Fifth Street Finance Corp. F1Q10 (Qtr End 12/31/09) Earnings Call Transcript

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Fifth Street Finance Corp. (NYSE:FSC)

F1Q10 (Qtr End 12/31/09) Earnings Call Transcript

February 10, 2010 10:00 am ET

Executives

Stacey Thorne - Director, Head of IR

Leonard Tannenbaum - CEO and President

Bernard Berman - EVP, Secretary, and Chief Compliance Officer

William Craig - CFO

Analysts

John [ph] - Stifel Nicholas

Chris Harris - Wells Fargo Securities

Joe [ph] - Morgan, Keegan & Company

Jeff Robert - Macquarie Capital

Casey Alexander - Gilford Securities

Jim Ballan - Lazard Capital

David Chiaverini - BMO Capital Markets

Keith Rosenbloom - CARE Capital Group

Operator

Good day everyone and welcome to today’s Fifth Street Finance Corp. first quarter 2010 earnings conference call. As a reminder, today’s conference is being recorded. I would like to turn the conference over to Ms Stacey Thorne, Head of Investor Relations. Please go ahead.

Stacey Thorne

Thank you. Good morning and welcome everyone. My name is Stacey Thorne and I am the Head of Investor Relations. This is the conference call to discuss the results for Fifth Street Finance Corp. for the quarter ended December 31, 2009.

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

Before I begin, I would like to point out that this call is being recorded. Replay information is included in our Press Release released yesterday and is posted on our Web site. Please note that this call is the property of Fifth Street Finance Corp. Any unauthorized rebroadcast of this call of any form is strictly prohibited.

Before we go into our earnings, I would like to call your attention to the customary Safe Harbor disclosure in our Press Release done yesterday, February 9, 2010 regarding forward-looking information. Today’s conference call includes forward-looking statements and projections and we ask that you refer to our most recent filings with the SEC for important factors that would cause actual results to differ materially from these projections. We do not undertake to update our forward-looking statements, unless required by law. To obtain copies of our latest SEC filings, please visit our Web site or call Investor Relations at 914-286-6811.

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

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

Leonard Tannenbaum

Thanks Stacey. From an economic standpoint, we continued to see stability. We also see the prospects for continued ramp in mergers and acquisition activity. As both strategic investors and private equity firms increase their activity, we expect loan demand in the middle market to accelerate. Fortunately for our business, there continues to be a limited amount of our competitors that can complete a transaction for the private equity sponsors without any syndication risk. This provides us with some additional pricing power and the ability to capture market share.

Increased mergers and acquisition activity has also allowed us and our private equity partners to sell a division of one of our portfolio companies Best Vinyl to a strategic investor. In addition another portfolio company TBA was able to sell a division that was breakeven in EBITDA to another competitor, a different competitor.

In the case of TBA in the last few days, we received a paydown of $2.5 million on our second lien loan with another $500,000 expected in the near future. It has been proactive portfolio management and a partnership approach with our private equity firms that allowed us to successfully navigate a very challenging environment. I am pleased to report that category three, four, and five rated securities account for less than 7% of the portfolio.

The first fiscal quarter of 2010 ending December 31, 2009 was very robust from an origination standpoint. During the December quarter we originated $144 million worth of deals. 100% of those were first lien and about 50% of those were floating rate loans. Recently our SBIC subsidiary received its SBA license, which Bernie will talk more about later. On average, these new investments have about 50% sponsor equity and rollover equity, IRRs in the mid teens, and just under 50% of loan amounts are floating with a LIBOR floor of approximately 3%.

On average, debt to EBITDA of the recent deals that we have closed is about 3.3 points deep. The increase in floating rate loans with floors will begin to serve at the hedge against a substantial increase in interest rates over the coming years. Our SBA leverage will also serve at the hedge against rising inflation and interest rates as the interest rate on that piece of debt is fixed for ten years. Although Fifth Street originates 100% of our securities, we have partnered with Ares Capital on one of the loans, and we have syndicated $7 million of our largest exposure to our partners in Unitran [ph].

We will continue to use financing partners to provide diversification in the portfolio. Our pipeline of loans remained strong at over $1.3 billion. We continue to expect a high conversion of our pipeline into signed term sheets due to our ability to commit to the entire loan without syndication risk by utilizing both our credit lines and the SBA facilities, and the desire for sellers to close by the end of the year due to the increase in the tax rates next year. We believe that these events coupled with our strong brand relationships have allowed us to capture premium pricing over the markets. We believe the opportunities in the middle market are large and growing as lenders still have not return to the middle market with substantial capital and in fact several have exited. We plan on continuing to take advantage of this environment to gain market share with top core top private equity sponsors as well as capture strong risk adjusted returns.

