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Prospect Capital Corporation (NASDAQ:PSEC)

F1Q 2014 Earnings Conference Call

November 5, 2013 11:00 AM ET

Executives

John Francis Barry III – Chairman and Chief Executive Officer

Brian H. Oswald – Chief Financial Officer and Chief Compliance Officer

M. Grier Eliasek – President and Chief Operating Officer

Analysts

Greg M. Mason – Keefe, Bruyette & Woods, Inc.

Jonathan G. Bock – Wells Fargo Securities, LLC

Robert J. Dodd – Raymond James

Andrew P. Kerai – National Securities Corp.

Terry Ma – Barclays Capital, Inc.

Casey Alexander – Gilford Securities Inc.

Operator

Good morning and welcome to the Prospect Capital Corporation First Fiscal Quarter Earnings Release and Conference Call. All participants will be in listen-only mode. (Operator Instructions) After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded.

I’d now like to turn the conference over to John Barry, Chairman and CEO. Please go ahead.

John Francis Barry III

Thank you, Andrew. Joining me on the call today are Grier Eliasek, our President and Chief Operating Officer; and Brian Oswald, our Chief Financial Officer, Brian?

Brian H. Oswald

Thanks John. This call contains forward-looking statements within the meaning of the securities laws that are intended to be subject to Safe Harbor protection. Actual outcomes and results could differ materially from those forecast due to the impact of many factors. We do not undertake to update our forward-looking statements unless required by law.

For additional disclosure, see our earnings press release, our 10-Q and our corporate presentation filed previously and available on the Investor Relations tab on our website prospectstreet.com. Now I’ll turn the call back over to John.

John Francis Barry III

Thanks Brian. Because we have so many new investors in our company and owning our stock, we invite new investors to review our recently reported webinars as an introduction to Prospect. You guys just can access our webinars through the investor relations tab on our website prospectstreet.com.

During those events we walk through our overview quarter presentation, it is also available on our website. In the same location on our website, investors can also access our archived Analyst and Investor Day that we held on July 10 in New York City. This is a five hour webinar that includes senior members of the Prospect team presenting our multiple origination strategies and in depth case studies intended to educate investors about Prospect’s business.

Now on to our financial results for the quarter; our net investment income or NII in the September 2013 quarter was $82.3 million or $0.32 per weighted average share. NII for the quarter increased a 11% year-over-year. Our net income for the September 2013 quarter was $79.9 million, up 69% on a dollars basis and up 7% on a per share basis year-over-year.

We just announced more shareholder distributions through June 2014 giving investors eight months of visibility on future dividends. The June 2014 dividend will be our 71st shareholder distributions and the 48 consecutive per share monthly increase.

Our November 1 closing stock price of $11.34 provides an 11.7% dividend yield. Our NII has exceeded dividends demonstrating substantial dividend coverage for both the June 2013 fiscal year and the cumulative history of the company. For the June 2013 fiscal year, our NII exceeded dividends of $53.4 million and $0.23 per share. We utilized a penny of that excess in the September quarter.

Since our IPO nine years ago through our June 2014 distribution at the current share count, we would have paid out $12.60 per share to initial shareholders and $1.1 billion in cumulative distributions to all shareholders.

Our NAV stood at $10.72 on September 30 stable from June 30. We had delivered solid NII while keeping leverage modest. Net of cash and equivalents, our debt-to-equity ratio was 53.7% in September, down from 55.7% in June. We estimate our NII per weighted average share in the current September quarter will be $0.28 to $0.33.

We have substantial debt capacity and liquidity to drive future earnings through prudent levels of matched-book funding. Our Company has locked in a ladder of fixed rate liabilities extending 30 years into the future, while most of our loans grow with LIBOR, providing potential upside to shareholders should interest rates rise.

Thank you. I’ll now turn the call over to Grier.

M. Grier Eliasek

Thanks, John. Our business continues to grow at a solid and prudent pace. As of today, we’ve now reached more than $5.3 billion of assets and undrawn credit. Our team has increased to more than 90 professionals, representing one of the largest dedicated middle market credit groups in the industry.

With our scale, longevity, experience and deep bench, we continue to focus on a diversified investment strategy that covers third-party private equity sponsor-related lending, direct non-sponsor lending, Prospect-sponsored operating buyouts, Prospect-sponsored financial buyouts, structured credit, real estate yield investing and club and syndicated lending. This diversity allows us to source a broad range and high volume of opportunities. Then select in a disciplined bottoms-up manner, the opportunities we deem to be the most attractive on a risk-adjusted basis.

Our team typically evaluates thousands of opportunities annually and invests in a disciplined manner and a low single-digit percentage of such opportunities. Prospect originations in recent months have been well-diversified across our seven origination strategies.

Our non-bank structure gives us the flexibility to invest in multiple levels of the corporate capital stack with a preference for secured lending and senior loans. Prospect’s approach is one that generates attractive risk-adjusted yields and our debt investments were generating an annualized yield of 12.5% as of June 30. We also hold equity positions in many transactions that can act as yield enhancers or capital gains contributors as such positions generate distributions.

While the market has experienced yield compression in recent months, which may have moderated in the current December quarter due to an uptick in deal activity. We have continued to prioritize first lien senior and secured debt with our originations to protect against downside risk while still achieving above market yields through credit selection discipline and a differentiated origination approach. Originations in the September quarter were $557 million. Originations have coming in at approximately $3 billion in the past 12 months. We also experienced a $164 million of repayments in the September quarter as the nice validation of our capital preservation objective.

As of September 30, we were up to 129 portfolio companies, demonstrating both an increase in diversity as well as a migration towards both larger position and larger portfolio companies. We also continue to invest in a diversified fashion across many different portfolio company industries with no significant industry concentration. Our originations in the September quarter were weighted towards the last two months of the quarter, resulting in only a partial quarter positive income benefit from such originations. We expect such originations to generate full-quarter positive benefit in the current December quarter.

