Patriot Capital Funding Inc. Q1 2008 Earnings Call Transcript

Patriot Capital Funding Inc. (PCAP)

Q1 2008 Earnings Call

May 9, 2008 11:00 am ET

Executives

Richard Buckanavage - President and CEO

Bill Alvarez - CFO

Tim Hassler - Investment Officer

Analysts

Vernon Plack - BB&T Capital Markets

Jon Arfstrom - RBC Capital Markets

Brian Hogan - Piper Jaffray

Greg Mason - Stifel Nicolaus

Henry Coffey - Ferris, Baker Watts

John Hecht - JMP Securities

Presentation

Operator

Welcome to the Patriot Capital Funding 2008 first quarter results conference call. During the presentation, all participants will be in listen-only mode. Afterwards we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded Friday, May 9th, 2008.

And I would now like to turn the conference over to Richard Buckanavage, President and Chief Executive Officer. Please go ahead sir.

Richard Buckanavage

Good morning and welcome everyone. This is the conference call to discuss the results for Patriot Capital Funding for the quarter ended March 31st, 2008. I am joined by Tim Hassler, Chief Investment Officer, and Bill Alvarez, our Chief Financial Officer.

Bill, would you please provide our Safe Harbor disclosure statement and then we get started this morning.

Bill Alvarez

Today's conference call is being recorded and webcast live through our website at patcapfunding.com. An archive of today's webcast will also be available on our website as well 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 Patriot Capital Funding Inc., any unauthorized rebroadcast of this call in any form is strictly prohibited. I would 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 with the SEC, for important factors that would 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 at 212-835-8500. Lastly, there will be a question-and-answer session following our presentation.

With that I'll turn it back over to Rich.

Rich Buckanavage

Thank you Bill. The challenges in the credit and financial markets continued and already being accelerated during the first quarter of 2008. We began 2008 with a modest transaction pipeline, that pipeline grew consistently through out the quarter but was back end weighted and therefore our average pipeline for the quarter was below peak periods in prior quarters.

What's most important however, was the quality of the pipeline in the first quarter. It was poor. There were more than a few transactions that operate in cyclical end markets, had inexplicable strength in near-term performance, weak performance with unsubstantiated expectations for new-term operational improvement, or non-underwritable risk such as outside customer concentrations. It was these factors among others that resulted in Patriot and the sponsor walking away from many of these opportunities.

While we had to work harder than ever we did identified attractive investment opportunities during the quarter. Those transactions that we did decide to pursue we were not able to close any during the first quarter. Our efforts to close the attractive investment opportunities were hampered by several factors, first the unusually draw out timeframe to close transactions, wide gaps between buyer and seller value expectations, unrealistic debt assumptions and increased diligence scrutiny resulted in an acceleration of revisions to indicative purchase prices. Purchase prices provisions have added four to six weeks of the closing process.

Second, the same factors that I have outlined in point number one, have in some instances resulted in terminated transactions. We have not experienced this level of terminated transactions in a five plus years since forming Patriot Capital Funding and represent some of the highest levels we have experienced in our 20 plus years in these markets.

Lastly, the lower end of middle market continues to be impacted by what we refer to as the single lender phenomenon.

In the syndicated loan market, transactions are priced on the last dollar in. The syndication process acts as a de facto governor, which prevents an individual organization for being able to materially underprice transaction. In contrast in our market transactions are priced equally by the first and last dollar because in most cases, it’s the same organization.

It is this phenomenon, then in our opinion has prevented our market from fully adjusting to macro factors in the credit markets. But pricing has migrated upward. We believe it has room to increase further.

What is most striking though was the persistence of leverage multiples. For the better part of the first quarter, multiples at our end of the market have fallen by only a quarter turn of EBITDA. Only recently, have we seen this begin to migrate towards one half a turn. We expect this trend to continue with leverage multiples settling close to the three quarters to a full multiple lower than peak levels experienced in mid 2007.

In addition to these factors we continue to be concerned about the weakness of the economy. The US economy expanded by only 1.6% in the first quarter of 2008, confirming what all of us already knew that the US economy has slowed rapidly under the weight of the housing slump, slower consumer spending, and the effects of the credit crisis.

Many economists believe we are headed into a recession. If this is an accurate prognostication in order so as to satisfy the academic definition of a recession, the US economy would have to contract for at least the next two quarters.

As we stated during last quarters’ earnings call, once we felt that we were closer to an earnings trough and a peak, shareholders can expect to see us accelerate our deployment growth. We do not believe this to be the case currently.

While we have a fairly pessimistic of deployment opportunities for the next one to two quarters in our core market, we do see an attractive opportunity to deploy capital in other parts of the market. Primarily in the upper middle market and broadly syndicated loan market. As I mentioned earlier, because of the role of syndication, the syndication process plays in those segments of the market, pricing and more importantly leverage have adjusted very rapidly over the past six months.

As raising capital has become increasingly more difficult, in the first quarter, we strategically made the decision to preserve our capital for our core market. Because we have not witnessed changes in the leverage of the magnitude that we believe is appropriate, we’ve begun to allocate a portion of our capital base to other segments of the market. Our strategy would be to invest relatively small amounts, approximately $1 million to $3 million across several of the bourse.

On a quarterly basis, our goal would be to deploy between $12 million and $15 million under this strategy. We believe this strategy has material benefits to our shareholders. We would be able to create more granularity and additional diversification in the portfolio across asset class in the industry, sustained growth in the portfolio will allow us to continue to leverage our overhead.

