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Garrison Capital, Inc. (NASDAQ:GARS)

Q4 2013 Earnings Conference Call

March 13, 2014 10:00 ET

Executives

Joseph Tansey - Chairman, CEO

Brian Chase - CFO, Treasurer

Mitch Drucker - Co-Chief Investment Officer

Analysts

Allison Taylor - Oppenheimer & Co.

Sinan Kermen – DRW Trading Group

John Hecht – Stephens

Andrew Kerai – National Securities

Bob Napoli – William Blair

JT Rogers - Janney Montgomery Scott

Operator

Welcome to today's Garrison Capital Incorporated Fourth Quarter December 31, 2013 Earnings Call. For the fourth quarter December 31, 2013 earnings presentation that we intend to refer to on the earnings call please visit the Investor Relations link on the homepage of our Web site at www.garrisoncapitalbdc.com and click on the fourth quarter December 31, 2013 earnings presentation under upcoming event.

Questions will be taken via the phone during the Q&A session at the end.

It is now my pleasure to turn the Web cast over to Mr. Joseph Tansey, CEO. Sir, you may begin.

Your lines will again be placed on music hold. We are experiencing technical difficulties at this time.

Joseph Tansey

Good morning everybody and thank you for joining us this morning. I'm joined by Brian Chase, our Chief Financial Officer and Mitch Drucker, our Co-Chief Investment Officer. Yesterday, we issued our quarterly earnings report and press release for the quarter and year ended December 31st. We also posted a supplemental earnings presentation to our website, which we will be referencing throughout today's call.

I'm going to spend a few minutes discussing the current market opportunity, our positioning and where we are finding the most compelling investment opportunity. Following my comments, Mitch will highlight a few specific investments and discuss the portfolio in greater detail. Brian will then discuss our financial performance before we open up the line for Q&A.

And our current dividend yield of approximately 10%, we continue to believe that we offer a compelling risk adjusted return profile relative to other fixed income investments including our peers in the BDC universe.

Given our largely first lien portfolio and modest balance sheet leverage, it is difficult to find many publicly traded fixed income comparables with similar risk and reward (indiscernible). A closer look at other publicly traded fixed income vehicles such as bank loan, mutual fund, high-yield debt fund, mortgage REIT and MLPs which will yield either more risks in underlying portfolio assets or higher balance sheet leverage often times short-term in nature.

The loan market in 2013 showed a very strong cash default, low default rates and positive investor sentiment. These characteristics grow demand for leveraged loans to record levels for the year. Increases in leverage and spread compression year-over-year reflected the increase of capital into the market. Some of this capital has migrated into the upper end of the middle market causing more aggressive turns in that segment. However, the lower end of the middle market where we are focused has generally experienced less pressure.

With our experience lending team, we are well-positioned to take advantage of market opportunities and realize superior risk adjusted returns. Garrison's broader platform enhances our capability and differentiates us from the groups we compete with. To-date it has enabled us to evaluate and execute on lending and non-conforming asset opportunities in sectors such as consumer finance, real estate and leasing.

For 2014, we will continue to build upon the objective that we established when we emerged as a public entity approximately one-year ago. This includes significantly improving the overall portfolio yield by transitioning to higher percentage of originated loans while continuing to maintain rigorous credit standards to ensure a high-quality pool of assets.

At this point, I would like to pass it over to Mitch.

Mitch Drucker

Thank you, Joe.

As Joe referenced, the lower middle market has been less susceptible to spread compression and leverage expansion. Regulatory pressures and banking foundations have had the effect of limiting liquidity into this market. However, we are starting to see banks and other non-bank finance companies continue aggressively to select one-off financings to improve their margins. This trend has not been widespread and has been limited mainly to regional banks.

This newly (indiscernible) into the marketplace deals are continued to be more than adequate relative to our size making it to the robust pipeline is a key objective and it enables us to pursue only those credits with adequate risk-adjusted returns.

We define core volume as deal slows that roughly generate a yield of 9% or better. Core volume for the fourth quarter totaled $82.4 million which was driven by $8 million investments into the core portfolio and upsizing of three existing core credits and additional investments in the consumer peer-to-peer lending portfolio. Consequently, core investments as a percentage of the total portfolio increased to 68% at the end of the quarter up from 57.2% in the previous quarter.

