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Fifth Street Finance Corp. (NASDAQ:FSC)

F3Q2013 Results - Earnings Call Transcript

August 8, 2013 11:17 AM ET

Executives

Dean Choksi - Senior Vice President of Finance and Head of Investor Relations

Leonard Tannenbaum - Chief Executive Officer

Bernard Berman - President

Alexander Frank - Chief Financial Officer

Robert Dodd - Raymond James

Analysts

Rick Chen - JPMorgan

Stephen Laws - Deutsche Bank

Casey Alexander - Gilford Securities

Operator

Good day, ladies and gentlemen, and welcome to the Fiscal Q3 2013 Fifth Street Finance Corp. earnings conference call. My name is Dominic, and I’ll be your operator for today. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I’d now like to turn the conference over to Dean Choksi, Senior Vice President of Finance and Head of Investor Relations. Please proceed.

Dean Choksi

Good morning and welcome to Fifth Street Finance Corp’s fiscal third quarter 2013 earnings call. I’m Dean Choksi, Senior Vice President of Finance and Head of Investor Relations at Fifth Street. I’m joined this morning by Leonard Tannenbaum, Chief Executive Officer; Bernard Berman, President; and Alexander Frank, Chief Financial Officer.

Before I begin, I’d like to note that this call is being recorded. Replay information is included in our July 17, 2013 press release, and is posted on the Investor Relation section of our website, www.fifthstreetfinance.com. Please note that this call is a property of Fifth Street Finance Corp. Any unauthorized rebroadcast of this call in any form is strictly prohibited.

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 forward-looking statements and 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 at 914-286-6855.

The format for today’s call is as follows. Len will provide an overview of our results and outlook. Bernie will provide an update on our capital structure, Alex will summarize the financials and I'll provide high level commentary on the BDC sector. Then, we will open the line for Q&A.

I'll now turn the call over to our CEO, Len Tannenbaum.

Leonard Tannenbaum

Thank you, Dean. The sugar high for loose monetary policy in global central banks continues to support risk assets despite recent comments from the Federal Reserve about a potential tapering of quantitative easing. Modestly improving economic growth and highly accommodative monetary policy should lead to continued money flows into risk assets.

We're finding attractively priced and structured assets with favorable risk reward characteristics due to a recent increase in new M&A volumes. We're using our investment expertise, infrastructure, relationships and balance sheet to source opportunities for our platform creates incremental value.

While higher prepayments have been a headwind to net asset growth, we're finding more opportunities in the last few weeks that we've seen all year. Our June quarter results reflect these trends with originations of $266 million coming at the high end of our $100 million to $300 million guidance range but partially offset by elevated prepayments of $167 million.

As a result, we achieved net investment income of $0.26 per share. Lower net investment income per share was driven mainly by three things. One, higher prepayments as borrowers refinance and exit the portfolios. Two, significant cash drag in connection with our first SBIC license and three, lower average leverage and credit facility utilization. We continue to target leverage of 0.6 to 0.7 times excluding SBIC data and fully understand that we need to increase leverage to improve our return on equity.

The credit performance on the portfolio however has been very strong reflecting our underwriting and portfolio management expertise. We ended the June quarter with no four or five rated credits and no companies are non-accrual. The team of Fifth Street has plans for potential future expansion into complementary credit assets for several years.

However only recently, we are finding attractive opportunities as banks and other traditional financial institutions aided certain businesses as regulatory requirements increase following the financial crises. We are able to grow our platform and brand in this environment by attracting talent and source unique investment opportunities.

Fifth Street remains consistent in its goal of providing many who have tailored financing solutions to sponsors. Private equity firms and their portfolio companies generate over 90% of our deal flows. We anticipate earnings growth to come for the following five initiatives.

One, the acquisition of Healthcare Finance Group as a portfolio company; two, expanding into venture debt lending; three, growing our capital markets presence; four, better utilization and the reduction cost of our bank credit facilities and five, rotating into higher yielding assets.

To elaborate, number one, we’ve closed our acquisition of Healthcare Finance Group or HFG, as a portfolio company in the June quarter. HFG is a leading asset based lender to a healthcare industry. The acquisition is already performing above our underwriting plan. We are currently working with HFG’s management to help them expand and loan syndication capabilities and sponsor relationships.