Lastly, this initiative will also help to mitigate the effects of the increase in our debt funding costs as we earn 300 to 400 basis points of incremental yield on these investments.

We will reassess the strategy each quarter and to the extent we see meaningful improvement and leverage and to a lesser extent pricing at a lower end of the middle market, we would deemphasized the strategy or potentially eliminate it altogether. Conversely if leverage and pricing in the lower middle market remain static, we would consider placing greater emphasis on the upper middle market and the broadly syndicated loan segments.

During the quarter, we continue to support our private equity sponsor partners, committing additional capital to three existing portfolio companies. There were modest increases 325,000 to L.A. Spas, 250,000 to Smart, LLC and 141,000 to Aylward Enterprises. And as a result, we were not able to mitigate portfolio run off both anticipated and unanticipated. On the anticipated side, we sold our $2.9 million senior secured loan-term loan commitment in Nice-Pak Products. Upon concluding that raising a senior oriented CLO fund would be challenging if not impossible in the near term.

We also sold half of the revolver of our revolver in senior secured term loan investment, which totaled $7.4 million in Fairchild industrial products with the same rationale as Nice-Pak. During the quarter, we received an unanticipated full repayment of our $9 million, senior secured term loan investment in Eight O’clock Coffee, due to a refinance at the company, for which we earned a $90,000 early repayment fee.

Lastly, we received a $4 million, partial pay down of our senior secured term loan investment in ADAPCO, Inc. This was particularly relevant as a portion of this investment is in our four rated category and demonstrates the benefits that Patriot enjoys by working with a committed sponsor in a collaborative manner.

Now, turning my attention to the portfolio; as a result of the foregoing portfolio activity, we ended the quarter with 34 portfolio companies totaling approximately $352 million of fair value. But we did have an up tick in our four rated assets during the quarter. It is important to note our total watchlist assets remained below 20% of total portfolio, which represent metrics that we consider acceptable for a matured portfolio of this type at this juncture of the credit and economic cycles.

I would like to highlight that currently in all instances we're working collaboratively with our private equity sponsor partners to address sub par financial performance of each individual portfolio company. You've heard me state on previous earnings calls about the importance of collaboration between the sponsor and Patriot Capital Funding, in addressing financial performance issues.

During this quarter we have tangible benefits of these collaborative efforts. We received a $4 million pay down of our senior secured term loan at ADAPCO as previously mentioned, and a $1 million pay down just after quarter end under our subordinated debt investment in Encore Legal Solutions. Along with a conversion of our remaining sub-debt investment into a meaningful equity ownership in Encore, which we believe positions us best for the full repayment of our initial invested capital. Both these events reduce our exposure to the four rating category.

During the quarter we recorded net unrealized depreciation on our investments to the amount of approximately $9.9 million. Of the $9.9 million of unrealized depreciation, $4.2 was the result of financial performance at the portfolio company level. With the remainder or approximately $4.5 million attributable to the adoption of Statement of Financial Accounting Standards No. 157, otherwise known as SFAS 157 and $1.2 million was attributable to lower market quoted prices on our syndicated loan portfolio as a result of disruption in the financial credit markets for broadly syndicated loans. We believe that the majority of the $4.5 million of unrealized depreciation, attributable to the adoption of SFAS 157, reflected in this quarter's results will ultimately be reversed when we exit these investments.

We invest primarily in liquid assets with the intention of owning these assets to settlement on maturity. This is in contrast to the premise under SFAS 157, that assets generally should be valued on the basis of their current market value and if no market exists, they are sold in a hypothetical market at each quarter end. We have not historically exited our investments through the sale of such investment rather we have typically existed our investments to sale of the portfolio company or through recapitalization of the portfolio company.

We believe that the majority of the $1.2 million of unrealized depreciation on a syndicated loan portfolio will also ultimately be reversed, but not in liquid. We invested syndicated assets with a similar philosophy as with our core asset, that is to hold until settlement or maturity as we do not frequently trade assets in the syndicated loan market. The concrete example of this is our investment in Eight O’clock Coffee.

In the third quarter of 2007, [quoted] market price dictated that we fair buy that asset at approximately 2.7% discount to cost or 97.3% of original cost. We ultimate not only received full payment of our original $9 million investment during the first quarter of 2008, we also received a $90,000 early repayment fee as well.

In conclusion we believe our investment history and valuations practices, support these socials as our actual realized loss on total commitment from inception to date is less than 1%. I would also like to highlight two other credit metrics for our shareholders.

First the portfolio continues its impressive performance by having no past due or non-accrual loans. And that despite the $9.9 million of total unrealized depreciation recorded this quarter, the portfolio fair value represents 96.35% of cost. These are metrics indicative of very solid portfolio.

With regards to our liquidity position, we have equal as positive news. On April 11 20008 we entered into in amended and restated securitization revolving credit facility with an entity affiliate with BMO Capital Markets, our original sole lender, and Branch Banking and Trust Company, who has added to the facility committing $50 million to our increased $225 million facility.

In addition to the increase from $175 million to $225 million, we also extended the maturity date from July 2010 to April 2011. We increased the interest payable under the facility from the commercial paper plus 1% to the commercial paper plus 1.75% on up to $175 million and LIBOR plus 1.75% on up to $50 million of borrowings under the facility. This was an important pricing mechanism adjustment, given the divergence of [CPMIR] Industries from their historical relationship.

The expanded debt facility enables us to continue to execute our business strategy, as well as provide us with a distinct competitive advantage versus some of the competing firms in our market.

