Fifth Street's CEO Discusses F4Q 2013 Results - Earnings Call Transcript

Nov.26.13 | About: Fifth Street (FSC)

Fifth Street Finance (NASDAQ:FSC)

F4Q 2013 (Qtr End 09/30/2013) Earnings Call

November 26, 2013, 10:00 AM ET

Executives

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

Leonard Tannenbaum - Chief Executive Officer

Bernard Berman - President

Alexander Frank - Chief Financial Officer

Analysts

Greg Mason - KBW

Douglas Harter - Credit Suisse

Robert Dodd - Raymond James

Andrew Kerai - National Securities

Casey Alexander - Gilford Securities

Ron Jewsikow - Wells Fargo Securities

David Miyazaki - Confluence Investment Management

Operator

Good day, ladies and gentlemen, and welcome to the fourth quarter 2013 Fifth Street Financial earnings conference call. My name is Celia, and I'll be your operator for today. (Operator Instructions) I would now like to turn the conference over to your host for today Mr. Dean Choksi, Senior Vice President of Finance and Head of Investor Relations. Please proceed, sir.

Dean Choksi

Thank you, Celia. Good morning, and welcome to Fifth Street Finance Corp.'s fiscal fourth quarter and yearend 2013 earnings call. I’m joined this morning by Leonard Tannenbaum, Chief Executive Officer; Bernard Berman, President; and Alexander Frank, Chief Financial Officer.

Before we begin, I would like to note that this call is being recorded. Replay information is included in October 24, 2013, press release and is posted on the Investor Relation section of Fifth Street Finance Corp.'s website, which can be found at www.fifthstreetfinance.com. Please note that this call is the property of Fifth Street Finance Corp. Any unauthorized rebroadcast of this call in any form is strictly prohibited.

Today's conference call includes forward-looking statements and projections. We ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these forward-looking statements and projections. We do not undertake to update our forward-looking statements unless required by law. To obtain copies of our latest SEC filings, please visit our website or call Investor Relations at 914-286-6855.

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

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

Leonard Tannenbaum

Thank you, Dean. U.S. equity and credit markets continue to be impacted by the Federal Reserve's quantitative easing program. While the middle market was initially insulated, it has now experienced yield compression and elevated prepayments for some time. The net effects of these trends are lower yields and in-returns in FSC's portfolio and across our BDC peers.

An example of our weighted average yield on debt investments, declined from 12.3% in the December 2011 quarter to about 11.1% in the September 2013 quarter. During the same period, the annualized current yield on the iShares' U.S. dollar high-yield corporate bond ETF declined from approximately 7.2% at the end of December 2011 to approximately 5.8% as of mid-November 2013.

In this market, most fixed income investors have two basic choices. They can either take a prudent risk and reach for higher yields or accept lower average returns. At Fifth Street, we source, structure and manage the majority of our investments. We use our platform to scale relationships and investment expertise to find niches, where there is less competition, where we can ultimately earn attractive risk adjusted returns. Over 90% of our deals come directly from private equity sponsor relationships that we have built over the years.

We outlined several initiatives on our last earnings call to improve net investment income per share, including the acquisition of HFG, as a portfolio company of FSC; expansion into venture debt lending; three, growing our capital markets presence; and four, better utilization and the reduction in cost of our bank credit facilities.

We continue to source deals from our key sponsor relationships, where partnership approach is valued more than lower yields. And we differentiate ourselves from many other middle market lenders by being a leader in the financing solution and larger hold prices in the unitranche.

Operating larger hold and commitment sizes enables us to generate incremental alpha, because there are fewer competitors able to commit to funding larger unitranche transactions. By utilizing our platform and expertise, we have been able to keep our asset yields from compressing more than the broader fixed income credit indices.

We've also reduced our funding cost by renegotiating lower pricing on revolving bank facilities. Nonetheless, net interest margin compression has pushed net investment income per share to lower form of dividend. And some of our initiatives are taking longer than initially expected to offset that pressure.

Our Board of Directors, therefore decided to reset the dividend to a level consistent with current net investment income per share, since dividend distributions have been in excess of net investment income for the last several quarters. The Board of Directors declared monthly dividends for the quarter ending December 31, 2013, totaling slightly over $0.24 per share, which is representative of net investment income per share of $0.24 earned for the quarter ended September 30, 2013.

