Apollo Investment Corp. F3Q08 (Qtr End 12/31/07) Earnings Call Transcript

Feb. 6.08 | About: Apollo Investment (AINV)

Apollo Investment Corp. (NASDAQ:AINV)

F3Q08 Earnings Call

February 6, 2008 10:00 am ET

Executives

John J. Hannan – Chairman, Chief Executive Officer

James C. Zelter – President, Chief Operating Officer

Richard L. Peteka – Chief Financial Officer

Patrick J. Dalton – Executive Vice President

Analysts

Robert Lacoursiere – Banc of America Securities

Greg Mason – Stifel Nicolaus & Co.

Carl G. Drake – Suntrust Robinson Humphrey

Jim Shanahan – Wachovia Capital Markets

Vernon Plack – BB&T Capital Markets

Dan Wirth – Bear Stearns

Russell Green – Wunderlich Securities

Operator

Welcome, everyone, to the Apollo Investment Corporation third quarter 2008 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question and answer period. (Operator Instructions). Thank you. It is now my pleasure to turn the floor over to John Hannan, Chairman and Chief Executive Officer. Sir, you may begin.

John J. Hannan

Thank you. Good morning, everyone. I’d like to welcome you to our third fiscal quarter 2008 earnings conference call. I’m joined today by Jim Zelter, AIC’s president and COO, Patrick Dalton, AIC’s corporate executive vice president and CIO, and Rich Peteka, our chief financial officer. Rich, will you give some opening comments and disclosure issues?

Richard L. Peteka

Thank you, John. I’d like to remind everyone that today’s call and webcast is being recorded. Please note that they are the property of Apollo Investment Corporation and that any unauthorized broadcast in any form is strictly prohibited. Audio replay information is available in our earnings press release.

I’d also like to call your attention the customary safe harbour disclosure in our press release regarding forward-looking information. Today’s conference call and web cast may include forward-looking statements and projections and we ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these projections. We do not undertake to update our forward-looking statements unless required by law. To obtain copies of our latest SEC filings please visit our website at www.apolloic.com or call us at 212-515-3450.

At this time I’d like to turn the call back to our chairman and chief executive officer, John Hannan.

John J. Hannan

Thanks, Rich. In light of the general volatility and certainty in the marketplace today, especially for financial stock, I believe it’s worthwhile to reiterate some of the specific business of Apollo Investment Corporation. AIC is an investment company that seeks to generate current income and capital gains in support of its quarterly dividends to stockholders.

The company is managed by its own dedicated and seasoned team of investment professionals who have deep credit and underwriting experience and strong long-term relationships with middle-market financial sponsors and commercial and investment banks. This dedicated team supplements their own experiences, relationships, deal flow, and investment acumen with that of more than 175 professionals from our affiliate, Apollo Global Management LLC – a global alternative asset manager.

AGM has over 18 years experience investing throughout market cycles, having invested in more than 150 companies across many different industries. Apollo Investment Corporation has the full benefit of that additional experience and insight.

The investment portfolio of Apollo Investment Corporation is invested primarily in senior secured and subordinated loans and some private equity. AIC’s portfolio does not contain investment in sub-prime or any other residential real estate. In addition, AIC does not purchase debt securities of any Apollo controlled portfolio company. Let me also state clearly that our portfolio and investment strategy remains unchanged since our IPLs from three years ago. It continues to focus on matching our assets and what we deem to be our obligation. That is, our dividend to stockholders.

We continue to focus on the middle of the capital structure of larger middle-market companies in an effort to better protect principal and have always thought the best relative value, whether public or private, whether in the primary or secondary market. And with many of the stocks in the financial sector trading with depressed valuation our strategy provides a relative advantage over strategies of investing at the top and/or bottom of the capital structure of generally smaller companies.

Now let me turn to our quarterly results. For the quarter ended December 31, 2007, we invested $360 million across five new and 10 existing portfolio companies. This brings our invested capital since our IPO to over $5 billion in 110 portfolio companies.

The quarter also saw two prepayments and other exits totalling approximately $123 million. In addition, our LP interest in GS Prysmian Co-Invest LP was reduced, thereby resulting in realized capital gains and added to both our liquidity and already harvested distributable earnings.

At December 31, 2007, our portfolio consisted of investments in 70 different companies and was invested 24% in senior secured loans, 55% in subordinated debt, 5% in preferred equity, and 16% in common equity and warrants measured at fair value.

With that, let me turn the call over to our CFO, Rich Peteka, to provide us with details on our third quarter results. Rich?