I am pleased to announce that we have achieved our goal that we set out last year of having 65% of the portfolio in the first three months. We currently have about 66% of the portfolio in the first lien loans taking December 31, 2009 fair value and adding our recent transactions. We believe that first lien loans are substantially safer than second lien and unsecured loans. We are pleased that the portfolio is well positioned to sustain an economic decline as well as benefit from an economic expansion. As our pipeline consists predominantly of the first lien loans, I expect this percentage to continue to increase to about 75% by the end of 2010. This strong first lien position coupled with further diversification and expansion of assets should position Fifth Street favorably to reduce its cost of capital over time. Another advantage for us is that our investment portfolio has a vast majority of loans generated in the recent credit dislocation thus providing strong risk adjusted return characteristics.

Our Board of Directors declared a 11% increase in the dividend this quarter to $0.30, which was up from $0.27 in the previous quarter, and $0.25 in the quarter before that. Due to the increased pace of originations just noted coupled with the use of leverage, we anticipate that dividend should continue to increase during 2010. As a (inaudible) we target a payout of between 90% and 100% of distributable income. Our distributable income per share for the quarter ended December 31, 2009 was $0.35. As the velocity of deals begins to return to normal, we expect to be able to realize some of our $7.8 million in exit fees. We also began to treat [ph] exit fees into income as appropriate. Our substantial prepayment penalties should allow us to retain many of our good loans as the credit market continues to recover.

Over the coming monthly newsletters, I look forward to highlighting what I expect will be several key hires to complement our team. We are continuing our hiring process to add to our underwriting portfolio management and marketing divisions and look forward to continue to deliver a strong product offering to the private equity community along with growing returns to our shareholders.

I want to thank our investors for their strong response to our recent offering. The Board and I are very pleased with Fifth Street’s ability to issue stock at a premium to NAV. Unlike many other BDCs, we are not seeking approval to sell shares for low NAV at the next shareholder meeting. I believe that it takes a very accretive opportunity to (inaudible) the investors to allow a BDC to issue shares for low book. As one of the leading firms of capital to deploy in the middle market both through use of our credit lines and SBA leverage, we look forward to levering our assets modestly to enhance investors’ returns.

I want to thank my partner Bernie Berman who has successfully navigated the important SBA process that we began in November 2008. To talk about where we are with the SBA licensing process and the deployment of our SBA equity capital, I would like to hand the call over to Bernie.

Bernard Berman

Thanks Len. We are very pleased to announce that our SBIC subsidiary’s license was approved as of February 1. We are now waiting for our capital commitment, which we expect to receive in the next few weeks. Once we receive the capital commitment, we will be able to begin accessing SBA leverage. We expect that we will be able to access up to $37.5 million in leverage upon the receipt of capital commitment and the balance of the commitment upon the completion of our first examination by the SBA. We are in the process of requesting an early examination in order to expedite our ability to access the full capital commitment.

Our SBIC subsidiary has invested $73 million of its $75 million in regulatory capital with the other $2 million held in cash. Over time, we expect to be able to access $150 million in leverage, which is the maximum permitted by current law. We are excited to be part of the SBIC program and look forward to a long partnership with the SBA. We are also working on a new credit facility, which will provide us to leverage against our existing portfolio including our second lien loans. We expect to make the formal announcement in the near future.

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

William Craig

Thanks Bernie. With respect to our balance sheet as of December 31, 2009, total assets were $453.2 million, which included total investments of $436.7 million at fair value and cash and cash equivalents of $11.8 million. Liabilities were $42.9 million, which included a loan payable of $38 million and stockholders’ equity was $410.3 million. With our offering in January, we have since paid down that loan payable and are now unlevered. Our net asset value per share at December 31, 2009 was $10.82.

With respect to our operations, total investment income for the three months ended December 31, 2009 was approximately $13.2 million, which included approximately $2 million of PIK interest and $0.9 million of fee income, which included approximately $27,000 of income from accrued exit fees. For the three months ended December 31, 2009, we recorded net unrealized appreciation of $1 million. This consisted of $1.2 million of net unrealized appreciation on debt investments, partially offset by $0.2 million of net unrealized depreciation on equity investments. We also recorded $0.1 million of realized gains.