As we believe, we will earn our dividend, our Board of Directors declared monthly dividends for January through May of 2014 of $0.0833 per share per month, which is a $0.25 per share quarterly dividend and $1 per share annual dividend rate.

The new annualized dividend provides an approximate 10% dividend yield to the current share price, which is still above our peers who have current annualized dividend yields between 7% and 9%. We believe this is an attractive yield considering approximately 80% of our portfolio consist of relatively safe senior secured loans and that no loans on non-accrual at the end of September quarter.

NAV per share has been stable for several quarters, despite earnings not matching the dividend. We understand that setting a dividend consistent with net investment income supporting to our equity investors, our debt investors as well as the rating agencies, to maintain and perhaps improve our investment grade rating. We believe our net investment income per share in fiscal year 2014, should meet or exceed $1 per share annual dividend rate.

The Board of Directors decision to realign the dividend to the current level is a reflection of the market environment and high quality of the portfolio. In short, we believe the realignment of the dividend is the right thing for our shareholders in the short and long-term. And here at Fifth Street, we are committed to ensure FSC's long-term success, which will in turn be beneficial to our shareholders.

We are hopeful, as the Fifth Street platform expands and our recent initiatives are successful and improving net investment income per share that our dividend can return to a higher level. In addition, by matching our dividend distributions with net investment income, we may report modest NAV per share accretion in recent quarters.

September quarter net investment income per share was below our expectations, due to higher prepayments early in the quarter and originations weighted towards the end of the quarter. We did close $307.4 million in gross originations in the September quarter, of which $294.4 million were funded. However, several deals slipped into October. Our net originations for the quarter were only one, which resulted in lower net investment income per share.

The December quarter is historically our strongest quarter, as sponsors are motivated to complete deals before yearend. This quarter shaping up to be consistent with historical trends, we have already funded a record $425.5 million as of November 25, 2013. We still have an active pipeline of deals through calendar yearend and maintain 20 of financial capacity. We do no have permission to sell shares below book-value and do not intend to do so.

HFG is performing above our original underwriting plan and benefiting from its affiliate issue with Fifth Street, as a portfolio company of FSC. Healthcare Finance Group is currently in the market with a $475 million syndication of revolver and term-loan for large hospital system. Our capital markets team, led by Fred Buffone should be a significant driver of earnings overtime, as we originate and syndicate loans to our other investors as well as source assets for own balance sheet.

The ability to originate loans and syndicate them to leading financial institutions is an indication of the strength and quality of our middle-market leading platform. Syndication capabilities are important because we may earn incremental fee income, better manage our liquidity and potentially earn premium yields by committing to larger deals, which can partially resold after funding.

For example, we syndicated a $20 million portion of our unitranche loan to AdVenture Interactive Corp, after the end of the September quarter. This reduced our debt exposure of approximately $113 million as of September 30, 2013, to a current level of around $93 million. We intend to actively use our capital markets desk to add additional liquidity in the calendar fourth quarter. We are in active discussions with other institutions regarding additional syndications and first Ad opportunities.

Our flexible and low cost liability structure benefit shareholders by enabling us to retain assets across the debt capital structure, and finance them in the efficient manner. We are working on expanding our assets to funding, lowering our funding costs and improving the terms and flexibility of our debt capital, which Bernie will discuss in more detail.

Management and the Board of Directors understand the importance to our investors of paying dividends, supported by net investment income per share and we believe that the share overtime lead to more attractive valuation for share price, as well as NAV accretion. Our Board of Directors also expressed their confidence in our portfolio by increasing our share repurchase program to $100 million from $50 million, which we intend to use at the shares trade at the meaningful discounted book-value per share.

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

Bernard Berman

Thank you, Len. The current frothy market enables us to improve the terms of our debt capital by reducing the cost of revolving bank debt, increasing our access to debt financing and extending the weighted average maturity of our liabilities.

Since the end of September quarter, we announced an increase in our syndicated credit facility led by ING and a reduction in our Sumitomo credit facility. We added three new lenders to our ING facility and increased the existing commitment from Sumitomo, raising the total amount of commitments to $605 million. We remain in discussions with additional lenders about joining the ING facility.

