Main Street Capital Corporation (MAIN) Q4 2014 Earnings Report, Transcript and Summary

Greetings and welcome to the Main Street Capital Corporation Fourth Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to Jenny Zhou. Thank you. Please go ahead.

Thank you, Brenda and good morning everyone. Thanks for joining us for the Main Street Capital Corporation fourth quarter and full year 2014 earnings conference call. Joining me today on the call are Chairman, President and CEO, Vince Foster; Chief Operating Officer, Dwayne Hyzak; and Chief Financial Officer, Brent Smith. Main Street issued a press release yesterday afternoon that details the company’s fourth quarter and full year 2014 financial and operating results. This document is available on the Investor Relations section of the company’s website at mainstreetcapital.com. A replay of today’s call will be available beginning about an hour after the completion of the call and will remain available until March 6. Information on how to access the replay is included in yesterday’s press release. We also advise you that this conference call is being broadcast live through an Internet webcast that can be accessed on the company’s webpage. Please note that information reported on this call speaks only as of today, February 27, 2015 and therefore you are advised that time-sensitive information may no longer be accurate at the time of any replay listening. Our conference call today will contain forward-looking statements. Many of these forward-looking statements can be identified by the use of words such as anticipates, believes, expects, intends, will, should, may and similar expressions. These statements are based on management’s estimates, assumptions and projections as of the date of this call and they are not guarantees of future performance. Actual results may differ materially from the results expressed or implied in these statements as a result of risks, uncertainties and other factors, including, but not limited to the factors set forth in the company’s filings with the Securities and Exchange Commission, which can be found on the company’s website or at sec.gov. Main Street assumes no obligation to update any of these statements unless required by law. During today’s call, management will discuss non-GAAP financial measures, including distributable net investment income and distributable net realized income. Please refer to yesterday’s press release for a reconciliation of these measures to the most directly comparable GAAP financial measures. Certain information discussed on this call, including information related to portfolio companies was derived from third-party sources and has not been independently verified. And now, I will turn the call over to Vince.

Thanks, Jenny and thank you all for joining us today. I will comment on the performance of our investment portfolio, discuss our recent dividend announcements, and conclude by commenting on our investment pipeline. Following my comments, Dwayne and Brent will cover our operating performance in more detail and comment on our fourth quarter financial results and originations, recently announced exits, our current liquidity position in certain key portfolio statistics. After which, we will take your questions. We were pleased with the performance of our investment portfolio as a whole during the fourth quarter. Our lower middle-market investments, our key focus area, appreciated by $7 million on a net basis with 23 of our investments appreciating during the quarter and 6 depreciating. Our middle-market loan, private loan and other investment assets depreciated by $14 million, $3 million and $4 million respectively during the quarter on a net basis. Our middle-market loan depreciation was primarily a result of retail leverage loan mutual fund outflows negatively impacting secondary trading prices of syndicated loans. Lastly, our investment in our external investment manager appreciated by $7 million during the quarter. We finished the quarter with a net asset value per share of $20.85, a sequential increase of $0.05 a share over the third quarter after adjusting for a supplemental dividend of $0.275 a share paid in December. Our lower middle-market companies with over $100 million of cash on their balance sheets collectively continued to exhibit highly conservative leverage in debt service coverage ratios which Dwayne will cover in greater detail. Earlier this week our Board declared our regular monthly dividends for the second quarter of $0.175 a share in each of April, May and June. This represents an increase of 3% over the monthly payout of $0.17 a share in the first quarter of this year. We are very pleased to be in a position to continue to increase our regular monthly dividend distributions. We continued to expect that we will pay semi-annual supplemental dividends in addition to our regular monthly dividends as long as we are in a significant undistributed taxable income position. We began 2015 in relatively same strong undistributed taxable income position we enjoyed the end of the third quarter of last year. We therefore anticipate asking our Board to declare a semi-annual supplemental dividend in June in the range of $0.25 or $0.30 a share. As of today I would characterized our investment pipeline is average. Not surprisingly over the last several months, we started seeing distressed energy opportunities which we are evaluating on a highly selective basis. We completed a small mineral interest financing earlier this quarter which we concluded was highly attractive from a risk reward standpoint and which represents a type of opportunistic investment that we will seek to continue to – excuse me that we will continue to evaluate in the current environment. We continue to seek and receive significant equity participation in our lower middle-market investments and as of quarter end, we owned an average of 35% fully diluted ownership position in the 95% of these investments in which we currently have equity exposure. Our officer director group has continued to be regular purchasers of our shares investing over $800,000 during the fourth quarter. With that I would like to turn the call over to Dwayne Hyzak, our Chief Operating Officer and Senior Managing Director to cover our portfolio performance in more detail.

