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THL Credit (NASDAQ:TCRD)

Q4 2013 Earnings Call

March 06, 2014 8:30 am ET

Executives

Stephanie Paré Sullivan - Chief Compliance Officer, General Counsel, and Secretary

James K. Hunt - Chairman, Chief Executive Officer, Chief Investment Officer, Member of Investment Committee, and Portfolio Manager

Terrence W. Olson - Chief Financial Officer, Chief Operating Officer, Principal Accounting Officer, Treasurer, and Assistant Secretary

Christopher J. Flynn - Managing Director, Portfolio Manager, and Member of Investment Committee

Analysts

Troy L. Ward - Keefe, Bruyette, & Woods, Inc., Research Division

Stephen Laws - Deutsche Bank AG, Research Division

Christopher York - JMP Securities LLC, Research Division

Jonathan Bock - Wells Fargo Securities, LLC, Research Division

Vernon C. Plack - BB&T Capital Markets, Research Division

Casey J. Alexander - Gilford Securities Inc., Research Division

Operator

Good morning, and welcome to the THL Credit's Earnings Call for the Fourth Fiscal Quarter and Full Year 2013 Results. It is my pleasure to turn the call over to Ms. Stephanie Sullivan, Chief Legal Officer and General Counsel of THL. Ms. Sullivan, you may begin.

Stephanie Paré Sullivan

Thank you, operator. Good morning, and thank you for joining us. With me today are Jim Hunt, our Chief Executive Officer; Terry Olson, our Chief Operating Officer and Chief Financial Officer; and Chris Flynn, one of our Co-Presidents.

Before we begin, please note that statements made on this call may constitute forward-looking statements within the meaning of the Securities Act of 1933 as amended. Such statements reflect various assumptions by THL Credit concerning anticipated results, are not guarantees of future performance and are subject to known and unknown certainties and other factors that could cause actual results to differ materially from such statements. The uncertainties and other factors are, in some ways, beyond management's control, including the factors described from time to time in our filings with the Securities and Exchange Commission.

Although we believe that the assumptions on which any forward-looking statements are based are reasonable, any of those assumptions could prove to be inaccurate, and as a result, the forward-looking statements based on those assumptions could also be incorrect. You should not place undue reliance on these forward-looking statements. THL Credit undertakes no duty to update any forward-looking statements made herein. All forward-looking statements speak only as of the date of this call.

A webcast replay of this call will be available until March 13, 2014, starting approximately 2 hours after we conclude this morning. To access the replay, please visit our website at www.thlcredit.com.

With that, I'll turn the call over to Jim.

James K. Hunt

Thank you, Stephanie. Good morning. Thank you for joining this morning's call covering the results of THL Credit's fourth quarter and year ended December 31, 2013. Our earnings announcement was released yesterday afternoon, copies of which can be found on our website, along with the Q4 investor presentation that we will refer to during this call. Our 10-K will be released shortly.

Before we get started, I'm pleased to announce that Chris Flynn, who is with us today, was promoted by our board this week to Co-President, serving alongside Hunter Stropp and Sam Tillinghast. Chris has successfully led the investment team in Boston, and more recently, built out our teams in New York and Chicago. Chris will be providing more details on the growth, composition and performance of our investment portfolio in managed funds shortly.

This morning, we will provide an overview of THL Credit's investment activities and highlights for the fourth quarter and the full year 2013. We will also offer our views on the current investment environment and how we are positioned for growth.

We completed the fourth quarter with 54 portfolio companies valued at approximately $649 million after investing $111 million during Q4 in 6 new transactions in 3 existing portfolio companies. Realizations totaled $35 million, resulting in approximately $76 million of net portfolio growth for the quarter.

Over the course of 2013, we have seen quarterly growth averaging approximately $60 million driven by strong originations averaging approximately $100 million in new investment with average realizations of approximately $40 million. Total growth in the investment portfolio for 2013 was $255 million. We will, as we always have done, continue to approach growth with patience, prudence and considering market conditions and seeking the most attractive risk-adjusted opportunities for our shareholders.