As Len mentioned earlier, we are actively moving towards larger and more secure first lien transactions as evidenced by the following. Our weighted average yield on investments was 15.7% at September 30, 2009, which included a cash component of 12.9%. Our average portfolio company investment at September 30, 2009 was $11.5 million. This compared to the current quarter, our weighted average yield on investments was 14.9% at December 31, 2009, which included a cash component of 12.7%. Our average portfolio company investment at December 31, 2009 was $14.6 million. At December 31, 2009, our portfolio consisted of investments in 32 companies. At fair value, 64.3% were first lien loans, 34.9% were second lien loans, and 0.8% were equity investments.

At December 31, 2009 approximately 19% of our debt investment portfolio at fair value bore interest at floating rates. All of our floating rate loans carry a minimum interest floor of at least 9%, which protects our return in a low rate environment and also serves as a hedge. During the quarter ended December 31, 2009, we invested $144.2 million across four new and three existing portfolio companies.

With respect to the portfolio, it is holding steady. As of December 31, 2009 we had stopped accruing PIK interest and original issue discount on five investments including two investments that had not paid their scheduled monthly cash interest payments. With respect to our ratings at December 31, 2009, the distribution of our debt investments on the one-to-five rating scale at fair value was as follows. The percentage of one and two rated securities for the quarter ended December 31, 2009 was 93.3% in comparison to 92.6% as of September 30, 2009. We are closely monitoring all of our investments and continue to provide managerial assistance as proactively as possible.

With that, let me turn it back over to Stacey.

Stacey Thorne

Thanks Bill. As a reminder for the month, Fifth Street does not report quarterly earnings. We release a monthly newsletter. If you would like to be added to our mailing list and receive these communications directly, please either call me at 914-286-6811 or send a request e-mail to ir@fifthstreetcap.com.

Alternatively, e-mail letters can be sent through the shareholder tools link under the Investor Relations tab on our Web site, www.fifthstreetfinance.com.

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

Question-and-Answer Session

Operator

(Operator instructions) We will take our first question from Greg Mason at Stifel Nicholas. Please go ahead.

John - Stifel Nicholas

Good morning, this is John [ph] filling in for Greg. Len you mentioned in your remarks that distributable income was $0.35 versus the $0.30 dividend, could you tell us what your options are with that excess distributable income?

Leonard Tannenbaum

We did carry over some income year-over-year and did pay some excise tax because many of the deals close at the end of December and there was really no way to declare a dividend in time to sort of moderate that. Clearly the dividend has to go higher during 2010 to slow towards our target of 90% to 100%. We probably will have to carry over income again year over year from this year into next year. A lot of the dividend growth depends on continued origination and portfolio continuing to be stable or slightly increasing. So this is what we are currently seeing.

John - Stifel Nicholas

No it will offset realized losses against that distributable income perhaps retain the capital.

Leonard Tannenbaum

Will we do more charge-offs, is that the question?

John - Stifel Nicholas

Yes.

Leonard Tannenbaum

We do not anticipate doing any more charge-offs. To do a charge-off takes a very high degree of certainty on a tax rate [ph] but in order to exclude it from taxable income, the threshold for taxable income and PIK non-accruals are two different thresholds. The PIK non-accrual threshold is much lower as my finance team is nodding towards me. So just because everything is on PIK non-accrual does not mean everything is at a taxable, distributable income. Though we tried it, it is too low a taxable distributable income by as much as we can. It is a different threshold.

John - Stifel Nicholas

Okay, turning to leverage, could you maybe give us some color on what you believe the appropriate leverage level is for your model?

Leonard Tannenbaum

I do not think we ever want to get towards the one-to-one leverage that the BDCs can max out at because what it does unfortunately is make it difficult to write down assets when you have credit lines outstanding because that would cause the one-to-one to get violated. My ideal leverage excluding our SBA leverage which we do anticipate we are going to get a relief from the SEC as many of the other BDCs have SBA leverage has gotten relief from the SEC to exclude that subsidiary from leverage requirement, I believe excluding that, the optimal balance is about 25 times lever, I think that has to fluctuate between 0.3 and 0.7 as you do small offerings to pay it down. Obviously the best use of capital for any offering is to pay down debt.

John - Stifel Nicholas

Okay and so given the $100 million facility you are currently working on in the Wells, can you say or maybe give us a road map of how you would plan to come up with the additional leverage near-to-medium term to come up to that 0.5 target?

