Apollo Investment's Management Presents at Barclays Capital Global Financials Conference (Transcript)

Sep. 9.13 | About: Apollo Investment (AINV)

Apollo Investment Corp. (NASDAQ:AINV)

Barclays Capital Global Financials Conference Call

September 09, 2013 02:45 pm ET

Executives

Edward J. Golthorpe – President

Leonard M. Tannenbaum – Chairman and Chief Executive Officer-Fifth Street Finance

Brian H. Oswald – Chief Financial Officer, Secretary and Treasurer-Prospect Capital

Kipp deVeer – President-Ares Management LLC

Unidentified Analyst

Okay, so we have this BDC panel today to address the outlook for the BDC industry. Some of you may know Business Development Companies or Specialty Finance Companies are focused on lending to the middle market.

Now on the panel today we have four of the largest BDCs. We have Ted Golthorpe, President of Apollo Investment Corporation; we have Leonard Tannenbaum, CEO of Fifth Street Finance; Brian Oswald, CFO of Prospect Capital and Kipp deVeer, President of Ares Capital.

So we will start off. What is the long-term market opportunity for BDCs in the middle market, given changing regulatory and competitive environment and how would BDCs capitalize on the opportunity to provide value for the shareholders?

Edward J. Goldthorpe

It’s probably the easiest question of the day. Listen, I think our view is probably very consistent with my peers over here, which is, we think the opportunity for BDCs, is they’re massive opportunity. If you think about the amount of illiquid capital that’s been sucked out of the space, the number is hundreds and hundreds of billions of dollars and the total assets of the BDC space is only $35 billion. So we just think that over the last four, five years, we think a lot of these changes that have occurred post-financial crisis are here to stay. I think there is some new leverage rules that came down for the large banks from the Fed in the last couple of weeks and we are really seeing the impact of that in a positive way in our business.

So I think there is a big, big opportunity for four of our companies to really take advantage of this. We think, if we compare where the BDCs are today to where REITs and MLPs were 10, 15 years ago, we think it pretends a much growing sector. There is not a lot of illiquid capital being raised in the space today, a lot of the illiquid capital being raised today away from the BDCs is looking for 15%, 20%, 25% returns, and I think there’s a big opportunity for all of us to provide capital to middle market companies that just filling the void that other people have left. So I leave it there, I can talk about this for the entire 37 minutes, so I leave it over.

Brian H. Oswald

I think the only thing I want to add and sitting here usually I am on a panel on the larger BDCs, we’re the fifth largest and every single one of them is bigger and but the big ones will win in this scenario. It usually happens in any industry where you are going to have a lot of these IPOs, the IPO calendar BDCs and everybody either at moment it’s one file, I want to take one public because they realized the same thing that Ted just said, which is the opportunity set that’s available for the alternative managers is unbelievable.

And I think Goldman started a private BDC, they stopped it in a smaller size and realized they have to actually develop origination. And that type of hurdles that we all went through, no maybe not Apollo, because they started big, but at least we went through as history, we were really small as there is a lot of hurdles this smaller BDC, the illiquid BDCs, the non-investment grade. And what’s happening now is the good banks like RBC has started pulling back in the space and they are going with the people that they care about and they are staying with them and they are leaving others. I think it’s going to be very difficult for the smaller BDCs to be able to compete in cost of capital and borrowing and so you will see a much bigger sector, but you will see it surrounding about seven to 10 firms.

Leonard M. Tannenbaum

Building on what Brian said, I think the big change over the last three years has been the access to the term debt market and the ability to finance our companies at levels that make sense and also allow us the BDCs that had some issue, one Patriot that we bought was doing their financing the bulk with 365 day paper, which having five year assets and 365 days paper financing, it just wasn’t a good model. Now we have access to the capital markets on the debt side that is which is the vehicle for us, the few other companies going forward.

