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American Capital, Ltd. (NASDAQ:ACAS)

Q4 2011 Earnings Conference Call

February 15, 2012 11:00 AM ET

Executives

Pete Deoudes – Director, Equity Capital Markets

Malon Wilkus – Chairman and CEO

John Erickson – President, Structured Finance and CFO

Analysts

Joel Houck – Wells Fargo

Greg Mason – Stifel Nicolaus

Vernon Plack – BB&T Capital Markets

Jasper Burch – Macquarie

John Hecht – JMP Securities

Dean Choski – UBS

Jared Cohen – Fortress

Jordan Hymowitz – Philadelphia Financial

Steven Horwitz – Westminster Financial

Operator

Good morning. My name is Debbie and I’ll be your conference operator today.

At this time, I’d like to welcome everyone to the American Capital shareholders’ call.

All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions). Thank you.

Mr. Pete Deoudes, Director of Equity Capital Markets, please go ahead.

Pete Deoudes

Thank you, Debbie. Thank you, everyone, for joining American Capital's fourth quarter 2011 earnings call. Before we begin the call, I'd like to review the Safe Harbor statement.

This conference call and corresponding slide presentation contains statements that to the extent they are not resuscitations of historical fact, constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All such forward-looking statements are intended to be subject to the Safe Harbor protection provided by the Reform Act. Actual outcomes and results could differ materially from those forecasts due to the impact of many factors beyond the control of American Capital. All forward-looking statements included in this presentation are made only as of the date of this presentation and are subject to change without notice.

Certain factors that could cause actual results to differ materially from those contained in the forward-looking statements are included in our periodic reports filed with the Securities and Exchange Commission. Copies are available on the SEC's website at www.sec.gov. We disclaim any obligation to update our forward-looking statements unless required by law.

An archive of this presentation will be available on our website and the telephone recording can be accessed through February 29th by dialing 855-859-2056. The replay pass code is 41247892.

To view the Q4 slide presentation that corresponds with this call, turn to our website at americancapital.com and click on the Q4 2011 Earnings Presentation link in the upper right-hand corner of the homepage. Select the Webcast option for both slides and audio or click on the link in the Conference Call section to view the streaming slide presentation during the call.

Participating on today's call are Malon Wilkus, Chairman and Chief Executive Officer; John Erickson, President, Structured Finance and Chief Financial Officer; Gordon O'Brien, President, Specialty Finance and Operations; Sam Flax, Executive Vice President and General Counsel; Brian Graff, Senior Managing Director; Rich Konzmann, Senior Vice President, Accounting and Reporting; and Tom McHale, Senior Vice President, Finance.

With that, I’ll turn the call over to Malon.

Malon Wilkus

Pete, thank so much, and thanks everybody for joining us. I hope yesterday you all spent some time with your sweethearts and you hopefully bought a lot of sweetheart candy, New England Candy Company, NECCO, is one of our portfolio company, and we always like our market and shareholder support for our portfolio companies.

Let's turn to slide three, and I want to start off by saying, we had a very good year for 2011, even though it was quite volatile and the markets were very concerned about a possibly impending recession. Nonetheless, for the full year, we did extremely well. We did have a weak third quarter, but we certainly reversed that in the fourth quarter.

And so starting on slide three is, you see our fourth quarter where we had $0.67 in net operating income or $229 million. However, I do want to point that we had the benefit of reversing the allowance for the deferred tax benefit that we had booked, and we'll talk more about that in a couple of slides, and we'll I'm sure take a bunch of questions on that subject. So prior to the impact of the deferred tax benefit, we had $0.24 in diluted per share NOI or $84 million.

For the fourth quarter, we had 10.7% effective yield on our debt assets and 4.3% weighted average cost of borrowings. For our earnings, we had $1.73, though that would be $0.48 before deferred tax benefit. And our NAV was $13.87, that is $1.95 per share increase or a $547 million increase from the third quarter 2011, and that's a 16% increase over the third quarter 2011, and that's in comparison to 11% increase for the S&P 500 financial sector.

I wanted to point out the bottom of that side you see the $1.30 per share increase for NAV that would have occurred – that's attributable – I'm sorry I should $1.30 that would be attributable to the $428 million of its deferred tax benefit. You're going to see that on the next slide as well or slide four for all of 2011.

And going there, we had $1.26 in NOI, $448 million that would be $0.85 or $303 million before the deferred tax benefit. We had $2.74 in net earnings or just shy of $1 billion, $974 million. For the full year in our net earnings it will be $546 million or $1.54 before the deferred tax benefit, again bringing our NAV to $13.87 at the end of the year, that's a 30% increase over 2010. And you'd see there again, the year was impacted by the $428 million impact of the deferred tax benefit. So our 30% increase in our book value compared favorably to the 17% decrease for the S&P 500 financial sector.

And since our low points of our valuations in the second quarter of 2009, we've had nine out of the 10 quarters being very positive net earnings, and $5.11 increase in our NAV per share or 26% annualized. Also for the year, we reduced our operating expense ratio to 1.3% down from the 1.8% that it was at in 2010. So we continue to manage ourselves I think appropriately for the delevering that we have been accomplishing.

