Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Bill Walton - Chairman and CEO

Joan Sweeney - COO

Penni Roll - CFO

Shelley Huchel - Director of Investor Relations

Mike Grisius - Managing Director

Rob Long - Managing Director

Analysts

Dan Furtado - Jefferies

Ryan Hogan - Piper Jaffrey

Tom Lamb - Weybosset Research

Vernon Plack - BBT Capital Market

Kelly Seng - Merrill Lynch

Greg Mason - Stifel Nicolaus

Paul Sedar - Sedar & Zack Capital Management

John Gillmor - FBR Capital Market

Allied Capital Corporation (ALD) Q4 2007 Earnings Call February 20, 2008 10:15 AM ET

Operator

At this time I would like to welcome everyone to the Allied Capital Quarter Fourth 2007 Earnings 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.

I will now turn the call over to Chairman and CEO of Allied Capital. Mr. Walton. You may be begin, sir.

Bill Walton

Thanks Diana. Good morning and welcome to Allied Capital's fourth quarter 2007 conference call. I'm joined today by Joan Sweeney, our Chief Operating Officer; Penni Roll, our Chief Financial Officer; and Shelley Huchel, our Director of Investor Relations. We also have with us today Mike Grisius and Rob Long, Managing Directors in our private finance group.

Shelley is new to these calls but not to Allied Capital. Shelley was recently promoted to the position of Director of Investor Relations. Dale Lynch has been promoted as well to the position of Executive vice-President, Capital Markets. In this role Dale will be spending more time in our public and private capital raising activities, while Shelley will focus Investor Relations.

Shelley, would you open the discussion today with the required conference call information, and a discussion about forward-looking statements?

Shelley Huchel

Of course. Today's call is being recorded and webcast live through our website at www.alliedcapital.com. An archive of today's webcast will be available on our website, as will an audio replay of the conference call. Replay information is included in our press release today and is posted on our website. Please note that this call is the property of Allied Capital. Any unauthorized rebroadcast of this call in any form is strictly prohibited.

I would also like to call your attention to the customary Safe Harbor disclosure in our press release today regarding forward-looking information. Today's conference call includes forward-looking statements and projections, and we ask that you refer to our most recent filings at 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 or call investor relations toll free at 888-253-0512.

For today's conference call, we have provided a companion slide deck that compliments our discussion, and lays out many of the numbers we will discuss. These slides are available in the presentations and reports section of the investor resources portion of our website. We'll make reference to data included in these slides throughout today’s call. Finally, as always, there will be a Q&A session after the presentation.

With that, I'll turn it back to Bill.

Bill Walton

Thank you, Shelley. We are here today to report on the 2007 results and to give you an update on our business and the current environment.

We invested $1.8 billion in 2007. After repayments and investment excess our portfolio increased by $285 million during the year, the yield on interest bearing securities improved to 12.1%. During the first six months of the year while the credit market bubble expanded, our investment activities significantly slowed.

As you know, we got leverage levels as purchase price multiple were too high, debt yields were too low, and investment terms seemed ill-conceived. As the market began to correct after August, we put somewhat more capital to work, but remained cautious, believing even better opportunities could arise. We are still pretty much in that mode. Default rates in both private equity deals and CMBS are likely to rise and the economic outlook for 2008 remains on uncertain.

Of course, as you know, we are known for our methodical, disciplined, investment approach and we believe that this discipline should serve us well if the economy weakens. Even in the best of times, we underwrite our investments, taking into consideration the possibility of recession, and we stress our models to anticipate economic downturn.

While pricing in the credit markets in the past few months appears to be anticipating an increased level of default rates, we've yet to see significant credit deterioration in our portfolio overall. Our portfolio quality statistics remain good as of December 31st 2007.

And we think our portfolio is well positioned with what well may be a gloomier economy. 2007 marks several significant accomplishments for us. We achieved a 7% increase in dividends per share, compared to 2006 dividends. And during 2007, some of our net investment income and net realized gains totaled $410 million, or $2.65 per share, which approximated to aggregate dividends paid in 2007 of $407 million, or $2.64 per share.

Our portfolio has generated over $1 billion in net realized gains over the last five years. Our net realized gains of this year totaled $269 million led by the sale of Mercury Air Centers. Portfolio gains have enabled us to generate excess taxable income.

In 2007, our dividends were paid almost entirely from income generated in 2006. Given the level of 2007 net investment income and net realized gains, 2008 dividends are to be expected largely to be paid from 2007 earnings. We ended 2007 with approximately $630 million of spillover income in future installment sale, taxable for income or dividends payments.

The key objective for us in 2007 was to diversify and increase our managed capital base. Over several years, we’ve increased our retail and institutional public equity capital base, and we’ve enjoyed good access to debt capital from both public and private institutional lenders.

In 2007, we had retail investors to our source of debt capital by offering 40-year notes, raising $230 million. We’ve enjoyed a strong retail equity shareholder base since Allied Capital IPO in 1960, and it was a natural fit for us to develop a fixed income product for our retail investors.

We further expanded our managed capital base during 2007 by establishing the Allied Capital Senior Debt Fund in June. This fund invests in middle-market senior loans. We invested in the fund along with other institutional investors and believe this fund is complementary to our business and establishes us as a manager of third-party capital.

In addition, we added to our managed asset platform with the $3.6 billion Unitranche Fund that we announced in December. We developed this fund with GE Commercial Finance to address the market of providing debt capital for larger middle-market companies, as other sources of financing have become scarce. Together with GE, we have invested in and co-manage the Unitranche fund.

Finally, last month we announced that we have entered into an investment agreement with the Goldman Sachs Private Equity Group, part of Goldman Sachs Asset Management. The first component of this agreement involved the transaction in January 2008, where we agreed to sell portions of 59 portfolio investments, including both equity and debt securities to an Allied Capital managed fund called AGILE Fund 1, which is a fund managed by Goldman Sachs. Goldman Sachs is the sole investor other than Allied Capital.

We have also received commitments from Goldman Sachs to invest in future investment vehicles managed by Allied Capital and our affiliates. Including this commitment from Goldman Sachs, our managed assets, including our own balance sheet and committed capital now totaled approximately $9 billion.

Our core business is investing in middle-market US companies. The recent increase in our managed fund activity maintains this focus and gets us the benefit of diversifying our managed capital base to include third party sources.

We look forward to growing our business with seasoned and experienced investment partners like GE and Goldman Sachs.

As [a thoroughly] managed BDC, Allied Capital has valuable asset embedded in the company in the form of our total investment manager. As we increased the BDC’s assets, as well as future managed assets, the value that internal managers should grow, enhancing the overall value of our company.

Our initiatives in managed assets have helped enhanced capital availability in this uncertain market and these funds should create an increasing base of recurring fee revenue that we expect will grow over the years. Joan, will you take us through 2007 and fourth quarter results?

Joan Sweeney

Yes, thanks Bill. Let’s start our discussion with a review of the December 31st 2007 balance sheet. Please turn to our summary balance sheet, which is on slide 3 of the companion slide deck.

