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

Fifth Street Finance Corp. (NASDAQ:FSC)

F4Q09 Earnings Call

December 10, 2009 10:00 am ET

Executives

Stacey Thorne - VP, IR

Leonard Tannenbaum - President and Chief Executive Officer

Bernard Berman – Chief Compliance Officer, Executive Vice President, Secretary

William Craig – Chief Financial Officer

Analysts

Chris Harris – Wells Fargo Securities

Greg Mason – Stifel Nicolaus

Casey Alexander - Gilford Securities

Jim Ballan – Lazard Capital Markets

Troy Ward - Stifel Nicolaus

Rob [Lakeney – Crossroad Clark]

Operator

Welcome to today’s Fifth Street Finance Corp. Q4 and fiscal year-end earnings conference call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Stacey Thorne. Please go ahead.

Stacey Thorne

Thank you. Good morning and welcome everyone. My name is Stacey Thorne and I am the Head of Investor Relations. This is the conference call to discuss the results for Fifth Street Finance Corp. for the fourth quarter and fiscal year ended September 30, 2009.

I have with me this morning Leonard Tannenbaum, CEO and President; Bernard Berman, the Chief Compliance Officer, Executive VP and Secretary; and William Craig, the Chief Financial Officer.

Before I begin I would like to point out that this call is being recorded. Replay information is included in our press release yesterday and is posted on our website. Please note that this call is the property of Fifth Street Finance Corp. and any unauthorized rebroadcast of this call of any form is strictly prohibited.

Before we go into the earnings, I would like to also call your attention to the customary Safe Harbor disclosure in our press release yesterday, December 9, 2009, 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 would cause actual results to differ materially from these projections. We do not undertake to update our forward-looking statements, unless required by law. To obtain copies of our latest SEC filings, please visit our website or call Investor Relations at 914-286-6811.

The format for today’s call is as follows; Len will provide an overview; Bernie will provide an update on the SBA, Bill will summarize the financials and then we will open up the line for Q&A.

I am now going to turn it over to our CEO, Leonard Tannenbaum.

Leonard Tannenbaum

Thanks Stacey. I am pleased to report the continued improvement in the economy as represented by the general EBITDA improvement in our portfolio companies. We publish the Fifth Street Index monthly which now has shown two consecutive increases. This continues the improvement in the market fundamentals we have highlighting for the past two quarters.

We had a successful fiscal year 2009 relative to the challenging economic conditions. During fiscal 2009 we originated $66.3 million worth of deals. 82% of those were first lien, 14% second lien and 4% other and equity. We also successfully replaced our one-year line of credit with a three-year line with Wells Fargo and progressed on our SBA license which Bernie will talk about later.

I reminded everyone in our monthly newsletter two months ago that while we were disappointed with the pace of origination we had a high quality $1.4 billion pipeline and we were optimistic we would see a pickup in M&A activity and additional lending to private equity sponsors. In the November newsletter we announced $75 million of signed term sheets and $6 million of closed deals. We now expect to close by the end of the year, or in January, $195.3 million of first lien deals minus some syndication including the $75 million we announced last month.

All of these deals are with strong equity sponsors. On average these deals have about 50% sponsor equity, IRR’s in the mid teens and just under 50% of the loan amounts are floating with a LIBOR 3% floor. On average, debt to EBITDA on these deals we have signed is 3.3 times deep. The increase in floating rate loans with floors will begin to serve as a hedge against the substantial increase in interest rates over the coming years. We also plan to swap part of our LIBOR exposure on the Wells Fargo line in the near future.

Although Fifth Street originates 100% of our securities, we plan on partnering with a large reputable lender on one of the loans and we have strong interest by syndicate partners for $15-20 million of our largest single exposure. This strong conversion of our pipeline into signed term sheets is due to our ability to commit to the entire loan without syndication risk by utilizing both the credit line and the SBA facility and the desire for sellers to close by the end of this year due to the potential for increase in the income tax rate next year.