Leonard Tannenbaum

I think you can assume that we can achieve an expansion to all facilities during the year up to $100 million, which we have already funded the subsidiary to accomplish and to assume a new $100 million facility which we should have the assets to be able to draw against, and we know eventually we are going to get through this $150 million of SBA leverage which we have been approved for or about to get a leverage approval for. And we have some cash on the balance sheet, we will be able to play between $300 million and $400 million this year without doing any additional offerings and that gets us to a little bit south, I think of 0.5, it gets us towards our target if we max the foot.

John - Stifel Nicholas

Thank you very much.

Operator

We will take our next question from Chris Harris at Wells Fargo Securities. Please go ahead.

Chris Harris - Wells Fargo Securities

Great, thank you, good morning everyone.

Leonard Tannenbaum

Good morning Chris.

Chris Harris - Wells Fargo Securities

Obviously origination is very strong here and your pipeline also looks great. I was just wondering, a lot of your competitors seem to be having difficulty generating primary opportunities and some of them have mentioned that that is probably a latter half 2010 event. And I was just wondering how you guys are differentiating yourselves here and how you are seeing so many opportunities when some of your other competitors seem to be kind of standing still from an originations perspective?

Leonard Tannenbaum

Yes we are seeing actually a lot of our competitors are calling us asking us to pick pieces of the securities that we just originated. So I think one of the big differentials in this market is the syndication market has not come back yet and the CLO market is starting to open but really has not come back yet. And there is basically two firms in our space that can take down a deal from an equity sponsor without any syndication risk, and the equity sponsors know that there is syndication risk and there is a lot of also battling back and forth between syndicate partners that we have seen. So they really want to just know their transaction is done and committed to and they are going to get their capital and the two firms that can do it are (inaudible) and I look forward on partnering on more things with them, they are a great shot. But, right now, I mean that competitive advantage is not only gaining us a little bit of pricing power but is winning us deals.

Chris Harris - Wells Fargo Securities

Okay that makes sense. You know, you have had a little bit of activity here since the end of the quarter, what kind of origination pay should we expect maybe for the balance of the quarter and maybe over the next couple of quarters?

Leonard Tannenbaum

I think the last quarter there were clearly a lot of deals being pulled in from this year into last year to close by December 31 as the administration potentially was raising some different taxes on this healthcare plan which got watered down. And I think I caused a lot of sellers to say we want to close by December 31. So we took that opportunity to capture a lot of great transactions at great pricing. I think this quarter will be slower. I know this quarter will be slower. The pipeline is pretty good. I think what you are hearing from the market in that M&A activity will increase as the year goes on is right because again you are going to have the capital gains increase from 15% to 20% and an income tax increase, I do not know, from 36% to 39% or 40% and I think those two things will drive additional M&A activity in the second-half of the year barring no economic increase. And we are basically looking at a flat year or budgeting our firm for a flat economic year, it could be better or worse but that is pretty much where we think the world is going this year. Therefore this quarter is going to be a bit slower. I think you will see an increase in the next quarter and increases each quarter after that.

Chris Harris - Wells Fargo Securities

Okay and then on the new $100 million facility, can you guys provide us with kind of a – is there a price talk range that you can kind of guide us towards or is it still too early to disclose any of that information?

Leonard Tannenbaum

No, I think the pricing – you saw the Ares transactions being announced where Wells I think did a $400 million facility and there was another very large facility that was done. I think Mike (inaudible) is very smart in what he is doing and we are following a little bit in his path as we have some of the same partners, we share all the same partners. The Wells Fargo, we are going to hopefully expand like he does, which is a separate facility, which we are hoping to expand just to $100 million line and the new facility should be, I think, around the same pricing, maybe a little bit higher. The good thing about the new facility, as Bernie said, maybe was not highlighted enough is it will give us leverage against second lien. So, as you know, we still have about one-third of the portfolio in second lien, none of those are in the Wells. Wells Fargo typically does not blend against second lien.

Chris Harris - Wells Fargo Securities

With the expansion of the Wells line, could we potentially see a better rate on that facility or the pricing will stay the same?

Leonard Tannenbaum

The pricing is LIBOR $400 with no floor and that is better than a lot of people and I think that is probably where it is going to be for the foreseeable future.

