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Edited Transcript of KCAP earnings conference call or presentation 7-Aug-19 1:00pm GMT

Q2 2019 Portman Ridge Finance Corp Earnings Call

NEW YORK Aug 11, 2019 (Thomson StreetEvents) -- Edited Transcript of Portman Ridge Finance Corp earnings conference call or presentation Wednesday, August 7, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Edward Joseph Goldthorpe

Portman Ridge Finance Corporation - Chairman, CEO & President

* Edward Udall Gilpin

Portman Ridge Finance Corporation - CFO, Secretary & Treasurer

* Patrick Schafer

Portman Ridge Finance Corporation - CIO

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Conference Call Participants

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* Christopher John York

JMP Securities LLC, Research Division - MD & Senior Research Analyst

* Christopher Whitbread Patrick Nolan

Ladenburg Thalmann & Co. Inc., Research Division - EVP of Equity Research

* Paul Conrad Johnson

Keefe, Bruyette, & Woods, Inc., Research Division - Associate

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Presentation

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Operator [1]

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Hello, ladies and gentlemen, and welcome to the Portman Ridge Second Quarter 2019 Financial Results Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would like to turn the conference call over to your host, Mr Ted Goldthorpe, Chief Executive Officer.

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Edward Joseph Goldthorpe, Portman Ridge Finance Corporation - Chairman, CEO & President [2]

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Thank you, operator, and good morning. Thank you for joining us on our earnings call.

Today, Portman Ridge announced it's second quarter 2019 financial results. As you know, on April 1, we closed on the externalization transaction. And at that time, an affiliate of BC Partners Advisors, LP, became the external manager of Portman Ridge Financial Corporation.

Additionally, on August 1, we announced that Portman Ridge has entered into a definitive agreement under which OHA Investment Corporation will merge with and into Portman Ridge. The transaction is subject to OHAI shareholder vote and to the extent approved, is expected to close in the fourth quarter of this year.

For more details about the merger, please refer to the press release issued on August 1, which is available on the Portman Ridge website, and a replay of the shareholder call hosted on the same day.

We're excited about this opportunity as it embodies an important step in our vision for the BDC space and is expected to be accretive -- an accretive transaction for both OHAI and Portman stockholders.

I'll begin with a few comments about the market and our strategy and then turn the call over to Ted Gilpin, our CFO, for brief overview of the financial results. And then Patrick Schaefer, our Chief Investment Officer, for a review of investment activity before concluding the call with some additional remarks.

The market has seen increased competitiveness over the last few quarters so we're being very selective in general. Specifically, within the unitranche asset class, which has been in the preferred structure and the sponsor universe for some time now, there's been a recent trend for unitranches to be increasingly clubbed up amongst few lenders versus going with one solution. And as a result, our hit rate for that product has increased.

We continue to find value in our non-sponsor vertical as well as in stretch senior deals. These stretch senior deals have materially less leverage than unitranches with only a minor reduction in spread. We are pursuing junior capital solutions in only the most attractive of circumstances and only in companies with economically resilient business models.

Over the next few quarters, we will look to continue to reduce our CLO equity of exposure and replace it with investments in our senior and unitranche joint ventures, which we continue to believe provide attractive risk-adjusted returns.

With that, I will hand it off to Ted Gilpin to review the second quarter financial results.

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Edward Udall Gilpin, Portman Ridge Finance Corporation - CFO, Secretary & Treasurer [3]

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Thank you, Ted. Good morning, everyone. Net investment income for the quarter was approximately $880,000 or $0.02 per basic share compared with net investment income of $2.5 million or $0.07 per share in the quarter ended June 30, 2018, and a net investment loss of $2.2 million or negative $0.06 per basic share in the first quarter of 2019.

During the quarter, we were required to take a nonrecurring, noncash, nondeductible impairment charge to write-down the lease right-of-use asset for office space previously occupied by the company that resulted in a hit to NII of approximately $1.4 million or $0.04 per basic share. Without the lease impairment charge, NII would have been $2.3 million or $0.06 per basic share.

