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Edited Transcript of TCRD earnings conference call or presentation 4-Aug-17 2:30pm GMT

Thomson Reuters StreetEvents

Q2 2017 THL Credit Inc Earnings Call

Boston Aug 12, 2017 (Thomson StreetEvents) -- Edited Transcript of THL Credit Inc earnings conference call or presentation Friday, August 4, 2017 at 2:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christopher J. Flynn

THL Credit, Inc. - Co-CEO, Co-CIO and Director

* Sabrina Rusnak-Carlson

THL Credit Advisors LLC - General Counsel

* Sam W. Tillinghast

THL Credit, Inc. - Co-CEO, Co-CIO and Director

* Terrence W. Olson

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

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Conference Call Participants

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* Jonathan Gerald Bock

Wells Fargo Securities, LLC, Research Division - MD and Senior Equity Analyst

* Kyle M. Joseph

Jefferies LLC, Research Division - Equity Analyst

* Leslie Vandegrift

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Presentation

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Operator [1]

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Good morning, and welcome to THL Credit Earnings Con Call for its second fiscal quarter ended June 30, 2017. It is my pleasure to turn the call over to Ms. Sabrina Rusnak-Carlson, General Counsel of THL Credit. Ms. Sabrina Rusnak-Carlson, you may begin.

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Sabrina Rusnak-Carlson, THL Credit Advisors LLC - General Counsel [2]

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Thank you, operator. Good morning, and thank you for joining us. With me today are Sam Tillinghast and Chris Flynn, our co-Chief Executive Officers; and Terry Olson, our Chief Operating Officer and Chief Financial Officer.

Before we begin, please note that 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, including the factors described from time to time in our filings with the Securities and Exchange Commission. Although we believe that the assumptions on which any forward-looking statements are based 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 Q2 investor presentation that we may refer to during this call. A webcast replay of this call will be available until August 11, 2017, starting 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 Sam.

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Sam W. Tillinghast, THL Credit, Inc. - Co-CEO, Co-CIO and Director [3]

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Thank you, Sabrina. Good morning, everyone. I will begin today's call with a general update on the second quarter including financial and portfolio highlights. Chris will discuss our investment activity during the quarter and provide more details on our portfolio, including the Logan joint venture. And then Terry will discuss our financial results in greater detail.

To begin with, I'm pleased to highlight that our BDC has repositioned into a predominantly first lien portfolio. Our core assets with our first lien loans and the Logan joint venture, which is a first lien focus vehicle, have grown to 74% of the portfolio, up from 64% in the previous quarter. We have achieved our initial target of 70% to 75% that we communicated with you on previous calls. We are extremely pleased with this progress. Notwithstanding this positive trend, we will continue to be focused on increasing our core asset allocation to 90% of the portfolio.

We aim to achieve a 9% core asset allocation by first using our internal and external resources to maximize our return on our restructured control equity investments, which constitutes 8% of our portfolio of fair value basis. Second, other noncore assets such as second lien and subordinated debt will decrease over time as a result of refinancings, sales and payoffs. Then subject to market conditions, we will utilize these proceeds together with increased borrowing base availability to build our core assets, specifically first lien Logan's -- first lien loans and the Logan joint venture, resulting in what we believe will be a more resilient portfolio.

I'm moving on to our financial and portfolio highlights. Our net investment income per share for the quarter was $0.31 relative to our dividend paid of $0.27 per share. We're pleased to announce on August 1, our Board of Directors approved a quarterly dividend of $0.27 per share for the third fiscal quarter of 2017, which is payable on September 29. NAV per share for the quarter was $11.48, which represents a 2% decline quarter-over-quarter. This decline was primarily due to marked balance on our investments in CRS and specialty brands. Chris will discuss these investments in more detail shortly.

Due to the total return provision in our Investment Management Agreement, our incentives fee was reduced in Q2 as a result of NAV declines. As of June 30, we had 46 portfolio investments valued at $674 million. Investments in first lien loans and the Logan joint venture grew to 74% of the portfolios previously mentioned. The remainder of the portfolio was invested 8% on second liens; 13% in equity, of which 5% is income-producing or pays the dividend; 3% of subordinated debt; and 2% in other securities. 90% of the debt portfolio was invested in floating rate loans with an average LIBOR floor of 90 basis points, leaving a portfolio well positioned in a rising rate environment.

The weighted average investment yield on the income-producing portfolio was 11% for the quarter, including the Logan joint venture. And the overall yield on new investments made during the quarter was 9.8%. As a reminder, our Logan joint venture, which represented 10% of the portfolio and generated a dividend yield of 12.7% during the quarter, materially enhances the overall yield of THL Credit's portfolio.

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

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Christopher J. Flynn, THL Credit, Inc. - Co-CEO, Co-CIO and Director [4]

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Thanks, Sam, and good morning, everyone. I will begin by providing some insights with highlights from the second quarter.

First, we invested $13 million in the first lien loan, which is structured as a unitranche investment and preferred equity in Matilda Jane, a leading designer and direct selling marketer, especially apparel and accessory for women and children. We partnered with a bank to provide a unitranche financing solution to support the sponsor's acquisition of this business. We also made a $5 million first lien loan and a $300,000 revolving commitment to Togetherwork, a provider of database management and payment software services to fraternities, sororities and other organizations nationwide. We made another $4 million equity contribution to the Logan joint venture and a $1.4 million in follow-on investments in 4 existing portfolio companies.