The weighted average yield of the core deals closed during the quarter was 11.1%. Yields on the originated credits continued to drive overall portfolio yield increases with reoriginated credits for the quarter, PD Products, Theragenics and Radiation Therapy services of all foreseen credits which yield at 12% or greater.

As we migrate our portfolio from transitory to core deal volume, we continue to see a higher proposition of investments coming from private equity community. Longstanding relationships and our solid execution track record as positioned us well and we continued to see new business from sponsors.

Loan demand remains relatively weak in the private sector as companies have been slow to deploy capital for expansion purposes. Club relationships have been a major contributor towards the new business funding and in the fourth quarter three of our closed transactions were generated from club partners with like minded credit philosophies. The yield is slightly lower for club transactions originated credits improving deals that we tend to take have generated premium yields. These higher returns were evident in the three originated deals enclosed during the quarter. We continue to employ a rigorous credit offers with tight controls in credit characteristics.

88% of our total portfolio comprises first lien structures. We expect this percentage to decrease slightly over time as the consumer loan portfolio grows modestly. Consumer loans totaled 3.9% of our portfolio and we feel these investments provide an attractive risk return profile.

Total portfolio weighted average risk ratings and average debt to EBITDA multiples have remained stable with average leverage in the portfolio standing at 3.6x. This is maturely below the average levels experienced by the upper middle-market and broadly syndicated markets.

We also exited one non-performing loan at the basis contributed at the time of the IPO. On the whole, our borrowers have demonstrated modest, but positive cash flow in the face of a weak GDP macro environment. These credit characteristics coupled with our flexibility, finance and clients targeted acquisitions allow us to maintain borrowers that otherwise might be at risk of finance. Modest terminations and repayments have been a positive chapter towards growth in total assets.

For the first quarter of the year, its typically slow in terms of new business volume, we closed a couple of originations to-date and are working on a number of existing situations that we hope to close by the end of the first quarter. To-date we closed $30 million in new core volume within a 11.4% yield against $9.5 million in core terminations.

Entering 2014, we expect to see a [few design] (ph) trends and occasional compensation from banks. With the depth of experience and the quality of relationships that we have developed over the years, we feel that we are well-positioned from a competitive standpoint to take advantage as there is risk of opportunities in growing our markets.

With that I would like to pass it to Brian.

Brian Chase

Thanks Mitch. For those of you reviewing our earnings presentation, please turn to Slide 6, which provides some of the financial highlights for the quarter.

Our earnings this quarter were $0.40 per share of which $0.32 came from net investment income; $0.12 came from a net change in unrealized depreciation and negative $0.04 from net realized losses.

We have announced the fourth quarter of $0.35 dividend that will be payable to shareholders on March 28. As previously mentioned on our third quarter earnings call, in order to ensure that our dividend payout consist entirely of net income and no return of capital, we waived approximately $300,000 of incentive fees during the quarter. The fee waiver will remain in effective over the next few quarters to provide the state insurance.

We made significant progress in the short period of time that is since in our public offering last year. This largely achieved our objectives, we had initially put of ourselves on both sides of the balance sheet.

We started the year with 37% of the portfolio in core assets and we have prudently grown the core portfolio to about 70%. During this transition, we have maintained risk pricing without sacrificing credit quality. In fact, book values have grown $0.16 since the IPO.

On the liability side of our balance sheet, we refinanced the credit facility in place during our IPO with new 10-year term financing. The new financing has significantly cheaper pricing and help to expand our balance sheet with about $35 million of incremental proceeds.

During the fourth quarter, we further expanded our balance sheet by another $10 million with the addition of a small credit facility collateralized by our consumer loans. With the addition of these new facilities current leverage is optimized approximately 0.9 to 1 debt-to-equity. Other than our pending FDIC application which is supposed to be reviewed by the SBA in the second quarter, most of our work is complete on our capital structure. While there is no guarantee that we will ultimately receive a license, we believe that our investment strategy and borrower industries fit well within the FDIC guidelines.

Fixed financing from the FDIC would represent a stable long-term component of our capital structure that would allow us to further expand the balance sheet and thereby drive top line revenue growth.

Our objectives for the New Year represent a continuation of where we left off in 2013. We are continuing to chip away at the transitory portfolio and hope to be fully invested in the core portfolio in the next few quarters. We expect this to be the main driver of earnings growth over that period of time.

This time we will open up the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) We have a question from the line of Allison Taylor.

Allison Taylor - Oppenheimer & Co.

