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Fifth Street Finance Corporation (NASDAQ:FSC)

F3Q12 Earnings Call

August 9, 2012 10:00 AM ET

Executives

Dean Choksi – SVP-Finance and Head, IR

Len Tannenbaum – CEO

Bernard Berman – President

Alex Frank – CFO

Analysts

Greg Mason – Fifth Street Finance Corp

Stephen Laws – Deutsche Bank

Jonathan Bock – Wells Fargo

Robert Dodd – Raymond James

Jason Arnold – RBC Capital Markets

Operator

Good day, ladies and gentlemen, and welcome to the Q3 2012 Fifth Street Finance Corp. Earnings Conference Call. My name is Andrew and I will be your operator for today. At this time, all participants are in a listen-only mode. We will be conduct a question-and-answer session towards the end of the conference. (Operator Instructions)

As a reminder this call is being recorded for replay purposes. I would now like to turn the call over to Dean Choksi, Senior Vice-President of finance and Head of Investor relations. Please proceed, sir.

Dean Choksi

Good morning, and welcome to Fifth Street’s third quarter earnings call. My name is Dean Choksi and I’ve recently joined Fifth Street as a Senior Vice-President of Finance and Head of Investor Relations. In my first few weeks, I’ve been extremely impressed by the quality of the team and the platform and look forward to meeting our shareholders and analysts.

This conference call is to discuss Fifth Street Finance Corp.’s third fiscal quarter ended June 30, 2012. I’m joined this morning by Leonard Tannenbaum, Chief Executive Officer; Bernard Berman, President; and Alexander Frank, Chief Financial Officer.

Before I begin, I would like to point out that this call is being recorded. Replay information is included in our July 12, 2012 press release and is posted on our website www.fifthstreetfinance.com. Please note that this call is the property of Fifth Street Finance Corp. Any unauthorized rebroadcast of this call in any form is strictly prohibited. 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 could cause actual results to differ materially from these forward-looking statements and 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 914-286-6855. The format for today’s call is as follows: Len will provide an overview, Bernie will provide an update on our capital structure, and Alex will summarize the financials, and then we’ll open the line for Q&A.

I will now turn the call over to our CEO, Len Tannenbaum.

Len Tannenbaum

Thank you. We’re excited to have Dean as our Senior Vice-President of Finance and Head of Investor Relations. Dean is our formal analyst at UBS, where he covered both BDCs and mortgage rates. I encourage you to reach after him, and learn about Fifth Street BDCs.

U.S. and European Union governments face an immense fiscal challenge. Its deficits continue to rise. A handful of EU governments are starting to cut spending after being required to do so, by bond markets and regulators. On the other hand, U.S. deficit spending is benefiting from record low interest rates courtesy of central bank’s quantitative easing and investor’s flight-to-quality assets. But how long will this last?

Polarized Congress, White House are avoiding the difficult positions on taxes and spending. The lack of compromise is creating a dysfunctional environment in Washington, with the Senate unable to pass a proper budget in over three years. But the markets will soon focus on the upcoming fiscal cliff, which we believe will not be addressed by Congress and the White House until 2013.

All of this uncertainty makes long-term planning difficult for investors and business owners. At Fifth Street, we are navigating this volatile environment by focusing where we have a competitive advantage. Our reputation, having the ability to offer a one-stop product, larger hold size and the ability to grow the platform companies to manage a premium in the market.

However, the abundant liquidity in the capital markets is increasing bank competition in first lien loans and leading to overall higher purchase multiples. As a result, we are seeing greater value at middle and upper-middle mezzanine loans and anticipates steering our portfolio mix slightly towards mezzanine with a new broader target range of 60% to 80% first lien loans, a change from our 70% to 80% previous target for first lien loans.

We will focus on using our currently unused $75 million of SBA debenture capacity to finance the mixed shift, which should drive an incremental EPS growth. On the right side of the balance sheet, we are constantly looking for ways to lower costs and improve the terms of our debt capital.