Chris Harris - Wells Fargo Securities

Okay and last question here then Leonard, I appreciate your comments about the hiring goals for the near term. I guess a few months ago there is a lot of talent seeking employment based on what happens on Wall Street, I am just curious to get your thoughts, are you still seeing a solid inflow of applications there? Maybe can you give us just a little color on what is happening?

Leonard Tannenbaum

Our hiring process and I actually use something called the top rating system, but our hiring process is very robust and anyone who has been through will attest to that. I mean, it takes us two to four months to hire someone as they go through competency interviews, tandem interviews, background searches, phone screens, all sorts of things. We are very careful to hire within our culture. We have a tight culture and we are also very careful about mis-hires.

Having said that, there has been a pipeline, you saw the hiring pipeline, which is I do not know almost a thousand people that have come through this pipeline in various positions, and as that is starting to funnel down, we are ending with some really great candidates and I feel confident in the next 30 days we will announce some of them, and we are also looking for another key hire, which is going to be chief risk officer and chief underwriting officer as we continue to grow and have multiple credit lines and build the very detailed – we have the detailed process and procedure but we are building the format that our credit line providers want to see.

We are going to hire this absolutely key hire, it is going to take a while for it but we are up there recruiting for it and everyone on the call know this grade chief risk office, underwriting officer. You can definitely send them our way but we feel really good about hires both in the portfolio management division, in the recruiting division, one with HR and so we are close on the number of really good hires.

Chris Harris - Wells Fargo Securities

Great, thanks Len.

Operator

We will take our next question from Robert Dodd of Morgan, Keegan & Company. Please go ahead.

Joe - Morgan, Keegan & Company

Hi guys, this is Joe [ph] in for Robert. A few questions here, could you give us an update on the five investments that are certainly not accruing on TIK?

Leonard Tannenbaum

We give you an update how?

Joe - Morgan, Keegan & Company

It looks like some of those assets are going from two or three to four and five, I was wondering if you have a little more color just in general on how they are doing.

Leonard Tannenbaum

So, no assets went, not that I know of, went from one or two. We view with two different baskets, and I apologize to say this on every call, we view ones and twos together as assets that are performing well and that they are not in the portfolio management positions hands in terms of working out or restructuring anything. We view assets in three baskets, three, four and five all together. They fluctuate between three, four and five quite often and I will take it with a grain of salt any moving between those three categories until it gets back to a category two, which means it is no longer on our watch list.

Every security in baskets three, four and five with the exception of one, which is Rose Tarlow is on PIK non-accrual. Rose Tarlow is not on PIK non-accrual, actually it is doing just fine, it is a basket three but we would like to also see things perform for an extended period of time before they would get back to basket two. So they stay on watch list. One of the ones that I want to say that is in three, four and five is our 95% owned company which is led by Gregory and just because it is in that basket does not mean it is not doing well.

Lighting by Gregory continues to actually perform really well, a little bit ahead of our plan, except when if you own something, we could pay ourselves, we cannot pay ourselves, we can pay ourselves all PIK some people do in say it is income, we determine not to do things like that. We are recognizing cash, sweet payments from Lighting by Gregory, so when they pay us cash we do recognize that. We recognize no PIK income from Lighting by Gregory. I do expect somewhere – if they continues to improve that we should be able to continue to get payments from them. So, actually baskets three, four and five are pretty stable. Portfolio management team now has the time to visit all of our two rated securities to determine and really go through all that analysis and that is what they are in the process of doing.

Joe - Morgan, Keegan & Company

Thank you. Another question on the accruing of exit income happening in this quarter and then going forward, is that going to be – how much really is that going to be going forward and can you give us a ballpark figure for this fiscal year?

Leonard Tannenbaum

Not sure. I think it will increase, I think it is safe to say that from $27,000 it has got to increase since we have $7.8 million of exit fees. And as a number of them – we do not have a history, the issue is we do not have a history of collecting exit fees. We would get an exit fee unless we thought it had some value but the issue is collectability and until we have a history of it, I do not think you are going to see it materially (inaudible) material but a large increase in the income from these exit fees. I almost think of it like a retailer, which has an uncollectible account against the collected mid receivables. We just do not have a history to determine what that uncollectible account should be. I think once you start seeing us recognize exit fees, and we started having a history of recognizing exit fees, and our auditors are going to say, okay, we need to take the history into account and change the amount we are recognizing.

Joe - Morgan, Keegan & Company

Thank you. And then you referred earlier, I might have missed this, $300 million to $400 million of new investments this year, is that calendar or is that fiscal?