Thanks Vince and good morning everyone. We are pleased to report another strong quarter which supports our goal of generating sustainable growth in our dividends per share and another year which supports our goal of also generating meaningful growth in our net asset value per share. We believe that the combination of steady long-term growth in our dividends and meaningful net asset value per share growth provide a unique value proposition that differentiates Main Street from most yield oriented investment options and has generated the premium total returns realized by our shareholders since our IPO in 2007. In the seven plus years since our IPO our unique investment strategy and efficient and leverageable internally managed operating structure have resulted in operating performance that has allowed us to grow our declared recurring monthly dividends per share by 59% and to return cumulative dividends to our shareholders of over $14 per share are greater than 95% of our IPO price per share of $15. During the same time period we have also grown our net asset value per share from approximately $12.85 to $20.85 or over 62%. In and our experience while most financial firms discussed capital preservation as the key goal far fewer have consistently achieved that goal over extended economic cycles. And even fewer have been able to increase the value of their invested capital. We believe that the primary driver of our success has been and continues to be our focus on the underserved lower middle-market and specifically our investment strategy of investing in both debt and equity and acting as a sponsor and a partner to management and not just the financing source in the lower middle-market. We believe that our equity ownership positions in lower middle-market provides significant value to our shareholders and these investments are the primary driver behind our significant pretax net unrealized depreciation of approximately $3 per share in our lower middle-market portfolio as well as our cumulative net asset value per share growth. These equity investments also support growth in our realized income and therefore our dividends paid to our shareholders through current dividend income received and periodic realized gains upon the exit of these investments. An example of the benefit of these equity investments is the significant dividend income we generated in the fourth quarter of 2014. Our net realized gains of over $12 million in the fourth quarter from the exit two lower middle-market equity investments and the $7 million of net unrealized depreciation from our lower middle-market portfolio investments. Now turning specifically to our investment portfolio at year end and our investment activity in the fourth quarter, we are pleased to report that our overall portfolio performance remained strong and the portfolio continues to improve as diversification in each quarter by issuer, industry, end markets, geography and vintage. Our investment activity in the fourth quarter included total investments in our lower middle-market portfolio of approximately $85 million, primarily as a result of our investments in five new portfolio companies which after aggregate repayments on debt investments and return of invested equity capital resulted in a net increase in our lower middle-market portfolio of approximately $55 million. We also had a net increase in our private loan portfolio of approximately $35 million, while our middle-market portfolio was relatively unchanged from prior quarter. As a result at December 31, we had investments in 183 portfolio companies that are more than 50 different industries across the lower market middle-market, middle-market and private loan components of our portfolio. The largest portfolio company investment is approximately 3% of our total income and approximately 2.3% of our total assets. And the vast majority of our portfolio investments represent less than 1% of our income and our assets. We believe that this portfolio diversification adds significant protections to our investment portfolio, recurring investment income, and cash flows and provides significant benefits to our shareholders. Additional details on our investment portfolio at year end are including in the press release that we issued yesterday, but I will touch on a few highlights. Our lower middle-market portfolio includes 66 investments at year end, representing approximately $733 million of fair value, which is greater than 22% above the cost basis. Consistent with our investment strategy, approximately 72% of our lower middle-market portfolio at cost was in the form of secured debt investments and approximately 90% of those debt investments held a first lien security position. As Vince mentioned, we continue to hold equity positions in 95% of our lower middle-market portfolio companies with an average fully diluted equity ownership position of approximately 35%. I would characterize the bulk of our lower middle-market portfolio as seasoned and that we have been in the majority of those investments for at least 2 years and in many of these investments for significantly longer. The seasoned nature of our lower middle-market portfolio is reflected in a de-leveraged lower risk position from many of these investments and an expanding list of equity investments with growing or accelerating unrealized depreciation. At the lower middle-market portfolio level, the portfolio’s median net senior debt to EBITDA ratio was 1.9 to 1 or 2.1 to 1 including portfolio company debt, which is junior in priority to our debt position. At December 31, our equity investment portfolio at a fair value that is over 1.9 times this cost basis, reflecting over $160 million of net unrealized depreciation. As a compliment to our lower middle-market portfolio, in our middle-market portfolio we have investments in 86 companies, representing approximately $543 million of fair value. And in our private loan portfolio, we had investments in 31 companies representing approximately $213 million of fair value. Our middle-market and private loan investments provide significant portfolio diversification and generated additional investment income to cover our dividends. The total investment portfolio at fair value at December 31 was approximately 108% of the related cost basis and we had five portfolio investments on non-accrual status, which comprised approximately 1.7% of the total investment portfolio at fair value and 4.7% at cost. In summary, Main Street’s investment portfolio continues to perform at a very high level and continues to deliver upon our long-term goals of sustaining and growing our dividends as well as generating meaningful growth in our net asset value per share. With that, I will turn the call over to Brent to cover our financial results and our liquidity position.

