Fifth Street Finance CEO Discusses F3Q2010 Results - Earnings Call Transcript

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Fifth Street Finance Corp. (NYSE:FSC)

F3Q2010 Earnings Call Transcript

August 5, 2010 1:00 pm ET


Stacey Thorne – Executive Director, Head of IR

Leonard Tannenbaum – CEO

Bernard Berman – President

William Craig – CFO


Troy Ward – Stifel Nicolaus

Casey Alexander – Gilford Securities

Jasper Birch – Macquarie

Robert Dodd – Morgan Keegan

Jim Ballan – Lazard Capital Markets

Keith Rosenbloom – Care Capital Group


Good day, ladies and gentlemen. Welcome to the Fifth Street Finance Corp. third quarter 2010 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will follow at that time. (Operator instructions)

As a reminder, this conference call is being recorded. I would now like to turn the conference over to Stacey Thorne. You may begin.

Stacey Thorne

Good afternoon, and welcome, everyone. My name is Stacey Thorne and I am the Head of Investor Relations for Fifth Street. This is a conference call to discuss the results for Fifth Street Finance Corp.’s third quarter ended June 30, 2010. I have with me this afternoon Leonard Tannenbaum, CEO; Bernard Berman, President; and William Craig, 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 15th press release and is posted on our website. Please note that this call is the property of Fifth Street Finance Corp. Any unauthorized rebroadcast of this call of any form is strictly prohibited.

Before we go into our earnings, I’d like to you call your attention to the customary Safe Harbor disclosure in our July 15, 2010 press release 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 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 914-286-6811.

The format for today's call is as follows. Len will provide an overview. Bernie will provide an update on each of our lending facilities. Bill will summarize the financials, and then we will open the line for Q&A.

I'm now going to turn it over to our CEO, Leonard Tannenbaum.

Leonard Tannenbaum

Thank you, Stacey. As many of know, I believe in transparency and straightforward communication with our shareholders. If our communication were perceived otherwise, I feel it is important during this call to shed further clarity around the Board’s dividend declaration and our dividend policy going forward.

So before I begin my prepared remarks, I want immediately clear out any misconception. We reduced the dividend to the September 30th quarter to $0.10 and paid out the low end of 90% to 100% distributable income range for the fiscal year. We switched to a monthly dividend starting in October with the new fiscal year.

Our Board of Directors for the first fiscal quarter of 2011 declared a $0.32 dividend, leaving the dividend unchanged from the June 30th quarter due to the Board’s confidence that the lower than expected earnings and distributable income that we experienced is only a one quarter issue, and now to my prepared remarks.

From an economic standpoint, we’ve continued to experienced stable to slightly increasing EBITDA, especially in our 2008 and beyond vintage portfolio. The growth and earnings is due both to margin expansion and revenue growth. These indicators of a raising economy are seen across several industry groups.

In addition, we are beginning to be told by some private equity sponsors of their intention to refinance some of our assets in the next 12 months. This is another signal of the lending markets reopening. Turnover of investments is an important component of earnings for BDCs, as refinancings typically raise short-term earnings and allow for the redeployment of capital.

We are also beginning to witness the increased ramp in mergers and acquisitions activity that we had forecasted earlier this year. As both strategic investors and private equity firms increased their activity, we expect loan demand in the middle market to accelerate. We continue to believe that this will increase through the year and will peak in the fourth quarter. Our pipeline, a good three to six months indication of deal closings is at a record high as companies look to sell before the end of the year.

Following our plan to have ample capacity for the increase in deal flow that we anticipate we raised over $100 million in June. At the time, we had over $130 million of signed term sheets. As we’ve talked about in our July month newsletter a rare event occurred, all of the deals were either postponed or cancelled following the outcomes of our robust diligence process.

Historically, over 80% of term sheets that are signed have ultimately resulted in closed deals. The good news is that we discovered these problems in the investments before we financed them. This will ultimately deliver a much better long-term outcome for our shareholders. Just to remind our investors we do not take any management fees on cash or cash equivalents.

Our 2007 vintage portfolio, which now represents about 18% of our total portfolio at fair value, continues to contain most of our underperforming assets. These investments in general are smaller, have weaker sponsors as partners, and are primarily second lien.

