these pro forma adjustments, these efforts largely offset the effect of the additional depreciation during the quarter. However net improvement has been constrained by declining asset values.

Depreciation in the first quarter was mostly concentrated in three portfolio company investments and our CLO portfolio. In fact, approximately $221 million or 61% of the overall unrealized depreciation resulted from these investments. The three portfolio companies which accounted for 38% of this quarter’s net unrealized depreciation were Earth Color, a commercial printer declined by $77 million this quarter, Ciena Capital declined by $44 million this quarter, and Wear Me Apparel, a marker of children’s apparel, declined by $17 million.

Earth Color is experiencing the difficulties of the economic cycle and is an example of a company that we believe should see some value recovery as the economy eventually rebounds. CLOs in general face structural issues as rating agencies continue to down grade their loan and debt assets to CCC status regardless of whether the instruments continue to meet payment obligations.

These downgrades impact the collateral coverage ratios of the CLO pool and impact the assumptions for the payment of future cash flows. As a result of this and the increased default assumptions, our CLO values declined an additional $83 million this quarter and accounted for 23% of overall unrealized depreciation.

Actual defaults in the collateral pools for our CLOs were only 2.8% at March 31, 2009 but our investments are valued assuming higher default rates. Other investments in the portfolio in the aggregate accounted for the remaining 39% of or unrealized depreciation in the first quarter of 2009.

Within these other portfolio investments for the companies where we use an EBITDA multiple valuation approach we saw enterprise values decrease primarily because of decreases in multiples. Multiple compression accounted for about 85% of the decrease in enterprise value and decreased EBITDA drivers accounted for about 15% of the decrease.

First quarter enterprise value multiples for these companies averaged 6.4x with a medium multiple of 6x. This compares to enterprise value multiples used in the fourth quarter 2008 valuations that averaged 6.9x and had a medium multiple of 6.5x for these companies.

In this economy no company is immune from challenge and even though we are continuing to see valuation and compression we are generally pleased with the operational performance of the majority of our portfolio companies.

So overall declining asset values continue to pressure our capital structure however as we focus on completing our restructuring activities and as the economy improves we should be positioned to meet our regulatory asset coverage requirements and move the company forward.

On another front we are continuing to look at our expense structure and improve our efficiency. In the slide deck you will find a slide that outlines our operating expenses, I believe slide six, we have significantly reduced headcount over the past year and have reduced compensation levels. For comparison purposes prior to these reductions, in 2007 our annual employee expense was about $105 million or an average of about $26 million per quarter.

For the first quarter of 2009 our employee expense was $11 million. We closed both our LA and Chicago offices last year to reduce administrative expenses and we are still reviewing other means to further reduce costs.

For instance, we recently signed a letter of intent to sell our corporate plane. We want to be as efficient as we can without compromising our operations. In addition to cost savings we are also looking to improve our overall current income by selectively repositioning the portfolio mix over time.

We would like to reduce the amount of non-interest bearing securities in the portfolio and redeploy the capital into interest bearing debt investments. We are also evaluating yields, risk, potential upside, and the expense burden of all assets so that we can upgrade and increase our current yield.

Now I’d like to turn the discussion over to Penni and Rob; Penni will take us through the financial results in more detail and Rob will provide an update on asset management and give you some more market color.

Penni can you take us through the first quarter results in further detail.

Penni Roll

Yes thank you John, let’s just start with a discussion of our March 31, 2009 balance sheet, if you’ll please turn to our summary balance sheet which is on page three of the slide deck.

We ended the quarter with total assets of $3.4 billion, total debt of $1.9 billion and total shareholders equity of $1.4 billion. Our leverage ratio at March 31, 2009 was 1.42:1. We had cash and investments in money market and other securities of $290 million. Our debt to equity ratio at March 31, on a pro forma basis if we assume cash and short-term liquid investments were used to retire debt, was 1.21:1.