Richard L. Peteka

Thanks, John. We closed our books on December 31st, 2007, with a net asset value of $17.71 per share, down $0.73 for approximately 4% from our NAB of $18.44 per share at September 30th, 2007. This was largely a result of a decrease in net unrealized appreciation during the quarter due to various mark-to-market quotes. Year over year our December 31st, 2007, NAB increased by 8.25% or $1.35 per share from $16.36 per share at December 31st, 2006. Adding back dividends of $2.06 per share paid during the calendar year of 2007, the NAB would have increased by $3.41 per share or more than 20%.

Gross investment income for the quarter totalled $92.9 million. This is compared to $86.1 million for the quarter ended September 30th, 2007, and $71.1 million for the comparable quarter a year earlier. Accordingly, our gross investment income increased 8% for the quarter and was 31% higher than the comparable quarter a year earlier.

Net operating expenses for the quarter totalled $49.7 million of which $32 million was management and net performance based incentive fees, $16 million was interest expense and $1.7 million was G&A expenses. This compares to the September quarter of $24.4 million in net operating expenses of which $7.5 million was management and net performance based fees, $15.1 million was interest expense, and $1.8 million was general and administrative expenses. For the comparable quarter a year earlier the net operating expenses totalled $32.4 million of which $18.1 million was management and net performance based incentive fees, $12.8 million was interest expense, and $1.5 million was G&A expenses.

The increase in expenses from the prior quarter is primarily driven by an increase in base management fees and interest expense due to the growth of our investment portfolio and an increase in the net realized capital gains based incentive fee due to significant realization during the quarter. In addition, excise tax of $1.7 million were accrued during the three month ended December 31st, 2007, as compared to $0.7 million for the three months entered a year earlier on December 31st, 2006.

Accordingly, net investment income was $41.5 million or $0.35 per share after deducting the accruals for the net realized capital gains incentive fee and excise taxes during quarter, as compared to $61.6 million or $0.58 per share for the quarter ended September 30th, 2007, and $38 million or $0.46 per share for the comparable December quarter a year earlier. As a reminder, net investment income can and usually does vary significantly quarter to quarter based on the quarter’s accrual to the capital gains based incentive fee, which is generally derived from changes to unrealized and realized gains and losses that are below the net investment income line on the company’s statement of operations.

Apollo Investment Corporation’s GAAP (inaudible) also continues to represent only a portion of our taxable earnings included in quarterly dividends. Taxable earnings also includes net realized gains and commitment in other up-front fees received from investments that we are amortizing over the respective terms of our loans among others.

As John mentioned earlier in the call, our investment sales and prepayments totalled $123 million during the quarter. These sales and prepayments, together with the reduction of our interest and GS Prysmian Co-Invest LP generated net realized gains totalling $80.5 million for the quarter as compared to net realized losses of $0.9 million for the quarter ended September 30th, 2007, and net realized losses of $0.5 million for the comparable quarter ended December 2006.

Also during the quarter we experienced a net decrease in unrealized appreciation of $147.6 million. This was largely due to the reversal of significant unrealized appreciation into realized gains, as well as the various mark-to-market quotes mentioned earlier. This compared to a net decrease in appreciation of $83.9 million to the quarter ended September 30th, 2007, and a net increase of $19.4 million for the comparable December quarter a year earlier.

At December 31st, 2007, our overall portfolio had net unrealized appreciation totalling $4.4 million versus net unrealized appreciation of $152 million and $117.8 million, respectively, at September 30th, 2007, and December 31st, 2006.

As a reminder, every one of our portfolio company investments in valued each quarter using independent third parties.

All totalled our quarterly operating results decreased net assets by $25.6 million or $0.21 per share versus a decrease of $23.2 million or $0.22 per share for the quarter ended September 30th, 2007, and an increase of $57 million or $0.69 per share for the quarter ended December 31st, 2006.

Now let me turn the call over to Jim who will take us through the current market conditions and our portfolio activity during the quarter. Jim?

James C. Zelter

Thanks, Rich. As seasoned credit market investors, the current environment comes neither as new nor unexpected to the entire Apollo team. What began as a technical overhang in senior debt and high-yield bridges in early summer of ’07 has now developed into a full credit crunch. The primarily lending environment over the last five years has virtually stopped. And while the fed has acted quickly and vigilantly, we believe there are significant opportunities in the current market. We are convinced that our access to long-term capital continues to be a strategic tool that we will expect will benefit our shareholders in the long run.