With a continuing competitive middle market lending landscape characterized by tightening spreads and increasing leverage levels, we have found the most attractive risk-adjusted opportunities in floating rate secured loans. Over 2013, we increased the amount invested in first lien including unitranche in second lien securities by 21% as a percent of our overall portfolio. And in the face of inevitable rising interest rates, we have tended to have a bias towards floating versus fixed investments.

We also continue to be opportunistic in strategically using our 30% bucket with attractive higher-yielding investments such as the 4 additional CLO equity investments we closed during the year, totaling approximately $32 million with an average weighted expected yield of 13.6%. These investments, along with some other broadly syndicated investments that we may make from time to time, are examples of where we are able to leverage the expertise of senior investment professionals from our SLS team to support our investment committee.

As of December 31, 2013, we had over $129 million of liquidity from cash resources in our revolver. You may recall in October, we increased our credit facility by $85 million. This additional capital, coupled with proceeds from ongoing prepayment activity and investment sales, provides us with ample liquidity to fund our near-term pipeline.

Referring to Pages 10 and 11 in our Q4 investor presentation, highlight our growth to date. Our pipeline remains active today, and it includes an increasing number of unsponsored opportunities. Unsponsored investments are approximately 20% of our portfolio as of December 31. We are off to a strong start in early 2014, having deployed $40 million in 5 new investments in Q1, and we realized repayments of $29 million. We are also pleased to have received $2.8 million in proceeds in Q1 from further recapitalizations of Surgery and Yellow Pages. I am pleased to announce that we had our final Greenway II closing in the fourth quarter. Through Greenway II and a related separate account, we raised $187 million from domestic and foreign institutional and high net worth investors. Chris will provide additional color on Greenway II in a moment.

Now to comment on our financial highlights. Net assets as of December 31 were $453 million or $13.36 per share compared with $13.38 on September 30. Our net investment income for the fourth quarter totaled $9.1 million or $0.27 per share, which was down from Q3, principally as a result of a significant amount of our new investments closing in December, lower prepayment fees than expected and the effective reclassifying dividends, which Terry will talk more about in a moment.

In Q4, we paid a dividend of $0.34 per share. Consistent with our past practice, we intend to pay dividends that are in line with earnings, which as you know, can be lumpy. We see the increase in our portfolio in Q4, actual and expected originations in Q1, our current yield and increased utilization of our credit facility providing a basis for sustainable net investment income that we expect to continue to cover our current dividend. We will continue to pay special dividends at the appropriate time as performance and realized gains allow.

We are pleased to announce that on March 4, our Board of Directors approved a quarterly dividend of $0.34 per share for the first fiscal quarter 2014 that is payable on March 31.

With that, I'll turn the call over to Terry to talk about the investment activity in more detail and our financial performance.

Terrence W. Olson

Thanks, Jim. Good morning, everyone. I wanted to start by describing our 6 new investment transactions this quarter and provide you with a little color on each.

First, we made a $23.7 million investment in the first lien term loan and delayed draw facility of Food Processing Holdings and received $14.2 million in proceeds from our existing investment in the subordinated term loan as part of our recapitalization of the business. Food Holdings is headquartered in Albertville, Alabama. We made $7.3 million investment, net of an anticipated sale of participation [ph] in the second lien term loan of the Allen Edmonds Corporation, a designer and manufacturer of men's footwear and accessories based in Port Washington, Wisconsin. We made a $22 million investment in the senior secured term loan of Copperweld Bimetallics, a producer of bimetallic wire products used primarily in the telecom and utilities industry applications, and they're based in Fayetteville, Tennessee. We made a $5 million investment in the subordinated notes, Flagship VII Limited, a CLO managed by Deutsche Investment Management. We made a $24 million investment in the senior secured term loan and second lien term loan of Hostway Corporation, as well as an equity investment in an affiliated entity. Hostway is a provider of hosted information technology solutions to small- and medium-sized businesses and enterprise customers and is based in Chicago. We also made a $27 million investment in the senior secured term loan of Charming Charlie, a fashion accessory retailer located in Houston, Texas. And finally, we made $2 million in follow-on investments in Key Brand to fund a revolver drawn and investments -- as well as investments in 2 limited partnership equity investments.

