Newtek Business Services Inc. (NASDAQ:NEWT) Q4 2018 Earnings Conference Call March 7, 2019 8:30 AM ET
Barry Sloane - President, Chief Executive & Founder
Jenny Eddelson - Executive Vice President & Chief Accounting Officer
Conference Call Participants
Peter Heckmann - Davidson
Casey Alexander - Compass Point
Leslie Vandegrift - Raymond James
Mickey Schleien - Ladenburg
Good day, ladies and gentlemen, and welcome to the Newtek Business Services Corporation's Fourth Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator instructions] As a reminder, this conference call is being recorded.
I would now like to introduce your host for today's conference, Mr. Barry Sloane, President, CEO and Founder. Sir, you may begin.
Thank you very much, operator. And to our Investors present today, we greatly appreciate you attending our full year 2018 financial results conference call. We do have a PowerPoint presentation that is attached to our website newtekone.com, Investor Relations section and we'll be following along with that presentation. I'd like to point all your attention to slide number 1 on the forward-looking statement and would appreciate if everyone would have the opportunity to absorb that.
We'll now move to slide number 2 and as we do on these calls regularly, we like to look at the company's historical stock performance. Obviously, last year was a challenging year for most public companies with respect to stock performance. However, if you look at our five year, three year and one year returns, all quite stellar. Newtek's total return for this calendar year, which does not include the first quarter dividend, 13.8% as of Feb 28 and that's with the stock trading at $19.84. We are higher than that. We closed yesterday around $20.19.
Moving to slide number 3, relative to outperformance, for the year ended December 31, 2018, total return, which would include reinvested dividends, Newtek is up 3.5%. We clearly outperformed the S&P, which was negative, the Russell 2000 and we look forward to continuing to be able to deliver that type of performance to our shareholders.
On slide number 4, we added a slide that we usually don't and probably won't in the future, however, there was a foreseeable jump in short interest on our shares to follow along from the middle of November to February 15th, which is the last active date. We've gone from about three days in cover to 14.63 days in cover. We see this activity as unusual. We wanted to point it out to the market. Our stock will go ex-dividend on March the 14th.
Moving to slide number 5. We're very, very happy and excited about talking about our performance in 2018 as well as future forecasting for 2019. Our future looks very, very bright, obviously, and looking at growth in key metrics, we had a year-over-year increase in the 7(a) business, which historically has been a driver for us. We look to add additional drivers, which we'll talk about on the call. Our loan volume was up a little over 20% for the year and we're forecasting 20 plus percent growth for 2019 in 7(a) volume alone. On referral volume, which obviously is key to us being able to grow the business as well as pick good credits, we grew to about $18.8 billion, a very healthy growth in loan referral opportunities over the prior calendar year. We have a slide on that in the presentation.
We've clearly been able to improve and increase our technological advances, which allow us to process loans quickly, get them through the system. We use technology to improve the customer experience as well as the employee experience and give loans through prequal underwriting into committee as quickly as possible. Obviously, things do change over time, and probably on the last call, everyone was concerned about rising rates, listening to Fed governors and certain pundits, that's a little bit less concerning. However, we clearly have a floating rate portfolio without any caps. Our liabilities are also floating rate. It's very well asset liability managed. We've been able to reduce our cost of capital by evidence in a 50 basis point reduction in our Capital One line last year, our refinancing of our Goldman Sachs line with Webster Bank, a savings of 350 basis points on approximately $40 million of debt.
We've increased our capacity in lending lines for 504 loans, which if you add in the accordion features on that business, we have approximately $150 million from Capital One and we're in negotiation with Sterling to bring that line up to a $100 million. So clearly our organization is bullish on the 504 component and being a growth segment and a future engine of growth at the portfolio company level in 2019 and beyond.
Moving to slide number 6, focusing on the 2018 financial highlights. Total investment income, up 27% for the year. Our NII, which most of you are aware comes in at a loss due to the fact that gain on sale is eliminated from a GAAP standpoint. However, the loss narrowed to an 11.1% increase on a per share basis, so NII improvement of 11.1%. Adjusted NII, which includes gain on sale that most of you are familiar with, we had a 9.6% increase to $36.4 million or $1.94 per share for the year, which did beat analysts' -- consensus estimates by $0.02 to $0.03. NAV, year-over-year increase, not quite 1%, but given the challenges in the fourth quarter, where our cost of capital clearly widened out, we're proud of our performance and having a steady NAV for the year.
From a leverage perspective, debt to equity came in on a GAAP basis at a 117%. If you exclude the result of government guaranteed portions settling over the quarter, that would get knocked down to about 105%. Total investment portfolio also increased by 18.5% for the year.
Moving to slide number 8, we like to focus on sort of the rationale for why people own Newtek Business Service Corp shares? Obviously, it's a dividend paying stock as a BDC and for that company we must pay out between 90% to a 100% of our taxable income in the form of the dividend. And as we always state in our public releases as well as to investors, we always and have always endeavored to pay that out of taxable income, which has been the case so far. So if you go back in our history and people say, gee, why has your stock performed so well? Well, look at the dividend increases. We started off at $1.50, last year we delivered $1.80. We're forecasting $1.84, it's a 34% increase over that period of time, over $1.50 base, so real nice increase, extremely impressive for a BDC. Dividend growth is clearly one of our primary objectives and as we look to add additional lines of business in at the portfolio company as well as growing 7(a) business, we're clearly excited about our future.
Moving to slide number 9, on 2018 SBA highlights, we funded close to $470 million of 7(a) loans, a 21% increase over $385 million. We are forecasting a midpoint range of $600 million, $580 million on the down, $620 million on the upside, and that would be a 27% increase. Given the volume that we have in 2018, which we do expect to increase this year, if we just nudge that closure rate up from 2.5% to 3%, which we are adamant about will not cut into credit quality. We pick up another $90 million of funding. So we feel very good about being able to increase the amount of fundings in 7(a), be able to execute better and close more as our 504 business matures and we're extremely excited about the opportunity in our non-conforming segment, which we'll talk about shortly.
