Oaktree Capital Group (OAK) Q2 2014 Results - Earnings Call Transcript

Jul.31.14 | About: Oaktree Capital (OAK)

Oaktree Capital Group, LLC (NYSE:OAK)

Q2 2014 Earnings Conference Call

July 31, 2014 11:00 a.m. ET


Andrea Williams – Managing Director, Head of Investor Relations

John Frank – Managing Principal

David Kirchheimer – Principal, CFO and CAO


Chris Harris – Wells Fargo

Patrick Davitt – Autonomous Research

Michael Kim – Sandler O’Neill

Brian Bedell – Deutsche Bank

Marc Irizarry – Goldman Sachs

Craig Siegenthaler – Credit Suisse Group AG

Ken Worthington – JP Morgan

Robert Lee – KBW


Welcome and thank you for joining the Oaktree Capital Group Second Quarter 2014 Conference Call. Today’s conference call is being recorded. At this time, all participants are in a listen-only mode, but will be prompted for a question-and-answer session following the prepared remarks.

And now, I would like to introduce Andrea Williams, Oaktree’s Head of Investor Relations who will host today’s conference call. Ms. Williams, you may begin.

Andrea Williams

Thank you, Shirley. And welcome to all of you who have joined us for today’s call to discuss Oaktree’s second quarter 2014 financial results. Our earnings release issued this morning detailing these results may be accessed through the Unitholders section of our website. Our speakers today are Oaktree’s Managing Principal, John Frank; and Chief Financial Officer, David Kirchheimer. We will be happy to take your questions following their prepared remarks.

Before we begin, I want to remind you that our comments today will include forward-looking statements, reflecting our current views with respect to, among other things, our operations and financial performance. Important factors could cause actual results to differ, possibly materially from those indicated in these statements. Please refer to our SEC filings for a discussion of these factors. We undertake no duty to update or revise any forward-looking statements. I’d also like to remind you that nothing on this call constitutes an offer to sell or a solicitation of an offer to purchase any interest in any Oaktree fund.

During our call today, we will be making reference to certain non-GAAP financial measures, which exclude our consolidated funds. For a reconciliation of each non-GAAP financial measure to its most directly comparable GAAP financial measure, please refer to our earnings press release, which was furnished to the SEC today on Form 8-K, and may be accessed through the Unitholders section of our website at www.oaktreecapital.com.

Additionally, references to amounts per Class A unit are after taxes and other costs borne directly by Oaktree Capital Group. Today, we announced a quarterly distribution of $0.55 per Class A unit payable on August 14 to holders of record as of the close of business on August 11. Finally, we plan to issue our Form 10-Q for the second quarter next week.

With that, I would now like to turn the call over to John Frank.

John Frank

Thank you, Andrea. Hello, everyone. We are very pleased with the results of the second quarter. Solid investment returns and strong inflows brought both assets under management and management fee generating assets under management to record highs. We raised gross capital of over $5 billion in the quarter and over $16 billion in the last 12 months representing the highest amount in six years.

Importantly fee-generating AUM grew an impressive 20% year-over-year due to strong inflows from our newest products, market value gains on our funds for which management fees are based on NAV and our latest funds from distressed debt and real estate.

From an earnings perspective, both adjusted net income and distributable earnings were down from the year ago period, which included recorded incentive income from our crisis area, distressed debt fund opportunities VIIb. Now this variability in incentive income is of course a fact of life in our business. But it shouldn’t obscure we achieved in the nearly two-and-half years since we went public in developing innovative investment strategies and broadening our business and creating and realizing investment gains.

Since our IPO, we’ve raised $29 billion of gross capital including $10 billion for recently launched strategies and at the same time $2.4 billion of fund level incentives and distributed $25 billion from our closed-end funds to our limited partners. In short, we believe our business has never been stronger and that we’re well positioned for whatever may come.

If the investing environment remains as is for a while, we’ve a number of growing strategies that will help our clients achieve their goals with risk under control while continuing to expand their business. And when the excesses that are becoming apparent in the marketplace eventually lead to a correction, our distressed debt team will be ready to help our clients reap the benefit of the significant opportunities that will emerge.

The investment environment was very salutary in the second quarter. Decline in interest rates and the stable economy encouraged investors to take greater risk setting the stage for a strong stock market rally. After severing significant volatility in the first quarter, equities performed well bolstered by the low interest rate policies to Central Banks.

The S&P 500 gained an impressive 5.2% on the quarter despite concerns over weak growth in developed economies. European activities also performed well, as the European Central Bank made the decision to further reduce interest rates and consider the introduction of U.S. style quantitative easing. Higher quality bonds were typically lagged in a bull market also achieved outsized results.