The reduction in our Sumitomo facility to $125 million from $200 million is reflective of the yield compression in the market for first-lien loans. We initially entered into the Sumitomo facility to finance first-lien senior loans. At the time, the facility was our lowest cost revolving bank debt and had attractive advance rates.

However, as yields for first-lien loans compressed, they became a less attractive investment, given our return requirements, so the facility was never fully utilized as intended. Sumitomo remains an important lender and partner to FSC and increased its commitment towards syndicated credit facility led by ING, making them one of largest lenders in the facility.

And now I'm going to turn the call over to our CFO, Alex Frank.

Alexander Frank

Thank you, Bernie. We ended our fourth quarter of fiscal 2013 with total assets of $2.1 billion, including portfolio investments of $1.9 billion at fair value and we had available cash on hand of $147.4 million. Net asset value per share was $9.85 at quarter end.

For the three months ended September 30, 2013, total investment income was $57.1 million. Net payment in kind interest or PIK accruals recorded in excess of PIK payments received, which is a key indicator of earnings quality was a low $2 million for the quarter or only 3.4% of total investment income. Net investment income increased 28.6% to $28.7 million for the quarter as compared to $22.3 million in the same quarter of the previous year.

We exited six portfolio companies in the quarter, all of which were exited at or above par and in line with previous fair value marks. The credit quality of the portfolio was excellent as net realized and unrealized losses were $2.6 million or only 0.1% of the investment portfolio.

The weighted average yield on our debt investments remained steady at 11.1% with the cash component of the yield making up 10%. The average size of the portfolio debt investment was $22.1 million at September 30, 2013, an increase from $19.7 million at the prior yearend.

We had gross originations of over $307.4 million in the quarter in 10 new and seven existing portfolio companies, bringing the total companies in our portfolio to 99 at September 30, 2013. During the quarter we also received a $176.5 million in connection with the exits of six of our debt investments.

Approximately 95% of the portfolio by fair value consisted of debt investments with 78% of the portfolio invested in senior secured loans and 67% of the debt portfolio consisting of floating rate securities. The investment portfolio continues to be very well diversified by industry sponsor and individual company.

Our largest single exposure continues to be healthcare, including pharmaceuticals at 21% of the total portfolio. Our investment in HFG, our Healthcare Finance portfolio company and largest single exposure represents 5.6% of total assets and our top 10 investments represent 32% of total assets, down from 35% at June 30, 2013.

The credit profile of the investment portfolio is as strong as ever. A 100% of the portfolio was ranked in the highest one and two category, which is favorable versus previous quarter and year ago period. During the quarter ended September 30, 2013, we had no investments in the portfolio on which we had stopped accruing income as compared to one at September 30, 2012.

Now, I will turn it back to Dean.

Dean Choksi

Thank you, Alex. In Len's remarks, he talked about our ability to generate attractive risk adjusted returns and unitranche loans, particularly for larger borrowers. I will take a few minutes to expand on his comments and explain why we believe we generate alpha in this type of loan.

A unitranche loan is where there is only one intercreditor agreement. In contrast, a more traditional debt structure with first lien debt provided by a bank and second-lien into our mezzanine debt provided by another lender. Normally includes at least two sets of intercreditor agreements, detailing the rights among the different lenders.

When Fifth Street offers a sponsor a unitranche solution, we are generally the only provider of debt. This type of financing solution offer several benefits to borrowers, which is why a unitranche loan pricing, makes net a premium over a combination of senior and mezzanine debt.

One, streamline negotiations, because there is typically one lender and no intercreditor agreement among the separate lending groups. The time and legal costs incurred to negotiate the documents are less than in traditional, senior and mezzanine debt solution.

Two, certainty of close. With only one lender, the sponsor has a higher degree of certainty to close within a specified timeframe as previously agreed upon terms. This is not always the case when dealing with a syndicate or a club, where certainty of close and terms can change throughout the process. This is an advantage for a sponsor, particularly when they are bidding for an acquisition.

Three, flexibility. With only one lender involved, it is easier to customize loan terms regarding amortization, covenants and pre-payments and origination and to make changes over the life of the loan. The flexibility enables the borrower to customize the loan specifically for the business and strategy. At Fifth Street, we take a partnership approach to lending by proving customized financing solutions, appropriately priced for risk.

After 15 years of lending to middle market companies we focus on lending to borrowers that value our partnership approach, not to achieve the source of capital. Over time, we believe lending to these sponsors should minimize losses, while generating attractive returns.

