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Edited Transcript of TCRD earnings conference call or presentation 5-Nov-19 3:30pm GMT

Q3 2019 THL Credit Inc Earnings Call

Boston Nov 21, 2019 (Thomson StreetEvents) -- Edited Transcript of THL Credit Inc earnings conference call or presentation Tuesday, November 5, 2019 at 3:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christopher J. Flynn

THL Credit, Inc. - CEO & Director

* James R. Fellows

THL Credit, Inc. - CIO, Co-Head of Tradable Credit and Portfolio Manager

* Sabrina Rusnak-Carlson

THL Credit Advisors LLC - General Counsel & Chief Compliance Officer

* Terrence William Olson

THL Credit, Inc. - Assistant Secretary, Treasurer, CFO & COO

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Conference Call Participants

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* Leon G. Cooperman

Omega Advisors, Inc. - President, CEO & Chairman

* Paul Conrad Johnson

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

* Robert James Dodd

Raymond James & Associates, Inc., Research Division - Research Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to THL Credit, Inc.'s earnings conference call for its third fiscal quarter ended September 30, 2019. It is my pleasure to turn the call over to Ms. Sabrina Rusnak-Carlson, General Counsel of THL Credit, Inc. Ms. Rusnak-Carlson, you may begin.

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Sabrina Rusnak-Carlson, THL Credit Advisors LLC - General Counsel & Chief Compliance Officer [2]

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Thank you, operator. Good morning, and thank you for joining us. With me today are Chris Flynn, our Chief Executive Officer; Jim Fellows, our Chief Investment Officer; and Terry Olson, our Chief Operating and Chief Financial Officer.

Before we begin, please note that the statements made on this call may constitute forward-looking statements within the meaning of the Securities Act of 1933 as amended. Such statements reflect various assumptions by THL Credit concerning anticipated results that are not guarantees of future performance and are subject to known and unknown uncertainties and other factors that could cause actual results to differ materially from such statements. The uncertainties and other factors are, in some ways, beyond management's control and include the factors included in the section entitled Risk Factors in our most recent annual report on Form 10-K, as updated by our quarterly report on Form 10-Q and our periodic and other filings with the Securities and Exchange Commission. Although we believe that the assumptions on which any forward-looking statements are based on are reasonable, any of those assumptions could prove to be inaccurate and, as a result, the forward-looking statements based on those assumptions also could be incorrect. You should not place undue reliance on these forward-looking statements. THL Credit undertakes no duty to update any forward-looking statements made herein. All forward-looking statements speak only as of the date of this call.

Our earnings announcement and 10-Q were released yesterday afternoon, copies of which can be found on our website along with the Q3 earnings presentation that we may refer to during this call. The webcast replay of this call will be available until November 15, 2019, approximately 2 hours after we conclude this morning. To access the replay, please visit our website at www.thlcreditbdc.com.

With that, I'll turn the call over to Chris.

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Christopher J. Flynn, THL Credit, Inc. - CEO & Director [3]

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Thanks, Sabrina, and good morning, everyone. I will begin today's call with an update on our Q3 financial results, and we'll then move on to the progress we've made in managing and repositioning our portfolio.

Our net investment income for the quarter was $0.22 per share versus our dividend of $0.21 per share. Our NAV was $8.34 per share as of September 30, representing a modest decline of less than 2% quarter-over-quarter. The NAV decline was primarily isolated to one credit, Holland, which we've highlighted on our last few earnings calls as a credit that we're closely monitoring. Our interest in the Logan JV were also marked down this quarter largely due to market technicals in the syndicated market, and we took a small markdown on our equity holdings in OEM. These changes were offset by the incremental NAV gain on our sale of Copperweld and a 5% accretion from our stock repurchase.