Edward J. Golthorpe

Yeah, I don’t know if all have answered the same question, but I will give it a shot. I think just to address your point about what’s the constraint, like we said all-in-all. The one key constraint that the BDCs all have obviously is the fact that we can only be leveraged one-to-one and so what that does is it obviously prohibits generally certain types of loans from being made, it’s hard for us to be a really, really active first lien lender with leverage capped at one to one. So the way for the business to continue to institutionalize and really grow is just for more of the traditional lending products to be available to us. So one of the ways you can obviously change that is just by moving the leverage governor around.

Unidentified Analyst

Okay. Ted, I think you just alluded to this before a bit, BDCs are right now where like MLPs and REITs were 10 or 15 years ago. So what do you think we need to happen to really facilitate the growth of the industry?

Edward J. Golthorpe

So, yes, say couple of things; one is probably the biggest surprise when I got into the BDC space is when you analyze what happened with the REITs and MLPs and their growth, the required yields for both those sectors came down as those sectors grew. And that’s a pretty interesting takeaway, you would think it will be the opposite, and I think the answer is lot of its investor education. When I spend my time with institutional shareholders, I spend 90% of my time talking about the BDC space and 10% of my time talking about Apollo specifically.

So, I think it’s a space that’s still under-covered and under-followed. I think there is some – I’d separate the pre-crisis times and the post-crisis times and I think there is some scar tissue built up among certain institutions about some historical situations within the BDC space. And I think over time, when you look at our shareholder base and when you look at it today, and if you look at lot of the biggest shareholders of us today versus 18 months ago. Institutions, I think are really begin to understand the way that all of us – I describe it as BDC 1.0 and BDC 2.0 what all of us are doing today and you look at the track records of last three, four years, the space has been able to operate at very high yields, pay at a very stable dividend yields and realize very little losses and grow their dividends.

So I think this space has been very disciplined about terminals or capital structures, have been very declined about their underwriting. When these people are doing stupid things in the market, it’s typically not our peers, its people outside of the BDC space. So I think some of this is going to be investor education and time and as long as all of us including ourselves perform, again, we think this sector is right for growth.

The one other thing, I’ll say by the way and I’ll let you go jump in which is, the other thing I think and I could be wrong in this, the other thing I think might change over the next three, four years is, we are one of the last high dividend paying sectors or high income generating sectors of the financial markets that still trades on an absolute basis versus a spread basis. And so, REITs made a jump from absolute spread basis and obviously this sector exploded, MLPs basically did the same thing. So I think overtime that will begin to happen with our space and I am not pontificating a high yield, but if high yield is yielding 5% today and our sector is yielding 10% and most of us with first lien senior secured for the new assets, that should change over time.

Leonard M. Tannenbaum

I have one small thing to add. And the other thing you will notice when you start seeing that change is all of us want to trade exactly the same and why I say that, we all trade between for the good ones, trade between 105 and 110 times book and that’s fine, but there is no differentiator, there is not enough differentiation between players, not to say that one of us is better than other, but they are all different.

We all have different philosophies and that should lead to us trading differently from each other and should create some opportunities, that’s why I have made the hedge fund investors invest into paired shorts, long and short and make a lot of money doing that, so that’s great for the hedge funds, but small only institutions and which is basically the majority of money that we want investing, thanks for the hedge fund first, long-term in the stock is, really you have to have that differentiation. Some day that will happen.

Brian H. Oswald

Yes, I think the biggest thing right now is we need to, as Ted said, get the word out about BDCs. Couple of months ago, all the BDC is traded down significantly because treasury rates were going up and no one could figure out that increases in interest rates were actually good things for most of the BDCs and it’s still a misconception out there, so it’s trying to clear up all these misconceptions about what BDCs do and how the markets are affected by external factors that needs to be cleared out, and I think then we’ll get a much better institutional following.