Powered by foreign interest rates for 10-year Treasury note and investment grade corporate bonds generally did solid returns in the upper 2% range. High yield bonds also performed well, but they lagged their more interest rate sensitive counterparts. Accordingly the best performing fixed income assets in the quarter were ones with higher risk and long duration.

Against this backdrop Oaktree’s closed-end funds largely participated in price gains along with the equity markets. Overall, our closed-end funds generated an aggregate gross return of 3.7% for the second quarter bringing the gross return for the last 12 months to 18.4%, longer term as of June 30, the gross IRR for all our incentive creating closed-end funds since inception was 20%. All 48 of those funds that are more than a year old had positive gross IRR since inception and 43 of them were at or above the 8% net preferred return hurdle. This extraordinary investment record over 26 years and $65 billion of invested capital is of course a significant key to our success.

As I mentioned, the second quarter marked another strong period for fundraising bringing our AUM to an all time high of $91 billion, up 6% in the past three months and 19% from the year ago. Gross capital raised of 16 billion in the last 12 months is our highest total ever for a period without a distressed debt opportunities fund.

We’ve raised about $10 billion among each of the last seven calendar years and the $8.4 billion raised in this first half 2014 more than maintains that pace for the eighth.

Let me touch on the highlights. First, capital contributions to our open-end funds totaled $8.5 billion over the last 12 months up almost 90% over the prior period. These strategies led by high yield bonds, convertibles, senior loan funds and emerging market equities represent about 42% of our AUM. Their global client base features significant institutional allocations and a growing number of mutual funds, sub-advisory or similar relationships, we had a strong head start in mutual funds having been hired in 1996 by Vanguard to manage its convertible securities fund.

Since that time our total mutual fund AUM has grown to over $8 billion spanning four investment strategies and featuring relationships with six prominent mutual fund sponsors.

Contributions of $1.8 billion to our evergreen funds in the 12 months were led by two of our newer strategy, strategic credit and value equities. We paused fundraising for strategic credit some time ago in order to ensure ability to invest the initial capital successfully, but having achieved a gross return of 15% over the last 12 months we plan to resume marketing for this strategy in the coming months.

Lastly, closed-end funds represented about $6 billion of total gross capital raised in the last 12 months. Again, newer step out strategies were prominent with real estate debt, European private debt and emerging markets distressed debt together accounting for over a third. Adding our second enhanced income fund which is a levered senior loan strategy which had its only close in April and is expected to reach over $2 billion and you can see why we’re so excited about the new dimension for our growth.

Looking forward, we’re excited about adding to this mix the new fundraising for our established closed-end strategies. A week ago, we launched Real Estate Opportunities Fund VII just months after completing the marketing and its $2.7 billion predecessor fund. Real estate investment opportunities within are near to remain plentiful, we’re also finding opportunities in our distressed debt strategy despite the absence of the usual corporate distress.

Our $5 billion opportunities Fund IX has reached 70% run fairly a year after its first investment. We expect to begin marketing its successor opportunities Fund X a little later this year. Mezzanine Fund IV and Principal Fund VI remain in the market and our power opportunities in first infrastructure fund are on the horizon of early next year.

Now, as you know, we don’t raise capital rotary simple because we can’t. Rather we do so when we believe we can deployment to generate attractive risk adjusted returns for our clients. So, where do we see opportunities in today’s environment?

Europe, real estate and power are among the sectors of regions where we’re finding attractive investments. There is no questions of bargains or order to come by, but our experience and relationships are great assets allowing us to continue to access opportunities even during the low in U.S. corporate distressed debt.

But, we have no doubt, distressed opportunities will eventually pick back up. Credit standards have dropped and non-investment grade debt issuance has reached levels. We can’t predict the timing but aggressive extensions of credit of the sort we’re seeing today have always a precursor to a substantial distressed debt opportunity. We will be prepared to take advantage whenever the opportunity arises.

Lastly, I want to touch on our previously acquisition of the Highstar Capital team. We’re specialist in U.S. energy infrastructure waste management and transportation. Highstar focuses on strategic infrastructure assets where organic growth and sustainable downside protection can be achieved through active management and enhancement of assets and businesses.

We’re excited to bring the Highstar folks on board. They will work under the supervision of Ian Shapiro, who heads our successful power opportunity strategy. Ian’s existing team has focused for many years on businesses that supply technology, equipment and services to the electricity and natural gas industries. This specialized strategy has been one of Oaktree’s most accomplished with a gross IRR of 35% over 14 years.