We also believe the increase and the extension of our debt facility demonstrates the lending community space and our business model and investment philosophy in the midst of turbulent credit markets.

The last formal remark I would like to make this morning is to reiterate the announcement from last week that our Board of Directors, after completing its process of estimating our distributable income for the second quarter of 2008, declared a dividend of $0.33 per share. The record date for the dividend is June 5, 2008, with the actual dividend being paid on July 16, 2008.

With that, I would like to turn over the call to Bill Alvarez who will discuss our earnings release for the quarter in more depth.

Bill Alvarez

Thank you. I will start with a discussion of our March 31, 2008 balance sheet. We ended the quarter with total assets of $365 million, total debt outstanding was $143 million and total stockholders equity was $211.1 million and our debt-to-equity ratio was 0.68 to 1.

At quarter end, we had a total investment portfolio of $351.9 million, down 8.5% from $384.7 million since end of 2007 and up approximately 29% from $272.3 million at March 31, 2007 a year ago.

The primary reason for the decrease in our portfolio during 2008, was a total $32.8 million related to investment repayment in sales in the quarter totaling approximately $25 million, realized depreciation of $9.9 million offset by [syndication] $1.2 million and $700,000 of increased commitments on existing portfolio companies.

The weighted average yield on our interest bearing portfolio was 12.2% for the 2008 quarter, which remained constant from the fourth quarter of 2007. Our weighted average fair value balance of our interest bearing investment portfolio during the quarter ended March 31, 2008, was 362.5 million, up from 342.1 million in the fourth quarter of 2007.

At March 31, 2008, our net asset value per share was $10.22, down $10.73 at December 31, 2007. The NAV decrease during the quarter by $0.51, primarily due to the recording of unrealized depreciation on investments and interest rates swaps during the quarter.

Before I comment on our earnings, I would like to summarize in details of our implementation of Statement of Financial Accounting Standards No. 157 fair value measurement and its impact on our financial statements this quarter. We're spending considerable amount of time in studying SFAS 157, addressing how the statement should be applied. Considering the fact that Patriot Capital Funding as a BDC had always reported portfolio assets using fair value methodologies. We have received guidance from our independent accounting firm, outside valuation firm, and legal counsel; as well as participated in numerous seminars and round table discussions in connection with our implementation of SFAS 157.

As a result SFAS 157 does not alter our requirement to record our investment as fair value. Rather the new statement emphasizes that fair value is a market-based measurement and focus on assumptions that maybe used by market participants. To quote SFAS 157 definition of fair value is the price that would received to sell an asset in an orderly transaction between market participants as the measurement date.

For our performing credits, historically we have used an enterprise value as a basis for estimating the fair value of these investments with the intention to hold the investment to settlement or maturity. If there was adequate enterprise price value to support the repayment of the company's debt the fair value of our investment normally correspond to cost plus amortized a regional issue discount, unless the borrowers condition or other factors lead to a determination of fair value at a different amount.

Beginning on January 1, 2008, as previously described we augmented this approach with a bond-yield model to estimate the fair value of dead investments, where there is not a readily available market and is based on the present value of expected cash flows. We still perform an enterprise value analysis in order to assess the credit risk of the dead investment. However, assuming that credit quality remained stable we use the value determined by the bond yield analysis as the fair value for our dead investments.

For investments that are under performing we will continue to use our historically valuation methodologies, which is consistent with SFAS 157. During the three months ended March 31, 2008 we recorded net unrealized depreciation of $9.9 million on our investments. The components of the unrealized depreciation resulted from the following; $1.2 million from quoted market prices on our syndicated loan portfolio, as a result of the disruption in the financial credit markets for the broadly syndicated loans.

Approximately $4.2 million from a decline in cash flow of our portfolio companies requiring closer monitoring and approximately $4.5 million resulting from the adoption of SFAS 157.

Now let's move onto discussion of our 2008 first quarter earnings. Total investment income for the 2008 was $11.2 million, which was an increase over the $9.0 million of investment income during 2007 comparable quarter, an increase of approximately 25%. And a slight increase over $11.1 million in a fourth quarter of 2007.

Investment income increased in 2008 primarily as a result of the $80 million in net growth in our investment portfolio since March 31st 2007, offset by a slight decrease in our portfolio yield. Included in investment income are fees and other income, which totaled $253,000, compared to $499,000 in the fourth quarter of 2007.

Total operating expenses were $4.5 million in 2008, as compared to $4.6 million in 2007 fourth quarter. Compensation expense decreased slightly and interest expense decreased by a $146,000, principally due to lower interest rates. Our weighted average borrowings in 2008 were $152.7 million compared to $127.9 million during the fourth quarter 2007. Professional and general administrative expenses remained flat in the fourth quarter.

Our net investment income was $6.8 million or $0.33 per basic and diluted share for the first quarter of 2008 as compared to $6.5 million of $0.32 per basic and $0.31 per diluted share in the fourth quarter in the fourth quarter of 2007.

During the first quarter of 2008 we recognized a net realized loss of $90,000 on the sale of one of our syndicated portfolio investments. We did not realize any gains or losses in the fourth quarter.

Net unrealized depreciation for 2008 was $9.9 million compared to net unrealized depreciation of $2.6 million in the fourth quarter. Net unrealized depreciation on our interest rate swap agreements totaled $753,000 in the first quarter of 2008 compared to $516,000 in the fourth quarter. Our net loss for the first quarter of 2008 was $3.9 million or $0.19 per basic and diluted share as compared to net income of $3.4 million in the fourth quarter of 2007 or $0.16 per basic and diluted share.