We invested $39.9 million in the first quarter of 2009 primarily related to existing investment commitments under revolving lines of credit or other facilities. As John discussed previously we have had several sales and repayments which in the first quarter generated cash of $241.8 million. After including the impact of this quarter’s valuation and other changes, our portfolio at value was $2.9 billion as of March 31, 2009.

The yield on our interest-bearing portfolio of $2.5 billion at March 31 was 11.8% as compared to 12.1% at December 31, 2008. At March 31, 2009 shareholders equity or net asset value was $7.67 per share as compared to $9.62 per share at December 31, 2008.

Please turn to slide four for a summary of the changes in NAV for the quarter. During the first quarter net investment income increased NAV by $0.16 per share, net realized losses decreased NAV by $0.15 per share and NAV decreased by $1.96 per share due to changes in net unrealized appreciation or depreciation.

Now let’s move to a discussion of our earnings and for this please turn to slide five, interest income for the quarter ended March 31, 2009 was $84.2 million as compared to $97.2 million in the fourth quarter of 2008. We sold interest-bearing investments, [inaudible] was $213.4 million during the quarter with an average yield of 12.3% which reduced interest income by $1.4 million.

In addition we placed certain interest bearing investments in six portfolio companies on non-accrual status during the quarter further reducing interest income by approximately $2.9 million for the quarter. Fees and other income were $6.5 million for the first quarter of 2009 as compared to $10.7 million in the fourth quarter of 2008.

The most significant components of fees and other income included fund management fees of $2.8 million, management fees related to portfolio companies of $2.2 million, and $0.8 million of loan prepayment premiums for the first quarter. Total operating expenses were $58 million in the first quarter of 2009 as compared to $73.5 million in the fourth quarter of 2008.

The comparability of quarter-to-quarter expenses was effected by several items so please turn to slide six for a discussion of the more significant operating expense items for the quarter. Interest expense excluding installment sale interest expense was $41.6 million for the first quarter of 2009 compared to $37.1 million in the fourth quarter of 2008.

Interest expense in the first quarter increased due to the accrual of default interest of an additional 200 basis points on our private notes and revolving line of credit which increased interest expense by $3.6 million. First quarter employee expense was $11.1 million as compared to $19 million in the fourth quarter of 2008.

The decrease was driven by a lower headcount and no accrual for IPA and IPB expense. Our administrative expenses for the first quarter were $9.8 million as compared to $13.3 million in the prior quarter. We continue to work to control and monitor our administrative expenses and we are also looking for ways to further reduce costs.

However we expect we will incur additional costs related to our debt restructure. As John mentioned we have entered into a letter of intent to sell our airplane. As a result we recorded an impairment expense of $2.9 million in the first quarter of 2009.

Please turn back now to slide five, during the first quarter we recognized a $2 million gain on the repurchase of debt at a discount. The gain results from the purchase of $2.5 million of our public notes in the market at a discount.

Income tax expense for the first quarter of 2009, was a benefit of $0.4 million related to our wholly owned subsidiary AC Corporation. Net investment income was $29.5 million or $0.16 per share in the first quarter as compared to $34.2 million or $0.19 per share in the fourth quarter of 2008.

Net realized losses for the first quarter were $27.1 million or $0.15 per share. Gross gains totaled $12.8 million for the quarter and gross losses were $39.9 million. Losses were substantially related to our asset sale activity but we believe that the need to improve our liquidity position in this market was worth the loss realized.

Net investment income and net realized losses totaled $2.4 million for the first quarter of 2009 or $0.01 per share. Please turn to slide eight, net unrealized depreciation for the first quarter totaled $351 million or $1.96 per share. This change resulted from $362.7 million and net unrealized depreciation from changes in portfolio value, a $17 million reversal of previously recorded unrealized depreciation associated with the realization of losses, and a $4.4 million reversal of previously recorded unrealized appreciation associated with the realizations of gains and dividend income.

Net investment income and net realized gains reduced by net unrealized depreciation resulted in a net loss for the quarter of $347.7 million or a loss of $1.95 per share. Now let me turn to a discussion of loans and debt securities over 90 days delinquent and of loans and debt securities not accruing interest. Please turn to slides nine and 10.