On slide number 10, some highlights, we talked about the reduction in our line for the payment business with a refi of Webster, saving 350 basis points. In November of 2018, we closed our ninth and largest securitization with Deutsche Bank and Capital One Bank as the underwriters. It was a great transaction for us that significantly sold the deal greater spreads 3.7 cover, and it was the largest deal that we have ever done. We look forward to doing more of those in 2019, as well as other securitizations, particularly in non-conforming.
In February of 2018, we closed an underwriting of $57.5 million of baby bonds trading above issue, stock symbol NEWTI on the NASDAQ. Baby bonds will be something that we'll continue to participate in going forward as well as our equity based ATM, both off of our shelf. And lastly, as we mentioned, we had a 50 basis point reduction in our $100 million revolver through Capital One.
On slide number 11, forecasting 7(a) loan fundings, as we've said, capital is sufficient both via equity or debt as well as capital on the balance sheet. We do think that our referral volume will grow significantly in 2019. We talked about our close rate being a very modest 2.5%. We also talked about expansion in our offices, both in the Boca office and in the Orlando office, Irvine office to help us grow our lending platform. We're picking up new alliances on a regular basis, that's adding to our referral count and obviously the launching of the non-conforming conventional loan program, we think will also be additive for the 7(a) and 504 business.
On slide number 12, we talk about our securitization in a little bit more granular basis, 83.5% advance rate, the best advance rate that we've had and the notes were priced at initial yield of 4.32%, with the gross coupon on those notes prime plus 2.75%, which is about 8.25%.
So on the loans that we're paying interest through the bonds versus the coupon, look, you've got close to 390 basis points spread, absent liability, and then you've got 17% of the pool that has no debt. That's the equity and the securitization throwing off an 8.5% coupon.
So you could see, the more of these types of transactions that we're able to add, we'll be able to get more interest income, less expense. Clearly, that's a growing segment of our contribution, which is one of the reasons why our GAAP NII continues to improve year-over-year.
On slide number 13, something we haven't historically talked about relates to exercise of optional redemptions in our securitizations. So, our typical securitizations have a call option at around 20% of bond base. That's value because our bonds are -- we use the term turbo structured, meaning that the collateral is fully dedicated to pay off the senior debt.
So, when we get to that call option, we're able to relever the collateral plus the cash in the reserve fund. So last year, we were able to redeem the 2013 notes and add them to our 2018 securitization. Through that call option, as a result, we were able to increase our borrowing ability by approximately $15.6 million, which represents the cash in the reserve fund, plus the ability to lever the collateral in, first, a warehouse line and then in a securitization.
The advance rate in the securitization at 83% is clearly above the advance rate that exists in the warehouse line of 55% and is also well in advance of the over collateralization as the bonds paid down in Turbo.
So this is useful to us, because we're able to take that additional cash and that's cash that's useful to making new loans, grow our business without having to raise additional equity. Very important, it pushes equity raises into the future and enables us to increase our adjusted NII and NII per share to investors. We do anticipate in 2019, announcing another such redemption, which we haven't done at this point in time, which will provide us a similar benefit that we had to the 2013 deal.
On slide number 14, we talk about the positive effects of rising interest rates. Who knows, on the next call we can talk about what happens in a declining rate environment as the world has changed, but clearly, with our portfolio being well asset-liability matched, quarterly adjust, plus floating rate on the liabilities, we're in a good position with a pretty good margin.
And although, higher prepayment speeds are negative with respect to the servicing asset and possibly to premiums, they are helpful in generating additional cash for paying the bonds down faster and reducing our need for equity capital.
On slide number of 15, we have previously announced through an 8-K and on this call that we, through a wholly owned affiliate of Newtek Business Services Corp., signed a joint venture with BlackRock TPC -- TCP, sorry, Capital Corp. And the purpose of the JV will be to originate commercial business loans to middle market companies, as well as small businesses.
We're excited about the venture. Newtek and BlackRock TCP are committed to contribute up to $100 million in equity capital each. We are working on closing a leverage warehouse facility, $100 million at the start, up to $200 million and an accordion feature.
We're very excited that we believe out of the existing $18.8 billion of referrals that there could be close to $300 million out of those historical looks that could be available right out of the chute to be able to do this type of business.
Company believes the JV investment in non-conforming conventional loan program could have a positive impact on 2019 performance, but we have not put it into our dividend at this point in time of $1.84, which also relates to being paid out of taxable income.
On slide number 16, obviously, we talked about that refinancing with Webster Bank, very positive. And in slide 17, we affected a very nice, attractive sale on a wholesale portfolio. Wholesale meaning, they were wholesale to Elavon, Elavon owned by U.S. Bank, one of our processing platforms. So we sold 1,200 merchants back to Elavon on their platform.
This is a portfolio that we picked up in the Premier Payments acquisition, which was approximately three years ago. I think a little short of three years and in that sale, we recorded a $5.6 million pre-tax gain. After tax, I think that's around $3.8 million. Some of those funds, which Jenny will talk about. And earnings were upstream, but there's still a healthy amount that's sitting down within our merchant processing portfolio company.
We received a $7.5 million upfront payment with a $500,000 earn-out, which we think and are hopeful we will receive, equates to a total of $8 million. We paid $16.5 million for Premier, little less than three years ago.
So if you look at the map and this, then the Elavon portfolio was about 25% of income and processing volume, so that would equate to approximately $4 million of the $16.5 million; you're looking at a double basically in three years.
So, we're very proud of our Payments unit, growing the business, making good on a solid acquisition. Now what this does do, however, is when you sell it, you lose that reoccurring income, which was somewhere approximately around $1 million.
We also exercised the call option on approximately 1,200 merchants with our distribution channels that allowed us to improve our cash flow by approximately $1.5 million. So that will offset the $1 million and we're excited about this, we have a nice forecast of about $15.5 million of EBITDA from our Payments unit going forward. And that helps our valuation, nice growth business for us and we're pleased to also note that one of our largest acquisitions to date has worked out well for the company and its shareholders.