HFG is reaping the benefits of being affiliated with the Fifth Street brand and balance sheet as a portfolio company. We expect our investment in HFG should generate incremental earnings overtime. Two, we added venture lending to our product offering by hiring an experienced and respected team in the industry. Michael David formerly the co-head and Managing Director of ORIX Venture will lead our new venture lending team Fifth Street Technology Partners.

Michael has over 20 years of industry experience and is joined by four others who will be based in our new Silicon Valley and Dallas offices. The team will originate loans to venture backed companies as well as augments our overall technology underwriting and origination efforts.

Venture debt is an attractive asset class that we have evaluated for several years with higher yields, potential equity upside, low historic average credit losses and a lower correlation to middle market M&A volumes. Loans to venture backed companies typically receive higher coupons with yields around 12% to 13% and often include warrants.

We expect earnings to benefit as we add higher yield venture loans to our portfolio and potential warrant gains may lead to NAV accretion by offsetting our existing capital loss carry-forwards. Number three, expanded our capital markets presence by hiring Fred Buffone as our head of capital markets. I have known Fred for many years and watched him successfully build several middle market lending platforms at firms such as CIBC World Markets, Jefferies & Company, and most recently at TD Securities USA.

Fred’s relationships creditability with investments, creditability with sponsors and investors in leveraged loan market should help us take our capital market activities to the next level especially when combined with our existing origination and underwriting business and whole size. We anticipate capital markets fees would be a significant driver to our earnings overtime as we originate and syndicate loans to other investors as well as source assets for our own balance sheet.

Number four, we lowered the cost of our credit facilities and plan to better utilize on going forward. We made multiple improvements in our credit facilities at Wells Fargo and our ING let bank syndicate. Including lower pricing, better structure and in the case of our ING net credit facility, a 5-year maturity comprised of a 4-year revolving period and a one-year term out. The recent amendments to our credit facilities also include a greater flexibility, regarding eligible collateral and higher advanced rates across multiple types of loans. Overtime, we should be able to take advantage of the structural changes and better utilize our credit facilities, which we anticipate will be to higher leverage and earnings.

Number five, we expect to rotate assets is higher yield investments. Over the last several quarters, we have improved the quality, flexibility and cost of our capital structure and have improved the overall credit performance of the portfolio.

Looking forward, we intend to shift our portfolio mix towards higher yield, first-lien unit tranche first-lien last out, second-lien loans. These assets are higher yielding, but offer the structural protections in light of being a senior lender.

Overtime, our portfolios should shift towards a higher mix of these assets to better utilize our credit facilities and to generate incrementally attractive risk adjusted returns for our shareholders. We ended the quarter with a portfolio of 79% senior secured loans including the first-lien, second-lien loans in the basket. 16% subordinating loans and 5% equity at fair value. These five initiatives should improve Fifth Street Finance Corp’s earnings power and are only possible after the significant investment in the platform that we have done and are continuing to do.

Our September quarter pipeline is strengthening that emanates the levels that sponsors are increasing. However, we have ample capacity to fund our growing pipeline particularly when combined with their near term expectation of continued higher pre-payments. The platform that we have built at Fifth Street is generating attractive deal flow in our core middle market lending business as well as the interest from teens and employees and other credit related assets that are looking to partner with an experienced institutional asset manager.

We look forward to updating you on future Fifth Street platform growth as we prudently expand and diversifying the asset classes with attractive risk reward characteristics.

I will now turn the call over to our President, Bernie Berman to discuss our capital structure in more detail.

Bernard Berman

Thank you, Len. As Len mentioned, we are working hard to reduce our cost of revolving bank debt. In the June quarter we announced a 25 basis point reduction in the rate of our Wells Fargo credit facility to LIBOR plus 250 basis points per annum. Yesterday we announced significant changes to our ING led credit facility, including a 50 basis points reduction in the interest rate to LIBOR plus 225 basis points per annum with no LIBOR floor, an increase in the committed facility size to $480 million and an increase in the accordion feature to $800 million.

The amended facility also includes a longer maturity and a greater level of flexibility on eligible collateral. The changes in the facility provide the flexibility we need to grow our portfolio across different parts of the capital structure. We currently have total debt capacity of over $1.3 billion, including $830 million to our ING, Wells Fargo and Sumitomo credit facilities, $276 million of unsecured debt and $225 million of SBA debentures.