Thank you for joining us on today's call. Celia, please open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) First question comes from the line of Greg Mason, KBW.

Greg Mason - KBW

Len, I'm a little surprised, last quarter you laid out your five-point plan to grow earnings, get earnings back up to covering the dividend. This quarter the earnings fell and the dividend was cut. I'm just surprised, of that kind of move after outlining that five-point plan last quarter. Could you just give us kind of the thought process behind that? And why, at least the five-point plan hasn't started kicking-in yet?

Leonard Tannenbaum

It's been extremely frustrating. The five-point plan including capital -- capital markets takes time to syndicate down transactions, win deals to syndicate, actually gets skim income. Venture capital takes time to ramp and get out there as a venture capital lender. I mean the ramp up time could be six to 12 months on both. I think capital markets have played a big part in this quarter. But I think the most frustrating part is earlier in the quarter, we've actually thought that we were going to earn a lot more money.

But having early prepayments early in the quarter, which means we have lower average balance during the quarter, and therefore higher unused fees, and then we closed deals at the end of the quarter, we had a lousy net origination number of $120 million, because deals slipped into October.

And as originator, that that's private equity, we just have no control over when these deals close. It's up to the private equity sponsors. As you could see that once they closed the October quarter, they closed $400 million something of gross originations already this quarter.

So we had an earnings push and at $0.24 -- the Board looked at $0.24 versus our dividend level, and said, all right, we just have not earned our dividend for several quarters and we have to put it at least temporarily in line with the current earnings level. And if we earned more than the dividend, we can change that.

I think the other major part of this is the rating agencies have written consistently about the importance of having dividends in line with earnings. And we are focused, we think we are a differentiated triple B minus company with S&P and Fitch, and we are very focused on trying to do everything we can to improve our ratings. And that we think this is a key factor that's necessary to do that.

Greg Mason - KBW

So obviously you've put out your dividend well in advance, now of what you're going to be doing and you've done that in the past. As you've been thinking about the dividend planning, did you know that you are going to be reducing this dividend when you did your offering at the end of September, less than two months ago?

Leonard Tannenbaum

Absolutely not. As I said, we actually thought we're having a much better quarter at that time and it’s just amazing how things change. This is why we don't give guidance anymore until we really do know. It's very, very volatile and deals that you think are closing between September 15, everything closes at the end of quarters.

Except magically we had a big quarter this quarter in October because things were supposed to close at the end of the quarter and got pushed into October. So I mean to put in perspective, right, a $100 million in deals, add a 2% OID is $2 million. And so it materially affects the quarter for every hundred millions of deals that push from one quarter to the other.

Greg Mason - KBW

And then, I think Alex talked about and you've talked about this in the past that you've moved to more first lien safer yielding assets in this environment. When the Board meets in January, do you think there is going to be any discussions around maybe 2 and 20 isn't the appropriate fee structure for these lower yielding assets? Obviously, you've got a much lower fee structure in Fifth Street floating rate, not that that's were these yields are, but clearly focusing more on the first lien is difficult to making yields, so any thoughts around the fee structure with this lower yielding high-quality focus?

Leonard Tannenbaum

Apollo and us have dealt with the fee structure in different ways. We were focused on reducing our G&A expense. Our total cost, I think what you should see this year is an improvement in the G&A as percentage of assets and we're really focused on it. As that's not been highlighted, we actually returned $3 million in fees during the year, so we actually did charge effectively less than 2 and 20.

We are focused on lowering the cost structure, but what I will say is we really don't want any more yield degradation and to some ways around that, by back levering deals, by having higher capital markets business which is fee income without a management fee attached to it, it should generate a better ROE and ROA. So I know my scorecard, and I know we're going to have Analyst Day next year and I know what I have to achieve.

I am going to use our December and March financial figures scorecard. But as you've seen there's been numerous other dividend cuts in our industry, there should be probably more. And as some people are not earning their dividend or using other vehicles to dividend up the income that was saved up from previous years to maintain their dividend, and that will have to end at some point. So I think all of us are facing the same thing. Look it’s a competitive environment, we're all up against each other.

Operator

The next question comes from the line of Douglas Harter, Credit Suisse.