On slide nine we show loans and debt securities over 90 days delinquent. Loans and debt securities over 90 days delinquent at March 31, 2009 were $67.2 million or 2.3% of the portfolio at value. At December 31, 2008 loans and debt securities over 90 days delinquent were $108 million or 3.1% of the portfolio at value.

Included in our delinquent loans was our senior loan to Ciena Capital that was $64.1 million or 2.2% of the portfolio at value at March 31, 2009. Excluding Ciena loans and debt securities over 90 days delinquent were $3.1 million or 0.1% of the portfolio at value at March 31, 2009.

Now if you turn to slide 10 loans and debt securities not accruing interest at March 31, 2009 were $228.4 million or 7.9% of the portfolio at value as compared to $335.6 million or 9.6% at December 31, 2008. Excluding Ciena Capital, total loans on non-accrual were 5.6% of the portfolio at value at March 31, 2009 as compared to 6.6% at December 31, 2008.

Our assets on non-accrual are higher then our loans over 90 days delinquent primarily due to the effect of payment in kind interest. A loan that has payment in kind interest experiences no payment delinquencies but collection of that payment in kind interest in the future may be doubtful and we may determine that the loan should be placed on non-accrual.

Loans and debt securities not accruing interest excluding Ciena as a percentage of the portfolio at value at December 31, 2008 are now in the similar percentage range we saw in 2002 during the last economic downturn. Given the severity of this economic recession we would expect that non-accruals and loans over 90 days delinquent may increase in the future.

And with that I will turn things back to John.

John Scheurer

Thank you Penni, now let me turn the discussion over to Rob to talk about our asset management activities and give us an update on the markets.

Rob Long

Thanks John, we continue to selectively and strategically build our asset management capabilities. These activities expand our investment capabilities beyond our own balance sheet primarily in the senior loan business. Our goal continues to be the development of a comprehensive asset management platform that can expand our investment capabilities at all levels of investing and across various asset classes, including potentially real estate.

At March 31, 2009 Allied Capital managed eight funds with total assets of approximately $3.2 billion. In addition our portfolio company Callidus Capital Management, managed nine CLO funds totaling $3.5 billion in loan assets.

Looking ahead we expect to see continued consolidation in the asset management industry as firms reduce their commitments to the business and investors look for replacement managers. We also believe that should the market for new fund investing reopen, Allied Capital will be well positioned to raise new investment vehicles to manage.

Now let me turn to a discussion of the current market environment, turning to slide 11 you will see that total leverage loan volume in Q1 2009 was down $11.3 billion, down 76% year over year. What little loan activity did occur, primarily involved amendments to existing facilities and liquidity driven deals like DIP financings and asset based loans.

Excluding DIP facilities, Q1 total loan volume was only $6.6 billion down from $7.8 billion in Q4 2008 and $44.3 billion in Q1 2008. Middle market loan volume was an anemic $280 million, down 43% from Q4 2008. On the positive side there have been some encouraging signs in the senior loan market.

Please refer to slide 12, where you will see that the S&P leverage loan index rebounded for the first time since July, 2007 rallying 6.3% to 65.6 from 61.7 at year end 2008. Similarly the LCB flow name composite which tracks a selected number of large institutional loans has rallied 18.4% since its all time low of 63.5 in December to 75.2 at March 31.

Since the quarter end this rally has continued with many loan prices materially higher. What drove the firming of loan prices was a fundamental supply/demand imbalance stemming from the lack of new primarily issuances and the slowing of secondary sales by [fore] sellers like hedge funds and other market value based loan vehicles.

Please refer to slides 13 and 14 which show two different supply drivers at work in the market today. First bids wanted in competition volume which represents large pools of assets for sale was down 67% in Q1 2009 from Q4 2008. Also loan buyback activity began to take hold as 30 issuers rolled out buyback programs in Q1 potentially worth $5 billion in outstanding loan volume largely driven by private equity sponsors working to de-lever portfolio company balance sheets and take advantage of the unprecedented discount prices.

