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Executives

Christopher Lacovara - Chairman of the Board, Vice President

Dayl W. Pearson - President, Chief Executive Officer, Director

Michael I. Wirth - Chief Financial Officer, Chief Compliance Officer, Treasurer, Secretary

[Jodi Bernstein] - Lippert Heilshorn & Associates

Analysts

John Hecht - JMP Securities

[David Vail - Vail Partners]

Troy Ward - Stifel Nicolaus & Company, Inc.

[David Niazoki - Confluence Asset Management]

Kohlberg Capital Corporation (KCAP) F2Q08 Earnings Call August 7, 2008 8:30 AM ET

Operator

Good day everyone and welcome to the Kohlberg Capital Corporation second quarter 2008 earnings conference call. Today’s call is being recorded. Currently all lines are in a listen-only mode and after management’s presentation a question and answer session will be conducted. Instructions on how to ask a question will be given at that time. At this time for opening remarks and introductions I would like to turn the call over to Ms. Jodi Bernstein.

[Jodi Bernstein]

Good morning everyone. This is [Jodi Bernstein] of Lippert Heilshorn & Associates. Thank you for joining us today to discuss Kohlberg Capital’s second quarter 2008 results. Joining me on the call are Chris Lacovara, Chairman, Dayl Pearson, President and Chief Executive Officer, and Michael Wirth, Chief Financial Officer. The company issued its second quarter earnings release yesterday after the market closed. A copy is available in the Investor Relations section of the company’s website at www.kohlbergcapital.com.

Before turning the call over to management I would like to remind everyone that certain statements made during this conference call which are not historical may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although Kohlberg Capital believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, it can give no assurance that its expectations will be obtained. Factors and risks such as those described in the Risk Factors section of the company’s 10K and sections of Form 10Q and other SEC documents filed during the course of the year could cause actual results to differ materially from expectations.

With that I would now like to turn the call over to Chris.

Christopher Lacovara

Good morning everyone. Thank you all for joining us for a review of our second quarter results. I will open the call with some general comments about what we’re seeing in the market place, our strategy and recent key developments. Then I’ll turn the call over to Dayl Pearson, our Chief Executive Officer, who will discuss our quarterly performance in more detail and also discuss our pipeline and our investment portfolio. After that our CFO Mike Wirth will provide a recap of our second quarter financial results and performance.

Net investment income per common share was $0.38 for the second quarter versus $0.40 per share for the first quarter, in both cases as adjusted for the issuance of 3.1 million shares in our May rights offering. We declared and paid a dividend for the second quarter of $0.41 per share equal to our first quarter dividend, and our first half dividends were completely covered by first half net investment income of $0.86 per share. For the second quarter we are reporting net asset value per share of $13.14 compared to $13.29 as of March 31, and again both numbers are adjusted for the company’s issuance of 3.1 million shares in the recent rights offering.

Overall our investment portfolio and asset management business continue to perform well despite growing economic weakness and ongoing credit market dislocations. We deployed the new capital raised in the rights offering over the past two months investing in $27 million of middle market loans at very attractive interest rate spreads. We believe that increasing our equity base and investment portfolio in this difficult environment distinguishes Kohlberg Capital from other players in the BDC space.

The credit markets continue to be very volatile. This is particularly true for larger cap names given the significant reduction in liquidity over the past 12 months as few new CLO funds have been raised and some hedge funds and banks have exited the syndicated lending market for the time being. While these trends have essentially shut down the market for large leverage transactions, middle market transactions are continuing to close but at much higher debt pricing and usually with lower leverage multiples than prior to the credit crunch, all of which benefit KCAP as a middle market lender. At the same time some players have exited the middle market particularly some hedge funds which has opened up new lending opportunities for KCAP. Dayl will discuss all these trends in detail in a few minutes.

While the credit quality of our portfolio companies remains strong, we are certainly monitoring the performance of each individual borrower very carefully. Our hard watch list remains unchanged in the second quarter at six issuers out of 88 and we do not see any of our other portfolio companies migrating to the hard watch list in the near future. While our nonaccrual issuers have increased from one to two over the quarter, this is still a very manageable level and based upon what we have observed from other middle market lenders relatively few.