Douglas Harter - Credit Suisse

Just wanted to touch, you've mentioned now several times it's a very competitive environment. Sort of want to understand why you've raised so much capital? Why you're sitting on so much sort of excess liquidity if you view the environment is so competitive? Why not be running with less liquidity, less capital and look to maximize ROE in that environment?

Leonard Tannenbaum

I've always had the idea. First of all, this quarter it looks like, we're going to run very close to our target leverage by the end of the quarter. And I know that we've never hit target leverage before, and we're going to try to get rid of those naysayers. And we understood that stock would trade down with a dividend cut, that's fine. We don't sell stock that's discountable either.

So you don't have to worry about any offerings this quarter probably. And that's fine too, because what we're going to be able to do is we've started having to scrape liquidity basket. So we've actually prepared for the environment by having a lot of deals that we see the sellers syndicate and generate income that way and rotate.

And I think the model is to support sponsors through the cycle. Look, I've spent 15 years developing sponsor relationships, and we are at the menu of choice to our sponsors. And we'll continue supporting our sponsors in any part of the cycle. Having said that, we're going to make sure the risk adjusted returns are there, that the equity in each deal is 30% to 50%. And as we think the market gets frothy and it goes to 10 x, we're just not going to lend past 5 x or 4.5 x.

So we understand that FSC has been viewed as a low-beta player, a safer bet, a lower leveraged bet, a higher credit quality thing, and sometimes our investors are frustrating that we're not reaching for yield or OpEx securities to drum-up the dividend or drum-up net investment income, we're just not going to do that. We're happy in our positioning. We're happy the way we run the company. We're happy providing the stuff to our sponsors. We're really targeting almost a zero non-accrual rate. And I think that's much more important to me than earning incremental dollar.

Operator

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

Robert Dodd - Raymond James

Just to kind of extend on Greg's comment, a little about the five-point plan, so you illustrated the reasons why essentially you had run out of patience on that and that's when the board had run out of patience, but that seems to be frankly a bit of an accidental time, in terms of couple of deals were late and for that reason a plan that have been laid out very carefully last quarter with a lot of detail, et cetera, was set aside because of a couple of things that didn't go coincidently, unfortunate timing by couple of weeks.

I mean that seems a lot of rapid reaction. So I mean is there anymore color in terms of do you expect more of these repayments, et cetera, in terms of how much the activity that you're seeing in December is refis that obviously you're going to syndicate and do some back levering, if you can, but are we just going to see between the elevated repayments even in the first fiscal quarter this year?

Leonard Tannenbaum

So I think spread compression is greater than expected. No question about it, because instead of going six times deep or seven times deep, like some lenders are doing, we're just not doing yet. We rather would be cheaper and stay high in the structure and stay safer.

Having said that, I think you're right, this quarter should benefit from the deals being closed early into the quarter. But even at $0.26 or $0.27 or whatever number, I mean we had a $0.28 dividend, right. And the board in the medium term, it's a not a quarter results, we have not earned our dividend for the past several quarters. There has to come a time, where you earn or siege your dividend, you accrete NAV per share. If you continue to lose NAV per share, which is the differential of earning, your dividend every quarter, you're losing your earning assets.

If the shareholders ever want stock appreciation, we have to increase our asset base per share. And the only way to do that is by earning a dividend, and that's really the base way. And we may have some equity gains, we may have some other things, but the goal is to actually stop the NAV slide, which I think we've done, but the actual idea is to accrete NAV overtime, even if it's slightly, so that we can start getting a better share price and a better return on equity and return on assets.

Robert Dodd - Raymond James

One follow-up. On the expectations that you're going to earn $1 or greater than $1 of NII in 2014. Obviously as you said, maybe you'll hit target leverage by the end of the year. It's not something that's been sustained generally. What's the implicit average leverage, if you will for 2014 to get to that number that you're using in your estimations?

Leonard Tannenbaum

To earn more than $1?

Robert Dodd - Raymond James

Yes.

Leonard Tannenbaum

I think we could actually run lower than target leverage and earn our $1. But the idea is not to cut the dividend twice, right. The idea is to get the dividend between a number that you can meet or exceed. And so I think most analyst had $1.04-ish as an estimate for next year. So I don't think that that's far off from where we are today.