Leonard Tannenbaum

I do not know that I said $300 million to $400 million of new investments this year, I said we had the capacity to originate $300 million to $400 million of new investments this year. I think on a quarterly basis, maybe excluding this quarter which is a bit slower as some of the deals got pulled into last year, we think $50 million to $100 million is a good budget on origination per quarter, and I think most of them are going to be if not best they predominantly will be first lien one-stop transactions because that is pretty much what is in our pipeline. I think maybe the (inaudible) second lien this year with sponsors that we have worked with before.

Joe - Morgan, Keegan & Company

Got you, thank you very much.

Operator

We will take our next question from Jeff Robert [ph] of Macquarie Capital. Please go ahead.

Jeff Robert - Macquarie Capital

Good morning gentlemen. Looking at your investment activity, it looks like you are still focusing in the dispensable industries. Could you just comment is that more of a macro view on where we are in the cycle or is that more just the best securities that you have seen at the right prices they have been in particular sectors?

Leonard Tannenbaum

From a weighting [ph] standpoint, we are healthcare overweight and always will be. At the BDC really with deep expertise in healthcare, and our previous funds, my fund two and fund one we had lots of healthcare exposure, we are hiring probably more consultants than ever before to go state by state and tell us how regulatory changes are working within the state and reimbursement rates in Medicare and Medicaid, so we just have probably have more information today than we have ever had in this sector.

So we feel really comfortable. We can expect that rating to stay between 30% and 50%, I think currently it is in the mid 30s, beyond that I am very conscious of diversifying among all the other industries whether it is food, consumer, manufacturing, etc, you are right in saying that a lot of the recent deals and probably a lot of deals have a recurrent nature to a lot of them. In some of them, and I just do want to mention this on the call, we even have, we do not have this necessarily in the queue, we do have guarantees on some of our securities, I have said this before on calls, especially when we work with a new sponsor and we want to make sure that their willingness and ability to react when a problem is there. And usually with our longer relationships they are less initial guarantees on that. There are usually lashed out guarantees from private equity funds.

So I do want to mention that we do have these things and we are very careful lenders. Look, as I am one of the large shareholders of the company and everybody here at least at the table and all in my Board own shares personally. We are very conscious to make sure that in any cycle we are going to do well and outperform. And that is why I think in my initial comments I said we are positioned probably better today for any economic downturn but we are also equally positioned for a nice economic upturn as we do have some substantial equity kickers and exit fees to gather.

Jeff Robert - Macquarie Capital

Okay thank you for the color. Could you just remind us in terms of the SBA license and the valuation as you said earlier, earlier evaluation, what is the normal timeline, about how many months would it be until an evaluation is complete? Under an earlier evaluation, when would you expect to see it will start to (inaudible) that leverage?

Leonard Tannenbaum

Okay, I am going to ask Bernie Berman to answer that question.

Bernard Berman

You know when you are dealing with a government agency, I am always cautious in putting specific dates because we have been told timelines before that have not always been met. But I expect that we will be able to get an early evaluation hopefully within the next few months and thereafter we will be able to access the balance of our commitment.

Jeff Robert - Macquarie Capital

Okay, thank you and then just one small question on the SBA again, if you got the exemption, which I am assuming you will, obviously the $150 million in borrowings will not be counted in your leverage on the debt bucket, just to clarify, the $75 million in equity in the subsidiary that is still in your equity bucket for your overall leverage calculation?

Bernard Berman

No, you cannot have it both ways. So effectively the way you could look at it is you would pull the subsidiary out of the calculation and look at it without the subsidiary.

Jeff Robert - Macquarie Capital

I understand, thank you guys very much.

Operator

We will take our next question from Casey Alexander of Gilford Securities.

Casey Alexander - Gilford Securities

Good morning.

Leonard Tannenbaum

Good morning.

Casey Alexander - Gilford Securities

Did you say exactly what the size of the portfolio pipeline is currently?

Leonard Tannenbaum

About $1.3 billion.

Casey Alexander - Gilford Securities

$1.3 billion, terrific. The investment on January 29, that kind of slipped through I assume that was kind of because of the quiet period from the offering, was there any syndication attached to that offering or did you guys do the entire deal yourselves?

Leonard Tannenbaum

I think it was a $22 million investment give or take a million or two, yes we held the entire deal ourselves.

Casey Alexander - Gilford Securities

So there was no syndication?

Leonard Tannenbaum

No.