We ended the quarter with total assets of $5.2 billion, a total debt of $2.3 billion and total shareholders equity of $2.8 billion. We invested $609.3 million in the quarter, and we repaid $125 million for net new investments of $484.3 million for the quarter. After including quarterly net valuation changes, our portfolio value grew to $4.8 billion as of December 31st 2007, from $4.3 billion at September 30th 2007.

In addition to an increase in the total portfolio, the yield on our interest bearing portfolio at December 31st, 2007 increased as well up to 12.1%, from 11.9% at September 30th 2007. We saw slightly higher coupons on our new loans originated in the latter half of this year as we did more subordinated lending. Mike and Rob will provide additional background on middle-market investing later in the call.

We closed the quarter with an adequate liquidity position, but slightly more leveraged. Cash and money market and other investments, including our liquidity portfolio, totaled $204.8 million and we had about $500 million in borrowing capacity under our revolving line of credit.

At December 31st 2007, our debt equity ratio was 0.83 to 1. Now subsequent to year-end, we agreed to the sale of our assets to the Agile fund, with net proceeds expected to be about $200 million, and we completed an equity offering with net proceeds of $86 million. These two transactions reduced debt and increased our capital available for new investments.

At the end of the year shareholders equity or net asset value was $17.54 per share, as compared to $17.90 per share at September 30th 2007. Please turn to slide 4 for a summary of the changes in NAV for the year. During the fourth quarter, net investment income reduced by net realized losses increased NAV by $0.07 per share, while dividends paid to shareholders decreased NAV by $0.72 per share.

For the entire 2007, year net investment income plus net realized gains were $2.65 per share, about the same as dividends of $2.64 per share. In fact, 2007 dividends were paid mostly from 2006 spillover earnings and 2007 taxable earnings will be available for 2008 dividend payments. Penni will provide details on our taxable income later in the call.

Also in the quarter, NAV increased by $0.10 per share, due to changes in unrealized appreciation or depreciation and Penni will provide more detail on those changes.

Capital share transaction increased NAV in the quarter by $0.19 per share. As undistributed earnings resulting from spillover income billed and then paid out, NAV will fluctuate accordingly. Also, as the portfolio changes in value over time, and gains and losses are realized, NAV will fluctuate.

Now to a discussion of our earnings. For this discussion please turn to slide 5. Interest and dividend income for the quarter ended December 31st, 2007 was $107.1 million, as compared to $105.7 million in the third quarter of 2007.

Fees and other income was $10.6 million for the fourth quarter, as compared to $12.7 million in the third quarter. This quarter's fees and other income included fees associated with new investments origination activity of $5.4 million; fees from portfolio companies of $2.7 million; commitment and guarantee fees of $2.3 million; and fees from managed funds of $0.2 million. Management fee income resulting from managed funds was minimal in 2007, but should increase over time, as those funds are inducted and increase in size.

There were no loans pre-payment premiums in the fourth quarter. Fees and other income will fluctuate from quarter to quarter, depending upon the level of investment activity and due to changes in the portfolio composition and related management fee income.

Total operating expenses were $62.1 million in the fourth quarter of 2007, as compared to $88.9 million in the third quarter of 2007. Please turn to slide 6 for an analysis of our 2007 quarterly operating expenses.

Interest expense, excluding installment sale interest expense, was $32.2 million for the fourth quarter of 2007, as compared to $39.7 in the third quarter. Total employee expense, excluding the IPA and related IPA mark-to-market was $20.3 million, and that's compared to $25.9 million in the third quarter. We decreased the amount in the 2007 bonus pool in the fourth quarter, which reduced fourth quarter compensation expense.

As we have seen in prior quarters, the IPA mark-to-market caused volatility in the employee expense line in the fourth quarter. You can see on slide 6 that as is a result of the decline of stock price in the fourth quarter, we saw a $10.4 million IPA mark-to-market benefit.

Following recent changes in tax regulations, our Board made a decision to terminate our deferred compensation plan and distribute the asset to plan participants in March of 2008. So the IPA for 2008 will be paid in cash on a semi-annual basis and this expense item should become more predictable from an earnings perspective after the termination of the deferred compensation plan.

Employee stock option expense was $3.7 million for the fourth quarter of 2007. For 2007 employee stock option expense excluding option cancellation expense was $20.8 million, and including option cancellation expense was $35.2 million. This compares to 2006 employee stock option expense of $15.6 million. As we mentioned earlier in the year, we granted stock option in 2007, with a vesting schedule that increased the expense allocated to the second quarter of 2007 and increased the expense overall for the year.

Administrative expenses for the fourth quarter, excluding investigation and litigation costs and senior debt fund expenses were $11.6 million, as compared to $9.7 million in the third quarter. We typically experienced a higher of administrative expense in the fourth quarter of the year.

In the fourth quarter, excise taxes were insignificant and we had a total income tax benefit for the quarter of $2.4 million.

Now, turning back to slide 5, you can see that we experienced net realized losses for the quarter of $46.4 million or $0.30 per share. Gross gains totaled $4.3 million for the quarter, while gross losses were $50.7 million.

During the fourth quarter, we wrapped up certain workout assets and realized associated losses. Overall 2007, it was a productive year for portfolio [of assets].

On slide 7, we have broken down our year-to-date bet realized gain activity. In 2007 we had realized gains of $400.5 million and realized losses of about $132 million for total net realized gains of $268.5 million. As we mentioned before, the first three quarters of 2007 were a great time to be a seller of investments.

Now let’s go back to the income summary on slide 5. Net investment income reduced by net realized losses was $11.6 million for the fourth quarter of 2007, or $0.07 per share. For the full year 2007, our net investment income and net realized gain totaled $409.5 million or $2.65 per share. Net unrealized appreciation for the fourth quarter totaled $15.9 million or $0.10 per share. Penni will provide more information on the performance of this number in a moment.

Finally, net income for the quarter was $27.5 million or $0.18 per share. For the year, our net income was $133.3 million or $0.99 per share.

And with that I’ll turn the discussion back to Bill.

Bill Walton

Penni, can you walk us through the results of our valuation process, portfolio qualities statistics, and provide an update on the status of our spillover income?

Penni Roll

Sure Bill, thanks. First, let me discuss the changes in value in the portfolio. And for this discussion, please turn the page nine of the slide deck. For the quarter ended December 31st, 2007, the total net change in unrealized appreciation or depreciation was an increase of $15.9 million. This change resulted from unrealized depreciation from changes in portfolio value of $34 million; $1.6 million reversal of previously recorded unrealized appreciation associated with the realization of gains; and $51.7 million reversal of previously recorded unrealized depreciation associated with the realization of losses.

Excluding changes in value in our investment in Ciena Capital, formerly known as BLX, our investment portfolio increased in value by $37.1 million for the quarter. The Goldman Sachs transaction that occurred in the first quarter of 2008 gave us values for 59 portfolio investments that were used in the December 31st, 2007 valuation process.