We clearly outlined three strategies in the fall that we believe this current environment brings to our company. They are: one, opportunistically making secondary market purchases in current portfolio companies at meaningful discounts to long-term value as many mark-to-market participants alter their short-term strategies; two, investing in the committed debt deals that are stuck on many of the financial institution’s balance sheets; and three, traditional sponsor-driven mezzanine investments priced to reflect the current lending environment. We have executed on all three strategies in the last quarter and intend to continue to do so in this quarter and in quarters ahead.

Permanent capital and liquidity are strategic tools as I mentioned earlier in today’s marketplace and we will not be daunted by short term mark-to-market challenges in we believe we are investing in strong companies at a discount to future value.

Patrick will discuss our portfolio in more detail, but now let me discuss this quarter’s activity. As John noted earlier in the call, we closed our third quarter having invested $360 million across five new and 10 existing portfolio companies. The quarter also saw prepayments in other exits totalling $123 million. Since our IPO in April of ’04 our total investment capital now exceeds $5 billion across 110 portfolio companies and has yielded a gross IRR achieving 19%.

We were active investors in the quarter and opportunities came from both new and existing middle-market sponsors, as well as from commercial and investment banks. Our investments during the quarter continue to focus opportunistically on larger companies. Accordingly, our average investment in new portfolio companies exceeded $45 million during the quarter and our overall portfolio company investment continues to exceed $47 million as of December 31, ’07.

Let me take you through a few of our larger investments made during the quarter. We invested approximately $75 million across the capital structure of Ranpac Corporation. Ranpac, a former AIC portfolio company, is a leading manufacturer and marketer of paper-based, in-the-box, protective packaging systems that compete as an alternative to materials like bubble-wrap, peanuts and foam packaging. Ranpac was purchased by Odyssey Investment Partners.

We invested over $80 million in the high-yield securities to support the buy-out of Ceridian Corporation by T. H. Lee and Fidelity National Financial. Ceridian provides a broad range of human resource outsourcing solutions and has been number one issuer of proprietary business-to-business payment cards in the transportation, retail, restaurant, and government segments.

Catalina Marketing Corporation is a leading media and marketing services company focused exclusively on delivering customized, targeted communications to consumers at the point of sale. We invested over $30 million in subordinated bridge loans and this loan was supported the take private of Catalina Marketing by Hellman and Friedman and was originated by underwriters Bear, Sterns, Morgan and Goldman.

Energy Future Holdings Corp., formerly TXU, owns and operates electricity generating assets across the Texas market. TXU Corporation was purchased by a leveraged buy-out by a consortium of PE firms lead by KKR, PPG, and Goldman Sachs. We invested over $24 million in the debt securities of the company.

We invested approximately $20 million in the debt securities of Generics International, formerly Qualitest Pharmaceuticals. Generics International is an integrated developer, manufacturer, and marketer of generic pharmaceuticals for the US market and provides a variety of prescription medications in both solid and liquid semi formats. Apex Partners acquired this company.

We invested an additional $39 million in the common equity of Grand Prix Holdings, the holding companies for Innkeepers USA Trust, increasing our overall investment to around $247 million across the common and preferred of that company.

And lastly, we opportunistically invested approximately $130 million in the secondary market in names that we currently hold, such as Assurion, Brentag, IPC Systems, Car Holdings, Laureate Education, The ServiceMaster Company, Thomson Learning, Travelex, and World Directories at discounts to original issue prices.

Ultimately our investment portfolio at December 31st consisted of 70 companies with a market value of $3.3 billion. And while we experienced a decrease in net unrealized appreciation during the quarter due to various mark-to-market quotes as the overall bank and bond markets write it off, we are comfortable with the overall fundamentals and credit quality of our portfolio.

By the quarter end the weighted average yield on our portfolio is 12.6%, as compared to 12.7% at the end of the previous quarter, and the weighted average yield on our subordinated debt and senior loan portfolios were 13% and 11.6% respectively, down from 13.1% and 11.9% respectively in the prior quarter. The nominal impact of our debt portfolio yield during the quarter was derived primarily from pre-payments of higher yielding assets, increasing credit risk premiums, and declining market and bench mark rates.

Before I turn the call over to Patrick let me say that we believe that we currently have a significant opportunity in this challenging environment that we have not seen in over five years. Of course, we will continue to navigate our way with discipline and strong focus on principle protection. With that I will turn our call over to our chief investment officer, Patrick Dalton.