Casey Alexander - Gilford Securities

Do you have any current term sheets under consideration right now?

Leonard Tannenbaum

That is a good question, I suppose these are modelling. Yes, we have term sheets under consideration but we do not have any signed term sheets I do not believe right now.

Casey Alexander - Gilford Securities

Okay, on the floaters, I know you have a 9% floor on them, what is the initial yield that those are going out at?

Leonard Tannenbaum

I mean, we just closed that at 7%, it is LIBOR plus 7 with a three floor, so it goes back to Bill’s comments, we at least are 9% or 10% on all of our floating rate securities.

Casey Alexander - Gilford Securities

Okay, alright, let me see, I had one question, on the SBA, when you start to lever into the SBA, if you do an offering, can you use that to delever the SBA pool or can you only delever that when a portfolio company pays down?

Leonard Tannenbaum

We are not planning to delever the SBA pool ever. The idea of the SBA pool is the seventh year recyclable pool capital. So as one pays down in that subsidiary, we can then redeploy that capital within seven years. And then the length of the SBA facility is ten years and it actually is expendable even beyond that under certain circumstances.

Casey Alexander - Gilford Securities

I see that G&A expenses are moving up and I assume that is related to your hiring pays, can we expect that to continue to move up during the year and any idea at sort of what rate?

Leonard Tannenbaum

I think you are going to finally see some G&A levered at least as a percentage of assets G&A should move down and the reasoning is the management fee, which is a constant on assets is paying for almost all of the new hires. Our base team is very critical is part of G&A or the expenses that are part of G&A will finally start getting leveraged over time as their assets grow.

Casey Alexander - Gilford Securities

Okay, alright great, that is all I have, thanks.

Operator

We will take our next question from Jim Ballan from Lazard Capital.

Jim Ballan - Lazard Capital

Okay, thanks a lot. One question I have is you mentioned the loan modifications in your press release, can you just talk generally kind of a typical order event that lead you to conclude that modifying the terms makes sense and then maybe talk about how frequently when you do a loan modification does that eventually lead to a loss or how frequent is that?

Leonard Tannenbaum

Let us see, it is 13 years that we have done this. It really varies. As a first step for us, physical in loans modifications where we are modifying the interest rate, it is obviously nobody really modifies a loan unless the loan is in distress and there are various reasons to do it though because there is multi-parties in a loan. The first thing for us, and I call it to bite the apple way of playing, is you take the secondary loan to the extent of second lien and you convert part of it to equity and you keep some of the interest and you encourage our equity sponsor partners to invest alongside that in the equity, and I think the most typical loan modification for us is that -- of course the bad news about it is over time you are reducing your interest income but the good news about that is the debt that you still have on the company is more stable, much more easily serviced and now you are capturing up with the upside.

So I expect, for example, Lighting by Gregory obviously was a loan modification. In fact, we own 95% of the company, at one point the EBITDA went to 0 and we worked hard and I think if you go visit our store in New York City down the Bowery, you will see the store is really nice. It was all re-done. A lot of money was put into it, not even by us but by the different venders and the sales have picked up and EBITDA is now insufficient not only to grow the business and to fund all of it internally but to pay us cash each quarter. So that is a loan modification but it takes portfolio management.

That is where my first hire, my first partner I brought on right around the time of Bernie was Mark Goodman our CIO with ten years of banking and law experience at Kramer, Levin and 10 to 15 years of turnaround experience, because we knew that there would be a couple of companies that we would have to have equity fighters in and help them turn around and make money, and I think we have been very successful doing it over time. Of course we have had our losses too and the difference is we take them right away. We write them down and at one point we actually take charge-offs in the truly distressed melt down and (inaudible).

Jim Ballan - Lazard Capital

Okay, great, that is helpful. Also this may be asking you to look a little far into the future, but on the SBA side, once you have fully levered that subsidiary and you are essentially rolling things through that as they pay back, do you have thoughts of creating a second SBIC subsidiary as they sort of -- most of it will go just into the BDC.

Leonard Tannenbaum

I note that many of the other BDCs with SBA subsidiaries have set up the second subsidiary. Currently the way they do it is you set up the second license, currently you can do that when you capture another $75 million of leverage. There are different bills floating through Congress that are going to expand on BDC’s ability to join with the SBA in doing loans to small companies. The timing of that is clearly uncertain, the timing of when would you benefit from that is clearly uncertain but I expect over the next couple of years this SBA subsidiary and license or its second license would definitely expand.