In this difficult market we continue to benefit from our strategy of investing in portfolio companies that generate strong free cash flow resulting in predictable recurring interest income for KCAP. Our focus in maintaining a high percentage of senior and junior secured corporate loans ensures that even when the company underperforms we will receive our interest payments and will cover our principal investments. And again, Dayl will give you more details and take you through our investment portfolio metrics in a moment.

The performance of the underlying assets of the CLO funds in which KCAP holds investments also remains strong. As you will recall, these funds invest in hundreds of broadly syndicated senior secured loans of companies across a diverse set of industry sectors and are therefore insulated from performance problems in any individual company or industry.

All of the funds in which KCAP holds investments have maintained their original issue credit ratings on all rated classes of securities and all of them continue to make all required cash payments to all classes of investors including paying quarterly cash dividends to the junior securities in which KCAP has invested. As a reminder, none of these funds holds investments in CDOs, mortgage backed securities or carry any exposure to the mortgage market subprime or otherwise and nearly all of the underlying investments of these funds are first lien secured corporate loans.

At the quarter close we had approximately $57 million invested in CLO funds representing 11% of the fair value of our portfolio. Our seasoned CLOs are currently yielding an annualized cash yield of 34% for the 12 months ended June 30 compared to 28% in the first quarter.

Turning to Katonah Debt Advisors or KDA our wholly-owned asset management company, as of June 30 KDA had $2.3 billion of assets under management and our 100% ownership of that company is valued at $64 million representing approximately 13% of our investment portfolio.

As a reminder, Katonah Debt Advisors manages funds that invest in broadly syndicated corporate term loans, high yield bonds and other corporate credit instruments and through KDA we have access to a stream of recurring management fees that continue to grow as assets under management increase. This aspect of Katonah Debt Advisors is a key differentiator for Kohlberg Capital as it provides an additional earnings stream to support our dividend beyond our investment loan portfolio. Any net income that isn’t distributed up to KCAP remains on KDA’s books as cumulative undistributed net income which provides a cushion to sustain and grow our dividend in future quarters. As of June 30, 2008 we had undistributed net income at KDA of approximately $3 million.

The challenge for KDA is to continue to grow its AUM and we are currently exploring several options to raise new managed funds.

Before turning the call over to Dayl, I want to touch on the shareholder approval we received on July 21 to sell newly issued shares of common stock below the net asset value per share at the time of any such sales. As you know, as a BDC corporate capital is precluded from selling newly issued shares of common stock at less than the net asset value per share without such approval or unless such shares are issued through a rights offering. We are extremely pleased by the overwhelming support we received for this proposal from our shareholders. In fact over 85% of our shareholders voted in favor of the proposal giving us the flexibility to raise capital more efficiently and quickly to continue to grow our asset base.

That said, we will of course be judicious in sizing any equity offering below net asset value balancing the opportunities for accretive new investments with the current trading value of our stock which we do not feel adequately reflects the value of our net assets for our dividend yield. With access to capital and availability under our revolver we have the resources to take advantage of investment opportunities that meet our risk return profile and continue to grow our asset base while maintaining a healthy and stable dividend.

Looking out to the second half of 2008 we are well positioned to come through the current uncertain economic environment relatively unscathed and to find ways to continue to build a profitable investment portfolio. In fact we continue to believe the current market conditions are creating some very attractive opportunities that align perfectly with our strategy of generating current income and capital appreciation from our investments. We have a solid pipeline of potential investment opportunities coming to us from our own sponsor network as well as some very accretive investments coming to us directly from distressed sellers which Dayl will discuss in more detail.

And with that I’d like to turn the call over to Dayl, our President and Chief Executive Officer.

Dayl W. Pearson

Good morning everyone. I’ll start with some brief highlights of the quarter and then review our portfolio of middle market loans and equities.