Finally while there was no meaningful new money entering the market in Q1 2009 two new CLOs closed during the quarter as compared to zero in Q4 2008. This and most other current activity however relates to the restructuring of previously committed warehouse facilities into permanent vehicles rather then net new capital commitments.

Today’s environment remains tremendously challenging for borrowers, lenders, and investors alike. We expect this to continue throughout 2009 as certain aspects of the economy weaken further, loan defaults continue to rise, and lenders remain on the sidelines driven by the need to de-lever and conserve capital for their own balance sheets.

Looking ahead it is difficult to predict what will be the catalyst for a meaningful improvement in credit availability, including the ultimate effect of continuing to [inaudible] intervention in the financial markets and overall liquidity preferences for the private sector.

Now, back to you John.

John Scheurer

Thank you Rob, before we open the line for questions, I’d like to summarize what I think are the most important takeaways from today’s call. First we are diligently working to achieve a resolution to our covenant default and restructure our debt facility.

Second we have made significant progress on improving our liquidity with selected asset sales at prices we believe are prudent in this very difficult market. Third while our asset values declined further overall we believe that a majority of our portfolio companies are holding their own operationally in this challenging economic environment.

Fourth we are working to further improve our current income through cost savings and through portfolio repositioning activity. And finally we continue to make strides in our asset management area and will look to grow this part of our business further.

And now let’s open the lines for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Vernon Plack - BB&T Capital Markets

Vernon Plack - BB&T Capital Markets

I wanted to get a sense, it was mentioned that employee expense for the first quarter was $11 million, I’m trying to get some idea in terms of a run rate for this year.

Penni Roll

If you look at where we are, the $11 million as we said reflects the reduction in headcount. And also just assumes a certain estimate for bonuses for the year and I think at this point given where we are early in the year its hard to determine what that bonus level will be. But I think you can use the first quarter number as kind of an estimate and we’ll give you an update as we go throughout the year on where we are on total compensation expense.

Vernon Plack - BB&T Capital Markets

And switching to non-accruals, you mentioned and I just didn’t catch the number, the impact of interest and dividend income, new non-accruals for the first quarter.

Penni Roll

The impact on this quarter’s income was a reduction in interest income by about $2.9 million.

Vernon Plack - BB&T Capital Markets

As it relates to non-accrual loans as a percentage of cost basis, do you have that number with Ciena and excluding Ciena.

Penni Roll

We don’t have it right here, all of our disclosures are for non-accruals at value in the portfolio. That’s something that I don’t have with respect to just on a cost basis.

Operator

Your next question comes from the line of Troy Ward - Stifel Nicolaus

Troy Ward - Stifel Nicolaus

Could you talk just a second about the asset sales in the quarter, could you reiterate what the number of assets sold was on a cost basis.

Rob Long

We had 12 portfolio companies in total and what, 21 securities if you include Advantage in that number. So Advantage was a big piece and then the rest of it was pretty diverse.

Troy Ward - Stifel Nicolaus

And what was the total value on a cost basis, fair value, you said one of the numbers.

Rob Long

We said it was about 90% of fair value as of December 31 and then on a cost basis—

Penni Roll

On the asset sales themselves I think the percentage of proceeds against the cost was about [$0.85]. So 85% on a cost basis, 90% on a fair value basis compared to the December 31 values.

Troy Ward - Stifel Nicolaus

And then historically I know when you’ve sold assets, what you sell it for is typically quite a much tighter spread to the last reported fair value and obviously that’s because we’ve always assumed that the sale process takes three to six months so the last reported fair value you’ve got a better indication of what you could sell it for, but yet these sales, like you said, came in at 10% discount and if you back out sales and marketing the rest of them probably came in at 87%, how do you explain why the sales were so far off of fair value.