We believe these events coupled with our strong brand and relationships have allowed us to capture premium pricing over the market. We believe the opportunities in the middle market are large and growing as lenders have still not returned to the middle market with substantial capital. In fact, several have exited. We plan on continuing to take advantage of this market to gain market share with top quartile private equity sponsors as well as capturing strong risk adjusted returns.

We do expect weighted average yield to decline for several reasons. One, the formula of weighted average yield does not account for the substantial amortization that we have in each of the loans we have signed term sheets for.

Two, these loans are to companies that are bigger in size, could be viewed as safer, with substantial equity contributions with private equity sponsors as I mentioned before. Almost 50% contribution.

Three, all of these loans are first lien. We do expect, however, to have a weighted average yield substantially higher than our competition.

We reiterate our plan to have 65% first lien exposure as a total part of the portfolio by the end of calendar 2010. Since all of the $195 million of new signed term sheets are composed of first lien investments and our substantial pipeline is almost all first lien unitranche loans we believe this goal may be reached earlier.

Our board of directors declared an increase in the dividend this quarter to $0.27 up from $0.25 the previous quarter due to the increased pace of originations just noted coupled with the use of leverage. We anticipate the dividend should increase during the next calendar year beginning with the next calendar quarter.

As the velocity of deals begins to return to normal we also expect to be able to realize some of our $6.8 million of exit fees. We are also putting in substantial prepayment penalties to offset reinvestment risk as the market begins to recover. We are working with several syndicate partners on expanding the Wells Fargo line and potentially adding an additional line of credit. While there is no guarantee that these parties will participate in our lending facilities, we are optimistic we will be able to get additional partners in the near future.

I am very pleased with the substantial progress on the origination front and the strong performance of our team members. We are continuing our hiring process to add to our underwriting, portfolio management and marketing divisions and look forward to continuing to deliver a strong product offering to the private equity community along with growing returns to our shareholders.

My partner Bernie has been working on many projects including leading the important SBA process that began last November. To talk about where we are with the SBA licensing process and the deployment of our SBA equity capital I would like to hand the call over to Bernie Berman.

Bernard Berman

Thanks Len. We continued to progress through the SBA licensing process which is a long and comprehensive process that we have been working on for a little over a year. We are now in the final stages of the process and we are cautiously optimistic we will receive a license within the next 30-60 days, the remaining steps for the approval of the provision committee and the agency committee. So far we have made it through every step of the process without any glitches.

We have already closed one pre-licensing investment which will count towards our $75 million of regulatory capital should we receive a license and we have received approval for a second pre-licensing investment to be part of our regulator capital. The closed investment is Trans Trade and the approved deal is one of the term sheets we recently signed. We have also just recently asked that two of our pending investments be approved to be part of our regulatory capital. If they are approved and all of the deals close then we would have invested $73 million of our $75 million in regulatory capital.

We have also asked that we receive a leverage commitment on an expedited basis so that hopefully we would be able to begin drawing leverage for additional investment in early 2010. We are cautiously optimistic we will be able to do that.

I am now going to turn it over to our CFO, Bill Craig.

William Craig

Thanks Bernie. With respect to our balance sheet ending September 30, 2009, total assets were $415.9 million which included investments of $299.6 million in fair value and cash and cash equivalents of $113.2 million. Liabilities were $5.3 million and stockholders’ equity was $410.6 million.

As of September 30, 2009 we had no borrowings outstanding. Our weighted average yield on investments was 15.7% at September 30, 2009 which includes a cash component of 12.9%. Our net asset value per share at September 30, 2009 was $10.84.

I would like to review our earnings. For the quarter total investment income was $12.5 million and total expenses were $4.7 million resulting in net investment income of $7.7 million. We ended with net investment income per common share of $0.26 and earnings per common share of $0.25. We waived the entire management fee we would have received on September 30, 2009 on uncommitted cash. The amount of the waived management fee was $172,000.