On slide number 18, that's sort of our pedigree in 7(a). We are still the largest non-bank 7(a) lender. In the fourth quarter, we're the fourth largest 7(a) lender including banks. And when I say, fourth quarter, that's fourth quarter calendar; it's first quarter government, because the government closes its books on September 30.
I think it's also always important to note, when you look at the risk in our loan portfolio, you're looking at $181,000 average balances, floating rate coupons, no caps. We think when you look at our portfolio versus other BDCs, the level of risk and diversification that's inherent in our portfolio, extremely attractive, given $1.84 dividend vis-à-vis what is currently, a $20.16 or $20.19 price.
Slide number 19, our SBA 7(a) loan pipeline, up about 35%. Now, one thing about our pipeline, our technology is allowing us to clear loans through the pipeline quicker. So, you're going to see lower and lower growth rates.
Don't fret, this is based upon efficiencies, it's based upon our ability to pick and choose through the credits, decides which ones we want to close, maintaining modest growth rate, not an out of control growth rate.
What's the different between a modest growth rate and an out of control growth rate? A modest growth rate for a lender means that you've got the right talent in place, you've got the right technology, you've got the right systems, you've got the right policies and procedures, versus just pushing things through the system to make accounting gains.
Well, we've been very successful in managing this business over the course of 16 years and we think that controlled growth, particularly making sure that you've got the right staff in place to do the business the right way and maintain your risk reward parameters is really, really important.
On slide 20, growth in loan referrals in dollars, $10.7 million to $18.7 million, a 74% increase. And in units, we looked at 64,000 units. That's a lot of people to talk to and in as many cases, or in most cases say no to.
21 is a graphic depiction of referrals, 22 talks about pricing in the secondary market or the government pieces and trends. So, for the three months ended September 30th, I think this is a typo. So that should be for the three months ended December 31, we basically moved our gain on sales sequentially from the end of the third quarter to the end of the fourth quarter from 109.28% to 109.97%. For the year, we averaged 10.52%.
Look, we talk about the decline in the weighted average at premium and we believe obviously it's an increase in speeds which has a correlation to higher levels of rates. But the decline in pricing is based upon prepayment speeds.
On Slide number 23 and we talked about this in the previous call, we're looking at an NPL portfolio about 5.7%; our charge-offs about 85 basis points. As we mentioned previously, we don't think that we have a 35 basis points charge-off portfolio in a given year.
We are now in the belly of the default curve. The seasoning of our portfolio I believe is 27, 28 months. The belly of the default curves is from 24 to 36 months. So, this should begin to level off.
If you go to the next slide on 24, sequentially from the quarter end in September to the quarter end in December, you can see that as appearing to flatten out and it not only is appearing, it is.
On Slide 25, looking at the context of the portfolio, loans that are backed by commercial real estate, important to note, we are not a commercial real estate lender. We are what's referred to in banking parlance as C&I lender, Commercial & Industrial. We make business loans.
In the course of making the business loan our credit thesis is the business must demonstrate the ability to pay the P&I; then we take all personal guarantees. We take all collateral available. The collateral of choice which has the best recovery for us, obviously, is commercial real estate. That's what we choose.
Now, just because we take commercial real estate as the first it doesn't mean that we're not taking marketable securities from the principal, inventory, accounts receivable, a lien on the home, machinery and equipment as a second third or fourth, we take all available.
That is the key to our underwriting and you could see real estate is important to us between commercial and residential liens as the primary still in excess of 55% quite a difference from 2007.
When you look at Slide number 26, the purpose, obviously, we're not a huge start-up fan. We're also not a huge business -- a business acquisitions fan, but we do do them. It's important to note.
Existing businesses, clearly, the bread and butter 83%; loans made to businesses that are around two to three years plus have a much higher likelihood of survival. These are things that we picked up over being in this business for 16 plus years.
When you look at geography, we love diversification and you could see particularly versus 2007, we're diverse and we're now -- I think we've gotten big enough that we can avoid what I'll refer to as domination of the four biggest GDP states Florida, Texas, California, and New York. If you look at the math you're probably close to 40%. From a GDP perspective, they probably represent 65% to 70%. We clearly prefer to be diverse in the other states beneath that and we'll continue to endeavor to do that.
Slide 28 and 29 are slides that have been present for 10 years in our presentations I'm not going to go over them. But for newcomers to the story it is important to know how we generate cash on a 7(a) loan and how we generate income on a 7(a) loan.
Looking at our portfolio company review which represents approximately 30% to 35% of our annual dividend. Our 504 business has continued to grow, albeit, at a slower pace than I'd like, but steady. The government slowdown did impact that a reasonable amount.
We were able to close in the calendar year 2018 between 504 loans and a conventional loan that we moved over at the last minute $42 million of those types of loans which enabled us to meet our guidance and we feel very good about our business going forward due to growth in referral volume as well as establishing growth in our loan processing offices in Orlando and Boca.
Moving to Slide number 33, it's important to note for the analysts that all 504 loans will be originated out of NBL standing for Newtek Business Lending. We had done some of the 504 loans out of CDS. CDS will wind up being a pure-play on conventional line of credit against inventory and receivables with NBL being the origination entity that will be responsible for 504 loans and as well as originating the non-conforming loans.
We're excited about a full year 2019 forecast of fundings of about $100 million. At the end of the first quarter, we will adjust that and to see how the shutdown has affected that financing.
Closings are higher. Closings are represented by the fact that in many instances 504 loans are done on a construction basis. So, even though you've got a contract to fund the fundings haven't occurred.
We make money in the 504 business on the points on the first and the second loan. We make money on the fundings on the coupon versus the cost of financing and then we make money on the sale of the conventional first. So, there is a cycle associated with income in the 504 business.
And although we have a de minimis contribution of 504 earnings to the $1.84 in calendar year 2019 we do believe this will be a nice engine of growth for us for the future and importantly lever the great infrastructure that Newtek Business Services Corp has created.
Slide number 35 is a simple sample of what a 504 loan looks like; 36 with the economics. Slide number 37, we have a valuation on our payments business of approximately $116 million that's a significant part of our NAV that we have across the whole organization.