Over the long term, we expect regulations such as Basel III to reduce bank competitions for middle market loans as capital charges increase, bond rate of borrowers. This should lead to a relative funding advantage for BDCs with investment grade ratings in the long term. Fifth Street is investment grade rated in both Fitch and S&P with a stable outlook.

Middle market M&A volumes declined in the June quarter, but our broad platforms still generate $221 million of gross originations, while maintaining our pricing and underwriting standards, enabling us to increase our market share. We are one of the premier middle market leading platforms after several years of investing in our platform and growing and diversifying our balance sheet.

For the third fiscal quarter, we delivered $0.27 per share of net investment income, which is slightly lower than the last two quarters, but still ahead of consensus. Higher cash balances from elevated re-payments in the March quarter primarily led to the decline in NII quarter-over-quarter. We should be close to matching our dividend with net investment income for the September quarter and the September fiscal year.

The fourth fiscal quarter is starting out strong, with over $70 million of originations closed as of today, putting us on-track to be within our target range of $100 million to $300 million in gross quarterly originations for the September quarter. We’re starting to see a pickup in deal flow, flowing in to the end of the year. This is occurring in the year, that we otherwise would have projected. Most of these deals however are still in auction stage. We look forward to providing an update on our originations outlook in Fifth Street’s next newsletter.

Our credit committee remains conservative in its underwriting standard, due to the potentials from market volatility from Europe, and U.S. fiscal cliff and the slowdown of the world economy.

However, we are comfortable continuing to increase our balance sheet leverage to our target of 0.6 times debt-to-equity, excluding our 10-year fixed rate non-recourse SBA debentures Due to; one, our substantial diversification with over 60 borrowers, two, a high first lien mix, three, strong credit performance of our 2009 to 2012 vintage loans, four, diversified long-term liability structure, and five, larger borrowing size with an average portfolio company EBITDA of over $20 million.

We anticipate increasing our average leverage closer to our target over the next fiscal year as we prioritize earning our dividend and optimizing our capital structure over raising additional equity.

Our net investment income should benefit from moving towards our target leverage, better utilization of our credit lines in our SBA subsidiaries by reallocating portfolio assets and potentially, negotiating more attractive credit facility terms. Our 24 equity investments, prepayment penalties and potential exit fees are additional sources of upsides as our portfolio seasons.

Our NAV is stabilizing. We expect a significant reduction in our non-performing investments as a percentage of our portfolio. Overall, we’re seeing healthy performance in our portfolio companies, with a vast majority of the portfolio performing within expectations. Each companies are ranked one and two and represent 98% of our portfolio as of June 30, 2012. As one of the most transparent BDCs industry-wide we’ll continue to provide regular updates to our investors on our credit performance and on our business as a whole.

In May, our Board approved $30 million stock buyback at prices below NAV. We’ve been frequently asked the question at what level will we repurchase shares. We intend to use some of our capital to repurchase shares if the price of the stock were to drop meaningfully below NAV to a level that in our view does not reflect economic reality. We are one of the few BDCs to ever repurchase shares in the past and to maintain the current Board authorization for share buyback. During the past year, we’re also one of the handful of BDCs to not seek shareholder approval to issue equity below NAV.

We are committed to increasing our leverage to our target of 0.6 times debt-to-equity, excluding our 10-year fix non-recourse SBA debentures. We understand our shareholder’s desire to – for us to operate at a higher leverage level. We also are focused on not issuing equity that jeopardizes our ability to earn our stated monthly dividend. As we and our Board are confident in our ability to sustain our dividends through cash flow and earnings, the Board has declared dividends for the next five months through February 2013, after which the board expects to return to evaluating dividend levels to three month periods.

Our available investment capacity and established institutional lending platform are enabling us to gain market share, maintain pricing and under-writing standards, as well as provide the high-level of service that our equity sponsors value. Fifth Street continues to grow and attract high caliber individuals to its intuitional, middle market lending platform.