If you look then on slide five, you will see in the upper right hand corner and the lower right hand corner of the chart showing our deferred tax assets at $428 million. And just to remind you, starting in the second quarter, we became taxable as a C Corp and we at that time recognized deferred tax asset and liabilities.

You could see that in the first column of $446 million, but at the same time based on the requirements of under GAAP, we booked a $456 million valuation allowance or a 100% allowance against that deferred tax asset. We booked full allowance against our capital portion of our deferred tax asset as well. But at the end of the year, in the fourth quarter, our deferred net tax asset at that time then was $428 million and we were able to reverse the allowance and book the entire $428 million of net ordinary deferred tax asset. We still have full allowance against our net capital deferred tax asset. And so bottom-line, we had $428 million of benefit associated with deferred tax assets and we know we'll have a lot of questions, so let's leave the rest of this slide to the questions that will come I'm sure in the call.

So moving to slide six, our private finance portfolio did well. Our One Stop Buyouts had $47 million of net appreciation that was driven both by improvements in multiples and the portfolio company performance improvements. We had $3.1 billion of aggregate total revenues in our majority owned companies and we had $711 million aggregate adjusted EBITDA in those companies. And just to remind you, we had approximately 40,000 employees in the aggregate in these companies and have produced a 13% IRR since our IPO, so over 15 years through two recessions on $11 billion of investments of senior debt, mezzanine debt and equity in these companies. And for the equity investments, we’ve produced 17% IRR on the $4 billion of equity investments. So we have done very well in our buyout business and we're very proud of that performance.

In our Sponsor Finance and Direct Investments, we had $21 million of unrealized depreciation for the quarter. Over the last 15 years, we’ve produced a 7% IRR on a blend of $9 billion invested in a blend of senior debt, mezzanine debt and equity co-investments. And for the quarter, we've had $356 million of realizations. Off of this portfolio, $108 million came from principal payments, $176 million from the sale of equity investments, but we also recognized losses, the depreciation that we already had booked in some cases many, many quarters before of a $154 million. And so we continue to clean out the underperforming assets in our portfolio.

Moving to slide seven, we wanted to talk briefly about one of the exits that we had in the fourth quarter, a company, CIBT Solutions, which we sold. This is one of our One Stop Buyouts, but let me tell you a bit about the history. This company is a leading global provider of expedited travel document processing services. So they expedite visas and passports. We were able to ultimately book $43 million gain. But if you look at the timetable below back in the second quarter of '06, we made an initial debt investment in this company, $58 million, and that was to support the acquisition of the company by a significant very successful private equity firm, and over the several quarters after that they made a number of add-on acquisitions, we helped fund additional add-on acquisitions by expanding our facility to $98 million in the second quarter of '07. And then the private equity sponsor wanted to exit their investment, they put it up for sale, and we bought it for $214 million after knowing quite a bit about this company and of course being involved in it for several years.

So in the first quarter of '08, we bought it. However, we did buy it at a tough time and the economy, as you all know, went to recession, and our $214 million of investments depreciated 43% down to $122 million by the third quarter of '09. But as you know and you're probably tired of me saying that we were a patient investor and looking out to maximize values for our shareholders. So we stuck with the company, we held it through this downturn, the company's EBITDA did compress some during this period, valuations came way down as you can see, but by the third quarter of 2010 the valuations have come back up to $207 million. It was still depreciated somewhat from the $238 million of cost basis.

We continued to support the company through additional add-on acquisitions that help to expand the company and its EBITDA. And by the fourth quarter of 2010, they were able to pay down a significant amount of debt. And as you all know then, this last quarter we sold the company with a $245 million of proceeds. We booked a $43 million gain. We also have a $15 million escrow, which we would expect to burn over the next year or two as that escrow bleeds off. And so this was a great success for us. We had a 15% aggregate IRR on the blend of debt and equity investments and interest and dividend fee income that we received from the company, and all despite the fact that at one time it had been depreciated by 43% at its low point. So we’re very proud about that exit. We've been able to accomplish a good number of these over the years, and you've all seen the various substantial amount of liquidity that we’ve experienced since the height of this last recession.

Now, let's skip a couple of slides and go to slide 10 and talk about European Capital, where we experienced some depreciation for the quarter, $85 million in total. And part of that was due to us, comparable companies declining in value as a multiple of their book value, and so we had a slight decline in our booking of our investment in ECAS. Relative to ECAS' own NAV, it dropped to 67% of the ECAS' NAV from 69%. $56 million of that depreciation was driven by a decrease in European Capital's own NAV, in part by its own NAV, and that's a slight increase in the implied discount NAV due to declines in multiples of comparable public companies. So though overall, as you can see, little further down in that chart, we’re experiencing slight aggregate revenue increases in the combined portfolio where we had 49 companies, but also a slight adjusted EBITDA decrease over the past three months year-over-year. So there is some impact associated with the economy. There is also this $29 million impact associated with the foreign currency translation of depreciation.