Our financial services controlled investments and structured credit investments are performing well with typical annualized cash yields ranging from 15% to 30%. Today, we’ve made multiple investments in the real estate arena with our private REIT American Property Holdings, largely focused on multi-family stabilized yield acquisitions with attractive 10-year financing. We hope to increase that activity with more transactions in the months to come.

We closed our acquisition of CP Energy last quarter and currently have other acquisitions under LOI at attractive multiples of cash flow with both double-digit yield generation and upside expectations. We’re also exploring other yield generating risk-adjusted origination strategies, including in the online prime consumer lending and leasing sectors. The majority of our portfolio consists of agented and self originated middle market loans.

In general, we perceive the risk-adjusted reward in the current environment to be superior for agented and self-originated opportunities, compared to the syndicated market, causing us to prioritize our proactive sourcing efforts. Our differentiated call center initiative continues to drive proprietary deal flow for our business.

Our credit quality continues to be robust. None of the loans originated in over six years has gone on non-accrual status. Non-accruals as a percentage of total assets declined only 0.3% in September 2013 from 1.9% in June 2012 and we’re stable from June 2013. Credit discipline is a key theme of the past quarter.

Origination channels other than sponsor and syndicated businesses, which are more subject to spread compression and leverage increases in billion [ph] markets increased from 45% in the four quarters ended September 2013 to 66% in the September 2013 quarter. This diversified origination allows for greater credit discipline is a highly differentiated aspect of the Prospect platform. We have booked 106 million originations so far in the current December quarter. Our advanced investment pipeline aggregates more than $1 billion in potential opportunities, floating well for the coming months. We expect a significant pickup in deal closings over the next several weeks.

Thank you, I’ll now turn the call over to Brian.

Brian H. Oswald

Thanks, Grier. As John discussed, we have grown our business with low leverage. Net of cash and equivalents, our debt to equity ratios stood at 53.7% in September, down from 55.7% in June. We believe our low leverage diversified across to matched-book funding, substantial majority of assets unencumbered and waiting towards unsecured fixed rate debt demonstrates both balance sheet strength and substantial liquidity to capitalize on attractive opportunities. Our company has locked in a ladder of fixed-rate liabilities extending 30 years into the future, while most of our loans float with LIBOR providing potential upside to shareholders as interest rates rise.

We are a leader and innovator in our marketplace. We were the first company in our industry to issue a convertible bond, conduct an ATM program, develop a notes program, issue an institutional bond and acquire a competitor as we did with Patriot Capital.

Shareholders and unsecured creditors alike should appreciate the thoughtful approach, differentiated in our industry, which we have taken toward construction of the right hand side of our balance sheet. As of September 2013, we held more than $3.9 billion of our assets as unencumbered assets. The remaining assets are pledged to Prospect Capital funding LLC which has a AA rated $587.5 million revolver with 20 banks and which can be increased to $650 million under an accordion feature at our option.

The revolver is priced at LIBOR plus 275 basis points and revolves for three years followed by two years of amortization with interest distributions allowed during the amortization period. We started the June 2012 quarter with a $410 million revolver in 10 banks, so we’ve seen significant lender interest as we’ve grown the revolver.

Outside of our revolver, and benefiting from our unencumbered assets, we’ve issued at Prospect Capital Corporation multiple types of investment grade unsecured debt, including convertible bonds, a baby bond, an institutional bond, and program notes. All of these types of unsecured debt have no financial covenants, no asset restrictions and no cross defaults with our revolver. We enjoy a BBB rating from S&P, and recently received a BBB+ rating from Kroll.

We’d now tap the unsecured term debt market to extend our liability duration up to 30-years. We have no debt maturities until December 2015 with debt maturities extending through 2043. With so many banks and debt investors across so many debt tranches, we’ve substantially reduced our counterparty risk over the years.

As of today, we have issued five tranches of convertible bonds with staggered maturities that aggregate $847.5 million at interest rates ranging from 5.380% to 6.25% and have conversion prices ranging from $11.35 to $12.76 per share. In the past, we have repurchased such bonds when we deem such purchases to be attractive to us. We have issued a $100 million 6.95% baby bond due in 2022 and traded on the New York Stock Exchange with the ticker PRY.

On March 15, 2013, we issued $230 million in aggregate principal amount of 5.875% senior unsecured notes due March 2023. This was the first institutional bond issued in our sector in the last six years. We have issued $519 million of program notes with staggered maturities between 2016 and 2043 and a weighted average interest rate of 5.6%.

During and since of September 2013 quarter, in addition to our revolver expansion and program notes issuance, we have issued equity at a premium to net asset value and therefore accretive. From July 1 through November 4, we sold approximately 34 million shares of our common stock in our ATM program at an average price of $11.20 per share and raised $379.8 million of gross proceeds.

We currently have no borrowings under our revolver. Assuming sufficient assets are pledged to the revolver and that we are in compliance with all the revolver terms, and taking into account our cash balances on hand, we have over $869 million of new investment capacity.

Now I’ll turn the call back to John.

John Francis Barry III

Okay, it’s time for questions.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session (Operator Instructions). The first question comes from Greg Mason of KBW. Please go ahead.

Greg M. Mason – Keefe, Bruyette & Woods, Inc.

Great, good morning everyone. I wanted to talk a little about the CLO income. You mentioned in the queue, but it fell a little bit this quarter, I believe to $26 million from $28 million last quarter. Could you talk about what’s going on in the CLO equity in your portfolio as well as the CLO market in general?