Previously, I reported that the IRS granted us permission to change our RIC tax year, from July 31 to December 31, effective on December 31, 2007. Accordingly, we will file a five-month short-period return with the IRS. Because of the change in our tax year, we have a 2007 bonus accrual carryover, which became deductible for tax purposes when paid in 2008. Accordingly, if the carryover accrual is excluded during the first quarter, our dividend payment of $0.33 approximated our distributable income.

And now, I will turn things over to Tim Hassler, our Chief Investment Officer.

Tim Hassler

Rich touched on our pipeline in the first quarter, which saw a meaningful increase total deals reviewed but poor quality. Since quarter end, we’ve continued to see an uptick in transactions and for the first time in several months, we've seen a solid improvement in quality as well. The past few weeks, we've issued six proposals to sponsors, which is more than the entire first quarter. While we don't have any current mandates in the core market to report, we are cautiously optimistic that our outstanding proposals could lead to some new deal closings in the coming quarters.

We continue to be very cautious on the economic outlook and highly selective in the opportunity that we are pursuing. As we highlighted in last earnings call, four of the five transactions that we closed in the fourth quarter were in defensive industries that we felt would not be meaningfully impacted by an economic downturn and the fifth transaction was levered very modestly to account for the company's end market cyclicality.

To expand upon Rich’s comments on our syndicated loan market strategy. We are primarily focusing on first lien senior secured transactions with contractual coupons of 3% to 4% over LIBOR and OID's in the low 80's to low 90's, which result in effective LIBOR spreads of 6% to 8%. Even with the recent strengthening of prices in the syndicated market, we're finding good opportunities to deploy capital at attractive risk adjusted returns.

Since first quarter end, we've committed $2 million to one syndicated senior loan and we are reviewing opportunities to invest in 5 to 10 additional syndicated senior loans with an expectation to invest a total $12 million to $15 million in the second quarter. These investments provide us not only attractive risk adjusted returns, but also additional obligor and industry diversification.

As we gain more visibility into the direction of the economy and as pricing and leverage continue adjust to major favorable levels in our segment of the market, you should expect to see a accelerate our pace of investment originations.

In the mean time, we will continue to keenly focus on credit quality as we review new transaction opportunities and manage our existing portfolio. We believe, we positioned our portfolio well for an economic downturn with an asset mix of 50% senior secured debt, solid industry diversification, no direct exposure to the residential or commercial real estate markets, only modest exposure to discretionary consumer products and no past due or non accrual loans currently. With our oil position portfolio and solid liquidity position, we look forward to profitably growing the portfolio as market conditions warrant.

And now, I am going to turn it back over to Rich.

Richard Buckanavage

That concludes management's prepared remarks this morning. I would like to ask the operator to open the lines at this time for questions.

Operator

Thank you. (Operator Instructions). And the first question we have comes from the line of Vernon Plack with BB&T Capital Markets. Please proceed with your question.

Vernon Plack - BB&T Capital Markets

Thanks very much. Rich I wanted to talk a little bit on Encore there at least -- I think there is also some two pieces of junior secured that you are holding and were they valued at the end of the first quarter?

Rich Buckanavage

You are right Vernon. We do have two junior secured term loans. We did record some additional depreciation with regards to those term loans, primarily the result of the bond yield analysis. And the actual amounts Vernon, I have to do a little math here, but it looks to be about $700,000 roughly on an aggregated basis.

Vernon Plack - BB&T Capital Markets

Okay. And what are they rated? And what's the investment rating on us?

Rich Buckanavage

There are currently four.

Vernon Plack - BB&T Capital Markets

There are currently fours, okay. And I know both of you talked Tim and you both talked about the deployment of roughly $12 million to $15 a quarter. Given your thoughts on payoffs can we expect the portfolio to stay at least for the next couple of quarter's based on what you know today, relatively flat, maybe decline a little?

Rich Buckanavage

I think Vernon with the syndicated strategy we would expect growth in the portfolio.

Vernon Plack - BB&T Capital Markets

Okay.

Rich Buckanavage

Absent that strategy it is hard to tell but flat wouldn't be a bad assumption.

Vernon Plack - BB&T Capital Markets

Okay.

Rich Buckanavage

And given what we are looking at and given the lengthening timeframes to get these deals across the finish line, I would say second quarter might be flat without it. We're obviously optimistic about the quality of the pipeline and we're optimistic about the proposal level that is higher than it has been and as Tim alluded to in all of the first quarter. So its hard as always to gauge these but I would say that there is no question or common theme, everything is just taking quite a bit longer it normally has.

Vernon Plack - BB&T Capital Markets

Okay. One quicker one then I'll jump in the queue. I know that you talked about some migration into or at least there has been some migration into the investment rating of four. That number essentially doubled from year-end to March 31 and I don’t know if there is any additional color you could provide us in terms of what's happening there?

Richard Buckanavage

It’s a combination of factors. There is a bucket that companies that have been impacted by the slowing economy.

Vernon Plack - BB&T Capital Markets

Yes.

Rich Buckanavage

So we are into - finally see -- what was anecdotal I think for a couple of quarters is now starting to reflect itself and since some lower performance at portfolio company level and then there is some companies specific issues not tied at all to the overall economy. So it was a little bit combination of both. And I think it is a tick-up but as I said about describing the Encore situation, the pay down that we received was through the infusion by the sponsor group and working very much in tandem with that sponsor group who are now part of the equity group as well in a meaningful way. So we are working as I said earlier we are collaborative and that always bodes well for the ultimate outcome, same thing with ADAPCO, the $4 million was the equity infusion. When you see those things occurring and watchlist credit Vernon despite the were not, I would say that we're encouraged that we are working collaboratively with these sponsors and they continue to support those companies with additional equities, which tells you what they think about the long-term prospects of those companies.