So we continued to support our companies there. We have a good credit facility where we can make new investments and so we continue to seek new opportunities, and we think there will be some great opportunities as Europe goes through some of its difficulties, particularly in the capital markets and with respect to sovereign and debt and so forth. So we think there will be some very good opportunities there. And again, we think we have great companies from which we can take advantage of some of those opportunities when they come.

Let's turn to slide 11 and talk a little bit about American Capital, LLC, our asset management company. To give you an update, we have just shy of $400 million of fair value at American Capital, LLC. That's on a cost basis of $46 million. And so we've really built a very fine company over the years.

And in the fourth quarter, we have grown the third-party assets under management to $62 billion. We've earned our fees on $7.4 billion of that, the equity components of that $62 billion, and we were able to increase that in the third quarter – since the third quarter 2011 by $1.1 billion, and that's due with great part to the equity raised for American Capital Agency in November of last year. And for the full year, we were able to increase the earning assets under management by $4.5 billion, and that drove in part the $111 million of unrealized appreciation in the fourth quarter. In addition, there was an increase in comparable company multiples, a reduction in the overall discount rate, and an increase in the forecasted growth of the company.

Moving to slide 12 – actually let's get slide 12, we can come to it in questions if you have any. I'll just point out that we had $1.2 billion of liquidity in 2011, which is really a tremendous amount of liquidity and done, we think at very good values relative to the prior quarter's valuations. In fact, I think it was over those assets of that – those exits about 3.5% higher than the prior quarter's valuations on average.

On slide 13, let's talk about the potential sources of growth in per share NAV. Just to remind you we had $2.2 billion of net earnings since the third quarter of 2009 when the US gross domestic product started to turn positive. And we think we continue to have potential for growth in NAV per share, because we're able to retain future ordinary and capital income as a C Corp, and we're benefitted by net operating and capital loss carryforwards. And we have the potential for accretion due to share repurchases. As you know, we established a share repurchase and/or dividend program back in the third quarter and we continue to operate under that.

If you look at the third bullet on this slide 13, you can also see that we believe we have potential for appreciation associated with our $547 million equity investment in European Capital. Just to remind you, we have a $267 million discount to its NAV. So if we were ever to close that discount we can pick up that value. We have $340 million of equity investments at European Capital and those are designed to grow in good equity rates of return. And we have $212 million of bond yield discounts on performing European debt assets. And if they’re paid at cost, then we will pickup that discount. However, it's all has to be caveated by the fact that if there were to be a recession in Europe, we could instead experience depreciation on just about every one of these components associated with European Capital. And then, finally, we think we have the potential for appreciation with respect to the $1.8 billion of other equity investments that we have in portfolio companies in US, if the US economy continues to recover.

So finally, let me turn to slide 14. And our outlook is the same as it has been for quite some time, though we do believe we're in uncertain macroeconomic trend. However, the portfolio's operating performance has been moderately positive in US, both in terms of revenues and EBITDA growth.

We remain focused on our portfolio companies, so providing the kind of operational and financial support that we provided to CIBT. We’re doing that across our portfolio and it's a high priority for us to appreciate our companies by funding in an organic growth and add-on acquisitions. So we are seeking unitranche, second lien and mezzanine investment opportunities on our Sponsor Finance business. We're pursuing American Capital One Stop Buyout as well and we plan to repurchase shares or pay dividends depending on our share price relative to NAV. So just to remind you, if we’re below NAV, we would intend to do share repurchases. And if we’re above NAV, we would intend to pay dividends, all in accordance with the policy that we've set out back in the third quarter. And, finally, as always, we’re a long-term patient investor planning to get fair values on realizations in the slow M&A market.

And, with that Debbie, if you would please, open it up for questions.

Question-and-Answer Session

Operator

Sure. (Operator Instructions). Our first question comes from the line of Joel Houck with Wells Fargo.

Joel Houck – Wells Fargo

Thanks and good morning. Normally on – after a quarter like this I would say great quarter guys. But I do think you deserve some credit for sticking to discipline and buying back stock and retiring debt. I think that's a benefit to shareholders.

The question I have is one in the similar direction and that is what are your thoughts about spinning off the senior and mezz credit portions into a new BDC, which would allow you to perhaps get a better valuation of assets and raise capital to grow which is something that's difficult right now? And then the holding company what we know is ECAS then becomes the manager of all these investments that you incubate like AGNC. Certainly I am sure it's not lost on your AGNC in a very brief time has gone from a startup entity to a $7 billion market cap company, one that's highly respected in the agency REIT space. What are your thoughts on that? I guess a related question, are there impediments with respect to the deferred tax asset, would that have to go to the new BDC, could it stay the whole co, and what are your thoughts around that issue?

Malon Wilkus

Let's start with the idea of spinning up of debt assets, debt-oriented assets in the format of the externally managed BDC. We do think that that's a scenario which could make some sense and we are actively looking at our various alternatives to enhance shareholder values by doing what could be a better job of capitalizing the various kinds of businesses that we operate.