M. Grier Eliasek

Sure Greg, this is Grier. We did have a decline in income in our CLO book related to how we do income recognition, which involves a number of factors including re-investment spread. There was a decline of re-investment spreads that occurred during the June quarter which showed up in the recently completed September quarter, but we see those spreads having stabilized and in fact maybe building up a little bit.

In terms of the book itself within CLOs, in that yield by the way is north of 15%. And in terms of the credit quality CLO book, I would describe that as Sterling. At the end of September, we were I believe below 0.2% in terms of our default rate within the CLO business compared to market average of over 2% that’s 1,100 less than 1,100 of the overall market and that’s a direct reflection of only working with the top 15% collateral managers in the industry, working on primary deals where we scrub out with new CCC assets and controlling the call which allows us to maximize the return and protect against risk, but on an ongoing basis and at the end of the deal.

And we saw a very nice confirmation on a full turn from as deals roll-off on uncalled period typically that’s two years. We’re now in our third year of that business that we’ve been ramping since the middle of 2011 and we just realized with [indiscernible] with 30% IRR.

We’re not guiding those to expect getting 30 in every single deal within the book, but we think that’s a positive reflection and we have a option value, we can either call a deal, cash or checks and then put capital into other origination strategies that we don’t like to risk award in the primary market, or we can do a new deal with the proceeds as we elected to do with the excellent team at CDT does that help Greg?

Greg M. Mason – Keefe, Bruyette & Woods, Inc.

Yes. Great and then on the CLO fair value, you mentioned in the queue that you had an increase in the fair value of CLO equity, we calculate about $21 million, could you talk about the causes of that particularly given you’ve got interest or reinvestment spread compression. Can you talk about the moving parts to get the fair values went higher?

Brian H. Oswald

Yes, Greg this is Brian. The most important piece in that is that taking into account the ability to call the deal. If you value the assets out to maturity, they would be – they would probably come in lower because the expected cash flows in the periods further out tend to come down as the leverage starts to go away. So because we control the call, we’re able to value the assets to the call date and that allows us to value most of these assets at a value above par.

Greg M. Mason – Keefe, Bruyette & Woods, Inc.

Great, and then finally one last question as you look at new CLO equity what kind of rate are you modeling out for those? I know previously I would think it was upper teens? Is that coming in a little bit with the reinvestment issues going on?

Brian H. Oswald

Well our CLO business which by the way is only about 15% of our business. It’s been kind of in stable band. It hasn’t necessarily been growing within our book. We actually underwrite to a low to mid teens return, but we use much more conservative assumptions than what the rest of the marketplace uses. We use much higher default rates, much lower recovery rates, much lower and declining reinvestment spreads et cetera.

And so a return modeled number you spread out is obviously a function of whatever you put into it. And then what’s occurred is the length of return so to speak has come in much stronger than t than our underwriting assumptions on all of these deals, which is what we would like to say you want to beat your budget, beat expectations so to speak. And as a result we’ve been really more in the mid-teens in some cases higher-teens from a yield perspective.

Greg M. Mason – Keefe, Bruyette & Woods, Inc.

And you expect that to continue as on the new investments you’re making?

Brian H. Oswald

Yes in fact, we’ve seen a little bit of a yield uptick recently.

Greg M. Mason – Keefe, Bruyette & Woods, Inc.

Great, thanks. I’ll hop back in the queue for more questions.

Brian H. Oswald

Sure, Greg thanks.

Operator

The next question comes from Jonathan Bock with Wells Fargo Securities. Please go ahead.

Jonathan G. Bock – Wells Fargo Securities, LLC

Good afternoon and thank you for taking my questions. Maybe staying on the CLO subject really quickly, Grier, you mentioned the removal of the triple fee bucket as well as very important items just controlling the call as part of the deals. As a result do you really believe that give you some enhanced ability to effectively let’s say drive material outcome for a majority of your CLO equity similar to what you had with the Apidos CLO that we just saw recently.

M. Grier Eliasek

Yes Jonathan, and thank you for your question. We have a role significant voice both upfront and on a going basis. These really are on these joint ventures that we put together with our collateral manager partners to put up significant equity and so called skin in the game. In some cases personally, in some cases institutionally or above along side our significant capital and our team of that numbers almost a 100 people strong now works and pours through individual credits on a bottoms up basis using our industry experts.

So we’re working at in hand with the collateral manager. On that up front selection a huge amount of modeling goes in on the front-end as well sometimes you feel like you make your money on buying this business and that’s true with this asset class. I know less than making sure you’re keeping a leverage appropriate on the loan, they’re keeping that purchase multiple appropriate on an acquisition.

So we do have the ability to drive outcomes up front and on an on going basis that call rate is a powerful one, it’s interesting. If you don’t own a majority of the equity in the CLO, you often times don’t know where the other holders are and certainly isn’t published in a place and the trustee doesn’t even know seen if having a call around or pieces together to figure it out sometime people never actually get there and as a result they’re not able to call things at the optimal time period especially there is a Manager that has different incentives involved.

We avoid all of that by holding the unilateral right to call the deals when it’s in our best interest, it also acts as a liquidity of protection and enhancement which is always a good thing to have, and our strategy continues to be too sound – I want to emphasize, we’ve spent lot of time in CLO here, this is only about 15% of our business.

We do we are optimistic in what we’re seeing in the current market, but a very small percentage of the time to think come together where our partner collateral manager and the right numbers that come together to make the so called arbor on the front end where the asset spread is rich enough and the liability spread is loaned up, they were dialing in to an appropriate return. Sometimes it’s hard for the outside world to see they were saying no 99 times before we say 1 yes and that’s true in this business as well.