In the ordinary course of business Ian and his team will often come across perhaps to pass on attractive opportunity suitable for an infrastructure fund. Similarly, the Highstar team would see opportunities that would have benefited from the expertise of our power opportunities group. We’re very confident that working together the two teams will accomplish much more than either could individually.

We’re going to close the transaction tomorrow and when we do Oaktree will become the manager of Highstar Fund IV with approximately $2.4 billion in AUM as of June 30, that fund is about 70% committed and as noted earlier, we expect to begin raising a successor Oaktree Infrastructure Fund early next year.

With that I’ll turn the call over to David to take us through the financials for the second quarter in detail.

David Kirchheimer

Thank you, John and hello everybody. We’re pleased with the positive trends that continued in the second quarter yielding sizeable benefits for the present and future. Another quarter of very solid returns drove growth in the many mark-to-market elements of our business.

Investment income from Oaktree funds alone rose 38% year-over-year. Management fees increased on the one-third of that revenue source based on NAV. Net accrued incentives and the portion incentive creating AUM currently giving raise to accruals each reached multi-quarter highs. And both total AUM and management fee generating AUM kept all time record highs.

In achieving their records total AUM grew 19% from a year earlier to $91 billion and management fee generating AUM rose 20% to $78 billion. This growth was entirely organic and it was achieved despite significant downward pressure from the ongoing liquidation of mature closed-end funds.

Market value gains explained part of the growth, but particularly noteworthy with a multiyear highs in fundraising that John described. In fact, our continued fundraising success drove net increases in management fee generating AUM from fund flows alone to $8.7 billion for the trailing four quarters, a five year high demonstrating the breadth of our momentum across the platform, each of our fund categories made meaningful contributions to that $8.7 billion total.

Thanks to those strong flows. The second quarter’s total management fees of $189 million represented our highest quarter ever before so called retroactive or other one-time items. Thus we more than compensated for the $25 million year-over-year in quarterly management fees attributable to Opps VIIb and other closed-end funds in liquidation.

Moreover, the new capital gives our management fees greater strength and momentum. Thanks to a younger skewing mix of closed-end funds and a fast growing pool of new strategies. Specifically, $77 million of the second quarter’s management fees arouse from closed-end funds in their investment period, up 13% from a year earlier. And management fees arising from newer investment strategies quite dribbled year-over-year to $12 million in the second quarter.

Many of these newer strategies pay fees based on NAV contributing to 19% year-over-year growth in that growing subset. Thus, our fees benefit from this ability of closed-end funds well participating more than ever in market value gains. And when market prices turn south, our ability to raise capital for distressed opportunities will give us a natural hedge.

As previewed in last quarter’s earnings call, second quarter incentive income fell to $59 million this year from $338 million last year. This reflected two phenomena. The first is the natural tendency for incentive distributions to shrink and become long peer, now that Opps VIIb is far along in its liquidation. The second is the fact that most other accrued incentives relate to fund that are not yet at the stage of their distribution waterfall where Oaktree is entitled to incentive distributions other than tax related ones.

Of the $59 million in gross incentive revenue, Opps VIIb generated $39 million. The remaining $20 million arose primarily from five principal investing, mezzanine finance and distressed debt funds.

I would like to point out that this quarter represented the 42nd consecutive quarter of positive incentive income at Oaktree. Thus, the quarter-to-quarter lumpiness is against the backdrop of a long history of positive incentive income and resulting cash flow straight through the markets’ ups and downs.

As a result of the decline in incentive income, adjusted net income fell to $135 million for the quarter from $297 million a year ago. Per Class A unit ANI was $0.75 in this year second quarter versus the $1.75 a year ago. Likewise distributable earnings declined to $0.64 Per Class A unit from a $1.94 a year earlier.

Fluctuations in incentive income are natural part of our business. Compared to most other public incentive asset managers we delay the recognition and receipt of that income that’s because of our use of the more conservative of the two choices for recognizing incentive income as well as our utilization of the European style distribution waterfall for closed-end funds.

The former means that we do not recognize incentive income until it is beyond plausible risk of clough back which per the latter typically occurs only after fund investors have first received back all of their drawn capital as well as their preferred return. As a result at Oaktree the future still awaits for incentive income and the resulting equity distributions that at many other alternative asset managers could lie in the past.

We track potential future incentive income using a metric called accrued incentive, which is essentially an off balance sheet receivable that reflects the mark-to-market method for measuring incentives. Consequently, accrued incentive serves as a leading indicator of potential incentive income and distributable earnings.