And for debt assets that are good earnings and performing debt assets that could support a high dividend, we think that's a BDC structure which – externally managed BDC structure, which is quite typical as you well know is a very good format to that. And as you probably know, Joel, about 20% best of our assets are in that category, but that's still a sizeable number, and so it's a scenario that we have to think about and consider. However, in doing, if we were to do something like that, the remaining assets would make it more difficult to be structured perhaps as a BDC in the RIC or a RIC BDC. And so we have to think about the resulting assets.

And so it's a complicated assessment and one, however, which we want to pay a lot of attention to, and we'll be thinking about it quite a bit and trying to address that question. But having an externally managed BDC could very well enhance the value of the debt asset that we have on our books and so that does make some – that could very well make some sense for our shareholders.

John Erickson

Yes, I mean the one of the factors in considering that is, as you know that a lot of our assets are currently encumbered others through the BLTs or through the $575 million that's still outstanding. But if you look, we've been generating about $1 billion a year of liquidity which pretty comfortably starts to release those assets over the next 24 months. If you were to assume the same level of liquidity, you can assume that we would basically fully delever both the BLTs and that $575 million pretty naturally just through the liquidity we have, which then increases our ability to look at those type of options where everything then becomes encumbered.

Then to your point on the taxes, obviously, that's an important asset now. And I think that there would be ways to do a transaction like that where you wouldn't lose the tax benefit as well. But obviously we're going to be keenly interested in utilizing and protecting the deferred tax asset.

Joel Houck – Wells Fargo

Okay. So obviously, given the level of detailing your answer, it's obviously something you're looking at, but it sounds like given the BLTs had to play out in terms of amortization before, you could actually affect something like that. Is that correct?

John Erickson

Right. And I think like I said if you start looking at each BLT, I think you'll see that the 2004 BLT probably would be retired this year and then the other ones you can pretty much project it in '13 and maybe a little bit into '14 they would get retired. So – and then there are some call options that we have if we want to accelerate that a little bit. But I think if you just assume that it’s the same kind of liquidity in the next two years that we've had in the last two or three years, it's a pretty comfortable pace at which we can amortize that debt down.

Joel Houck – Wells Fargo

All right, thank you. I’ll get back in the queue. I’m sure others want to ask about the deferred tax asset and the accounting on that.

John Erickson

Okay, thanks.

Operator

The next question comes from the line of Greg Mason with Stifel Nicolaus.

Greg Mason – Stifel Nicolaus

Great, thanks. Yes, touching on the deferred tax asset, is that $428 million – is that your operating loss carryforwards or is that a tax adjusted number, meaning your operating loss carryforwards are over $1 billion and this is the effective tax rate on that number.

John Erickson

Yes, that’s the effective tax rate. So it’s over $1 billion of ordinary losses. And so that’s – that would represent the tax expense number that you would – we would have.

Greg Mason – Stifel Nicolaus

So excluding kind of Joel’s concept of switching the structure here, if we think about $300-ish million of operating income this year, would it be logical then to assume – we’re king of looking at three to four years to kind of burn through all these ordinary tax assets before the dividend would need to be reestablished. Is that logical?

John Erickson

Yes. No. It’s logical that it will take three to four years to burn through the deferred tax asset, but the dividend is unrelated to the deferred tax asset. I mean keep in mind, under the share buyback program, we already have said that we’re going to allocate capital to a dividend just like every C Corp out there that pays a dividend, you don’t have to be a RIC to pay a dividend. And so as our stock gets closer to book value, if that were to happen, we would look at switching the capital we’re allocating those stock buyback then to a dividend. So then I think those are really kind of unrelated.

Greg Mason – Stifel Nicolaus

Got it, okay. And then one quick question. The interest in dividend income seemed jump this quarter to roughly a $150 million versus running a $130 million in the last couple of quarters. Was there any one-time income in there this quarter?

Unidentified Corporate Participant

Yes, we had a – this quarter an impact from reversing nonaccrual loans going to quarter, some approximately $27 million of loans preferred investments that were nonaccrual in the previous quarters that were reversed, and that’s a positive nonrecurring impact for the quarter.

Greg Mason – Stifel Nicolaus

Okay, great. Thank you, gentlemen.

John Erickson

Yes.

Operator

Your next question comes from the line of Vernon Plack with BB&T Capital Markets.

Vernon Plack – BB&T Capital Markets

Okay, thanks. Most of my questions have been answered. But John, as it relates to Greg’s last question on the income side, what about on the expense side? I noticed that G&A went up a whole lot. And just trying to assess what – and the salaries went up some versus last quarter – just trying to establish what a run rate would be there. Was the fourth quarter representative of a future run rate or what can you tell me about that?

John Erickson

Yes, I think third quarter was a weak quarter; we had the depreciation and the downturn. So I think the bonus accrual was down in the third quarter and then was reestablished in the fourth quarter, so it’s not lumpy. Obviously the bonus accrual would have been lower had the fourth quarter been weak like the third, but it did get reversed. So that part what you’re saying flows through that compensation line.

