Allied Capital Corporation Q2 2009 Earnings Call Transcript

| About: Allied Capital (AFC)

Allied Capital Corporation (NYSEARCA:ALD)

Q2 2009 Earnings Call

August 10, 2009 10:15 am ET


John Scheurer – President, Chief Executive Officer

Shelly Huchel – Director IR

Penni Roll – Chief Financial Officer

Rob Long – Head of Asset Management


Vernon Plack – BB&T Capital Markets

Greg Mason – Stifel Nicolaus

Jasper Birch – Fox-Pitt Kelton

[Jim Atchel – Aviation Advisory Services]

[Jeff Lignalli – Stonebrook Funds]

Maynard Lichterman – Morgan Stanley, Smith Barney


I would like to welcome everyone to the Allied Capital second quarter 2009 earnings conference call. (Operator Instructions) I would now like to turn the call over to Mr. John Scheurer, President and CEO of Allied Capital.

John Scheurer

Good morning and welcome to Allied Capital's second quarter 2009 conference call. I'm joined today by Penni Roll, Rob Long and Shelly Huchel. Shelly would you open the discussion today with the required conference call information and a discussion about forward-looking statements.

Shelly Huchel

Today's call is being recorded and webcast live through our website at 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 unauthorized rebroadcast of this call in any form is strictly prohibited. I'd also like to call your attention to the customer 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 projection. We do not undertake to update our forward-looking statements unless required by law. To gain 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 companion slides 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 date included in this slides throughout today's call. Finally, as always, there will be a Q&A session after the presentation.

With that, I'll turn it back to John.

John Scheurer

I'd like to start today's conference call with an update on our debt restructuring. We have made progress in the negotiations since our last call with you. We have agreed in principal to terms with our private note holders and our line of credit lenders. This has been a long and complex negotiation in a very difficult financing market and has involved a large number of lenders, many of whom have differing objectives.

Our objective in this negotiation has been to achieve a comprehensive restructure that provides us with more favorable financial covenants. The principal terms we have agreed to are non binding and still subject to final documentation, and the documentation process will take time given the number of parties involved and the comprehensive nature of this transaction.

The cost of debt in this capital market is high for a financial firm such as ours. We expect our restructured debt will be very expensive and will bring a significant cash burden to the company both at closing and as we move forward under the restructured terms.

Given our expectations of increased costs and cash burden association with the restructured debt, we will need to continue to sell assets to generate liquidity to delver and will need to further reduce operating costs.

We are focused on completing this restructure and hope to be able to announce a final agreement in a timely manner. We will disclose the terms of the restructuring when it is completed. However, there can be no assurance of the timing of any debt restructuring or that we will complete the restructuring of our debt. Until the restructuring is completed, this debt remains subject to acceleration.

While the completion of this restructure would put us back in covenant compliance and enable us to move forward, we expect our increased cost of capital would substantially reduce our profitability and will therefore cause us to not be able to pay a cash dividend for an extended period of time.

As we've stated previously, our plan this year will be to continue to selectively sell assets, further delver the company and reduce operating costs. We also plan to continue to focus on assisting our portfolio companies that have been hardest hit by the financial crisis and on re-balancing our portfolio with an emphasis on current income.

At June 30, 2009 we had cash and cash equivalents totaling $484 million as compared to $51 million at December 31, 2008. We have continued to make significant progress in selling and refinancing some assets to generate capital to de-lever our balance sheet.

In the second quarter we sold or had repayments on portfolio investments totaling $346 million in cash proceeds. The majority of this quarter's asset sales have been complete under distressed conditions in a very difficult market, yet our proceeds from the assets sold or refinanced, represented about 94% of the aggregate fair value of these assets as of March 31, 2009.

For the first six months of the year, we sold or had repayments on portfolio investments totaling $587 million in cash proceeds. Proceeds from assets sold or refinanced represented about 93% of the prior quarter's fair value.

Many of the asset sales we have completed have included subordinated debt that was at modest leverage levels as compared to the current market. As a result of these sales, we have seen a shift in our remaining portfolio to more senior assets. From December 31, 2008 to June 30, 2009 subordinated debt has decreased as a percentage of our portfolio from 52% to 47% while our senior debt and tranche debt has increased from 23% to 28% of the portfolio.

We plan to complete additional asset sales and various re-financings throughout the course of the year, but only if we believe the prices for the assets sold are prudent. The cash generated from our asset sales and repayments will be used to pay significant fees with the anticipated debt restructuring, reduce debt and provide ongoing liquidity.

During the second quarter, we purchased $132 million of our publicly issued notes at a discount to par in the secondary market using $50 million in cash to purchase these notes. Net of any unamortized original issue discount we recognized a gain of $82 million associated with these discounted purchases.