Patrick J. Dalton

Thanks, Jim. During the quarter we were patient yet opportunistic investors. Again, as a relative value investor we reviewed a wide range of opportunities from a variety of different sources. First, we were showing several investment opportunities from both new and existing middle-market sponsors. We also saw extraordinary value developed in the secondary market for subordinated debt of larger companies and, as a result, accessed our strong relationships with investment and commercial banks to partner with a few of these institutions that were seeking to free up capital by selling selected high-quality bridge loans and high-yield securities of larger companies to us at significantly discounted prices.

As part of the Apollo franchise we are generally afforded the benefit of Apollo’s overall relationship with these banks, including the business leaders within the capital markets and leverage finance groups, to source both primary and secondary market opportunities. Furthermore, we continue to focus on industries where we believe Apollo’s expertise offers us an edge.

Since the very beginning we have had this flexible and unique sourcing model where we source deal flowed directly from financial sponsors as well as from investment in commercial banks. We have built a large portfolio of investments by directly backing financial sponsors, like our investment in Anthony Incorporated alongside Aurora Capital back in July of 2004, as well as our recent investment in Ranpac Corp. alongside Odyssey Investment Partners just this past December, and the many, many more investments in between.

Additionally, we have also utilized the broad based relationships of the entire Apollo platform to create partnerships with leading investment and commercial banks to obtain access to upcoming transactions and to assist in the structuring and underwriting of these investments alongside these banks where we can truly add value. For example, in 2004 we invested in the high-yield securities of portfolio companies like Language Line Services and in Vista.

Also, in the late summer of 2006 when we witnessed a brief dislocation in the high-yield market we took advantage of that opportunity to invest in the high-yield securities of Nielsen. Nielsen is a well-known market research company with over $1 billion of EBITDA. We were able to work closely with the underwriters and invest $50 million at 12.5% coupon with five years of call protection. In January and in February of 2007, when the high-yield market rebounded, we sold roughly a third of our position at approximately 125% of accrued value for an internal rate of return of more than 70% on the securities we sold. Now, once again, we believe we are seeing these same kind of opportunities.

We continue our steadfast strategy of investing in mezzanine and subordinated debt securities with a focus on increasing our investment in larger companies with strong free cash flow. Accordingly, our average investment in new portfolio companies exceeded $45 million during the quarter. More importantly, the weighted average EBITDA for new portfolio company investments added during the quarter exceeded $600 million per company and the weighted average EBITDA for the total portfolio is now well in excess of $100 million.

We believe that a focus on larger companies, especially during this current economic climate is a more prudent, less competitive, and ultimately more attractive investment strategy. We believe that larger companies are better able to manage through less robust economic climates.

The dislocation in the credit markets which began last summer and the subsequent exit of liquidity throughout the global capital markets is now providing firms with access to capital, like Apollo, with the ability to make investments in even larger companies than in previous markets at what we believe are attractive yields.

We are also pleased with our strategy of making selected co-investments in private equity. We believe this strategy has worked. We are happy to have realized another substantial capital gain from a secondary sale of our equity interest in GS Prysmian during the quarter.

Due to the nature of our investment strategy we do have a larger portion of our portfolio that is subject to mark-to-market than most of the other BDCs. As such, we have experienced mark-to-market decline in certain of our portfolio valuations. It is our strong belief that the market should distinguish between transparent mark-to-market unrealized gains and losses and actual credit impairments.

During the quarter we reinvested in many portfolio companies at prices below our initial purchase prices. In these companies we have no underlying credit concerns, we just now expect to have a better return for the same risk. We see this as an opportunity presented to us by the current market dislocation.

Our portfolio remains highly diversified by issuer and by industry. As of December 31st our weighted average risk rating and the total portfolio remained at a rating of a 2 and our weighted average cash interest coverage was over two times. There were also no new non-accruals during the quarter.

Of the 110 portfolio companies invested in since the IPO we only have had two investments placed on non-accrual and we believe that the additions to the portfolio since the market dislocation began have been advantageous and we expect these opportunities will continue.

We are also pleased with the Federal Reserve’s recent interest rate reductions. The feds rate cuts have lead to a reduction in benchmark interest rates for US corporate credits. For instance, the three-month liable rate has decreased by over 220 basis points in 5.36% just six months ago to the current rate of under 3.14%. This will have an immediate positive impact on our underlying portfolio companies. Our companies will now have a significant reduction in their interest costs and thus produce more cash flow for every dollar of revenue earned.