Thanks, Dwayne. We are pleased to report our total investment income increased by 16% for the fourth quarter and 21% for the full year over the same periods in 2013 to $38.8 million for the quarter and $140.8 million for the year. Both increases were primarily driven by increased interest income associated with higher levels of debt investments and increased dividend income from equity investments when compared to the prior year. With the fourth quarter increase primarily driven by a $3.6 million increase in interest income, a $1.6 million increase in dividend income. Investment income in the fourth quarter includes $700,000 of unusual dividend income, which represented approximately $0.02 per share. This was consistent with the amount of unusual dividend income recorded during the fourth quarter of 2013. Fourth quarter 2014 operating expenses, excluding non-cash share-based compensation expense increased by $1.5 million over the fourth quarter of the prior year to a total of $11.2 million. The increase was primarily the result of a $2 million increase in interest expense due to the issuance of our investment grade notes partially offset by lower cost in other areas. The ratio of our total operating expenses, excluding interest expense as a percentage of our average total assets, which we believe is a key metric in evaluating our operating efficiency, was 1.4% on both an annualized basis for the fourth quarter and for the full year, representing improvement from 2013 and which continues to compare very favorably to other BDCs. Our efficient, internally-managed operating structure continues to allow us to deliver a greater portion of our gross portfolio returns to our shareholders and we believe that it also provides for greater alignment of the interest of our management with the interest of our shareholders. Our increased total investment income and continued leverage of our internally managed operating structure resulted in a 16% increase in distributable net investment income for the fourth quarter of 2014 to a total of $27.5 million or $0.61 per share exceeding our recurring monthly dividends paid for the quarter by $0.10 per share or 20%. Our net investment income includes the benefit of the fees earned by our external investment manager under its sub-advisory relationship with the HMS Income Fund, with the external investment manager generating approximately $1 million of contribution to our net investment income during the fourth quarter of 2014, including the cost allocated to it during the quarter. Based on the funds current fund-raising efforts and activities, we currently project that this relationship will contribute approximately $0.02 to $0.03 per share of net investment income per quarter during 2015. As Dwayne previously mentioned, we completed the exit of investments in two lower middle-market portfolio companies in the fourth quarter, which resulted in net realized gains of $12.4 million. And as Vince discussed, we recorded net unrealized depreciation on the investment portfolio in the fourth quarter of $17.8 million. This was primarily the result of the previously mentioned realized gains, which resulted in a corresponding reversal of unrealized depreciation recorded in prior periods and net unrealized depreciation from portfolio investments of $7.2 million, which was primarily related to our middle-market investments due to the volatility in the leverage loan market. This was partially offset by net appreciation on our remaining portfolio investments, including $7 million related to our lower middle-market investments and $7 million related to our external investment manager. The operating results for the fourth quarter of 2014 resulted in a net increase to net assets of $22 million or $0.49 per share. On the capital resources front, our liquidity and overall capitalization remains strong. At year end, we have $60.4 million of cash, $9.1 million of marketable securities, and $354.5 million of unused capacity under our credit facility. Today, we have $28.8 million of cash, $9.2 million of marketable securities, and $296.5 million of unused capacity under the credit facility. As we look forward to the first quarter of 2015 with more visibility than we typically have due to the timing of this conference call and consider the impacts of sequential reduction in usual and seasonal dividend income and the estimated $0.01 per share of incremental interest expense in the first quarter of 2015 relating to our investment grade notes. We currently expect that we will generate first quarter 2015 distributable net investment income of $0.53 to $0.55 per share. This estimate is $0.02 to $0.04 per share above our previously announced dividends for the first quarter of $0.51 per share. With that, I will now turn the call back over to the operator. So, we can take any questions.

[Operator Instructions] Our first question comes from the line of Bryce Rowe with Robert W. Baird. Please go ahead with your questions.

Thanks. Good morning. Just wanted to touch on a couple of topics here. Maybe Vince and Dwayne and Brent, could you guys speak to current yields on opportunities within each bucket of the portfolio? We saw a little more yield compression out of the lower middle-market in the private loan books and then you had increase on the middle-market side of thing. So, just maybe to speak to some of that if you don’t mind?