Vernon Plack - BB&T Capital Markets

Thank you Rich.

Richard Buckanavage

You are welcome.

Operator

Thank you. And the next question we have comes from the line of Jon Arfstrom with RBC Capital Markets. Please proceed with your question.

Jon Arfstrom - RBC Capital Markets

Thanks. Good morning.

Richard Buckanavage

Hi, Jon.

Jon Arfstrom - RBC Capital Markets

On the syndicated credits you are looking at, what's the typical size of the company that you are looking at and how does that compare to your traditional strategy?

Richard Buckanavage

Quite a bit larger, Jon. Probably looking at companies with $20 million to $75 million of EBITDA. And we are not as focused, Jon, on the size of the company, per se. We are focused on, in other words, if it were an $18 million EBITDA business, we would have some interest, and if it were $80 million we would have interest. Its really an opportunistic investment strategy looking at across the spectrum and where we might deploy capital and right now, we just feel that the risk adjusted returns are substantially better in that end of the market. Can't really give you the exact range that reflects that but its really those facilities that require a significant number of lenders to get the deal done on a new issue deal and serving the secondary market where continuation of a large group of lenders has necessitated in those quoted prices that Tim alluded to, low 80s to low 90s, make those particularly attractive to us.

Jon Arfstrom - RBC Capital Markets

Okay. Good. That’s helpful. And then, on the pipeline, the lower quality pipeline you talked about, I guess the question is, is it sponsor driven? Is it company driven? And is it something that makes you rethink some of your sponsor relationships or maybe you feel like you need to broaden them or look at more sponsors. What exactly do you think that poor pipeline is attributable to?

Richard Buckanavage

Mostly, its company specific Jon, in other words we're -- when we go to meeting with a sponsor and we don't receive adequate explanation of as I mentioned, inexplicable near term performance and we are cyclical company that's operating at peak level that means, there needs to be some sort of explanation, the sponsor along with us are walking away potentially from that deal together. So, we are not playing things as the sponsor, in most cases, its is really at the company level where we are in the discovery phase along, side by side with the sponsor. We both come to the conclusion that we haven't received adequate explanations for certain things that are going on at the company and we collectively decide to walk away. So, most of its there, a little bit would be in the area of what is achievable in today's market from a debt perspective. Clearly a lot of the reason that the leverage multiples haven't abated a bit. purchase prices aren't down that much either in our end of the market. And so, sponsors wants they want leverage levels that they are more closely related to your prior periods. We don't think that's appropriate. So, there is, in some cases its related to leverage, but in most cases, its issues at the company level, where we and sponsor decide that they the seller and potentially management team, they could one and the same. All in all adequately explaining some of the things that are going on and we again, collectively decide to walk away from that transaction.

Jon Arfstrom - RBC Capital Markets

Okay. But then just the last question; in your comments you also talked about purchase price revisions, taking a deal maybe four to six weeks longer to close. What drives that, what -- somebody that's going to go out to another potential private equity firm and look for another price or what drives that 4 to 6 week extension?

Rich Buckanavage

Yeah I think its largely driven by the fact that no one wants to be the bad guy. The investment banker doesn't want to tell seller that his business is more liquid than it was. The private equity group doesn't want to be the -- its kind of don't kill the messenger concept, so they get it to the meeting with a very wide range of value, probably knowing that the values are going to coming in at the lower end of that range, the seller who has expectations that were largely formed during 2007 realizes the business isn't work what they thought it was and the seller then reflects on the revised purchased price over a course of couple of weeks.

And as I mentioned in record numbers many of the sellers are deciding to pull the transaction from the market. And so, that's what drives that timing and some of its is true revisions, mean some of it is bonafied based on diligence where the sponsor fine-tunes their model and comes to a conclusion where they don't want to pay 6.5 times, they want to pay 6 times and so the seller will ask for that justification and then backup data, how they arrived at 6 versus 6.5 and some of that takes time as well.

So some of its legitimate, I think the lot of it has to do with the fact that we're still in this very much a transition period for at least our end of the market, where buyer and seller expectations are not quite aligned yet. That's probably going to be another quarter or so away and this is not atypical for the market. There is always this change -- we specially are having to change so quickly in the market where sellers still think their business are worth something that they are not in today's market.

So it'll run its course and I think you'll see closing timeframes compress again back to more closely to historical levels. But this period is kind of a normal expectation adjustment period that occurs and that's driving lot of this.

Jon Arfstrom - RBC Capital Markets

Okay, great, thank you.

Operator

Thank you. And the next question comes from the line of Brian Hogan with Piper Jaffray, please proceed with your question.

Brian Hogan - Piper Jaffray

Thank you. The portfolio down 8.5% quarter-over-quarter and the yield looks flat but at the same time, the investment income was actually up. Can you kind of explain anything unusual going on there?

Richard Buckanavage

Well, couple of things, the yield which I think a lot of people are focused on because of declining LIBOR, one other things for us is we have about 60% of our portfolio in floating rate assets, a lot of our borrowers don't borrow as short-term as we borrow. They will be in three and six month contracts. So that the adjustment due, there is kind of delayed effect in our portfolio and as LIBOR would settle out, you would start to see the impact of that.