I will now turn the call over to Bernard Berman, our President.

Bernard Berman

Thanks Len. On May 15 we officially received our second SBIC license. This license along with the leverage commitments we also received allows us to issue $75 million in SBA guaranteed debentures. That is an addition to the $150 million in debentures we issued pursuant to our first license.

We’ve begun investing a regulatory capital for the second license and we expect to begin utilizing the leverage for the second license in the near future. Based on current rates, the interest rates for the new debentures would be even more favorable than the rate on our existing leverage.

This should have a positive impact on our earnings as we utilize the leverage. We’ve not made any structural chances to our Sumitomo, Wells Fargo or ING-led credit facilities since the last earnings call. But we do continue to grow our investment bases and to ramp up the facilities.

At June 30, 2012, our leverage increased to 0.42 times debt-to-equity, excluding SBA debentures and we had over $350 million of remaining investment capacity still available for deployment. Net investment income should benefit in future quarters from higher leverage, better utilization of our multiple credit facilities and potentially negotiating more attractive terms from our lenders.

I’m now going to turn it over to our CFO, Alex Frank.

Alex Frank

Thank you, Bernie. We ended the third fiscal quarter of 2012 with total assets of $1.3 billion, an increase of $231 million or 21% over the year ago period, reflecting growth in net new originations and the strength of our business platform.

Investments were $1.2 billion at fair value and we had available cash on hand of $106 million. Our quarter-end cash balance was unusually high, since we held cash in connection with the funding of investments that closed at the beginning of our fourth fiscal quarter.

Net asset value per share remained stable at $9.85 versus the prior quarter NAV of $9.87. For the three months ended June 30, 2012 total investment income was $41 million. Payment-in-kind interest remained a low percentage of total income, at $3.9 million for the quarter or 9.6% of total investment income as compared to 11% for the year ago period. Net investment income per share increased 8% to $0.27 for the quarter as compared to $0.25 in the same quarter of the previous year.

Turning to the portfolio performance, all three of our debt investment exists were at or above par, at an average price of 102% of par. The value of our portfolio was stable and we did not have any material realized or unrealized gains or losses in the quarter. The weighted average yield on our debt investments decreased slightly to 12.1% at June 30, 2012 versus 12.4% in the prior quarter.

The cash component of the yield decreased 0.2% in the quarter to 10.9%. The average size of the portfolio investment was stable at $19.3 million. We originated $220.6 million in investments in the quarter, in 10 new and six existing portfolio companies, bringing the total companies in our portfolio to 76 at June 30, 2012 versus 60 a year ago.

We also received $55.1 million in connection with the exits of three of our portfolio companies, all of which we were exited at par or better. We did experience a decrease in the level of early repayments from the previous quarter to a more normalized level, which ranges from $25 million to $75 million per quarter, which allowed us to reach a record high portfolio size. Approximately 97% of the portfolio by fair value consisted of debt investments, 69% of the total was in first lien loans, and 68% of the debt portfolio was at floating interest rates.

The investment portfolio continues to be well diversified by industry sponsor and individual company. Our largest single industry exposure is to healthcare at 23% of the total portfolio. The largest single company exposure is only 3.7% of total assets and our top ten investments represent 28% of total assets.

As Bernie stated, the leverage commitment for our second SBIC subsidiary, provides us with cost effective capital to grow and diversify our portfolio mix in the future. With the expanded leverage of our second license, we can fund an additional $112.5 million through our SBIC, bringing total SBIC investment capacity to $337.5 million.

The investment portfolio continues to be at high credit quality and the credit profile was stable versus the prior quarter. We rank our debt investments on a one to five ranking scale and the highest performing one and two ranked securities were 98.3% of our portfolio, versus 98.5% as of September 30, 2011 and 97.7% a year ago. During the quarter ended June 30, 2012, we had four investments in the portfolio in which we stopped accruing income which is unchanged from the previous quarter.