After the large amounts of incentive already realized by us, it would be natural to assume that our accrued incentives had fallen significantly from a year ago, quite the opposite the balance has increased. As of June 30, accrued incentives net of associated compensation expense stood at $1.3 billion or $8.46 per operating group unit. That $1.3 billion is up over 5% from the year earlier balance and just 5% shy of our all time high. Thus, while we’re quite proud of the record levels of incentive recognized in 2013, we’re equally proud that our investment teams more than restocked accrued incentives with new incentives created.

Over the four quarters ended June 30, 2014, this restocking aggregated $1.07 billion of gross incentives created. To put that amount in perspective, it exceeded 2013’s record annual incentive income revenue of $1.03 billion.

Now, I want to highlight something we’ve been quick to know in the past. Namely, that 63% of the $1.3 billion in net accrued incentives as of June 30 is in funds that are not yet at the stage of their waterfall with pay incentives. And that three quarters of the remaining 37% is attributable to Opp VIIb. Those factors speak to the timing of future incentive realizations.

I would make two additional observations regarding the prospects for further growth in accrued incentives and the momentum toward their realization. First, $1 billion of the $1.3 billion of net accrued incentives is in funds that are in their liquidation period. Second, as of June 30, 95% of our incentive creating AUM or $33.5 billion was creating incentives, the largest dollar amount since year end 2010 when Opp VIIb was at its peak.

Our value creation also is captured by economic net income or ENI, a metric that calculates incentive income using the same mark-to-market approach as accrued incentives. For the second quarter our ENI was the $1.17 Per Class A unit versus $0.75 per unit per ANI.

And now to few final items. As John described the acquisition of the Highstar team will serve to diversify and grow our franchise. We structured the transaction such that Oaktree will share more in their future funds than the existing ones reflecting our confidence in the team. We expect the bottom-line impact to be negligible until management fee start from our first Oaktree Infrastructure Fund next year.

Our disciplined approach to growing our equity base and managing our balance sheet enables us to fund growth such as Highstar without impairing our ability to payout a healthy share of distributable earnings in the form of equity distributions as we’re doing for the 73rd consecutive quarter.

Since our IPO, we paid out about 80% of operating group distributable earnings on average, retaining the balance for investment in our funds, to use impossible corporate transactions and to enhance our liquidity and financial position. The magnitude of the retained 20% of distributable earnings puts us in an excellent position in all regards. Indeed, we’ve never had stronger financial resources, liquidity or momentum to our business. Thus, we’ve decided to increase our standard payout ratio to 85%, resulting in the upcoming second quarter distribution of $0.55 Per Class A unit.

Let me take a brief look at the current third quarter which is underway. With respect to incentive income, we expect the same two phenomena that I described to cause another year-over-year decline in quarterly incentive income and therefore distributable earnings.

To-date in this third quarter, we’ve had no incentive income distributions and $7 million of investment income proceeds. And no incentive income distributions are on the immediate horizon.

With respect of Opp VIIb, my best guess is that the fund will generate net incentive income in an amount equal to or possibly somewhat larger than the $21 million generated in the second quarter, although that’s far from certain and of course subject to the usual caveats surrounding market conditions and other variables.

Finally, our strong balance sheet is getting even stronger, thanks to our recent issuance of $250 million in senior notes of 10 year to 15 year maturities in a heavily oversubscribed offering at fixed rates we found very attractive starting at 3.91% for the ten-year tranche. This debt which retains our A rating should fund in five weeks.

In summary, we couldn’t be more pleased with where we’re and where we’re headed. Investment performance is driving success across the platform in fundraising, product and distribution channel development and value creation and realization.

And with that we’re delighted to take your questions. So, Shirley please open the lines.

Question-and-Answer Session


Thank you. We’ll now begin the question-and-answer session. (Operator Instructions) Our first question comes from Chris Harris with Wells Fargo, you may ask your question.

Chris Harris - Wells Fargo

Thanks, good morning guys. So, there is some press reports that have been floating around indicating that you guys were part of consortium that was bidding for some Spanish bank loans and ultimately lost that bid to Blackstone. If you want to comment on that that would be great, but if not my broader question is, I guess is, way you’ve seen out there from a competitive perspective, I know it’s probably pretty harder to source opportunities today. But, have you seen much change in the landscape say over the last couple of quarters that would prevent you from originating maybe what should like to originate?

John Frank

So Chris, yes, as you anticipated, I don’t particularly want to comment on particular deals although the situation you reference is the situation where Blackstone out bid others for a portfolio which is true. In terms of what we’re seeing, we’ve talked on these calls before about the fact that the European opportunity was something that lot of folks raised a lot of money to take advantage of and the flow of loans was never quite what people anticipated over the last few years. But there is no question that there is more flow now and that there are many more portfolio transactions coming to market.