Sure, Bryce and thanks for the question. When you look at the lower middle-market, I would say that we have seen some yield compression when you look at the numbers, but I think it’s really a result of us looking at some larger lower middle-market companies than what we had seen a couple of years ago and just having your sum rotation of the portfolio that results from historically smaller lower middle-market companies rotating out and being replaced with new companies that are slightly larger. And therefore, you will come with a little bit of a lower yield on the debt investment. That would be the primary driver on the lower middle-market side. And as you can see with our numbers when you look at the percentages of assets in the portfolio, we continue to focus on first lien senior secured investments. And as you move up in the larger companies, those types of companies will merit a little bit of a lower rate. So, you are seeing that in lower middle-market stats. When you look at the middle-market, I would say, that in the current environment we are seeing a little bit of an improvement in the rates there just given the market activity that Vince touched on in his comments. And I think we will continue to see that as you look forward at the next quarter.

Okay. And then just kind of a follow-up to that, Dwayne, with some dislocation in the market especially on the energy side and you talked about the opportunistic investment already here in the first quarter trying to kind of gauge what the growth prospects are within each bucket of the portfolio? And what you are seeing from a pipeline perspective, I know you described it as average, but maybe a little more detail there would be helpful?

Well, just on the particularly the lower middle-market pipeline, Bryce, we have had kind of an abnormally high amount of conversion of our pipeline into closed deals at the end of the fourth quarter and at the beginning of the first quarter. So, as a result, we kind of monetized the pipeline, if you will, so we need to build it back up again. Again, the opportunities are fairly constant. We never know what’s going to make it through diligence and what’s not. Unfortunately, we were able to get a lot through and a lot close. So, we got to build it back up again. In terms of growth prospects I am not sure I completely understood the question, gross prospects in the existing portfolio, Dwayne, you want to…..

Yes, Vince, I am trying to get a sense for you talked about some – maybe some more opportunistic deals within the middle-market portfolio and the lower middle-market portfolio, but just curious if you are seeing better opportunities now on the middle-market side given recent market dislocation?

Absolutely, yes. And there is kind of the non-energy and the energy opportunities. The non-energy opportunities arise from kind of technical market conditions, where there have been retail outflows that have continued even this week, which causes its open and mutual funds to have to sell to meet redemptions and dump loans on to the market. So, you are seeing technical opportunities. They are driving yields up at least temporarily. You are not seeing anything really fundamental that’s unusual. So there is opportunities there, but that’s almost a day by day inflow, outflow type of condition. On the energy side of the equation, obviously there is a lot more volatility and it’s pretty interesting. I mean, what you worry about is how much debt, how much revolving debt outstanding in the capacity thereof that’s in front of you? How these borrowing bases are impacted as they get re-priced as hedges – are revaluated as hedges roll off? And then of course with respect to the service companies, things were a little bit more dire, because there is really nothing to hedge. And so there is just a lot of work involved and there is kind of seemingly unlimited supply of opportunities. We just have to determine how much exposure we want to take. I think for the very, very best opportunities, I think we are willing to take some more exposure. Our credit facility really causes us to have to be very diversified. And so you wouldn’t see our exposure book more than a few 100 basis points. And so we are trying to be very selective as to how we fill up that buck, but there is a lot of opportunity there. So, really its times are good in terms of opportunities out there.

Great, that’s helpful. Thanks guys.

You bet.

Our next question comes from the line of Robert Dodd with Raymond James. Please go ahead with your question.

Hi guys. I am not focusing on energy since you had – on kind of the balance sheet side in the past you have tended to match the amounts or more closely in terms of the middle-market balance and do they have all focused obviously both floating rate and tried to basically match book funding assets and liabilities. That clearly isn’t the case at the moment, especially after the most recent one with – at 4.5. Is it the intention to keep the asset mix much more skewed to floating versus liabilities with a view obviously to rising rates or is this just a temporary timing thing and you intend to more balance that?

Yes. Robert I would answer that and when you kind of look at the assets side of our business, I don’t think our intend is to change what we have done historically as it relates to the types of assets from a floating or fixed rate standpoint just to refresh everyone’s memory the lower middle-market is predominantly almost exclusively fixed rate investments whereas the middle-market is almost exactly the opposite almost all floating rate. So when you look at our activity in the – the end of 2014 kind of the fourth quarter to utilize our investment grade rating to access the institutional debt markets and get some additional fixed rate debt. Obviously, that was more of an opportunistic long-term capital planning initiative as opposed to something that would shift – indicate a shift in the types of assets we are looking at.