I think the other thing is that the we did shed some of the lower yielding assets that we mentioned, we sold actually over $10 million of senior secured debt in the first quarter, those were by far some of the lower yielding assets in our portfolio and quite frankly there is also some repricing of risk that's occurred in our portfolio, as we talked about some of the four rated credits as companies default and financial covers defaults, we do have the right to charge higher interest during that period of time than during times when they are in compliance. So I things there are lot of reasons that drove that Brian despite the 8.5% decline in the portfolio.

Brian Hogan - Piper Jaffray

Okay. Can you spend a moment on this kind of competition? I mean has kind of abated substantially? Can you go and just kind of touch on that?

Richard Buckanavage

We do believe competition has abated. There are a couple of instances where we know that the organizations have either run out of money or have downsized substantially or in one case gone out of business completely. I think evidence of it though is, the concrete evidence is in our pipeline. And we measure our pipe -- we have a lot of metrics that we pull out of our pipeline on a weekly basis and the metric that we believe tell us the story is the fact that we are receiving calls from sponsors that we haven't spoken to in a very long time. They tend to be kind of that tier, kind of high tier two, and two or three sponsors, a sponsor who is a little bit too large for us to have a meaningful relationship with.

And now all of a sudden they are calling us, kind of inbound call, because either they can't convince their some of their other partners to come down-market or some of their partners have either migrated up-market or moved in on and done something else. So a lot of things point to the conclusion that we are coming to, which is that people who are in our market, opportunistically have moved up-market to where they probably wanted to be in the first place. There have been some people who have ceased activity in our market. And I think there is and I think this some bigger sponsors are now looking into our market and want to find a partner that can be there for them for this size company.

Brian Hogan - Piper Jaffray

All right. And then on the six proposal you have out. What types of company that they are, are they are kind of defensive like they were fourth quarter or what's going on there?

Tim Hassler

There is obviously mostly defensive NFAR. They have economic sensitivity to them, that our proposals would be reflect that in very modest leverage.

Brian Hogan - Piper Jaffray

Thanks.

Operator

Thank you. And the next question comes from Greg Mason with Stifel Nicolaus. Please proceed with your question.

Greg Mason - Stifel Nicolaus

The additional investment in LA Spas, Smart and Aylward, all those investments had negative marks last quarter showing some here. Can you talk about the purpose of your capital infusion and more importantly, how are the sponsors working with you on those investments and other investments that are showing some problems during this environment?

Richard Buckanavage

The three investment that we made not isolated investments, in other words they were made in conjunction with more comprehensive solutions that were put in place by us and the sponsor. That really can take a lot of different forms Greg. Each case is a little different, but its suffice it to say that its wasn't just us funding $140,000 to $350,000 in any one of those companies. They were part of a more comprehensive solution and again, as that kind of goes back to my opening remarks, that we will support business, will be there to support our private equity sponsor partners. But we need to do it collaboratively and collaboratively which can mean a lot of different things. And I think that as I said in every instance right now and our watchlist credits, we are working collaboratively and in many cases receiving additional equity infusions to support the business

And in some cases we are investing alongside the sponsor to protect our own position. You'll see us from time to time put additional capital into businesses that are watchlist credits. We're doing it again collaboratively with the sponsor and we wouldn't do it unilaterally, its only done in watchlist credits when there is collaborative outcome there. So, that point is specific that it is much broader approach to a watchlist credit than just providing the company with another couple of $100,000. That -- we don't tend to look at band-aid approaches, we like approaches that are more holistic and long-term oriented and again we want to support those types of activities when the sponsor is willing to take that approach.

Greg Mason - Stifel Nicolaus

And I assume those three investments are on your watchlist?

Richard Buckanavage

That is correct.

Greg Mason - Stifel Nicolaus

Okay. And then about this collaborative effort, can you talk about how it worked in the Encore situation because it appears you probably diluted the equity sponsor out pretty meaningfully with your conversion. Is that true and how do you work with the sponsor to come to that kind of conclusion? Dilution in their equity?

Richard Buckanavage

Yeah the answer is yes. There was dilution to the original equity group. I think what's operative here is that there was additional equity coming in from the sponsor group, so again our willingness to convert our sub-debt was only done in conjunction with the equity infusion, not unilaterally.

So again it was a much broader approach and long-term approach to this business and to your point with regards to what our conversion was worth versus their new dollars, there's always a negotiation. We're focused on getting our capital back in and getting our shareholders an adequate return. There is no magic to the exact level, I mean if they are going through negotiation and I think there was a reasonable range that we were willing to convert our sub-debt out to give the company time to affect the strategic change that's undertaking and certainly alongside, a very meaningful equity investment on part of the equity group.

So it’s a long-term approach, its collaborative, we are happy to be a part of the equity group now, we are going to have a meaningful voice in the business and at some point when we exit our debt position completely, we would assume a full Board role and begin to take a more active approach in that business.

Greg Mason - Stifel Nicolaus

And does that equity in Encore, is that having any type of yield like a preferred equity or just street common?

Richard Buckanavage

There is preferred return, its kind of a liquidation preference, Greg, not a preferred coupon.

Greg Mason - Stifel Nicolaus

Does any of it come in to interest income or should we exclude those assets going forward from our interest income line?

Richard Buckanavage

You should exclude those assets, nothing would come into interest income.

Greg Mason - Stifel Nicolaus

Okay, then quickly on the ADAPCO repayment infusion from the equity sponsor, why was that to pay the 9% senior debt instead of 14% subdebt? Is there some kind of call protection on the sub or…?