Although net asset value per share declined by $0.12 to $3.73 per share during the second quarter, a significant portion or approximately $0.08 of the decline was attributable to the aforementioned lease impairment and a stockholder distribution in excess of net investment income earned during the quarter.

The remaining $0.04 per share or 1% of NAV was driven by realized and unrealized losses in the underlying portfolio, mostly in our structured products portfolio.

Investment income from debt securities in the quarter was approximately $3.8 million compared with approximately $2.9 million in the first quarter of 2019 and approximately $4.3 million in the second quarter of 2018.

Investment income on CLO fund securities in the second quarter of 2019 was approximately $1.7 million compared with approximately $1.8 million in the first quarter and $1.5 million in the second quarter of 2018.

Investment income from joint ventures, both the Great Lakes JV as well as F3C JV, increased in the second quarter of 2019 to approximately $1.3 million from approximately $1.0 million -- $1 million in the first quarter of 2019 and approximately $700,000 in the second quarter of 2018.

On the liability side of the balance sheet, as of March 31, 2019, we had approximately $122.8 million of par debt outstanding, $77.4 million of 6.125% notes due in 2022 and $45.4 million of -- under our L plus 3.25% revolving credit facility.

Our asset coverage ratio at quarter end was 211%. As of March 2019, Portman Ridge increased leverage to the new statutory ratio of 150%. However, we are currently restricting our ability to do so under the covenants in our outstanding publicly traded debt But the new asset coverage ratio will give us significant more flexibility in the future.

The Portman Ridge Board of Directors has approved a cash distribution of $0.06 per share on August 5. The distribution is payable on August 29 to stockholders of record at the close of business as of August 12, 2019. The new dividend level is based on the Board's desire to more closely align dividends with net investment income and taxable distributable income being generated by the fund.

When including the first 2 quarters of distributions, we are on pace to distribute $0.32 per share for the full year 2019, excluding the $0.67 per share special distribution associated with the externalization. The Board evaluates several factors in serving the amount of quarterly distribution, including the amount required to be distributed in order for the company to maintain its status as a regulated investment company under the internal revenue code.

With that, I would like now -- like to now turn the call to Patrick Schafer, CIO of Portman Ridge.

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Patrick Schafer, Portman Ridge Finance Corporation - CIO [4]

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Thanks, Ted. I'd like to now discuss the current state of the portfolio and how we've begun to reshape it since the externalization.

During the quarter, we made investments into 12 borrowers, 4 of which were into existing portfolio companies and 8 of which were brand new borrowers. In aggregate, these investments totaled $46 million of face value, 27% of which were first lien securities and 63% of which were second lien securities, with the remaining investments being add-ons to the Great Lakes joint venture and a small preferred equity investment.

The weighted average spread on these first lien securities was 534 basis points and the weighted average spread on the second securities was 897 basis points.

Additionally, over the course of the quarter, we exited 12 legacy KCAP positions at an aggregate carrying value of $22 million for an aggregate gain of $236,000 relative to their carrying value as of March 31.

The largest gain was related to the paydown of Verdesian Life Sciences, which is marked at 90% of par as of Q1 2019 and was repaid at par.

With respect to the portfolio as a whole, there were no incremental nonaccruals during the quarter nor any material credit events as evidenced by the relatively limited realized and unrealized losses, Ted Gilpin highlighted.

Finally, post quarter, we have committed to $21.7 million of face value loans, all of which are first lien securities at a weighted average spread of 564 basis points. And we continue to have a strong pipeline of opportunities, both sponsor and nonsponsor that the team is actively pursuing.

With that, I'll turn the call back over to Ted Goldthorpe.

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Edward Joseph Goldthorpe, Portman Ridge Finance Corporation - Chairman, CEO & President [5]

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Thank you, Patrick. During the second quarter, we began to reposition the portfolio, including reducing the company's exposure to CLOs as a portion of total investments and net asset value, and we continue to seek opportunities in the middle market lending space to prospectively enhance net investment income.