We have already taken significant write-downs in some of these assets and took further markdowns this quarter. Due to the postponement or cancellation of recent deals as a result of diligence concerns along with minimal deal funding so far this quarter, we believe we will sell [ph] par earnings in the quarter ending September 30th.

The good news is newly signed term sheets and the record pipeline convinced me that the earnings shortfall is a one quarter issue. With about a $100 million earning minimal interest and with approximately 20% more shares outstanding, we needed a typical conversion rate of our signed term sheets to offset the negative earnings impact. Even if origination to the balance of this quarter, coming as expected, it will have too late of an impact to this quarter’s results to generate significant investment income.

While we typically do not give guidance on earnings, especially this early in the quarter, we can define the range of net investment income, NON-INTEREST INCOME, to the September 30th quarter to be between $0.20 and $0.25 per share. In order to meet our goal of distributing between 90% and 100% distributable income during the fiscal year, we’re allowing for a charge off in our Martini Park investment. The Board declared a dividend of $0.10 payable in the September quarter.

Given our increased confidence in originations through the balance of the year, coupled with the higher distributable income associated with them, the Board has left the $0.32 dividend intact to our first fiscal quarter of 2011 ending December 31, 2010.

We have had a great deal of input from our retail shareholders that they would appreciate a monthly dividend. We therefore have converted to a monthly dividend for the new fiscal year.

Thus our $0.32 dividend will be paid out to shareholders as follows, $0.10 in October, $0.11 in November, and $0.11 in December. As we collect interest monthly from our investments, a monthly dividend better reflects the actual cash flows of our company.

From a credit line perspective, we are undrawn on both our ING and Wells Fargo credit facilities, but we have begun to drawn on the SBA facility. We believe we will be close to $75 million strong by the time the SBA fixes the debt into a 10-year instrument in September. We also continue to have conversations with other lending partners to expand our credit capabilities.

Despite recent IPOs in the BDC sector, there continues to be a limited number of our competitors that can complete a transaction for private equity sponsors without any syndication risk and with a whole size of $30 to $50 million.

This provides us with some additional pricing power and the ability to continue to be a major lender in the middle and lower middle markets. We firmly believe that there is still the preference for private equity sponsors to partner with a trusted lender, rather than rely on syndicate group to complete transactions.

We are concerned, however, about a potential softening of the market. There have been a flurry of recent BDC filings and new entrants sometimes use price to try to win deals as their brand and origination pipelines are less established than existing lenders.

It has been proactive portfolio management and the partnership approach with our private equity firms has allowed us to successfully navigate a very challenging environment. The addition of several team members has enhanced our ability to monitor and manage the existing portfolio. The best prevention of a problem is by having a strong underwriting process. We have three strong teams in place led by Ivelin Dimitrov and Chad Blakeman. I’m pleased to report the category 3, 4, 5 rating securities account for only approximately 6% of the portfolio at fair value.

The investing environment is changing, as I highlighted in our recent monthly newsletters. We were fortunate that currently over 80% of our portfolio took advantage of the higher return environment as we rewarded a few BDCs that had ample capital to invest during the credit dislocation. We expect our vintage 2008 and beyond credit portfolio to generate strong return as the economy recovers.

We continue to be focused on the potential for inflation to increase at anytime, given the very pro-liquidity stands of the Federal Reserve. Our increasing floating-rate loans should begin to service the hedging and the substantial increase in interest rates over the coming years.

The current percentage of our debt portfolio with floating rate loans is approximately 25% with a vast majority of our pipeline, consisting of first lien floating rate securities. Our SBA leverage will also service the hedging and rising interest rates. The interest rate on that piece of debt is fixed for 10 years. We expect our first tranche of debt to fix in the September timeframe, as the SBA securitizations typically occur twice a year in March and September.

We will continue to use financing partners to provide diversification of the portfolio. Our pipeline of loans in conjunction with equity sponsors rose to a new record. Our diverse pipeline now stands at approximately $1.9 billion, which is up from $1.4 billion on the last earnings call. We believe that our strong grandeur relationships allow us to capture premium pricing over the market. We believe the opportunities in the middle market are large and growing, even as lenders continue to return to the middle market.