In addition, we have repaid $50 million in private long term debt in July 2009 and another $50 million today and intend to use a portion of our cash on hand to further reduce outstanding debt upon the closing of the restructure.

We continue to remain focused on ways to reduce employee and administrative expenses. We have previously discussed our cost reductions in these areas which have significantly reduced our year over year expenses. However, we realize we may need to take additional steps to further reduce these costs.

Now if you could turn to Slide 10 in the slide deck for a discussion of portfolio value changes, you'll note that unrealized depreciation in the second quarter was $101 million as compared to $363 million in the first quarter of 2009 and $605 million in the fourth quarter of 2008. While the numbers are still negative, you can see on Slide 10, we did see some stabilization in asset values this quarter.

Now if you turn to Slide 11, you can see that we experienced $30.6 million of additional depreciation on our CLO investments this quarter. In total, this accounted to 30% of the depreciation during the quarter.

As we have mentioned in the past, CLO's are experiencing structural challenges as rating agencies continue to downgrade their loan and debt assets to triple C ratings 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 timing of payment of future cash flows. In addition, to a lesser extent, higher default rate assumptions and lower recovery assumptions are continuing to impact valuations. For valuation purposes, we are using higher future default rates than we are actually experiencing in the CLO's generally.

Our non buy out loans and debt securities valued using a yield analysis had $23.8 million of net depreciation and accounted for 24% of the total net depreciation for the quarter. Our investment in and related receivables from Sienna Capital had depreciation of $18.9 million and accounted for 19% of the total net depreciation for the quarter.

Other investments in the portfolio in aggregate, accounted for the remaining 27% of the net unrealized depreciation in the second quarter.

While the economic environment remains challenging, we were generally satisfied with the operating performance of the majority of our portfolio companies. To highlight this point, if you flip over to Slide 12, we have summarized the components of total net unrealized depreciation of $1.9 billion on our balance sheet as of June 30, 2009.

Net unrealized depreciation at June 30, 2009 is largely concentrated in a handful of companies with approximately 47% coming from four of our portfolio companies that we have previously discussed with you; Sienna Capital, Earth Color, Hot Stuff Foods and Wear Me Apparel.

I'd like now to take a minute to give you examples of how we are working with our portfolio companies to improve results. Hot Stuff Foods manufactures and delivers branded food products to convenience stores across the U.S. Rising fuel and other commodity prices had put pressure on both Hot Stuff's revenues and expenses in 2007 and 2008.

Management has been working to increase profitability by growing same store sales and improving the mix of high quality stores and streamlining operations. Year to date in 2009, the company has seen revenues stabilize and EBITDA improve due to their efforts to reduce operating expenses. In addition, Hot Stuff has benefited this year from lower food and fuel costs. Since December 31, 2008 the value of our investment in Hot Stuff has increased by approximately $27 million.

Another example of working with a portfolio company to improve performance is the deal most recently completed with Insight Pharmaceuticals. We have been the majority owner of Insight since 2004. Insight is a platform company whose strategy has been to acquire and reinvigorate orphaned over the counter pharmaceutical brands such as Sucrets. In today's difficult environment we identified an additional acquisition opportunity of a portfolio of niche brands at an attractive price.

As capital for new investments remains scarce, we brought in a new equity partner to finance the acquisition and to provide new equity capital to support the continued growth of the company. We remain a minority owner of the company in addition to holding the subordinated debt.

The acquisition was accretive to Insight, and we believe it provided us larger, more diversified and more stable cash flow base. In addition, the acquisition significantly de-levered Insight's balance sheet.

We have focused our efforts on a number of key investments to maintain or grow value for our shareholders as these businesses adapt and improve their performance. Our teams are intensely focused on this and we have firm wide effort for realizing the potential of each investment. Helping portfolio companies through rough patches in part of our business and we have nearly 50 years of experience doing just that.

Finally, we believe there are potential opportunities to expand an asset management in areas such as middle market credit and commercial real estate. We continue to evaluate opportunities for this part of the business.

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

Penni Roll

Let's start with a discussion of our June 30, 2009 balance sheet. Please turn to our summary balance sheet which is on Page 3 of the slide deck. We ended the quarter with total assets of $3.2 billion, debt of $1.8 billion and total shareholders equity of $1.3 billion.

Our cash and other money market securities at the end of June was $484 million. We invested $62.1 million in the second quarter of 2009 in the portfolio. Investments in the second quarter primarily related to this commitment.

New investments included $47.4 million in the senior secured loan fund which was the tranche fund to support that investment made by the fund. The investments made by the fund refinanced debt investments in three of our portfolio companies and generated repayments to us of approximately $107 million. In the second quarter the tranche fund was named as the senior secured loan fund.