Kipp deVeer

To play out some of these points, I don’t think communication, track record that’s actually worth backing. Right, I mean we’ve been in business now for 10 years. We like to think we have one of the best track records in the space. I think retail shareholders have and always will own our stock because obviously paying a high dividend is beneficial for the traditional retail garners. So I’ll conclude it, but if we are able to consistently grow with good performance, deliver earnings growth, deliver dividend growth over long period of time through market cycles, we know that, that attracts significant institutional investor following. And we’ve spent over 50% owned for 10 years by institutions we’ve always had very strong institutional support, many of the folks in this room. So I think that will continue but obviously I think we have good performance.

Unidentified Analyst

Do any of you guys want to elaborate on how this asset class can be more institutionalized just alluding on Kipp’s comment?

Kipp deVeer

I mean I hate saying this, because I don’t think any of us feel pressure to grow, but I think it’s like a self fulfilling prophecy as the sector grows. The bigger sector is the more it’s worth some analyst at some large institution spend time on sector, educate themselves there is some nuances about BDCs that you have to learn, and I think this is a $200 billion sector. I think it’d be worth to have a dedicated BDC, and also a lot of large institutions. So I actually think part of it will come with growth. Although I just add, I don’t think any of us feel a need to grow, but as the sector grows I think that will obviously help for us.

Leonard M. Tannenbaum

I wanted to point you about smaller BDCs and we used to be a lot smaller than we are today. The reality is, if you get to a certain size, and you can actually be viably owned by an institution or either it’s not aftermarket liquidity, you can build real positions, you can buy and sell the stock on a day-to-day basis.

We understand it mean something for you all, and we made the point about skilled or that many BDCs that actually have enough scale on either of the assets for market cap side where it makes a difference for a lot of folks that aren’t focused on small cap stocks. So as more and more of us continue to generate good performance and growth that should help the sector.

Unidentified Analyst

Okay. So recently there is a lot of talk about increasing leverage limits for the industry, maybe you guys can elaborate on that, what do you think the risks are, and how would you guys view it? Let’s start off with Leon?

Leonard M. Tannenbaum

Sure. I’m one of the few CEOs that don’t believe that we should expand leverage limit, and I’ve taken a lot of flack for it, wrote a nice white paper, and if you guys want it, distributed one of these things and had a lot of Twitter chatter back and forth. I did sign a small business alliance letter to the government that was written by the CEO of Mainstream, and he in this case, I saw from the language enough that I could sign it.

He basically is asking for review of the leverage limit, which look the review of anything is a good thing, and so I did agree that we should certainly look at something that was created a long time ago in a different time period with different goals, and we should look to see if it’s appropriate.

Having said that, I think that the responsible players and you can tell us who are responsible you are investors, can handle bigger leverage. My fear is that, irresponsible players that may exist cannot handle additional leverage. And the additional leverage would have created losses to banks in the financial crisis from some BDCs, one of which maybe that Ares acquired, and Ares being a good acquirer of a BDC that’s [indiscernible], and that would have caused my banks to lose money.

My banks, our banks that went to all of us lost money. They would not feel as comfortable lending to BDCs, and we’ve heard this time and time again, I’m going to committee and saying, hey no senior lender has ever lost money in a BDC even bad ones, good ones maybe not the other challenged ones no issue. That reputation is so critical to us having a low cost of capital for us investment grade companies. I don’t see a reason to jeopardize that. And I don’t see why we need to extend the leverage from it. So that’s my personal view. I think the sector will do really well with not having to do that.

Brian H. Oswald

I’ll take the counterpoint slightly. So our view on leverage is number one; it can be incredibly dangerous and Leon makes the right point particularly for those who don’t know how to use it. You always do run into that risk where we are grouped in with the people who leave themselves up because they can understand how to utilize the leverage. For us, we think of it is something that actually would significantly expand the BDCs market in terms of our ability to underwrite loans and type of assets that we can look at, right?