As Chris mentioned, net asset value on a dollar basis was $279 million at the end of the quarter up from $252.9 million at March 31 an increase of just over 10%. That is related to our rights offering which we completed in May and the full investment of the equity proceeds of that offering during the remainder of the quarter. Taking into accounts the rights offering of 3.1 million shares NAV per share was $13.14 compared to $13.29 at the end of the first quarter.

I want to comment briefly about how that relates to our current stock price which closed yesterday at $8.96 per share. Our current NAV would have to flow by $89 million for our stock price to be equal to our NAV of $190 million and the cost space of our investment portfolio excluding KDA would have to fall by $120 million. As you know NAV we’ve taken some unrealized losses on that portfolio despite the fact they continue to prepay at par. What that implies is we would have to write off more than 30% of our investment portfolio for our NAV to fall to our stock price. Working backwards to come up with what that means for a market default rate given the recovery rate on the type of securities we invest in, that would be a market default rate of close to 70% in order for us to have our NAV equal our stock price. Obviously that’s a historical event that’s never happened. Generally at the bottom of the credit cycles the default rate peaks at 10% to 12% in the worst years.

And it compares to our current payment defaults of less than 1.4% of assets and our hard watch list which is a total of approximately 5% of assets.

We did end the quarter with total assets of $532.9 million and total investments of $506.4 million increases of a little over $18 million in both cases. As Christ mentioned we fully deployed the net equity proceeds raised during the quarter in eight new investments totaling $27.2 million in cash with a par value of $29.1 million. We believe that all of these new loans will eventually pay off at par which could result in approximately $2 million of net realized gains.

Net unrealized depreciation increased by approximately $466,000 during the quarter. This consists of approximately $338,000 net decrease in the fair value of corporate debt securities and equities as a result of current market conditions and approximately $824,000 decrease in the net value of the CLO equity investments and an approximate $1 million increase in the value of Katonah Debt Advisors reflecting an increase in assets under management.

Now looking at the composition of our investment portfolio, our portfolio quality remains strong. At the end of the second quarter our debt securities not including our CLO investments totaled approximately $381 million. As in the past, first lien loans represented the majority of our debt securities portfolio at 57% down slightly from 60% at the end of the first quarter. Secondly, loans represented 33% of the portfolio which means that the secured debt portion of our portfolio was approximately 90% of our loan portfolio.

By industry our middle market portfolio remains very diversified across 26 industries with very little exposure to the construction real estate, retail or finance. The portfolio’s comprised of 88 issuers compared to 86 at the end of the first quarter and the average loan balance remains under $5 million. Our top 10 investments account for approximately 17% of the portfolio which has been consistent throughout our life as a public company. As a reminder, by design we avoid concentrations in any one industry or issuer and we have a very active portfolio monitoring program. Approximately 10% of our debt securities are fixed rate and the average fixed rate is approximately 12%.

As noted earlier our credit quality remains good. Our hard watch list as Chris mentioned remains unchanged at six issuers and there is a strong possibility that by the end of the third quarter that could shrink by at least one issuer, not because that issuer is no longer an issuer but because its performance has been stronger and it comes off the hard watch list. Two of those issuers are currently on nonaccrual which totals less than 1.4% of total assets. We do not anticipate any additions to the hard watch list in the near future.

Despite market related unrealized losses on our loan portfolio we continue to see significant prepayments at or above par. So far in 2008 we have received more than $28 million in prepayments including $14.4 million in the first quarter and $9 million in the second quarter and almost $4.8 million in the month of July alone.

Middle market deal activity remains strong as Chris mentioned. We have seen approximately 234 new transactions from 46 different financial sponsors with the decline rate in excess of 95%. Subsequent to June 30 our investment committee has approved two additional transactions which have not yet closed.

And now I’ll ask Mike to walk you through the details of our second quarter performance.