Overall, the portfolio is performing well. We did however reduce the value of our investment in Ciena by an additional $71.3 million this quarter. Ciena relies on the asset backed securitization market to finance its loan origination activity. That financing source is an unreliable one, and as a result, Ciena has significantly curtailed loan origination activity.

To value our investment this quarter, we determined that no value could be attributed to Ciena's origination platform or enterprise, due to the state of the securitization markets. In addition, Ciena's book value declined this quarter. We valued our investment in Ciena, solely based on the value of Ciena's net realizable assets and the cash flow's generated from Ciena's retained interest in its current servicing portfolio, which include portfolio servicing fees as well as cash-flows from Ciena's equity investments and its securitizations in its interest [only scrip].

Ciena's Class A equity interest remains at a non-accrual status, and its value has been written down to $68.6 million. We continue to work with this portfolio company on its business plan. But given the current capital markets and access to the securitization funding, we believe that a turnaround process for this investment will take time.

We recorded $63.4 million in net depreciation on the portfolio in 2007, excluding the change in value in Ciena. The rest of the portfolio saw a net unrealized appreciation of $111.1 million in 2007. As we have routinely said, changes in values can vary substantially from quarter-to-quarter, therefore, quarterly comparisons may not be meaningful.

Let’s move on now to slide 10 in the valuation process. We continued to receive third party valuation assistance for our private finance portfolio. We received third party assistance for 91.1% of the portfolio for the fourth quarter of 2007. Of the remaining 8.9% of the portfolio, 4.4% represented deals closed during the fourth quarter. You will be able to review the changes on portfolio valuation in more detail in our Form 10-K that we will file next week.

Now, let me turn to the discussion of our portfolio quality metrics. Grade 4 and 5 assets our workout assets, loans and debts securities not accruing interest, and loans and debts securities over 90 days delinquent.

Please now turn to slide 12. Here you see a summary of our Grade 4 and 5 assets; our workout assets for the last 10 years and for the past eight quarters. We have also presented the data including and excluding our investment in Ciena. Excluding Ciena, Grade 4 and 5 assets were $134 million, or 2.8% of the portfolio value at December 31st, 2007. Including Ciena Grade 4 and 5 assets were $203 million, or 4.2% of the total portfolio valued at December 31st. Taking a longer term look on an annual basis, you will see that over the past 10 years, Grade 4 and 5 assets have ranged from a high of 5.7% of the portfolio in 2000 to a low of 2.3% of the portfolio in 2005.

Now moving on to slide 13, we have a similar analysis for loans and debt securities not accruing interest. Excluding Ciena, loans and debt securities not accruing interest at December 31st, 2007 were $143 million, or 3% of the portfolio valued.

Including Ciena, loans and debt securities not accruing interest at December 31st, 2007 were $212 million or 4.4% of the total portfolio at value. Taking a longer historical view on an annual basis, loans and debt securities not accruing interest over the past 10 years have ranged from a high of 6.4% of the portfolio in 2002 to a low of 2.1% in 1998.

On slide 14, we have similar analysis for loans and debt securities over 90 days delinquent. Excluding Ciena, loans and debt securities over 90 days delinquent at December 31st, 2007 were $81 million, or 1.7 % of the total portfolio valued.

Including Ciena loans and debt securities over 90 days delinquent at year end 2007 were $149 million or 3.1 % of the portfolio value.

Again, taking a longer historically view in an annual basis loans, debt securities over 90 days delinquent over the past 10 years have ranged from a higher side percentage of the portfolio in 2003 to a low of 1.1% in 2006.

Overall the portfolio continues to perform well. The economy appears to be headed towards unsettled times, but we believe that our investment selection and investment structures over the past several years should enable us to weather an impending recessionary economy well.

Now, I'd like to move to a discussion about our taxable earnings and spillover income. We have now paid all 2007 dividends, including an extra cash dividend of $0.07 per share. Almost all of the 2007 dividends were paid from 2006 taxable income, thus substantially all of our taxable income earned in 2007 will spillover for 2008 dividend payments.

We ended 2007 with an estimated $400 million of spillover income available to pay 2008 dividends. In addition to spillover taxable income at December 31st, 2007, we have an estimated $230 million in deferred taxable income resulting from installment sale gains. These gains may be deferred for tax purposes until the installment notes are sold or collected in cash. So in total, spillover income and deferred taxable income is about $630 million.

And we want to point out that we experienced numerous temporary and permanent differences in the recognition of [book] taxable income, and as a result, to-date our taxes on undistributed earnings exceed our book of undistributed earnings. I encourage you to read our tax disclosure and our 2007 Form 10-K, which will be filed next week for a more detailed discussion of our taxable earnings.

And with that, Bill, I will turn things back to you.

Bill Walton

Thanks, Penni. Mike and Rob could you give us an update on our business and the market?

Mike Grisius

Yeah. Thanks, Bill. First let me summarize this quarter's investment activity and then I'll pass it onto Rob to expand on the market discussion and our view going forward.

Please turn to slide 15. We invested $609 million in the fourth quarter of 2007 and $1.8 billion during the year. In the first half of 2007, we found it difficult to find enough good deals at reasonable prices. Our investment's pace for the year was as a lower result than we expected.

As we move into the second half of the year, however, the market started to become more rational with respect to pricing and structures, and we are able to selectively pursue a fair number of very good investments.

Turning to slide 16, you will see that we continued a balanced approach to investing in 2007, with our emphasis on making investments where we can lend money and generate current interest income.

During 2007, we originated senior loans of $312 million with an average yield of 9.1%; Unitranche debt of $184 million with an average yield of 11.7%; subordinated debt of $914 million, with an average yield 12.7%; and invested $116 million in CLO equity, with an average of 16.4%. In addition, we made new equity investments of $302 million.

Now turning to slide 17, you can see that in the fourth quarter of 2007, we originated senior loans of $95 million with an average yield of 9%; Unitranche debt of $56 million, with an average yield of 11.8%; subordinated debt of $321 million, with an average yield of 13.6%; and invested $74 million in CLO equity, with an average yield of 15.5%. In addition, we made new equity investments of $62 million.

The blended yield for loans and debt securities originated in the fourth quarter was 12.5%, as compared to 12% in the third quarter. We are seeing some improvement in the yields in terms in our debt investment.

Now let me talk a little bit about the nature of some of our new investments this quarter. As Bill mentioned earlier, this quarter was one where we focused primarily on debt investment opportunity and specifically on junior debt investment opportunities. Our biggest investment in the fourth quarter was $83 million to support the buyout of DirectBuy. DirectBuy is one of the largest domestic franchisors of membership-based consumer buying centers in North America, with over a 150 locations in the US and Canada. Our investment took the form of senior subordinated debt and equity co-investment.

In addition, we supported the buyout of the Gilchrist & Soames for $46 million. Gilchrist & Soames is a leading supplier of branded, luxury personal care products for the hotel industry. Our investment took the form of a multi-tranche debt facility, including both senior and support subordinated debt, and a revolving line of credit that was undrawn at closing.