Holland is a first-lien investment and one of our 3 remaining energy credits. The business continued to face market headwinds this quarter due to overall reduced M&A activity in the energy space, and was marked down accordingly. Aside from the markdown in Holland, we continue to believe the fundamentals of our portfolio are moving in the right direction. We are very pleased with the results of our Copperweld exit this quarter. Copperweld, as one of our control equity positions, was originally an unsponsored deal that we took through a restructuring in 2016. With managerial changes and the retention of an adviser, operations were stabilized and EBITDA grew, positioning the company for a sale. Cash proceeds received and dollars escrow totaled $35 million, which were 1.6x our original investment and a $1.5 million markup from June 30. The total return on this investment, including interest and dividends, was 2.2x our original investment.

The proceeds from Copperweld, one of our most concentrated positions at over 7% of the portfolio as of June, can now be deployed across several new investments, also improve the overall diversity of the portfolio and may also be used for additional share buybacks under our $15 million 10b5-1 stock repurchase plan. Since we initiated this plan in March 2019, we have repurchased $13.7 million of our stock or 91% of the target plan at a substantial discount to NAV. Repurchases in Q3 were accretive to book value by $0.05 per share. At the current repurchase plan in place, we expect to hit the $15 million amount by the end of the next month, at which point, we will reevaluate our new plan.

Moving on to our portfolio repositioning efforts. Our objective since 2008 has been to reduce the risk in our portfolio by: one, improving diversification; two, continuing to exit legacy noncore assets; and three, continue to grow our first-lien senior secured assets. We are doing this by proactively exiting concentrated names, control equity positions in subordinated and unsponsored investments and transitioning those assets into senior secured positions and growing our Logan joint venture.

Let me continue to provide more color on our progress. First, we have substantially improved overall diversification of our portfolio by proactively exiting more concentrated positions and adding smaller ones. As of March 31, 2018, we had 14 positions of the hold sized greater than 2.5%. With the exit of Copperweld, a 7.1% position; and Fairstone, a 3.3% position. In Q3, we have now exited 8 of these.

Since the start of 2018, the average size of our 21 new investments is $5.9 million or 1.5%, well below our target max hold of 2.5. TCRD continues to benefit from our coinvestment capabilities across our private funds and middle-market CLO platform, allowing us to take smaller positions and achieve our diversification goal. As a result, the average size of our investment debt portfolio at cost has decreased from $14 million in Q1 2018 to $8 million as of Q3 2019. While we are focused on our remaining concentrated positions from a risk and diversification perspective, we continue to be especially focused on Holland, which I mentioned, and OEM, which continues to execute on its plan. We are actively working with both companies on some strategic options to derisk or exit our position in the first half of 2020.

The second thing I'd like to emphasize is that we continue to make progress on our remaining legacy noncore investments and significantly reduced the overall risk on our portfolio. Since the beginning of 2018 and with the sale of Copperweld, we have reduced the number of investments in unsponsored companies from 6 to 2. We control the remaining 2 investments in C&K and OEM. We reduced our total equity from 12% to 5% of our portfolio over that same period and, more importantly, nonincome-producing equity from 7% down to 2%. Control equity investment has also been reduced from 5 companies to 3: OEM, C&K and Loadmaster.

Third, we have successfully redeployed our proceeds in the core first-lien investments in the Logan joint venture. 100% of our new investments in 2018 and 2019 have been first-lien loans, and we've continued to grow the Logan JV, which is comprised of predominantly first-lien loans. Logan now represents 20% of the portfolio as of September 30, which is right in line with our target size for this vehicle and generates an 11% to 12% return on equity. Returns over the last 2 quarters have been closer to 11% due to recent LIBOR contraction and leverage optimization. Jim will talk to this more on Logan shortly.

Overall, we believe the portfolio risk profile continues to decrease. Outside of the 2 concentrated credits that I highlighted, performance all across our noncore -- across our core assets and the broader portfolio has been strong. For the remainder of 2019, our focus remains to substantially complete the rotation of our portfolio away from legacy noncore assets and concentrated positions into highly diversified first-lien loans.