I mean it could be $1 or it could be more than that sure, but $1.04 and your $1.15 dividend rate, you have a disconnect. And what we didn't want is the constant rating by every analyst and the constant comments of, boy, it's another quarter, they don't have dividends, and its net asset value pressure down, it has to end.

And I think, we're really paying attention to, as investment grade credit, we really are paying attention to our credit ratings. This will cycle again at some point. And I would like to be a little bit higher rated than we are, even though we're double investment grade, because I think it's very important to be positioned into the next cycle. And I've always had that attitude, I can't tell you when the cycle is going to come, otherwise I'd be in a different business.

Operator

The next question comes from the line of Andrew Kerai, National Securities.

Andrew Kerai - National Securities

First question, just a housekeeping item. The administrator expense that was negative 69,000, if you strip that out, you guys get to $0.23 NII for the quarter. Can you just tell me, I guess was that just a one-time reversal or what exactly was that contract expense item?

Alexander Frank

Our significant portion of the compensation that we paid people is discretionary and we determine that compensation at the end of the year. So we make accruals over the course of the year. And we true that up at the end of the year. And the compensation came out a little bit lower than we anticipated in terms of what FSC was allocated.

Andrew Kerai - National Securities

And then, just two, kind of looking at the SBA leverage, right. So this is the fourth quarter in row, you guys have been under the $225 million allotted. I mean this is clearly accretive capital. If you can just give us some sort of sense as to why it's been trending below the $225 million for so long? And if you guys intend it to take that up and get the remaining $44 million of that over the next quarter or two?

Leonard Tannenbaum

It's even more frustrating than what you just said, because what happened in Fund I. So there is two funds, this I with a $150 million leverage and other one $75 million. Earlier in the year, I mean fortunately for us, a lot of the repayments at Fund I, we actually in the year, we were holding $60 million of cash. My CFO is raising his hand, more than $60 million of cash in Fund I. And to the deploy these, remember you can't just deploy in one deal, they have to spread out, because there is a limitation to how much you can put in each deal, and they have to qualify.

So our first idea was to use the cash, right. We're paying 4% on cash earnings zero. This cash is trapped there. We can't take it out of the SPV and so we got that deployed and this quarter we're finally deploying into the second license, but even that is $11 million maximum at a time. And so that takes time, but with the new venture lending initiative, and almost every venture lending deal fitting the SBA, I feel good that we'll get there in the near future.

Andrew Kerai - National Securities

And then, just the last question I have, sort of the $660 million-plus that you have, sort of closed in calendar Q4 so far. Can you just give us a sense of what the yields are on those deals, kind of compared to your current weighted average portfolio yield?

Leonard Tannenbaum

It's consistent with about 10.5% or 11%. Look, the idea it's $400 million-something funded, which is the more important number. But it's consistent with the 10.5% to 11%. Look we didn't want yield degradation from 12%, now we're at 11%. We really would like to stop this. And so we can do that in a bunch of ways and we're going to have to do it.

And one way we actually earn the money is some times when we do a 9% one-stop or 8% one-stop, we'll just syndicate down enough of it to make the IRR go up, and so that's a net up in captured administrative fees. So I mean there is other ways we're using this environment to generate extra income for the shareholders.

Andrew Kerai - National Securities

And then I just had one last question as well. So if you look at the leverage ratio on sort of your kind of investment category too, kind of you're performing in lien loans. I mean that has crept up a little bit. I mean, if you look a year ago it were at about 4.7x or so. Now, I mean certainly there has been some pressure on deal structures I think across middle market lending. But can you kind of comment of sort of that 4.7x maybe 5x range is kind of way down the line in terms of sort of you appetite to when you're sort of looking at the underwriting on these new deals?

Leonard Tannenbaum

So I think there is a couple of dynamics. First of all the average portfolio is not for 4.7x, right, it's 4.5x to 4.7x, which is the blend of the ones and twos, which is what we have. The ones, when you think of our ones in the portfolio, those are the ones most dangerous to repay. So you see those leveraged at 2.67x. And the reason they're at 2.67x is they had a lot of amortization, they've done well. So their leverage ratio is dropped, while new loans have not started to amortize. In fact, in the first year it's very lighter than any amortization, almost every one of our loans.