Also, during the fourth quarter, we invested $49.5 million in eInstruction, which is a provider of interactive classroom solutions serving the K-12 in higher education markets. Our investments took the form of a second lien loan, subordinated notes, and an equity co-investment.

We also completed the buyout of the CitiPostal Inc., a leading post service document storage and management company. Our $72 million investment took the form of first lien tranche notes, subordinated notes and a majority of the common equity.

For 2007, we continued to focus on seeing as many deals as possible and remaining very selective during a time where the markets were very aggressive. We closed on approximately 2% of what we saw in 2007.

Now let me turn over the discussion over to Rob to expand on the markets in our positioning.

Rob Long

Thanks Mike. Let me start with the review of some statistics on the overall private finance investment environment.

On slide 18, you can see that despite the bull back and deals in the second half of the year, total 2007 LBO volume almost doubled that in 2006.

Turning to slide 19, which shows purchase price multiples per LBO’s with values of $250 million to $500 million, you can see the purchase price multiples decreased from a peak of 10.3 times in the third quarter to approximately 8.7 times in the fourth quarter. As debt financing has become scarcer and more expensive, we expect to see purchase price multiples remain below the heady levels that we saw in early 2007.

Slide 20 shows that industry-wide leverage loan debt multiples remain high, although they too have declined from their high point in 2007. For the fourth quarter of 2007, industry average debt multiples for leveraged loans show total leverage multiples of 6.6 times EBITDA, down from 7.4 times in the second quarter of 2007.

Allied Capital continues to generate deal flow in the middle-market at leverage multiples well inside those of the large leverage loan market, consistent with our careful approach to the markets.

We are seeing leverage structures with total debt in the five to five and one half times area, with senior debt in the three to four times range. There has been a lot of attention paid recently to the dramatic contraction of the larger debt markets. The middle-market did not experience the same heights, nor as it contracted as sharply. In fact, according to S&P data, the total volume of middle-market senior loans actually declined 16% in 2007. This was in marked contrast to the surge in large LBO financings provided by the major banks and investment banks.

The middle-market is still a relationship oriented business that has become less competitive but is still active. We believe that this unsettled capital market presents an opportunity for us. Debt structures and leverage levels for new loans in the market are much improved and pricing has widened somewhat, but we think that the correction continues to evolve. We are seeing wider spreads for senior loans, and fixed Grade subordinated debt pricing has improved moderately, as Mike discussed earlier.

We think that the competitive landscape is beginning to change significantly and many lenders who rely on securitization funding are on the sidelines. Some may never return to the market, and their absence should improve opportunities for us.

We think Allied Capital has many advantages in a market like this. First, we do not rely on the securitization market. Second, we believe we are one of the few players in the private equity space that can offer a one-stop debt alternative or a one-stop buyout alternative for an equity sponsor looking to recapitalize or sell a portfolio company. Third, our managed senior debt fund is ideally suited to provide liquidity for senior loans, and our managed Unitranche Fund is able to fund large Unitranche debt opportunities.

Finally, combined with the expertise offered by our portfolio company Callidus Capital, we are uniquely positioned to selectively invest in certain CLO securities that offer strong returns but requires significant diligence and monitoring capability. In short, between Allied Capital and our managed funds, we think we are exceptionally well positioned for a market like this one.

I would like to add a comment on the three new managed funds Bill mentioned earlier. These represent a new dimension to our business model. This should result in future management fees and broader access to capital for our investing business. The first was the launch of the Allied Capital senior debt fund, the second was the formation of the Unitranche Fund with GE Commercial Finance, and the third was the sale of assets to Goldman Sachs through the AGILE fund, which closed in the first quarter of 2008 and the resulting commitment to future investment vehicles by Allied Capital.

Today the BDC has about $5 billion in total assets on our balance sheet, and we will continue to grow and expand that asset base. In aggregate including capital committed to our managed funds and our balance sheet, we have about $9 billion in managed capital. The managed funds should provide the BDC with greater investment opportunities, expanded deal flow, and will be a future source of management fee income.

And with that I'll turn it back to you, Bill.

Bill Walton

Thanks, Rob. Thanks Mike. Before we open the line for questions let me add a few more points. Our Board declared the first regular quarterly dividend for 2008 at $0.65 per share. As Penni mentioned the vast majority of our 2007 dividends were paid from 2006 earnings. As a result 2007 earnings will be available for 2008 dividends. Given the substantial capital gains realized in 2007, we estimate today that our 2008 dividends may have substantial capital gains components of about 70%. The capital gain component of the dividend is typically taxed below our 15% tax rate for individuals.

Let me summarize the few takeaways from today's call. First, the portfolio generated significant net investment income and net realized gains in 2007, and then we have substantial undistributed earnings for future dividend payments.

Second, we believe we have numerous competitive advantages in this capital market where debt capital providers have become more scarce. We are encouraged by better pricing and better structures and we believe that 2008 could be a year to add some very attractive investments to our portfolio.

Finally, we continue to add depth to our business through our managed capital base. Managed funds broaden our sources of investment capital and leverage our investment talent. Allied Capital, as an attractive investment management business embedded within our core investment businesses, has only begun to grow and develop.

Diana, could we now open the lines for questions?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Dan Furtado of Jefferies.

Dan Furtado - Jefferies

Can you hear me?

Shelley Huchel

Yes.

Dan Furtado - Jefferies

Okay. Excellent, and two quick modeling questions and then one more philosophical. On the employee expense, what do you expect that to look like in the March quarter?

Penni Roll

Well. If you go to I believe at slide six, we have the kind of quarterly progression there. And if you look at that, my guess is that the base employee expense, because we did have raises in employment compensation, it will increase slightly. The IPA will be pretty much at the same level. And then we'll probably have some sort of wrap up accounting as the deferred comp assets are distributed to participants and I'm not sure what that’s going to be at this point.

Joan Sweeney

That will depend on the stock price of Allied Capital moving up or down from year end.

Dan Furtado - Jefferies

Okay. And so it will operate relatively similar to what it's done in the past?

Penni Roll

Right.

Joan Sweeney

We'll continue to have the mark-to market until we have the termination event.

Dan Furtado - Jefferies

And from there we would expect about, well like $5 million in cash expense every six months there or…?

Joan Sweeney

Yeah, it should be -- the IPA amount is probably going to be fairly similar in 2008, right around on an annual basis. So its not what you spend quarterly.

Dan Furtado - Jefferies

Okay, perfect. And then, debt balance has increased about 10% for the year and yields were up 40 basis points, yet the top line interest income was only up about 5%. And I'm just wondering what I'm missing here in that, yields are improving, balances are improving, but it doesn't appear that the interest income line is really gaining the traction I would anticipate?

Joan Sweeney

Yeah, part of it really has to do with timing. The trouble is when you look at fourth quarter closings, so those happen at the very end of the year, and so you don't get much traction in the current year. The other thing that always effect things is interest income will move around as things that we are on non-accrual payoff and we take the interest income into income at that point and that will distorted things, and I believe we had some of that activity in 2006, which kind of, I guess you should say increased debt because of good news, we have a non accruing asset payoff, but that does cause the interest income line to move around a little bit.