Leverage at the end of June quarter was 0.4 times debt-to-equity excluding SBA debentures. We continue to target leverage of 0.6 to 0.7 times debt-to-equity excluding SBA debentures. I am now going to turn it over to our Number five, we expect to rotate assets is CFO, Alex Frank.

Alexander Frank

Thank you, Bernie. We ended the third quarter of our fiscal 2013 with total assets of $1.9 billion, an increase of $508 million or 37% from 2012 fiscal year end. Portfolio investments were $1.8 billion at fair value and we had available cash on hand of $59.6 million. Net asset value per share was $9.90 at quarter end, which was unchanged from the previous quarter but an increase of $0.05 from the year ago period.

For the three months ended June 30, 2013 total investment income was $58.1 million. The level of gross payment in kind interest, a key indicator of earnings quality declined to 7% of total investment income as compared to 9.6% in the year ago quarter. Net PIK accruals recorded in excess of PIK payments received in cash was $3.2 million for the quarter or 5.4% of total investment income. Net investment income increased 38.7% to $30.4 million for the quarter as compared to $21.9 million in the same quarter of the previous year.

The performance of the portfolio was stable as net realized and unrealized losses were $4.4 million or only 0.2% of the investment portfolio. As a reminder, the realized losses recognized in the quarter were already accounted for in NAV as a unrealized depreciation in prior quarters. Therefore the realized losses had no material impact on either net investment income per share or GAAP earnings per share.

The weighted average yield on our debt investments remained steady at 11.4% with the cash component of the yield making up 10.2%. The average size of a portfolio debt investment was $22 million at June 30, 2013, an increase from $21.1 million at the prior quarter end.

We had gross originations of over $266.3 million in the quarter in nine new and eight existing portfolio companies, bringing the total companies in our portfolio to 98 at June 30, 2013. During the quarter we also received a $166.7 million in connection with the exits of eight of our debt investments, all of which were exited at or above par at an average price of $102 and were exited in line with previous fair value marks.

Approximately 95% of the portfolio by fair value consisted of debt investments, with 79% of the portfolio invested in senior secured loans. The investment portfolio continues to be well diversified by industry sponsor and individual company.

Our largest single exposure continues to be healthcare, including pharmaceuticals at 21% of the total portfolio. Our investment in HFG, our specialized finance portfolio company represents 6% of total assets. The overall largest single individual company exposure is 6.1% of total assets and our top 10 investments represent 37% of total assets.

The investment portfolio continues to be of high credit quality and the credit profile remains strong. We currently rank our investments on a one to five ranking scale and the highest performing one and two rank securities or 98% of our portfolio, which is flat versus previous quarter and year ago period.

During the quarter ended June 30, 2013, we had no investments in the portfolio on which we had stopped accruing income as compared to one at September 30, 2012 and four at June 30, 2012. Our Board of Directors has declared monthly dividends for September of 2013 through November of 2013 of $9.58 per share reflecting a continuing annualized rate of $1.15 per share.

Now I will turn it over to Dean.

Dean Choksi

Thank you, Alex. One area I believe is sometime overlooked by investor in the BDC sector is earnings quality, more specifically PIK, our payment-in-kind income. PIK means that interest in generally not paid in cash during the life of the loan but through an increase in the principal of the loan.

At history, our level of PIK interest has declined from 14.7% at the end of fiscal year 2008 through around 7% in the recent quarters as a percent of total investment income. The lower level of PIK interest indicates that we are receiving higher relative levels of current period cash income.

In leverage lending it is not unusual to have some PIK interest. PIK interest is generally included in most mezzanine loans with a typical structure being a 14% coupon consisting of 12% cash interest and 2% PIK interest. Other times our borrower may request a loan with a greater amount of PIK interest for a specific business reason, such as to consider cash flow to fund an increase in capital expenditures.

In our opinion, investors should scrutinize a BDC with a relatively high level of PIK income more carefully because one PIK interest that is accrued as income must be distributed to investors as dividend even though cash may not be received until the loan repaid if at all. Two, high levels of PIK interest for a loan maybe assigned if the borrower has weak cash flows, particularly this should be a warning sign if an all cash paying security is restructured into a security with a coupon with a high PIK component.

We also believe investors should scrutinize companies where PIK interest is not clearly disclosed within our SEC filings. This should include cable that clearly discloses a level of gross PIK or PIK income accrued in the quarter and the level of PIK income collected as loans repaid. We also disclosed in the table if loans are on cash non-accrual and/or PIK non-accrual, in addition to the dollar amount of revenue a non-accrual status. Looking at our disclosure over time you can clearly see the quality of our earnings has improved.