We continue to internally value all of our investments on a quarterly basis. For the three months ended September 30, 2009 we had $2 million in unrealized depreciation. This consisted of $1.9 million of reclassification to realize losses and $0.1 million of net unrealized appreciation on equity investments.

At September 30, 2009 approximately 5% of our debt investment portfolio at fair value and 4.9% of our debt investment portfolio at cost bore interest at floating rates. All of our floating rate loans carry a minimum interest floor of at least 9% which protects our return in a low rate environment.

With respect to the portfolio, during the three months ending September 30, 2009 we invested $11.9 million across one new and two existing portfolio companies. At September 30, 2009 our portfolio consisted of investments in 28 companies, 26 of which were completed in connection with investments by private equity sponsors and two of which were small, limited partnership interests that were unfunded as of September 30, 2009. These investments at fair value consisted of 48% first lien loans, 51% second lien loans and the remaining 1% is equity and other investments.

As of September 30, 2009 we had stopped accruing PIK interest and original issue discount on five investments including two investments that had not paid their scheduled monthly cash interest payments or were otherwise on non-accrual status. With respect to our rating at September 30, 2009 the distribution of our debt investments on the 1-5 investment rating scale at fair value was as follows:

Investment rating 1 investments totaled $23 million or 7.7% of the portfolio. Investment rating 2 investments totaled $248.5 million or 82.9% of the portfolio. Investment rating 3 investments totaled $6.1 million or 2% of the total portfolio. Investment rating 4 investments totaled $68.3 million or 5.5% of the total portfolio. Investment rating 5 investments totaled $5.7 million or 1.9% of the total portfolio. If you include cash in the above calculations our rated 3, 4 and 5 investments are 6.8% of the total investment portfolio plus cash.

The percentage of 1 and 2 rated investment securities for September 30, 2009 was 90.59% versus 86.48% for the prior quarter ended June 30, 2009. We are closely monitoring all of our investments and continuing to provide managerial assistance as needed to help the companies navigate through the current economic downturn.

With respect to recent developments, on October 2, 2009 Storyteller Theater Corporation drew $250,000 on its line of credit. Prior to the draw our unfunded commitment was $1.75 million.

On October 8, 2009 we funded $153,972 of our previously unfunded limited partnership interest in Riverside Fund IV LP upon receipt of the first closing notice of the fund.

On October 16, 2009 Elephant & Castle, Inc. repaid $3.9 million of principal outstanding under its term loan to us. The balance of the loan was assumed by Repechage Investments Ltd., the equity sponsor’s holding company. We received a first lien on the assets of Repechage as a guarantee on the balance of our debt.

On October 21, 2009 we invested an additional $6 million on the second lien debt in Western Emulsions, Inc., an existing portfolio company, to support its growth initiatives.

Since October 26, 2009 we have executed nonbinding term sheets for five investments totaling $195.3 million in commitments. All term sheets are first lien investments and are subject to our completion of our due diligence, approval process and documentation and may not result in completed investments. We may syndicate a portion of any of these investments. Further details can be found in the earnings release and in our form 10-K.

On November 12, 2009 we declared a $0.27 per share dividend to common stockholders of record as of December 10, 2009, payable December 29, 2009.

On November 12, 2009 we executed a letter agreement for the potential sale of our second lien term loan in CPAC Inc. and our 297 shares of our common stock of CPAC Inc. We received a nonrefundable deposit of $150,000 in connection with this letter agreement.

On November 16, 2009 we entered into a three-year credit facility with Wells Fargo and Wachovia Bank in the amount of $50 million with an accordion feature which will allow for the potential future expansion of the facility up to $100 million and will bear interest at a rate of LIBOR plus 4% per annum.

On November 23, 2009 we received a cash payment in the amount of $0.1 million representing payment in full of all amounts due in connection with the cancellation of our loan agreement with American Hardwoods Industries Holdings LLC on August 3, 2009.

With that let me turn it back over to Stacey.