Michael I. Wirth

Good morning everyone. Picking up with our income statement, we reported total investment income of $12.3 million compared to $8.6 million in the year ago period. Net investment income for the second quarter was $7.7 million or $0.38 per share compared to $5.3 million or $0.29 per share in the second quarter of last year. This increase primarily reflects the growth in our investment portfolio to $506.4 million from $366 million a year ago and increased dividends on our CLO equity investments. Interest income was $7.5 million driven primarily by interest earned on our debt securities.

Net investment income for the six month period was $16.4 million or $0.86 per share and we paid dividends equal to $0.82 per share. For the second quarter we declared a $0.41 dividend which was payable on July 28, 2008 to holders of record as of July 9, 2008. Nearly all of the dividend was covered by investment income and the balance was contributed by undistributed earnings from the first quarter. It is important to note that even with the slight dilution from our completed rights offering during the quarter, net investment income for the six months ended June 30, 2008 was more than sufficient to pay our dividends for the period without relying on capital gains to support the dividend while returning capital.

At June 30, 2008 KDA had $3 million accumulative undistributed net income. Net unrealized loss on investments for the quarter was $466,000 or $0.02 per share reflecting approximately $1.3 million in decreased fair value of the company’s middle market corporate loan and equity securities and CLO fund securities offset in part by $824,000 of the increase in fair value for the company’s investment in Katonah Debt Advisors.

After total expenses of $4.6 million we generated $7.3 million net increase of stockholders’ equity from operations or earnings per share of $0.36 based on weighted average shares outstanding of 20,322,611.

Moving on to the balance sheet, at June 30, 2008 we had debt outstanding of $230 million under our $275 million securitization revolving credit facility that has a term maturity of October 1, 2012 giving us additional borrowing capacity of $45 million. Keep in mind this facility is not subject to margin calls, interim or annual renewals during its term or changes in the state of interest spread of 85 basis points over the commercial paper rate. As a percent of total assets, debt outstanding was 43% equal to an asset coverage of over 2.2 to 1. The debt to equity ratio was 0.82.

Weighted average interest rate on weighted average outstanding borrowings was approximately 2.9% in the 2008 second quarter compared to 5.3% last year and 4.1% the first quarter.

Total assets were $532.9 million and stockholders’ equity was $279 million. The aforementioned discussions on second quarter and annual results are also discussed in our 10Q that will be filed no later than August 11. Our second quarter 2008 10Q and our 2007 annual 10K are available at our website www.kohlbergcapital.com or at www.sec.gov.

With that I’d like to turn the call back over to the operator to start the question and answer session.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from John Hecht - JMP Securities.

John Hecht - JMP Securities

You guys gave some information related to the gross investments and repayments during the quarter, but I wonder if you could summarize them. It sounded like you had around $27 million of gross investments and if you could classify those and then maybe also classify and give us the number for repayments during the quarter again as well.

Michael I. Wirth

During the second quarter the repayments were approximately $9 million and I did mention also the July number which was $4.8 million. And that’s made up of various different issuers. But again all those were at par or in some cases above par if we had call protection. In terms of the eight investments that we made, several of those were things we were able to buy at discounts in performing credits due to the fact that there was either a seller that needed to sell or just overall market conditions. Three of those were really originated transactions. The makeup was again a little bit more heavily weighted towards the junior securities. It was probably about 50% junior securities versus 50% first lien loans and it’s a little bit difficult to figure out the weighted average spread because some of these were bought at discounts, but our bogey has really been to try to get to in excess of 12% yield on all new transactions.

John Hecht - JMP Securities

Your CLOs continue to move upward so it appears that you’re recycling capital nicely in those vehicles. I’m wondering if you can give us a similar type of discussion with respect to the extent you can determine how much free payments you’re getting their and what the incremental yields are as you recycle that capital.

Michael I. Wirth

It’s a complicated statistic because what we really see at the KCAP balance sheet is essentially the yield on our investments in the junior securities of the fund, and as I mentioned that’s been moving up. It’s currently at an annualized rate for what we call the seasoned CLOs, these are ones that have generally been outstanding for more than a year so they’ve reached their full dividend distribution ate, of about 34%. Now part of the move up in that is a result of the fact that we have written down the value of our CLO investments in previous quarters because of reductions in the underlying trading value of some of the loans; again, not because of performance problems.