We’ve looked at a number, we’ve been successful in our efforts to acquire some, not successful in other. It is a competitive environment, a lot of our investing that we do is more proprietary than that. Yes, do we look for portfolio transactions like others, absolutely? But a lot of what we’re doing in Europe is more off the run where we’re developing proprietary opportunities with management teams and taking advantage of the fact that the banks while concerned with their own balance sheets and dealing with their own problematic assets are not in a position to provide the same financial report they did historically.

And so, we’re finding ways to provide that capital. So, it’s a competitive environment for sure, but we’ve deployed roughly $10 billion in capital over the last 12 months across a number of sectors up largely power, Europe, real estate and we’re continuing to do so. So, I guess in brief, we wouldn’t be raising the capital that we’re doing and that we anticipate doing that if we didn’t think we could deploy it effectively.

Chris Harris - Wells Fargo

Understood, thanks John.


Thank you. Your next question comes from Patrick Davitt with Autonomous, you may ask your question.

Patrick Davitt – Autonomous Research

Hi guys, good morning. The question is about LP overlap between Highstar and yourselves to what extent there are opportunities to cross market new LP if not that you guys really need any (inaudible) lock at this point. But just curious how that situation is?

John Frank

Patrick, there is overlap and I think 6 out 10 of the largest investors in Highstar are also investors who invest with us. Now as you know a lot of these huge institutional clients have many, many employees in different division. So the fact that you may manage money for one part doesn’t that so mean you know the same people and different part of the organization. But, I’ll you that one of the things that gave us great comfort in pursuing the Highstar acquisition was the fact that we knew so many of their clients well and were able to depth them with those clients, in addition they were all knowledge of them and their own due diligence.

Patrick Davitt – Autonomous Research

Okay, thanks.

John Frank

Thanks Patrick.


Thank you. Your next question comes from Michael Kim with Sandler O’Neill, you may ask your question.

Michael Kim - Sandler O’Neill

Hi guys, good afternoon. Just curious to get your take on the current M&A environment in terms of maybe competitive landscape and/or pricing particularly as it relates to increasing the payout ratio to 85%, just curious about sort of the dynamic there?

David Kirchheimer

Sure. Hi Michael, first of all, we built up the liquidity and certainly as I mentioned in my remarks strengthened our balance sheet to be prepared for whatever strategic opportunities such as Highstar. Just in the last several months we’ve had the five year extension of our bank credit facility, we’ve had the issuance of the $250 million in senior notes and we coupled that with the strong momentum across the platform and the increase in the payout ratio at 85%, to us certainly was appropriate. And by the way the 85% is higher than the 80% that we had maintained since our IPO, it’s in fact roughly comparable to what we had averaged for all the years for the IPO. So, it’s proven to be a sustainable level for our business model and we feel that we certainly have ample drive potter for whatever opportunities continued to come our way which there many that we may choose to pursue.

Michael Kim - Sandler O’Neill

Okay, that’s helpful, thanks for taking my question.


Thank you. Your next question comes from Brian Bedell of Deutsche Bank, you may ask your question.

Brian Bedell - Deutsche Bank

Hi, good morning folks. I think John, I think if I heard you right, you said, you deployed about $10 billion in various opportunities, I guess, I want to make sure I heard the number right. Maybe the better way to ask the question is, what is the size of your deployment currently money in the ground for the direct lending opportunities that I think you were referring to in Europe as a much better opportunity for you versus the bank loan sales. And then, maybe if you could just talk about your view of how that might grow and whether there is strong demand to raise new funds that directly target those opportunities, directly to corporate?

John Frank

So, first of all to clarify what I said, we’ve invested about $10 billion over the last 12 months, I did say that across real estate, shipping and energy, other European investments. So that will clarify that.

With respect to the direct lending opportunity, thankfully one of the advantages are platform as we can access that opportunity through a number of different strategies including our distressed strategies, our principal strategy which is sort of our version of private equity through what we call strategic credit, through our European private equity strategy. And in each of these different strategies we’re addressing the opportunity – through our mezzanine strategy. We’re addressing the opportunity to do private lending in different ways.

In Europe the largest amount of capital that we had probably deployed has been through our European principal strategy where they’ve probably deployed $3 billion or more. In opportunities that are building out we talked about them on the last call where they’re funding platform type development opportunities in areas like student housing, senior living facilities and a lot of other, rail leasing, some shipping opportunities etcetera where they’re providing the capital that European banks might have in the past provided, but are no longer in a position to. It’s a competitive world out there and there are lots of people trying to do things equal to or similar to what we’re doing. An advantage we’ve is London is our second largest office in the world. We’ve 150 people or so in London. Our folks have been operating on the ground in London for a number of years now.