We plan on continuing to take advantage of this environment to gain market share with top quartile private equity sponsors, as well as to capture strong risk adjusted returns. First lien loans stand at approximately 70% of our portfolio at fair value and over 90% of the pipeline contains first lien [ph] one stop loans, so this percentage may experience a further increase. We believe this gives us one of the most secured portfolios of any BDC. We do not plan on investing in unsecured PIK toggles or many of the vehicles, which we believe will generate higher default rate and provide for lower recovery in an economic decline.

Our strong first lien position, coupled with further diversification and expansion of assets, should position Fifth Street favorably to reduce its cost of capital over time. We’ve announced several key hires to our team, which have greatly broadened our platform and expertise. As a leading player in the middle market, we are able to attract talent that serves as a key source of enhancement to underwriting, origination and portfolio teams.

I will now hand the call over to our President, Bernie Berman.

Bernard Berman

Thanks, Len. We were very pleased that we’re able to lower our cost to debt during the quarter by amending our Wells Fargo facility, closing the ING facility and joint leverage from the SBA. On May 26, we amended our facility with Wells Fargo. The amendment increased the size of the facility from $50 million to $100 million with an important feature which allows for future expansion up to $150 million.

The pricing of the facility was lowered to LIBOR plus 350 basis points with no LIBOR floor. In addition, we extended the maturity date of the facility to May 26, 2013. On our last call, we told you that we had successfully renegotiated our commitment from ING. On May 27, we successfully closed on a syndicated three year revolving credit facility, led by ING Capital. The ING facility closed in the initial amount of $90 million and it’s extendable up to a total $150 million.

The pricing on this facility is LIBOR plus 350 basis points with no LIBOR floor. In addition to ING, the other participants in the facility are Royal Bank of Canada, Morgan Stanley and UBS. During the quarter, we began to utilize our SBA leverage. We drew $35 million during the quarter. We expect to draw an additional $35 to $40 million in leverage during the fourth fiscal quarter, which would then mean, we are 50% drawn on the maximum $150 million available to us.

We expected the pricing on most of the initial $75 million in leverage will be fixed in the September securitization, and we’re in the process of asking the SBA for a formal commitment for the remaining $75 million. We anticipate that we will have access to the remaining $75 million by the end of the calendar year. Between the SBIC, ING and Wells, we have ample capacity to make new investments in the coming months at very favorable rates.

I’m now going to turn it over to our CFO, Bill Craig.

William Craig

Thanks, Bernie. With respect to our balance sheet as of June 30, 2010 total assets were $611.2 million, which included total investments of $494.8 million at fair value and cash and cash equivalents of $106.7 million. Liabilities were $42.2 million and net assets were $569.0 million. Our net asset value per share at June 30, 2010 was $10.43.

With respect for our operations, whole investment income for the three months ended June 30, 2010 was approximately $19.4 million. This was comprised of $17.4 million of interest income, including $2.4 million of PIK interest and $1.7 million of fee income. For the three months ended June 30, 2010 we recorded net unrealized depreciation of $13.9 million. This consists of $30.3 million of net unrealized depreciation on debt investments and $0.6 million of net unrealized depreciation on equity investments.

Our weighted average yield on investments at June 30, 2010 was 14.9%, which included a cash component of 12.6%. Our average portfolio company investment was $15.1 million as compared to the previous quarter with a weighted average yield on investments at March 31, 2010 of 15%, which included a cash component of 12.7% in our average portfolio of company investment of $14.9 million. At June 30, 2010 our portfolio consisted of investment in 36 companies.

At fair value, 99% of our portfolio consists of debt investments, 70.3% were first lien loans, 27.6% with second lien loans and 1.1% were subordinated loans. At June 30, 2010 approximately 24.5% of our debt investment portfolio at fair value or interest at floating rates. All of our floating rate loans carry a minimum interest rate floor of at least 9%, which protects our return in a low rate environment and also serves as a hedge.