Hi, guys. Thanks for taking my question. So, going forward for 2014, how should we think about the incremental portfolio growth? Is it going to be predominantly more flowed to transitory to core transition? Or are you kind of willing to use up some of the cash on your balance sheet in order to grow the portfolio just a bit in the New Year?

Joseph Tansey

I’d say that, this is Joe Tansey, we’re willing to do both.

Clearly, the – as we get through, you’ll always have some cash of course just because things get paid off and what have you. But – so we are working through both of those things and trying to get to a stabilized, kind of fully invested level to sort of drive the earnings power.

Allison Taylor - Oppenheimer & Co.

Okay. And going forward, I mean, I know you called the portfolio transitory, which is the predominantly, you know, large syndicated leveraged loan deals. Do you intend to have any portion of the portfolio in the future allocated to that strategy?

Joseph Tansey

I would think that you’ll always have some because you can never perfectly optimize. So you know I think that you’re – if you can use your cash and have a little bit of that as a cash replacement, I think that’s probably as well as we do.

Allison Taylor - Oppenheimer & Co.

Okay. Sure. Thanks for taking my questions.

Joseph Tansey

No problem. Thank you.

Operator

(Operator Instructions) We have a question from the line of Sinan Kermen.

Sinan Kermen – DRW Trading Group

Good morning. Of views, I may – starting with leverage, you guys are skewing towards the high end of your BDC comps. I was wondering, excluding the potential SBIC financing what your – if you have a longer term leverage target – as to where you’d like to run the company at.

Joseph Tansey

I think we’re – we’re pretty happy with where we are on a leverage basis. And I think that the reason we’re towards the higher end of the comps is our portfolio is more senior.

If you look at, you know, basically nearly 90 percent of the total assets are first lien loans – you add in, you have 4 percent of the consumer stuff we – which has some financing on it we’re, you know, 92 percent of our assets are first lien, which I think is also very high relative to the competitive landscape or the other comparable BDCs. So I think that the portfolio should have more leverage because it’s not loaded up with a bunch of second lien to mezz.

Sinan Kermen – DRW Trading Group

Okay, which leads me to my second question. You mentioned the consumer loans opportunity. And you expected some growth there. Can you talk a little bit more about, you know, what that opportunity is like and how is it better than the, you know, first lien lending – or your existing lending to more of corporate lending and if you had a target on, you know, where you’d want that to grow, longer term?

Joseph Tansey

Whether it’s better, I think they’re both good. But I wouldn’t make a comparison of one versus the other. I think that the – you know, the growth yield net of projected losses and servicing costs are similar and, you know, kind of 10-11 percent range to where are a lot of the lending – your first lien lending is getting done.

And you know we’re able to get attractive financing against the assets as well. And so I think that the sort of – on equity – a return on equity basis, they’re very similar.

I think it adds a good diversification to the business. And I think we’re well underutilized in our nonconforming asset ratio with really just – at this point just that and one deal that we did in the first quarter so far, also more of a real estate situation that’s also using our nonconforming asset bucket. I think that is part of the strength of Garrison, is that we have a large business in financial assets and in real estate that we can use those nonconforming buckets opportunistically. And we hope to grow, whether it’s consumer assets or commercial real estate assets or something else that we haven’t done yet, we hope to grow and utilize that nonconforming asset to add shareholder value over time.

Sinan Kermen – DRW Trading Group

Perfect. And final question is: You guys have been – to the extent there was a short fall in income to dividend has been sacrificing some GP incentive fees. Are they, A, accumulating/accruing somehow that, you know, once you – are you going to try to make up for the ones that have – you’ve been postponing? Or – and also how long can you continue to postpone to the extent that you don’t meet the dividend? Like could this go all the way to the first half of 2015? Or do you need special approvals from your GP? Or like how would that structure work?

Brian Chase

First part of the question was whether we are accruing or not. And it’s actually a full waiver. So at the end ...

Sinan Kermen – DRW Trading Group

Okay.

Brian Chase

…of the second quarter, on a combined basis, if we haven’t earned – truly earned 35 cents per quarter, 70 cents over those first two quarters, then there would be a waiver to make up for it. And those…

Joseph Tansey

And then the $300,000 we waived in the fourth quarter is waived. It’s not going to get paid back to us later if we do that.

Brian Chase

Correct.

Sinan Kermen – DRW Trading Group

Okay.