Our Board of Directors has declared monthly dividends for October of 2012 through February of 2013 of $0.958 per share reflecting a continuing annual rate of $1.15 per share. The dividend rate continues to be set at level of commencement with our earnings capacity and we remain confident that our dividends going forward will be covered by net investment income.

Now, I’ll turn it back to Dean.

Dean Choksi

Thank you, Alex. Before I open the lines for Q&A, I would like to remind everyone that for the months Fifth Street does not report quarterly earnings, we generally released a newsletter. If you would like to be added to our email list and receive these communications directly, please call me at 914-286-6855 or send a request email to ir@fifthstreetfinance.com.

Thank you for participating on today’s call, Andrew, please open the line for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Okay the first question we have comes from Greg Mason of Fifth Street Finance Corp. Please proceed.

Greg Mason – Fifth Street Finance Corp

Great and good morning, and before I ask my question, I just want to add, I appreciate the comments on utilizing the leverage and growing earnings before raising equity, we think that’s a key part of the story. Len, I was kind of surprised about your comments on the banks getting more aggressive and you’re shifting your focus slightly more to mezzanine. I was curious if you could give us a little more color exactly what you’re seeing there and if leverage multiples are going up because of the banks, why do you think mezzanine is the place to play in that scenario?

Len Tannenbaum

First, thanks for the question, but I just want to point out that Greg is from Stifel, Nicolaus and not from Fifth Street. Greg, I think what we’re seeing, when you talk about mezzanine in the middle and upper middle market, you’re talking about the spread over to first lien and when the banks are being very aggressive, they’re doing deals at LIBOR 400. And if the senior is priced on a typical deal it’s 3.5/5, so 3.5 turns of senior, 5 turns of total leverage. And we just don’t do deals as they do.

Some deals are stretching to 5.5 and 6; we’re just not doing them, typically. We’ve seen some of our competitors reach for yield and take too much leverage; we’re just not doing that. But the mezzanine piece, the 1.5 turns of mezzanine in $20 million EBITDA business, is a lot safer than the mezzanine in $5 million EBITDA business. And as we moved up market, we feel much more confident that the mezzanine is a better risk adjusted return.

But the way we view this, it’s a good question, it’s kind of interesting. It’s the spread over the first lien. So if the first lien is at LIBOR 400 and the mezzanine is at LIBOR 1000 or LIBOR 1100, that could be a good risk adjusted return rather than being a LIBOR 400 (inaudible). While the first lien is at LIBOR 600 and much less willing to do 12% or 13% mezzanine. So we’re seeing the first lien (inaudible) is providing a lot of extra cash for the company, which allows and support the mezzanine a lot better.

Greg Mason – Fifth Street Finance Corp

Great and then as you talk about you’re getting bigger, you are moving up-market a little bit, we’ve obviously seen at some point getting too big or moving too high up-market doesn’t work, Apollo tried that strategy. Where do you think you go from moving to bigger companies is okay, versus you get too big and if the market just becomes too competitive...

Len Tannenbaum

So we’re...

Greg Mason – Fifth Street Finance Corp

...what account for you for that line?

Len Tannenbaum

We are all the way through the – yeah, up it’s down to the lower middle market, the middle market and the upper middle market. At our size, the great part about sort of being at $1.3 billion in assets, about $815 million of equity is we can go both ends of the market and go wherever the best risk-adjusted returns are. We believe that we’ll start losing that flexibility to go up and down market at about $1.5 billion of equity, $2.5 billion of total assets.

And I’ve been pretty consistent saying that over the past three years, and I – as we now are in the sweet spot, are really – it’s really nice to do – or we’re doing $10 million mezzanine loan that goes in the SBA that’s yielding 14%, kind of great industry with a good sponsor. And we’re also doing a piece of a very large mezzanine loan, with $40 million EBITDA. So we can go both ends. And that flexibility is just great. But if actually, you’re right, we do lose it, but we are quite a bit to grow before we can lose that.