Dan Furtado - Jefferies

Understood, perfect. And then finally, the whole asset management strategy makes a kind of sense for the BDCs. I'm just kind of curious as to why now. It seems strange that '06/'07 is when senior management in the space decided that the asset management strategy is one that makes sense, why not earlier. Can you give us some sense of why this makes so much sense today and not five or seven year or 10 year ago?

Bill Walton

Well the short answer is better late than never. I think we felt like we were making really good progress with the core BDC business, and I think the thing is happened is that we've been able to establish ourselves in a way that, I think is real for an asset management business. The things that we felt are more important is if we look at the senior debt we attracted some very substantial third party investors. With the unitranche fund, we had General Electric commercial as a partner, and now with the equity fund, potentially, we're looking at the relationship with Goldman Sachs. I think there was a time, maybe a few years ago, we would not be able to attract partners like that, but we can today because of the record we have and we felt like watching it with this kind of partnership was probably more powerful way to go.

Rob Long

I would also add that we actually began an asset management strategy over three years ago with the establishment of Callidus Capital, and Callidus Capital is now grown substantially but that is one of our portfolio investment rather than plus ourselves, though we are the largest shareholder. So, it isn't completely new this year, it has been growing for the last three years.

Dan Furtado - Jefferies

Thanks so much, thank you for the insight.

Operator

Your next question comes from the line of Ryan Hogan of Piper Jaffrey

Ryan Hogan - Piper Jaffrey

A quick question primarily around leverage, you had an equity raise just recently and actually last quarter, and you sold $200 million to the Agile fund and at the end of that fourth quarter, the leverage was 0.83 times to 1, a year and a half ago, it's 0.45 times, I was just wondering what's your thoughts on the appropriate leverage ratio targeting 0.8, till hang around there, what's your thoughts on that? Thanks.

Joan Sweeney

Well, in the first place, I think that we were, perhaps, a little bit too under levered when we read that 0.47 to one and I'm looking at Slide 3 on the slide deck. Our target range has been more on the 0.5 to 0.7, just the way fundings happened at the end of the quarter, we were a little bit higher than that, but then again, we knew we were doing the AGILE sale, and we planned on doing an equity raise which we completed, right after the first of the year.

So I think we feel we're very comfortable with respect to our leverage ratio. We also, of course, as you know maintain a liquidity portfolio, but I don't think you're seeing this ratio at the end of December, if any shift in policy.

Penni Roll

It’s a timing matter.

Joan Sweeney

Yeah.

Ryan Hogan - Piper Jaffrey

Alright, and then just kind of quickly on the unitranche, you also had a $65 million, I guess you announced maybe yesterday or so investment, and does that work sort of like the Goldman Sachs Agile Fund, or can you kindly elaborate on that please?

Joan Sweeney

Yes, yesterday we announced the first investment into the Unitranche fund, which actually the announcement made by the fund, with GE and Allied contributing to the press release, but that's an investment that we thought that the fund funded and it will be part of our investment in the fund. So we're only again in the junior capital of the fund so we did not fund the entire $65 million ourselves.

Mike Grisius

The underlying Unitranche loan was $65ish million and that's what the fund funded for the borrower and there were investor in that fund, and of course, we're getting return on the junior securities in the fund which is a nice return, it’s a leveraged return because the cost of capital in the fund is very low. We're also sharing the management fee income from the investment that we make through that fund.

Rob Long

If you think about it, the way the fund is structured, our portion of that each investment will be approximately 20% to 25% of the amount that you see as new investment that will come on the Allied balance sheet, and that will tend to have a pretty high yield because of a structure of the fund.

Ryan Hogan - Piper Jaffrey

Sure. The management fee is 2% fairly typically, how long do we start seeing that coming into the fee and other income line on the income statement being meaningful?

Joan Sweeney

Yeah. Well, it's going to be a while before it's meaningful because in the case of the senior debt fund, that fund is still fairly small and it will grow over time, but that fund is based on committed equity capital, sorry, that fee is based on committed equity capital. And in the case of the Unitranche fund, the management fee on that will grow over time but only if the capital is invested; it's not on a committed basis. So, that's why we say it's minimum for now but it will grow over time.

Bill Walton

And as I mentioned earlier, the managed asset business is really to provide other ways to basically do what we've always done, which is invest in middle market companies based in the US, and we've got more pockets of different types of capital to do that. And think there is strategic value here, if you look at lot of our successful buyout investments it's come from deals that we had already provided debt capital to, and one of the thoughts is as we see more opportunities to buy debt capital, the senior fund or through the Unitranche fund where we will have additional flow of semi-proprietary buyout opportunities.

Joan Sweeney

Thanks

Operator

Your next question comes from the line of Tom Lamb of Weybosset Research.

Tom Lamb - Weybosset Research

Good morning everybody. Here is a question from [Flay Willis] one moment. Hello, if my memory serves me well, we were going back into the CMBS market, do I remember correctly?

Bill Walton

Well, I think what we are doing as we have John Shure, who ran our CMBS business now taking responsibility for CNF. And John has got extensive aspects and also taking responsibility for CNF, and John's got expensive aspects in all sorts of - in all pieces of the commercial real estate market, and I think the CNBS piece is something where we did have a non-compete that runs out this spring. And so we will have an opportunity to reenter and what we are trying to figure out is where we are in the cycle.

As I mentioned earlier we don't think we have seen the end of default rates and are likely to increase and that may create even better buying opportunities than we see today. So, we are gearing up to reenter the real estate business, but it is still too early to know exactly what form that is going to take, and that part of which John is helping us to figure out.

Tom Lamb - Weybosset Research

So, you are interested in selling client, but not there yet, right?

Joan Sweeney

We're carefully studying to help us in those areas.

Bill Walton

I think everybody is looking at this market with lot of caution, because you can see things or bargains relative to where they would have been six months ago, but I think it will look like bargain six months from now, and so I think we got to be a little bit careful as this unfolds.

Tom Lamb - Weybosset Research

Okay thanks.

Operator

Your next question comes from the line Vernon Plack of BBT Capital Market.

Vernon Plack - BBT Capital Market

Question is for Rob and relates to Slides 19 and 20 in the slides. Rob just interested to have a little more color regarding what your opinion and outlook is, and what you anticipate in ’08 in terms of multiples where we see levels like we saw on ’06 where we’d have a debt-to-EBITDA somewhere around 5.7 and price-to-EBITDA around 8.1. I am just trying to get a sense for how much lower you think multiples are going?

Rob Long

Sure, I’ll give you the best of my crystal ball here. One of the back drops to this is, we obviously saw this surge in LBO financings last year that has caused the pressure and the decline in the markets, but we also saw $300 billion of capital raised in private equity last year.