Brian Chase

Right, so that’s – that’s money we took out of our pocket to make sure that we weren’t returning capital to people because that’s not the intent of the dividend. The second part of your question was something about approval of the GP or – I had missed that…

Sinan Kermen – DRW Trading Group

Well, basically if you…

Joseph Tansey

We’re the GPs so…

Sinan Kermen – DRW Trading Group

Right. I guess basically it’s completely at your discretion - if you want to do this a couple of more quarters, you could without – there’s any – no hurdles to jump over.

Brian Chase

Right. That’s right.

Sinan Kermen – DRW Trading Group

Okay. That’s what I wanted to say. Thank you.

Joseph Tansey

Yes.

Operator

Your next question comes from the line of John Hecht.

John Hecht – Stephens

Morning, guys. Thanks for taking my questions. First of all, thus far into Q1 of 2014, is the sale and repayment activity consistent with what we saw last quarter?

Mitch Drucker

I think, you know, when you look at the first quarter, typically, it – it’s a slow quarter, you know. And that goes for all BDCs and financing sources.

That being said, you know, we’re still seeing a fair amount of business relative to our size. We’ve still closed, you know, a number of deals. We closed two deals. We’ve upsized two or three deals.

So we have the consumer portfolio. We have the rest of Garrison’s platform, which assisted us in finding business, and right now we are working on two or three other deals, interesting deals that look like they going to be closing by the end of the quarter.

John Hecht – Stephens

Okay. I appreciate that color. I was also interested though in sort of the of the sales and repayment activity within the portfolio. I think you were kind of in the mid-80s last quarter, $80 million of sales repayment activity within your portfolio. Is that consistent with what you’re seeing so far this quarter?

Joseph Tansey

You know the sales are obviously directly correlated to the amount of new transaction volume. So the repayment obviously have been – you know fourth quarter had some of the repayments.

What we’ve had so far in the book is what we’ve actually realized. And it’s been consistent with the fourth quarter, there have been repayments. The sales are probably – as we’re moving out of the transitory portfolio, the sale number is overstated relative from what we think it would be long term because once you sell it and transition it, you won’t do that again.

John Hecht – Stephens

Okay. And then do you – what is – can you – do you have a number of undrawn commitments handy?

Brian Chase

They’re – you mean on the revolver and the CLO side?

John Hecht – Stephens

Well, just commitments you’ve – you’ve made to potential borrowers that they haven’t drawn the full amount on.

Brian Chase

There is some revolver commitments out there - fairly light. I think it’s, you know, maybe around $5 to $10 million. It’s not significant.

John Hecht

Okay. That’s helpful.

Mitch Drucker

To that point, a fair amount of our deals are bifurcated deals. So we’ll provide the term loan and bank asset based lending units will do the revolver. So we don’t have any, you know, revolvers in place in those structures.

Brian Chase

Yes. It’s not very efficient for us to carry around revolvers. So we try and avoid that as much as we can.

John Hecht – Stephens

Yes. That’s what I was looking for and you guys have answered it. Thanks very much. And then…

Joseph Tansey

And there’s a strong bid from the banks to do it. So it actually works well.

John Hecht – Stephens

Yes. Okay. And then the – on the core portfolio yield, it – it’s then – it move – it’s been stable around the 11 percent zone. You – your new asset generation in the core portfolio this quarter was just a little above that. But given the pipeline, given kind of competitive trends, do you think that the core portfolio yield should – sustain around the 11 percent level for the – I guess, for the visible future?

Mitch Drucker

Yes. I think there’s been a little pressure on rates. You know it’s a natural progression in the economy. You know regional banks are getting a little more aggressive, you’ve got some asset based lenders stepping up and doing some stretch.

You know that being said, you know our originated business is still, you know, over 11 percent, so we’ve seen somewhat of an immaterial drop. And we feel very comfortable with the yields, you know, based on – the relationships, some of the execution premiums we get, the nature of the bifurcated deals on a blended basis to the borrower. It’s only 7, 8 percent. But we could be getting 11, 12 on a term loan. And it’s matched up with an asset based lender, which is getting 2 to 3 percent. And we get comfortable in certain industries were we get a premium such as cable, you know, insurance businesses and some oil and gas deals.

And then the platform also helps us enhance yields, you know, by being able to do deals like real estate, you know, some leasing deals and consumer deals. So we’re comfortable, you know, that the yields will remain in this range.