Jonathan G. Bock – Wells Fargo Securities, LLC

I appreciate that and appreciate your comments on this one of many businesses, I guess the question is so let’s say for example, as you own let’s say 95% of the equity in IMGs 2012 CLO, there are several there, you know one want to probably say that’s you are the primary beneficiary. And I’m curious how does this look relative to an accounting rule ASC 810 that would say if you’re the true primary beneficiary of the off balance sheet levered investment that you would then need to consolidate that for purposes of the regulatory one to one test. Brian, have you received any questions on this as you start to think about whether or not this is going to need to be consolidated?

M. Grier Eliasek

No we’ve not gotten any questions on this to be to clear the air on that we actually had a conversation with the SEC before we started the strategy in which we cleared the accounting treatment in advance. So the bottom line is that because we do not do the day-to-day control of this investment, we are not required to consolidate it, the only right that we have is the right to call the deal.

Jonathan G. Bock – Wells Fargo Securities, LLC

Which is the pretty powerful right as you stated recently, I guess, the only question though is as I look at commentary that the commission likely add with the Palo which is out there publicly, they are already asking you is it appears as still evaluate whether or not consolidation under A10 this is the group broadly it’s something that should be considered. So I appreciate your comments on that.

Moving to one other vehicle and I do find unique this is the REIT and may be help me understand this broadly as it relates to the amount of PIK that you’re collecting. I just noticed that that changed a bit in here I’ve got – you have your debt investment and then that debt investment in APH gives a yield of 6% cash, 5.5% PIK, can you walk through considering you control the entity why you would elect a 5.5% PIK component?

M. Grier Eliasek

That PIK is actually being paid in cash.

Jonathan G. Bock – Wells Fargo Securities, LLC

Okay. Then why do you have a PIK component in the statement? I’m just curious.

M. Grier Eliasek

Because there is sometimes seasonality associated with different real state assets the summer months might be slow as people are moving in and out multi-family apartments, the apartments vacant for two weeks or four weeks as a result. So it’s relates to write off seasonality, but all has been paid in cash.

Jonathan G. Bock – Wells Fargo Securities, LLC

Okay, that’s good. Then if I look at the investments that you make within your REIT. So let’s take Pembroke Pines for example. You had a purchase price of the property at $225 million versus mortgage debt of $157.5 million, 70% LTV and that’s a $67.5 million, we’ll call it active equity into the property right that’s what you would be putting up. Yet as I look at your investment in the APH, I see a total of $76 million into the absolute REIT itself. So I’m curious if you only paid $67.5 million per Pembroke Pines on an equity basis after leveraging with GSC debt why put in $76 million?

Brian H. Oswald

I’m sorry, what’s the last sentence there, the $76 million?

Jonathan G. Bock – Wells Fargo Securities, LLC

Yes, so if you look at your – and you make a point after each one of your acquisitions in the REIT to announce how much debt you’re going to apply to APH and how much equity you’re going to apply to APH to effectively facilitate the transaction. I was just adding those up and then it seems a little, it seems different particularly in that the total debt attached to APH is $63 million and $13 million for equity. This is just related to Pembroke Pine was $76 million yet the effective equity in the property was only $67.5 million. So it’s about $9 million more than what you’ve announced, you paid in your finance. I’m just curious what accounted for that delta?

Brian H. Oswald

Yes, Pembroke is a highly priced asset. I think it’s the largest, I told it’s the largest garden-style multifamily trade in the State of Florida and very attractive for the GSC’s to finance. They were sort of stumbling allover to finance that asset. So we were able to get more attractive financing. The asset itself is pending by the everglades and there really is no new land available so to spending any amount of time in South Florida. So asset values are rising substantially and we see a significant upside from our equity position and not just the debt side of things.

So it’s sometimes certain assets will have a little bit of higher leverage ratio associated with them because of the scale and the location and barriers to entry. In other cases there might be a little bit lower, but we sort of claw back the return by paying a higher cap rate, i.e. lower multiple for the business.

Jonathan G. Bock – Wells Fargo Securities, LLC

Okay. So I guess you needed $67.5 million to finance the business where you have equity in that property. You paid $76 million for a $9 million kind of delta above it. Maybe turning to the GSC debt itself, my guess is that it was sort of something like CapEx. Can you give us a sense as to the interest only term on the GSC debt? I’d imagine that this is interest only for a certain period of time?

Brian H. Oswald

Yeah, our multifamily deals are typically interest only for three to four years. We’ve seen lender terms get more attractive over time. In some cases, we’ve been pitched five years. We like a longer interest only period before amortization kicks in because obviously it’s a very low cost, we’re talking about 3.5% to 5% funding on a non-recourse basis against a single asset that’s very attractive.

And I want to emphasize that none of those deals are cross collateralized with one and another. Let me get pitch those deals. We turn and walk the other way. And then typically the financing term is 10 years with 30 year and more when that kicks in.

Jonathan G. Bock – Wells Fargo Securities, LLC

If you had to pay interest and pay interest today, would you be earning your stated deal that you expect on the property today, right? Or is there some amount of expected growth in rental income that would need to come alongside the fact when interest payments are going to be required once the GSE debt stops its interest only periods.

Brian H. Oswald

Right, so we typically underwrite these deals such that if nothing else happens and you’re looking at the run rate profitability of the business, we’re diving into a double-digit yield. And then you’re right that if this zero change over a three year period and amortization kicked in, you’d have some compression, but the reality is you’ve had income growth, there is inflation which works to your advantage, albeit modest 2% inflation is still going to inflate rents and inflate your returns, there is a little bit of inflation hedged by the way built-in with this real estate business, there is another benefit of it. And it’s not a problem...

Jonathan G. Bock – Wells Fargo Securities, LLC

Well go ahead.

Brian H. Oswald

And our model show that we believe that yields will grow through not only that inflation, but also most of these properties are kind of 10-year to 20-year old properties sort of A minus, B plus properties and there is typically upside through a capital expenditure program that’s been proven out the property, let’s say 25% to 45% give or take of the units have already been upgraded to nice amenities cabinets, appliances et cetera and it’s typically a rent bump and the IRR associated with that incremental investment depending from the deal we’re seeing anywhere between 15% to 30%.