John Scheurer

I don’t know if you noticed, the first quarter was pretty stressful period in our economy. We started the quarter with $50 million in cash, we were very tight on cash, we were in default. We needed to raise some cash which is what we did and that’s why we ended up selling some assets at still what we think during that period of time were attractive prices.

Troy Ward - Stifel Nicolaus

I know you can’t speak specifics on the negotiations, but is there any, is it a one month, three month, six month, one year, can you give us some type of timeframe on the estimated time for these negotiations.

John Scheurer

I would certainly hope that we have this resolved this quarter some time.

Troy Ward - Stifel Nicolaus

And finally on the unrealized depreciation, I may have missed it, can you characterize what you thought was credit deterioration versus a mark to market and deterioration in the portfolio.

John Scheurer

We can get you that number exactly, I don’t know that I have it.

Penni Roll

As John talked about on just the portfolio overall, we had three companies which accounted for about 38% of the depreciation and those have been driven by the performance, Earth Color, Ciena Capital and Wear Me. So you have those and then we also had the declines related to and primarily driven by declines in multiples where we use a multiple of EBITDA.

And if you look at the kind of roughly 39% of the depreciation in the first quarter that included a lot of depreciation related to the multiple declines.

Operator

Your next question comes from the line of Greg Hillman – First Wiltshire Securities

Greg Hillman – First Wiltshire Securities

Could you maybe talk about the economic sensitivity of the portfolio or what percentage of the investment portfolio would be economically sensitive, the debt or the equity type portions.

John Scheurer

Everything is sensitive to the economy, I think as we said during the call here, there was, if you look at the depreciation as Penni was just talking about, we had 39% of the unrealized depreciation was really due to, 85% of that was due to multiple compression. So when we’re talking about those companies which is a lot of different companies, those companies were doing fairly well. They all feel some part of the, what’s going on in the economy.

However from the standpoint of depreciation, it was mostly multiples there. Then you saw 38% was due to the some companies where there was real deterioration or more concentrated depreciation in those companies and it was because of their business. Earth Color for example it didn’t really lose many customers but it, all of its customers seemed to cut back on what they were ordering.

And I think that we have a couple of other companies that are in the after market parts business in the RV industry and there’s what, nine manufacturers in the RV industry and maybe two survived this whole thing. Those companies are certainly severely impacted by what’s going on in the economy.

So on an overall basis I think as we said in the opening comments we feel pretty good about most of the companies that are in our portfolio but certainly there are selected one that are feeling the impact of the economy far more then others.

Rob Long

The other way I might characterize it is that John mentioned about 40% of the depreciation was in the rest of the portfolio and he mentioned that 85% of that was due to compression of multiples and only 15% was EBITDA declines and that’s because a lot of those businesses are in areas that aren’t as economically sensitive, business services held up pretty well, and where we have gotten hurt and I thinks its reflected in today’s marks or certainly been reflected in marks through the last four to six quarters is that printing companies are suffering, that would be Earth Color.

Some consumer sectors have been hit, Wear Me Apparel, children’s apparel, that’s been hurt with the decline in retail sales. I think those are all, if you look at the statement of loans investments you can see the impact of the economically sensitive areas in our current marks to fair value.

Greg Hillman – First Wiltshire Securities

Okay, and then also could you just talk about some of I guess the bullet maturities of your debt over the next two to three years and how you plan to get there to be able to satisfy those maturities.

John Scheurer

We have $250 million coming due in November of this year and we’re sitting on more then that in cash today. Next year we have what $400 million I guess in total coming due so we will continue to do what we need to do to make sure that we have that cash available.

I guess your question is if there’s never a refinancing market and you can’t refinance any debt between now and next year, could we raise the additional capital that we need to do that? We’re certainly focused on doing that.

Penni Roll

And we ended the quarter with $3.3 billion in assets, so on a relative basis to our asset base the $252 million which we have cash today for is a smaller number and then $408 million that goes over the course of I think $147 million due in May and the rest due toward the end of the year, so we also have some time to focus on monetizing liquidity to be able to make those payments and have a good asset base to draw from.