Vernon Plack – BB&T Capital Markets

Right. And G&A looks like it jumped from $12 million up to $19 million. Is that right?

Unidentified Corporate Participant

Yes, that sounds right. The G&A cost went up a little bit during the quarter. I wouldn’t say there was anything substantial in terms of nonrecurring items. There was a couple of million dollars in there related to some franchise related taxes. But other than that, they were probably more for like – for an equivalent for an all full-year amount versus quarter amount. So I’d say it’s probably about $1 million or $2 million of nonrecurring franchise taxed numbers in the fourth quarter, but other than that, nothing substantial.

John Erickson

Or loss.

Vernon Plack – BB&T Capital Markets

Okay. So maybe more of a recurring rate will be somewhat in the $17 million and $18 million range rather than $19 million.

John Erickson

I mean that’s not unreasonable.

Vernon Plack – BB&T Capital Markets

Okay, thanks.

John Erickson

Yes.

Operator

Your next question comes from the line of Jasper Burch with Macquarie.

Jasper Burch – Macquarie

Hi, good morning, gentlemen. Most of my questions have been answered. Just a little bit – if you could give us a little bit more color on the valuation of the asset manager. I mean how did you – how much of an impact did adjusting with discount rate and the growth assumption have? And can you give us any color on what those actually are, how much growth you’re actually expecting?

Malon Wilkus

I think the biggest impact was the actual equity offering, $1.1 billion equity offering which was, of course, real as opposed to any forecast associated with it. And – but there was some multiple expansion, but honestly I don’t think we really have at our fingertips the – there was a – the percentage components of those improvements.

Jasper Burch – Macquarie

Is there anyway – I mean maybe offline you could get us any of those assumptions or what the discount current rate is?

John Erickson

We generally don’t provide that much detail on any of our valuations. But I think –

Malon Wilkus

I think we gave you the complexion of that improvement.

John Erickson

And I think if you went pulled asset manager peer’s outlook at Q3 valuations versus Q4 that will give you some directional view on multiples.

Jasper Burch – Macquarie

Okay, well thank you for your time. I appreciate it.

Malon Wilkus

You’re welcome.

Operator

Your next question comes from the line of John Hecht with JMP Securities.

John Hecht – JMP Securities

Good morning and thanks for taking my questions. First question, you provided some information related to the majority owned portfolio companies in the press release. Does that – do the majority owned portfolio companies, does that include American Capital LLC and/or ECAS?

Malon Wilkus

John, it includes the management company, but does not ECAS.

John Hecht – JMP Securities

Okay. And then it would exclude some of the investments in other buyouts and structured products I assume as well.

Malon Wilkus

It would exclude structured products, it would exclude any private financed investment or not majority owned. So we have minority equity or debt investments only in a portfolio company.

John Hecht – JMP Securities

Okay. And second question, is – Marlon, I’m just wondering, you talked about the sources of liquidity and your liquidity position. Maybe can you just give us your perspective on capital allocation for this year in terms of mezz opportunities you see, you see additional potential activity in the One Stop Buyout category and/or what you get more aggressive on buybacks if those other categories didn’t become more active?

Malon Wilkus

Yes, we’re very keen on making new investments. When the opportunity is right and we think there is good investment opportunities, we certainly are bidding on quite a number. And looking forward to doing both, quite a bit of Sponsor Finance business, where we’ll be doing senior mezzanine and unitranched financing for other private equity buyouts and also our one-stop buyout. And so when we see the opportunity, we’ll be taking advantage of it. However, you should know that the odds that to win any given buyout bid isn’t really quite low, it’s a highly competitive environment out there. And then the same with the Sponsor Finance business, you not only have to bid and we compete with other mezzanine providers, but then the sponsor that you’re supporting also has to win. But we would expect to do quite a bit of mezz business this year in both categories.

Now your question though is, if we didn’t, would we do use more of the capital for repaying debt or buying shares back, and I have to say for 2011, we had anticipated doing more private finance business and it simply did not materialize, despite our bidding efforts. And so we did indeed use more of that liquidity for debt repayments and share repurchases. And so that would be the same circumstances in the year. We’ll see how it develops. We – we’ll work very hard on finding very good new investments, but we always have the fallback that’s quite good in our case, because if we buy our shares back, if it’s at a very substantial discount, we think it’s a fantastic investment, and if we pay down debt we’re leaving ourselves on the – this marginally expensive debt that’s about 8.75%. So that’s a riskless kind of use of our liquidity and so we’ll consider doing all of that for this year.

I hope that answered your question.

John Hecht – JMP Securities

Yes, that gives me plenty to go with. Thanks very much.

Operator

(Operator Instructions). Your next question comes from the line of Dean Choski with UBS.

Dean Choski – UBS

Good morning, gentlemen. Malon in your last response you mentioned that the win rate for deals is uncertain. But without a revolver how do you manage the liquidity that’s coming in from realizations with what your new deal pipeline is going forward? For example, avoiding one quarter where you win a lot more details than you expected.