I think that’s right. I mean when you – we really wanted to tap that investment grade market and what was available to us was what it was it was fixed rate. The duration was more or less dictated to us. We are first time issuer, the size was kind of dictated to us and so but we wanted to go ahead enter that market and impost ourselves to become a repeat issuer, where we will have more options. So it’s really more opportunistic than trying to design a certain liability structure for our assets to finance our assets.

Great. Thank you. And just second one, I mean on the past couple of quarters you talked about may be adding a new strategy that’s an exaggeration, but another revenue stream beyond the lower middle-market and middle-market, etcetera, I mean can you give us an update on where you stand on that?

Yes. It’s a good question. There are really three categories of opportunities that we are evaluating kind of simultaneously. The first category is what if any vehicle – the Hines people decide they want on the – at least on the loan front, they want to launch following the completion of the fund raising for HMS, is there going to be an HMS 2.0 if so what will it look like that the non-listed BDC world is changing as a result or is projected to change pretty materially as a result of some new regulations. So that’s kind of an ongoing area of study and a lot of that is dictated by the independent broker dealers and the type of product that they want on their platform and then we will have to decide if it fits us or not. The second category is kind of a whole senior loan fund concept and does that make sense for us or not and we are continuing to evaluate that. And the third category is asset management and there is a specific opportunity out there for another public company that has a lease versus buy type decision with respect to some assets that they need to manage, do they want to bring on their own people or do they want to do something with us and that’s a particularly promising opportunity there that we will spent quite a bit of time on. So, yes, I predict one or more of these is going to materialize by the end of the year, just kind of hard to say and probably just be one, it probably won’t be two.

Okay, got it. Thank you.

Sure.

Our next question comes from the line of Christopher Nolan with MLV. Please go ahead with your question.

Hi, guys.

Good morning.

Just a clarification, was there any detail provided in the comments and I might have missed it, and I apologize if I did on the non-accruals in terms of the makeup of those credits?

Chris, the information we have provided on the non-accruals was that we have five companies on non-accrual and the percentage of fair value is 1.7% and it was 4.7% of cost.

Okay. Those are in the press release, but no other details in terms of what industry exposure or anything?

We did not provide additional color on that, but I would say that it’s diversified. There is a not a concentration among of those five companies in any particular industry or geography or otherwise. It’s just company specific issues that have created those non-accruals.

Got it. And then a broader question, looking at the metrics for the lower middle-market sector, it seems like you are starting – you are seeing a continuation in terms of a slow deterioration of some of the key metrics and I point to the fair value to cost, the EBITDA coverage, the yields, do you expect continued compression of various metrics like that for this bucket?

Yes, Chris. I would have to look back at some of those metrics to see, which you are referencing. I think one of the previous callers asked the question about the weighted-average yield and we addressed that with kind of a movement, some larger companies that obviously as part of that process, can and will be able to get a lower rate. But we are evaluating to those and provided their credit profile is better. We are willing to give them that lower rate, but outside of that we haven’t seen deterioration or any negative movement in the other trends in the lower middle-market portfolio. So, I would have to kind of spend more time talking to you about which ones you are looking at.

Yes. When – what we have noticed is some early questions we received from the shareholders and analysts after the press release yesterday resulted some confusion between middle-market and lower middle-market. Those terms kind of sound the same and if you read the press release real quickly you can – you might not be clear, which is which, but the middle-market is strictly loans, company’s average, I think, it was $77 million in EBITDA and lower middle-market those companies about one-tenth of that size. And almost always involved equity ownership – significant equity ownership and loans that we design lead companies that we sponsor, frequently control, share controls, so really they are completely different and we really don’t see much deterioration in the quarter for lower middle-market metrics other than there is some yield compression as you are transacting with larger companies. They will begin to have other opportunities for financing but you have to be competitive with. The way we look at it though when we are – when we are financing a larger company in the lower middle-market and we might receive a nominal yield of 10% instead of 12% or something like that, remember that because of our exempted relief, we are placing a material part of that investment with HMS and we’re getting a 1% fee. So the way we are kind of looking at it, it’s more than 10. We are going to compensate it for transacting with larger companies to fulfill the demand that HMS has particularly during the fund raising ramp, which isn’t going to be forever. And we are getting compensated there – and we are getting compensated on essentially everything, so would you express any other right way?