To come back to your question, I think it is fair to say that as cash comes into the underlying funds you’re basically replacing loans that would have been written at maybe 225 basis points over LIBOR for senior secured at currently rates that are probably approaching 3% or 300 basis points over LIBOR, and in those funds with their leverage and their fixed funding costs which in some funds is as little as 50 basis points over LIBOR, the increase in that recycled rate is very powerful for us in future quarters.

Dayl W. Pearson

And also those loans are being bought at discounts [inaudible] and that discount obviously also accrues to the benefit of the junior securities.

Michael I. Wirth

Exactly. So to sum up, you really have three things that are working in our favor with regard to our CLO investments. One is that despite the fact that we’ve written down those values and that’s reflected in our NAV, the funds are continuing to pay at or even above the cash rates of prior quarters so the yield on our carrying value is moving up; and then you have the impact of much higher reinvestment rates in the underlying funds that improve their economics; and then as Dayl said because that reinvestment in many cases is at a discount to par, the gain as those loans repay at par comes directly to the equity in which we’ve invested. And that you’ll see in future quarters.

Dayl W. Pearson

And keep in mind that 34% yield is based upon our cost basis in those securities, not on the written down values that we carry them on our balance sheet. It’s not going up because we’re writing them down. It’s because we’re calculating that based upon our cost side.

Michael I. Wirth

That 34%, if we were to equate it to fair value would be in the 50% range.

John Hecht - JMP Securities

Mike this is probably a question for you. Last quarter you recognized some income from your asset management or KDA and this quarter you didn’t. Is this something that was just sort of a timing issue or how should we see that going forward?

Michael I. Wirth

The KDA of distributed income obviously doesn’t hit the P&L unless we actually dividend it out. We didn’t make a dividend distribution from KDA this quarter. Frankly we didn’t really think that we really needed to because we did earn the dividend through the first six months. So it’s something that we decide to make a dividend through KDA, one we look at where we think we’re going to end up the quarter with, just our normal net investment income but we also have other considerations as far as “Do we need to have cash balances at KDA for any particular reason?” We are accruing bonuses which get paid in January of each subsequent year so we want to keep a cash balance to pay for those types of accruals and that type of thing. There are a lot of metrics that we look at but in the second quarter, bottom line was we just didn’t feel that we needed to make any kind of distribution at this point from KDA up to the parent.

Operator

Our next question comes from [David Vail - Vail Partners].

[David Vail - Vail Partners]

I saw that recently you had issued some restricted stock in Kohlberg to members I think in lieu of some options issuance that had been previously recorded. So far that was correct, right?

Michael I. Wirth

Yes, that’s correct.

[David Vail - Vail Partners]

It seems like you’ve been saying that Kohlberg has been hitting all-time lows lately in stock price and it seems like an attractive value at this point. I agree with you what you’ve been saying and yet I don’t really see any insider buying on your part. The only insider I saw that really bought was Gary Cademartori if I’m pronouncing that correctly bought 276 shares in May. Otherwise it’s just been constituents of restricted stock. If it’s such a great buy right now, why aren’t you guys eating your own cooking? Why aren’t you buying more shares? You want us shareholders to support you and believe in the company, why aren’t you buying shares of the company at this point?

Michael I. Wirth

First of all, let me sure we’re clear on one point. The issuance of the restricted stock in exchange for the retirement of the stock options was something that was planned previously. In fact the option plan that we put in place at our IPO was really a placeholder for the type of restricted stock program that most BDCs have for management so management can get the benefit of the dividend, but we couldn’t put the restricted stock plan in place at the IPO because it required an SEC approval that we just got this spring. So this was not a result of the current trading price. It was a plan that had been in the works for some time.