Lastly, we are very much aware of the current economic environment that we are all living through. We recognize that what we currently own is much more important that what we do not yet own. We are, as always, first and foremost focused on the preservation of your capital. We believe that our portfolio strategy of limiting the total number of portfolio companies to a manageable number in scaling our assets by focusing on larger, healthier companies will prove prudent over time. As of December 2007 we had 70 portfolio companies compared to 54 at December 2006. Yet our portfolio has grown from $2.25 billion at fair value to over $3.3 billion during the same time period.

During this time we’ve also continued to make additions to our investment professional team. We also have the benefit of working closely with all of the investment professionals, operating executives, lawyers, and accountants that we have on staff across the entire Apollo platform.

Our firm has a long history of successful investing in building companies throughout market cycles. We are experienced and we are prepared to work closely with all of our portfolio companies should there be any further stress from the current economic environment and are focused on creating and preserving value for our shareholders.

Before I open up the call to questions let me say that we remain committed to our consistent business model and are excited about the current investment environment. And, as Jim stated, we will continue to navigate with our investment disciplines and our focus on principle preservation.

Moderator, please open up the line for questions. Thank you.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Your first question comes from Carl Drake of Suntrust Robinson.

Carl G. Drake – Suntrust Robinson Humphrey

Thanks for the additional disclosure on the portfolio. That’s helpful. In terms of maybe talking about the current portfolio, if you could talk a little bit more about certain sectors that you’re seeing perhaps weakness in. There’s been consumer and housing. There’s been some, anything directly tied. There’s been some softening there, of course. I don’t think Eurofresh is necessarily a macro-economic problem, but maybe you could touch on other sectors, if you’re seeing any signs of stress in the industrial, retail, transportation sectors.

James C. Zelter

Well, let me start off broadly, Carl, and then I’ll pass it over to Patrick. Certainly since last summer everybody was talking about the home building sector and residential real estate. It’s certainly safe to say that the cause of consumer slow down, the ensuing consumer slow down has hit more businesses per say across the overall with the exception of probably some energy and other industries.

We also see the companies that are more global, i.e. the larger companies, are showing a great deal of resilience, quite frankly, than the companies that are domestically based. So that’s what the continued theme over the last 12 to 18 months larger companies with more heft, if you would, we have found that to benefit our portfolio.

So to answer your specific question, we have seen a little bit of a widening out to some situations in the transport sector, some consumer oriented businesses like restaurants and retail, per se. But that’s my generic comment. I’ll pass it over to Patrick if he has anything else to add in particular.

Patrick J. Dalton

Sure. Thanks, Jim. Hi, Carl. What we’re seeing, as Jim mentioned, is there has been some stress in the consumer businesses, retail, restaurants, transportation, but what we are pleased to see is that for the vast majority of our portfolio companies the budgets that we are reviewing for 2008 appear to be strong to us. We are keeping a very close eye on economic indicators by industry. We are looking at the companies that we think may see some stress.

We are very pleased, as Jim mentioned, the larger companies. The vast majority or showing pretty strong for 2008, but we are not necessarily going to agree with all that growth. We’re going to manage our portfolio as if it’s going to see more stress. We are in active dialogues with all of our companies, all of our management teams, and all the sponsors who control these companies. To the extent that we see something it will be reflected in our ratings as well as our valuations.

Carl G. Drake – Suntrust Robinson Humphrey

Patrick, what about year-over-year EBIDTA growth? Is that something that is slowing to kind of a flattish number for the broad portfolio?

Patrick J. Dalton

Yeah, I would say it’s generally correct in that there’s less growth than there was before, but we’re still seeing year over year better performance to date. For ’08 I’d say on balance we are assuming modest growth for the entire portfolio projected, but we are not necessarily behaving in a way that we’re going to expect to see growth. And as a debt provider mostly we are very happy that we don’t necessarily need growth. As long as we’re underwriting companies with strong free cash flow we’ll see deleveraging even at flat to slightly down EBITDA in revenue.

Carl G. Drake – Suntrust Robinson Humphrey

Thank you. That’s helpful. How should we think about investment pace going forward given the fairly tight capital out there? You all are in good position with pretty good runway, but how should we think about investment pace? You’ve got some natural liquidity. It looks like prepays are slowing as well.

Patrick J. Dalton

Yeah, Carl. Yes, prepay, we always had the view that in a robust capital market the average life of our portfolio would be around two, two and a half years. We think the average life of our portfolio now will be certainly north of three, three and a half years. As I outline those three opportunities we have found that we’ve never been ahead of budget on investment pace, but certainly we’re seeing more opportunities in the first two buckets and the last bucket that we did the Ranpac investment in the fourth quarter – which we’re very pleased about – I think you’re going to see more of that traditional middle-market mez as the MNA market. There’s more clarity in it into the second and third quarter, as the senior loan markets open up and there’s a little bit more clarity in the middle-markets (inaudible). That third area will increase in size, but again, we’re highly demanding in what the rates we’re charging right now and we’ll continue to do so. But it’s hard for us to translate that into a pace, per se.