We have owned and operated payments organization. I believe since 2003 or 2004 so quite a bit. We know the business well. We processed over $6.1 billion of volume. We reduced our cost of capital by 350 basis points on about a $40 million drop. That's about a $1.4 million annualized savings in interest expense.
The business had grown nicely and obviously we came in at a $14.7 million adjusted EBITDA. That came in a little lighter than expected because we sold off a piece of the Elavon portfolio and which reduced some of the reoccurring income.
But we talked about the change in 2019; A, with respect to income coming in from the call on the other residuals. I believe that $15.5 million figure does not include much or any of an increase between gain on sale that's sitting down at the portfolio company.
So, we look at that $15.5 million and look at it as conservative. We're excited about the payments business, a lot of really good things changing. And in the publicly traded segment entities like i3 Vertcals, Jet Pay just got bought, EVO trading at very nice publicly traded multiples.
Slide number 38, we talk about our technology portfolio companies. Obviously, about a $20 million market value represents a little under 10% of our NAV, an important growth vehicle. We're working hard to get these businesses online on track to make significant earnings and cash flow contribution to the company. When people ask us, what are you doing in this particular segment? The goal is for Newtek to have a full suite of IT infrastructure services. There is a huge opportunity existing in the cloud services space.
We want to lever our existing customer base. We want to lever our existence to provide a managed service to clients both new and current. We believe we can cost effectively provide timely provide solutions, while providing -- and providing a significant market opportunity for Newtek Technology Solutions.
Products such as IT-as-a-Service, Desktop-as-a-Service, Disaster Recovery-as-a-Service, Security-as-a-Service, secure email, hybrid cloud, private cloud and managing public cloud and managing workloads in Azure, AWS and Google are our goals.
In summary, looking at Newtek for those of you that are new to the story, we're an internally managed BDC. We don't pay two and twenty to a management company. All our expenses are fully loaded. We have a differentiated business model. As you can see we've got operating businesses underneath the publicly traded mutual fund.
We believe that -- we obviously got a proven track record, established privately 1998 publicly since September of 2000. We're clearly not new to business lending. We went through multiple lending cycles and have tremendous depth and experience in this particular space.
It's important to note we don't buy package loans. We're true retail-based originator using strategic alliance relationships. Our average loan balance of $181,000 exudes diversification and distribution of risk throughout the portfolio, geography, loan type, et cetera.
We do not invest in derivative securities. There is no SBIC leverage. We don't buy CDOs with equity kickers. And we are not a second lien or mezzanine lender and have no direct exposure to volatile industries like oil and gas. We frankly like stable businesses that we repay principal and interest.
And with that, I will hand over the financial presentation to Jenny Eddelson.
Thank you Barry, and good morning everyone. You can find a summary of our fourth quarter and full year results on slide 42 as well as the reconciliation of our adjusted net investment income or adjusted NII on slides 44 and 45.
For the fourth quarter of 2018, we had a net investment loss of $1.1 million or $0.06 per share, as compared to a net investment loss of $2.9 million or $0.16 per share in the fourth quarter of 2017, a 63% improvement on a per share basis. Adjusted NII which is defined on slide 43 was $10.8 million or $0.57 per share in the fourth quarter of 2018, as compared to $9.2 million or $0.51 per share for the fourth quarter of 2017, a 12.6% improvement on a per share basis.
For the full year of 2018, we had net investment loss of $7.5 million or $0.40 per share, as compared to a net investment loss of $7.9 million or $0.45 per share, an 11.1% improvement on a per share basis. Adjusted NII for the full year of 2018 was $36.4 million or $1.94 per share, as compared to $30.8 million or $1.77 per share in 2017, an improvement of 9.5% on a per share basis year-over-year.
Focusing on some of the fourth quarter 2018 highlights, we are pleased to report $14.7 million in total investment income, a 40.7% increase over the fourth quarter of 2017. Both interest and dividend income were the primary drivers for the increase, with interest income increasing by 34% resulting from a higher interest rate on our SBA loan investments year-over-year, as well as an increase in dividend income from our controlled portfolio companies.
Our dividend income in the fourth quarter of 2018 included $2.4 million from NMS, $375,000 from Sidco and $1.6 million from Premier Payments, which included a portion of the gain that Premier recognized on the sale of the Elavon portfolio in the fourth quarter of 2018.
Total expenses increased by $2.5 million quarter-over-quarter or 18.5%. Salaries and benefits increased by 13.1%, due to an increase in headcount coupled with higher compensation costs, and total interest expense increased by $1.4 million in the fourth quarter of 2018, primarily due to higher average outstanding debt balances.
Origination and servicing expenses increased by $821,000 in the fourth quarter of 2018, as compared to the same period in 2017, due to higher referral fees for the current quarter as well as increases in other loan related expenses period-over-period. Realized gains from the sale of the guaranteed portions of SBA loans sold during the fourth quarter totaled $13.1 million, as compared to $12.8 million during the same quarter in 2017. In the fourth quarter of 2018, NSBF sold 168 loans for $108.6 million at an average sale price of 109.97%, as compared to 136 loans sold during the fourth quarter of 2017 for $94.3 million at a weighted average sale price of 111.44%.
Looking at realized losses for the full year, we recognized $2.7 million in 2018, as compared to $1.2 million in 2017. Net unrealized depreciation on investments totaled $5.7 million in 2018 and $10.8 million in 2017 a decline of approximately 47%, which was primarily due to higher appreciation in 2017 on controlled investments.
Overall, our operating results for the fourth quarter resulted in a net increase in net assets of $7.6 million or $0.40 per share, and for the full year $35.7 million or $1.91 per share. We ended the year with NAV per share at $15.19, an improvement over our 2017 NAV per share of $15.08. And in terms of capital resources, our liquidity remained strong at the end of the year with approximately $48.4 million of availability under our credit lines and $2.3 million of unrestricted cash.
I would now like to turn the call back to Barry.
Thank you. Operator, we'd love to take questions now.