As we look forward to 2020, I want to highlight several factors that we believe will position the BDC for continued progress and performance. First, the vast majority of our portfolio, 87% as of September 30, is invested in first-lien senior secured assets and our Logan JV, which we believe will provide more stable earnings. Second, since our shareholders approved the reduced asset coverage requirement earlier this year, we have the ability to take on increased leverage. Our plan is to target modest leverage levels of 1.05 to 1.15 range into 2020, subject to us successfully amending our credit facility. This will allow us to continue to diversify and grow the portfolio. Third, and I can't emphasize this enough, we expect the BDC to continue to benefit from the growth and the resources of the broader THL Credit platform, which currently manages $17 billion in assets and employs 93 professionals across just direct lending and tradable credit strategies. We continue to have success raising private funds in middle-market CLOs, and our direct origination has never been stronger.

Since 2018, our Direct Lending platform has committed over $1 billion across 43 new portfolio companies. Our coinvestment capabilities across these vehicles allow us to take smaller positions within the BDC and achieve our diversification goals while still executing our strategy as being a leading investor and originator of middle-market private credit. As we look forward, we strongly believe we have the right team in place to complete the execution of our repositioning plan. We believe this action we have taken in 2018 and thus far in 2019 are the right ones, and the overall risk of the portfolio has decreased and become increasingly isolated. We expect continued improvement and diversification will result in more stable and predictable returns to the BDC and for our shareholders and will position us well going forward.

With that, I'll turn the call over to Jim to talk more on our investment activity in the Logan joint venture.

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James R. Fellows, THL Credit, Inc. - CIO, Co-Head of Tradable Credit and Portfolio Manager [4]

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Thanks, Chris, and good morning, everyone. First, some highlights on our investment activity. 2019 has been a strong year for originations across THL Credit's platform. The broader THL Direct Lending platform has closed over $500 million of commitments across 18 new investments, of which the BDC has participated in 12. During the third quarter, the BDC closed 2 new first-lien investments in Comlinkdata and Simplicity which, together, with follow-on investments made during the quarter, totaled $19 million.

Historically, the fourth quarter of the year tends to be the most active in terms of deal flow. However, this year, we're seeing deal activity actually slow pretty much over the second half of this year, and this is likely due to increased market volatility in the larger, broadly syndicated loan market and record-high purchase price multiples for LBO transactions. The quality of deals we are seeing has declined a bit as leverage has crept up a bit. We continue to maintain a strong credit discipline, first-lien sponsor-led transactions in industries where we have a favorable outlook.

During the quarter, we recognized proceeds from realizations totaling $68 million, which included the sale of our second lien and control equity investment in Copperweld, as Chris mentioned earlier; the repayment of our first-lien loan in Fairstone; the repayment of our Sciens first-lien term loan; and the conclusion of the liquidation of our Charming Charlie position.

Lastly, I'll touch upon the Logan JV, which continued to perform well and represented 20% of the portfolio at 9/30. The $350 million portfolio of 132 issuers continues to generate attractive returns for our shareholders. We believe the long-term yield expectation continues to be in the 11% to 12% range, absent any market conditions.

In Q3, we saw a further decline in LIBOR that has contributed to some yield compression. Logan was marked down by $2.3 million or $0.07 per share for the quarter due to broader market movements. The syndicated loan market has been fairly choppy over the past 6 months, and we continue to believe that, that will continue over the next 3 months. Overall, the portfolio continues to perform well, and credit quality remains strong. There was 1 loan on nonaccrual status as of 9/30 with a cost basis of $2.4 million, representing less than 1% of the Logan portfolio.

With that, I'll turn the call over to Terry to give you some more information on our Q2 -- Q3 financial results.

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Terrence William Olson, THL Credit, Inc. - Assistant Secretary, Treasurer, CFO & COO [5]

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Thanks, Jim, and good morning, everyone. First, a few portfolio highlights. As of September 30, our portfolio of $404 million was invested 67% in first-lien senior secured debt and 20% in the Logan JV. As a reminder, the Logan JV is 97% invested in first-lien assets. The remaining 13% of TCRD's portfolio was held in second lien, subordinated debt and other income-producing and equity holdings. You can see Slides 13 and 14 in our earnings presentation, which highlights these trends over the last 2 years.