Malon Wilkus

Well, it’s simply by managing our cash balances. So if you look at our balance sheet, we ended the year with $204 million of cash and we manage it in that way, and that’s really quite plenty to be able to do the investing that we do on a per quarter basis. Keep in mind that the liquidity’s event figured – the liquidity that we experienced and – maybe we can turn to the slide that shows our annual liquidity – is so substantial – and what you’re probably aren’t aware of is how granular that liquidity is. I would say probably the average liquidity there is in the order of $35 million. So we really do have a lot of ability to manage ourselves with respect to making new investments and we have not had any issues with respect to that. Frankly, except I would say in the very heights of the recession and the liquidity, the worldwide liquidity crisis, but outside of that very brief period there has never been a time when we haven’t been able to make new investments from both our cash and liquidity.

Dean Choski – UBS

All right, that’s good to hear. And can you just prioritize what the strength of the realizations that have been coming in? Like how you prioritize the uses of cash between buying back debt or delevering stock buybacks and then new investments.

Malon Wilkus

Well, it’s complicated. I don’t think we can do a very good job of telling you the priority in that respect. We think every – all of it is important for our business in each and its own various ways. And so our priority is to do all three, make excellent new investments – well all four. Support our existing portfolio companies for growth through organic growth and acquisitions and financing capitalizing them properly. Number two is we think it’s very important to originate new opportunities and participate in the market. Three, we think obviously everyone needs to payback their debt as they come due and we’ve got plenty of timeframe for that, but we like to bring our debt down on a regular basis so that there is no doubt about it. And number four is our share buybacks. I mean you’re trading – at the kind of discounts that we’ve been trading at, we think it’s a spectacular investment opportunity. And so we think all those are very important and we intend to do all four of this.

Dean Choski – UBS

Okay, thank you.

Malon Wilkus

You’re welcome.

Operator

Your next question comes from the line of Jared Cohen with Fortress.

Jared Cohen – Fortress

Hi, good morning, guys. Just following up I guess from the last question about the priority of capital allocation, if you can maybe get a little more granular, you had talked about how there is a lot of new investment opportunities that you’re looking at. And just if you can remind us again how you balance internally the yields and what you’re seeing on the new investment opportunities relative to the discounts that your stock is trading to book value.

Malon Wilkus

We think all four of the investing and – all four of ways in which we’ve been using our liquidity and our income is very important and we intend to pursue all four of those uses of capital.

Jared Cohen – Fortress

But can you touch upon the sort of yields that you’re seeing on the new investment opportunities?

Malon Wilkus

Well, we’re seeing – we are seeing attractive yields. We, like I said, we don’t always win, so sometimes they’re not as attractive as we think they need to be, but we’re seeing attractive yielding opportunities, we’re seeing attractive equity in buyout opportunities, we’re seeing some very attractive opportunities to support our portfolio companies. And as you saw with the CIBT exit that supports through those times for acquisitions is just critical to be able to make a good company, build a good company that we can then exit at a great return on our investment and good gains. And so we continue to think all four of the uses of capital are very important to the business, we intend to continue to pursue all four.

Jared Cohen – Fortress

And so no specific hurdle rate for now I guess supporting existing investments. I guess moving on, when you think about debt levels, you’ve repurchased a good amount of debt in the fourth quarter, you talked about continuing to buyback debt. What’s the ideal leverage ratio and then also any thoughts on taking advantage of the current credit markets and refinancing debt right now?

John Erickson

I don’t think we feel like there is a need to term out the existing debt. The more opportunistic refinancing we would look for is one that we’ll put a revolver in place that would give us more flexibility in terms of being able to originate assets. So I don’t think – given – if you look at liquidities, I said that I think over the next two years, we can comfortably basically really payoff all of the debt and have a lot of additional capital for share buybacks and reinvesting. So I think that the refinancing view is one towards, can we put a revolver in place, and we have to retire I think some of that debt on the $575 million with the revolver in place, but that would give us more flexibility in our business if we can do that.

Malon Wilkus

The revolver will essentially – having the revolver essentially eliminates the drag of having or otherwise have cash that’s of course earning very, very little income. And so eliminating that drag would be very nice enhancement to our income.

Jared Cohen – Fortress

And then, I guess, I would only add that, pushing out the maturity probably helps out the credit rating, it probably helps out the cost of any new revolver financing. So it all becomes circular that all those things would ultimately be beneficial.

And the final question I had is really just on flows and volumes, and think at any given time you guys are in talk with multiple on selling assets in realizations and you’ve been pretty consistent looking back on the past quarters with the amount of capital coming in from realizations. Can you – any kind of texture, you can give a color around the flows of volumes today relative to different points in time?

Malon Wilkus

In terms of realizations were you asking?