So that bump would also add to rent growth and the upside not reflected in the run rate purchase price that our hope is would levitate the yield and cause it to grow even through the financing going from interest only to interest plus and more years up.

Jonathan G. Bock – Wells Fargo Securities, LLC

Okay. I mean this is one any logical investor would ask is that given that we’re near peak rental occupancy even somewhat peak rental rates, your view is that it’s possible to take a much older property that compete with newer ones, fix it up and then be able to effectively pay for the interest expense that will come on GSE debt of 70% LTV in this deal that will then allow you on top of that for making the largest payments earn respectable IRR?

Brian H. Oswald

Yes, because we’re looking at replacement costs for new construction in these areas and our purchase, our all-in cost is somewhere in the order of 60% to 75% of replacement cost and so it’s just not economically feasible in any case because the construction cost for a new property to be competitive with what we’re going on that’s one piece. The second piece is in many cases these properties are advantageously located and that can’t be easily replicated. And I mentioned the number of times arena there really is no location, no land to build a property like that in South Florida anymore. So that creates a barrier to entry, it’s highly beneficial to us as the owner.

Jonathan G. Bock – Wells Fargo Securities, LLC

Appreciate it, thank you.

John Francis Barry III

Jon, and thank you for these questions they are good ones. When you buy in an area where there is lots of land available and lots of available supply, new housing available to come on stream. The thesis of buying a somewhat older building and upgrading it, will not be as effective as it will be in an area where as Grier just mentioned the available supply is constricted. If you’re upgrading in an area where somebody can build a brand new building across the street or down the road. You will need to upgrade in order to just keep up, in order to just maintain your rents in the worse case. So obviously the worse case things can go down.

In an area of constricted supply, where you’re not seeing new supply coming on stream and there were not alternatives for people to move with new buildings out of yours. You have the ability to upgrade and earn these IRRs as Grier mentioned and so we are targeting the later case.

Secondly, we don’t target it just on a pro forma basis or imaginary basis or looking at REITs data, conducting market surveys, we focus on buildings where in fact the owner has already done those renovations on some of the apartments. So rather than guessing we can see not exactly, but with some precision what the expected IRR will be per dollar of upgrades.

Jonathan G. Bock – Wells Fargo Securities, LLC

That makes sense, good. Thank you so much.

John Francis Barry III

Thanks, Jonathan.

Operator

The next question comes from Robert Dodd of Raymond James. Please go ahead.

Robert J. Dodd – Raymond James

Hi, guys. A lot of my questions have already been answered. But I have one of them, could you give us a little bit of that one with a $70 million dividend recap or now in a position to pay sustainable dividend obviously at lower number $7 million. I would think pay the dividend in full?

And then secondly just on some deal which you closed essentially in the quarter and it’s been marked down a very small amount of $2 million kind of $1 million close, could you give us an update if anything has changed there?

John Francis Barry III

Okay. Thank you, Robert. On the first item for Airmall and that business has continued to perform well because Airmall is the business that has four U.S. airports for and operates the food concession and retail establishments and the performance of that business is significantly driven by employments and faster spend for employment each of which overall are up. Anyone flying today knows there is not a lot of empty seats of their Aircraft, maybe and that’s a great for fast unencumbered, but good for the airport concession business.

And that’s a business Airmall, which does that capital expenditure that occur from time-to-time related to specific airport needs. There is also new business opportunities, other airports, contracts that the company is pursuing, and sometimes capital need to be held back and potential anticipation of those other needs.

In this case we have accumulated significant amount of cash within the business as well as earnings, and I would like to take a dividend. We’re still evaluating what our potential recurring dividend will be possible out of the business and haven’t decided that at this juncture. And then what was your second question Robert, could you repeat that please?

Robert J. Dodd – Raymond James

Yes, CP Holdings, which you closed essentially in the quarter and the equity was mark down $2 million from cost when you closed, which is almost $2 million is very small, but…?

John Francis Barry III

Right.

Robert J. Dodd – Raymond James

Particular driver, for that given it was so close to when you made the investment?

John Francis Barry III

Yeah, I wouldn’t read too much into that Robert and in our independent valuation process does bottoms up, whether or not we closed the deal three seconds ago or three years ago. We’re very happy with the performance of CP and in fact, made additional investments into the business, I call them particularly smart money investments or when you buying energy services company I know you get a lot of expertise in that sector as well, however, the smart money goes in and buy the equipment and tries to avoid paying someone else big enterprise multiple and premium to book.

So we’re doing some of those trades right now which we think are going to set us up very well for the future. This is a company by the way is try before you buy deal and that we are a lender to the company first, like the company, like the management team and then we should deal with the sponsor to acquire the business on a consensual basis with everything performing well, sponsor need a realization.

We view this attractive opportunity to buy the business at an attractive price and shows again the strength of our diversified originations during a controlled deal which obviously all the BDCs do in the past quarter.

Robert J. Dodd – Raymond James

Perfect. Last one on that [Indiscernible] other income price I assume that was some legal re-investment. Is there anything coming to resolution with that company?

M. Grier Eliasek

Yes, that was a legal reimbursement associated with a settlement and when you ask about its resolution with that company there is a lot of different store houses of value we’ve looked to over the years. There is a building, there was D&O insurance claim, we had this other legal aspect and we’re hopeful to maybe other pieces of value out there in the future.

Robert J. Dodd – Raymond James

I appreciate it guys. Thanks.

Operator

The next question comes from Andrew Kerai of National Securities. Please go ahead.

Andrew P. Kerai – National Securities Corp.