So, they’ve developed and we’ve a private equity group that has relationships with a lot of management teams and a lot of knowledge about a lot of industries. So, we don’t have folks who are just sitting at desk waiting for our call from a syndication person at an investment bank or whatever. But, they’re actually out on the ground, out in the field and creating their own opportunities. And we think that’s a very significant proprietary advantage.

Brian Bedell - Deutsche Bank

So, should we be thinking of the debt opportunity in Europe (inaudible) space over the next one to two years as a very substantial way for you to deploy capital versus obviously the public markets where credit conditions have gotten real lofty?

John Frank

I think it’s a, we never predict, we’re not big in predicting at Oaktree, but yes, it’s fair say that we favor opportunities where we have significant downside protection. We’re not in competition with a lot of others and we’re not engaging in a race to the bottom in terms of lending standards.

Brian Bedell - Deutsche Bank

Got it, okay. Great, thanks so much for taking my question.


Thank you. Your next question comes from Marc Irizarry with Goldman Sachs, you may ask your question.

Marc Irizarry - Goldman Sachs

Great, thanks. John, it sounds like there is more of things to maybe worry about in terms of opportunities for distress in today’s credit becoming opportunities. It sounds like also like Opps X maybe happening a little bit sooner, maybe in 2014, I think you spoke about it maybe being more of a 2015 activity for you guys. Can you just maybe expand on that a little bit? Thanks.

John Frank

Hi Marc, how are you doing? Sure, we’ve been clear from the last call that we would begin to raise opportunities Fund X this year and would not yet formally launch that but we will do so shortly and it remains in flux, but if you would ask me what I expect today, raise reasonable size to fund X and we may well raise a backup fund somewhat of what we did prior to the last crisis so that we have capital available in the event that the environment changes.

Now, I want to be clear, we’re not ringing the bell and saying this is it and something is going in the next three months or six months, we’ve no idea when it will occur and we’ve no idea what the timing is. But, we’re quite confident there will be a significant distressed opportunity in the future and we want to be prepared for it and we want to have the capital to ensure we can take advantage of it. So, I do anticipate that we will put in ourselves in a position to have that capital available. But, the details on the extent of it remain to be worked out over the coming months. And it may not again, we don’t want to overhype this, the opportunity may not be immediate and it may not immediately affect our financials because we may raise a substantial standby fund and not have it generating fees right away.

But, I think the point for people to take away from this, and my perspective is, really what I foreshadowed in my remarks which is we’ve got a very healthy, very nice growing business, our new strategies are doing very well, we got established strategies that we’re going back to the market for. So things are really pumping on all cylinders and at the same time we will be preparing ourselves for the distressed opportunity that will eventuate at some point and that will create another big opportunity for Oaktree. So, as I said, kind of whatever happens we will be prepared and frankly we are pretty excited about it.

Marc Irizarry - Goldman Sachs

Okay. And then just, I guess there was a report out there about some changes on the mezzanine funds in terms of some folks on the management side, can you just talk about the – or do you have any notices of early redemptions there mezzanine and maybe how if it all that affects sourcing for other credit strategies? Thanks.

John Frank

Sure. What Marc referring to for anyone on the call not familiar. Our long time ahead of mezzanine strategy, a gentleman named Bill Sacker, we accepted Bill's resignation couple of week ago and would communicate of that to all of our limited partners and the leadership of our mezzanine group has been assumed by Bill's very, very long time indeed two lieutenants have been with, had been with Bill since the inception of our strategy in 2001, Bill Casperson and Raj Makam, so they have become Bill's replacements.

LP reaction to their succession has been very, very positive. We’ve already had a first closing of our new mezzanine fund. We gave the opportunity to all the investors in that fund to withdraw their commitments if they wanted to. We weren’t legally obligated to do so, but as you guys all know that's the way we run our business. And to the best of my knowledge, no investors availed themselves of that opportunity and in fact, I believe all of those investors and I know for sure, that the very, very largest investors have all re-committed. So it's to be honest, it's sort of a non-event, we like Bill respected and we are sorry he is gone, but we are looking forward, we’re very happy about our position. We don't view this as diminishing our opportunities, diminishing our prospects, it's sort of a non-event.

Marc Irizarry - Goldman Sachs

Great, thanks.

John Frank

Thanks Marc.