Stacey Thorne

Thanks Bill. Earlier in the call Len referred to the Fifth Street Index. We release this Index monthly on the first of the month with a two month lag. You can access the index by visiting our website www.fifthstreetfinance.com and then clicking on the Small Business index tab. Over the past few months there has been an increased interest in our monthly newsletter. For the months that we do not report quarterly earnings we release a newsletter.

If you would like to be added to our mailing list and receive these communications directly, please either call me directly at 914-286-6811 or send a request e-mail to ir@fifthstreetcap.com. Alternatively, e-mail letters can be sent through the shareholder tools link under the Investor Relations tab on our website, www.fifthstreetfinance.com.

Thank you everyone for participating on the call. I will now turn it over to the operator, to open up the line for questions.

Question and Answer Session

Operator

(Operator Instructions) The first question comes from the line of Chris Harris – Wells Fargo Securities.

Chris Harris – Wells Fargo Securities

First off, maybe just start with a little look at the portfolio here. You talked about potentially selling your interest in CPAC back to the company. I am wondering is it safe to assume you will be selling that interest at kind of a loss here? I am looking at the value and it looks to be written down by about 50% of cost. What is the strategy for that investment if that sale does not come through?

Leonard Tannenbaum

CPAC obviously has been one of our most distressed securities. It has come back on accrual recently. The portfolio group did a really good job with it. They sold parts of the units to an overseas firm and they continue to do that. It is just a long process. The price at which we are going to exit the investment is close to the price we have it marked at. I can’t really say more than that because it really depends on the timing of the investment close as we receive a little bit more as time goes on and it also depends on the continued progress of the company. I feel relatively confident that the price we are going to exit is close to the price we have it marked.

Chris Harris – Wells Fargo Securities

A follow-up in regards to dividend, I know you talked about it but I just want to make sure I heard you correctly. Are you anticipating potentially raising the dividend in the next quarter so that would be the quarter ending in March?

Leonard Tannenbaum

I believe the dividend will increase. Of course the amounts all depend on timing of closure of deals and deal pipeline and expansion of credit and just lots of toggle points to how much dividends increase but I feel confident now that we have $195 million of term sheets signed of really terrific first lien loans that the dividend will increase that quarter and will continue to increase next year.

Chris Harris – Wells Fargo Securities

I noticed here you talked about that you have two investments in these limited partnerships. I guess none of them have been funded yet. I was wondering if you could talk a little bit about how those investments work. I noticed the industry concentration is multi-sector so maybe just talk a bit about what those investments will be allocated toward.

Leonard Tannenbaum

I think I have talked a little bit about the strategy but we have top quartile private equity sponsors that we have developed as core sponsor relationships. Because our underwriting process incorporates both the credit and the sponsor we really do underwrite the sponsor in very high detail, we are able to hopefully discern successful sponsors from the unsuccessful sponsors. To our core sponsor relationships we are going to dedicate over time, ten $1 million investments that are going to be commitments into their new funds. What that allows us to do is first capture some of the upside we believe the sponsors are going to generate over time in their equity investments while giving us high diversification.

Just as importantly for us is the information it gives us about our sponsor partner and the dedication we have to them and they have to us. So it increases that relationship tie. We really look forward to that. It is not going to be a material amount of the portfolio. We are talking about a $10 million overall commitment of which so far we have done two of these relationships and it is going to happen over a four year investment period. So it is really very small relative to the overall portfolio but I think it is critical to our strategy of sponsor partnering.

Operator

The next question comes from the line of Greg Mason – Stifel Nicolaus.

Greg Mason – Stifel Nicolaus

Could you give a little bit more on the syndication proceeds? You said 15-20 in your largest deal. When you look at all five of these deals what is your hope in terms of syndication capital from those total five deals?

Leonard Tannenbaum

I think the idea is to have a diversified portfolio and to that extent we have one of our commitments which is relatively large with a core sponsor that we believe we have received premium pricing on. We have gone out to 4-5 syndicate partners on this one deal. Believe me, if we had a double the size or triple the size portfolio I don’t know I would want to syndicate any of it. I think it is a terrific deal.