Greg Mason – Fifth Street Finance Corp

Great, thank you guys.

Operator

Thank you. And the next question comes from Stephen Laws, Deutsche Bank. Please proceed.

Stephen Laws – Deutsche Bank

Hi, good morning. Nice originations during the quarter and thanks for the visibility with the dividend. I’m trying to get a little bit better idea looking at kind of net portfolio growth. You talked about a normalized kind of pay down or exit level of $25 million to $75 million. Is there any seasonality in that or any kind of one-time events you guys see can see it in the portfolio that we should think about as we look to grow our portfolio to targeted leverage level?

Len Tannenbaum

So, I think besides being a little bit of line sighted in the first, a couple of quarters ago with very high repayments; we really do have some forecastability because, unlike most platforms, we’re an origination platform. These are our equity sponsors, these are our partners, we’re in three and four and five deals with them.

Because of our relationship, because we’re not just participating in syndicates, they’re constantly telling us when things go to auction, when things are for sale, when they’re thinking about refinancing us, whether it’s clarity of our service, this – which is currently at auction, we hope – we’ll sell for a very good price in this environment. Where we now have equity, they told us they were going to refinance us. I mean that refinancing was coming for a substantial amount of time. We already see some refinancings coming in the fourth calendar quarter and we believe right now, given our outlook, that’s between the $25 million and $75 million number. I can tell you – there is no way to forecast exactly.

Stephen Laws – Deutsche Bank

Sure.

Len Tannenbaum

But it’s for sure within that number. It’s just like we feel that the wide range of $100 million to $300 million in gross is appropriate, because if you’re an origination platform, it’s taking us over a 100 days from the time a deal enters the pipelines to close the deal, typically. And because we do all the diligence, we do diligence for the auction stage of our sponsor, then – our equity sponsor then wins. We then determine whether they went to a one stop bank (inaudible) financing and we may follow (inaudible) or we may do a one stop depending on the credit underwriting and also depending on what the equity sponsor wants.

Stephen Laws – Deutsche Bank

Right, so with the 100 day lag on that, you have a good idea of originations there for the next three months for the – exits that may be a little bit less clear from a visibility standpoint?

Len Tannenbaum

I think yeah, exists we’ll know two months in advance and originations will have a feeling for a little bit more than that.

Stephen Laws – Deutsche Bank

Great and then on the SBA side, how quickly can you, will that new $75 million you employed, the comments during the calls of near future, is that within the next three months or is it more of nine-month timeframe, how should I look at that?

Len Tannenbaum

So they can only be deployed in $11 million chunks and so, and we only, we want to deploy it utilizing some mezzanine and so, we’re carefully putting deals in there that are appropriate to match up against the 10-year fixed horizon. So we’re better allocating our portfolio mix in all of our credit facilities, which we believe is going to generate some additional earnings and so, it’s going to take 6 months to 12 months I think to do the second license.

Stephen Laws – Deutsche Bank

Great that’s helpful, thanks for taking my questions.

Operator

Thank you and the next question comes from Jonathan Bock, Wells Fargo. Please proceed.

Jonathan Bock – Wells Fargo

Yes, thanks for taking my question. Len, just on the Q about $180 million in unfunded commitments, can you just give us a sense as to how much powder that you want to keep drive in order to fund those in the event they can’t recall on your capital.

Len Tannenbaum

So I think maybe you missed it, it $108 million, not $180 million.

Jonathan Bock – Wells Fargo

No, $108 million, I’m sorry.

Len Tannenbaum

Yeah, and the $108 million is really September 30, 2011. June 30, 2012 is $95 million. So actually we’ve actually reduced our unfunded commitment substantially over the last year, so I appreciate pointing that out and so what the reason we did that is so that we could optimize our leverage better because we do reserve against our unfunded commitments to make sure we have enough capacity. And so, we’ve been able to reduce our, even that we’ve grown our portfolio; we’ve reduced our unfunded commitments substantially.