Thank you. Your next question comes from Craig Siegenthaler with Credit Suisse. You may ask your question. Craig your line is open, go ahead with your question.

Craig Siegenthaler – Credit Suisse Group AG

Good morning everyone. Just looking at the recent balance sheet growth here, I wonder if we should expect the balance sheet continue to grow and I am wondering kind of on two issues, one is net seat capital needs and also if you want to store maybe a little bit of capital for future acquisitions?

David Kirchheimer

Sure. Well, yes. Balance sheet certainly has grown as we have invested in both existing strategies and the seat opportunities and we haven’t talked too much about CLOs, but that's one of the prominent areas where we are able to deploy our balance sheet and use it to strategic advantage as we grow that area as part of our commitment in the senior loan area. And that's one of the reasons why we re-access the long term debt market for the sixth time in the last, what I guess has been 13 years as part of our planned growth of the balance sheet, but in a very disciplined fashion, we have worked hard to get to our A rating and we certainly intend to maintain that. So, the growth of the balance sheet is in the context of the same kind of ample liquidity that we like to have at the fund level.

But yes, you have noted the right thing Craig, in terms of using our balance sheet, our liquidity, our financial strength to see these opportunities that then create this new capital racing that John described in the newer products. And if you think about it value equities, strategic credit, emerging market long loan equities and merging market stat etcetera, etcetera. They all sprang from either us, seating initial sort of incubating funds and/or having a 12 to 18 months runway in terms of funding initial operating losses for those areas before we felt comfortable to go out in market then and you should expect that to continue.

Craig Siegenthaler – Credit Suisse Group AG

Great, thanks for the color.

John Frank

Thanks Craig.


Thank you. The next question comes from Ken Worthington with JPMorgan. You may ask your question.

Ken Worthington - JPMorgan

Hi good morning. Just a couple of questions on Highstar, maybe first talk about how you came to acquire Highstar and why you thought they were a good fit and then talk about maybe how are these deals in general are structured and what safeguards are in place to make sure they work? So when you structure them, are you getting carried on existing funds or is it just on the future funds and how does your team kind of oversee a business that's really half way across the country, like how close do you look at the investments they are making, how are you sort of to observe versus participate? So I think I had dozen questions in there. If I need to, I can repeat them if you want.

John Frank

Great, thanks Ken. I think I pretty much got them, but you feel free to follow up. I think the initial part of your question was how do we find them, why were they in attractive target, what were we thinking, I think it’s generally what you are asking about it. And the answer is, as I referenced in my prepared remarks, for some time we have seen opportunities in the ordinary course of business of our power opportunities strategy that did not hold sufficient return to be a good investment for that strategy. But we’re clearly a very attractive investment for an investor looking for someone lower return and we headed throwing those opportunities back into the sea if you will.

So, we started at least 18 months and it may have been 24 or 36, I don’t quite remember. Looking for people to help us expand into the infrastructure area and it won’t shock, we are kind of particular about who want to hire and our efforts to find folks to help us in that area, we’re not as productive as we would have liked. And we came across from the course of that activity, the Highstar folks and it was less that we were looking to acquire a firm and more that we were looking to associate ourselves with people whose talent and expertise we respected and knew we would benefit from. And so, the attraction at Highstar was the very high quality, the folks at Highstar and the fact that they had a record and established presence, the fact that they had a record and established presence in our, I think recognized as one of the leading firms in the infrastructure space that was all kind of gravy, what we really wanted to telling the people.

In terms of the transaction without getting into the details particularly of it, we structured it so that we took over their existing investing fund and that we will, the new funds that are raised with their help will be Oaktree funds going forward. In terms of the how we are going to work together, how we know. So, there is very little exposure to us, there is very little downside. So, how do you protect yourself or the economics of it all going forward and that’s probably a good segway and how do we expect to work together in the future and how we know what they are doing. This is going to be very much an integrated effort, again as I referenced in the script, the effort will be led and supervised by Ian Shapiro, who is one of our very, very talented portfolio managers and the investments will all be subject to his supervision, the structuring of them. Ian has already developed a very good relationship with the Highstar folks as have many of the rest of us at Oaktree. And we anticipate that we will work closely in an integrated way, just in the same way we worked in a very integrated way with our colleagues who are in New York or in Europe or in Asia, so I don’t anticipate that being an issue at all.