If you refer to Pages 13 and 14 and Pages 20 through 23 of our investor presentation, you'll see the details on our portfolio investments, specifically their composition, credit profile and yields. The weighted average yields on all of our debt investments made in Q4 was 10.3%, with yields of 10.1% on the first lien loans, 10.2% in the second liens and 13.9% on the CLO of residual interest. The weighted average yield on all of our income-producing investments at December 31 was 11.7% and 11.4% for our debt-only securities.

And you'll see that we've provided additional information on Pages 15 of our investor presentation on the breakdown of the yields over time. Chris will talk more about the portfolio mix shortly, but our debt investments based on funded loans at 12/31 were invested 41% in fixed rate and 59% in floating rate as compared to 57% in fixed and 43% in floating as of December 31, 2012.

Notable sales and prepayments for the quarter included $6 million in proceeds from the repayment of our remaining debt investment in AIM Media, which included a prepayment premium, $9.7 million from the sale of a portion of our investment in Oasis Legal Finance to a co-investor and $1.5 million in proceeds from the repayment of delayed draw facility of Food Holdings.

From our portfolio, we derived $18.5 million in investment income for the quarter, $18.3 million was from interest income and included approximately $800,000 from prepayment premiums and acceleration of unamortized discount. During the quarter, we also had net reclassifications of $810,000 of dividend income to realized gains and against cost related to Surgery and Yellow Pages proceeds we received earlier in the year due to changes in tax estimates provided by the company over the course of the year. The other income of $986,000 included principally fee income from our managed funds, Greenway, Greenway II and related separate [ph] accounts.

For the year, we generated investment income of $74.7 million. $66.8 million was from interest income. $4.1 million was from dividend income related to the proceeds from Yellow Pages and $3 million of income principally from Greenway and Greenway II and related separate [ph] account.

During the quarter, we incurred $9.4 million of expenses, including $2.2 million in base management fees, $2.6 million in incentive fees, $2.3 million in general, administrative and professional fees and $2.2 million of fees and expenses related to our facility, as well as $200,000 related to excise taxes. Expenses included approximately $300,000 related to GAAP incentive fee expense.

Expenses for the year totaled $33.3 million and included $7.5 million of base fees, $10.7 million of incentive fees. 2013 expenses also included $7.5 million in general and administrative and professional fees and $7.1 million related to our credit facility, as well as $0.5 million related to excise taxes and taxes on undistributed earnings and income taxes related to consolidated blocker corporations.

Net new -- net investment income for the quarter was $9.1 million or $0.27 a share. Net investment income for the year was 14 -- $41.4 million or $1.37 per share. We realized net gains of $212,000 in the quarter, which included $327,000 unrealized gains related to reclassifications from dividend income due to changes in tax estimates, offset by $149,000 realized loss from a write-down of an escrow receivable. During the year, we had realized gains of $2.6 million, driven primarily from realized gains related to proceeds received from YP and Surgery in the second quarter.

The net increase in unrealized depreciation for the year was $2.4 million -- sorry, for the quarter. During the year, unrealized depreciation was approximately $310,000. These changes in portfolio company valuations were impacted by changes in capital markets conditions, as well as the performance of certain of our investments.

During the fourth quarter, we also recognized $780,000 of the provision for unrealized gains related to investments held in tax blocker corporations. And for the year, we recognized approximately a $2 million tax provision for such unrealized gains related to these investments held in blockers.

Our interest rate derivative -- on our interest rate derivative, we had a net loss of $112,000 in the quarter as a result of the amounts paid under our swap and had unrealized depreciation of only $30,000 for the year -- for the quarter. And for the year, we realized a net loss of $433,000 and had unrealized appreciation of $769,000. These changes were a result of changes in swap rates.

And with that, I'll turn the call back over to Jim.

James K. Hunt

Thanks, Terry. As we continue to grow our portfolio of investments and expand the size of our managed funds, I thought it would be helpful for Chris Flynn to provide a summary of our investment activity through the end of 2013.

Christopher J. Flynn

Thanks, Jim. Good morning, everyone. As we approach our fourth anniversary of the public offering for THL Credit, I wanted to take a few minutes to highlight some portfolio statistics.

Over the period of time, we've invested approximately $1.1 billion across 62 portfolio companies through our THL Credit and supporting Greenway platforms. We have had investments in 26 companies realized over that time -- same time frame, representing approximately 33% of invested capital. We have not had any net realized losses across the $1.1 billion invested.