During the quarter ended June 30, 2010 we invested $56.3 million across 2 new and 7 pre-existing portfolio companies. With respect to our ratings at June 30, 2010, the distribution of our debt investments on the one to five scale at fair value was as follows: The percentage of one and two rated securities for the quarter ended June 30, 2010 was 93.6% in comparison to 94.9% as of March 31, 2010.

We are closely monitoring all of our investments and continue to provide managerial systems as proactively as possible. To emphasize Len’s earlier comments about the dividend, in order to stay in line with our distribution guidelines, the board declared a dividend for the fourth quarter of $0.10 payable in September. Separate and apart from that, to give visibility on the following quarter which would be Q1 of 2011, they declared monthly dividends of $0.10, $0.11 and $0.11 for October, November and December or $0.32 for the quarter.

I’m now going to turn it back over to Stacey Thorne.

Stacey Thorne

Thank you, Bill. One year ago, Fifth Street released its Fifth Street Small Business Index. This index which is calculated by S&P custom indices tracks the TPM [ph] EBITDA of its portfolio companies, both in the BDC as well as their second fund. I encourage everyone to visit our website and click on the small business index tab at the top. The index is updated monthly and was recently redesigned to make it more interactive.

For the past six months the index has been an up tick and TPM across the two portfolios. And finally, as a reminder for the month that Fifth Street doesn’t not report quarterly earnings we generally release a monthly news letter. If you like to be added to the mailing list and receive these communications directly, you can either call me at 914-286-6811 or send a request by email to IR at Alternatively email can be step up through the shareholder links, under the Investors Relation tab of our website, again

Thank for participating on the call. I will now turn it over to operator, to open the line for questions.

Question-and-Answer Session


Thank you (Operator instructions) Our first question is from Troy Ward of Stifel Nicolaus. Your line is open.

Troy Ward – Stifel Nicolaus

Great. Thank you and good afternoon. Len, first of all, I like to start up by saying that we do appreciate that the way you open the call with the increased transparency. We were in the camp that the release wasn’t may be as transparent as we would have expected from you, and your comments definitely cleared that up and we definitely appreciate that.

Leonard Tannenbaum


Troy Ward – Stifel Nicolaus

And then, can we talk quickly about the new deals that you are seeing out there in the pipeline, specifically, where in the capital structure do you think the best risk return is, and then also from a fee income perspective, could you tell us kind of what you’re seeing and if there is any kind of softening on the upfront fees?

Leonard Tannenbaum

We really have a pipeline full of first lien one stop loans. And in fact, I can think of may be one secondly mode in the entire $1.9 billion pipeline. The loan side for us are bigger than usual. These are companies typically with EBITDA between $10 million and $20 million, the general area which we’re seeing most of the loans.

We are planning to syndicate some of the debt from the larger loans to keep our whole [ph] sizes between target whole size between $30 million and $50 million as we told you. But we’re really -- we are seeing some robust activity. Rates are down from last December, probably by 200 basis points. They are a little bit better from this past April by 100 basis points due to, I think, the market -- little bit of market dislocation and lack of new capital coming into the area. If that changes, I’m sure rates will drop by 100 basis points.

The upfront fees add about 2% on average. We’re really not doing much below 2%. It did go as high as 3% for the time and it drifted right back down to 2% and spreads are being maintained.

Troy Ward – Stifel Nicolaus

Okay, great. And then can we talk just a little bit about some of the problem companies in the portfolio, I know, you said they are basically in the older vintage and the other ‘07 vintage. Obviously, Martini Parks are non-issue any more but it looks like those total and real acquisition, both were unpicked, non-accrual. Can we comment on those and then also may be Lighting by Gregory and Premier Trailer?

Leonard Tannenbaum

Sure. I’m clearly frustrated by the performance of the ’07 asset class and we worked really hard. The number of problems, of course, is high and the dollars of problems is not that high, but each one of them takes just as much time as any big deal. Unfortunately, the entire vintage that really is under stress because these deals never had an economic cycle to at least pay-down some of their debt or increase their earnings.