Yes, good morning guys. Thanks for taking my questions. First question if you could just kind of talk about the dividend income for a second as well too, $7 million from Intermodal not much during the quarter, I know you guys have kind of talked about this previously and it can be kind of lumpy if you were going to – but I mean what is kind of a fair number to assume if you had the kind of handicap it for that dividend income number, and I know in the past sort of think about $3 million to $4 million from all the industry set that didn’t transform the quarter, but I mean is $7 million a little bit too high or do you think that’s a fairly decent run rate to kind of expect on a quarterly basis?

Brian H. Oswald

Well we’d have to look across the whole book and it wouldn’t be fair I think to blow it out and I don’t have the specific answer to blow it out to you right now because every company has its own set of needs. We look at the capital expenditure needs of the business with [indiscernible] acquisitions the whole list of top issues that are highly customized an individual to each company.

I would say on the operating control side of things you mentioned are we there in Intermodal there might be a little bit more variability. Our financial bio side is much more predictable, which is probably foreseeable to you because those are loan instruments, credit instruments and therefore high contracted recurring cash flow types of businesses and recall we have two installment businesses and an auto finance business in the book. So those have been fairly predictable and we’re looking at other businesses within the – sort of consumer finance and other diversified specialty finance sector as well.

We have been too active in recent months other than supporting our existing companies, but we are working on some other deals which look interesting in that sector.

Andrew P. Kerai – National Securities Corp.

Okay sure, thank you and just kind of talk about first half was relative to – you market the equity about little under $15 million or so in the quarter, maybe you said in the Q that it was related to sort of an improvement in that operating results. Can you kind of I guess maybe give us a metrics or why you felt that was appropriate to kind of mark that up on at the end of July through September quarter?

Brian H. Oswald

Sure. It’s interesting. It’s all in consumer finance across a lot of different companies an uptick, not a huge uptick, but an uptick in charge-offs that occurred in the spring. And then over the summer months and moving here into the fall, we’ve seen that really level off. So we haven’t seen increases, significant increases really in charge-offs. So that moderated and I think that had a positive impact on evaluations for the quarter.

Andrew P. Kerai – National Securities Corp.

Okay, thank you. And just I guess kind of get back if you could just kind of talk about the regulatory risk. I mean First Tower kind of like you’d mentioned before is more focused on the installment lending. Is any of kind of what you’re seeing from evaluation perspective would that company maybe some of the regulatory head up in the States kind of some of the more short-term payday lenders and maybe that business is kind of, I guess helping the sort of lower regulatory and installment lending business a bit which First Tower focuses on more?

M. Grier Eliasek

Well, we think there is, were a couple steps removed from payday with Tower because when the Tower is an A1 installment lender. It’s not even a B1 installment lender like some other comps you would see world [Indiscernible] primarily, our B1 installment lenders. You’re going to see higher APRs with the B1 crowd and a little bit more regulatory risk. We do on Credit Central, which has exposure to that, but that’s a much smaller business than Tower. Tower is the most significant holding we have. So Tower is more of a 30%-ish APR business as an A1 loan lender as opposed to say 70% for B1 installment lender and now they’re all at 300% plus for payday.

The higher on the APR level, the more the regulatory risk by and large. So we feel very comfortable about that and Tower is in compliance with all State and Federal laws and as diversified across multiple states having diversified from three states to five, since we purchased the business about 16, 17 months ago and they’re looking at other states as well, more state diversity reduces regulatory risk as well.

Andrew P. Kerai – National Securities Corp.

Right, so and then I guess kind of ask differently. So I mean if I would say, well to the extent there is regulatory headwinds and kind of be all about sort of short-term payday or kind of more of the higher APR or sort of installment levels, so to the extent of that the best trying out in that market. Do you think on the margin that’s kind of benefiting First Tower, which could also be kind of driving, kind of some of the improvement in our operating results, kind of if you look at the data in terms of then trying to grow their loan book?

Brian H. Oswald

Yeah, I’m not sure regulation is a significant driver other than enhanced regulation with banks creates opportunities for the non-bank sector, broadly speaking for our entire business, not just in consumer finance, but across all of our businesses with rules promulgated by the Fed for cash flow loans and limitations on amortization leverage and like with the bank market.

But the specifics on how Tower is doing day-to-day, week-to-week is much more driven by the blocking, tackling basics of the business with managing, underwriting, people, processes, charge-offs, the same thing that Company has been doing for the last 30 years of its existence.

Andrew P. Kerai – National Securities Corp.

Sure, thank you. And just my last question as well as you said, you so if you look at the leverage ratio the sort of gross debt equity I mean it was 0.59, it still really below your kind of 0.7, 0.75 times target. I mean is there any reason to believe that you guys maybe increase that it was a little bit tough towards that target, I mean that we’ve got enough from my point of these things have improved given some of the yield compressions within, what kind of senior secured time in the market that you’ve been seeing?

John Francis Barry III

Sure, we have run our business with low leverage and modest leverage for a long time as you know and we’ve also have messaged that hey, since we’ve got [indiscernible] fundings, since we’ve got access to something different credit markets in a diversified fashion then we should be able to walk up from ultra-low leverage, still prudent leverage category, not necessarily in a straight line because there might be a quarter, which that will fluctuate, for example the last quarter, our leverage actually declined a little bit, which was a function of originations being a little bit lighter.

So healthy, but a little bit lighter and that comes down to credit discipline, we passed on a lot of deals, especially in the sponsor and syndicated channel last quarter. We do like to have debt-to-equity capital on just-in-time basis. We think that’s highly protective of our company and stock retirement have posted large offering that’s not done in stock.