Carl G. Drake – Suntrust Robinson Humphrey

Yeah, I understand. The best opportunities right now are in the secondary market at discounts, it sounds like. And the mezzanine market hasn’t truly reprised. Is that fair?

Patrick J. Dalton

Yeah, that’s an accurate statement. I think the first two opportunities that I pointed out, those have been actionable, which we have done, and I think that third bucket is one that will, that is our core business and again we’re finding, as we’ve always said, there’s lots of competition for $25 million or $30 million mez deals and that pricing in our mind has not really re-priced, quite frankly. And since we are a relative value investor we want to find the best relative value for our dollars in investment capital.

Carl G. Drake – Suntrust Robinson Humphrey

Okay. Thank you.

Operator

Thank you. Your next question comes from Jim Shanahan of Wachovia.

Jim Shanahan – Wachovia Capital Markets

Good morning. I had a question about a couple of the investments as well. I’m really curious about R-ban (sp) Natural Products Group. It looks like over the course of the last few quarters it was kind of on a downward trend from say June to September and then the fair value increased. But it looks like it was also, there was an incremental investment there in R-ban. Can you talk about what’s happening there with R-ban and why you elected to make an incremental investment in a company given the downward trend?

Patrick J. Dalton

Yeah, Jim. Hi. It’s Patrick. There was no incremental investment in the company. That was the result of pick interest that was received on the holding company. So we have not made any new investments in the company. And that was with the security we invested in.

Jim Shanahan – Wachovia Capital Markets

So the pick increased your cost basis by about $4.4 million but the fair value only increased by $3.3 million?

Patrick J. Dalton

That’s a quoted instrument by (inaudible) deals and third parties, so we just take the quote as they present it to us.

Jim Shanahan – Wachovia Capital Markets

Understood. And a question about Innkeepers. Is there anything you can update us on regarding the strategy there? We’re starting to hear in fact some operators of lower-end hotel changes actually reporting lower revenue per room trends. Are you seeing anything like that with Innkeepers and what is the strategy here as you can update (inaudible).

Patrick J. Dalton

Sure, Jim. And that’s a great question. Certainly we’re spending a lot of time on Innkeepers given the size of the investment. I’m happy to report that as of today we’re not seeing any degradation in performance of the business in total. Regionally we’re keeping a very close eye on what’s going on when we have strong assets and with the generation of performance, especially in the west coast. But at an extended stay hotel maybe the full service top of the line hotels will probably see pressure first. We’re not seeing pressure yet.

We have just finished the renegotiations for group rates for corporates. We’re very pleased that the ADR rates are up for negotiated prices for rooms, which is always a very good sign. We’re working very closely with the management team. We put in place several contingency plans should the economic environment start to put pressure on results. We spent our last week budgeting with the management team and are pleased with that progress. But we’re keeping a very close eye on it. We are getting a lot of inbound inquiry on acquisition opportunities, which we will prudently take a look at if it makes sense for us to execute on or not.

Jim Shanahan – Wachovia Capital Markets

Okay. And how did the opportunity to make the incremental investment in Innkeepers come about and why make another $39 million investment in Innkeepers?

Patrick J. Dalton

You know, this was something that was generally part of the original plan is that we were going to acquire the company for the capital that it took to acquire the company. We have several development projects and pit programs which I’m sure, Jim, you realize, given your background, are improvements that are required to be made when you do a change in control with some of our brands. We are not going to decelerate those programs. We are going to accelerate those programs. We also are going to look at opportunistic acquisitions going forward and want the company and management team to know that we’re backing them in this environment.

Jim Shanahan – Wachovia Capital Markets

Thank you, Patrick.

Operator

Thank you. Your next question comes from Vernon Plack of BB&T Capital Markets.

Vernon Plack – BB&T Capital Markets

Thank you. How much you’ll leverage your balance sheet in this type of environment? Where can we expect over the next 12 months that your debt to equity ratio will go?