As I mentioned beginning a real constrains that we have just around the economic model as a result of the one-to-one limitation. So I agree with Leon on a lot of fronts I would say. Number one; is the option to utilize the leverage, so no one’s going to say there is now a two-to-one leverage cap, go use it all, by all means. If you want to run a BDC with no leverage you can, but if you want to run at leverage two-to-one subject to legislation passing you can do that too. And to your point of that differentiation I bet there are people who are going to say those guys are levered at 1.7 to 1, I don’t want to own them, that’s too risky and that’s sort of how markets made I think.

Leonard M. Tannenbaum

Yeah. But some of the risk Tier 1, they’re going to use more of the leverage. Look the other three parts of the bill, so there is four parts of this bill that should – that three parts of the bill all four of us, I believe are in agreement on which is preferred, it’s ridiculous to prefer to contest that. We should be able to incorporate by reference like everybody else. It’s ridiculous that we have extra legal fees, extra aggregations, extra all the stuff. Right, yes, only NRA is only beneficial to the shareholders. If you allow us to own RA’s you guys will make more money, or management companies will make less money and everybody still be very happy, thus it will be able to grow a great business.

So three of those things are should pass, stupid that they are not passed. The only issue is leverage and honestly whether I support it or not by the way I’m sure Ares is going to follow-up [indiscernible] in Congress, so I. If congress does not in the mood to raise leverage on anything right now, in fact, if there is anything Congress is thinking we go the other way. So we cannot all these different views and talk to you about it I don’t see it passing.

Brian H. Oswald

Yeah, I think the one other issue that would be a problem for four of us is what would happen to our investment grade ratings with S&P. I don’t think S&P is going to live with leverage above one-to-one and still be investment grade entity. So I’m not sure that – we agree with Leon, we would never use it, so…

Kipp deVeer

Yeah, I would add one more point which is a little separate apartment, when you look at what the sector is doing, I don’t think anybody is running their business as it going to pass. I don’t think anybody is hanging on how that’s going to pass or not going to pass.

So I think from my perspective it passes, it gets us more flexibility in many ways and I think there is ways that we can de-risk our portfolio, we should have self counter intuitive, but it opens up certain various senior secured asset classes that may make sense to buy in all 500 loan and lever it 1.5 times versus buying a private mezz deal at 9% to 10%, 7 times levered where it was wrong you loose money. So like there’s arguments in both sides I hear, but I think the key point to make is that I don’t think any of us running our business as if it’s going to pass. In fact it’s what we assess…

Edward J. Golthorpe

It sounds as great, and the reason is we have more operational flexibility.

Brian H. Oswald

Yeah. The pass is great, doesn’t pass it’s fine. We think we can hit our business plan without it.

Unidentified Analyst

Okay, so besides leverage, do you think there is any rule changes that may benefit the industry, like the leverage bill or anything you want to pass?

Leonard M. Tannenbaum

And we talked about the other three.

Brian H. Oswald

Well, I think the other big thing is not having so much rules for BDCs, but rules for others. There is a lot of things going on right now in the world. I don’t think, this is kind of indirect answer to your question. There’s a lot of things going on in the world away from BDC space at this point right into our hands, and I think a lot of – I’m the poster child of Financial Reform, as Goldman Sachs running much of proprietary businesses, I’m not a BDC, I mean it kind of tells you something about what I think might be a financial regulation.

But I think with each passing quarter, it’s becoming clearer and clearer that as banks get more clarity on regulations, and to Leon’s point, not only Congress, but also the regulators are in a big mood to take the foot off the neck of lot of these foreign investment banks. I think again, that just opens up the breadth of what we can do.

So you look at kind of what BDCs are doing today, when you look at what BDCs were doing four years ago, where we’re all going, as we’re going to whole bunch of new really interesting risk reward asset classes, that have been vacated by large national institutions.

So I think there are a number of different rule changes that are being proposed today away from the BDC space that can be huge, huge, huge home runs for our business.