And we think that’s just-in-time capital benefit to us and allows us to move quickly when there are opportunities to take advantage of in the marketplace and right now we’re seeing a big uptick of activity, part of it maybe seasonal, like everyone to close the deal by year-end looking at the book or accomplish where we have go, they are trying to do. We seen they have a lot of deals in category A more than 1 billion as I said earlier and we anticipate a lot of activity between now and year-end.

Andrew P. Kerai – National Securities Corp.

Great, thank you.

John Francis Barry III

Thank you.

Operator

Your next question comes from Terry Ma of Barclays. Please go ahead.

Terry Ma – Barclays Capital, Inc.

Hi, guys, I think most of my questions have been answered. But can you give us a little color on what you’re seeing in the market with respect to refi’s and recaps, I think you guys finance a couple of large deals on recaps this quarter?

John Francis Barry III

Sure Terry. Thank you for your question. Yeah, refinancings and recaps have been a significant percentage of activity in the last 12 months, I don’t know financials exactly what the breakdown is between acquisitions, M&A and recaps, it seems like there has been a significant amount of recaps.

We’re seeing a pickup in M&A in terms of kind of primary activity in the marketplace and a healthy amount of our category A deal flow, which related to, related to change of control situation as opposed to our refi’s and recaps. In those situations we’re going to underwrite the credit in the same fashion.

Of course we will give a bit of a nod to new money at risk, from an owner, from a sponsor as opposed to obviously money being cashed out in a dividend fashion. And it will faster that into the overall underwriting of how we look at risk for particular credit. We won’t just look at one particular item, we look at everything involved in the deal.

Terry Ma – Barclays Capital, Inc.

Okay, great, thanks. And just one quick follow-on First Tower, how should we think about the net revenue interest on First Tower that sitting there?

John Francis Barry III

In terms of its stability, well, Tower has been sort of 18%-ish annualized yield range to us, since we closed the investments that’s been reasonably stable. We’d like to see that that grow over time obviously all the things being equal, but we’re very happy with 18% and we’re looking at that on the acquisitions for Tower. We’re looking at additional states for expansions as I mentioned. But probably won’t see dramatic changes in product mix or underwriting.

Frankly, we’ve been running that business with the capable management team for a long time. They have a tried and true underwriting processes and procedures, which has served the company well for decades. And we’re not so eager in a touch down fashion to insist upon deviations from what’s been working for a long, long time and Brian wants to add another piece here.

Brian H. Oswald

Yes, the net revenue interest adds about an additional $1.3 million of income per year at least it has over the last year.

Terry Ma – Barclays Capital, Inc.

Okay, great. Thanks.

M. Grier Eliasek

Thanks Terry.

Operator

The next question comes from Casey Alexander of Gilford Securities. Please go ahead.

Casey Alexander – Gilford Securities Inc.

Hi, first is a maintenance issue. Do you have the proportion of fixed to floating rate loans in your portfolio?

M. Grier Eliasek

Let’s look for that and continue if you have a second question.

Casey Alexander – Gilford Securities Inc.

Okay. My second question in looking at your presentation that you offer along with the quarter on the website I was – couldn’t help it to be drawn by the slide outsized its potential return. I was wondering if you have an opinion perhaps in market caps your valuation because of the perception that you are always out there in the market with your after market equity program and if you think that contributes to your under evaluation?

Brian H. Oswald

Okay. A couple of things there, first of all 89% floating rates, for assets and liabilities 96% fixed. So we are very well poised to benefit all of things to be equal of course from an increase in rates.

Casey Alexander – Gilford Securities Inc.

Yeah.

Brian H. Oswald

On your question about equity issuance, we really think based on our experience that after-market issuance captured a low volume is much more protective and see what stocks then a large kind of gap down offerings, obviously some have might [indiscernible] capital rates are. But when we look at, for example, an offering we did about a year ago, since a year ago in 2012, it took a significant amount of wind out of the sales from that deal.

So we’re just not anxious to go back there and there has to be enormous justification to do so from our standpoint and it’s just really not our preference. And we like the efficiency that’s from a stock price perspective, but also in spread I mean, you are going to pay several basis points to this tree from a large offering, where as if we do in ATM, we run that a 100 bps. So we’re stating the shareholders a curved line, using that approach instead.

I think part of it we’re trying to really get the message out about that. I think the overall question about discount or premium is going to have a lot of different opinions. We had really made a conservative effort in recent months to do a lot more communication about how and what we do everyday and to communicate more about origination, our strategies, we held our Analyst Day in July, folks can see that on our website and learn much more about our seven origination strategies.

We walked through case studies. We have the senior members of our team presents which gives folks a sense of the breadth and depth of the organization of almost 100 people now. And that’s those sorts of things we think from awareness building, from education, from greater communication that we hope and think will make a significant difference.

Casey Alexander – Gilford Securities Inc.

Now just on the ATM.

Brian H. Oswald

Yes, on the ATM, I’m glad that you asked about that. I believe it’s been more than a year since we have done and underwritten or bought deal or marketed or whatever you would like to call it, common stock offering.

One of the reasons that we have avoided issuing stock that way in over a year is that if I were a person looking to buy BDC stock, I would be concerned about any BDC doing an offering that way in any short period of time or even interim period of time after I purchased my stock because for certain the underwriters need to be offering in for 2% or 3% maybe 4% or more at a discount.

And the stock pull as we all know on this call, immediately trade at this new floor created by the need to lower the price in order to cause the market to absorb a huge supply at one time. I mean, it’s like anything in this world.

If you have one bicycle to sell, maybe you can get a certain preference. If you can sell 100 bicycles this afternoon, you are going to need some marketing done. So for that reason simple microeconomics, we have avoided that and it’s not been such an operating in over a year. We have avoided the gyrations in our stock price that occurs as a result of those offerings.