Thank you for participating on today's call. Please open the lines for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Rick Chen of JPMorgan.

Rick Chen - JPMorgan

Hey guys good morning and thanks for taking my question. Just want to circle back about the shift in the portfolio that you described and I actually sort of try to characterize it as a shift versus a rotation, and by that I mean do you expect that you will shift the portfolio by skewing your future originations or do you expect actually to sell off some of the legacy stuff to accelerate that shift?

Alexander Frank

I think, primarily its future origination to the shift and as you know we’ve moved up market substantially in the company that we’re typically underwriting in the mid-20s to mid-30s EBITDA so much safe for more establish companies, we are still being very careful about leverage but we’re going to increase our second lien loans we’re going to increase out first lien loan that have to do with [bencher] which is almost all first lien and we are going to reduce over time the proportional loans that are 7% and less on the portfolio, so it’s going to be shift it should create additional yield without significant additional risk.

Rick Chen - JPMorgan

Got it. And again I don’t want to put you find a point on it, but from a modeling perspective it helps us think about things whether it’s going to be sort of static portfolio size and mix shift with in it or dynamic portfolio growth with a skew and it sound like it’s the latter.

Leonard Tannenbaum

It’s mostly the letter, the main thing as you’ve seen a lot of our loans repaid at 102, I think that’s what Alex said, our average loan repayment. The senior loan market, our loans are trading very, very well. When we can opportunistic exit at 102 or 103. I think we may take select opportunities but still it will be primarily new retention.

Rick Chen - JPMorgan

I am going to apologize in advance if you address this but you know, today we're balancing in between a lot of calls. I would love to get your thoughts on where you stand versus the report card that you set for yourself back in February?

Leonard Tannenbaum

I am not ready to give myself grades yet, but one of the thing I will say is that I am disappointed in the report card is this quarter we are short off, there is no question we are short at the dividend. We are very cognizant of it and I know a lot of analyst modeled in that we get there by fiscal year end and we're still doing our best to get there. So we're working hard to try to do better on the report card. I am certainly not scoring straight ace, but I still have a little more time to improve my score.

Rick Chen - JPMorgan

Just remember the market doesn't grade out of curve.

Leonard Tannenbaum

They are still a lot better.

Operator

Your next question comes from the line of Stephen Laws of Deutsche Bank.

Stephen Laws - Deutsche Bank

Like the previous caller I’ve bouncing around too so I apologize if you have already covered this but wanted to really get the perspective from FSC with regard to having the new FSFR vehicle in the market. Were you in the process of being approved for co-investments between the two vehicles and how is that going to change FSC? Is it going to enable you to do larger transactions to change the pipeline? Just kind of what are the inter comments from the FSC side of things about the new vehicle?

Leonard Tannenbaum

Bernie I want you answer the approval process.

Bernard Berman

So we filed with the SEC for an exemptive of orders will allow us to go invest and we originally file that, I believe that February stepping in the winter quarter and then we amended that application in July to include FSFR as part of the application. So we are hoping that we will receive permission prior to the end of year to coinvest.

Leonard Tannenbaum

So far the lack of commission to co-invest beside maybe one stock that I would have like to split between vehicles hasn’t hurt us that much, because some of the transactions that FSFR is recently entered and today we announced $26 million of deals have been done in FSFR start deploying the equity. Some of them have been mass mutual type deals, some of them which belonged there set of FSC, and I think that’s part of it. If you take FSFR fee structure, which is lower than FSC and you take the leverage which is actually cheaper than FSC and you pick the leverage target which is higher FSC, then for FSFR a lower yielding senior deal makes more sense and in diversified manner and FSC, which really doesn’t make sense if the deals is too low to put it into our fee structure, leverage structure. So I think you will see deals belong there, go there, deals that belong to both places be split once the SEC approves it, we think in next few months we’ll get that approval.

Stephen Laws - Deutsche Bank

Something is going to be complementary and may be leverage some investment opportunities there?