But as they start amortizing in year two and/or start performing, that leverage ratio drops. So a lot of why you see the leverage ratio increase is simply the fact that we've replaced unfortunately for us, right, a lot of the old loans with new loans, but we really have not been more aggressive in the market. We're really still on average, coming in at around 4x, 5x to start. And at 4x, 5x, we hope to get that number delevered overtime by amortization and by amortization and hope that company grow in at least modestly.

Operator

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

Casey Alexander - Gilford Securities

The 78% of the portfolio that is senior debt, do you have the breakdown of first lien to second lien in that?

Leonard Tannenbaum

It's in the 10-K. It's individually into our investment. Some of the other BDCs are confirming to senior secured and the other differential, as you know, Casey, is second lien loans in the upper market, it's mostly first lien loans obviously, but second lien loans in the upper market are very different than second lien loans in down market, which is very different than mezzanine anywhere. So I think the more important disclosure is senior secured, which a number of other BDCs follow that disclosure.

Casey Alexander - Gilford Securities

Now, as you said a bunch of deal slipped over into the fourth quarter, as we can see based upon what you've funded already. But usually, Fifth Street's past experience has been a big rush at yearend. Do you see that happening again this year?

Leonard Tannenbaum

I think we've already had it. I mean we have a lot of it. I think it's very spread out this year. There is no rush to December. There is no magic to December. So we've seen October extremely busy and November extremely busy and we're seeing December extremely busy. So it's more spread out than years past. There is no magical past change or any reason why deals have to close, and so it's more spread out.

Casey Alexander - Gilford Securities

In relation to the new share repurchase plan, there is a calculus to when buying your stock is a better deal for shareholders than putting money in a new deal. What level of discount do you think that is?

Leonard Tannenbaum

I'm not giving a discount, because then I'm tipping my hand as to where I'm going to buy the stock. But we're one of the few BDCs I believe that's actually bought in things. When the convertible bond traded to 85, even 90, even 95, I bought it in, and I bought in $35 million back in 2008, 2009. I bought in stock. I mean I saw Solar buy at a very small discount to book. We haven't really decided what the appropriate discount to book is, but I know when I tip my hands even if I had decided.

Operator

The next question comes from the line of Ron Jewsikow, Wells Fargo Securities.

Ron Jewsikow - Wells Fargo Securities

On the AdVenture deal that you syndicated a little bit post-quarter end, could you give us a sense of kind of the yield enhancement and the yield the investors are receiving on that 20% slice?

Leonard Tannenbaum

On the $20 million that we sold?

Ron Jewsikow - Wells Fargo Securities

Yes.

Leonard Tannenbaum

So we sold, apparently just a slice, but we're actually working on back levering that same yield, that we'll back-lever to the benefit of the entity that we sold it to. But we do receive skim income, right. We receive a portion of the points upfront as a fee. And then, obviously no risk attached to that. So it's positive for the shareholders and that they're getting more fees without risk.

Ron Jewsikow - Wells Fargo Securities

And then, just on the quarter-to-date originations, I appreciate the yield color. But could you give us a sense of kind of the first lien, second lien maybe venture and aircraft breakout in that, is it similar to this quarter?

Leonard Tannenbaum

Venture and aircraft, everything takes time to ramp, right. Venture and aircraft are still a very, very small piece of the portfolio. And so that that's not really where anything is driving, it is all just basic unitranche originations from private equity sponsors. In fact, I would argue as a bigger first lien mix probably in this quarter. So it's a normal first lien mix in the quarter, but it's a normal mix from sponsors really that's driving this course of originations.

Operator

The next question comes from the line of David Miyazaki, Confluence Investment Management.

David Miyazaki - Confluence Investment Management

I'd like to just follow-up a little bit on a comment that Bernie referenced with regard to return requirements and sort of related to what Greg and Robert also asked about was, when you look at the current environment and your business model, what do you think is a reasonable rate of return on the equity?

Leonard Tannenbaum

We've had that discussion overtime. Look, we're not that far, right, if I am just saying no to everything and when putting in a floor, and I've hit that floor a couple of times over the 15 years I've been investing, over five years now as a public entity. And we're going to say now we're very near to where we are and we have helped align.

Fortunately, some of the sponsors, in one case, from even our competitive BDC, it was a LIBOR 6%, 50 deal at 100% floor and we wanted a LIBOR 7.25% at 100% floor. So we got a premium even over that, as the product responses today. We'd much rather work with Fifth Street, we've done three deals with you and we just don't trust those other BDC.