No, I agree with what you said Vincent and Chris is that kind of tossing more about your question, I don’t know if this will answer it or provide any additional color. But when you look at certain of the stats that we provide and one of those would be the fair value as a percentage of cost. When you look at our third and fourth quarters as we have significant realized gains that historically unrealized depreciation moves to realized gains, so when you compare that to a cost basis, that percentage will decline. But we view that as a good thing because not only did we prove out the mark, but if you look back at our realized gains, they historically have always been above our mark. So we think that should give investors additional comfort, but when you look at that one stat and compare Q2, Q3 and Q4 and we have $20 million plus of realized gains in the last two quarters. It will impact that type of percentage if that’s one of the ones you are looking at.

And I think you are monetizing unrealized depreciation.

Got it. Final question is how are you guys looking at equity raises and I ask this from the context of now you have institutional debt investors now with you and your leverage ratios are starting to approach levels where in the past you raised equity?

Yes, that’s a good question. We kind of formally announced a target in connection with our S&P rating of 75% leverage target if you will including the SBIC debt. And we are at that level. You are absolutely right. So we really have as – when a new investment comes in we have two decisions. We can raise equity or we can monetize some of our middle-market portfolio because that is reasonably liquid and it might take 3 weeks to 4 weeks to settle, but there is a lot of liquidity that we can tap there. And so that will be our – that’s our decision kind of fork in the road is do we want to – are there assets there we would rather monetize and rotate over the lower middle-market. We actually I believe slightly shrunk, that’s kind of what happened in the fourth quarter. Middle-market actually went down, not much, but went down a little bit because we began monetization process to finance the robust lower middle-market activity. And we are just going to have to assess that. And we like the assets we have so we are reluctant to sell them. So I wouldn’t be surprised if we decided to raise equity and then in terms of it the precise timing of that you get into the unfortunate mechanics for the BDC industry of having a shelf have to be refilled every year. And the timing of that, but the possibility that you could be down while your new shelve is being reviewed etcetera. That’s why we are advocating strongly for this BDC monetization legislations we can be an equal footing with other issuers. So that’s kind of the decision making that we go through.

Okay. Thanks for the detail.

Our next question comes from the line of Doug Mewhirter with SunTrust. Please go ahead with your questions.

Hi, good morning. Most of my questions have been answered, maybe two bigger picture questions. First, you are obviously very broadly diversified across industry and geography. You do have a slight overweight to the Southwest and I was just wondering if you have seen any I guess knock on effects of the distress in the oil patch carrying over into other parts of the economy in those areas and is it affecting any of your I guess investments that would maybe second or even the third degree of a move from the oil patch?

I think there is probably some of that but on the other hand thinking about businesses we have in Texas in and around Houston and Gulf Coast maybe up to Dallas. We’ve any RV consignment center, the largest in the U.S. and these lower fuel prices are fantastic for that and they are just a few miles from here. We have another RV group of dealers in the East Texas and in the Louisiana you have got their customers having more discretionary income and the RVs are not as costly to operate etcetera. So we have got retail restaurant establishments in Texas. We have a jewelry chain. So I think it would be an exhaustive analysis you dwelled through to try to assess the impact of prolonged energy prices, if they were to stay where they are now or go down. And I think it would kind of be a watch. It’s our best guess.

Okay, thanks for that. That’s a very helpful answer. My second and final question was actually triggered by your discussion about you mentioned the BDC Modernization Act, have you have any, I guess, thoughts about what the probability of that might be passing in this session of Congress or the Senate?

Yes, I mean – yes, we are really pretty encouraged about that. There is two pieces of legislation. We are pushing kind of independently and with our industry association, SBIA, small business investor alliance. And with respect to – when one surrounds the BDC modernization and the other involves lifting the cap on the SBIA leverage or the SBIC program leverage for family of funds like ours. So, we are pushing both legislation on the SBIC fund was introduced in the House and the Senate earlier this week and I am not able to see a text of the bill, but they are probably very similar to bills that were introduced last session. So, we are pretty encouraged there. On the BDC front, we are encouraged because the industry has coalesced behind – more or less behind the SBIA’s approach and the SBIA’s approach is one of comp. There is something – there is one part of it that everyone – virtually everyone agrees, which is the monetization piece. It really isn’t controversial. The additional leverage that piece of it, which is more controversial I think we are taking – the industry associates taking a more moderate approach and more of a compromised approach. For example, if you are going to allow additional leverage, you have to give the existing shareholders a chance to rotate out of the investment before you do that to them. For those that don’t want that, that’s not what they signed up for when they bought the securities and you have that not only with respect to listed BDCs, you have it with the non-listed BDCs, which they don’t have a liquidity option, so how do you accommodate those guys that don’t want that if they can’t sell. There is shareholder approval options that are being considered in addition to a transitional period to allow shareholders on the listed side to trade-off. So, we really made a lot of progress and we are coalescing behind the SBIA’s approach. And I think we like the layout of the congressional committees, etcetera now better than we did last session. So, I think we are cautiously optimistic there.