Second, I want to correct a misperception. There perhaps has not been a lot of buying in the open market recently but management and the Board did participate substantially in the rights offering. I can tell you that I personally bought another 50,000 shares and I think cumulatively the Board and management probably bought several hundred thousand shares in the rights offering. So the reason you don’t see a lot of buying in the open market is quite frankly that we have a very restrictive window in terms of when management and the Board can buy around disclosure periods. But there was a considerable amount of subscription buy management and the directors in the rights offering.

Dayl W. Pearson

Since the rights offering, the open window for insiders to buy KCAP stock has been closed and will not open until sometime next week. And then even then it’s a short window.

[David Vail - Vail Partners]

So you’re saying basically that at these kinds of prices if you had the window to buy, you would be buying the shares.

Michael I. Wirth

I can only speak for myself and the answer is yes.

[David Vail - Vail Partners]

That’s good to know. Another issue is, a lot of other BDCs have passed this resolution to issue stock below NAV and as soon as they passed it, one of them in particular like I was looking at Patriot Capital, their stock got hammered. I mean, whether you think it’s a good idea or not it just seems like the market seems to like this issuance of shares below NAV. And I wondered what your thought process is on whether you will issue shares below NAV and at what point? I know like [inaudible] their Board of Directors passed a resolution where they won’t issue shares below NAV if the stock’s trading more than 5% below NAV. That gives shareholders some assurance that you’re not going to have a really diluted offering. I wondered if you could give any assurance that you won’t issue shares that are really priced below NAV like maybe where they’re trading right now?

Michael I. Wirth

Let me reiterate the comments I made before about the thought process because that’s a very good question. A BDC has to balance the dilution to NAV from issuance below NAV with the potential accretion to the dividend of deploying capital at what are historically very high investment rates. Interest rate spreads are very high for middle market loans and you don’t want to miss that opportunity to the extent it can expand the overall yield on our assets and grow our dividend in future quarters. So you really have to balance the NAV dilution of the issuance below NAV with the attractive investment opportunities that we’re seeing in the market today. And that is our Board’s thought process.

And I can assure you that the Board is not going to just issue stock at any rate. We have very stringent guidelines. Dayl pointed to the 12% target reinvestment rate that has to drive those decisions if we’re selling below NAV.

Maybe the other assurance I can give you is that corporate capital has what for BDCs is a very high level of insider ownership. You sort of looked at the down side that there hasn’t been a lot of open market buying but as I said, there was considerable subscription to the rights offering and the management and Board own I think more than 15%. And this is again an internally managed BDC so there is no value to an external entity that gets a fee on the market cap by issuing stock to increase the market cap. It’s quite the opposite. The insiders take the same dilution as everybody else with that issuance and the insiders are substantially represented on the Board of Directors.

So I think you do have a natural check against issuing at any old price beyond as I said the dynamic of looking at the reinvestment rate and the accretion to the dividend.

[David Vail - Vail Partners]

What were the expenses excluding the interest for the BDC this quarter as a percentage of assets?

Michael I. Wirth

The expense ratio excluding interest was 3.4% for the six months ended June 30.

[David Vail - Vail Partners]

Is that picking up a little? I noticed from the previous quarter it was like 2.something. Is there a reason for that?

Michael I. Wirth

We had some higher professional fees in the first quarter; not so much in the second quarter. Typically it’s going to annualize and stabilize somewhere hopefully south of 3%. We try to keep it somewhere around 2% if possible but again we did have some higher fees related to legal costs as well as valuation costs since we do outsource some valuation work to third parties to get comfort on our valuation. And we’ve been sending more and more assets to third parties for external review.

Dayl W. Pearson

We do expect that to continue to decrease as we increase our investment portfolio. Obviously it’s been more challenging because of the capital markets environment to grow that portfolio but there is a large fixed component to that so that ratio should drop as we grow.

[David Vail - Vail Partners]

How liquid is the portfolio at this point? If you needed to sell off some of those first lien securities to raise cash to invest in maybe higher yielding assets, could you do that and would you do something like that?

Michael I. Wirth

We can and we have in particular circumstances. We don’t really feel like selling good yielding assets which we believe are par securities that continue to pay off at par at substantial discounts but we have a substantial amount of liquidity in our portfolio.