Edward J. Golthorpe

I mean the aircraft leasing paper being one of them. You’re seeing the aircraft leasing paper actually and the European banks stopped all assurance of paper basically, it’s their cost of issuing if it’s enormous. And there is so many billions at market, nobody can stop it out. We are not going to yet we just started hanging little roughly seeing start our business because I think in two or three years, it’s going to be the time to invest. And I think if you have foot in the door and you got to get ground it, that brand name recognition but if you are big enough you want to be able to zig everybody else’s zag and I know Apollo has an effort so as an effort, we have an effort on various tasks, but we at least want to be positioned to be take advantage and where banks have massively pulling back when the opportunity present itself.

And I think that’s the opportunity as Basel kicks in full and it gets fully defined is to be able to go with the banks or not. The leader of our industry in £1 million roll off, [indiscernible] GE Capital, let’s be honest about it, GE Capital still with $700 billion in size not $450 billion. This industry may or may not have grown as fast as it did, my argument is it probably would not have. I don’t think that trend for GE is stopping for the people we talk internally 50% of their time is spent on regulation.

By the way they have the best franchise, they could create originators, they have the best brand name, their press release have got the biggest pipe, there is nobody in close. They were the leader, they are great, nothing anything bad about GE. What I’m saying is the regulatory environment is really franchised packs them into shrinking which is allowing the other alternative managers I think even have an outsized form.

Unidentified Analyst

Okay, great. So there is some investors that actually prefer internally managed BDCs over externally managed ones and you may make the argument that internal managers actually had more value, so sitting here is for externally managed BDCs, how do you respond to that?

Edward J. Golthorpe

I don’t think it’s a surprise, they were all externally managed, I think to answer the question, we established to pay with investors a lot 10 years ago and I used to go haywire about it, but to the point where our bankruptcy can have that conversation with people anymore.

So look, when we started 10 years ago, we built a team of 30 people pretty quickly, none of them have left, very talented folks are still around, we now have 80 people dedicated to our business and our BDC is attached to an alternative manager that has 700 people and $70 billion of AUM investing globally in a bunch of assets classes. We feel that, that manager affiliation so to speak being externally managed offers so much more value to shareholders than any internally managed company could possibly deliver to shareholders.

I think the argument against the external managers has always been two-fold, it’s been, number one; we don’t like your fees structure or the reality is our expense load is about the same as most internally managed funds. Our company is in the second point. I think as that we want you to get paid in stock, which we think makes no sense we get paid based on the performance of our assets, not based on the performance of our stock and it’s our belief that if our assets perform well, our stock will perform well.

So I think that there’s always been a misalignment of incentives frankly on the internally managed model. I think that by the way there’s been a huge change in terms of the investor perception certainly I figured from anyone in the audience, but we don’t get that question much any more, whereas we did a lot 10 years ago.

Kipp deVeer

I think that was extremely well said. But I think the investors need to ask a different question today, which is okay, externally managed is better than internal managed, but you have seen that overtime, all right Fitch had clearly a report on this. The real cost of internally managed and externally managed and if you read the Fitch report, you’ll see that we’re all actually costing just about the same overhead, whether externally or internally managed versus very interesting. So don’t think one is better than the other in terms of gross margin, if you read the Fitch reports there, more detail they have explained there.

I think you should ask, today in the some of the BDCs in the space, how many partners get 8%, own 8% not a profits allocation of the fee, because you’re giving us fees to manage this business. How many people at the firm get the fee, own an actual equity piece of the fee and think that’s one of the questions we start seeing from investors that you guys should ask. I think the question has changed and certainly not as interim as defined, how much they own, how they get compensate, how people get compensated.

Unidentified Analyst

Okay, great. And how do you guys think about the non-qualified assets for the 30% bucket, does it means get shareholder return or is there any assets you guys may consider appealing or is there any assets there in BDC portfolios right now that you guys think of risk?

Edward J. Golthorpe

The 30% bucket.

Unidentified Analyst

Now it sounds like my question.

Edward J. Golthorpe

I think all assumed the 30% bucket in all of this year is a little bit differently. Ours is probably one of the ways we differentiate ourselves from the other BDCs. We use it for basically two investments; one, is to purchase the equity components of CLOs, which we use for about half of the basket for that, and the other is we use it to buy financial companies, consumer finance companies.