In light of the fact we don’t have that large portfolio yet we think it is prudent to syndicate a part of it. We have received strong interest from 3-4 parties in a range of $15-20 million. We are going to do that. Another deal that is in the term sheets, in the $195 million, is double the size of our commitment and we are splitting that investment with a large, reputable lender which everybody on this call would know but I don’t feel like announcing it until the deal closes and in partnering with that lender we are learning something about each other and learning that we could be good partners too.

So while in the past we have really only syndicated one loan, which is Caregiver Services, to our partners at which they own 1/3 of that loan. We haven’t really syndicated much. I think going forward as you do large, first lien unitranche loans in the middle market that are far safer, larger companies, you may see us partner with other BDCs that we view as reputable. Strong BDCs. I think that is a positive for us and a positive for the industry.

Greg Mason – Stifel Nicolaus

Of the $195 million in term sheets it looks like $36 million is in revolving credit facilities. Will those be undrawn at the time of closing? I am just trying to get to how much actual cash will be going out the door if and when all these deals close.

Leonard Tannenbaum

I can’t say yet. I think there may be some small draws. All of it is unfunded as is typical for a lot of our loans when they close because we want to make sure there is a lot of opening availability in the loan and so we insist on opening availability on each one of our deals. My assumption right now is almost all of it is unfunded but there might be some small funding.

Greg Mason – Stifel Nicolaus

So when you look at that $36 million of unfunded plus your other commitments can you remind us how much unfunded commitment lines are out there and how much capital do you need to have on hand to cover potential near-term draws on those unfunded credit facilities?

Leonard Tannenbaum

We have several other things we are working on that should we need additional cash with different parties. Safe to say that we wouldn’t sign term sheets we couldn’t fund. I am a little surprised at our hit rate here in that a number of factors sort of converged to allow us to convert a lot of the pipeline at once and we held rates and held pricing premiums on all of our deals because we had that strong a pipeline. So these are really great deals and we have to close them.

It does use all of our cash obviously. We have enough cash and availability to close on all of these deals. Safe to say without an SBA license and without an expansion to the credit facility we won’t be signing a lot more term sheets until those two events happen but as Bernie said we anticipate those events will happen.

Greg Mason – Stifel Nicolaus

So you use a lot of your cash. What are your thoughts towards additional capital raises? What do you feel you need to accomplish or prove before you go back to the market and raise additional capital?

Leonard Tannenbaum

It is nice to say we have signed term sheets. By the way, 23 of our last or even a higher number than that, 23 of the last 23 or 27 of the last 27 term sheets that we have signed converted into closed deals. So we have a high degree of confidence these term sheets are going to convert into deals. Obviously if they are closing by the end of the year these things are documenting. One or two of them might close in January. It is hard to say the exact timing of anything. Before we raise capital what we have told the investors is we want to go into leverage because when you raise capital, we haven’t had that ability in the past, the ability to pay down leverage makes it much more accretive to shareholders.

The second thing we have said is we don’t want to raise capital until we have actually gotten approval for an SBA license. I know it is a critical part of the overall investment strategy. It is one of the big drivers of earnings for the next three years for us and we are going to accomplish that goal as well. Assuming we accomplish that goal and we go into leverage the opportunities in the middle market are terrific. The market share we are capturing is great. These new private equity sponsors are large. They are reputable and it is important that we choose the right ones to partner with and to become integrated with and we want to satisfy their deal flow. So we will raise capital in the future. I can’t tell you when but I know I want to accomplish the two events of leverage and the SBA license before we do that.

Operator

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

Casey Alexander - Gilford Securities

I can review the call and do the math, but if you can tell me if you did syndicated amount of these deals you ideally wanted to what would your net investment takedown be of the $195 million?