Thank you. [Operator Instructions] Our first question comes from Peter Heckmann with Davidson. Your line is open.
Good morning, everyone. Thanks for taking my questions.
Thank you, Peter.
Barry, what are you contemplating – you may have said it, I may have missed it but in terms of average debt-to-equity for the year, do you see that ramping with or going within a range, but kind of where are you seeing the average now that you can lever up a little bit more?
Sure. Well, I think that we look at the real risk not necessarily what is reported on a GAAP basis at the end of a quarter where we get a little bit inflated, but you know we're averaging a little bit over one-to-one and we've historically stated that we want to modestly grow that side of the leverage and take it in. Now when you look at leveraging risk, it's important to note once again we're primarily leveraging loan balances of $180,000. So these aren't mezz. These aren't sub debt. These aren't leveraged buyout loans at four, five, six times multiples that require growth. So, we feel that, we can clearly handle substantially higher levels of leverage. But we're going to – we're going to monitor what we're doing. We're going to look at the capital markets, the ability to issue equity at attractive prices. We've been very modest, I think Jen, if you don't have the number handy, but in the fourth quarter we raised a small amount of equity.
Couple of hundred thousand – couple of hundred thousand dollars yeah. So we keep our eye on stock price that's important to us and we've been a premium to NAV. We don't hit the accelerator. We don't want to hurt shareholders. So I think that Pete, the best way to describe it is do not expect us to zoom up to 1.8 or 1.9. It will be modest. We want to demonstrate to the markets that we can handle it. Realistically speaking most non-bank lenders are levered three to four to one, forget BDCs.
Now BDCs are little bit special in the sense that they typically have to go a little bit out on the risk spectrum to pay the two in 20 and I say it's two and 20, maybe it's one and half, one and half the market is conceding a little bit more there, but we don't do that. We've got an infrastructure. We have a higher return on equity. So I would say a modest slow increase quarter-by-quarter.
Got it. That's helpful. And then I didn't understand the mechanism exercising the call option on that block of merchant accounts within the payments business. Is that – you're taking those in from like an ISO network?
It's a little bit convoluted. I also want to mention Peter that, that particular option is not something that you'll see reoccurring. It was something that we acquired when we acquired Premier as one of the assets. But we had a basic – we had the opportunity to call the portfolio at modest valuations and we took advantage of that. So that allows us to pick up significant cash flow with very low cost of acquisition and we manage those accounts over a period of time and that helps our overall cash flow. So when you look at the transaction that we did in Q4, even though we gave up about $1 million of reoccurring cash flow to Elavon we've picked up approximately and this is conservative $1.5 million by calling in other residual that were going to third-party participants in the distribution channel.
Okay. And was the consideration to exercise that calls to get to that?
Was the consideration – well I'm sorry. The consideration was cash. We had to pay cash for those, but the math in the accounting treatment was favorable to us.
Okay. Okay. And then just last question; I'll get back in the queue. But on the joint venture with BlackRock in terms of timeline getting the funding in place and then starting to actually look at underwriting some loans do you expect that to happen summertime or so?
I would like to answer that question with a song yesterday all my troubles. I'm just kidding. For others that are listening. No, I would have liked this to have been completed by now. So I am hopeful we'll have a Spring Fling on this.
Great. Good to hear. Thank you.
Thank you. Our next question comes from Casey Alexander with Compass Point. Your line is open.
Hi, good morning.
Hi, Casey. Good Morning.
The JV if I read it right it's sort of a hybrid vehicle? Am I guessing that you're going to be sort of contributing half of the assets and BlackRock is going to be sort of contributing half of the assets from an underwriting and origination standpoint do I get that right?
You're pretty close Casey. So relative to the concept of and I'll use the word contribution the venture is clearly an origination venture and BlackRock TCP [ph] will contribute half of the equity, Newtek Business Services Corp will contribute half of the equity, we'll get a leverage line from a third-party and that through the Newtek – the Newtek system we are going to be taking in the referrals just as we always have been creating that big funnel and when appropriate we're going to take referrals and direct them assemble them and underwrite them to the conventional business. BlackRock TCP and Newtek will each control 50% of the credit committee and both require an approval to be able to fund the loan in the venture.
But the infrastructure for creation of the loan, which won't be bought won't be previously made will be the Newtek infrastructure through its alliance relationship so that the UBS's, the Morgan Stanley's, the Raymond James's, the Navy Federal Credit Union et cetera, et cetera will be bringing us referrals as they always have been and we'll be channeling when appropriate those referrals into what we refer to as a non-conforming. We use that term because it's non-governmental program bucket in which BlackRock and Newtek will each own half of the equity and a special purpose vehicle, in which we will be doing securitizations out of and generating good returns for the equity. The equity Casey will show up on our schedule of investments and the leverage in the SPV. We'll not consolidate, because this is a true joint venture between BlackRock and Newtek.
Right. So this is then similar to from a portfolio standpoint to how other BDCs do JVs that just your equity is going to show up like a portfolio company and that will pay dividends to the BDC?
Yes, sir. Exactly right. You got it right, yeah.
Okay. Great and thank you for clarifying, what non-conforming means because sort of non-conforming conventional sound sort of like an oxymoron. The dividend should we think in terms of the dividend from portfolio companies as in 2019 sort of ratcheting back to the trend that it had been working on given that this dividend included a part of the gain from the Elavon transaction?
A – Barry Sloane
It's a good question Casey. I think that realistically speaking in the last couple of years, we have been between 30% to 35% in contribution, from the portfolio companies to the ultimate dividend of which that 30% to 35% given that they come from taxable entities is considered a qualify dividend. I think for the 2019 purpose, it's fair to assume that we're going to be within that range; that's our forecast. However, I would say as a goal, I would like to get that number to be a higher number and that's beneficial to all the shareholders because it just demonstrates diversified sources of revenue apart from just what you might call 7(a) gain on sale and the spread of the 7(a) loans on the book. So we look to grow dividend income from payments from 504, from non-conforming, from tech solutions, from insurance agency, from payroll health and benefits to grow that side of the business.