And we along with most of the legislators cannot understand why consumer finance businesses are in the 30% basket and actually have some legislation proposed to try to eliminate that, but we’ve been able to buy these companies which generate interest income and we’ve been able to convert them from tax paying entities to non-tax paying entities and generate significant returns. I think all of us use the 30% basket for the barbell, the highest barbell end of our investment strategies.

Kipp deVeer

Yeah, I’m going to say like, I think if you compare all the BDCs, this is like BDC 1.0 or 2.0 analogy which is, all BDCs is relatively comparable, people will differentiate themselves or utilize their different baskets in different ways and you know the one thing that couple of people on this panel has done very good job of is when you break down the yields from the 70% assets and yields from their 30% assets they’ve done a really, really good job of using that scarcity value, could use bad assets to their advantage to higher yields for shareholders.

And then because others, quite frankly like ourselves who – we’d five things we really wanted to do, we’ve done four of them, and one is, it’s a huge opportunity for us to continue to optimize our 30% basket, they got 30% assets kind of yield, kind of relatively similar to our 70% assets, if you break down any of these portfolios, it’s just very different and it’s also a huge opportunity for us. So yeah, but the one thing I will say is, also a lot of us are very constrained by their 30% basket and just saying that people are just too focused on.

Leonard M. Tannenbaum

I don’t know, we’ve only used 2%, so I can’t say that it’s any good, we thought our HFG acquisition, which we recently did will be a bad asset and it wasn’t. Aircraft leasing new company start, it’s not a bad asset, Prospect figured out how to do a [indiscernible] within a BDC and make it a good asset, which I can’t believe we actually figured it out of this, which is amazing, I never would have thought us to be that asset. So things that we would have thought within bad assets, just starting to feel like which we know is one, aren’t.

So I don’t know. I have some issues even trying to find stuff that fill up only these analysts, I think we write it wrong, you should use your 30% asset buckets for choosing something up, but they do only buy a mortgage, you have to buy a mortgaged debt is probably good for that 30% stock right, that fits them, I don’t want to do that.

Brian H. Oswald

So that’s the thing I mean we thought we don’t talk about as much broader. Our 30% basket for better for worse is utilized for the joint-venture that we have with GE.

Edward J. Golthorpe

Right.

Brian H. Oswald

And for bank portfolio company that we control called [indiscernible].

Edward J. Golthorpe

That will be a good idea.

Brian H. Oswald

And we are happy with those and they are strategic, they are core to what we understand. I think the danger right is that, we get used for exactly that to boost things up when you start doing things in asset class that you don’t understand. So I think the focus is figured out how to use them strategically for good financial investment in asset classes that truly understand. I think that’s where if you guys, I would understand.

Kipp deVeer

And that’s a big differential, maybe we will go to previous question what Ares did with the GE unit trend transaction, it’s the big differentiator in the space. Today to get a leverage, to be able to capture almost leverage on the first lien one stop transaction that they control and all the power that leverage with GE and GE sources a lot of that, I mean that relationship is one of the big differentiators. Why Ares I think has done really well. Look, we are looking as we are I am sure also looking at that type of relationship, it’s difficult to find a party to have that relationship with, but only the larger I will tell you for sure, only the larger firms will be able to have relationships like that to go back to point that I made much earlier.

Unidentified Analyst

Okay great. So we have some audience response questions before we are going to open it up for Q&A if you guys would like to proceed, there are those sort of controllers. So let’s go to first one. What evaluation metric do you feel is most relevant for BDCs is it one; price to book, two; price to earnings, three; dividend yield or four; a combination of the above?

[Music]

So everyone response was a combination of the above, 49% and roughly evenly split between price to book and dividend yield. Yes, if you do want, use those controllers in your front and just press the button. Can we go into the next one?