So, that probably means that we aren’t in a complete freefall here for values and as the market has come down, some of that $300 billion is likely to be put to work. So as I look at it, I think that the purchase multiples, particularly in the middle markets will be declining but there is support from all these new funds out there, so it wont probably decline back to the '01, '02 levels. But I'm happy to say that I think the leverage multiples are in fact declining more, because the combination of the oversupply of the large loans along with dramatic reduction in securitization market activity has really meant that there has been a sharp reduction in capital available for debt.

And so as we mentioned earlier, the debt multiples that we are looking at on a senior basis are three to four times , perhaps with an emphasis on the three, at least for our portfolio, and we are seeing total debt ratios in some cases below 5 times.

Vernon Plack - BBT Capital Market

Okay.

Rob Long

And I think that’s compared to slide 20 tells you that you'll still see some improved capital structures as a result of the larger contraction in the debt market than the equity side.

Mike Grisius

And what I'll add to that is that, what you don’t see in the slide is the first quarter of '08 and just in the last couple of months, the market has changed so fast in our favor that I would say that a lot of the capital structures we are seeing, and I think you referenced to '06 are from a leverage standpoint better than that. So, less leverage than what you are looking at in '06 which is great.

Rob Long

And I have to also point you to page 21. The numbers I just mentioned were for the average market transaction. Again, at Allied Capital, our disciplined approach enabled us to take an average of 4.3 times total leverage last year in our debt investments, which is really quite extraordinary compared to a 6.6 times R.O.W. So, I think we’ll still continue to do the same kind of conservative deals that we've always done and we just have perhaps a better opportunity set in which to do them in 2008.

Bill Walton

And there is another factor I would to add which is, you look at multiple, these are multiples of EBITDAs and we know EBITDAs are not cash flow and all sorts of different kind of companies that have different kinds of quality EBITDA numbers. But EBITDA as a percentage of revenue is I think at record levels now. In certain ways if you look at corporate profitability which has averaged roughly 10% of economy since World War II is now averaging around 14%, maybe little higher.

And if you believe in reversion of the mean, you got to believe that profitability levels are going to come down as the economy softens and so we may see two things at work in 2008, which is multiples come down but we might be looking at softer EBITDA numbers. And so, if you just look at the enterprise value, you might be getting a better bargain in this period than you would have got just looking at the multiples standalone.

Vernon Plack - BBT Capital Market

Sure, sure. Okay, great. Thank you very much.

Operator

Your next question comes from the line of [Kelly Seng] of Merrill Lynch.

Kelly Seng - Merrill Lynch

Question on adjustment of Ciena this quarter, is that adjustment account entirely the write-off of the value of the origination platform or was it also evaluated to the servicing business? And also can you comment on the health of the servicing business?

Penni Roll

Well I think the value was determined essentially based on what the value of the net realizable asset at Ciena are, and then part of that net realized loss is the value of their serving stream of income, and their stream of income off of their residual interest. They don’t service for third parties they service only for their managed securitization pool. So if you think of the cash flow coming of the managed securitization pool a piece of that is allocated to servicing fee income but it really is simply cash coming off of the securitization pool.

So yes there was no value attributed to any sort of loan origination platform and that simply because they don’t have access to the securitization market right now for new origination. They significantly curtail loan origination activity, so I didn’t think reasonable to include that in the valuation analysis.

Kelly Seng - Merrill Lynch

I see, okay thank you. So you think the servicing business are still pretty healthy or..?

Penni Roll

It's be simply on the cash flow that is coming off if that, as I said, we generally call it a third party business for simply servicing their securitization pools.

Kelly Seng - Merrill Lynch

Okay got it, thank you

Operator

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

Greg Mason - Stifel Nicolaus

Could you talk about FAS 157 and how that’s going to impact you next year, particularly given the decline in the levered loan indexes in January and February?

Penni Roll

Yes with regard to 157, just in general, we are continuing to have discussions with our valuation professionals in the accounts on the impact of the adoption of FAS 157 on the company we are going to continue analyze this effect at that at this time. The actually impact on our financial statement has yet not been determined, and obviously the interesting thing about evaluation is, when we get to March 31st, we'll have to use March 31st data.

So even sitting at it today, it's hard to say what the impact of the current markets could be on the adoption of 157. That would have to be determined at March 31st. And then subsequent to those periods, each quarter, we'll have to use data available to us each quarter. So, I guess the answer is stay tuned, we're still working on it and we will have a result on what the impact of adoption is, as of March 31st, when we release our first quarter earnings.

Greg Mason - Stifel Nicolaus

And you might not be able to comment on this, but just any estimation, does it not impact control investments or does it, only certain investments that you feel like you have enough public marks to impact them, or are you looking at just overall bond yields as impacting the value of your investments?

Penni Roll

I mean, we obviously have to look at the impact of the adopting FAS 157 on the whole portfolio and as we said, we're still in the process of working in that, for the portfolio, and we’ll that answer for you at the end of March.

Greg Mason - Stifel Nicolaus

Okay, I had a question on Slide 13, non-accruals. When we include Ciena, it looks like third quarter to fourth quarter non-accruals declined by $38 million, excluding Ciena they declined by about $12 million. But we had a write down in Ciena of $71 million in the quarter. I'm trying to get a feel for what was going on or what impact Ciena had, it doesn't seem like the number add up right, could you get me a little more color on those?

Penni Roll

Yeah, with respect to the data that’s' in the portfolio of quality statistics, it's the value of Ciena at the various states, and at December 31, the value of Ciena was $68.6 million, the $71 million was a change in value during the quarter. So, it's the $68.6 million that's in the slides as the delta at yearend between the -- with and without data.

Joan Sweeney

We actually break that out in our press release that was put today with respect to the Grade 4 and 5 assets and the loan on non-accruals. And so, loans on non-accruals include that Ciena class A equity interest that was $68.6 million at December 31st 2007 and $66.6 million at December 31st 2006. So you can get that more specific detail in the press release.

Greg Mason - Stifel Nicolaus

Okay. And going on to Ciena with the securitization pools, do you still have your loan professionals out there even though they can't securitize any products or have you shut down the origination business entirely?

Joan Sweeney

No, Ciena still has the loan origination force. They have laid-off some of that origination force, But they're still maintaining origination force, it just they really have curtailed activity as they were testing what is the state of the securitization market.

Greg Mason - Stifel Nicolaus

Okay. And then assuming that the origination don't really comeback and or kind of in a runoff mode of the interest and servicing on these residual, on the securitization pools, what's the life of those pools? How long will these continue to spit out income and value?

Joan Sweeney

Well, the underlying assets are typically 25-year fully amortizing loans. Now history would show that these loans don't really go to full maturity, because small businesses get bought and sold, and they typically get refinanced. So my guess it's not going to be a 25-year fully amortizing asset. My guess is it will be much shorter than that but that all gets into the assumptions that they use on prepayments and defaults and the like.

Greg Mason - Stifel Nicolaus

And then one last question related to Ciena. Do some of these losses impact your tax liability that you have if you would choose to sell this before 2013 or do you still have that potential $40 million taxes?