I think we managed many of their issues. We quickly put things and picked non-accruals when we realized that there is a chance that we may not collect the interest, and the reason we do that is to make sure that we don’t earn an incentive fee when we don’t deserve it. And if you put it on PIK nonaccrual, there is no incentive fee taken on any of the PIK. So, I think and that’s part of it. And part of it is simple quality wordings [ph] issue where if these things are all PIK or high-PIK security and put it into earnings when it really doesn’t belong there potentially, not really enhancing your quality of earnings.

As for these two cases, Rose Tarlow has been in a lot of trouble for the past three years. It is a high-end furniture brand. Clearly, doing that in 2007 was not a good choice for anyone doing anything in that industry. And it continues to founder along while the company itself is not negative in cash flow, we found it prudent to put on PIK non-accrual at this time. And we also hired outside valuation sources for the security and I think this valuation reflects a very credible outside valuation source.

As for Premier Trailer, Premier Trailer has been on non-accrual for -- I can’t remember how long. Bill, you remember?

William Craig

About a year.

Leonard Tannenbaum

About a year. We haven’t collected PIK or cash on it. My hope was that the economy would rebound. And this is definitely a security. If the economy were to have a stock rebound, it would quickly come back into the money and may be even start paying.

The problem is we just have not had the economic lift necessary for this second lien piece of paper behind a very large first lien. With an equity sponsor that is not going to support the deal, even though they said they were going to, it is not going to for various different reasons.

So we felt that -- but I think the board felt it prudent to mark down the security to where they did this quarter.

Troy Ward – Stifel Nicolaus

Great. Thanks Len.


Thank you. Our next question is from Casey Alexander of Gilford Securities.

Casey Alexander – Gilford Securities

Hi, can you give us sort of an idea of, what type of percentage or dollar amount of the existing portfolio which you think may be subject to being refinanced in the next year?

Stacey Thorne

I think there are three securities out of the 36 that I know about that if they -- they certainly indicated that there is a potential -- or they were looking to refinance it. I’m pretty confident by the end of the year, you’ll see at least one refinancing. And there may be more. I think the size of the refinancing environment is definitely the lending environment coming back; obviously, we’ve all been waiting for some velocity in order for our earnings to start lifting.

Casey Alexander – Gilford Securities

Okay. That’s the only question I have. Thank you.

Stacey Thorne

Thank you, Casey.


Thank you. Our next question is from Jasper Birch of Macquarie. Your line is open.

Jasper Birch – Macquarie

Hi, good afternoon, guys. First of all, I’m sorry I missed the beginning of your call. So I’m sorry if I ask anything that you’ve already gone over. So starting off with, I was wondering if you give us little more color and clarity on why exactly a lot of your deals fell through last quarter? I mean, I know you said that they weren’t up to standards. Was it really a pricing issue or is there something else going on there?

Leonard Tannenbaum

I’ll definitely give you clarity. And actually, the issues -- the four issues were all different which is even more miraculous. One of them had to do with all healthcare companies have issues in Medicare and Medicaid and we sent diligence teams in to look at potential Medicare upcoding, which was called.

And it basically means charging the wrong reimbursement code perhaps accelerating income because of that. So one issue was around some of the diligence we did around, how that company charged, and by the way that’s not that uncommon but if you find it measurably, you really have to make sure that that’s absolutely clean before a company is purchased.

Another one, I think you misrepresented EBITDA by a couple of million dollars, and we found that in our quality of earnings reports. And therefore the private equity sponsor has to go for a price reduction or settle the deal altogether. And a third one, actually went with one sponsor and then switched to a different sponsor based upon simple fit.

Private equity sponsors often say that, they fit well with management and they feel like that’s a great fit and therefore they win at a better price. And I can tell you that private equity firms that really have the right structure and the right people in it, really do have to pay price. And in this case, here is an example where the private equity firm would be better fit with management one and at a lower price. So in order for that to happen, the exclusitivity period has to terminate.

So the fourth one was, we do background searches on these -- what now, I think, is the former CEO of the company and the search has turned up items that we just weren’t comfortable with at all. And so then the question does that person leave and if the person leaves, how does the company absent that person and is this is a person issue or company issue, and so more diligence had to be done surrounding that. So those are the four circumstances.