So we really do have around $250 million, $300 million comfortably, to be able to invest, before we’re “out of money” and but – we heard some of our peers go to max leverage and use up all of their capacity, I mean, we’re never going to be doing something like that. I don’t think that’s ever prudent.

Jonathan Bock – Wells Fargo

And another thing I wanted to...

Len Tannenbaum

(inaudible)

Jonathan Bock – Wells Fargo

So, it went from $108 million to like $98 million something like that?

Len Tannenbaum

Yeah, it’s down to $95 million today. September 30, last year it was $108 million.

Jonathan Bock – Wells Fargo

Okay (inaudible) my bad perception of those numbers. Next, when we build out the – as you’re building out kind of the Midwest and we think about the larger platforms that you obviously been working towards expanding over the past few months and years, maybe give us sense of just that office is kind of the additional deal flow and the looks that you’re seeing now that they’ve really been really up and running?

Len Tannenbaum

So, Chicago, the Chicago market was a very tough market to crack and what we realized a couple of years ago that we needed to hire some veterans within that market. And Sunny Khorana runs that market for us, and he brought into our partnership. Sunny is doing a great job. Chicago currently probably accounts for one-third of our originations and we expect it to continue to grow and that’s up from probably close to zero, two or three years ago.

And that’s the Chicago sponsors like Chicago Growth Partners, Beecken Petty, Baird, it’s all of them. And that it’s really great relationship and I think they really want that local office, that, you can just walk over to their offices and talk about deals, talk about the environment, talk about our underwriting processes. So it’s working very well. I think the next hire for us Telegraph – I guess Telegraph will be another East Coast originator to look more up market. Casey Zmijeski is awesome. He’s been a partner here for a while and he does a great job and he’s actually asked for some help. So we’re in search to continue to expand our origination team.

Jonathan Bock – Wells Fargo

Okay great, and then on the new investments, particularly the sub-debt, just tackle on with Mr. Mason’s question. Could you give us the average leverage level kind of through your security and then also that the minimum and the maximum leverage on that the sub-debt transactions today or did you originate this quarter?

Len Tannenbaum

No, I’m not going to give that level of detail on the call because I don’t feel like giving all the detail in every call. But what I will say is, we’re one of the only, we’re the only BDC to my knowledge to release what the debt to EBITDA of the one rated and two rated tranches are and you just need to find that in the Q and those two leverage levels I think are – if our peers were to release them, would compare very favorably and that is that, well, we don’t see – well, you don’t see it for three, four and five because it’s really not material, one and two rated securities I think we’re 98.2%, 98.3% of the overall.

So from 98.3% of our portfolio, we know that the rated one securities only have leveraged up to 3.16 times debt to EBITDA. And the rated two securities which is to be honest the most, the biggest really wrong one.

Jonathan Bock – Wells Fargo

Yeah, the June 30.

Len Tannenbaum

I’m sorry, the June 30 numbers. So I even read the wrong column. June 30 rated one securities were 2.07 times debt-to-EBITDA and rated two securities with 3.89 debt-to-EBITDA. So that gives you a pretty good sense that, we’re really staying safe and high in the structure and we were just not reaching for this deals, it’s just not worth it.

Jonathan Bock – Wells Fargo

I really appreciate that and then just two last ones. What – Alex I think in your release, the originations to date, do you happen to have the repayments to date if I missed that somewhat this quarter?

Alex Frank

No, we haven’t really released the repayments to date. Yes, for this quarter.

Jonathan Bock – Wells Fargo

Would it be your view guys that repayment activity is getting slightly moderate in light of kind of the economic malaise?

Alex Frank

Yeah it’s in the – it’s going to be in the range for the quarter.

Len Tannenbaum

This quarter, I think repayment were at $55 million.

Alex Frank

So far in September, we got a couple of small repayments we should be – fine to be in the range of....