Over this time period, we have partnered with 34 private equity firms on transactions and have established strategic relationships with key lender groups, which enabled us to provide more creative financing solutions for our clients. These relationships will be critical to our continuing growth. Our focus has been, and will continue to be, finding the most appropriate place in the capital structure to deploy.

As we continue to leverage our ever-growing origination platform, we strive to select the best businesses for investment. To that end, our portfolio companies performed well, and our credit quality remains strong. Portfolio investments representing 84% of our holdings continue to meet or exceed our expectations. For those investments that are not meeting our expectations, we continue to monitor their performance and provide the necessary support to management.

As of December 31, there were 2 investments on nonaccrual, which represented approximately 3% of the cost of our portfolio. As our balance sheet has grown, our portfolio of investments has evolved into a more diversified pool of first lien secured including unitranche structures of 41%, second lien loans of 24%, subordinated debt of 24%, other income-producing investments of 9% and equity investments of 2%, as previously mentioned. We believe this diversification delivers a strong asset mix, providing attractive risk-adjusted return to our shareholders.

The Greenway vehicles continue to perform and provide strategic value along with a solid earnings stream to our shareholders. Greenway I, originally $150 million single investor fund, is in harvest mode at this point, with over 85% of total capital returned to date. And Greenway II and related managed accounts with multiple investors providing capital commitments of $187 million recently had its 1-year anniversary of its first closing and has called approximately 50% of capital to date. We would expect to continue with the managed fund strategy in the coming quarters.

With this, I'll turn it back to Jim.

James K. Hunt

Thanks, Chris, for your comments. I'd like to make a few summary closing points. First, overall, we're very pleased with our growth in Q4 and with the investment opportunities we are seeing today and have already closed on in Q1. The growth -- and secondly, the growth of our origination and investment teams in 2013 in New York and Chicago has materially added to an already strong national origination footprint. Third, our liquidity is strong, and we anticipate growing using leverage as we seek to optimize ROE.

I would like now to open the lines for questions, operator.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Troy Ward of KBW.

Troy L. Ward - Keefe, Bruyette, & Woods, Inc., Research Division

You talked about CLO, the addition of CLO. And of course, in the past 5 or 6 quarters, you've put about 6% of the portfolio in the CLO equity. One question is, was the addition this quarter, was that a primary or a secondary market purchase? And can you just give us some color on what the returns look like in the CLO market for equity today?

James K. Hunt

That's a good question, Troy. And we are a primary investor. And that is where we have seen the most compelling opportunities. That being said, so the recent investment had returns consistent with those we'd made before, where Terry had mentioned it was in around 13.5%. That being said, returns in that market are less -- the returns available now are less than we have experienced in the past. So you might see us seek different opportunities than pursuing those today. That being said, we have 2 senior folks who are constantly looking at the market. And if we see another what we think is a wholesale opportunity in that space, we'll pursue it. The -- I think it's a reasonable expectation that we will stay certainly under 8% or 9% of the total portfolio if returns are available again, consistent with that we've experienced in the past.

Troy L. Ward - Keefe, Bruyette, & Woods, Inc., Research Division

Okay, great. Terry, one of the comments was you -- first of all, it's either $2.1 million or $2.8 million of additional proceeds quarter-to-date from Surgery and YP. Can you give us just some color, first of all, whether you expect that to be categorized as dividend income or capital gains? And also, just give us some color on kind of that topic for what happened in the fourth quarter.

Terrence W. Olson

Sure. To answer the first question, still in the process of sussing that out, Troy. As you know, the classification -- the characterization of the income is really based on the tax answer. So we'll work closely with the portfolio companies over the course of the Q1 closing here to get the information we need to allocate to dividend versus gain. That being said, I would expect most of it to probably end up in the gain line. But we will -- it's largely -- it will be driven by what the tax answer is. We're pleased to have the proceeds in. Tying that back to what we did, the reclassification you saw in Q4, I mean, the Surgery recap that closed in -- I believe it was May. And at that time, we were -- received -- we had information that would suggest that they would taxable, if you will, earnings and profits available, by which the character of the distribution we received would have been characterized as income. Through the course of the year, more recently as part of the Q4 close, we received updated tax information as a result of their work that suggested that there would not be tax, if you will, tax earnings and profits. And as a result, any proceeds we received should be classified as a return of basis to the extent you have any, and we did in Surgery, and the difference would go to capital gain. It's the double-edged sword here of owning equity interest in LLCs. We are at the -- where you're at the, I wouldn't say the whims, at the mercy of enterprises that typically don't finalize their tax positions until the end of the year. But we do the best we can with the information we have in booking our estimates each quarter.