Q – Casey Alexander
Okay, I appreciate that. I also appreciate your commentary about the non-performing loans and the charge-offs that you believe you're sort of at the belly of the loan curve and so they should be stabilizing here. But let me ask you a question, if you expect referrals to increase and you're going to increase your capture from referrals from 2.5% to 3%. Even though your NPLs and your charge-offs are at manageable levels, if you're increasing the size of that funnel, should we expect to see those reset at some higher level than where they're at right now?
A – Barry Sloane
It's a good question. I'll try to give you kind of a blanket answer. I think that as a percentage of the portfolio, we are hopeful and optimistic that from a 7(a) standpoint levels out. Some of the things you're going to start to see is a decoupling because we're going to wind up putting a bigger percentage of non-conforming loans on our books. So Jenny and I have had conversation and what you're going to see in Q1, you should begin to see a breakout of that particular number which loans are 7(a) and which loans are -- and I want to define conventional and non-conforming for you because -- for you and everybody else.
You know as an old Ginnie Mae and Fannie Mae and Freddie Mac mortgage-backed security sales person, any loan that went into a government program was called a government loan. Any loan that was done private was considered conventional and the concept of non-conforming means, it doesn't conform to a government program. By the way Casey these are my definitions, it's not GAAP. So I kind of use them synonymously.
With that said, we are hopeful that the 7(a) portfolio which is in the belly of the curve, if it picks up a little bit as a percentage of the total portfolio, it shouldn't grow, it may grow a little, but it shouldn't grow and we'll start to begin to segregate out. There are certain loans that are in that category. Here's an example, I've currently got loans that are in the category that are current pay, but the borrower is in bankruptcy. Now why would you say a company in our business is currently paying it in bankruptcy? Well they've got other obligations outside of our obligations that they are renegotiating. We don't think that's a non-performing loan.
However based upon how we've historically defined it, it's sitting in that bucket. We are going to redefine that going forward in our upcoming Q and reset the parameters. We have been extremely conservative in defining what is an NPL? To me, if the loan is current pay and performing in this segment, I'm happy. I'm very happy. And we have some loans that are in that bucket. We also have some loans that are in that bucket that are conventional. They will need to come out.
Q – Casey Alexander
All right. Thank you very much. I appreciate you taking my questions.
A – Barry Sloane
Thank you very much.
Thank you. [Operator instruction] Our next question comes from Leslie Vandegrift with Raymond James. Your line is open.
Q – Leslie Vandegrift
Hi, good morning.
A – Barry Sloane
Hey Leslie, how are you?
Q – Leslie Vandegrift
Doing well, back in business this morning. You mentioned guidance on the call for 7(a) in 2019 about 20%-plus volume growth. That's pretty healthy growth. How much of that is because competitors such as [indiscernible] et cetera are starting to move away from it.
A – Barry Sloane
I definitely think some competitors that don't have our system and efficiencies back out of the market and that's going to be helpful. But -- and maybe wind up, giving us more business and more opportunity and we do have a lot of people coming to us saying, oh gee, I give you all my business, just pay me two or three points for a loan and we say, sorry not interested, it's just not what we do and it's not our model.
But putting that aside, I think that a lot of that growth is based upon the fact that when we launch the non-conforming program, when we look at getting a -- so by launching non-conforming program, we're just going to get more looks. Businesses come to us not looking for a 7(a) loan or a line of credit where we come. They just come to us for funding.
So by being able to state that we can do loans up to $15 million by broadening our horizons with alliance partners, we just think that's where the growth is coming from. We believe that by going into the market and saying, we lend money to businesses, 10 to 25 year AM schedule, no covenants, single-digit interest rates; that's our business. That's totally different that OnDeck, Kabbage. They are like six to 24 months. They're 25% to 80%. They're not long-term capital.
So our ability to position ourselves in the market as a real provider of credit to this market based upon our 16 years' worth of experience in dissecting this market and being able to take a funnel and weed through 64000 referrals in a given year. I mean it's funny because people say to me a lot of times and they go oh, you're an SBA lender and then I like you know my head tilts and I'm kind of bummed out; and no that's not what we do.
What we do is we figure out a way to create distribution channels, to process business whether it's loan, technology, payment, et cetera faster and better. So we think that our growth is not based upon our competition; it's not based upon market conditions; it's based upon the fact that we have created what we believe is a better funneling system, distribution channel, mousetrap to improve the client experience, to improve the alliance partner experience, and to improve the employees experienced in processing a lot of business more efficiently. We think that's why we're going to grow.
Okay. And then on the third quarter call, you gave a bit of guidance for what you're seeing possibly for premiums in 2019 you said about the 109 handle level would be your expectation. Is there any update there?
Yeah. So, we finished off the year close to 110, and the market is higher in the first quarter. I'm not going to say how much higher. This is publicly available information I tried to stay away from price discovery, but I think the other factor in price is what's your split between the 10-year paper, which tends to trade close to 109-110 give or take and the 25-year paper, which tends to trade close to 114 plus but we net 112 because we split the premium. So I mean I would like to think and hope and the quarter’s not over and we have a lot of work to do that we could be north of 110 in the first quarter and we've given guidance that our models are based on 109. So hopefully that's a little helpful to you it.
Got it. Thank you.
Thank you. And our next question comes from Mickey Schleien with Ladenburg. Your line is open.
Yeah, good morning Barry and Jenny. Barry, I wanted to start by asking you about how the government shutdown affected your business in January?
Thank you. Well, you know, like all government shutdowns they're always challenging. This one was a little more challenging given the duration. So approaching December 21st when it became apparent to us that the government was shutting down. I think at the same -- at the same time the market and cost of capital was going crazy, which frankly did affect our NAV marks for the year and will most likely rebound in Q1, stock market down 10%, in December up 10%, in January effectively. So the government shutdown basically forced us to push some of our fundings back into the quarter, but frankly we've been through this. We've got our -- being a PLP lender, we were able to cover the existing pipeline. We sold forward that pipeline as it closed. We held back on fundings through the first four to six weeks, which by the way if there ever was a shutdown having it happen in January isn't a bad thing, because that's usually our weakest quarter people typically don't do much borrowing in Q1 or I should say closing.