Jonathan Bock – Wells Fargo

so that (inaudible)

Len Tannenbaum

In June quarter.

Alex Frank

No, for the June quarter....

Len Tannenbaum

For the September (inaudible) correct...

Alex Frank

(inaudible)

Jonathan Bock – Wells Fargo

Okay great and then the last question relates to equity outside, I know – currently in this environment that’s I know that people do pay attention to you and there has been several restructuring, so perhaps could you give us a sense as to how would you look at potential values of equity in realizing values for your shareholders over the next, let’s say near term to maybe over the longer term for your shareholders?

Len Tannenbaum

Well, we still have this capital loss carry forward of $60 million and we have endeavored over the past few years to make a substantial numbers of equity investments. I think we talked about 24 of them and some of those equity investments take time to mature and to be realized. It typically takes 2 years to 5 years for equity investments to work and they are starting to mature. As we talked about Caregiver Service is now is up for auction and you know we have 5% of the company, so we hope to that work.

The other great, the best news that happened this past week is Traffic Control and Safety is going to exit bankruptcy and we own the substantial amounts of the company. It was a very tough turnaround for us. We are very pleased with where it is currently. It still has a lot of wood to chop, but and it was very much helped by the infrastructure bill passing through this dysfunctional congress.

So the one thing they did pass is that something that really helps our largest equity position. Having said that, we have very conservative mark on the equity, I think it’s marked at zero. So it can’t go any lower than zero and there’s substantial upside for that, but we need to see the company perform first and we are excited by our new management team. I mean, our existing management team being re-energized by having substantial amounts to the equity upside and stock options and I’m sure they’re going to work very hard to realizing their stock options.

Jonathan Bock – Wells Fargo

All right, great thank you.

Operator

Thank you. Your next question comes from Robert Dodd of Raymond James. Please proceed.

Robert Dodd – Raymond James

Hi guys. Most of them have been answered, but just on kind of can you give us any color on how these structures are changing, I mean just looking at the new originations in the quarter, the coupon, not the all in yield looked to be about $9.5 million, which looks like – looking at the structure of fees, recognized versus cash income, are you seeing a shift towards more structured exit fees in deals that are being done at the moment, in terms of back-end loaded or is that we reading things that aren’t there?

Len Tannenbaum

So over the past years, one of the comments – we had a young portfolio. Well, our portfolio is not so young anymore. It’s sort of a teenager or older and as the portfolio ages, something normal happens, which is recycles. So we’re getting these repayments and these re-payments are generating prepayment penalties. It’s generating some of upfront fee realization.

It’s generating some new investments, so you put out new fees and because of that fee income on a sustained basis, and we already did see it the September quarter, we’re just going to have fee income every single quarter because that’s what happens in the normal asset management front, where you have the recycling of assets.

We just haven’t had these levels of recycles in 2011 and 2010 because the portfolio was relatively young, these are five-year assets, typically. So I think we’re going to continue to see this all this good income coming and hopefully, we’re going to see some capital gains even that’s not an NII what it does for us is it’s going to start replacing NAV. And, so we’re looking forward to some capital gains as well.

Robert Dodd – Raymond James

Okay yes, but and I always head in when somebody starts sounding like that. But if we look to last year, right, your cash flow since these was above recognized income versus this year, we’re seeing cash flow below. If it’s a prepayment fee, the recognition GAAP and cash flow occurs in the same period. So the lag that has to be, that should be (inaudible) in the accruals, so is that back-end loaded or front-end loaded?

Len Tannenbaum

So there always been a – in the past, we’ve earned lots of cash and we’ve, as you pointed out in NII was lower than it might have been and as those deals repay, you could get back the amortized amount or a capitalized amount, which increases your income, but doesn’t necessarily increase you cash. So that’s correct.

You’re starting to see the reversal out of what we call note four which is, has about $20 million of capitalized or it did have roughly $20 million of capitalized income and that’s going to come into income over some point. Having said that, we’re pretty much seeing, we believe over the next year, which is 2013, not only we’re going to cover dividend with NII but we’re looking to cover the cash. And I – I think both of those metrics will work for us in 2013 and so, we’re excited about that.