Troy L. Ward - Keefe, Bruyette, & Woods, Inc., Research Division

Okay, great. And then, Jim, one more and I'll hop back in the queue. But if we start talking about Greenway I and Greenway II, Chris gave a really good update. Just one question about how the mechanics of that work. I know that basically -- I remember that once they get their -- all their capital deployed, it basically starts immediately in runoff mode. And I think Chris said 85% of Greenway I has been harvested already. If you have what I'll call a drive-by refi where something in your portfolio is just -- you flex it down 50 basis points but stays in the portfolio, is that an action that the Greenway fund can continue to hold as well? Or would that effectively cause them to be out of that asset and the AUM would go down by that much?

James K. Hunt

Chris is going to jump on that, Troy.

Christopher J. Flynn

Sure. I think if you look at the structure inside of Greenway I, a repricing would have resulted in a realization. Greenway II, we have more flexibility to manage and keep more dollars deployed inside the vehicle.

Troy L. Ward - Keefe, Bruyette, & Woods, Inc., Research Division

Great. That's helpful. I was surprised at the amount of the capital returned in Greenway I, but you're saying that Greenway II may not run off quite that fast?

Christopher J. Flynn

For that reason, yes, that would be correct.

Operator

[Operator Instructions] Our next question comes from the line of Stephen Laws of Deutsche Bank.

Stephen Laws - Deutsche Bank AG, Research Division

Let me just -- a couple of general ones. But the yield on new investments looks like it's a little over 10%. Can you talk about how much of that kind of yield on new investments is slightly below the overall portfolios due to increased competition versus how much is due to maybe a focus on more adjustable rate investments, which I would assume today are slightly lower in yield, and if you did the same investment on a fixed rate basis?

James K. Hunt

That's a good question, and I really am glad you asked it. Folks, I don't know if you can pull it up from where you are, Stephen. But Page 15 of the investor deck that we posted last night reflects a -- the trend line for yields in the portfolio and then overlaid on it is the percentage of first and second lien investments in the portfolio. And there has been -- our feeling is there has been a real shift in what is most attractive to us and what the market wants. And the market -- our unsponsored, to some extent, and sponsored borrowers are really attracted to the ease, the certainty of unitranche -- financing their investments with unitranche. We're similarly attracted to keeping a -- or moving to a higher proportion of floating rate investments and a little greater certainty in an investment where we don't have to worry about whatever the behavior could be of the first lien provider. So while our yield on the portfolio has gone down, the -- our feeling is it has been compelling from a risk-adjusted return standpoint. So I'd like to think that you or the other analysts on the call can reflect on that our sharp ratio may well have improved in our investments.

Stephen Laws - Deutsche Bank AG, Research Division

Great. That color is helpful. Switching sides to maybe the prepayments. I know you touched on it a bit on the prepared remarks. And you're right, I don't have that presentation pulled up at the moment. But could you -- how much time, typically, these guys -- do you guys have any advanced kind of knowledge on prepayments? A lot of those borrowers work with you. Are those something that's largely unexpected? And kind of following that up, as you look at the portfolio today, are there any larger-than-average investments that you think are near-term prepayment risks? Or is it any kind of trend like we've seen in the last couple of quarters although, obviously, some lumpiness in there based on timing?