In addition to new investments during the quarter, we also funded $48.1 million to support Sienna's term securitizations in lieu of draws under related stand by letters of credit that matured.

We had sales and repayments generating $345.5 million in proceeds during the second quarter. After including the impact of this quarter's valuation effects and other changes, our portfolio at value was $2.6 billion as of June 30, 2009 and included 120 investments.

Our portfolio is comprised of 28.1% first lien debt securities, 46.5% subordinated debt securities, 9.3% interest bearing equity securities and 16.1% in other equity securities. The yield on our interest bearing portfolio was $2.1 million at June 30, 2009 with 11.8% in line with our 11.8% portfolio yield on March 31, 2009.

As June 30, 2009 shareholders equity or net asset value was $7.49 per share as compared to $7.67 per share at March 31, 2009. While we have seen some stabilization in our portfolio values during the quarter, our net asset value continues to be impacted by the net unrealized depreciation John spoke about earlier.

Please now turn to Slide 4 for a summary of the changes in the NAV view for the quarter. During the second quarter net investment incomes increased in NAV by $0.10 per share. Net realized losses decreased NAV by $0.71 per share. The gain on repurchase of debt increased NAV by $0.46 per share and NAV decreased by $0.02 per share due to net changes in unrealized appreciation or depreciation.

Now please turn your attention back to Slide 3. Our leverage ratio at June 30, 2009 was 1.35 to 1 and our asset coverage ratio was 174%. While our asset coverage ratio at June 30, 2009 is still below the regulatory threshold of 200%, we have made significant repayments of debt in the second and third quarters.

In total, between the purchase of public notes at a discount in the second quarter, and the $100 million principal pay down in the third quarter as part of our debt restructuring, we have repaid a total face amount of debt of $232 million since the beginning of the year.

We will continue to pursue our strategy of selectively selling assets and retiring debt with the goal of continuing to de-lever the balance sheet and achieving 200% asset coverage of our senior securities.

Now let's move to a discussion of our earnings on Slide 5. Interest income for the quarter ended June 30, 2009 was $71.3 million as compared to $84.2 million in the first quarter of this year. This decrease was driven primarily by sales or repayments of interest bearing investments.

Fees and other income were $9 million for the second quarter of 2009 as compared to $6.5 million in the first quarter. The most significant components of fees under income included fund management fees of $4.3 million. Management fees are related to portfolio companies of $1.9 million, short term in diligence fees of $1.5 million and commitment, guarantee and other fees from other portfolio companies of $1.2 million.

Total operating expenses were $63.7 million in the second quarter of 2009 as compared to $68 million in the first quarter. Please turn to Slide 6 for a discussion for a discussion of the more significant expense items for the quarter.

Interest expense was $43.1 million for the second quarter of 2009 in line with the first quarter amount. Interest expense in both quarters included the accrual of default interest of an additional 200 basis points on our private notes and revolving line of credit.

The second quarter employee expense was $11 million also in line with the first quarter amount. Our administrative expenses for the second quarter were $8.5 million as compared to $9.8 million in the first quarter. We've worked diligently over the past year to reduce our employee and administrative expenses.

Please turn to Slide 7 where you can see the progress we've made. From 2006 to 2008, our average quarterly employee expense ranged from approximately $20 million to $26 million. In 2009, our average quarterly employee expense was $11 million.

From 2006 to 2008 our administrative expenses were approximately $10 million to $13 million per quarter. In 2009 our average quarterly administrative expense has been $9.2 million. These are significant savings and as John discussed, we continue to look for ways to reduce costs throughout the organization.

Income tax expense for the second quarter of 2009 was $2.7 million related to our wholly owned taxable subsidiary AC Corporation. Net investment income was $18.2 million in the second quarter down from $27.5 million in the first quarter.

Net realized losses for the second quarter were $126.1 million. Gross gains totaled $8.6 million for the quarter and gross losses were $134.7 million. Realized losses in the second quarter included at $70.7 million loss in HF Logistical Solutions.

The remainder of this quarter's losses were driven by our asset sales activity, but we believe that the need to improve our liquidity position in this market was worth the loss realized.

Gain on our purchase of debt was $81.5 million for the second quarter as compared to $2 million in the first quarter. As discussed earlier, this gain results from the discounted repurchase of our public debt. Net investment income, net realized losses and gain on repurchase of debt totaled a negative $20.3 million for the second quarter of 2009.