The weighted average yield on the debt income-producing portfolio, including Logan, was 10.1%. Nonaccruals as a percent of TCRD's portfolio at fair value and costs decreased to 2% and 3.2%, respectively, with the liquidation of Charming Charlie in Q3. Loadmaster was the only company on nonaccrual as of September 30. There's -- no new names were added during the quarter.

Moving on to the financials for the third quarter. As Chris mentioned, our net investment income was $0.22 per share. And looking at some of the components of our $12.8 million of investment income this quarter, the income of $8.8 million decrease this quarter from last, primarily due to portfolio contraction and some tightening spreads -- LIBOR, sorry, and dividend income was $3.6 million and reflected dividends from Copperweld, C&K and the Logan JV. The decrease in other income quarter-over-quarter was related primarily to the onetime $1.5 million exit fee realized in connection with the sale of LAI in Q2.

On the expense side, total expenses for the quarter were $5.9 million compared to $6.5 million in Q2. The decrease was primarily due to lower interest and fees on borrowings as we paid down a substantial portion of our revolver in Q3 with proceeds from the realizations Jim mentioned.

Moving on to a few balance sheet items. Our cash balance of $14 million at September 30 was higher than normal just due to the timing as it included proceeds from the realization of Sciens at quarter end and some escrows, and other receivables increased in Q3 with the liquidation of Copperweld and Charming Charlie. We expect to receive proceeds from the finalization of the Charming liquidation in Q4, and most of the remaining Copperweld proceeds are expected in early 2020.

The realized loss of $7.7 million in Q3 was primarily related to Charming Charlie, net of a realized gain on the sale of Copperweld, and this net realized loss was offset by a corresponding change in unrealized depreciation. From a leverage and liquidity perspective, leverage levels were lower at September 30 at around 0.7x with the repayment of the 3 positions in Q3, and we anticipate increasing leverage back to that 0.75 to 0.8x range in the near term.

With that, I'll turn the call back to Chris for some closing remarks.

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Christopher J. Flynn, THL Credit, Inc. - CEO & Director [6]

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Thanks, Terry. We appreciate the opportunity to update you on our continued progress in Q3. We believe our continued diligent execution of our plan is a clear pathway to more stable and predictable returns. Thank you, and we look forward to your questions. With that, I'll turn the call back over to the operator to start the Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Lee Cooperman with Omega Family Office.

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Leon G. Cooperman, Omega Advisors, Inc. - President, CEO & Chairman [2]

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Just a few questions, Chris, if I may. I missed it if you said something, but is the cash flow covering your dividend if you took your incentive fee per your arrangement? That's number one. So are we still subsidizing the distribution or we no longer have a need to subsidize the distribution?

Secondly, if you had to take a stab at the question, if you took all the questionable assets and wrote them down to what you thought was a reasonable level, what impact would that have on the book value?

And third, I think you're doing the right thing in buying back stock, but you're obviously shrinking the size of the company, you're shrinking your footprint. Are we economically viable as a kind of entity we're structured presently? Those 3 questions, any help you could give would be appreciated.

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Christopher J. Flynn, THL Credit, Inc. - CEO & Director [3]

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Well, thank you, Lee, appreciate the questions. The first, as it relates to the incentive fee as it relates to our dividend, I'll be honest, I don't recall the last time we actually took an incentive fee on the BDC, so it's been quite some time. So if we pro forma that in on our existing results, the earnings per share would be less. It's about a $0.03 or $0.04 reduction. But given our existing structure that we have as it relates to our fees and the look-back over time, we're not anticipating taking an incentive fee given the losses that we've incurred in the portfolio for the remainder of 2020. So we think the dividend itself is sized accordingly and is okay. To the extent the portfolio itself has been diversified enough to enable us to add more leverage, I think the leverage that we've put on the system would enable us to potentially earn an incentive fee in the future and still cover the dividend as outlined.