James K. Hunt

We do. There's a couple of good things. We care a lot, as I think you have observed, about the relationships we have with people to whom we provide capital. And we have a -- on more than half of our investments, we have a board role, typically an observation right. And that does give us insight not only in terms of monitoring the credit, being a good supervisor of the capital, but a window into the prepayment. One of the things we are very proactive on is, you could call it, either defending an investment or being proactive in recognizing material credit improvement and working with the borrower to refinance on terms consistent with their current credit quality. So we do have a window. We have what we think are a depth and strength of relationships where borrowers want to continue to finance with us and sometimes at a click better than they could obtain -- maybe 2 clicks better than they could obtain elsewhere in the market. So we do see it. But to the other point of your question, I don't foresee -- I feel like the market is in some level of stability right now, and I don't think we're going to see the big gap down with the corresponding step-up in rates and corresponding prepayment activities that we saw in the fall of 2012. Is that right, Terry? It was fall of 2012? So that was -- there was a seismic shift in, and I feel like the market now -- Chris, do you agree that it's in some level of balance?

Christopher J. Flynn

I do. I think it is. It's a -- if you look at where the portfolio is priced today and the discussions that we're having with the portfolio companies, it feels like we're -- had a good equilibrium between expected cost to the issuer and where we want with the asset class from our perspective.

James K. Hunt

As some folks on the call know that Steph, Terry, Chris and I are coming to you live from Houston, Texas, where we have a very important office to THL Credit headed by Sam Tillinghast. And last night, we had an origination event built around our sources, private equity firms and middle market investment banks who bring us unsponsored transactions. So it's care and feeding of those relationships and really making sure that we've got the depth of relationships to appropriately participate in the continuum of a credit's life. So if you hear a little background noise on this call, it's because we are coming to you live from Houston, Texas.

Operator

Our next question comes from the line of Chris York of JMP Securities.

Christopher York - JMP Securities LLC, Research Division

Terry, forgive me if I missed this in your prepared remarks. But just curious on some timing of your $111 million in investments in Q4. How did that trend from October, November and December?

Terrence W. Olson

70% was closed in the second part of December.

Christopher York - JMP Securities LLC, Research Division

Okay. And then second question is kind of piggybacking on Stephen's question with prepayments. You guys -- on your commentary, how are you guys thinking about leverage throughout the year? You guys ended the quarter, I think, around -- the model is not pulling up here, but about 0.5x. Do you guys think you can get to maybe a 0.7 multiple by year end? Or how are you guys thinking about using leverage as -- or excuse me, throughout the year?

Terrence W. Olson

Sure. I think the comfortable level of ongoing leverage for us is probably in the 0.5 to 0.65x, depending on where we are in any given point in the origination cycle. And that being said, ultimately, our decision to pursue capital, whether it be equity or additional debt, will be driven by what these -- the investment teams are seeing in the marketplace from origination opportunities. Our goal would certainly be to hold the leverage at or above where we are at today. As we said before, we would expect to and we have grown the leverage level. So we would expect that any follow-on capital raises will either increase that leverage or if reduce it, reduce it to the level at which we expect to continue to run at.

Operator

Our next question comes from the line of Jon Bock from Wells Fargo Securities.

Jonathan Bock - Wells Fargo Securities, LLC, Research Division

So Terry, much appreciate the guidance on leverage. And as we look at the level, whether 0.4, 0.5, 0.6, I mean, one question about cost of capital can tie in with what you're investing at today. And so Terry, as you mentioned about a 10-ish percent on essentially all of your first or second lien loans, depending -- 10.1%, 10.2% and a 13.9% on some CLOs, if we look at the math right, even at a 0.5 leverage level, the required return to breakeven on your current dividend once we add in the fact that there's 400 bps or so of expenses in the model plus puts us at 12%, 12.5-ish percent. And so the question would be if that's your required return to keep the dividend flat and current returns in the market because you're conservative and focusing on high-quality investments, returns are sub-11%, walk us through how the math of raising equity would actually work.

Terrence W. Olson

I would say the math of raising equity today, Jon, is not the right thing for the business. So -- and two, I would think there are opportunities for us to improve our cost of capital over time as we continue to utilize the revolver and explore expanding it under the accordion features that exist today. So I think there's certainly some additional spread to be generated from that.

Jonathan Bock - Wells Fargo Securities, LLC, Research Division

Okay, okay, appreciate that. And then as we dive into some of the investments real quick, in terms of CLO equity, can you walk us through equity returns and valuations in the event of a rising interest rate or LIBOR environment?