Please now turn to Slide 9. Net change in unrealized appreciation or depreciation for the second quarter was a negative $2.8 million. This resulted from the following; $101.2 million in net unrealized depreciation from changes in portfolio value, $17.9 million related to the reversal of previously recorded unrealized appreciation associated with the realization of gains and dividend income, and $116.3 million related to the reversal of previously recorded unrealized depreciation associated with the realization of losses.

Please turn back to the income summary on Slide 5. To finish up, net loss for the quarter was $29.1 million or a loss of $0.16 per share.

Now let me turn to a discussion on loans, and debt securities over 90 days delinquent and loans and debt securities not accruing interest. Please refer to Slide 13 and 14. On Slide 13, we show loans and debt securities over 90 days delinquent. Loans and debt securities over 90 days delinquent at June 30, 2009 were $96.7 million or 3.8% of the total portfolio value.

Loans and debt securities over 90 days delinquent at March 31, 2009 were $67.2 million or 2.3% of the portfolio value. Included in our delinquent loans was our senior loan to Sienna Capital that was $93 million at value as of June 30, 2009 and $64.1 million at value at March 31, 2009.

Excluding Sienna, loans and debt securities over 90 days delinquent were $3.7 million or .1% of the portfolio at value as of June 30, 2009 and $3.1 million or .1% of the portfolio at value at March 31, 2009.

Now if you turn to Slide 14, loans and debt securities not accruing interest at June 30, 2009 were $254 million or 10% of the portfolio value as compared to $228.4 million or 7.9% of the portfolio value at March 31, 2009.

We placed a net $26 million of debt investments at value on non accruals during the quarter. This has the effect of reducing interest income by approximately $.9 million for the second quarter of 2009. Excluding Sienna Capital, total loans on net accrual were 6.3% of the portfolio value at June 30 as compared to 5.6% at March 31.

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

Loans over 90 days delinquent and loans on non accrual should not be added together as they are separate measures of portfolio asset quality and a given investment may be included in both measures.

And with that John, I'll turn things back to you.

John Scheurer

Now let me hand the discussion to Rob who will give us an update on markets and talk about asset management activities.

Rob Long

Let me begin with a discussion of the current market. The private finance marketplace continues to be characterized as a tale of two markets; the primary market and the secondary markets. New leverage buy out and primary leverage loan activity remained anemic in the second quarter and only slightly above the record low levels of the first quarter.

What little primary activity that did occur was dominated by refinancing, exit financings and dip loans. M&A activity, particularly in the middle markets remains in a deep recession. That said, we did recently participate in a new senior financing for an acquisition.

On the demand side of the primary market, we saw both banks and institutional investors begin to return to the loan market in modest size. Please turn to Slide 15. While new bank financing remains muted, and concentrated largely in ABL transactions, high yield funds, distressed investors and hedge funds have stepped in to account the for the majority of new institutional activity.

Most of the action has been in the secondary market. We saw renewed investor activity in price recovery in the secondary market for leveraged loans during the quarter. Please refer to Slide 17 where you will see that the S&P leveraged loan index jumped 19% in the second quarter to 78.0 on a scale of 100 after hitting a record low of 60.3 in December 2008. For the first half of 2009, this index is up approximately 26% as compared with its precipitous 35% drop in 2008.

This activity has been driven by a continued lack of new supply of loans coupled with increasing demand from investors reaching for attractive yields. Please turn to Slide 18. During the second quarter, a rally in the corporate public bond markets spawned a flurry of high yield offerings with much of the proceeds being used to repay leveraged loans.

Repayments for the first half of 2009 totaled $36.9 billion as compared to $48.9 billion for all of 2008. These refinancing's as well as an increased number of amendments and extensions seen during the quarter have allowed leverage loan borrowers to extend the maturities and in some cases, ease covenant restrictions in order to stabilize their capital structures.

The signs of recovery in the secondary markets are encouraging, and a necessary condition for a recovery of primary market activity. However, much of our economy remains in a deep recession. Loan default rates have continued their sharp rise seen over the last six months and our financial system still faces a long road of delivering.

Now let me give you a brief update on our asset management business. We continue to look for opportunities to grow our asset management platform across core asset classes. Our focus during the second quarter however was on managing and integrating the eight loan funds that we now manage.

At June 30, 2009 these eight funds had a total of approximately $3.4 billion in assets under management as compared to a total of approximately $2.1 billion at December 31, 2008. These managed funds are primarily focused on the senior loan asset class.

Looking ahead Allied Capital is evaluating opportunities to raise new third party capital to manage ourselves or in partnership with certain of our portfolio companies across a number of asset classes including potentially real estate, senior loans and other middle market credit product.

Now, back to you John.

John Scheurer

As you can see our focus in this economic environment is to create liquidity, de-lever our balance sheet, assist our portfolio companies, further reduce our costs and position the company to move forward. We believe we have accomplished a lot in this regard in the first seven months of the year, but we still have a lot of work to do.