We're excited about our recently announced proposed merger with OHA Investment Corporation, which demonstrates BC Partners' commitment to pursue attractive opportunities in the market. If approved by OHAI stockholers, the combined company will be managed by Sierra Crest Investment Management, and is expected to increase total assets by approximately 20%, allowing it for larger hold sizes on the portfolio and increasing earnings per share by spreading out our public company costs over a larger base.

As Patrick mentioned in his remarks, since April 1, we have deployed or committed to deploy $67.7 million of capital in predominantly first lien securities. Most of these investments were proprietarily sourced through the BC Partners platform, and the ability of Portman Ridge to co-invest alongside other BC Partners entities pursuant to the co-investment order previously discussed at the time of the externalization, will allow us to compete with other major market participants in a way that the fund historically could not.

Going forward, we will continue to work towards reducing non-core and low-yielding assets, including opportunistically exiting our structured credit exposure. In short, we believe the portfolio is trending in the right direction, and we are looking forward to continuing our repositioning work.

We'll continue to reposition the portfolio in subsequent quarters based on the long-term objectives of net investment income growth and NAV stability, for which the restructuring of the dividend policy approved by the Board on August 5 was a key element.

Rightsizing the dividend to track more closely to earnings power of the company will improve NAV stability and allow us to deploy more capital and high-yielding illiquid investments generated by the broader BC platform.

We also believe that the expenses incurred due to externalization have been realized and expect more earnings stability going forward. Thank you for your support.

And with that, we'd like to turn over the call to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first response is from Paul Johnson of KBW.

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Paul Conrad Johnson, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [2]

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I just had a couple today. I was going to ask as far as the higher G&A costs this quarter, I imagine some of that is due to probably the OHA merger transaction. Is that what drove the higher G&A? And do you expect any of that continue in the coming quarters?

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Edward Udall Gilpin, Portman Ridge Finance Corporation - CFO, Secretary & Treasurer [3]

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Really, there really was not a lot related to OHA. Yes, there's still some noise in the expenses related to the externalization, mostly related to sort of insurance costs and some -- and obviously, the lease impairment and other lease-associated expenses. But I think, generally speaking -- and a little bit of professional fees still associated with putting that all together. But I think one of the reasons the OHA transaction is so attractive is that you're going to be able to spread our G&A costs of semi-fixed across a bigger platform. So I think that you'll see it moderate a little bit. But as Ted said, we have washed through a lot of the KCAP externalization expense now through this quarter.

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Paul Conrad Johnson, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [4]

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Okay. So you're saying you'd expect G&A expense to be relatively calm from where they're at today than going forward, maybe moderate a little bit?

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Edward Udall Gilpin, Portman Ridge Finance Corporation - CFO, Secretary & Treasurer [5]

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Yes, it should moderate a little bit, and you'll see some relief on some of the other lines like insurance expenses.

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Edward Joseph Goldthorpe, Portman Ridge Finance Corporation - Chairman, CEO & President [6]

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Yes. So as we mentioned in the last call and publicly the last couple of months, there was some lingering expenses that from the externalization. So those are now through the system. So -- and those mostly manifest themselves as legal bills. The OHA expenses, there's nothing in here related to OHA. And so that's not what drove it. And obviously, you saw the lease impairment, which is noncash, really an accounting issue. It had nothing to do with cash or anything else. And so -- and that's a new accounting pronouncement that just came out in the last quarter. So that to me is just a noncash accounting issue. It -- that doesn't represent the core earnings power of the vehicle.

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Paul Conrad Johnson, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [7]

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Okay. And then secondly, is the Board obviously sets the dividend at a level you guys be covered by earnings? As I sort of look at your earnings today, I know there's obviously the onetime lease impairment charge in there, $0.04. I think you guys made $0.02 this quarter that gets to roughly $0.06 kind of maybe a run rate from here today. I am just curious, do you guys see a path going forward for earnings to get maybe higher than the dividend just to comfortably cover that dividend? And if so, I mean, can you walk through some of the steps to get there?