Jim Ballan - Lazard Capital

Okay great, thanks a lot Len.

Operator

We will take our next question from David Chiaverini at BMO Capital Markets.

David Chiaverini - BMO Capital Markets

Good morning guys, thanks for taking my question. Could you comment on the revenue and EBITDA trends of the portfolio?

Leonard Tannenbaum

The EBITDA trends is probably stable. I do not think it is getting a lot better or a lot worse. It got a bit better towards the end of last year and now I would just characterize it as stable and that along with revenue one thing that is getting better is liquidity, which is to a lender quite important. The reason liquidity is probably getting better and why the economy is not having jobs faster than everybody would like is people are very cautious on whether we are going to double dip, whether it is sustainable with the effect on increased tax rates, so pretty much throughout the portfolio we are seeing CEOs being very cautious with adding new costs, with adding new people, with adding new expenses, and because of that even though you are seeing slight revenue increases, you are definitely seeing more liquidity, they are also managing inventory very tightly. So we are experiencing better liquidity, probably stable revenue, and stable EBITDA and Mark is nodding his head to me, so that must be the right answer.

David Chiaverini - BMO Capital Markets

When you say better liquidity, are you talking about the portfolio company balance sheet where they have a bit more cash where they are paying down debt a little bit more, is that what you are referring to?

Leonard Tannenbaum

Yes, I think you are bringing up a good point, which I do not normally say on calls, almost a lot of our securities are amortizing down their debt and this happens every month. We get monthly cash payments, monthly amortization not quarterly as many of our competitors do. Sometimes we get quarterly amortization, we get monthly cash payments. Also as we pay our dividends, I also want to point out that our amortization exceeds our PIK and that is really key because when we pay out a dividend, we are paying up all cash that we are receiving and that is in contrary to some BDCs that have PIK that have to include that into their dividend and then they pay it out but they do not necessarily get the cash or have the realization. So we are very closely monitoring cash, cash payments, and so if the liquidity is increasing a little bit it is also because the debt is getting paid down, therefore less interest expense, therefore a little bit more liquidity.

David Chiaverini - BMO Capital Markets

Okay that is helpful. Thank you for that. Second question is related to the SBIC. Now once that is fully ramped and fully levered, will that be consolidated or will that be accounted as like a portfolio company?

Leonard Tannenbaum

It is consolidated now, it is always consolidated.

David Chiaverini - BMO Capital Markets

Okay, great, thanks a lot.

Operator

(Operator instructions) We will go next to Keith Rosenbloom at CARE Capital Group.

Keith Rosenbloom - CARE Capital Group

Hi guys, congratulations again Bernie, terrific job on the SBA license.

Bernard Berman

Thanks Keith.

Keith Rosenbloom - CARE Capital Group

Len, as you talked about moving into first liens, maybe you could speak a little about the equity checker environment that you are seeing, are you guys still able to get nice equity kickers on your loans, and how are you marking them in the portfolio?

Leonard Tannenbaum

So much of our equity has been marked down because unfortunately in some of the waterfall methods in valuation equity goes first, and even as Bill said for this last quarter, we saw a $1.2 million net unrealized increase but a $0.2 million decrease due to further write-downs in equity. So it is what it is. We are getting limited equity kickers, in fact we are working on a deal that we are actually going to get another one. We typically take exit fees instead of equity kickers, the reasoning is exit fees are at the same level as the debt or can be at the same level as the debt and the equity kickers are uncertain when we ever get them, but there are certainly limited opportunity that we are going to get equity kickers.

Keith Rosenbloom - CARE Capital Group

So you are focused more on building your optionality with these exit fees as opposed to the equity kickers.

Leonard Tannenbaum

Yes.

Keith Rosenbloom - CARE Capital Group

And is that factored all into your NAV calculation?

Leonard Tannenbaum

Exit fees are very limited, I do not know, a couple of hundred thousand dollars into our NAV of these $7.8 million. And the equity of course is marked at fair value so that is in our NAV, but I would say that our equity is marked down substantially from where we started it.

Keith Rosenbloom - CARE Capital Group

Got it. Guys again great quarter and keep up the great work.

Leonard Tannenbaum

Thanks Keith.

Operator

(Operator instructions) And there are no further questions in the queue, and that will conclude today’s question-and-answer session as well as today’s conference call. We do thank everyone for their participation. You can disconnect your lines at anytime. Thank you.

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