Greg Hillman – First Wiltshire Securities

Okay, and finally you talked about your asset management business, when the market rebounds, how high is up for that business or where do you think it could go.

Rob Long

I think we’ve shown a steady trend over periods of years to have gotten to where we are now, it took four or five years but as you know from the presentation we are up towards $6 billion or so in assets that we’ve built in this business over the last four years or so. So I think we’ll continue to see these same type of opportunities, 2009 may be a year with more opportunity then usual because of the changing dynamics in the industry and asset management and again particularly the senior loan business, there will be a number of managers who decide to leave the business, similar to Emporia which as you know we were able to bring in in the first quarter of this year which had $1.2 billion of assets.

So I think we’ll be able to continue to find these opportunities to consolidate certain other outstanding platforms. But in addition we have a critical mass in asset management. We have a particularly good track record in these funds in general and so I think as we looked towards the latter half of 2009 the opportunity to resume organic growth by raising new funds from institutional investors or potentially high net worth in retail investors is clearly on our minds.

So we hope to do growth through both further consolidation in the industry and through raising new funds probably beginning in the second half of 2009 or the first half of 2010.

Greg Hillman – First Wiltshire Securities

Will you have funds that you offer to the retail public more like a mutual fund type product.

Rob Long

That is one of the items we’re considering. We have not made any decisions but with the very, very low levels of yield in money market funds and the very large amount of capital in money market funds its obvious that an income based fund that does invest in senior credit of corporate credit and potentially real estate credit, could be very appealing in a retail context.

Operator

Your next question comes from the line of Faye Elliott – Banc of America/Merrill Lynch

Faye Elliott – Banc of America/Merrill Lynch

Could you characterize the assets that you were able to exit during the quarter, where they came from in the capital structure, where were they.

John Scheurer

We can give you some more detail, if you look at it I’d say probably, I don’t know what the percentage is but probably a greater percentage was sub debt and then there were a few pieces of senior debt that had been sitting on our balance sheet and waiting to go into one of the managed funds or some place else.

And then there were a few pieces of equity. But I said earlier, the big chunk was Advantage which was a piece of sub debt and then the rest of them were all kind of small bites, $5, $10, $15 million.

Faye Elliott – Banc of America/Merrill Lynch

But that being the case, why would you be hesitant to pledge some of the higher, I guess some of the assets that are higher up in the capital structure if that is indeed what is keeping some of these renegotiations from going through.

John Scheurer

As I said we’re working on this comprehensive restructuring and I don’t think we’re ready to discuss the details of any of that right now but we are optimistic that we can get some resolution that will make everybody happy.

Faye Elliott – Banc of America/Merrill Lynch

And then could you discuss the EBITDA trends of your portfolio companies and if there are any particular areas of weakness particularly by sector, would you be able to mention that.

Penni Roll

We did go through quite a bit of that, John had walked through just again if you look at the depreciation for the quarter, 38% of that related to just some portfolio performance related matters and with Earth Color, Ciena, Wear Me Apparel, and then—

Faye Elliott – Banc of America/Merrill Lynch

I got that, I was just wondering beyond what is already on non-accrual or that’s been marked for the unmarked pieces what do the EBITDA trends look like. I know you were talking about we’re likely to see more [dissolves] or non accruals going forward, are there particular sectors that you think would be effected more then others and can you give any guidance as to what you think about the timing of future deterioration.

John Scheurer

That is a difficult question. I think if you go back to one of my initial comments, we talked about sort of the concentration and I think Bill reiterated this as well, on some of these other companies, and then if you take sort of the balance of the rest of them, 39% of the unrealized depreciation, 85% was a result of multiple compression and then 15% was due to EBITDA drivers.

So while we don’t exactly release the, I don’t know, forward-looking information that you’re talking about what you could glean from that is that the bulk of the companies, while they probably experienced some level of EBITDA decline, most of them were in pretty good shape and that the bulk of the depreciation was related to multiple compression.