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Edward Joseph Goldthorpe, Portman Ridge Finance Corporation - Chairman, CEO & President [8]

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Yes. Why don't I start, and my partners can weigh in. I think, number one is, I mean, we obviously see a path towards earnings growth. Here number one, just the natural reposition of the portfolio. If you look at where we've been monetizing assets and where being originating assets, we're picking up a decent amount of spread. So I think you'll get some NII expansion. We have been hurt by the LIBOR reduction. And I think that's probably going to be an issue for a lot of BDCs. Obviously, we don't have matched funding. Part of our funding is fixed. So that's been a bit of an earnings headwind. And to the extent we're able to close the OHAI transaction, clearly, that's very accretive for shareholders on an NII basis. So we try to set the dividend at a level where we really felt we're well covered by operating earnings. And we think we can actually grow earnings off of where we are today.

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Paul Conrad Johnson, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [9]

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Okay. And then just to make sure you guys are still committed to waving the fees to that -- for that $0.10 dividend level basically through, I think, the first quarter '19, is that correct? First quarter '20, is that correct?

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Edward Joseph Goldthorpe, Portman Ridge Finance Corporation - Chairman, CEO & President [10]

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Yes. So let me just take a step back and explain the NII guarantee. So the NII guarantee was set at a level that gets adjusted for any non-accruals that happened before April 1. So if you run the math through it, we are still doing that and still committed to doing this. It's contractual. But the actual guarantee is now around $0.33.

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Paul Conrad Johnson, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [11]

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Okay. And then lastly, I just was hoping that you could provide a little bit more color. I don't think I'm quite as familiar with the BCP Great Lakes JV. Can you just kind of remind me exactly what that is? And what the planned mark for that in the future?

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Edward Joseph Goldthorpe, Portman Ridge Finance Corporation - Chairman, CEO & President [12]

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Yes. Yes. Why don't I -- so we have a unitranche joint venture with a large bank. Whereby, when we do a unitranche, it goes into the vehicle. Very, very similar to a lot of the other SSLPs that you've seen other BDCs do. The difference between this one and most of the other ones is this bank has a lot of origination. So we get to leverage off their origination. We can veto any deal. And so last year, I think we saw 180 unitranches and approved 6. So we've been pretty selective about what goes into the vehicle. So it's not just a pure leverage play like you've seen some of the joint ventures. This actually is a true partnership where we get to leverage off a big bank's origination.

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Paul Conrad Johnson, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [13]

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All right. So are you guys putting leverage into that vehicle?

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Patrick Schafer, Portman Ridge Finance Corporation - CIO [14]

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Yes. There -- the vehicle itself is a -- again, similar to the Antares Bain vehicle or the Ares vehicle well before, it's a kind of first-out, last -out unitranche structure in kind of a fund dynamic.

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Edward Joseph Goldthorpe, Portman Ridge Finance Corporation - Chairman, CEO & President [15]

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Yes. So it's no different. It's not -- like when we do a unitranche, oftentimes, we'll sell a first out piece. It's basically a whole bunch of -- it's basically selling one big first out piece against the unitranche portfolio. So leverage is pretty low, like it's -- CLO equity is probably 5x more levered than this vehicle. And the returns are kind of similar. So we actually think it's a very good risk reward for our shareholders.

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Operator [16]

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Your next response is from Christopher Nolan of Ladenburg Thalmann.

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Christopher Whitbread Patrick Nolan, Ladenburg Thalmann & Co. Inc., Research Division - EVP of Equity Research [17]

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Hi, Ladenburg Thalmann. Either Ted, is there a target for ROE for Portman Ridge now?

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Edward Joseph Goldthorpe, Portman Ridge Finance Corporation - Chairman, CEO & President [18]

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I think, listen, I think, over time, obviously, judge -- you have to just -- you always you get to overhang of low rates right now, the 10-year treasury is below 170, which is pretty amazing. I think we should be striving to have a double-digit ROE. I mean, that's where we should bring it to be. I think if you look at our projections and earnings models, I think there's a path to achieve that, both through all these initiatives you talked about. And to the extent that where interest rates rise, we greatly benefit from that. So absent a rise in rates, our goal should be to hit a double-digit ROE. And today, we're tracking like high single digits.