Penni Roll

No. In fact the built-in gain that you're referring to which is the disclosed in detail in our foot notes to our financials if anyone wants to look at it there, would only come into play if the value of the asset sold resulted in a built-in gain. And as of the valuation at December 31, there would be no built-in gain tax liability. Now if the value of Ciena comes back overtime, we would continue to reassess that and what that means to that liability. But you're right, that obligation would expire 10 years from the date of conversion of the LOC which was back in 2003.

Greg Mason - Stifel Nicolaus

So it sounds like if you wanted to, you could sell this without any tax implications right now?

Penni Roll

At the current valuation that would be correct.

Greg Mason - Stifel Nicolaus

Okay. And then one last question, you increased your investments in CLO equities this quarter; is that something you're seeing in the market as an attractive opportunity or is this in part because Callidus really starting to pick up it's velocity?

Rob Long

Well. I think that Callidus has a reputation of being one of the top tier managers in the states, and in difficult times only the very best managers are able to create new securitization. So Callidus was in fact successful in creating three securitizations last year, two, after the August problems, and we have been approached by a number of parties looking to have us help solve the process of creating one, and this is more business for Callidus to manage.

So I think the combination of a very strong reputation of our Callidus affiliate, and the ability for us to do the work, to pick through and select only the best assets for CLOs, gives us the ability to create some pretty attractive investments for Allied, and continue to grow the Callidus business in 2008, as we did in the later part of last year. The total CLO activity will be down substantially in 2008, but we continue as you might expect to look very carefully for, maybe, situations where there are holders of securities today that have to sell. About 10% of the CLO market was in market structured deals as opposed of cash-flow collateralized deals, and in the first part of this year we have seen forced liquidations and the values of some of papers trading as a result of forced-liquidations is clearly worth us looking at carefully.

Greg Mason - Stifel Nicolaus

Just to follow up, this is [Troy]. I saw a new relationship with Dryden, obviously that's a name that has a lot of pull in the space. Is that relationship something you've had ongoing or is that just an opportunity to pick-up some CDO equity, and what's the market currently for other folk's equity and do you think you’ll be picking up more of that?

Rob Long

You’re correct in saying that the Dryden relationship was a new one. We believe that they also represent one of the top tier names in the CLO manager space, and so we were approached to see if this was something that we could structure something that would be attractive and we did. We continue to be approached by people who need help in executing transactions in this space, and I think we’ll continue to take a very prudent careful approach to trying to structure transactions that are truly attractive and perhaps exceptional returns for us.

Greg Mason - Stifel Nicolaus

I saw the Dryden issue you brought in to is a synthetic CDO, is that your first or do you have others on the books that are also synthetic?

Rob Long

No that actually is a regular way, not a synthetic structure, so our component is just like all of our others and we do not have any synthetics CLOs at the current time. Most of the synthetics were done in the very sort of peak of the market, with very large leverage loan pools and that's not something that we have yet to enter into.

Greg Mason - Stifel Nicolaus

I apologize, I goggled it, and that one came up as a synthetic.

Rob Long

They probably have some synthetics, but this is a traditional structure.

Greg Mason - Stifel Nicolaus

Okay, great.

Bill Walton

Diana, we got time for couple more questions.

Operator

Your next question comes from the line of [Paul Sedar of Sedar & Zack Capital Management].

Paul Sedar - Sedar & Zack Capital Management.

Two things. What is your current interest rate on your line of credit approximately?

Penni Roll

It is LIBOR plus 105, mostly (inaudible).

Paul Sedar - Sedar & Zack Capital Management

The other is on your deals with Goldman Sachs and GE, they are not traditionally middle market, they are not involved in that, and I’m wondering how you can get deal flow from them versus they getting it from you?

Bill Walton

There is two answers, one with regard to GE. This is their senior finance group that's been financing middle market buyouts, probably the leading market player for last five years or six years. And so, they are in the place, and they are people that we’ve been in deals with for year, so that’s a continuation of that. And with Goldman it's probably even more interesting from our perspective, the fact that they were not in the middle market particularly, was one of the reasons they wanted to partner with us, and they see us as an ability, as a mechanism through which to invest more in the middle market with us taking the lead.

Rob Long

You may remember that GE owns Antares, and Antares is the largest senior loan provider in the middle market, and that’s why there was a very good partnership between us since we have as Bill said we've been doing business together for a long time.

Mike Grisius

I think it would be hard for us to overstate how excited we are about the Unitranche fund right now. It really seems to be taking shape very, very well. The economics worked wonderfully for us, but the best thing about it is, I think your question was partly strategic. GE has as much market share as we have, and we think it's as strong as anybody that typically plays in the juniors capital position. GE has tremendous market share and in the senior debt world, and so we are seeing an awful lot of deals that we would otherwise not see and it's giving us an opportunity to do a lot more transactions and grow our relationship base with folks in the middle market.

And of course on top of that the market is coming our way perfectly as well. The syndicated loan market is just about shut down, and the deals that are coming down are getting done at really high yield. So if you can imagine six or eight months ago, senior deals, middle market senior deals, were getting down at considerably higher leverage that will help us to do something, and sometimes [induce a freeze].

Now if you look at the senior loan, when you factor in issue discounts and the spread that they are charging on that, you are really looking at all in pricing that's at or in some cases above L plus 500 and that plays well into our hand as we go out and look for Unitranche opportunities. Because there aren’t that many alternatives. So we are seeing an awful lot of deals that are coming on our way, and our pipeline right now is very robust. We have expectations that we are going to do a number of yields through the Unitranche fund with GE.

Rob Long

And I would just add that Goldman Sachs has invested with us through their Goldman Sachs Asset Management Group, which is a fairly large group and does have a number of middle market private equity investments in that group. So, while you think of Goldman as a large market firm, their asset management side is quite knowledgeable in the middle market and quite active, and they also saw as Bill said, in us, a way to get through part of a market that they would like to get to, but couldn't have easily got there themselves. So, I think that partnership is also going to provide some interesting future activities, but perhaps, not the least important of which is they are investing in future managed products that we manage.

Paul Sedar - Sedar & Zack Capital Management

Would you'd be taking, getting into the higher end of the middle market, a bit with these deals with these partners and sharing the risk in a sense?

Bill Walton

That’s not really the idea, I mean, we typically focused on the $50 million to $300 million, or $400 million, $500 million enterprise valued business, that's still our primary focus. Of course as we grow assets under management, and their balance sheet, we may look at somewhat larger deals, but it's always going to be with the mind to portfolio diversification, and not getting overtly concentrated in any particular company.

The strange thing that Rob alluded to, was that the financing markets have been a lot more stable in the middle market than they have in the large deal markets and there may be some opportunity do something there, because capital is, at least of today, a lot scarcer, so there may be buying opportunity that have not been there in the past.

Okay, we got one more here. Diana?

Operator

Your final question comes from the line of [John Gillmor] of FBR Capital Market.