Leonard Tannenbaum

That is interesting. We are looking for a syndicate partner for a larger deal of $15-20 million which I think I said on the call and we may or may not syndicate some other small pieces to lenders which we don’t need to syndicate to them but the equity sponsors have some relationships with some smaller lenders and we may want them to participate. Needless to say, if I could do all of these deals I would. I think they are all great deals at great premium pricing with 50% new equity, all in first lien, all very high in the capital structure but I think it is prudent to do some syndication.

Casey Alexander - Gilford Securities

How many of the deals that you have signed term sheets here are for new sponsors you haven’t worked with before?

Leonard Tannenbaum

We have known a lot of these sponsors for awhile. In fact, we know every sponsor that would fit our box. That is our job and they know us. I think what happens here is Casey when we hired him from Churchill and he really has the reputation that we know he has and he is bringing a lot of soft addition to the Fifth Street reputation as well as great relationships, really had a great three months. So a lot of these relationships like I can think of one $300 million something fund that I wanted to work with for a long time. They know us and Casey came over they said okay we are going to work with Fifth Street. The senior partner team came here twice. We have had multiple conversations throughout the firm. Those are the types of partnerships we really want and look forward to and is one of our signed term sheets and their pledge to us and our pledge to them is we are going to look at every deal with you going forward and we are going to continue developing a deep relationship because now we are going to be one of their two primary lenders.

That was the case again with another one of these signed term sheets. The biggest deal though is with one of our core sponsors. I might as well disclose this one, Riverside Fund IV which is also one of our LP investments. Riverside, we anticipate Riverside and [Marlett] to be our two leading core sponsors in the near future. Riverside, I was reading one of these private equity magazines or Bios magazine and I think they said it was a wildly, wildly over-subscribed fund. This is a top quartile fund. They are on Fund IV. We are investing $1 million that was the draw that Bill talked about. He talked about the draw on Riverside Fund IV.

I think David Belluck, Phil Borden and others run an amazing firm. Their diligence is terrific. They are healthcare focused. We are really pleased to be their lead relationship in terms of lending.

Casey Alexander - Gilford Securities

There was obviously an increase in Class 4 classifications during the quarter. Was there any common theme to that by industry or by nature of the market that you can see that drove some investments into Class 4 and can you give us some color as to how your conversations with those investments are going in terms of an advisor and in trying to help advise and manage them back up to Class 3?

Leonard Tannenbaum

First of all there is no apples-to-apples comparison among any BDCs in terms of what is a 1, 2, 3, 4 or 5. In fact we could call a class 4 a class 3, or we could call a class 4 a class 5 or we can qualify a class 5 a class 3. I can point references to large BDCs that they would re-characterize them differently. The way I look at this is I don’t differentiate between class 3, 4 and 5. It is one bucket. That bucket, as Bill said, if you count cash in is in total 6.8-ish% of the portfolio. I think you are going to see a lot of fluctuation between 3, 4 and 5. One example we pointed out on Analyst Day and I know all the analysts are on the phone was Lighting by Gregory. Lighting by Gregory is fully owned by Fifth Street. It is a class 5 rated security. We said that on the Analyst Day.

It is doing better. Could we upgrade it? Sure. But we don’t view it that way. We view it as a bucket. A distressed bucket of 3, 4 and 5. If you look bucket over bucket there really wasn’t a lot of movement. These are the 2008 numbers still but…

Casey Alexander - Gilford Securities

The way you would look at it is you had 86% class 1 and 2 at the end of your third quarter and you now have better than 90% class 1 and 2?

Leonard Tannenbaum

I think the portfolio is getting better. I think the problem children as I classify them are getting reconciled. You can see that from CPACs agreement. One way or another this is going to get reconciled in the next few months. I feel really good about the fact we are working through our problems. Just because we work through our problems and are going to have less problems does not mean I am not going to expand the portfolio management team.

We are going to expand this team so that in the next cycle which could happen in 2011 we are able to take more companies if we have to and handle more distressed situations. So we are building for the future but yes the problems are lessening. Our portfolio management group has clearly less problems than they did a quarter ago.