Brian Chase

Yes. And there’s a little bit of a barbell in the core portfolio, John. Where, you know, the originated stuff is kind of, you know, above the average. And some of the club stuff and other stuff is kind of below the average. And so it all kind of blends to where we’re at. And so there’s a real mix in there that you don’t really see in the stats.

John Hecht – Stephens

Yes. Okay.

Joseph Tansey

But – and I do think when you’re only looking at generally the five or six transactions a quarter, there could be some volatility in that number in a quarter based on the mix, right?

If you’d had a quarter that was all originated or 4 or 5 of the 6 ended up being originated, it would be higher and if it went the other way, we had two originated and four, you know, maybe, clubs in a quarter - it could be lower. And that might not – that might not – that might overstate the trends. But I think the trend is modestly tighter for sure.

John Hecht – Stephens

Okay. That’s helpful. And I guess sort of a good segue from that is can you characterize your pipeline and maybe just, you know, beyond that characterize your opinion of what happened, you know, what you’re hearing from private equity groups, so forth this year in terms of where the mix of deals might come.

Might it be sponsor driven, might it be, you know, club driven, is it, you know – we still going to see a lot of refi activity? Or is that going to be replaced by more M&A activity and expansion capital?

Mitch Drucker

I think at this point, we expect to continue to see more sponsor volume. The sponsors aren’t entirely happy, you know, with their pipelines. That being said, they are still active doing add-ons and acquisitions as you compare sponsors to just private companies.

Private companies usually go out to the market when they are – they’re experiencing growth. Because of the weak economy, they’re not looking to do a lot of expansion and – as such, they’re not seeking, you know, expansion capital. So we expect to see the mix continue to be sponsor deals.

Our mix right now is running about 60/40, 60 percent sponsor, 40 percent private. Over time, I would think that would even out as the economy starts to grow.

Joseph Tansey

But I think the – we’re very busy now because the pipeline, you know, big picture, relatively – and I think we’re busy on an absolute basis. And I think on a relative basis for this time of year, we’re much busier than we usually are at this time of year.

So I do think that that means people are trying to do more things as there is more optimism in the economy now than there was last year. And obviously, it remains to be seen what percentage of that pipeline gets converted. But usually, it – it’s been pretty good. So I think I feel pretty good about, you know, closing a few deals here in the end of the quarter or in the early part of the second quarter. And that the pipeline for the second quarter seems pretty robust at this point.

John Hecht – Stephens

Great. Good to hear. Thanks very much, guys.

Joseph Tansey

Thanks, John.

Operator

Have a question from the line of Andrew Kerai.

Andrew Kerai – National Securities

Yes. Hello, good morning. And thank you for taking my questions.

Joseph Tansey

Great.

Andrew Kerai – National Securities

The first thing I had – so if you look at the interest incomes, as a percentage of the – of the portfolio during the quarter, it looks like that trended up a little bit more than the direction over yield. Was any of that sort of, you know, acceleration of fee income from some of those repayments that happened during Q4?

Brian Chase

There was some fee income in there as a result of some pre-payments. I wouldn’t say it was an unusual amount. But that is a component of it.

Joseph Tansey

I think on a relative basis, for the third Q, a lot of the assets were added in the third quarter, were added right at the end of the quarter. So they didn’t get the benefit in the income for the full quarter. So the fourth quarter got a lot of the third quarter origination volume benefit.

Andrew Kerai – National Securities

Got you. Certainly. Fair enough. And then so just looking at – there were a couple of deals within your core portfolio. But it looks like you guys purchased in the secondary market. Just will somebody give a little bit more color around the pricing and structure on those couple of deals relative to the rest of your core portfolio? As well as, if you’re seeing any other opportunities for secondary market purchases that kind of meet your 9 percent yield threshold within the secondary market?

Mitch Drucker

Sure. We classify deals that we book as originated, those are deals in which we lead. And clearly, the preference is to do as many of those as possible.

You know, because the average yield in those deals was close to 12 percent. Now, the next category would be club transactions, in which we’re not leading but there’s – we’re one of, you know, relatively few members, and a bank group deals typically, you know, under $75 million. And you’d expect the yields to be slightly lower on those deals.

And then the third category would be the purchase deals in the syndicated market. And we have, you know, a lot of capital markets experience in the group. And we’ve been opportunistically purchasing certain loans that have generated over 10 percent.

I think we’ll continue to see those opportunities as well as, you know, portfolio opportunities.

Joseph Tansey

And I think…

Andrew Kerai – National Securities

Sure.