James K. Hunt

That's an interesting one, and I'm going to chat while Chris Flynn has a chance to think about it. In some respects, a rising rate environment, and a lot of folks have written that, that is a reflection of a stronger economy where the Fed has courage to let rates rise and the -- so that is probably a reflection of increased growth. And certainly, what I've read that with the Q4 -- and again, this is not reflective of our portfolio, which is so hyper-selected. But Q4, the U.S. economy is now, what, 2.4%. We may have a soft first quarter as a consequence of a pretty nasty winter. So I don't think rates are rising soon. But it could be a positive for the equity investments and a reflection of the Fed having a little more courage about the economy.

Christopher J. Flynn

Yes. I think that makes sense. And I think as you've seen over the years, we've transitioned to a much larger percentage of the portfolio being floating rate. As rates were to move higher, it's a natural hedge not only for our book of business but also our shareholders as we look to protect the growth of dividend in a potential rising rate environment.

Jonathan Bock - Wells Fargo Securities, LLC, Research Division

Got it. Great. And Chris, maybe just looking at Copperweld really quickly. When you think of commodity risk, and I think this business -- just looking at the past, it's gone bankrupt before and received DIP financings in 2002 and '03. Obviously, 12% on the first lien implies some amount of additional risk. And just looking at it, I'd imagine that you've got a couple of factors at play here. Can you walk us through what gets you comfortable with that investment just in light of the bankruptcies of the past? Or perhaps we were wrong with the bankruptcies in the first place?

James K. Hunt

It's interesting, Jon, I don't remember that about -- so we generally don't comment on any specific investments, but we are very focused on what the right capital structure is in terms of total leverage, our attachment point, unitranche versus a 2- or 3-tiered capital structure. And the -- certainly for -- turning to generality, businesses that are, for example, more associated with housing velocity, it's we're more comfortable with a lower leverage and attachment point and very likely a unitranche structure where if there is a quarter or 2 speed bump, that we have predictability in credit management. So it's -- this is probably the area of greatest sensitivity for us. And one of the things we like a lot about the way the market is working now is in the latitude, if you think about your chart and all the different ways the BDC can be a constructive financier, that's definitely a page out of our playbook as to what's the right capital structure for a business and certainly a business that could have cyclicality.

Operator

[Operator Instructions] Our next question comes from the line of Vernon Plack from BB&T Capital Markets.

Vernon C. Plack - BB&T Capital Markets, Research Division

Most of my questions have been answered. But just thinking about your comments in terms of where you're placing money and where the risk -- where the best risk reward is these days in addition to the fact that you plan on leveraging a little bit more, can we expect -- is the thought a year from now -- I know that we've seen the migration into first lien, 41% at the end of the fourth quarter. Could we expect this time next year, based on conditions today, that number will be higher, not only first lien, second lien, probably more first lien in the range of, say, 50%; second lien, higher; subordinated debt, perhaps lower; and the other categories, lower? Is that the way that we should look at this, the key migration of portfolio of the balance sheet?

James K. Hunt

I think that's the $64,000 question in that the market dynamic now is that traditional mezzanine is less sought after by borrowers. The transactional ease and certainty of unitranche and second lien is more desired. But that could change. And I think that one of the things is we are consistently seeing choices, and we think about what is -- what's the right choice for us. But the demands in the marketplace, we don't think, are necessarily constant. So to say that you -- what you've described, Vernon, is accurate in terms of what the trend is today. But I think looking forward, what we like a lot is having the ability to be flexible in addressing the risk-adjusted return opportunities.

Christopher J. Flynn

I think that's right, Jim. The only thing I would add, it's -- we are seeing some mezzanine opportunities. It's just that they're very difficult to get comfortable with from a credit perspective given where you need to be from an attachment point. From that, I mean what our total leverage is and then what the coverage ratio looks like. So from our perspective, there are certain times when it makes sense to do mezz and there's certain times when it's not. And based on the opportunities in the [indiscernible] that we've seen in mezzanine given very tight coverage ratios with subordinated security, it doesn't seem to be a reasonable place for us to put our shareholders' capital to work. So we'll continue to look for opportunities where we do believe it makes sense. And if mezzanine opens back up and creates more attractive yields, we'll obviously jump in with both feet. You've obviously seen the portfolio over the last 4 years include more mezzanine. It's just that it's got to make sense for us.