Operator

The next question comes from the line of Jim Ballan – Lazard Capital Markets.

Jim Ballan – Lazard Capital Markets

With the larger commitments you are making are you finding there are different challenges in working with larger companies or larger dollar amounts? Is it a different kind of process or is it pretty much steady as she goes?

Leonard Tannenbaum

It is so much easier. I can’t tell you how much easier it is to work with companies that already have their finance team already in place with a robust financial process with multiple legs to their business with private equity sponsors that are robust, have lots of available capital, great reputations, funds 3, 4 and 5’s that have been down all through the cycles and know how to deal with them.

Wells Fargo likes the larger deals far better than the smaller deals. This is what they are used to. I think the middle market is so much easier than the lower middle market in terms of closing deals, doing deals and working with sophisticated partners with really terrific management teams. So if anything it is less taxing to our team to close these five deals than probably two years ago when we closed five $10 million deals or $8 million deals especially with second lien loans where you have to deal with different creditors and a bank and a smaller key sponsor that might be only doing one deal a year versus these sponsors that do multiple deals every year.

Jim Ballan – Lazard Capital Markets

The other thing I wanted to ask about it sounds like your conversion rate from signed term sheets to closings has been pretty good in the past. What has historically been the timing from getting the term sheet signed to actually closing the deal? Do you think again with these larger companies do you think it will be similar, faster or slower?

Leonard Tannenbaum

I think the normal timing is about 30 days. But, there are exceptions to that in the transaction itself. For example, an education company might take longer because an education company as opposed to an [LLC] has some regulatory issues, etc. When there are regulatory issues or some government hurdles or dealing with IRB bonds or anything like that you may delay the process. Of course our timing is dependent entirely on the private equity sponsor’s timing. So private equity sponsor, also the other delay could be if a private equity sponsor or us through our accounting due diligence finds anything it comes up and there is often a renegotiation with the seller over something. So that renegotiation has to take place and that often delays deals. While I think a lot of the five deals or all of the five deals would say we would like to close by the end of the year it easily could slip into January.

Operator

The next question comes from the line of Rob [Lakeney – Crossroad Clark].

Rob [Lakeney – Crossroad Clark]

I was looking at the press release you put out yesterday to get a little more detail about the five or so deals that you are announcing. That is $41.25 million deal that you are doing for the post secondary education kind of popped up just because there has been a lot of high profile issues in the for-profit education space on the public side, i.e. revenue recognition, questionable marketing practices. I was wondering if you could give a little more detail on this particular one. I know it is not closed yet but can you kind of give a little more detail on why you think it is a good investment?

Leonard Tannenbaum

We look in the pipeline at six or more education deals. So many. We map them all against each other. We did some real heavy industry analysis on Title IV funding, on the amount of money they spend on marketing versus other and all of the metrics the government is looking at and actually the government came out with some new guidelines to what they are looking at and how they are going to evaluate these firms.

In addition, really the Obama Administration I think would like to spend more on education and would like to increase the funding to education companies, cognizant however of some companies which just market for a degree that may not be all it is cracked up to be. With all of that in mind, the one we are doing and we have done all the work on it and the private equity sponsor obviously has done even a better job than we have not only fits all the buckets but easily fits the buckets. It has a lot of cushion because the company really does deliver a good product to its students that is value add and improving value add.

I think that is the key. Also student retention is very, very high. That is the other key, graduation rates and things like that. While I don’t think before a year ago we said was Fifth Street an expert in the education space I would have said well not really. We sort of know it but we haven’t done a lot. Over the last six months we have become comfortable in the space with the pluses and minuses and the different factors that affect these companies.

Operator

The next question comes from the line of Greg Mason – Stifel Nicolaus.

Greg Mason – Stifel Nicolaus

Can you talk about we have been hearing that upfront fees are a big part of new investments these days. Can you talk about what you are seeing on the upfront fees on the five deals you closed? Are those funded or fees based on the full $195 million commitment or just what you fund?