So I think you will not see an effect, I think that this won't affect our guidance, this won't affect our loan quality. And what happened Mickey was we were able to build up a substantial portfolio, which when the government opened we then got guarantee numbers and we're able then to close loans, which we're in the process of doing and consequently sell them into the market. So we're in good shape.
So from a volume perspective, you think you'll be able to make up for whatever opportunity you lost in January -- in February and in March, is that correct?
That's what Pete Downs tells me.
And I know he's listening. So I just put some pressure on him.
Barry, in terms of the close rate that's obviously an important factor for this year. We're almost -- well we're a couple of months into the year, it's early days. But have you seen signs of that close rate improving so far if you look at the year-over-year numbers?
I think Mickey that what we try to do is we try to maintain what I'm going to call modest controlled disciplined growth in our lending business. And I think relative to the close rate and focusing on the close rate of 7(a) we're very comfortable, 2.5%, 3%, 3.25%, 2.25%. We're going to do what's required to put the best credits that we see on the books within our numbers.
So we're very comfortable with the numbers that we put out into the market and do manage to a generic close rate. I'd say this because there is going to come a point in time where our referrals aren't growing by 74% that's just unsustainable.
The reality of it is we have such a huge portfolio of opportunities to pick and choose good credits from given the underwriting guidelines, the close rate -- I mean, I'm not saying we're going to go from 2.5% to 15% because our model, the referrals that come to us and this is a good question, they're raw, they're not packaged, they're not assembled, they're not structured. That's what our great team under Bob Rabuck does who manages 25, 26 people.
So you know I think that the key question is we are very comfortable. I'm going to use the term with a 2.5% to 3% close rate and the current 7(a) growth, although we're going to be scrambling a little bit, but I think we're going to be able to do it.
Okay. Thank you for that, Barry. Looking ahead for the last few years, always talked about rising rates. But if you look at the forward curve now, the market is expecting rates to start to decline next year and we all know that the curve can be wrong. But I'd like to understand, I do understand that the balance sheet is match funded but when you consider also CPR and how an economic slowdown could affect all of your businesses. Net-net, how would an interest rate decline impact Newtek particularly since you've lived through cycles before?
Yeah. So I'm going to also assume this is important, interest rate decline with a subsequent slowdown in the economy. So I'm go take that hand -- because look rates can go wherever they want to go, we believe that holding everything else constant by the way it doesn't make a difference.
However, rates moving I think are a consequence of the economy speeding up or slowing down. So assuming that the economy slows down, look I think that gain on sale will pick back up again. We get higher prices for the government guaranteed securities, and I also think that loan demand in a slower economy would pick up, because banks become a little bit less aggressive in a slower market. So it would be a little bit more competitive, but look Mickey for 16 years we've been doing this, we don't feel we -- in this one segment of the business, I'm just focusing on 7(a) lending that we get much affected by rates going up or down. I think we've kind of proven that in an up-rate scenario. Now by the way, one of the provisions is that we continue to get a good asset liability match on our portfolio. The capital markets do well. I think we're in pretty good shape Mickey. I'm not overly concerned about rates going in either direction. I don't think we'd benefit or lose by a rise or an increase in rates. It's pretty balanced.
I understand. Barry, I do want to follow-up on the questions about the JV maybe to get a little bit away from the jargon in the market. Can you just sort of give us a bigger picture of what kind of a loan might go into the JV that just couldn't go into 7(a) or 504 to give us a sense of what kind of assets you're looking at for that vehicle?
Sure. So first off, the balance. So if you are a borrower and you need more than $5 million, you can't qualify for an SBA 7(a) program, because it's -- the max loan is capped at $5 million; that's item number one. So someone comes in for $7 million loan and $10 million loan they're going to go into this bucket. Then there are certain vagaries of the SBA program. First of all, the only loan that we do under 7(a) is prime plus 2.75%. So if you've got a borrower that says, I've got to be fixed, this program will be fixed for five years.
So if somebody wants a fixed-rate loan and won't do a floating rate loan, it will wind up going into this program. That could mean, they could be a $2 million borrower, but they're going into this program. Let's say you've got three guarantors that own 33% and 30% of the business. One of the guarantors that is an outside investor will not personally guarantee the loan. With a debt service coverage two to one, commercial real estate behind it been in business five years can get an SBA loan. That's going to go into this program.
So the concept of the term non-conforming, loans that do not conform to the strict SBA policies and procedures within the $5 million cap will be offered this program and we think there is voluminous amount of those opportunities. Secondly, borrowers that want more than $5 million will go into this program. In addition, we have borrowers in the portfolio that have used up their $5 million of SBA guarantee, they're great operators, they're great owners and they had got a new business opportunity. We now can offer them additional financing.
So Barry taking all of that into consideration and I'm sure you analyze this backwards and forwards before you launched it. What sort of coupons are you talking about and cost of debts and leverage and ultimately ROE in the JV?
Sure. I think that on a gross coupon, we're probably going to be out on the street from like 8% to 10.5% and that will be fixed for five years.
And I know you haven't finalized your debt capital, but what kind of spread can you capture and how much leverage your lenders going to allow in that JV?
Yeah, I think I'm going to have to stop at this point until that's baked Mickey. But I certainly appreciate the question and I know that you and others are going to be working on building a model for this. So we'll try to be as helpful as we can.
Until this gets baked, I think, we're going to hold off on that. I would hope to be able to give you more guidance at the end of the next quarter and we've been pretty clear not to include any of this income for 2019, but it is on the table and it could generate some income for 2019.
Okay. Well, do you suspect that it could generate ROEs at least in the low double digits? Is that a reasonable target?
Well, let me say this, given that we've got to payout a healthy market dividend and we'd strongly prefer -- look, when we look at stuff at time, sometimes I look at stuff and it's like, okay, we can earn 9% or 10%. So one of my challenges are, okay, do I do that, because that will basically pay the dividend, right? So that's okay.