Jasper Birch – Macquarie

Thank you for the color. I guess, Len, you were talking about your nonaccruals and so you are tough spots here in the portfolio. I was wondering that we get a little more color on one of the bright spots namely Traffic Control & Safety Corp. since you had write-up and add on investment in it.

Stacey Thorne

So Traffic Control & Safety was an example and I personally wasn’t -- I’m involved in this company. In fact, I personally took over as chairman of Traffic Control & Safety, which is the only portfolio company that I’m on the board of. Obviously, my team is on the board or observers in every company, but this one I’m personally involved in. As it is now, I think it is a controlled investment, right, Bill. It’s not a controlled investment?

Bernard Berman

Not by the guideline.

Stacey Thorne

Not by the guidelines but we have two for 5.6. So Traffic Control & Safety basically ran into an issue of lack of bonding and a private equity sponsor that did not have the capital anymore to support that company. It also ran into an issue of buying too many companies at once.

So what we did was, we went in there and used our resources including, really terrific resources of certain new -- one of our new portfolio of management team leaders, which is Rob Rakowski, who is the director at AlixPartners, who is now spending one out of every two weeks out there, and amazingly this thing has turned -- at least not necessarily earnings yet, but in the structure, in the integration and in the team leadership, the new CEO also has really done a great job and has exemplified somewhat by our backlog build.

And we as a firm are using Fifth Street to support the bonding requirements necessary for their business. I’m actually very excited about the potential. There’s certainly no guarantee that this thing will turn into a winner, but all of our early indications shows that Traffic Control is getting cleaned up, and is in very good shape and positioned well, should the economic continue to recover.

Jasper Birch – Macquarie

Great. Thank you. And then lastly what was the thought process behind the monthly dividend?

Leonard Tannenbaum

There are two thought processes. One, we’ve heard throughout the year from -- we actually do -- so we do institutional and we also sometimes do retail visits. And our retail visits consistently have said, oh, why don’t, we really like much the dividends, we like interesting cash flows.

So recently we’ve asked lot of the institutions, the institutions say, well, we don’t necessarily -- we don’t really need monthly dividends, we are happy with quarterly but we understand that the cost of capital drops from to monthly instead of quarterly, we would be supportive of it.

We do talk to our shareholders very frequently. The other issue, especially in this quarter where we did cut the dividend, we reduced the dividend in the September quarter to $0.10. Because we wanted to make sure -- the Board really wanted to make sure that the shareholders had the visibility into the next quarter’s distributions, and at the end of our fiscal year.

So it was a very good time to switch to monthly. The idea was not to make believe and reduce the dividend in the December quarter. The idea was to do really what many of our shareholders wanted, which is a monthly dividend but also give the confidence that we all do feel that this is a one quarter issue for our company.

Jasper Birch – Macquarie

Okay. Well, thank you, guys for your time. I appreciate it.


Thank you. Our next question is from Robert Dodd of Morgan Keegan. Your line is open.

Robert Dodd – Morgan Keegan

Hi, guys. One housekeeping one and one more detailed one about credit quality, on the dividend income that you guys have seen in the quarter, popped up quite nicely on this 400 debt of dollars. I’ve searched in the Q, and I can’t find if that how that is, is that a sustainable lay or was that a one-time dividend income?

Leonard Tannenbaum

This dividend income was a one-time dividend income, but what I would tell you, BDCs have core earnings and then they have many one-time events that are contributed to earnings. For example, if perhaps the deal would you get refinanced this quarter and we got potentially, prepayment penalty and an immediate write up to the point upfront that had not been amortized. Well, that’s a one-time event, right that we have refinanced and we have to invest in a new loan. It will increase earnings for that quarter. So I might hope as you see more of these one-time events creep into earnings over the next year.

Robert Dodd – Morgan Keegan

Okay. Got it. On the credit crisis, you highlighted the index and if I look at it, the index is trailing EBITDA and its bottomed down back in November and it's been trending more positively since then. At the same time we’ve got more non-accruals in this quarter. Is that -- and you have mentioned that the difference between ’07 versus ’09 vintages et cetera. I mean, is there a continued divergence in terms of EBITDA performance in those companies by vintage, or is there some other selective non-accrual type driving event? I don’t know if that was clear.