With that, let's open the line for questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Vernon Plack – BB&T Capital Markets.

Vernon Plack – BB&T Capital Markets

I'm just trying to understand the reversal line. Am I to assume it's correct that you had $7 million in the second quarter related to dividend income that you also recognized in the second quarter so does that $7 million also show up in the interest and dividend income line?

Penni Roll

It does. It's very similar to the way we realize gains or losses when the dividend income in realized it's included in the dividend income in the income statement and then any related unrealized appreciation that we had related to that would be reversed out through the unrealized line.

Vernon Plack – BB&T Capital Markets

Is that the result of income that's not being recognized?

Penni Roll

It's a result of when generally speaking, for dividend income recognition into our financial statement, we recognize it when the dividend is declared and paid by the portfolio company. Prior to that declaration of payment, we will consider it in the valuation of our related security that has that dividend paying capacity to it, so therefore it may be included in the value of our investment, but once it's distributed out, we would have an adjustment to the remaining value of the company because we've now recorded that dividend income to us.

Vernon Plack – BB&T Capital Markets

I don't know if there's any other detail or color you could give us on your operating thought in terms of perhaps additional reduction to head count. Just curious in terms of you've made a lot of moves here the past 12 months, should we expect material changes the way you're set up as a company going forward?

John Scheurer

As I said in the conference call script, we are evaluating further cost savings of all types and we'll probably have some announcements about those kinds of things at some point in the not too distant future.


Your next question comes from Greg Mason – Stifel Nicolaus.

Greg Mason – Stifel Nicolaus

Could you just provide a little bit of color on the asset sales, maybe what percent is as versus senior and maybe what the carrying cost of those type of assets are being sold, where they're being carried?

Penni Roll

If you look at where we are, we pulled a combination of both debt and equity securities and I don't have the statistics right off the top of my head, but it's been more debt securities than equity securities as they come through, probably about 90% debt if you look at year to date sales for both the first and second quarter.

We really focused our efforts on gaining liquidity within the portfolio where we can maximize value of the assets that we have. If you look though at the statistics of where we were from a cash proceeds perspective, somewhere between 93% and 94% of the last quarter's fair value was where we came in with respect to cash proceeds against those assets.

From a cost perspective, we'd have to get you that information, but it's kind of like mid to 80% realization on a cost versus proceeds basis.

John Scheurer

The other piece of it, I think if you think back on what I said in the script, we sold more subordinate investments and decreased sub debt as a percentage of our portfolio from 52% to 47% and senior debit and tranche increased 23% to 28%. So I guess it's fair to say that some of the things, while shifting to more senior debt and we reduced sub debt which was probably of a slightly higher yielding nature.

But you also see the yield on our income producing portfolio of $2.1 billion remained at about 11.8%.

Greg Mason – Stifel Nicolaus

On the structured finance, the CLO's, can you just give us a little color there, how the underlying CLO's are actually performing? What percentage of them are cashing and maybe what percentage, kind of a round number of which ones are still accruing income?

Rob Long

Let me answer this in two ways. Our experience across our portfolios has been a significantly lower default experience than the market overall so we feel comfortable with the assets. However, if you think about valuation, valuation is fundamentally a backward looking process and as I discussed in the first and second quarter of this year, we were dealing with a uniquely weak period of time.

If you look at the second quarter that was the peak in anticipated default rates according to observers in the marketplace, and it's interesting to note that Moody's has in the last couple of months decreased their default expectation for the high yield market from 15.4% in the first quarter to 12.7% currently and they factor in a very sharp reduction to 4.5% by July of 2010.

This is just in the last couple of weeks that they've reduced these default expectations as everyone is more comfortable with the market valuing. So as you look at valuing your CLO investments on a mark to market basis, the second quarter was about the peak expectation of future default rates.

So we have t factor in an assumption for future default rates and we this, and that's a very different process from looking at the actual defaults, because we're trying to anticipate the future. So that long answer is to say that our default experience remains a fraction of the overall default experience of the market, but we still are being fairly conservative in looking forward and perhaps assuming higher default rates than even the overall market default rates as is now being assumed by Moody's and others.

Greg Mason – Stifel Nicolaus

To take that a step further, I understand the valuation is what you were talking about and how you arrive at a value and what input you use, but what about tangibly, what percentage maybe are trapping cash and if they are not trapping cash, is that income being accrued?

Rob Long

There's different funds here. I would tell you that the majority of our middle market funds that are managed by Allied are continuing to cash flow and not trapping cash. We did recently relay the contracts for the Emporia funds and that's a different case they had been managed, and we had assumed that they would be trapping some cash, but not the senior management fees which was a primary cash flows we were looking to.