And I talked about some of the other areas of the other companies that are experiencing issues in this economy but I think you’ve seen, if you look across the economy, we’ve seen almost every sector of the economy hit to some degree and certainly some like the RV industry and the auto industry are hit very hard.

We have just a couple of investments related to the RV industry, really hardly anything related to the auto industry and consumer spending is effecting things certainly like Wear Me and companies are cutting back on printing which we discussed before but some of those things can come back quickly. I don’t know that we’re in any kind of position to forecast what’s going to happen over the next three to six months.

Its been a pretty amazing ride over the last three to six months.

Penni Roll

I think just what we’re saying is from the perspective of the risk we have in the portfolio and the overall economy in general, we believe there is still risk that we may have further impact of non accruals or delinquencies just given the overall economic environment we’re all experiencing right now.

Faye Elliott – Banc of America/Merrill Lynch

Okay so you’re just saying that from a macro perspective and not based on what you’re seeing in your portfolio.

Penni Roll

I mean there are obviously things we’re watching and monitoring very closely but I just think given the current environment no one’s really immune from the current situation.

Operator

Your next question comes from the line of Robert Dodd - Morgan Keegan

Robert Dodd - Morgan Keegan

Can you tell us what percentage of your asset sales went to any of your fund entities.

Penni Roll

None of them, none of the assets in the first quarter were sales to managed funds.

Robert Dodd - Morgan Keegan

And then on the admin expense, I think you kind of hinted it should go up in Q2 with all these negotiations with lenders etc., but can you give us kind of an underlying trend for admin through the course of the year once we get past some of these hopefully short-term expenses and start looking into Q3, Q4. Is that a 9.5 million number, or is it 7.5 million.

Penni Roll

Well its always hard to pin it down to a certain number per quarter because if you look at our history our quarterly expenses have been a little bit lumpy from quarter to quarter, like for example in Q2 we have more expenses because we have our Annual Shareholder Meeting and more investor relations type of costs.

But we are watching expenses very closely trying to make sure that we are efficiently operating with still having a focus on making sure we haven’t compromised our operations in doing that. And right now we do expect we’ll have some additional costs related to our debt restructure which is hard to estimate at the moment, but those will come through as we wrap that up.

So I think probably where we are is not, it’s a close approximation but we’re going to watch costs as we go through. You can see some of our historical trends and then we’ll be able to report on debt restructure costs as they occur.

Operator

Your next question comes from the line of Matthew Howlett - Fox-Pitt Kelton

Matthew Howlett - Fox-Pitt Kelton

I know you’re still deep in negotiations with your lenders, but just in general if you had to envision the perfect waiver or the ideal restructuring agreement that could be reached with your lenders, how would that look.

Bill Walton

I think John put it pretty well, we’re going to negotiate an outcome that’s satisfactory to all parties and so my dream resolution may not be their dream resolution. We think we’ve got the elements here. We’ve got enough cash to work with. We’ve got a good portfolio of quality, I think we can get them what they want and give us the operating flexibility we need so we’re not back in this situation six or 12 months from now.

Matthew Howlett - Fox-Pitt Kelton

Could that possibly include some type of exchange, is that one of the avenues that you may be pursuing.

Bill Walton

We can’t get that specific right now. I think we’ll just have to wait and see. Hopefully we’ll be able to give you a very detailed result as John mentioned, hopefully this quarter.

Matthew Howlett - Fox-Pitt Kelton

Can you at least tell me if the negotiations are they friendly, are then contentious, or is any there any—

Bill Walton

I think they’re constructive.

Matthew Howlett - Fox-Pitt Kelton

We’ll wait for more clarity on that. Is there a dollar amount of portfolio companies that are in the pipeline for sale, have you given that number out.

John Scheurer

No, I don’t believe we have.

Bill Walton

No we haven’t given it out but I think John said it pretty well, we think the prices we got for the sales in the first quarter considering the market conditions were quite attractive considering very few people were investing dollars and so we feel very good about what that says about the quality of our assets and I think we would expect to continue to sell assets through the year but only at prices that we think are attractive, as we think the ones were the first quarter.