Jared Cohen – Fortress

Yes. Well in terms of the conservations you’re having with buyers, the stuff you guys are having out there for sale and –

Malon Wilkus

Yes, okay, I will give you some sense just a little bit here. I think slide 35 shows the quarterly realizations, and you can see it’s hard to predict in a given quarter, it can be quite a bit higher than say any other quarter – random quarter, but it is a lot of liquidity. However, in the third quarter of last year or in August of last year, there was a material change in the M&A market. So in the first half of last year it was incredibly robust, very powerful, and it’s a great environment to sell companies into. Starting in August – or at the end of August or starting in August with all the troubles that occurred to Europe and in the US in terms of debt downgrade in the US and the sovereign wealth concerns about Greece and Spain, Portugal, Ireland and Italy, that seems to have changed quite a bit.

And so the M&A activity dropped in the third quarter, it did pick up some more in the fourth quarter, it’s still low-ish in the – it seems to be in the – so far in the first quarter. And so it is a harder environment. And we probably hadn’t more of our deals pulled from the market in the second half of last year relative to say the first half of last year. We always are considering some companies to sell and it’s not uncommon for us to yank the company half the market when we do feel like it’s being properly valued in the marketplace. So that’s always happening. And the question is has it happened more or less than other times? And I would say it happened more in the second half than it did in the first half of last year. And that environment we’re still operating in.

Now, despite that, I do think things are getting better. And with the improvements that have occurred starting in December with respect to the liquidity crisis in Europe and the concerns seem to be diminishing about the possibility of a recession in the US and in Europe and in worldwide. I think the M&A market is getting better. There is a lot of capital on the sidelines and so this continues to be a very good market to sell into. And if you look at multiples, even through the fourth quarter – this fourth quarter of last year, the multiples for the M&A, the middle market M&A market is at some of the high period, high multiples historically. And so it's still a very good market, it's still into – it's just that there – it is a thinner group of buyers out there I would say.

I don’t know if that answers your question, but Jared we probably should move on and give some folks a chance.

Jared Cohen – Fortress

Thanks a lot.

Malon Wilkus

Thank you.

Operator

Your next question comes from the line of Reid Riker [ph], an investor.

Reid Riker – Investor

Hi there. Do you have any intentions to return to the BDC status with non-qualified dividends, et cetera, in any time in the near future or stay at C Corp.

Malon Wilkus

Keep in mind, we continue to be a business development company. But what we no longer is a registered investment company, a RIC. So it was into the second quarter that we started to pay taxes as a regular C Corp or be taxable as a regular C Corp. And the question really came up earlier too whether we would go back to being a RIC BDC and that’s definitely a scenario and possibility and there is several ways in which we might be able to do that, we want it for the whole company and the other is for a subset of our assets, which could perhaps be spun out to our shareholders and continue to be managed by us that structure and format of a RIC BDC.

But I should say that these scenarios – the various scenarios that we might consider, all of them probably are to some degree governed by the amount of ordinary net operating losses that we have and whether we can utilize them and we can do that, and we can roll them over as a regular C Corp taxable entity, and we can’t do that as a RIC. And we have on our balance as we just showed everyone through the booking of this asset in the fourth quarter, we have a very sizeable amount of those NOLs.

But finally, I will say, and John had said it earlier, the dividend – the decision about paying a dividend is completely separate from that issue. And we have already put in place a policy back in the third quarter – at the beginning of the third quarter a policy of either buying back shares if we’re under book value – if we’re trading under book value or paying a dividend if we we’re over or near being at book value. And the amount of that is driven by our net cash from operating activities from the prior quarter and the accumulation of that. And so our Board is quite prepared to pay a dividend, would love to pay a dividend.

We would have loved to pay it all out of the dividend the $137 million that we used to buyback shares in 2007. But it makes a much more economic sense to do that if you are trading above book, whereas it makes more economic sense for our shareholders if we use it as share buybacks when we’re trading below book.

Reid Riker – Investor

Understood. To the extent that you are – that you end up paying a dividend while you’re still a C Corp, I presume that that would be a qualified dividend for tax purposes.

John Erickson

Yes. I mean we fall under the C Corp act regime, so it could end up being a qualified dividend.

Reid Riker – Investor

Good. Understood.

Pete Deoudes

Next question, please.

Operator

Your next question comes from the line of Jordan Hymowitz with Philadelphia Financial.

Jordan Hymowitz – Philadelphia Financial

Just a couple of small follow-up questions. One is what is the amount of NOL that’s not being recognized from capital gains on the balance sheet?

John Erickson

We would have the $800 million benefits of roughly at $2 billion.

Malon Wilkus

At the end of the year, our capital loss carryforwards is $471 million. Keep in mind that our deferred tax assets that we have in our books, they both are ordinary and deferred tax assets, isn't strictly just operating loss carryforwards. It's also built in unrealized losses on things like our unrealized depreciation and both the tax differences and interest income recognition and some other factors. So as of the end of the year, our capital loss carryforwards is $471 million growth.

John Erickson

That said and the rest would be like depreciation on the rest of our capital assets.

Malon Wilkus

That's right. Our gross deferred tax assets – gross deferred capital deferred tax asset is $836 million, which is a tax effective number. So the – and the tax effective component of that is related to capital of the carryforwards is $180 million which is a tax effective number of our capital carryforward as of December 31st.