Patrick J. Dalton

We have always been consistent in saying that we operate lower than some of our peers and yet in times of opportunity like we’re seeing right now we would edge up to a higher level. I think that we will never operate, you know, close to one-on-one that would get us into any kind of challenging environment. I think you should expect us this 0.75, 0.821, somewhere in that zip code. Again, if we believe that we are adding incremental assets that benefit the bottom line of our business. But certainly in the past we’ve been under 50%. This quarter you saw it ticked up a bit and in that 0.7, 0.75 is the zip code that we’re probably most comfortable operating in.

Vernon Plack – BB&T Capital Markets

Thank you.

Operator

Thank you. Your next question comes from Dan Wirth (sp) of Bear Stearns.

Dan Wirth – Bear Stearns

Yeah, good afternoon, gentlemen. A couple of questions, if I may. First of all, do you have any hedging instruments in a CDX or LCDX or the European itraxes (sic).

Patrick J. Dalton

That’s a very good question. We review that all the time to see if it makes sense for our portfolio. We like the investments we make in our portfolio to the extent that we saw something that was acute and we wanted to protect against it we would evaluate it. We at the firm understand those instruments and how they work, but as of today we’re not using any of those instruments.

Dan Wirth – Bear Stearns

Okay. Second one is, after the yield you talked about how much of those are actually in (inaudible) pick if we spread out the liables. On a spread basis how much is pick, how much is cash across the portfolio.

Richard L. Peteka

We haven’t disclosed that information historically. It’s one of the reasons why we don’t disclose it. It’s a number that we have many or have had many since our IPO securities that have been structured as pick, but they cash cash. Quite frankly, when they cash cash every quarter occasionally they make pick. Again, it becomes a number where cash and pick is (inaudible) and ultimately we’re underwriting good credit to big companies. It’s just not a number that we’ve ever segregated out because the change would be hard to track because of these securities that have cash then they’ve got pick.

Not (inaudible), but we may have cash for the two quarters or we may say pick once and then maybe cash all the way until the maturity or till they pick us out. So it’s really hard to categorize that. That’s the best I can tell you.

Dan Wirth – Bear Stearns

Okay. What (inaudible) earlier is marked by independent brokers or independent sources who use broker quotes?

Richard L. Peteka

About half the portfolio is quoted by broker dealers as guided by primary dealers and the rest of the portfolio is valued by independent valuation firms.

Dan Wirth – Bear Stearns

And for making sort of available investments, what’s the debt capacity you have on the revolver and how much cash are you sitting on if you need to put to work?

Richard L. Peteka

Well, we have approximately $600 million left on the revolver to be drawn and probably another $400 million over and above that within our leverage restrictions to the extent we need to add that debt capacity.

Dan Wirth – Bear Stearns

Okay. And lastly, just as a technical question. On the balance sheet, what is the “payable for investments and cash equivalents purchase” mean? Are they future expenditure you’ve already committed to in the form of new investments?

Richard L. Peteka

Yeah, I would point you to our cash equivalents note nine in our financial statements. You get a clear definition of what that is, but largely those are open trade and including some of those treasury bills over quarter end. Again, I would ask you to read our footnote nine in our financial statements. That’s been there every quarter.

Dan Wirth – Bear Stearns

Okay. Thanks a lot then.

Richard L. Peteka

Thank you.

Operator

Thank you. Your next question comes from Greg Mason of Stifel Nicolaus.

Greg Mason – Stifel Nicolaus & Co.

On top of the $1 billion of excess capital you have now you said you have good long-term access to capital. Could you talk about some of those means you have for additional capital? And also, what are your thoughts on some of the BDCs developing these off-balance-sheet funds, like the Allied mez fund? What are your take on those kind of products and are you interested in them?

James C. Zelter

Well, as I said earlier, as Rich said, we have our existing credit facility which gives us ample liquidity right now for the opportunities we’re seeing. And certainly with our prominent position as part of Apollo, we believe that there are plenty of opportunities for us to augment that at the proper time through a variety of vehicles. So we’re not concerned about having access to our full leverage capacity when that does come in the future.

In terms of your second question, certainly there’s a variety of paths that some BDCs have gone with how they’re turning their business and growing their business. Certainly we have been, we are very proud of our current portfolio and if there are things that we think make some sense for incrementally providing those types of vehicles underneath our business that would benefit our investors we’re going to consider that in due course, but have not felt the need in the past. But again, as we’re in the market of a new credit environment, as people want to be a part of our investment structure, we’ll consider those as appropriate.

Greg Mason – Stifel Nicolaus & Co.

And can you talk about the current investing period, what you’re actually aquantifial (sic) major, what you’re seeing spreads going out to, as well as asset quality of investments out there.