Joseph Tansey

…that also some of those are not necessarily new issue. And I think that when you look back to some of the assets that are in that bucket were from the loan portfolio purchase we did a couple of quarters ago that were, you know, sort of a liquidation of a portfolio by a fund. And those kinds of transactions that come around, that although they are purchased and they may be an existing credit that has been seasoned, they look more like our originated or club transaction than they do, you know, a broadly syndicated levered loan. Which is why they’re sort of classified there.

So you know I don’t think there is too many opportunities in the traditional broadly syndicated loan market for us to go and, you know, buy. Those loans are L+300, right? You can’t – you’re not going to make too much money doing that. And that’s not going to make it to our core portfolio.

So when you see purchased, sometimes, it’s in idiosyncratic story. And we’ve had for many years, you know, at Garrison here had a lot of success finding idiosyncratic assets to buy that we’ve done very well on. And so we hope that we can continue to do that. And there is some – you know, always opportunities that come your way because people know we do that kind of stuff that I think a lot of other people do – can get a lot of calls on it.

Andrew Kerai – National Securities

Yes. Sure.

Joseph Tansey

Whether it’s at the end of their life or whatever it is.

Andrew Kerai – National Securities

Yes. Sure. Thank you. That’s certainly helpful color.

And then just back to the – to the SBA as well too, assume you guys get approval for that, you know, possibly sometime towards the end of 2014. What percent roughly of your originations can we think about as being potentially funded by SBA debt from just a modeling perspective.

Brian Chase

I mean we – we’ve never actually done the analysis here. But I would say, you know, kind of back of the envelope, I’d be surprised if not greater than 50 percent of what we do would sit within the SBA guidelines.

I mean just given the space we play in, you know, focusing on that kind of 5 to 25 million dollar of EBITDA company, when you look at the taxable income of those companies, you know, it would – typically fits within the SBA program, so quite a few.

Andrew Kerai – National Securities

Sure. Thank you. And then just the plan is to eventually access a full 150 million of SBA debt available under that first license – as you – as you grow the balance sheet. Correct?

Brian Chase

Absolutely.

Andrew Kerai – National Securities

Great. Thank you for taking my questions, guys.

Joseph Tansey

Thank you.

Brian Chase

Thank you.

Operator

You have a question from the line of Bob Napoli.

Bob Napoli – William Blair

Thank you. Good morning. I just – I guess, as we look at the core / transitory mix, is that – would it be reasonable to think about that being like a 90/10 percent would be your preferred mix of the two?

Joseph Tansey

That’s right. I think that’s as good a guess as any and…

Bob Napoli – William Blair

Okay.

Joseph Tansey

…sometimes probably a little higher, sometimes a little lower. But I think you can never be 100 percent core.

Bob Napoli – William Blair

Right. And then as far as mix of direct lending club and syndicated originations, I mean, obviously you want to do as much direct lending as you can. But what – where do you think that mix will – the current run rate or – somewhere, you know, looking at like 30 percent direct, and is that reasonable? Or you – are the – are you targeting getting that direct lending up much higher than that?

Joseph Tansey

You know it’s been growing steadily. If you can, you know, look at the page there, only a couple of quarters ago was – it was only 16 percent and probably…

Bob Napoli – William Blair

Right.

Joseph Tansey

…26 – 32. We hope to continue to grow it. But at the same time, we’ll – we’ll be reasonable and opportunistic on what else we see. But I think we would like that percentage to grow – to continue to trend up as it has been.

Bob Napoli – William Blair

Okay. And then just on credit, if you could remind me about your tier – risk rating number three and the mix at 20 percent of your – of your – of your loans are in risk rating three. You have no nonperformers.

And what qualifies as risk rating three? And what do you expect the loss rate to be on loans that are – that are in risk rating number three?

Joseph Tansey

I think that three is just generally situations where the leverage is a little bit – little bit deeper than at two. You know we don’t anticipate necessarily a greater loss rate on those transactions.

It just generally means that the – that the leverage point or the trend also is not – is a little bit – either the trend is potentially slightly negative or the starting point leverage is a little bit higher. It doesn’t mean necessarily that we think there is any greater risk of immediate loss. I think that’s a good way to explain it. Mitch, I don’t know if you want to that.

Mitch Drucker

I think the – you know the objective obviously is to continue to over –originate and be selective. And you know the trends in the portfolio are very good.