Your second question as it relates to the assets, we obviously value these assets at what we believe to be the fair market value each quarter. Fortunately, we've got 2 names that are sizable as it relates to the overall concentration around those. You see them. We've highlighted them. It's not that we're not being transparent. It's OEM -- are both areas of focus, and folks can do the math on what that risk is, but we value those assets every quarter on what we think the fair value is.

And then I think your last question regarding the economic viability of the BDC itself, as a standalone entity, I think you're right, it would be difficult for -- as we are sitting here only managing a $500 million vehicle for us to say that it makes sense. But the fact is we're not, we're part of a much larger platform. We don't manage $500 million. We manage $17 billion. And we try to make that point in the prepared remarks that our ability to execute on our strategy of being a lead investor across unique proprietary middle-market senior secured loans is alive and well, and we've done more than $1 billion of that program over the last 18 months. So that part is working. It's just we're much more efficient and practical as it relates to how we're allocating assets down to the BDC.

Part of the issue with this, and we've said this in past calls, is that we went public too small, and we didn't have the diversification of capital around the BDC, and that forced us into -- or forced the vehicle into some outsized concentrated positions, and that's no longer the case. So yes, I think as part of a larger platform like we have here today, I think the BDC is able to do that. If we are booking concentrated names again, if we were doing unsponsored deals, if we were doing other things in the past that led us down this path, I'd say that the shareholders have the right to be upset. But the fact is we've booked a number of names, we're holding less than 1% to 1.5% positions and we're doing it on a diversified way and covering our dividend. And we feel great about that.

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Leon G. Cooperman, Omega Advisors, Inc. - President, CEO & Chairman [4]

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Yes. I think as I've said frequently in the past, nobody I know of has gone more out of their way to support what they brought to the public than you guys. But on the other hand, we've done a very poor job. What I was really referring to is the cost of running a public company, which is being absorbed by the shareholders as opposed to the $10 billion or $15 billion or $17 billion in your private company. But we don't have to belabor that now. I just -- that was the point I was trying to make. I think that we're just marginalizing ourselves as we shrink.

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Christopher J. Flynn, THL Credit, Inc. - CEO & Director [5]

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Lee, I don't disagree, we need to get bigger, not smaller. But as there's still a dislocation between our book value and our stock price, we'll continue to aggressively buy back stock and accrete that to our shareholders as a good use of capital. But you're right, the long-term ultimate goal is for us to get bigger, not smaller.

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Operator [6]

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And our next question comes from the line of Paul Johnson with KBW.

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

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First, I just wanted to ask you on the distribution from the JV was slightly smaller this quarter. Was that due to the nonaccrual in the JV?

(technical difficulty)

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Christopher J. Flynn, THL Credit, Inc. - CEO & Director [8]

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Hey, Paul, you're fading out a little bit. I'm sorry. We're having a hard time hearing you. Can you repeat that?

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

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Sorry about that. Can you hear me now?

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Christopher J. Flynn, THL Credit, Inc. - CEO & Director [10]

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Yes.

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

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Okay. I was just asking on the distribution from the JV this quarter was slightly lower than previous quarters. Was that due to the nonaccrual in -- the new nonaccrual in the joint venture? And also, would you expect that to pick back up in the future?

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Terrence William Olson, THL Credit, Inc. - Assistant Secretary, Treasurer, CFO & COO [12]

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Paul, this is Terry. Appreciate the question. There was a nonaccrual last quarter that's -- that obviously is rolling through there. And obviously, the impact of a decreasing LIBOR has put a little bit of pressure on the earnings, which you can see in the yield we stated just being under 11%.

So look, I think it will go -- we think we'll probably operate closer to 11%, 11.5%. But I would expect probably a stabilization of that number in the zip code of what we paid this quarter.

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

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Okay. And then lastly, just on your progress on the rotation. You guys have made some pretty good progress over the last several quarters in rotating out of that noncore stuff. How would you describe -- I guess, how you stand today in that process? I mean do you believe that you've substantially completed most of that or you expect to have -- if you have any sort of transactions on the horizon to continue to expedite that? How would you describe that?