So we're winning some really interesting deals, but we're hoping a lot, it's just that we're not matching the pricing that we want to come into close. And I think we're really at that stage. There has to be a minimum yield, and unfortunately I've pushed out my credit facilities to $225 million, so that I have a little bit better leverage.

I think we've indicated we're going to attempt to hit the unsecured market. So that's going to be an interesting data point in terms of our borrowing capacity and our leverage capacity, in terms of what yields we have, but there is no doubt about it, David, that yields are depressing in this type of entity that we are not going to be able to do much lower than what we're doing.

David Miyazaki - Confluence Investment Management

I think that it is certainly a challenge that every bond investor is going to be facing, when rates decline and remain low for an extended period of time. If credit is available there is going to be a lot of refinancing, a lot of natural deleveraging, but if I had to still, what you've communicated today, it's just really basic points, that if you think you're going to be able to earn next year $1 in NII, then that indicates off of your current net asset value just for round numbers, about a 10% return on the equity.

And if subtract out, where you're managerial fee 2 and 20 is, and if you take out your G&A expense, and if you take out the loss assumptions, its just really hard to see how a LIBOR of 6.5% with a 1% floor is going to get up to that ROE level?

Leonard Tannenbaum

But we don't do that one, right, so that's below the threshold. We did about a 100 basis points higher, and then what we have to do is either back-lever them, so it doesn't come into that. We have to reduce the amount of assets that hit the management fee is the idea. So while we're not going to do a fee reduction, it will be an effect. You're not wrong in saying, those yields, you can't charge a management fee on all assets. And the way you do that, it's by back levering, so effectively we were managing an asset, but half of the asset hitting the management fee.

You're syndicating down assets. It will hit the incentive fee, of course, but it will not hit the management fee. You syndicate down assets, same idea you're collecting extra income from syndication fees or the agency fees by managing assets, but not having those assets on the books, therefore not hitting the management fee. You have to generate revenue in HFG, which doesn't hit the management fee compared to the amount of assets that they have, so that you can generate ROE that way.

So there is lots of different ways to do it, and including the fact that we're going to focus on G&A leverage and some other ways to reduce to lower the fee structure. Having said that, that's what we're going to do have to do. We're going to have to do a 10%. I think that's right, we're have to do a 10% return on equity and we're going to have to focus on doing that. And we're going to have to utilize all of those different tools to get there.

David Miyazaki - Confluence Investment Management

It does seem though that you sort of a created a pretty steep uphill challenge for yourself, given that the amount of capital you have to put to work, and even though leakage around things like unused capacity on your credit facilities or just putting them in place, and paying the fees to get them set, or as you referenced, the trapped cash in SBIC's, that all of these things are situations that are going to dilute your return on equity, because there is cost associated with it.

And then from our perspective, the shareholders, it's little hard to get our arms around really what is the reasonable return on equity expectation, because when you take things, assets, and you're not applying a managerial fee to it, those are the things that you might be able to see, but as we look forward into 2014 and beyond, it's hard to know how you're moving those assets around, in such a way to effectively lower your management fee when the explicit fee we see at the 2 and 20 level.

Leonard Tannenbaum

I hear you. I mean you're going to see that in overall cost structure and overall leverage, in total cost versus leverage and you'll see those. But look I agree with you, we've hit some as well. This year has been really frustrating, especially the $60 millions of cash trapped. I never even thought I was going to face that. I planned for facing it. And you learn these lessons, which I'm saying is a good thing. But you're right, remember a lot of the unused fees by the way, the credit facilities are matched by the unused fees collected by the credit lines we have outstandings, we collect on those too. And those are not hitting the management fees.

So there is a lot of offsets to what you just said, but I agree with you, better utilization of leverage, which we're now able to do, because you're able to quickly basket that you can manage liquidity with having SBA being fully functional, which I think we've gotten to that point. I'm sure as you pointed, there probably will be another problem that I'm not foreseeing, and I can't predict those things, but I think we've addressed the ones that we've actually learnt lessons on.

Operator

At this time, we're going to turn the call back over to Mr. Dean Choksi for closing remarks. Please proceed, sir.

Dean Choksi

Thank you, Celia, and thank you for joining us on today's earnings call.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.

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