You know if you look at again the leverage: 3.6 times, you know, it’s not like we have to reach out for yields here. You know we’re sticking to, you know, the core characteristics that we look for, you know, tight structures, zero loss tolerance.

So a three would be one where, you know, maybe there’s a little blip in a quarterly or a monthly basis. But from the standpoint of protection, you know, as long as we stay in the first lien, which again were close to 90 percent, you know, the recoveries are going to be around par. And we just have to stick to the knitting and not get too deep into second lien or mezz.

Brian Chase

And if you look at the weighted average, you know, we’ve been pretty steady…

Bob Napoli – William Blair

Yes.

Brian Chase

…over time here. So there is no – and the portfolio has changed a little bit obviously with some of the broadly syndicated stuff leaving and taking in more core. But you know as a whole, I think this may not be a bad sort of dispersion of where the risk ratings may be at any given time in a sort of benign environment.

So I wouldn’t read too much into the 20 percent on the risk rating three as Joe was pointing out. Sometimes, it just indicates little deeper leverage at the starting point.

Bob Napoli – William Blair

Okay. And then last question. Just can you remind me what your consumer loans are and how you originate them? Are these – you know, what types – are they home eq mortgages? Or are they unsecured consumer loans?

And where – how do you originate them? Who do you buy them from?

Joseph Tansey

So, they are unsecured consumer loans. And they’re fully amortizing loans and with different maturities based on credit rating.

And some of them are shorter. I think the average maturity is around 36 months for those loans. The weighted average credit score, FICO score’s around 700. And so it’s not a, you know, portfolio where we’re reaching, you know, higher risk, higher return type of consumer lending.

I don’t – I have to just – hold on one sec. So I just didn’t know if we could disclose – that then the name of the company that we buy the loans from is Prosper.

Bob Napoli – William Blair

Okay. So you’re buying from Prosper. Okay.

Joseph Tansey

And you also see that we own a small piece of the equity in Prosper if you look on ...

Bob Napoli – William Blair

Yes. I saw that.

Joseph Tansey

…see that. So there, we’ve – we – when we originally started buying loans from Prosper, we invested some money in their equity. And we’ve been buying loans from them now for around a year and a bit.

Bob Napoli – William Blair

Okay. And Prosper is actually servicing the loans. Is that correct?

Joseph Tansey

Correct.

Bob Napoli – William Blair

Okay. Great. Thank you.

Joseph Tansey

Thank you for your question.

Operator

Have a question from JT Rogers.

JT Rogers - Janney Montgomery Scott

Hey, good morning. Thanks for taking my question.

Joseph Tansey

Thank you.

JT Rogers - Janney Montgomery Scott

I – first off, you know you guys have been trading below book value and, you know, getting fairly levered. I was wondering how you view the opportunities in the market versus the book value dilution you might experience from raising capital below book.

Brian Chase

Yes. We have – we’re – we have no plans of raising capital below book.

So we’re – you know we’ve got plenty of liquidity right now for the next few quarters. And it’s not our intention to raise capital below book.

JT Rogers - Janney Montgomery Scott

That is good to hear. I mean I think that conversely, you know, although you, you know – you don’t appear to have any lack of opportunity to put capital work, you know, with the Russel re-constitution, I think BDCs, you know, could experience some pressure, you know, based solely on nonfundamental factors. Have you all considered putting a buyback in place in case there is an opportunity to buy your own shares at a significant discount? It seems like an opportunity to buy into the – you know, a portfolio that you really like and know very well at a discount.

Brian Chase

Yes. We haven’t – we haven’t talked about that yet. I mean we’ve frankly been kind of keeping our head down and making loans here.

Obviously, if the stock got really dislocated, which I - obviously it hasn’t traded the way we’ve expected it to. But I don’t think it’s gotten into a territory where a buyback, you know…

JT Rogers - Janney Montgomery Scott

Yes.

Brian Chase

…would have been obvious. If it does get there, I mean I think it’s something we could talk about. But I have – we’re not there today. And we’ll see what happens with the Russell.

JT Rogers - Janney Montgomery Scott

Yes. I mean it – certainly would agree with that. Just would be interested to see. And it seemed like an opportunity for you guys to add further to book value.

But thanks a lot. I appreciate you taking my questions.

Joseph Tansey

Sure. Thank you.

Operator

There are no further questions at this time.

Joseph Tansey

Great. Thanks, everybody, for your time this morning. And thanks for all the questions.

Operator

This concludes today’s conference call. You may now disconnect.

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