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Christopher Whitbread Patrick Nolan, Ladenburg Thalmann & Co. Inc., Research Division - EVP of Equity Research [19]

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Okay. Great. And then so it sounds like that the current dividend, the new $0.06 a quarter dividend sort of implies roughly a 9.7% ROE according to my back-of-the-envelope calculation. So assuming that you're able to hit the high single digits, that $0.06 should be pretty stable?

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Edward Joseph Goldthorpe, Portman Ridge Finance Corporation - Chairman, CEO & President [20]

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Yes. I mean we want to set a dividend policy at a place where we don't have to talk to you guys about it ever. Because we want to set a level that we know we can hit. So again, we feel very comfortable that the new dividend policy is going to be stable. And then again, we want to be in a situation where we can create earnings and NAV stability. And again, we've been over distributing income, vis-à-vis, our earnings power for quite some time. So we think this actually achieves the dual objectives of not forcing us to stretch for yield, allowing us to pay a nice distribution to shareholders and still maintain a very high dividend yield. Therefore, we can potentially have upside appreciation of stock. But at the same time, stabilize NAV. We can't just have a situation where NAV just continues to go down because we're over distributing income.

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Christopher Whitbread Patrick Nolan, Ladenburg Thalmann & Co. Inc., Research Division - EVP of Equity Research [21]

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Understood. Okay. Turning to the balance sheet debt. Your unsecured notes, I believe, are callable in September. What's the writing around that?

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Edward Udall Gilpin, Portman Ridge Finance Corporation - CFO, Secretary & Treasurer [22]

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Yes. I mean, they're callable in September to the extent that we want the flexibility to go above the 1:1 leverage that we could either try to restructure those or call them and issue new debt, whether that would be fixed through baby bonds or through other types of structures, we're not sure yet. But I think -- the thinking is that eventually, we'll put ourselves in a situation where we have the more flexibility.

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Christopher Whitbread Patrick Nolan, Ladenburg Thalmann & Co. Inc., Research Division - EVP of Equity Research [23]

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Is the inclination towards another debt issuance or to expand the revolver?

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Edward Udall Gilpin, Portman Ridge Finance Corporation - CFO, Secretary & Treasurer [24]

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Well, we're looking at both. I mean, I think that there's room to do another debt issuance, but we are constantly looking at revolver possibilities, whether it's expanding it or doing something similar. But I don't think either one is off the table.

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Christopher Whitbread Patrick Nolan, Ladenburg Thalmann & Co. Inc., Research Division - EVP of Equity Research [25]

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Got you. And then final question. The impact from the -- on earnings from the recent Fed move, do you guys have any guidance as to what -- how that might hit earnings?

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Edward Joseph Goldthorpe, Portman Ridge Finance Corporation - Chairman, CEO & President [26]

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Yes. I mean, you'll see that -- you'll see the exact activities laid out in our 10-Q. Yes, we will provide you guys that information. I mean, the reality is we don't have a -- again, we're not match funded. So cuts and short-term interest rates definitely affect earnings. But again, we -- that's all factored into our earnings models and dividend policy. So I think in the Q, it's on Page...

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Edward Udall Gilpin, Portman Ridge Finance Corporation - CFO, Secretary & Treasurer [27]

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95.

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Edward Joseph Goldthorpe, Portman Ridge Finance Corporation - Chairman, CEO & President [28]

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95. So you can see, now obviously, cuts and short-term rates are not good for the BDC sector. And then to the -- you always ask the question like, why they're cutting rates? Again, the good news is for BDC sectors's, usually cut rates in an environment where we're in a recession or the economy is very weak. The middle market U.S. economy is still very strong. So things like Chinese tariffs and currency moves and trade wars, you have a much bigger impact on multinational companies than the companies that we service. So we are -- the credit quality is still very, very good in our portfolio, and our company's continue to do on the whole pretty well.