We have avoided the big gap down it’s very distressing to someone who bought the day before or the week before. And as a result, we think that we provide a better value proposition over the course of the year, not clear to me that we end up offering anymore stock than we would otherwise and probably less. So we feel that this is a very stockholder friendly approach just in time financing at the lowest possible cost.

Casey Alexander – Gilford Securities Inc.

Brian, I appreciate you taking my question.

Brian H. Oswald

Thanks Casey.

Operator

The next question comes from Greg Mason of KBW. Please go ahead.

Greg M. Mason – Keefe, Bruyette & Woods, Inc.

Great, thank you guys and thanks for all the great answers to the questions. You addressed the positive movements of first hour in the CLO equity. I wondered if you could give us a little bit of color on the two negatives in the quarter Ajax and Gulf Coast. And you’ve done a great job of having no non-accruals for six years. What is potentially the risk of those going on non-accruals you analyzed those two businesses?

John Francis Barry III

Sure. Both of those companies are in the forging business, I mean industrial forging business and Ajax particular did lot of business with companies like Caterpillar and there has been a significant slowdown in end-user markets in the mining industry related to a decline in certain mining related commodities and anybody watching Caterpillar as a public company can see what occurs there.

So we look at that with Ajax which is a well-run company [Indiscernible] for a long time and it’s familiar with the volatility of the cycle. And I hope that’s a temporary phenomenon and that’s the company will continue to develop our end-user markets that add value and grow the business. And Gulf Co is more focused on some of the energy then necessarily mining related end markets, but also has a cyclical aspect associated with it. When we make a loan or purchase a cyclical business, we try to correct for that with being as high up in the capital spec as possible to be the senior security lender which is the case with both of these.

We endeavored to have a prudent leverage as well typically significantly lower than a non-cyclical business. And we also potentially look at investing equity and delevering the business if that’s the right approach. Even if we’re having a third party to do that if we’re not in the control seat and that can result in less interest burden on the company, which could also be the right thing to do. So non-accruing loans, but with a lower attachment point or lower dollar amount of such leverage which is good for all involved.

And then when the business recovers and grows again, we may look to either recapitalize the business or sell the business and we were the owner of a highly cyclical company called energy manufacturing for example, and we sold that business after a significant surge and profitability for a number we thought was attractive and monetize that deals. And that upside of that is available to us in our control book, which we’ll look to capture just probably not anytime soon within the forging sector.

Greg M. Mason – Keefe, Bruyette & Woods, Inc.

Great, thank you guys.

John Francis Barry III

Thanks Greg.

Operator

The next question comes from Andrew Kerai of National Securities. Please go ahead.

Andrew P. Kerai – National Securities Corp.

Yes, hi thank you. I just had a follow-up question if I could. So if you could just kind of comment on the kind of origination outlook you have for the current quarter, I mean you are kind of consistent with – we know with what you’ve seen historically I mean certainly borrowers or sponsors looking to close deals towards the end of the year, it will be positive for you guys. I just wondered if you had I guess some additional commentary on in terms of kind of the yields that you’re seeing as a kind of close up the year, I guess to the extent if you’re seeing kind of the pick up in load demand at least kind of supporting the yields that you’re just kind of broke that your book into these new assets as the year closes?

John Francis Barry III

Sure, we’re seeing a real stabilization in yields right now, which I think is driven by supply and demand that there has been an uptick in activity. So there is sort of more deals to go around right now in the marketplace than in three months ago or even six months ago. And so desperate lender syndrome as I’d like to call it that people shoving money up the door on a – in an imprudent basis accepting higher leverage and a too higher risk attachment point has moderated a bit because people have more to feast on. So that’s what we’re seeing generally speaking the current quarter. It’s hard to hear on November 5, that’s exactly what our originations will be when the ball drops on New Year’s Eve that’s just the deal business. But we do have more than a $1 billion in category right now which is close to record high.

Andrew P. Kerai – National Securities Corp.

Got it. Thank you and that sort of – better origination on Cloud and sort of going is that that’s primarily new, but it’s not sort of the refi volume you are seeing out there right?

John Francis Barry III

That is primarily for yeah, there has been a significant increase in change of control situations and is not that refi or recaps has gone to zero that just been a little bit of a mix adjustment which I think is probably a good thing.

Andrew P. Kerai – National Securities Corp.

Got it, I mean do you guys can’t fill up in your portfolio I mean kind of lot of call it refi burnout kind of if you were the lot of the refi activity that maybe it’s kind of already kind of that has already kind of played out and do you expect kind of headwinds from maybe additional refi to kind of play out on the yield little bit here going forward?

John Francis Barry III

Well we would call that I mean about half of our business in the last year is sponsor related business and in fact in the quarter just ended was well like a quarter two third of our business. So a lot of the businesses origination strategies that we focused on aren’t part of that lot of money efficient, eBay like options here the sponsor who get vendors do not hedge together and did out their capital at ever higher leverage and ever lower yield. So resist that from a business mix standpoint to start with, but within the Sponsor segment itself as I want to give you sense of that completely unattractive because it has been very good business for us for long time, but is subject to more competition.

Within that business there we’ll continue to be refinancing, recapitalizations that will occur driven by strong performance of underlying portfolio companies but I do think there is a mix of shift that’s occurring at least right now with an uptick in M&A and talking about the amount of options going on and pent up capital, equity capital has been on the sidelines looking for a home. A lot of people are saying that 2014 will be an uptick in M&A versus 2013, we’ll see that, we’re not taking any – making any prediction I’m just relaying what I have heard from others.

Andrew P. Kerai – National Securities Corp.

Great, thank you so much.

John Francis Barry III

Thank you

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to John Barry for any closing remarks.

John Francis Barry III

Well thank you very much. All have a wonderful lunch time.

M. Grier Eliasek

Thank you all.

John Francis Barry III

Bye now.

Operator

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

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