David Kirchheimer

And, Ken I’ll just add, your question really focused on our interest in acquiring the Highstar team, I would just add, looking at it from the Highstar perspective that it confirms the trend that we’ve talked about a lot and I know we hear from other public alternative asset managers and that is post crisis, the trend towards groups like that wanting to be a part of an organization with the marketing, the global platform, the risk management, all the types of front and back office types of aspects that an Oaktree has built up in over the years. Highstar is delighted to join us and to be a part of Ian’s very successful team because they know that they are going to really have the win behind their backs in terms of growing their own franchise and that's not unique to Oaktree, but in fact I think it is a relatively rare or small, not rare but small group of the public alternative asset managers who are seeing a disproportionate amount of those opportunities and it's win-win and it's great for the clients then because then they can invest in those funds confident that the risk management compliance and all the other important elements of investment management that they now absolutely require all the reporting etcetera that has really mushroomed post crisis, but they are going to get it to best in class standards.

Ken Worthington - JPMorgan

Yes, you did great, I think you got them all.

John Frank



Thank you. Your next question comes from Robert Lee from KBW. You may ask your question.

Robert Lee – KBW

Thanks and good morning everyone. First question is real simple for David, just kind of one clarify, your commentary around the incentive so far in the quarter so that if I had it correct, I think you mentioned that to this point there has been nothing realized, none in the horizon and then I think you also said that Opp VIIb may generate something similar to what it did in Q2 perhaps, I mean, am I misunderstanding something between those two?

David Kirchheimer

No. You understood absolutely correctly. Too early to know for sure and subject to how to carry outside alluded to in my remarks but no, you got it right. VIIb generated gross incentive income of $39 million net of comp, $21 million in the second quarter and where I sit today, I would expect that there may be a similar amount, maybe little larger in the third quarter, but that by no means certain. So, it may not occur.

Robert Lee – KBW

Okay that's helpful. And then, and I apologize for asking this, but lot of earnings today kind of gone in the call a little late, so could you just maybe repeat which closed-end funds you are currently fundraising or expected to be, obviously there is Opps X infrastructure next year, but you maybe go through couple of the others that maybe, you are currently in the market where they will be in shortly?

David Kirchheimer

So, just on the closed-end side of the shop, remember we have got a number of evergreen and open-end strategies that are continuing to raise money, but on the closed-end side of the shop, we’ve just launched the fundraising for our real estate fund VII. We are in the market right now with our newest mezzanine fund and our newest principal opportunities fund. We have indicated we will launch later this year fundraising for opportunities for the new distressed fund, the opportunities Fund X. And then, we anticipate early next year raising that successor fund for our power opportunity strategy and then they are after launching fundraising for our new infrastructure fund. So, those are number of closed-end strategies that will be established closed-end strategies plus infrastructure that we will look to be raising money for over the remainder of this year and next.

John Frank

A new dimension Rob, I will also point out in the closed-end fund area is senior loans i.e., enhanced income funds and CLOs, in fact, you will see greater detail on that when you have a chance to look at the earnings release. And we just had this one and done closed enhancing fund too. I think it maybe that we will have another one in the future for that. We have started issuing CLOs, that all goes into the closed-end fund area at lower fee rates as we are quite transparent on disclosing in the release. But nonetheless, you know, certainly with the benefits of locked in capital.

Robert Lee – KBW

Great. And then, maybe just one more question on Highstar and I apologize if you did touch on this also, but understanding your take over the existing fund to 70% invested, but kind of from an economics perspective and I think you may have alluded to this that at least on that fund and any other legacy assets, the existing fee streams, set of streams remain, you didn't pay anything for that or I don't think or correct me if I am wrong, and it's really kind of the go forward on the new funds where your economics will start flowing in?

David Kirchheimer

Yes. We are going to start managing Highstar Fund IV, so starting in the third quarter at least for the last couple of months of it because in case you didn’t hear it on the remarks that we expect the transaction to close tomorrow. So, it will be the last two months to third quarter that like you will see essentially as a grossing up of the segment income statement to include management fees for Fund IV and roughly comparable amount of expenses offsetting it, compensation of the sort and what you should expect is that the economics really kick-in once we raise and then start managing the first Oaktree infrastructure fund which will be sometime next year.

Robert Lee – KBW

Great, that’s helpful. That was it, thank you guys.

John Frank

Great, thank you Rob.


At this time we have no further questions, Ms. Williams?

Andrea Williams

Thank you, operator. Thank you everyone for joining us for our second quarter 2014 earnings conference call. A replay of this conference call will be available for 30 days on Oaktree’s website in the Unitholders section and by dialing 866-463-4956 in the U.S. or 1-203-369-1394 outside of the U.S. That broadcast will begin approximately one hour from now. Thank you.


Thank you. And this does conclude today’s conference. We thank you for your participation, at this time you may disconnect your lines.

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