James C. Zelter

Well, let me start out. I could pass you to Patrick if I miss anything. I mean, certainly I use my term credit crunch. We’re asked all the time, are we in a recession? Are we going in a recession? As credit investors we live and breathe the credit market every day, so it’s argued that by the time the economists actually declare a recession we’ll probably be six months into it. So what we were saying earlier is we’re not seeing a lot of new paper hit the markets. What you’re seeing is an overhang on the senior debt and on the bridge market.

So we know those credits, some of them are very large and some we think highly of, some we have issues with. But in terms of new product hitting the market, there has not been a great degree of new names that have come because of the lag effect of the middle-market, MNA market, and the overall MNA market.

So in terms of, we are seeing lots of $25 million to $30 million mez opportunities that we quite frankly think are companies that we don’t think have the robust nature that we’d want to invest on the current terms are being provided to us. I.e., that type of market we don’t believe has re-priced respectively to what it should relative to the other opportunities in front of us. That will happen over the course of the year and we will see product in that space, but we would expect it to re-price by a few hundred basis points at least and certainly not only in coupon pricing, but we’ve always talked about and Patrick’s been consistent in redemption provisions. We expect we’re seeing better redemption provisions, non-call, six months, going out to non-call two and three, that’s the minute we see coming back and obviously better covenants overall.

Greg Mason – Stifel Nicolaus & Co.

Touch on Eurofresh. I know that has traded down, but it also seems like they are paying their cash interests. Could you give us an update there?

Patrick J. Dalton

Sure. Obviously it’s been publicly disclosed that Eurofresh was originally late on its payment, but did make a cash interest payment. As some middle-market companies do as they’re working through challenges if they have them and we are encouraged and you’ll see the prices actually come back up over the last couple of days in Eurofresh. The sponsorship group is working very, very hard with its lenders across the board, including us, on ways to continue to perform over time. The company actually has good products, it’s just a matter of some operational challenges that they’re facing and we’re very much in a dialogue with them.

Greg Mason – Stifel Nicolaus & Co.

And lastly, could you update us obviously with the big write-down in Lexicon this quarter what the future outlook is for that investment?

Patrick J. Dalton

As you can see from our write-off of our investment in totals, we are not confident at this point in time that they be valued through our securities. We hope and we are still in active dialogue with the sponsor group and the lenders to give the company the best shot it possibly can have to come through the cycle, but at this point in time we’re not confident enough to see value in our security.

Greg Mason – Stifel Nicolaus & Co.

Great. Thanks, guys.

Operator

Thank you. Your next question comes from Robert Lacoursiere of Banc of America.

Robert Lacoursiere – Banc of America Securities

Question on one of the strategies you talked about buying, making incremental investments in existing portfolio companies through secondary transactions. You characterize them as being made less than your original cost basis, but how were they made recently relative to what you had them at fair value or markdown?

James C. Zelter

Fair value, at fair value that’s the prices we’re paying. For secondary trades that we’re making in assets. When we bought them they were fairly valued, in our opinion. The markets have gotten heavy. Prices have come down. We purchase them. What you see in our fair value is the weighted average cost.

Robert Lacoursiere – Banc of America Securities

Okay. So it didn’t, because you made a subsequent investment at lower than your previous cost that you’re just doing weighted average not re-pricing everything down.

James C. Zelter

Yeah, our cost is weighted average, but the fair market value is the latest price.

Robert Lacoursiere – Banc of America Securities

Okay. All right. Thank you.

Operator

Thank you. (Operator Instructions). Your next question comes from Russell Green of Wunderlich Securities.

Russell Green – Wunderlich Securities

Hello? Yeah, I’m just trying to understand just a couple, I’m from the retail side. Two things: How comfortable are you currently with the dividend policy? And the other question is concerning, do you have any sort of ability to do some sort of stock buy-back given the price of the stock compared to what the net asset value is at the moment?

John J. Hannan

This is John Hannan. On the dividend policy we’ve been very consistent that we’ve looked at that as an integral part of our business and our policy is to have a steady, stable dividend. We’ve continued to do that and that’s going to be part of our focus going forward.

As to a buy-back, it doesn’t make a lot of sense in a structure that we have to be going in buying back stock in these volatile markets because basically we want that capital to grow the business. And it doesn’t make sense to spend a lot of money raising equity and then to turn around and buy it back.

Russell Green – Wunderlich Securities

All right. Thank you very much.

John J. Hannan

Thank you.

Operator

Thank you. This concludes the question and answer portion of today’s call. Thank you. This concludes today’s conference call. You may now disconnect.

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