Great. Thanks. That’s all my questions.

Sure.

Thank you.

Thank you. Our next question comes from the line of Mickey Schleien with Ladenburg Thalmann. Please go ahead with your question.

Yes. Good morning, everyone. Not to beat a dead horse, but I wanted to ask the energy question a little differently. Just anecdotally I have heard that sort of the first half of this year’s oil production has been hedged and when you look at how sticky air prices have been that seems to be the case. So, what I would like to understand is as these hedges roll off, how do you think your portfolio will perform or looking it at another way, how much has the portfolio been shielded by those hedges?

Well, when we look at our energy exposure, we really have not very much upstream exposure relative to midstream, relative to services, maybe a little bit of downstream. And so with respect to the upstream, it’s really a credit-by-credit analysis. I think its sub-5% of the portfolio and we would really have to talk to you about it company-by-company. They are in different basins. They are having different leverage profiles. They have different credit structures etcetera. And one thing you are beginning to see when we listen to their conference calls is to put some pretty significant savings at the expense of the service companies with respect to their operating costs and you have to factor that in as well. So, we are just kind of waiting and seeing, but clearly ‘16 is where your concern really is going to be focused as opposed to ‘15 when these hedges roll off and they are not able to get the cost savings from the service companies, because particularly if you are in the shale area, it’s really not E&P, it’s really mining, right. So, if you cut your CapEx because of the front-end production profile and the quick decline with few quick drilling your production is going to go down very quickly. And if they got to cut their CapEx they don’t get enough savings from – on the operating cost side and prices stay marginally too low for them to make money. ‘16 is going to be at a real issue for them. And I think your worst case is your credit position if you enjoy being in the first lien position which we are, you would equitize those positions. And you would own the companies on a debt free basis. And they could survive on that basis so you could sell the assets. So we are not terribly concerned about where we are. And most of the analysis we are doing really is what happens a year from now. Nick Meserve is our Managing Director, in-charge of our middle-market area that has some of these credits. Nick would you add anything else to that.

Yes. I think that pretty much covers that. I think the key is most of the E&P companies we will see out there in the loan space will be hedged well north of 50% probably goes to 75% through ‘15, ‘16 is really where the differential hits. Some names cover up to 50%, some names are lower than 10%, and you really see the flow-through at that point.

Alright, thank you for that. Vince just switching gears to one more question what level of assets do you think clients will expect to list its BDC, and when that happens, will that affect your relationship with them and the accounting for that relationship in terms of the financial reporting?

Yes. Well, I don’t – first of all I don’t think it’s given that they list it in their publicly filed documents. They have made a commitment to seek a liquidity alternative. And I think its 5 years to 7 years after the fund-raising stops I believe that’s the timing in their filings. And that liquidity alternative could be a sale, it could be a listing, it could be a conversion to a closed end fund. It really is going to be dependent upon the opportunities at the time, and what’s in the shareholders best interest. They have their own Board that they are going to make that decision. But if they do decide to list and if you had to back you would probably back that would be what they seek to do. Then I think a good example is Franklin Square where the GSO Franklin Square had a co-advisory relationship I mean technically it’s an investment advisor and a sub-advisor that roughly equally split the economics if not exactly split the economics of the external management contract. I would bet that would continue. I don’t think we are particularly interested in running another public company and they are not particularly interested in Hines in beefing up and hiring a bunch of investment professionals on the loan side. So I think we would just kind of march-off in the sunset together both advising the public company. And it would really be no different because it already is public, it’s just whether it’s listed or not. So we really don’t foresee much change if they decide to list.

But in the example you gave which I am familiar with Franklin Square Partners is not listed, but you are – so you would have a listed company acting as an external manager for another listed BDC, does that cause any [indiscernible] in terms of the accounting?

You got, Blackstone that’s listed, so they own GSO. So, I mean you have one as public and one is not, I mean you founded the same thing, although we are the sub-advisor as opposed to the advisor.

Right.