John Gillmor - FBR Capital Market

Hi, good morning, thank you of taking my questions. The first one stays on the same theme as the senior debt fund, and I think you actually portrayed it as sort of the velocity of this senior debt market seems to have certainly slowdown and you will have capacity with regards to the one-stop financing and the senior debt fund that you have. How do you think about the availability of the amount of capital you have at your disposal with regard to the senior part of the capital structure in facilities that you already have in place?

Rob Long

Well, I think that we have several different varieties. One, the senior debt fund has increased capacity at the moment, so it is continuing to deploy on a very steady and very careful way on the assets. Overtime, we would expect additional capital raises by that fund. So I think we produce the kind of result so far that market is looking for. We had no credit impairments in the fund and it’s performing well.

The GE fund is a moment in time where we initially thought the unitranche was our primary focus, because of the dislocation in the first lien syndicated loan market, we are actually seeing the pricing on the first liens get into the target range of the fund itself. So we may end up a fund that is actually a meaningful percentage in pure first lien loans that we are having difficulty getting syndicated and that’s a very large amount of firepower in the middle market because that’s a very large fund.

So I think that between those two and we should also mention obviously that Callidus has nine structure vehicles and we expect this will grow. So I think that between those three exposures from the senior debt side, we are very well positioned to be a significant and very active party in that marketplace this year.

John Gillmor - FBR Capital Market

Great. If I was just sort of did now hone in the GE fund and it seems like today, we’ve got in the first transaction is part of it, I believe you it announced yesterday. How is it that you guys come to the conclusion that this is an Allied source originated deal, as to what goes to this GE fund and what stays on balance sheet at Allied?

And then finally, with that, as one of the things that certainly has been across the headlines is, due diligence in underwriting and credit protection. How did the credit protection differ in the GE fund, as opposed to the ones that might sit on the balance sheet? i.e. does the senior loan itself have an undue or less or more control over the asset, potential workout process. Can you can take me through sort of a investment process, and then sort of any contractual terms that might be inside of that GE fund and how we should be thinking about that?

Mike Grisius

Let me try to answer that, I think the first question was, which assets do we share at the fund versus what we might retain on our balance sheet. The way this fund is structured, it's cost of capital is low enough that we're highly motivated to try to put any Unitranche opportunity in the fund. We have an agreement with GE as we structured it that we would and they would do the same to the extent that they are looking at any Unitranche opportunities above the certain size range.

That we would show them to the fund and give the fund an opportunity to invest in those. And we make that decisions jointly. So, presently we are showing just about every Unitranche opportunity that we have and we know they are doing the same to the fund, which is why pipeline is so robust.

Rob Long

And if I could add one thing here, the Unitranche is that we were originating in the second half of last year had an average coupon on it, I think about 10.7%. So, by having them done in the unitranche fund, we receive a much higher return on the capital that we deploy because that is a structured vehicle that by design a better place for us to put the Unitranche spent on our own balance sheet, which has a very low level of leverage.

Mike Grisius

Now the second question was the credit one; which as you can imagine was, very, very important to us and to GE when restructured this vehicle. One of the big virtues of a Unitranche security is that remains its first lien security, and the case for anything that goes into the fund.

So, we will continue to have a first lien on assets to go in to that front and, we and GE as investors in the fund will control the underlying loan and determine its direction, if there is a work out or what have you. So we preserved one of the key virtues of the Unitranche from a credit perspective, but through this vehicle we are able to enhance our yields very considerably.

John Gillmor - FBR Capital Market

Okay, and then finally, I think this is a question that redirects back at Penni and I hate to bring it back up again, about FAS 157. And I clearly appreciate that while we don't have the marks from March 31st, but I'm wondering if you can take me through the logic of implementation of FAS 157?

Is there a change in the approach that you may take asthere has been some theories out there that have suggested that, the approach of using enterprise value as a method of valuing an enterprise coverage, for valuing debt relative to taking an implied mark on the balance sheet that, under the application of FAS 157, you would be forced to take a mark on the asset that would capture the liquidity, discount or premium, however, you chose to look at it. It's associated with those assets.

And I guess question my question is more of a philosophical one, which is, is that a correct interpretation with numbers to be provided later or is there something else that may not be correct in that interpretation?

Joan Sweeney

As I said before, we have not yet determined what the impact would be with 157 for the key portfolios ,but keep in mind we have a portfolio of highly adequate privately negotiated securities from which there is no market for the bulk of what we have in our portfolio to get a mark. There is no market to point to for selling a debt security for example.

There a little amount of theoretical discussion going on out there, I will agree with that, but for us we are continuing to work with our professional service providers including our evaluation professionals and our accountants to look at all those theories and make sure before coming to the appropriate determination on the impact of 157. Which is why I hesitate to comment one way or the other because it’s a work-in-process and we will know where we are by the end this quarter.

John Gillmor - FBR Capital Market

Okay, great. And then my final question for you, is in terms of portfolio, sort of churn of velocity. How should we think, you’ve done a very nice job of harvesting gains at the right time, freeing up capitals to deploy in what is the more advantageous market. And seemingly increasingly each day, how should we think about the velocity of that churn going forward into 2007 and the amount of capital that might be freed up to reinvest. As you certainly exited some investments this quarter, what is you prospect or guidance or can you help us in modeling on a go-forward basis?

Joan Sweeney

I think it’s a tough think to model to tell you the truth. We expect, we will probably see a reasonable number of repayments as private equity sponsors as Rob said, they still have funds, they still have to post exit they have to post IRRs for their investors. So we anticipate that we will see a reasonable number of exit, it’s a not a great market to be seller, however. So we don’t have to harvest a gain, this may not be the absolute best environment to do it. So we -- theoretically that should indicate you should see somewhat of a slowing, but it is very difficult to predict.

Rob Long

One thing to add here, in 2007 you saw us raise the senior debt fund, which was initially funded with a $183 million of loans that has previously been on our balance sheet. We also let you from the Goldman Sachs transactions, started a new fund with assets that had been in our balance sheet and as we continue to grow our asset management vehicles, it is possible to think that other assets could find a home in a vehicle that we create with third party investors.

So I think to answer to your question is probably more of the same and we continue to have a desire to grow the managed capital businesses that will represent in some cases a more efficient place or a good place to have asset that we’ve been originating on our balance sheet. And so I think there will be continuing liquidity coming to us from these activities.

Bill Walton

Yeah just underscore one point there is off a lot of alternative asset capital out there looking to do things and the thing is different. I guess things are always different in cycles but the thing is I think what is truly different here is amount of private equity money that’s there looking to keep investing and hedge fund money is there and I think we would expect to see a fair amount of liquidity in the markets, even though the credit bubble has burst.

John Gillmor - FBR Capital Market

Thank you very much for your time.

Bill Walton

Okay good questions. Thanks for all for listening. We’ll be back in three months to talk about our results for the first quarter 2008 and of course we’ll be talking about FASB 157. We will know a lot more than. Any way thanks to you all. We’ll see you; talk with you in 90 days or so.

Operator

Thank you for participating in today's conference. You may disconnect at this time.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Allied Capital Corporation Q4 2007 Earnings Call Transcript
This Transcript
All Transcripts