Leonard Tannenbaum

Good question. I don’t have a definitive answer. I can give you general direction. An industry leader, which you cover, basically is loaning at 3 points up front and we are following that industry leader. A lot of our loans while they have previously been two points up front are between 2-3 points up front. So we are getting an increase in the upfront fee which is goods but the upfront fee typically gets shared with syndicate partners pro rata. Or to a large extent gets shared with syndicate partners pro rata. So yes it is what we fund, not the gross amount.

Usually the collateral management fee which we charge in each loan is able to be kept by the partner that originates the loan. Again, we haven’t been done with our documentation on syndicate partners so when we get done we will know the answers.

Greg Mason – Stifel Nicolaus

As we understand it there is some leeway in GAAP accounting where you can recognize those fees either the quarter they are received or amortized over the life of the loan and different BDCs do it differently. What is your approach to the accounting policies for those upfront fees?

Leonard Tannenbaum

Traditionally we have amortized them over the life of the loan. Yes, we have been notified also that there is variation within the industry in how they are characterized. I don’t know that we are going to shift that policy right now but we clearly have been alerted to the fact that we can do both.

Greg Mason – Stifel Nicolaus

Correct me if I am wrong but for tax purposes those do get recorded into income and have to be distributed. Is that correct? If so, how does that impact your dividend policy especially if you take the GAAP accounting where you amortize those so your GAAP earnings wouldn’t go up as high but your taxable income could be higher?

Leonard Tannenbaum

Right. Distributable income will be very high. This is what I have said for the past couple of quarters, as we ramp the portfolio and at least double the size of the portfolio in the next year which is something else I have said which obviously now given $195 million of signed term sheets looks very likely, we are going to generate a lot of distributable income. You are right, it should be distributed in the taxable year that is incurred or it can get carried over from year to year and we may do some of that depending on how much closes this year literally December 31 versus January 2nd.

If it is pushes to January 2nd it becomes distributable income next year. So our policy in dividend is to earn our dividend. One of the big things we focus on is even when we have PIK in the securities we amortize many of the securities with PIK in them so that we actually receive cash to distribute them. I think that is really important. When we distribute these increased dividends, we are earning and we receive this cash. So we are not distributing phantom income.

Greg Mason – Stifel Nicolaus

To clarify, your tax year end is December 31, even though your fiscal year end was September. That is correct?

William Craig

No, the tax year-end for certain taxes is 9/30 and then for exit taxes it is 12/31, the calendar year.

Leonard Tannenbaum

For carry over distributable income it is 12/31.

Greg Mason – Stifel Nicolaus

You were just talking about amortization and earlier you mentioned the amortization on your new loans is going to be significantly higher. Can you talk about what that level is and does it distinguish between amortization on the Term A part versus the Term B part you kind of break out in your press release?

William Craig

We haven’t gotten into the details of the actual…some of those are term sheets that are under negotiation and I haven’t fully computed the duration of all those. It would include differentiation between A and B.

Greg Mason – Stifel Nicolaus

Can you give us a feel for if assuming all these potential deals close what portion of your portfolio would then be floating rate versus fixed rate?

Leonard Tannenbaum

I haven’t done the math but I think Bill said about 50% of the…one of the term sheets we should have some floating too and we sort of ended up fixed but the subsequent four term sheets we signed have a floating component. I think you are going to see that from us going forward that we are going to have a substantially increased floating component as we are going to continue to attempt to hedge against an increase in interest rates by changing basically what we had before as a fixed rate portfolio to a mix between floating and fixed.

So 50% of the $195 million is floating and 50% is still fixed. I think going forward you are definitely going to see an increase in the floating.

Operator

That concludes our question and answer session for today and our conference call. We thank you for your participation.

Leonard Tannenbaum

Thanks everybody.

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

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

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

Source: Fifth Street Finance Corp. F4Q09 (Qtr End 09/30/09) Earnings Call Transcript
This Transcript
All Transcripts