Robert Dodd – Raymond James

Okay, got it. Last question if I can, just a small one, BMC, very small investment in the quarter, but can you give – walk us through the rationale for doing that as a cash coupon of 6%, 6.5%? Seems much lower than your target.

Len Tannenbaum

Oh, it’s SBA let me as soon as you come along, right guys?

Robert Dodd – Raymond James

Yes.

Len Tannenbaum

So the Sumitomo facility, we’re going to put some of those – it matched up against our LIBOR 225 borrowing, two times leverage for Sumitomo. So when it – yes it’s a little bit lower yield. The interesting thing with some of these lower yield, things that we buy had 98, 97.

We did one last week for $5 million and we asked some favors of our capital market schemes to give us a nicer allocation. And they immediately traded from 98 to 101. So I think now, why you’re seeing some of lower yielding things, we’re using them opportunistically sometimes and that sometimes, we’re just matching them against the very low cost leverage for Sumitomo.

Robert Dodd – Raymond James

Got it, I appreciate it.

Operator

Thank you. And the next question we have comes from Jason Arnold, RBC Capital Markets. Please proceed.

Jason Arnold – RBC Capital Markets

Hi, yeah good morning, guys. I was just curious if you could comment on where you’d anticipate rates coming in from the new SBA facility, and how would that compare to the current SBA facilities that you have out there?

Len Tannenbaum

Well, rates for the SBA facilities are locked in twice a year typically at a spread over 10-year treasury. The spread has been approximately 50 basis points to 100 basis points. So a 10 year treasury is at 1.6, which – so I believe is artificially low due to the treasury buying, 70% of treasury – during the fed buying 70% of the treasuries, but you know that.

As we deploy and lock that amount, we really could experience 2.5% 10 year paper versus 3.6% on average for the first facility. The other thing which I heard mentioned on a number of other BDC conference calls, yes there is a bill passing through. Yes, it would increase the family fund’s limit for the SBA. What I’ll point out that I don’t think it has been properly talked about is let’s say, the family funds limit goes from $225 million to $350 million as this by parts into – which is actually out of committee contemplates.

To get the second amount of money you need a second license, scenario of our second license and we have our second lever. So we’ve been told is potentially our second license could go from $75 million to $150 million, if this passes without having to apply for any new licenses or apply for any leverage.

But there’s also another limit to the SBA which is $150 million limit per license and that’s not going to change anytime in the near future. So even though you may see $350 million as a family funds limit, until they raise the per license limit which they do from time-to-time, we expect to just get another $75 million of leverage in addition, maybe that will happen in sometime in 2013.

Jason Arnold – RBC Capital Markets

Okay, good color, thank you. And then I guess, would you for your older facility, have any opportunity to refinance, I know you mentioned, some of your peers I think one of your peers has done that more or less repaid and then took out another line at a lower lot.

Len Tannenbaum

You’re talking about our main facility?

Jason Arnold – RBC Capital Markets

Yes correct.

Len Tannenbaum

We are definitely exploring, we’re the fifth largest BDC, the largest, the second largest and so are just did a very nice facility. I think if you look at Solar’s facility which I thought he did a good job. Michael did negotiate the facility and advanced rates and they have used – we’re definitely looking at that type of format for our next facility in order to replace and now if they were to replace or be transferred from the ING line. But we’re not there yet. Whenever, we do announce it, I think we are definitely looking at that in that pricing because we’re BBB minus company as well and we think that that’s the right format for our size.

Jason Arnold – RBC Capital Markets

Okay terrific thanks for the color.

Len Tannenbaum

Thanks.

Operator

Thank you for your question. We have no further questions. So ladies and gentlemen thank you for joining today’s conference. This concludes the presentation. You may now disconnect and have a very good day.

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