Leonard Tannenbaum

It’s pretty exciting because one of the reasons why we sometimes win deals in fact, we made a lot of deals this year that we’ve won this way is by participating in a senior with a great sponsor who asked us to do that, and then we go for a refinance and then all of a sudden they need a last out senior or they need secondly loan or they need a mez loan, and the incumbents always have the advantage because they are already in the loan and they’ve already done their diligence and for them to expand is much easier. So the sponsor would much rather go, first choice of any sponsor is usually is to go any incumbent unless they choose somebody or something goes wrong and then feels out to market. So by being the incumbent in many senior loans when the opportunity presents itself for an acquisition even for a dividend and cases we are going to get first look and I think that’s a really important thing to be as many loans of our clients as possible. Good loans.

Operator

Your next question comes from the line of [Greg Mason] of ABW.

Unidentified Analyst

I wanted to say may you touched on this already, but the return expectation from HFG, what are you modeling out as you expect to return and then what is the ability or desire to continue to grow that platform and how big do you think it could get.

Leonard Tannenbaum

First thing we had to do was make sure that everybody was on the right page and tick over the brand. It helps them with branding and helped them with helping see where the overlap is between HFG and FSC as to how we can help each other. I can tell you the several deals where HFG is bidding for the same business we are and it’s great, because we are offering response to multiple solutions and multiple cross points, it has been points to their loans. So that I think that phase is pretty much done and HFG is performing above or under, what we under wrote them at. So should generate excess earnings overtime. The excess earnings as you’ve seen many of peers be able to do, can be divided up at our option and then in addition the HFG needs more capital and they actually pretty incredible leverage lines that we're still working on lowering of cost of capital there. But they sold plenty of capacity to extend their business, but if they need it more, we'd be happy to inject it for the good risk adjustment returns that they are, but they are very well capitalized at the current time and they are generating some excess earnings

Unidentified Analyst

And what is that kind of the stable earnings in mid-teens range, 12% range, just kind of what are your underwriting expectations for returns on that business.

Leonard Tannenbaum

We are not ready to say and we give you we just recently acquired, I think we want some history first. Clearly when they generate excess earnings and on a sustained basis, we think that it should be able the dividend up to the parent, but we don't know, when would that will occur, certainly that’s going to occur three months later.

Unidentified Analyst

Okay, great. I can appreciate that. And then you have said that September pipeline is building, can you give us anymore indications on what you're saying is are is pricing holding steady, the kind of mix refi versus new M&A activity just a little more color on the pipeline that starting to build?

Leonard Tannenbaum

I would say 4 weeks or 5 weeks ago, I want to made that comment and that was actually an adjustment to me making that comment, a bit more recently, and it's really amazing that we normally think August is slow and everybody is pretty much here saying and maybe it's the history crawling on but I know as you're listening to all the earnings calls that we are seeing a busy August. So I think it slows down at the end of August and everybody can go to vacation, great spots or whatever, and I don’t think that’s going to be the case here. I think we are going to work hard throughout August. And I think we are seeing a variety of deals it’s not one deal, its lots of smaller deals, you see then the high amount of a lot of M&A coming to market, so we are cautiously optimistic that it continues, but we’ve also seeing start and stop before, so I think we’ll try to update for sure in our September newsletter and we promise, we plan on issuing at September newsletter and we planned on addressing M&A volumes and underwriting volumes.

Operator

Your next question comes from the line of Casey Alexander of Gilford Securities.

Casey Alexander - Gilford Securities

I was just wondering, I like the ventured debt space quite a bit, but I would just wondering given the size of your platform in the way you’ve moved up market with your platform, is the smaller deal size of the venture lending space efficient for your platform and sort of what your thoughts about that?

Leonard Tannenbaum

So that’s a very good point, and actually that was the right characterization. These deals are smaller, general FSC has moved towards just out into the middle market and left the lower market, and so by doing that we have several vehicles that can utilize the smaller loans and higher yield rotation will help those vehicles. So I think that was the big positive, and I think the venture technology buckets, it’s a non-scalable platform, but it’s very additive to our currently technology effort, our normal technology effort to have technology experts in the Palo Alto. So that's another plus.

Could this scale to $200 million, $300 million over the next two years? That's what our hopes are. Do we think it's going to get much bigger than that? I don't know but we will have life sciences at some point to it but we think it is very additive. I think the biggest driver for me is we have this capital loss carry-forward almost a $100 million of them and I want to have capital gains offset capital loss carry-forward and we do have some really nice capital gains beginning the portfolio but we don’t have enough in diversified manner. I just feel better to having more capital gains and one great way to generate that.