Richard Buckanavage

There is. And quite frankly, again we look at this holistically and if we are going to continue to support the business, we can't do it at 9% return. As you know on a BDC balance sheet 9% is not a sufficient return for us to continue to support the business long-term. At the company level, there is probably argument that that they are better off paying higher coupon debt but that wouldn't necessarily get us to agree to the longer term solution. So it's, again these negotiations are always a give and take.

Then I've said, there is --I think you probably, heard me say this a number of times. No two workouts are alike. Because what gives rise to the problem is never identical and you've got different perspective at the equity group level and so its always a give and take and we feel good about that one as well, about where we are and the fact that the sponsor has stepped up and then infused a very significant, has made a very significant equity investment in the business on top its original investment. It speaks volumes to us about what they feel, the long terms prospects for that business are. And again, that then allows us to take a longer term approach to that.

Greg Mason - Stifel Nicolaus

Great. And then one last quick question. Can you give us the number of investments that are in rating four this quarter and last quarter?

Richard Buckanavage

Last quarter, it was one, I believe. And this quarter -- it's a little hard to answer this quarter, Greg, its actually parts, certain asset, because we have fully covered tranches by assets, by liquidation value of assets , we split rates in certain of those portfolio companies, but its parts of four this quarter.

Greg Mason - Stifel Nicolaus

Great, thanks.

Richard Buckanavage

Welcome.

Operator

Thank you. And the next question comes from the line of Henry Coffey with Ferris, Baker Watts. Please proceed with your question.

Henry Coffey - Ferris, Baker Watts

Good morning. Obviously from listening to the call, appears that you've got no pool of assets that are going to be around for a long time. Are we talking months and quarters or what is sort of the horizon on resolving some of these issues?

Tim Hassler

Are you talking about the watchlist credits Henry.

Henry Coffey - Ferris, Baker Watts

Yes.

Tim Hassler

I think that’s accurate. The size companies that we invest in is not typical to see very quick turnaround or quick corrections to situations, in other words they are not multiple divisions where they can go out and sell one division and pay down debt and bring everything back into balance. So, there is generally a little bit longer-term work outs and we don't necessarily have an active distressed that market, in our end of the market, where we can sell pieces and reduce our exposure that way, interstate notwithstanding.

So, they tend to be a little bit longer-term workouts than you would see in the upper ends of the market. And I would suspect these to stick around for a while, but I would say that the good news is that we've in [both of the] two cases we talked about at with the ADAPCO and Encore, we have certainly made a lot of progress towards rewriting the balance sheet and that’s big part of obviously the problem situation, when you are over levered that's never a good. And we bring it back down, it allows the company to have some breathing room and to make some of these operational strategic changes that they need to make to address some of the sub-par operational performance.

So, I think its safe to say we're going to be around for a while. Its always hard to say exactly how long, but do they take a little bit longer than you would see in other parts of the market.

Henry Coffey - Ferris, Baker Watts

And then we dance around this a lot, but it sounds like, when you talk about your syndicated loan strategy as well as your new investments. This all primary -- new originations or are you going to be buying in the secondary market and either way on -- where exactly is pricing coming out at this point.

Richard Buckanavage

Its both Henry, primarily I would say our activity has been focused on secondary, early part of this quarter largely because there is not a whole lot of new issue out there, but we have interest in both, because even on the primary side the coupons are substantially wider than they were where they were and they are still getting done at OID, its not quite 82 to 92 but still an attractive OID to get these deals done. So most of our focus is done in secondary, that's probably at least in this quarter given what we -- as far as the pipeline in the syndicated loan market, probably most of our activity will be secondary purchases that -- but not to say we won't plan primary as well.

Henry Coffey - Ferris, Baker Watts

Would it affect the deals that the way you are today 12% to 13% or that are credits at lower prices?

Tim Hassler

Yeah depends Henry, its probably on a yield to maturity basis it probably it appears a little low. Its probably closer to 10.5 to 11.5, but our experience tell us that these types of loans almost never go to maturity even in markets like this. This market will correct itself over the next couple of years and we think there is some upside there that we get paid back early and we correct all of that OID earlier than at maturity. Those yields could be set substantially higher than the levels I just quoted for you.

Henry Coffey - Ferris, Baker Watts

Great, thank you.

Operator

Thank you and the next question comes from the line John Hecht with JMP Securities. Please proceed with your question.

John Hecht - JMP Securities

Morning and thanks for taking my questions. Just a little bit more commentary on what we should expect to happen with the yield in the near-term. Obviously you told that in the consideration where LIBORs go in there in the quarter which you suggested that there is delay there given, I guess duration of your asset yields, can you tell us when we should see some compression in relation to the movement in your relative indexes?

Richard Buckanavage

Hey, John, we think we would expect to see some compression in this quarter that we are in. What we are seeing is borrowers I think are reading the same press that we all are reading and I think what we are seeing is people that were traditionally borrowing under six month LIBOR are now borrowing in one to three month LIBOR. So I think you will see some of that start to occur in this quarter and into the third quarter. As LIBOR settles out it will, that's reflected from a profitability perspective because of our own borrowing cost kind of being out ahead of theirs but I think in this quarter we'll see little compression and I think probably the bulk of the other compressions assuming LIBOR stays where it is today will be in the third quarter.

John Hecht - JMP Securities

I mean is it simple now to take the 60% adjustable rate [pro rata] LIBOR standard a couple hundred basis points. So the overall yield should come down, like 120, 130 basis points?