In the broadly syndicated product area, some of those CLO vehicles are currently trapping cash. As John had mentioned, the sensitivities to the OC ratio's in those CLO's is a little bit greater as they're exposed to the broadly syndicated market. But that's why it's important to understand the cash may be trapped for a period of time, but then gets turned back on as your OC ratio's come back into line.

So again, the ultimate test is really the default rates over the period of time, and on that basis, we continue to out perform the market.

Penni Roll

Just maybe answering from more of a what's the impact on the financial statements of our GAAP yields and where we are, we look at similar cash flow models for purposes of determining what we think the appropriate effective yield is on a GAAP basis for these securities and we will be filing our 10-Q later today so you can see this more in detail and note the financials.

But if you look at just the yield on our preferred share income notes of the CLO's that we own, those yields have come down from about 16.4% at the end of December to today of about 11.1%. So we have adjusted down our GAAP accrual already to reflect the risk of cash flows being disrupted to us and being lower in these future forecasts so that we can keep our GAAP income recognition kind of consistent with our expectations are for future cash flows as we see them today.

And then each quarter we go through and we adjust those GAAP yields accordingly to the most recent information we have on those cash flows.

Greg Mason – Stifel Nicolaus

On the expenses, what was the amount of additional expense related to the negotiations and defaults this quarter, and obviously it's probably going to continue through the third quarter, but would you expect it to lighten up in Q4?

Penni Roll

With respect to expenses related to the debt negotiations, as is typical for this accounting recognition of those costs, those have not run through the P&L yet because a lot of those will be paid at closing. So when we get to the point of closing the deal, what we anticipate doing is providing you with more information as to the income statement effect of the transaction. So stay tuned for more details there.

Greg Mason – Stifel Nicolaus

During this process I know another competitor in the market is unfortunately going through the same thing. Are you liable for the legal cost of the defaulted debt as well?

Penni Roll

As is typical with these types of agreements and borrowings, the borrower typically pays the cost of the lender.

Greg Mason – Stifel Nicolaus

So what we could expect probably is kind of a big one time item when the negotiations are finalized?

Penni Roll

Yes. There will be cash that has to go out the door at the time of closing, and as we said earlier, this will be very expensive and create a cash burden both at closing which would reflect those upfront expenses and costs that will be incurred to close the restructuring as well as going forward living under the new terms of the restructured debt. So stay tuned for more information.


Your next question comes from Jasper Birch – Fox-Pitt Kelton.

Jasper Birch – Fox-Pitt Kelton

Congratulations on making some headway with your negotiations. It's pretty encouraging. You've had a very strong origination platform, that's one of your strengths. In terms of reducing your costs and your head count, how are you balancing maintaining that platform at least to an extent where you'll be able to ramp it up versus continuing to cut costs?

John Scheurer

As I stated in our opening remarks, we focused a lot of our staff on helping companies that are being dramatically affected and even those that are doing fairly well on improving their results. So you're right. We do have a strong origination platform. We still have many of the people that were involved in that and they have been re-assigned and are working diligently to help portfolio companies which is the main focus of our business right now.

There were many cost reductions last year which did reduce the size of our origination platform, but we still have a good core group that is working to help rebuild shareholder value through helping portfolio companies.

Rob Long

One other point here is that across the senior loan platforms, there is about 700 different loans and we expect the next year or two, to largely be an exercise in refinancing existing facilities as they're maturities come due, so there's a very good window we have to future debt deals from the very large reach now of our portfolios of our loan pools.

Jasper Birch – Fox-Pitt Kelton

You mentioned a few times that you reduced your subordinate debt exposure, selling off those deals. Was that a meaningful decision that we should look at that you're going to continue to cycle your portfolio or was that more just the opportunities have presented themselves at the best price in the quarter?

Rob Long

I think as we said during the last conference call, the one big piece of what we did was our sub debt note on advantage sales and marketing and we did that because we needed to get some liquidity quickly and that was really the first piece that we could accomplish.

Beyond that, we've been working diligently on a whole number of pieces of things keeping in mind overall portfolio quality and trying to shift somewhat the balance to more current income. So there's been sort of a combination of those things.

Jasper Birch – Fox-Pitt Kelton

In terms of your portfolio valuation, you mentioned of the course the indices were up quarter over quarter pretty substantially and your portfolio let's call it flat to down a little bit, can you give us some color on portfolio trends, EBITDA trends, that coverage ratios and also what contributed to the discrepancy and fair value movement?