Casey Alexander - Gilford Securities

You answered my second question. So, thank you. And the sort of net $4 million of unrealized depreciation in the portfolio of this quarter is that just mark-to-market for a lousy bond market?

Leonard Tannenbaum

Really, no. It's actually a relatively good new story. A lot of our loans that we exited, we had marked up to our plus prepayment penalty because as a policy, we don’t mark the investments above our plus prepayment. So when we get prepaid, the prepayments penalty comes in to NII. So you see just sort of a shift between the unrealized NII.

Casey Alexander - Gilford Securities

So, some of the unrealized that we're seeing below the line shows up in the fee income up above the line?

Leonard Tannenbaum

When it's realized.

Operator

Your next question comes from the line of Robert Dodd of Raymond James.

Robert Dodd - Raymond James

I want to ask you about leverage, obviously you restructured some of the facilities, what is that and lowering the cost, I mean is that come the price of any changes in advance right, particularly if you’re looking to do more second lean, how are those advance say from a new facilities looking in terms of what you could actually achieve in terms of those leverage level?

Leonard Tannenbaum

So it actually comes at not only no cost advance rate but better baskets for everything. And I have look at it’s a different environment, when lenders like, borrowers like us who are investment grade who now establish a large are now being able to and you have seen this with the a couple of -- none of peers areas push down their facility and we pushed a little bit wider pricing than arrears but as soon as they pushed on ours we took that opportunity to go up to call since we are direct comparable.

We said okay it will be a little bit wide, but we want things that list of things we want, but the most important thing we’ve got was five years maturity, which means you can use this leverage revolving basis and not have to worry year to year to year about renewing this facility. So it’s a much more stable, diversified, long-term facility and actually our basket for second lien, our baskets for first lien are very good. We are definitely be able to utilize it and will be utilized it as a much more cost at 225 instead of 275 which makes material difference as we get leverage into that.

Robert Dodd - Raymond James

Okay. I mean and just one, I know you put in (inaudible) but as you shift the mix with certainly the -- do you have target although we were talking closed portfolio yield, target coupon that you are looking to embed into that mix if obviously we can do some math and figure out a number that’s necessary to cover the dividend. Do you have a particular target?

Leonard Tannenbaum

I think we continue to strive towards generating higher ROEs and earning our dividend and I think those are the focal points. We are going to do that by having obviously by having higher yielding assets by additional leverage, continuing to diversify. We are going to do that by generating earnings power, right which is increasing NAV, I mean all these things all can work together and doing that, and there is a lot of different (inaudible). I can’t tell you which ones are going to be divested returns to do it any given time. But we are definitely now to try optimize the capital structure.

One of the things which we talked about that we had an issue with cash drag in the SBA where we carried quite a bit of cash against what we pay is 3.5% and we recognized that. And so I think first of all there is a number of origination efforts that are going to go against this quarter and we are going to file on that situation, but definitely it was the problem last quarter and that was due to a number of repayments that’s just happened in that facility and that cash is trapped. We can’t pay down credit lines used in our cash.

So I don’t know what to say that we made a mistake, we just didn’t have the originations against that type of facility that we would have liked last quarter and we quickly reacted to that.

Operator

Your next question comes from the line of [John Bagh] of Wells Fargo Securities.

Unidentified Analyst

Len a few questions on some of the pillars that you outlined. Start first with AdVenture and I apologize I missed it; I have been part of the same group jumping between conference calls. The venture debt loans and sales will be placed on your balance sheet correct and this will not be as subsidiary similar to HFG?

Leonard Tannenbaum

Correct, that will be directly on our balance sheet

Unidentified Analyst

Okay. Thank you for that. Just a small house keeping point there. And then now focusing on higher yield securities, the weighted average yield of our new investments, can you give us what ballpark, what the average yield be originating at in new investments this quarter?

Leonard Tannenbaum

This quarter meaning,

Unidentified Analyst

I'm sorry in 2Q.

Leonard Tannenbaum

I think you said relatively stable. So I think average yield stayed relatively.

Bernard Berman

It was flat.

Leonard Tannenbaum

Flat.

Unidentified Analyst

Okay. So the weighted average yield you are originating on new investments and not on your portfolio, your new investments was at what level?

Bernard Berman

I think about 11%.

Leonard Tannenbaum

A little bit lower than the weighted average yield, but not and up to change the overall average yield.