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Christopher J. Flynn, THL Credit, Inc. - CEO & Director [14]

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Now Paul, I appreciate the question. I think we've made very, very good progress. I mean it's not as easy as just saying you want to exit these names. You actually have to take time. We've got a handful of names that are still concentrated that are performing and are -- we're on our process of working through or reducing those. But the 2 main areas of focus, as we said in the call, were our OEM and Holland. And we're pushing forward as fast as we can to turn that -- turn those investments into cash.

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Operator [15]

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And our last question comes from the line of Matt Tjaden with Raymond James.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [16]

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It's actually -- it's Robert here. Can I -- on the timing during the quarter of the repayments, it looks to me like they were late in the quarter. So can I assume you've got the normal dividend from Copperweld this quarter but we should expect that to go away next quarter, would that be fair?

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Terrence William Olson, THL Credit, Inc. - Assistant Secretary, Treasurer, CFO & COO [17]

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Robert, this is Terry. Yes, we took a dividend in Q3 similar to prior quarters, and we would not expect a dividend in Q4 given the investment's gone. With respect to the first statement between Copperweld and Sciens, it's about $42-ish million of proceeds. Those -- Sciens closed on the last day of the quarter, and I think Copperweld was a few days before quarter end, so it was very back ended.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [18]

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And then you've given comments on OEM and Holland and in C&K because, obviously, that's a good asset that's been doing well and also been paying you a dividend. Is there any outlook you can give on that whether you've had -- there's been incoming expressions of interest or anything like that or if you expect to exit that in 2020 as well?

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Terrence William Olson, THL Credit, Inc. - Assistant Secretary, Treasurer, CFO & COO [19]

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Our expectation is to be out of that investment in the first half of 2020. Along the way, we will continue to receive a dividend. The company continues to perform well and will be able to support the dividend payment on a quarterly basis.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [20]

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Got it. Got it. And then on the -- your comment about the pipeline -- well, not technically about the pipeline, but you said you see the disruption in the market is maybe reducing deal flow a little bit. I mean we've heard that in -- particularly in the upper ends of the syndicated market, there's been disruption, and that has created maybe more incoming inquiries to private lenders rather than syndicators. So can you give us any -- I mean are you seeing that as well, that there's less activity in the syndication market, in the syndication inquiries? But is any of that showing up more so in the private markets that, obviously, you guys are more exposed to?

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Christopher J. Flynn, THL Credit, Inc. - CEO & Director [21]

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Yes. Thanks, Robert. Appreciate the question. I think that statement is true but not necessarily reflective of our traditional origination source. So if you think through larger issuers, they have the ability to go to the syndicated market or to a much larger direct lending platform. These are businesses that are average EBITDA is, say, north of $50 million to $100 million. The syndicated market is a bit choppy, to use Jim Fellows' description. And therefore, some of those assets are moving into more of an underwritten or buy-and-hold strategy on the direct side.

Our core investment focus is on smaller businesses, at $10 million to $40 million in EBITDA. Our average EBITDA in our portfolio is right around $20 million. They traditionally don't have the access to the syndicated market anyway. So the fact that, that market may be closed periodically does not really affect our traditional resources. What we're seeing on our side is we're trying to see some price discipline, if you will. As you see larger issuers pricing cap out, we feel, from a relative value standpoint, you should see increased pricing on our issuers as well. And that has not played through yet. And that's why we're being patient with our capital, and we're going to wait until we see good value on assets that we like and execute accordingly. So a little bit of a bifurcation, if you will, versus the broader market and, what I'd say, the core middle market, but those are the comments as it relates to the question that you made.

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Operator [22]

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And this concludes today's question-and-answer session. I would now like to turn the call back to Chris Flynn for any further remarks.

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Christopher J. Flynn, THL Credit, Inc. - CEO & Director [23]

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Thanks, everyone. We look forward to providing you with another update on our progress in 2020.

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Operator [24]

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Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.