Penni Roll

If you look at the valuation for the quarter, like we resolved some stability in valuation this quarter, but if you look at the pie chart on Page 11, you'll see that a lot of the valuation sensitivity this quarter was still focused in financial or financial related types of assets, the CLO's, CDO's, Sienna Capital, the senior secured loan fund.

All those are financial related investments. And I think we're still going to see some sensitivity in financial related valuations for awhile just given where we are in the economy and the market. But if you look then at the rest of the portfolio more broadly, there was only net $15.8 million of changes for depreciation for the quarter, so we felt like for the rest of the portfolio, we've been satisfied with the operational results of those companies.

Now it's not to say we won't still see some downward pressure in valuations generally. We are in a downward economic environment. Who knows how long the recession is going to last, but at least we feel like this quarter we did see some stabilization away from our financial related assets.

Rob Long

Just to elaborate, the reason that most of the depreciation that Penni refers to are the financial assets, our valuation methodology looks primarily to the primary issuance market for our benchmarks. And in the second quarter the primary market did not show a recovery and if fact, our primary benchmarks were slightly worse in the second quarter than they had been in the first quarter which is why you see a negative instead of a positive for the pure mark to market aspect of our valuations.

As the secondary market rally has been so very strong, if it continues to maintain at these levels, one would expect the primary market to begin to recover and begin to improve and that is the point at which our valuation methodology will be able to show a reversal. But that did not happen during the second quarter.

In fact, if you look at the S&P data, the first and second quarter of this year, their activity was so small that they did not even report leverage statistics or transactions. The absolute value of LVO's in the first half according to S&P was down 99% from last year, and that was just statistically not enough for them to reveal the debt ratios of just a handful of deals.

So that's why you see continued pressure on the financial markets and not so much of the pressure on the operating companies.

Jasper Birch – Fox-Pitt Kelton

So the take away is that maybe broadly across the portfolio things aren't deteriorating as quickly. That's really where you're getting your valuation methodology and comparing your company to, that's driving those valuations right now?

Rob Long

This quarter is was the tail of the primary market benchmarks being down and therefore the financial assets being down as opposed to deterioration in the fundamental quality of the portfolio.

John Scheurer

I think additionally, if you look at numbers of companies where we had unrealized depreciation and unrealized appreciation, this quarter significantly we had a number of companies with unrealized appreciation whereas the prior couple of quarters we had very few.

Jasper Birch – Fox-Pitt Kelton

Can you provide us the current cost basis and current fair value at Sienna?

Penni Roll

It is in the Q and that will be on file today so you can certainly get it from there. Related to Sienna we have our portfolio investments which is our debt and equity securities as well as you may recall, I referenced some funding of some letters of credit that related to Sienna securitizations that we made.

So if you combine the cost basis of the portfolio plus what we have in accounts receivable, our total cost basis in Sienna is about $615 million. It is currently valued at $95 million.


Your next question comes from [Jim Atchel – Aviation Advisory Services]

[Jim Atchel – Aviation Advisory Services]

I don't have the 10-K right in front of me, but as of December 31, you had a significant figure, I think it was in the hundreds of millions of dollars for investments that you were committed to fund and I also remember that there was a significant debt repayment on a bank facility in November. What is the total balance of the remaining commitments to fund investments and do you anticipate having the resources both to meet those commitments and refinance or take care of the debt you have coming due in November?

John Scheurer

We talked about the debt restructure. I gave you some information on that. We can't disclose anything else about that currently. If you're talking about the debt that was repaid at the end of last year, I don't think that was in November, I think it was in December.

[Jim Atchel – Aviation Advisory Services]

I remember somebody in investor relations told me at one point at the end of last year that there was something that was due in November of this year.

Penni Roll

I think your question is, with respect to our debt obligation what we have due in payable. At the end of 2008 we did repay our line of credit to the tune of about $170 million so that may be one number that you heard.

With respect to our contractual maturities on our debt today, there is a contractual obligation of $252 million of medium term notes due in November of 2009. So basically at this point, I think the best way for us to answer that is, we are in the process of negotiating because of the defaults under those medium term notes a comprehensive restructuring, and we will have to get back to you on those maturity questions at the time we announce the detailed terms of such restructuring.

[Jim Atchel – Aviation Advisory Services]

That's part of the negotiations.

Penni Roll

FAS 252 is part of that negotiation.

Rob Long

Also we should point out there was $100 million repaid recently of debt, so we have been repaying some of the debt while simultaneously negotiating an extension. A part of your question had to do with what our forward commitments were and you referred to a number you had seen of a large forward commitment.

One of the largest components of the forward commitment is our participation in the senior secured loan fund and that commitment exists. However, it requires us to vote affirmatively to do a transaction, so therefore it is not a commitment that can be drawn down without us making a decision to invest in something.