But the more of that that I do, the more it dilutes from the higher returned activity like 504 lending or like 7(a) lending. We would like to believe that this activity, as we modeled it, will be a higher return on equity after charge-off and severity than our dividend coupon, so that it's not dilutive to shareholders. But that's a forecasted guess at this point in time. And my Chief Legal Officer has an imaginary finger on my shoulder and he's telling me to stop talking.
Okay. Fair enough. But maybe, just one last broad question on the JV, given the collateral constraints in your funding on your balance sheet, maybe a question for Jenny. How does Newtek fund the cap or the equity commitment for the JV, if it happens in the next few quarters?
Well, I think, what we'll be doing, Mickey, is on a very balanced approach. Number one, we're liquid at the moment. We've got a lot of capacity on our lines of credit across the board. We've got ATM, we got baby bond capability, so we definitely try to stay away from giving out our plans, less the market jumps in front of us and starts front running us.
But I'm very pleased with our capital structure receptivity of the market. Every baby bond we've done is trading at a premium. I think, you'll be hearing positive news on our lines of credit, as well as additional lines to fund these businesses. So I guess after 16 years of paying people timely and principal interest, they get comfortable with you and they should.
I will be honest with you and I've said this on a regular basis, I look -- I wake up every day and figure out what crane is going to hit me on the head and we are not carried away with where we sit in the market. We have a lot left to do.
We have a lot of blocking and tackling and I think we're just at the beginning of really doing a nice job for our clients that being medium-sized companies all across the United States, as well as stock investors and creditors, et cetera.
So we can't be more excited about 2019 and going forward than where we are today. We're very well set up and I thank all the investment banks and investors and creditors for being helpful in that endeavor.
Okay. So just to follow up on that. The credit lines would allow you to draw with the use of proceeds to be injected into the JV. There's just no restriction on--
Yes, I've got underutilization on every single one of my lines.
Okay. I was just curious from a collateral perspective. And lastly, I just want to--
I think I just want to say -- now that you're on that -- I want to say one thing. So, given that somebody that really wants to have multiple avenues, I could draw my credit lines, we could do baby bonds, we could do ATM, we could do this -- not this -- joint venture specific, but mind you our goal, from Jenny and my perspective, is to always be diverse, have diversified pools of capital because markets do shut, they do change. So, we've always made sure we've got as many levers to pull as possible. We don't want to be reliant on any one thing.
No, I agree with that and appreciate it. And just sort of a housekeeping question. I think in the past Barry, part of the 504 business was actually reflected on Newtek's income statement, but now that all of that business will be in NBL starting this year, will that business completely be reflected through the dividend from NBL or will those still be some sort of straggler affecting the income statement at the Newtek level?
Broadly speaking the 504 business should be reflected out of a portfolio company NBL and that would relate to spread, underwriting fees, and gain on sale. That's the goal and that was why we put that slide in there today. It's been a little convoluted in the past. As you sort of put things together and part of it was with CDS and I think there was one point we made a -- I think we made a conventional loan out of the BDC, but that's a portfolio company.
Okay thanks. That will be cleaner that way. I appreciate your time this morning Barry and Jenny. Thank you.
Our next question comes from Fred Cannon with KBW. Your line is open.
Hey guys this is Luke on for Fred. How is it going?
Hey Luke, how are you?
Good. Just a housekeeping thing. Jenny my speaker went out when you were giving the loans sold in dollar amount for the SBA. Do you mind just reiterating that?
Sure, for the fourth quarter?
So, in 2018, we sold 158 loans for $108.6 million and that was at an average price of 109.97%.
Okay, perfect. Thanks. And then just a couple of questions. I'll keep it quick. On the origination and servicing expenses you guys saw that was a little bit higher than previous quarters, but it looks like it was similar to last year. Was that just year-end seasonal?
Exactly that's basically referral fees that do tend to be higher in the fourth quarter.
Okay got you. And I know there's a lot of talk earlier about the sale to Elavon did you guys quantify the dollar amount that was impacted or that their dividend income was impacted by that?
About $1 million.
$1 million. Okay. Thank you very much. And then just one last one you guys have talked extensively over the past couple of quarters about how you've been able to bring down some of your interest cost and credit lines, how do you see your interest expense going forward?
Well, obviously, in a growing business the total number will definitely increase, but I think that tapping a variety of different markets being diverse leaves us in a pretty good position. We've got longstanding relationship with a lot of our capital providers and we're appreciative of that. So, you know, we try to keep a good balance on that.
I would say this, I do believe that our thought process, going forward, is not a major change in rates up or down in the next 12 to 24 months. So from that perspective, being floating rate is useful to us because it gives us the most value without a lot of volatility. Baby bonds being fixed are problematic, but they can be swapped back into floating and we haven't done that yet, but that might be something that we'd look at.
I think when you look at the spread of our assets, with the floating cost of money to the fixed coupons we're talking about, it's attractive. And I don't see -- and you got to be careful here just because the trade issue is the big swing in the market right now. I mean, that could move equity and debt markets in a big way. So, I reserve the right to see what happens in the next 60 days regarding trade. I think if Trump -- this is a -- if Trump cuts a deal with China and our whole trade balance -- all bets are off. There is going to be a lot of changes. So, we'll answer that question again at the end of the next quarter.
Q –Unidentified Analyst
Thank you. And then -- sorry -- just one other one. I know there's been a lot of talk about the conventional loan program. You guys have -- and as you said, you're trying to target a 2%, 2.5% to 3% close rate on referrals, the rest of the conforming or the non-conforming loans could come out of that other 97.5%, right?
Q –Unidentified Analyst
Perfect. Thank you very much. Thank you for taking my questions.
Thank you. And I'm not showing any further questions at this time. I'd now like to turn the call back over to Mr. Barry Sloane for any closing remarks.
Well, wanted to thank everybody for their participation today and want to thank the staff, all the employees associates at Newtek. They did a great job. We are optimistic that we'll deliver equal to or better results next year and look forward to our first quarter call which will come up very quickly. Thank you everyone.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program and you may all disconnect. Everyone have a wonderful day.