[David Vail - Vail Partners]

One other question I want to ask is, I saw on a note that a Mr. Kohlberg is leaving the Board. I wondered if you could just maybe go into a little detail about the reason for that and what that means to Kohlberg?

Christopher Lacovara

Jim has actually decreased his time commitment to the other Kohlberg & Company buy-out activities as he’s focused on some other business projects. So it was really part of an overall program where he’s focusing his attentions on some other activities. Jim also recently joined the Board of the New York Times Company which is taking up a lot of his time so he felt he just really couldn’t devote enough time to KCAP. It also made room for Dayl Pearson, our CEO, to join the Board which again is something that had been planned for some time.

[David Vail - Vail Partners]

And will he be holding on to his shares or is he going to be selling them off now that he’s leaving?

Christopher Lacovara

I really can’t comment on Jim’s personal plans. I can tell you that he views the current stock price the same way the rest of us do as not a price that we should be sellers at. I don’t think he has any immediate plans to sell any of his shares.

Operator

Our next question comes from Troy Ward - Stifel Nicolaus & Company, Inc.

Troy Ward - Stifel Nicolaus & Company, Inc.

I apologize in advance here. We hopped on late so if this has already been addressed. Can you give us some color on EBITDA trends at the portfolio companies? What are you seeing as far as the underlying fundamentals in your portfolio?

Dayl W. Pearson

Again it’s a very diverse portfolio as you know and so it’s hard to comment globally. I would say the vast majority of our portfolio continues to see EBITDA trend positively. We are seeing some weakness across the portfolio; not significant necessarily down moves but flattening out of EBITDA. Again as we commented our hard watch list remains very small and is not growing and may actually be declining in the coming quarter.

Troy Ward - Stifel Nicolaus & Company, Inc.

We’ve heard that EBITDA trends in several other portfolios maybe are not reacting quite as favorably. How do you account for your portfolio doing maybe a little bit better? Is it less cyclicality or [inaudible]? Is there any way you can put some color on that?

Dayl W. Pearson

I think we have stayed away from the heavy cyclical businesses at the top of cycle though we do have some of those but the vast majority of our portfolio if you look at our largest industry concentrations has been health care, education, things that really not are sensitive to the economy. And again it’s a function of the fact that we’ve been turning down 95% of what we’ve seen.

Christopher Lacovara

To elaborate on that I think two others points. One as Dayl said we stayed away from some sectors that have actually been a large segment of leveraged loan issuance like retail, like restaurants, and I think people who bought those names because they were a large part of the issuance obviously with what’s going on in the consumer economy those names are seeing substantial declines. And we just don’t have a lot of that.

On the flip side, and I think this surprises a lot of people as to why some companies are actually seeing growth, the manufacturing sector is actually doing very well and a lot of that is export growth. So we have a number of manufacturing companies particularly those that have global exposure that actually are seeing substantial increases year-over-year driven by export growth, growth in foreign markets in which they have existing operations.

So it really is very portfolio specific and our strong performance is a clear result of the choices we’ve made over the last 18 months as we assembled the portfolio.

Dayl W. Pearson

And just a comment on our largest single exposure as an example of that, it’s an industrial business which its EBITDA is up substantially year-over-year due to very strong economy both here and overseas for their products. The weakness I think as Chris mentioned is mostly tied with anything that’s related in some extent of either housing or the consumer. And while we do have some exposures to those, we’ve kept those very low. And I think that’s when you get outside of the sectors we’re not seeing a tremendous amount of weakness.

Troy Ward - Stifel Nicolaus & Company, Inc.

Moving from the current portfolio into the current opportunities, what are you seeing with regard to new investments? We’ve had a bit of conflicting information I think so far in the earning season from management teams with regard to current leverage and pricing points that may be available, new opportunities that are available.