Jordan Hymowitz – Philadelphia Financial

I'm sorry, I apologize, I didn't follow. I’ll ask one more way, but if not I’ll follow-up later. If you had recognized all of the NOL related to both ordinary income and capital gain, how much greater would the book value have been this quarter?

John Erickson

If we didn't have a valuation allowance on our capital deferred tax asset, it would have increased by an additional $836 million. That's the valuation allowance.

Jordan Hymowitz – Philadelphia Financial

But you have valuations – but do have the valuation allowance?

John Erickson

Yes, on the capital portion.

Malon Wilkus

A 100% allowance.

John Erickson

Correct.

Jordan Hymowitz – Philadelphia Financial

And then the other question is on the bond discount that ECAS has carried out, I think it's $212 million of bond yield discount. What is the earliest you can repay it at cost?

Unidentified Company Participant

Jordon, it's not where we're paying it, it's what our debt assets at ECAS are been held below par, and as they get closer to maturity that will creep back into the value.

Jordan Hymowitz – Philadelphia Financial

But you can refinance that if I understand correctly, or am I incorrect there?

John Erickson

No, those are our debt assets. So it's up to the borrowers to do this side of refinancing right, so where we made a loan to a middle market company.

Jordan Hymowitz – Philadelphia Financial

Okay. This is not the corporate gap between you –

John Erickson

It's just the discount below par that we're carrying those assets at.

Jordan Hymowitz – Philadelphia Financial

Is it there some discounts that you're being held on the bonds yourself that you could have refinanced this year or has that already happened?

Unidentified Company Participant

No, we don't have. We didn't implement FAS 159 on the right side of our balance sheet and this doesn't even come into play which we're talking about ECAS.

John Erickson

Yes.

Jordan Hymowitz – Philadelphia Financial

Okay. Great, thank you.

John Erickson

All right.

Malon Wilkus

And I'd also point out that we actually have a lot of liquidity at European capital for 2011. How much liquidity?

Unidentified Company Participant

EUR200 million roughly.

Malon Wilkus

In most of all I'd say – virtually all of that is on bonds that were held at a discount and that came back to us at par.

Unidentified Company Participant

That's correct.

Malon Wilkus

So we picked up all of that discounts when we got repaid at par. So that's – you pick that discount up when you get repaid or you pick it – and you pick it up as you get closer and closer to being repaid or you pick it up if the world starts valuing those assets and the yield on those assets at a higher level. On the other hand the world could value it at lower level and so you might be experiencing the more bond yield discount if everyone wants it at a 20% return in Europe all of a sudden. But if you get repaid at par, you’d pick it all up 100%.

Pete Deoudes

Next question, please.

Operator

The last question comes from the line of Steven Horwitz with Westminster Financial.

Steven Horwitz – Westminster Financial

Hi guys.

John Erickson

Hello.

Steven Horwitz – Westminster Financial

If the policy is to reinstate the dividend when the net asset value is trading at parity with the stock price and the stock price in your view represents a great opportunity, what is the secret of getting the stock price in the NAV, because one could argue the NAV might even be more than the book values, you can exit many of the investments above what your carrying them on at the – on the books. So, yes, I understand that's a – this is more of a philosophical question. I'd love to see the thing trading at NAV also.

John Erickson

I do think having a regular program of repurchasing shares should help close the discount over time as investor see that you're going to do that on a steady basis. Outside of that, it's up to the market and all we can do is try and perform in terms of delivering good ROEs, and hopefully that the market puts a higher value on those efforts over time.

Steven Horwitz – Westminster Financial

Yes, I appreciate that. The assessment of the stock being a great investment is complicated by the fact that there is no dividend.

Malon Wilkus

Well, if there is a – it is making more economic sense for our shareholders in our view and we've gotten a lot of feedback from the market and our shareholders on this to be buying shares back at this great discount then to use the same money to pay a dividend. That equation reverses when we're trading above book and we would love to trade above book and be able to use the same net cash from operating activities to pay the dividend on a quarterly basis, and we look forward to being able to do that. And that's true whether or not we are at that time or not a RIC. So – and we just have to continue to operate the way we do, we have to continue to perform.

As I mentioned, we had nine out of last 10 quarters a very positive performance. And if we keep doing that we think our shares will continue to rise relative to its book value. And once risen enough, we'll convert the cash that we're returning to our shareholders through the stock buyback, we'll start to use it to pay dividends instead.

Steven Horwitz – Westminster Financial

Yes, understood. Okay, thank you for that answer.

Malon Wilkus

You’re welcome. I think we've been able to cover the points that were important for the quarter. We're real pleased about everybody joining us. I think we did have a very fine quarter, but more importantly an excellent year and we look forward to having a discussion about our performance of the first quarter in a few months. So we look forward to seeing you again and we hope everyone takes good care between now and then. Bye-bye now.

Operator

This concludes today's conference. You may now disconnect.

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