Unidentified Analyst

Okay. And if we were to take out the 10% first term lien loan that you're going to be getting on HFG, would you still say the new loans that were there were also very close to the portfolio weighted average yield?

Leonard Tannenbaum

Alex

Alexander Frank

Yeah. They were pretty close, yeah.

Unidentified Analyst

Okay, great. Thank you. So then as we -- you mentioned moving into larger transactions Len in particular, I mean you highlighted second lien debt. And I'm curious as banks as well as leveraged loans funds etcetera become a bit more aggressive and leverage levels creep up. It was my understanding that they will either be A, less second lien debt outstanding. Or B, the second lien debt that's outstanding is going to be down at higher leverage levels because first lien lenders are more than happy to stretch a bit. So if you can walk us through how one can keep the risk reward the same, given that yields have compressed in this environment that’d be very helpful.

Leonard Tannenbaum

So, I think last out first things are still very prominent and that's always a preferred way to do it. On the upper middle market loans, secondly liens are still very prevalent. In fact, as you often see a multi (inaudible) structures with even money going below the second lien loans. So we're just being very careful. The whole idea that five times leverage is now seven times leverage, we don’t play in to that. We're not doing higher levered loans. What we are primarily, I don't think we are entering any higher levered loans. The second lien that we're doing are upper middle markets that are primarily upper middle markets, second liens. What that means and this is why it's materially different than lower markets, second liens this is why not all liens are the same, as there is no payment blockage and that’s enormous differentiator.

Not only that, these companies are $30 million in EBITDA or $50 million in EBITDA. So that when there is a problem, if there is a problem, and when there is a problem, these are still real companies with real infrastructures and real cash flow paying ability, which is really great. I am not saying by the way that we are hearing from a second lien lender. We're still going to be first lien lender, but what I am saying is that the second lien loans as a percentage of the portfolio may increase to some degree but we're being very cognizant about the unsecured, the mezzanine and the preferred and we're going to try to at least keep equity constant because we do want some equity gains in the portfolio.

Unidentified Analyst

I appreciate that and then when as you moved up to the upper end of the middle market, I was always wondering about competitive pressures because the more one finances larger businesses, particularly as levered loans funds and others dip down to middle market in order to maintain yield, which is non-existent on BSL collateral. That would likely increase the competitive dynamic for the types of loans that you are targeting. Have you seen that in recent quarters and do you expect that to continue?

Leonard Tannenbaum

The good news about past few weeks is there is so much volume in the upper market that we're not seeing anyone down here. So this is great. But yes, two or three or four months ago, we certainly saw a lot of number lenders drop in to our markets. So when that happened, we try to differentiate by doing bigger whole sizes and remember we're coming direct from sponsor. So for us, in the (inaudible) transaction, for example, there will be (inaudible) an area as primary competitors on A, senior transaction, we're not really competitors, it's club deals and the smaller transaction that we do with equity sponsors, often they just come to us and one other and they tell us what we have to do win the business and we get last look so we get primary looks. And we work with them on the bidding process. So I feel like, I don’t feel any more competition this year than last year but I would say over the last three weeks, I think it’s been less competitive not more competitive.

Unidentified Analyst

I appreciate that and moving to HFG, I can mind the queue but I was just curious if you have these numbers and it would be very helpful. What is the portfolio size outstanding right there at that entity today as of 6:30?

Unidentified Company Representative

It's their financials.

Unidentified Analyst

Is that something that you would expect to do overtime given that a crystal as well as the GE unit truant and other off balance sheet leverage vehicles, do we have bit more disclosure, Alex?

Alexander Frank

No, we don’t we wouldn’t because the size of the investment isn’t material, so there is no necessity for doing those kinds of disclosures.

Leonard Tannenbaum

HFG it represents 6% of our assets.

Unidentified Analyst

Okay. Okay I appreciate that. Thank you and then one last question on a Eagle Hospital physicians, just noticed that first term lien loan actually had a bit of mark and I was just curious is to where you fit in that transaction and perhaps what the outlook is on that investment in particular?

Alexander Frank

So Eagle is paid in full and all interest and we are working on restructuring that investment and the market is appropriate. And that’s all we can say about it at this time.

Operator

This ends today’s question-and-answer session. I’d like to hand the call back over to Dean Choksi, Senior Vice President of Finance and Head of Investor Relations.

Dean Choksi

Thanks for joining us on today’s call. Have a good day.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect and have a wonderful day.

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