No I think it’s either way our shareholders win. They are getting whatever economics we have. And I think that really its going to be what they decide to do is really a function of how big they end up being and what the prospects are for, are they going to do another HMS 2.0 in which case how do you pass through that versus the existing one which is why you have seen – when you have seen Franklin Square for example do a power and energy non-listed launch versus I think they did a global opportunistic credit one or something like that. And so Hines has those same type of decisions and their decision with respect to this one is going to be impacted by what else if anything they might do in the space.

And I think you referred in your prepared remarks to issues surrounding non-listed BDCs and there has been more scrutiny around them. Has the growth should trajectory at Hines changed over the last couple of quarters?

No, it’s kind of increased. But I think that – no, there is a – and I think most of the – the scrutiny that you are talking about really is more focused on the non-listed REITs and whatever changes they decide to make there spillover on to the non-listed BDCs. And the REITs weren’t – they didn’t have a fair valued NAV requirement like BDCs do. So, those – the REIT changes don’t really impact the BDC as much, but it doesn’t really matter what we think it matters. It really matters what the large independent broker dealers think and what they want to do and what they want to sell.

I understand.

And indications are that things are going to change.

I understand. I appreciate your time this morning. Thank you.

Sure. Appreciate the question.

Thank you. [Operator Instructions] Our next question comes from the line of Bryce Rowe with Robert W. Baird. Please go ahead with your questions.

Thanks. Vince, just to follow-up to one of the comments you made previously. You talked about banks and how they are reacting from a borrowing base adjusting the borrowing bases with the revolvers. Can you maybe just talk about the behavior of the banks, is it spotty, is it consistent and are you seeing some banks being more conservative versus others being more aggressive? Thanks.

Well, yes, I mean, I made that kind of connection with the reserve based borrowing basis that these energy – the upstream revolvers typically have. And it’s kind of – it’s kind of too early to tell what the banks are doing, because the reserves are getting evaluated on a hedge basis right now. And so until those hedges come up, we don’t know what the banks are going to do. If it’s like other cycles, they will probably be pretty reasonable. They don’t want to have a bunch of issues on their balance sheets. They are probably going to give these companies some leeway and don’t want to cause in a creditor war, but that kind of remains to be seen. And Nick would you?

Yes. I think the thing to remember is the reserve based lenders are I would say at a low LTV from the very beginning. They are advancing 50% against the discounted oil curve. See what the oil curve coming in there is a fairly heavy – a very low LTV. So, their risk of actually principal loss is fairly low. Historically, they have been very conservative on how they move forward and they are working with the companies, they don’t have a lot of assets on their balance sheets. They want to have performing loans. So, I think our expectation is that the banks here should be a very competitive to those companies.

Okay, thanks.

Sure.

Our next question comes from the line of Christopher Nolan with MLV. Please proceed with your questions.

Hey, guys. Thanks for the follow-up. Dwayne, you mentioned the distributable net investment income guidance for the quarter is $0.53 to $0.55, was that correct?

Yes, that’s correct.

And is the adjustment on that to GAAP EPS roughly a subtraction of $0.03 a share, is that still hold?

Yes, it’s going to be pretty $0.02 and $0.03, probably closer to $0.03.

Okay. I am just trying to understand because right now the consensus estimates for GAAP EPS in the first quarter is $0.58. So, right now you are sort of giving roughly EPS guidance of $0.50 to $0.52. I am trying to understand where the correction is coming from? Where is the mismatches? Are you expecting a slowdown in growth in assets or an impact to yields or growth in expenses or give a little detail on that?

Yes. The primary component is dividends. Our lower middle-market companies are primarily take the form of LLCs back ended in the year when they have better visibility on what their taxable income is. So, we end up in the fourth quarter with seasonally high tax distributions, which get translated as dividend income for GAAP purposes and that’s – we struggled with how do you describe that we use the term unusual, I mean it’s not that they are all non-recurring but they are recurring at different levels. And Q1 is a seasonally lower time for that. On the expense side Q1 is seasonally high because we pay for our auditors. And when we do our annual reporting and all that it’s a cost heavy quarter and a dividend like quarter and that basically explains the difference.

Great. Please go ahead.

So, one other thing and Brent tried to point this out in his comments and I think it’s also in some of the comments you will see in the press release, but you have to also take into consideration the investment we made in the future through the issuance of the 4.5% notes and that’s when you look at it on a quarter-over-quarter basis, that was not fully reflected in Q4. So you have got some additional costs there as you look at the higher rate versus a lower rate on the revolver.

Great, okay. Thanks for the detail guys.

Thank you.

Thank you. This concludes today’s question-and-answer session. I would like to turn the floor back to Vince Foster for closing remarks.

Great. Well, thank you all for joining us. And we look forward to doing this again next quarter.