We did not own shares of BDCs or underweight the group. What would need to happen to change your mind? One, increase liquidity; two, higher return potential; three, more clarity portfolio risk or four, lower fees structure

The overwhelming response was more clarity around portfolio risk followed by increased liquidity. So let’s move onto the third question.

Over the next six, 12 months what do you expect will happen to your exposure to BDCs? One, increase; two, maintain; three, decrease or four, remain uninvolved? It’s like what we’d have to say, there were increased exposure. Okay. So with that…

Leonard M. Tannenbaum

Probably we’d be here otherwise.

Brian H. Oswald

Yeah.

Edward J. Golthorpe

So let’s open up for Q&A.

Question-and-Answer Session

Edward J. Golthorpe

We got a question out there with a mike. Sorry about that.

Unidentified Analyst

Just if could elaborate on your thoughts of [indiscernible] purchasing insurance activity, particularly on the asset side. You look at Gregory Hunt backing up assets with, and backing up the policy otherwise always with the – LA Dodgers for example. Can you touch on that?

Leonard M. Tannenbaum

I assume that’s for me. I mean, I’m not that well qualified to speak about it. I run the BDC. I don’t run a team. But I think the answer is, again if you look at our insurance company, what they’re investing in, to date a lot of it is traditional assets. So I don’t think you’re seeing at least from my seat. I don’t think you’ve seen us do anything that is putting policyholders at any kind of risk like we have done the LA Dodgers transaction or anything else that you referenced.

And I think, you go through that portfolio and you look at what they’re invested in. I think the vast, vast, vast majority of it is traditional, relatively traditional asset class that we know, as Kipp pointed earlier that we have a lot of expertise.

Edward J. Golthorpe

And I think we’re seeing the same thing. There’s a lot of mingling of kind of the insurance world and the asset management world at that point reason for that. In fact insurance companies have lots of assets to manage and asset managers were in the business of managing assets for people that need their asset manager, all right. So it’s sort of something natural. Now whether somebody should be owning this or owning part of this that’s a whole different discussion, but I think that the confluence of those two worlds is something you guys should except to continue.

Unidentified Analyst

Okay. I’ll ask the question that Leonard proposed. Have you guys compensated, how many people get compensated from the fees you collect?

Kipp deVeer

Yeah. We typically mentioned that the answer is generally a lot. Frankly, I mean we and all of our businesses really pushed down our performances fees whether it’s in our private debt business or private equity business or loan and high yield businesses, very deep in the teams. We want an alignment of incentives amongst our professionals so that everybody feels that they get compensated when our performance is good.

Unidentified Analyst

All right. This is a supplementary thing. What percent of Ares shares is management owned?

Kipp deVeer

What percentage of the company do we own at the management company?

Unidentified Analyst

Right.

Kipp deVeer

Gosh, that’s actually a good shot. I think we own 3% or 4% if you took their management company ownership and the individual ownership, but that’s just a guess. That’s right.

Brian H. Oswald

I think what I’d add to that is, again we’re very similar, which is the number of people get paid out of that earnings stream is very, very, very broad; number one, and you want that, because for both of our platforms, you want the breadth of the platform to be brought to bear on the BDC.

So I think we gain a lot. Probably half of our transactions are sourced from outside of dedicated BDC professionals. So we think we want to spread that around as much as possible to be able to do that. Anything away from that, every member of the Board of Directors, all the management team, all the executives all own equity and the parent company bought $50 million of stock last year for the same reason. As I mentioned before, we are not allowed to be compensated in stock. So all the stock that people own was people bought in the open market.

Edward J. Golthorpe

So we have 62 employees. 13 of them are actual equity partners. So it’s a different model. It’s sort of I fashioned it probably from 15 years ago, but I fashioned after, I think do now ultimately work as they went public, the Goldman Sachs partnership model, which I think did work pre Goldman Sachs went public and they actually get incentive fee every quarter. They get checks just like any other partner. They tax the same way as that.