Leonard Tannenbaum

No. I understand the question. And really what’s happening is our medium to stronger securities are just doing well. But the companies that got into trouble through the ’08 crisis -- the economy is not strong enough to bail them out. And they are operating with a debt load often that they just can’t sustain. So they are making decisions that are crimping their operations and so there’s a divergence between our basket, three, four and five rated securities and everything else securities, which is the ones and twos.

And 6% of our securities are clearly stressed [ph] and that’s why they are in those baskets. And the other 94% are actually doing better and improving.

Robert Dodd – Morgan Keegan


Leonard Tannenbaum

I’m not -- I’m saying in general, obviously there is some better [ph] and some are improving. But in general I think I made such statements true.

Robert Dodd – Morgan Keegan

Okay. Thanks a lot.


Thank you. Our next question is from Jim Ballan of Lazard Capital Markets.

Jim Ballan – Lazard Capital Markets

Great. Thanks a lot. Obviously, the spending is lumpy and that is what we obviously this quarter? Since you declared the dividends through year end, can you talk about like how much incremental investment do you need to make in order to meet those numbers or are you already at the run rate where you can -- where you’re sort at the pace that you are showing with the new monthly dividends?

Stacey Thorne

That was the primary question the Board asked me, when they deliberated on what to do with distribution policy. And where the Board made the decision, often BDC is get on, what I call a treadmill [ph], where they are forced [ph] to maintain a dividend and/or their dividend is in covered by distributable income. And they continue paying a dividend that of capital. And they will continue to do that in hopes that origination bails them out. And I do not want to ever be on this treadmill.

However, the $0.32 dividend which was weighted at the Board was maintained because the Board and I have confidence, that this is a one quarter issue. And it really doesn’t need much origination to maintain this dividend rate and we looked out about 12 months. Having said that, you never know what other events, capital lies. So there’s no guarantees, but I think also the nice thing about a monthly dividend is the shareholders can feel comfortable, because we are really declaring ahead by an additional quarter. So you have a lot of visibility as to the dividends in the future.

Jim Ballan – Lazard Capital Markets

Great. Thanks a lot Len.


Thank you. (Operator instructions) Our next question is from Keith Rosenbloom of Care Capital Group. Your line is open.

Keith Rosenbloom – Care Capital Group

Hey, Len. Hey, guys. Len, could you speak a little bit to the differences that you’ve put in place with your credit, your credit assessments if you will. The 2007 portfolio, as you talked about has gotten hit as a vintage and it’s applied both to first lien and the second lien loans. Currently, you are able to make first lien loans, can you talk to us as to what the team or what you guys are doing differently and why we shouldn’t expect similar results from the current portfolio?

Leonard Tannenbaum

Well, first is that -- the 2007 vintage was I think -- from what I remember all the slides, 85% second lien and 15% first lien. It was really -- it’s a second lien portfolio, not to say, we didn’t have plenty of experience in second lien portfolios, we did. That’s what I’ve been doing since 1998. But clearly, a second lien portfolio through an economic cycle performs far worse, and the recovery rates in this cycle have been worse than many have expected.

So both of those worked against us, but I think also we’ve enhanced the underwriting teams a lot. We are a very different company than we were back in 2007. I mean, having the addition of Chad Blakeman, who managed $1.5 billion for Freeport in the 65 securities, has given a lot of confidence to us and to our lenders. And he is a very risk focused individual. In fact he doesn’t care what price we charge and we get. He only cares about what the downside is and Evelyn [ph] who built the underwriting teams, making them work together as co-CIOs is very powerful from an underwriting process, having three individual teams with individual and industry specific expertise is more than we’ve ever had before.

So -- as we grow bigger, obviously we get better and we attract better talent. And I hope that helps in the future, but again there’s no guarantees.

Keith Rosenbloom – Care Capital Group

Great. Thank you.


Thank you. (Operator instructions) This concludes today’s question-and-answer session. I would now like to turn the conference back over to management.

Leonard Tannenbaum

Thank you very much for attending and we look forward to reporting some results in our September monthly newsletters.


Ladies and gentlemen, thank you for participating in today’s conference. This concludes the program, you may now disconnect. Good day.

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