James K. Hunt

Just one thing. Chris mentioned coverage ratios. More often, folks on this call, including us, speak about attachment point relative to EBITDA. But at the end of the day, it's really the coverage ratios that are the real credit driver. And we have thought long and hard about how we can provide more detailed information on the underlying performance of our portfolio, which we do monthly monitoring of every credit and so forth. And it's more challenging than you would think in the reporting requirement, and Terry can weigh in on all the specifics. But at the end of the day, it's really the cash flow and the coverage ratios that drives the quality of our credits.

Terrence W. Olson

That's right.

Vernon C. Plack - BB&T Capital Markets, Research Division

That's great. And outside any particular opportunity, am I also hearing this correctly, Jim, we should not expect an increase in your CLO equity outside of maybe a particular transaction that looks attractive?

James K. Hunt

Well, the -- overall, you should expect being under 10%, in that 8% to 9% range I mentioned if the arbitrage producing the underlying returns improve. So we're very pleased with the investments we've made. It's -- we think the expertise that 2 of our senior SLS team members, Bob Hickey, Mike Herzig, bring to the table, in addition to all their resources, gives us a real advantage in considering those investments. But at this exact moment in time, they are less attractive than other risk-adjusted returns that we're seeing elsewhere.

Operator

And our next question comes from the line of Chris York.

Christopher York - JMP Securities LLC, Research Division

Yes. So one additional question for me. With the SBA considering expanding the annual commitment to the SBIC program to $4 billion from $3 billion, how does that change your guys' view in pursuing a license again? Or does it?

James K. Hunt

I don't know that it -- yes, it changed it, but it's certainly something that we think about going forward. Our -- Stephanie Sullivan, one of the hats she wears is paying a lot of attention to the program and considering whether or not we should pursue it. So it is a hat she wears.

Operator

Our next question comes from the line of Casey Alexander of Gilford.

Casey J. Alexander - Gilford Securities Inc., Research Division

I hope this doesn't sound a little naive. But I'm just kind of wondering, the yield compression is obviously pressuring net investment income per share, and your focus on credit quality is admirable. At what point in time do you make the calculus or the decision that the focus on credit quality is so paramount that perhaps in order to match up covering net investment income that you should bring the dividend down a hair?

James K. Hunt

One thing is philosophically, if what you said is the case, we would -- the dividend would match net investment income. Terry, you might just comment upon looking at net investment income over quarters and where we are relative to that.

Terrence W. Olson

Yes, absolutely. We take a holistic view to looking at what our assets, as a whole, generate. So certainly, a compression in spreads would contribute to one of the negatives, if you will, against ROE. But there's also other components. We've historically been underleveraged a bit. So I think there is a natural return to the equity through increasing the leverage of the business. I think the continuation of our Greenway vehicles add a level of ROE as well that will -- we expect to at least sustain in the short term and over the long term, continue to grow that program. And then with any portfolio and with any credit underwriting, we write prepayment penalties into all the credits we do in an effort to make sure we're rewarded for the likes of prepayment in an environment where interest rates or spreads are compressing. So, I think, we think of things holistically about what we're earning for the shareholder relative to our dividend, and I think the point you bring up is a component of that. And we are of the mindset ultimately, you pay what you earn, and there is a lot of different ways of getting that return to equity. And hopefully, one of the few that I've mentioned have been helpful in helping you how we -- think about how we think about it.

Casey J. Alexander - Gilford Securities Inc., Research Division

Well, let me ask a quick follow-on because as you push the leverage ratio in order to more adequately cover the dividend, it's not a step function. It doesn't happen necessarily overnight. How much undistributed income on a per share basis do you have to sort of buffer you while you work your way down that path?

Terrence W. Olson

I believe we have about $0.10 of earnings between the undistributed gains and net investment income in the portfolio. And that's largely because we've had a bias towards distributing what we earn, either through the course of the ordinary dividend or through special dividends that we attach to specific events in quarters and activity that are rolling through the portfolio.

Operator

And I'm showing no further questions in the queue. I'd like to hand the call back over to Mr. Jim Hunt for any closing remarks.

James K. Hunt

Well, thank you folks for joining us today. We look forward to seeing you in a short couple of months. And thanks for your support and your participation. Take care.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may now disconnect. Have a great day everyone.

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