Dayl W. Pearson

Let’s start with pricing first because that’s the easy answer. Pricing has moved up dramatically over the last 12 months. I think it’s sort of stabilized. It really can’t go up much higher just because there’s only so much pricing you can put on these leveraged companies. But I think it’s stabilized. I think the mezzanine pricing has started to move up in line with the first lien pricing which moved up a bit earlier. In terms of overall leverage in credit, one of the reasons we still are declining 95% of what we see is the fact that in a lot of cases there are still very leveraged transactions getting done which we’re not comfortable with. But we are seeing some very good transactions at very nice pricing and at very reasonable leverage.

Troy Ward - Stifel Nicolaus & Company, Inc.

What about the competitive landscape? When you see a good deal is it still very competitive?

Dayl W. Pearson

It’s very competitive on the junior capital side; less so on the senior. And where we do get some value for the buck is our ability to take some senior in order to drive our ability therefore to be involved in the junior side.

Operator

Our next question comes from [David Niazoki - Confluence Asset Management].

[David Niazoki - Confluence Asset Management]

I was curious about some of the add-on positions that you’re making even with regard to the capital that’s being redeployed in the funds. The prices that you’re able to execute them at you alluded to discounts to par that are attractive. I was just wondering, how do those prices compare to where you’ve been marking your book? Have you been surprised where they’ve come in or have they been higher or lower or about where your marks have been?

Michael I. Wirth

It all depends. I think in the stuff that is more broadly syndicated. We’ve been able to actually buy stuff in and around the marks have been in the bigger transactions. In the smaller middle market transactions which may not even have any third party marks of if they do have third party marks they’re not based upon trade, that’s really based upon our ability to source those transactions from people who are exiting the business and under a significant amount of pressure due to redemptions to sell. And in those cases we’re able to, because that’s a “distressed seller” and not a distressed loan but a distressed seller of the loan; if they have to sell we’re able to drive a much better discount from where the mark might be.

[David Niazoki - Confluence Asset Management]

In those kinds of situations, presumably if you’re marking those kinds of investments as multiples of EBITDA or -

Michael I. Wirth

We mark them in the same way we mark everything which is consistent with our valuation policy.

[David Niazoki - Confluence Asset Management]

Does it create a situation though when you’re taking advantage of a distressed seller where the rest of your portfolio that may have similar kinds of credits or investments where the terms and the maturity and the industry are the same that your compelled to have to bring your valuation down?

Michael I. Wirth

No. Again we look at that as a one-off transaction from a distressed seller and we look at the fundamentals of the business just like we would in any other company, and where the risk return is from our perspective and what a proper risk return is for an asset like that.

Dayl W. Pearson

Essentially, to come back to your original question, what the buying is is at buying at levels that are essentially reflected in our current NAV. We’ve had three quarters where we’ve taken reductions because of the trading values of loans coming down due to illiquidity in the market. So that’s already reflected in the NAV. Now with the additional capital we’ve raised and with some redemptions coming in, we’re able to buy at those same levels. So it is the good news of the reduction in trading values that we’ve had to reflect in our NAV over the past few quarters.

[David Niazoki - Confluence Asset Management]

That’s actually what I wanted to hear. It sounds like if you look at the glass half full, your ability to buy loans at the current level is also mirrored in the ability for public shareholders to buy the stock at your current price.

Michael I. Wirth

Exactly.

Dayl W. Pearson

That’s correct. And one of our strategies has been over the course of the year to build in some potential capital gains by buying things at substantial discounts so that when they do pay off at par, and obviously we’re buying things which we think are going to pay off at par, there’s a potential for capital gains down the road.

Operator

And with that, we have no further questions on our roster. Therefore, Mr. Lacovara I will turn the conference over to you for any closing remarks.

Christopher Lacovara

I think we’ve covered everything we wanted to cover. Again we thank you all for your participation and we look forward to talking with you in future quarters.

Operator

And again Ladies and Gentlemen, this does conclude the Kohlberg Capital Corporation second quarter 2008 earnings conference call. We do appreciate your participation. And you may disconnect at this time.

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Source: Kohlberg Capital Corporation Q2 2008 Earnings Call Transcript
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