And fortunately we’ve raised enough cash that we don’t have to force anything.

Matthew Howlett - Fox-Pitt Kelton

I certainly want to congratulate you on the sales in a very difficult quarter. And just on credit did you say there were six new non accruals put on non accrual status this quarter and if you could you just maybe elaborate on how the internal watch list rating, the movement went quarter over quarter.

Penni Roll

With this quarter we put interest-bearing securities on non-accrual in six portfolio investments so it’s the number of companies that we had additional securities go to non-accrual on.

John Scheurer

As far as the watch list goes, we’re looking at as you know we did away with our grading system because in this environment it was difficult to make it work and be relevant. So we’re looking at a whole variety of new ways to monitor the portfolio which we’re experimenting with internally and when they’re ready we’ll release them to the outside world.

Matthew Howlett - Fox-Pitt Kelton

And then we’ll see the six non-accruals when the Q comes out.

Penni Roll

And the thing with investments we note which securities are on non-accrual.

Matthew Howlett - Fox-Pitt Kelton

And on the CLO investments, I know they were written down in the quarter and I know most of that exposure is in equity or some of the mezzanine pieces, do you feel good about an ultimate recovery in those pieces or is this just mark to market or is it a some point do you think ultimately the performance of the will come back.

Rob Long

Let me give you a little bit of a background on how these values are achieved, we use the assumption of default rates for each given pool based on what is in each given pool and also we review the assumptions that the rating agencies are using and work with our third party advisors. As you’re probably aware, particularly the rating agencies have increased their expectations of the defaults by hundreds of percent higher levels then have existed historically.

So we too in coming up with our estimates of value use default assumptions that are now hundreds of percent higher then our actual experience. I think as John mentioned we have about a 2.8% default experience right now in these CLOs across them and that represents barely a third of the default experience of the marketplace overall.

Yet for purposes of valuation we have to use a much higher default then we’ve experienced and you also may remember and can see in our Q and K that we use a very high DCF rate because of the price decline of this sector. And so that discounted cash flow number isn’t necessarily something that we would have ever thought we were trying to achieve, its much higher DCF number then what we actually believe this set of investments will be but it has a big effect on reducing the value of these.

And finally as John also mentioned there’s been a dramatic increase in the number of CCC ratings by the rating agencies and this has the effect of causing some of the individual structures to take their cash flow and put in new collateral and it basically pushes out the cash flow that will come to the junior securities.

And this also with the very high discount rate we’re using leads to another reduction in the value. All of this is the mathematical modeling that we do and we work with our various outside third parties. So in a somewhat long winded answer to your question, we do expect that most of these securities will pay us the returns that we think are good but in this type of environment where you’re using such draconian assumptions for defaults and recoveries and valuation, its very painful.

But at some point in the future we look to a time when these cash flows will start to come back and perhaps some of the assumptions we’re making we’ll start using lower default rates after we go through this recession and that will have a positive effect on the valuation metric. I hope that wasn’t too complicated.

Matthew Howlett - Fox-Pitt Kelton

No, that answers the question and I think we’re already seeing a little bit of the rally in April and here in May so hopefully that’s a good sign.

Operator

Your final question comes from the line of Maynard Lichterman – Smith, Barney

Maynard Lichterman – Smith, Barney

Can you characterize at all the progress or lack of progress on Ciena and what’s going on there.

John Scheurer

We are making progress on Ciena and we’re hopeful that there’s going to be some sort of resolution here at some point of its bankruptcy with, a reasonable period of time and what that is, is that three months or six months, I’m not sure. But we really can’t at this point talk about much of what’s going on at Ciena because some of those things are within the court so to speak.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

John Scheurer

Thank you all for listening to this conference call and we will see you next quarter and look forward to some good news. Thank you very much.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Allied Capital Corporation Q1 2009 Earnings Call Transcript
This Transcript
All Transcripts