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Operator [29]

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Your next response is from Chris York of JMP Securities.

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Christopher John York, JMP Securities LLC, Research Division - MD & Senior Research Analyst [30]

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And also, forgive me if they have been asked as I've been managing a couple of calls. So Ted, I have a couple of strategic questions about the advisor this morning. So given the BDC's co-investment exemption and the advisor's management of Mount Logan in Canada and then a growing demand for debt capital by the cannabis industry. I'm curious if the advisor is evaluating the investment in any cannabis companies or the industry for a bigger picture? And then how are you thinking about this potential specialty funding niche?

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Edward Joseph Goldthorpe, Portman Ridge Finance Corporation - Chairman, CEO & President [31]

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A good question. I think it's a -- listen, for Portman Ridge shareholders, it's not a vertical that we're going to pursue. I think the risk cohort in the sector is actually is pretty interesting. But we are limited being a NASDAQ-listed company and a Fed-related company on what we can and cannot do in that sector. So as you know, there's -- just because it's state legal, doesn't mean it's federally legal. And so we have -- we are -- we have some restrictions around what we -- even when we love the sector, and we thought it was a great place to lend, it'd be very difficult for us to do it at Portman Ridge. And then vis-a-vis, at Mount Logan in this vehicle, there's limited circumstances we'll co-invest. I mean, the reality is that our cost of capital and where we need to be from an ROE perspective, it just doesn't allow us to do low-yielding first liens, it's just hard. And Mount Logan allows us to do that. So when we're talking to a sponsor or a family about doing a deal together, we are able to offer them a full suite of products. And to the extent that a security is too low-yielding for our Portman Ridge shareholders, that might work for our Mount Logan shareholders. So Mount Logan is basically a lower yielding, higher levered vehicle.

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Christopher John York, JMP Securities LLC, Research Division - MD & Senior Research Analyst [32]

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Got it, makes a lot of sense. And then switching gears. So BC Partners confirmed a strategic minority investment by Blackstone this week, which was quite a positive announcement. So the terms weren't disclosed, but I think the journal reported it being about EUR 500 million. So should investors expect that BC Partners credit could receive some of this investment to grow your credit business? And how may this strategic investment help BDC?

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Edward Joseph Goldthorpe, Portman Ridge Finance Corporation - Chairman, CEO & President [33]

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Another great question. So yes, this was just announced a couple of days ago. What it provides us is a balance sheet and credit to expand our business. Obviously, in direct lending, there is some benefits to scale. This allows us to scale our business and invest alongside our LPs. So this is undoubtedly good for Portman Ridge shareholders. We are much better capitalized, BC Partners, the partnership. And now we've got a pool of capital that we can invest in different credit vehicles and products. So as the head of our credit business, I can't be more excited about the transaction. And over time, I think Portman Ridge shareholders will see the benefits of the transaction.

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Christopher John York, JMP Securities LLC, Research Division - MD & Senior Research Analyst [34]

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Got it. And then is it may be reasonable to think that you could be investing in the team? And then maybe could you remind us of your team size in terms of originators or investment professionals?

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Edward Joseph Goldthorpe, Portman Ridge Finance Corporation - Chairman, CEO & President [35]

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Yes. So I mean, that's obviously part of these proceeds. So today, we've got 16 investment professionals and a very large non-investor -- investment professional operation. And that's for a company of our size. So obviously, we are built to grow and built to be bigger. And we are firmly of the belief that the bigger the funnel, we can create the better risk/reward opportunities our shareholders will see. So yes, I mean, this is not a transaction that is like us cashing in, this is a transaction meant to help grow and strategically elevate our business.

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Operator [36]

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I am showing no further questions in the queue at this time. I would like to turn the call back over to Ted Goldthorpe.

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Edward Joseph Goldthorpe, Portman Ridge Finance Corporation - Chairman, CEO & President [37]

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Great. Well, thank you very much for dialing into our call, and thank you very much for your continued support, and we look forward to continuing engaging with our shareholders over the next couple of months. Thank you.

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Operator [38]

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Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may all disconnect.