I think that there are no BDCs that I know of that have as many partners as we do, actual equity ownership partners. Yes, everybody gets compensated also by different pools of things, but we don’t have the management company. We are the biggest. All our shareholders in both FSFR and FSC, and FSC is much bigger one, just benefit from our management company expertise right now.

So we are all working for you guys, our shareholders. Yes, we are all owners of stock. I also think I bought more stock than any other CEO of any other BDC. Yes, some got granted stock, but none of us can get granted stock. These were externally managed. And I think that that support brought the shareholder inside of buying is really important to look for in any stock we actually own.

Unidentified Analyst

Yes. So I guess I wanted to talk a little bit of exception with the comments you made to know bond investors corresponding to BDC. And I guess going back to LA Capital during the turmoil, I think eventually sort of worked out for bondholders, but grading certainly, once in our investment grade there was turmoil bond investors who could maintain positions at those rate levels or forced to sell and I was also looking at American Capital, which I think sort of was forcing a debt exchange to its bondholders and sort of the bankruptcy and things got kind of noisy there.

So I’ve a feeling that maybe part of your marketing because nobody ever lost money and maybe if you could hold it to maturity, maybe that’s the case or if you got ratings triggers, or if you’ve got other problems of holding a security through maturity through those potential bankruptcy or whatever that there were bondholders that did loose money.

So I’m just sort of wondering to get your reaction to how should [indiscernible] the financial crisis happen, I mean what happened? But as we look forward for bond investors going forward, what gives us some sot of comfort that would push become the shelf and unsecured bondholder won’t be subordinated or can take that there are some reason that they are likely to ratings while we maintain that they are likely to recover? It’s a long question. I am sorry.

Edward J. Golthorpe

Do you realize you will loose money as an unsecured bond? Maybe I look at in different way. For you modestly – when one say buy stock or the bonds, I say well, we can’t. It’s very difficult mom, never say never, right, you’ll lose money and that. We have to wipe out all of our network. All of my 2% of the company you own personally. You could wipe it all out. If the bondholders will lose $0.10, any money or we can’t let them more than one to one, more diversified, what’s our largest asset at 3.4%. I mean, I just can’t picture this. Yes, you have to hold the mission [ph]. Yes, there is going to be dislocation. Yes, who knows what the rating agencies do from time to time. Guess what, S&P, as grace we all are has one of their factors, the market.

Well, none of us are going to control S&P’s variable of the market. I mean it’s not possible. So could S&P downgrade all of us? Sure, they may downgrade the entire sector and we have no control over what S&P is going to do.

Brian H. Oswald

The real question you talk about Allied [ph] emerging capital similar runway to real issues just mark-to-market assets, right. So you have to be very careful about what you put in mark-to-market portfolios, right. The problem what the BDC is facing, you have a lot of managers running mark-to-market portfolios. You don’t know how to run mark-to-market portfolios versus non mark-to-market portfolios.

So one of the things that would make our life easier if we didn’t have to mark our portfolios, I am not suggesting that we could, but if you are a bank and you make a loan and you put in hold to maturity basket, just like you’re an aftermarket. So that’s a significant disadvantage that we have relative to the bank.

If you are not aware of that and you don’t understand how to manage the asset side of your portfolio in a BDC, you can create significant problems for yourself and for your vendors. That’s what happen with those companies.

Leonard M. Tannenbaum

I’m looking to warning those bondholder, look at our BDC portfolios, make sure you read the schedule of investments. If you have a BDC that takes in all cash security, converts it to an all fixed security and doesn’t market down, don’t believe their marks. They are mine and I will say that in front of any judge, [indiscernible] or whatever. It’s very difficult to change in all cash securities and all fixed security and not have a problem nor have a markdown without great justification.

So just make sure that the managers read the schedule investments, watch the quarterly schedule investment changes and make sure that you can trust your managers with remarks. That’s the only way you really can’t lose money.

Unidentified Analyst

Great. I think that’s all the time we have today.

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