And in the most recent quarter, we did invest through the fund in several transactions, but those were refinancing existing positions that generated net cash to us. So that one fund which is a meaningful portion of the future commitments is not really something to be concerned about being drawn down against our ability to do so.

[Jim Atchel – Aviation Advisory Services]

As long as you're talking about the senior secured fund, in one of the slides you showed a portion of the write downs of the unrealized depreciation. Why is that?

Rob Long

This relates to our use of market benchmarks for our FAS 157 valuation purposes. So as we look at that fund, the credits within the fund are very good performing credits, but the investment in the subordinated notes that we have on our balance sheet need to be adjusted for market changes, and we had decline in the benchmark or have an increase in the market benchmark rates for that type of security, we reflected a FAS 157 type valuation adjustment for our interest in those notes.

But it did not have anything to do with the underlying credit in the fund itself which are all performing in accordance with their covenants and have no violations of any covenants in them.


Your next question comes from [Jeff Lignalli – Stonebrook Funds]

[Jeff Lignalli – Stonebrook Funds]

I thought one of the positives in the press release was you actually bought back a significant amount of debt at a meaningful gain to preserve the NAV while you had some write downs, and I was just curious your plans going forward for using some of your cash to buy back some of the public notes at a discount.

John Scheurer

To the extent that there is an opportunity to do that, and we have sufficient liquidity to do it, and we're in compliance with all of the requirements of our lending agreements, we will continue to do that as the chance presents itself.

[Jeff Lignalli – Stonebrook Funds]

Can you give a little more detailed answer than that because obviously as of the last quarter you had $484 million of cash on the balance sheet less the $50 million you just talked about paying back? So you have $434 million probably earning very little interest and it's obviously attractive to buy back some of these bonds. So what's your plan just generically speaking with the $434 million on the balance sheet?

Penni Roll

As we said on the conference call, we've earmarked that cash for a number of things. One is to have it available to repay debt and we have $484 million of cash at the end of June. We've since used $100 million of that cash to repay medium term notes that are private notes.

And today, we have about $400 million of cash in the bank. We need to have that cash available to us to complete the restructure transaction that we talked about and for other operating and liquidity needs for the company, and we just have to consider all the needs and uses of cash for the company to determine where we best deploy that capital and de-lever the balance sheet.

[Jeff Lignalli – Stonebrook Funds]

Obviously there's going to be some sort of meaningful cash pay down of the notes whenever you sign the final restructuring documents, but what do you feel that gives the amount of cash you need to keep on the balance sheet just for working capital perspective going forward?

Penni Roll

I think we probably thing around $75 million to $100 million is a good place for us if you look at our existing commitments as well as our other needs. Of course that can change at any point in time depending on how much liquidity we think we need for other uses. It's not just the core working capital, that's probably a reasonable number, but we may find that we need to keep more on hand as we sell assets and then figure out how best to use that capital to use in our operations and de-lever the balance sheet, so it's a day to day monitoring determination.

[Jeff Lignalli – Stonebrook Funds]

I know you haven't provided details on the restructuring, but just generically speaking, I'm just curious what's the philosophy of the restructuring? Are all these notes going to be reset at a coupon that would basically make them trade at par in this market environment or are the maturities being shortened or being lengthened? Just generically speaking, what's everyone trying to accomplish? And also, the investors in the private notes, do they want their money back sooner rather than later or would they just prefer to have a market priced instrument that they can hold in their portfolios going forward?

John Scheurer

As we tried to say at the beginning of this, we can't give you all those details now. We'd be happy to give you all the details when we can announce the terms of the restructure. For us, the major things that we're trying to accomplish was achieve some flexibility in the financial covenants so that we can continue to operate.

[Jeff Lignalli – Stonebrook Funds]

It sounds like you're going to be re-pricing all these notes at market from some of the comments you made.

Penni Roll

Like we said, we can't give the details, but all we can say is it will be expensive, and I will tell you it's a very difficult market as a borrower, as a finance name in a very difficult capital market. So stay tuned for more details.


Your next question comes from Maynard Lichterman – Morgan Stanley, Smith Barney.

Maynard Lichterman – Morgan Stanley, Smith Barney

I wonder if you provide any color at all, any idea at all on Sienna and when it might be resolved. It's been going on for a long while. I just wonder if any progress has been made lately.

John Scheurer

I wish that I could give you a more definitive answer. However, and you're right it has been going on for a long time, much longer than we all care to think about. We are making progress, but I can't give you any definitive time frame quite yet and as soon as we can, believe me we will be happy to announce it.

With that, I think we're finished. I want to thank everybody for calling in to our second quarter conference call.

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