Tim Hassler

No, I don't think it will be that substantial. Again there is still I'd say there is a trend where many -- its interesting it's the small companies and we are not talking about big staff at the CFO level what lot of CFOs do in these small companies, they just want to borrow and forget about it and so there is still a desire to simplify their borrowing activity is that they are not looking to play the curve if you will. So I am not sure we will ever fully see that kind of compression and again unless it stops at some point and doesn't reverse course. I guess at some point out later this year, we could see something of that magnitude. But I don't think that that's going to be the case.

John Hecht - JMP Securities

Okay. And with respect to your pipeline, just so I guess your six proposals, can you give us a sense for, if all of them then came to fruition, what that would equate to in terms of origination sizing?

Tim Hassler

I mean it’s a combination of one-stop deals and standalones that were admitted to debt transactions. And just to give you a sense for our normal deal size, kind of average deal. We are looking typically on a sub-debt only transaction anywhere from $5 million to $10 million, $11 million, $12 million range and one-stop, generally between $10 million and call it $20 million. And I think there, of the six proposals, there is probably , some of them more rated towards one-stops than standalone sub. So you can gauge the total in that.

John Hecht - JMP Securities

Okay. And it seems like you are going after higher quality deals, lower [average], maybe more defensive industries in this mix here. I mean, are we seeing a flight to quality where maybe the bidding amount is highly competitive or have we lost sufficient competition as that's not taking place?

Richard Buckanavage

I would say that, I don’t think we feel we are losing a whole lot, John. There might be competition out there. But the yields in our market have increased pretty materially. We think there is room to go. But compared to 2007 for example, where senior debt was getting priced L3 to L4 there is not senior loan that's has been quoted in our market that doesn't start with an L5 something. And we think its, it can approach L6. So, while we are going for maybe senior oriented investment via the one-stops and leverage levels are better lower than historical levels, we're getting paid despite the fact that we're -- we think we're taking less risk. So, it kind of rolls back the metrics to something in the 2004 timeframe where you could actually lend senior, on a senior basis and get a decent return.

John Hecht - JMP Securities

Great. And the rest of my questions have been answered, thanks very much.

Richard Buckanavage

Welcome.

Operator

And we have a follow-up question from the line Brian Hogan with Piper Jaffray. Please proceed.

Brian Hogan - Piper Jaffray

Yes, very simple question I think. Could you give us a break out between your debt investment and equity investment please?

Bill Alvarez

Okay. Our equity investments at 3.30 is about $12 million, little over $12 million and the rest would be debt.

Brian Hogan - Piper Jaffray

All right, thanks.

Tim Hassler

Or 3.5% on fair value.

Operator

Thank you. And we have follow-up question from the line of Greg Mason with Stifel Nicolaus. Please proceed.

Greg Mason - Stifel Nicolaus

Hi guys, just a short word. Just real quick, can you give us a little color, I mean if you are willing, you've been very opportunistic moving in and out of the syndicated market in the years past. I think it served you fairly well. And your comfortable moving in there, but you're not as comfortable to do the private finance. Is there some color on, you are more comfortable with the current credit crunch abating versus the underlying US economy, how are you looking at those two risk in the market right now?

Richard Buckanavage

I think it largely comes down to the leverage. We think the returns relative to the as Tim alluded to, these are first lien secured term loans, that are at, what we think reasonable levels for much larger companies and we're earning more than we can earn at risk adjusted leverage levels in our own market.

So, that's the reason why we're -- we kind of look at the two components and that leverage adjust in the lower end of that market that equation will adjust and will obviously reverse course and deploy capital in the lower end of the market. So, it is really a -- it’s a leverage multiple. Again we just don't feel like a small business at this juncture of the credit cycle and economic cycle, ones leverage at four times and where we can lend four time to a $50 million EBITDA business and earn 11% or we can lend that business in the lower end of the market at L5, which effectively create 8%. We are just not going to do, it makes no sense.

Greg Mason - Stifel Nicolaus

Okay, very good. And on the revised the amendment credit facility I am assuming there is an annual renewal on that, can tell us when the first renewal date is?

Richard Buckanavage

For the credit facility?

Greg Mason - Stifel Nicolaus

Yeah.

Richard Buckanavage

One year from the day it was renewed in early April.

Bill Alvarez

Of April 11th.

Tim Hassler

Yes.

Greg Mason - Stifel Nicolaus

Okay. And then briefly you were able to both expand and get what appears according -- compared to some of your peers pretty favorable terms on that. Can you talk about the process that you went through first of all, did -- I am assuming you started well before April and its all processed. Did they become more comfortable with the credit environment and willingness to extend credit or can you give us some color on that?

Richard Buckanavage

It has in flowed. We started on that actually right after year-end and that was a almost four month process. We did benefit from some structural changes that we agreed to make to improve the credit profile of our securitization to counter that. What we think is a very attractive execution relative to some of our peers, but it didn’t come in at cost we did to contribute some unencumbered assets to improve the credit profile to achieve that outcome but in the end we thought it was wroth it to get the cost of capital that we were able to achieve at 1.75, when of our peers are well in excess of 2%.

Greg Mason - Stifel Nicolaus

And the structural changes, is that you were just referring their additional assets?

Richard Buckanavage

Correct. Over collateralization, in the securitization thereby improving the credit profile.

Greg Mason - Stifel Nicolaus

Okay, great. Thanks guys.

Operator

Thank you and we have no further questions.

Richard Buckanavage

All right. Well, I would thank everyone for your participation this morning. We look forward to discussing second quarter later this year. Thank you very much.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you very much for you r participation and we asked that you please disconnect your lines.

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