Subsequent to quarter end, we also closed 1 new and 1 follow-on first lien investments totaling $21.7 million. Notable realizations during the quarter included the sale of our second lien loans in Hostway and WIS and the repayment of our first lien loan in HEALTHCAREfirst. As we mentioned on our last call, the Hostway sale, as a result of a reversal of $2.7 million of previously recorded unrealized depreciation, had a favorable impact on NAV of $0.05 per share in Q2, despite realizing a loss of approximately $1 million. The impact of our final disposition of WIS resulted in only a nominal impact on Q2 NAV. We also realized our equity positions in Yellow Pages or YP in connection with the sale of the company for $1.3 million realized gain and sold a portion of our preferred equity in A10. Post quarter-end, we also were repaid on a $90 million first lien loan in Food Holdings at par and received a $1.2 million in proceeds from the realization of our equity investment.

Moving on to credit quality. Nonaccruals represented 6.8% of the portfolio on a cost basis at June 30 with the Tri-Starr, Loadmaster together with CRS with specialty brands, which were both added to the nonaccrual status in Q2. While nonaccruals increased this quarter, we are taking steps that we believe will maximize recovery on these investments through restructurings or the debt position of our positions, which we believe may be warranted.

As of June 30, 85% of the companies in our portfolio on a fair value basis were rated either 1 or 2 on a credit score, which means they are performing at or above our expectations. 9% were rated at 3, meaning they have performed below our expectations, but interests and payments are not past due. Specialty brands was moved to a 4, representing 2% of our portfolio, meaning the interest payments are past due, but a full recovery is expected. Tri-Starr, Loadmaster and CRS were all rated 5 credit scores, meaning that our original principal and interest are not expected to be fully collected and represents the remaining 4% of the portfolio.

The decrease in our 3 credit scores from December 31, 2016, is due largely to improved performance of certain investments, including certain energy-related investments and consumer products investment that was completed and completed a refinancing this quarter, where we now hold the first lien loan instead of a previously held second lien. Additionally, contributing to the decrease were 2 investments previously rated 3, that were put on nonaccrual status for EBITDA moved to a 4 or a 5 . It is worth mentioning that any investment rated 3 or lower would significantly increase our level of monitoring.

Michelle Handy, the Managing Director, and Head of our Portfolio Monitoring, placed this effort to spend 100% of her time monitoring and managing these existing investments. Michelle has joined our team earlier this year from GE Capital where she was a Chief Operating Officer of the workout group. Michelle's extensive work adds experience directly negotiating and closing over 30-plus restructurings. She has been a valuable addition to the team, and we look -- as we work to rotate out of our underperforming noncore assets.

We continue to be pleased with the progress made on our restructured credits, including Tri-Starr, OEM, Copperweld and C&K. In our view, performance trends continue to be positive for these companies as we position the companies for an eventual exit through our control equity position. Before turning the call over to Terry, I would like to provide an update on the investment in the Logan joint venture. We increased our investment in Logan to $67 million or 10% of the portfolio.

As of June 30, Logan consisted of loans to 107 borrowers, totaling $224 million at par. 88% of the portfolio is invested in first lien loans with the remainder in second lien. The portfolio, which we believe continues to perform well, was marked at 100% of cost at June 30 and recognized a $1.9 million net change in unrealized depreciation quarter-over-quarter by the financial performance of certain companies. We recognize $2.1 million of dividend income for the quarter, representing a dividend yield of 12.7%. Over the last 4 quarters, the yields have ranged between 12.8% and 14.1% based on average invested capital. We will aim to grow our investment at a similar rate in prior quarters as a reasonable based -- which is reasonable based on current market conditions.

I will now turn the call over to Terry.

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

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Thanks, Chris, good morning, everyone. I'll provide a little more color on our financial performance this quarter. We generated $20.3 million of investment income this quarter compared to $19.8 million in Q1, including an investment income of $14.5 million of interest income on debt securities, which included $0.4 million of the PIK income. We did not earn any prepayment fees during the quarter. We earned $3.3 million of dividend income during the quarter from the Logan JV and our equity investment at C&K, and we generated $1.1 million of interest income from other nonincome-producing -- from other income-producing securities, including our interests from our investment in the Duff & Phelps tax receivable agreement. And finally, we had $1.4 million of other income comprising a few from our managed funds and fee income related to certain portfolio of companies.

We incurred $10.1 million of expenses during the second quarter compared to $9.9 million in Q1 fees and expenses related to our borrowings, including the amortization of deferred financing costs worth $4.3 million. We also incurred $2.8 million of base fees, $1.2 million of incentive fees. And as Sam mentioned, we did not collect our full incentive fee during the quarter due to a decline in NAV. And finally, our administrative, professional and other G&A and tax-related expenses totaled $1.8 million, which is in line with prior quarter.

During the quarter, we had realized a net loss of $10.9 million resulting from the sale of our second lien term loans in WIS and Hostway. As you may recall, we marked our investment down in WIS, a loan that was on nonaccrual last quarter; and sold our investment in Q2, resulting in a minimal impact on book value. As mentioned on the last call, we also sold our investment in Hostway in May at $0.94 on the dollar of accrued interest generating a realized loss of $1 million. In connection with that sale, we reversed unrealized depreciation in Q2, totaling $2.7 million. These realized losses were partially offset by a $1.3 million gain in connection with the sale of our equity investment in YP, and we also recognized a tax benefit in connection with the sale of $1.1 million as a result of the change in unrealized gain quarter-over-quarter.

In aggregate, the portfolio of the net change in unrealized depreciation of $0.8 million, which was largely driven by the additional markdowns taken on CRS and specialty brands, as Chris mentioned previously, these were offset by the disposition of the reversal of unrealized depreciation on WIS and Hostway. As of June 30, our leverage was at 0.82 equity, which is slightly above our target of 0.6 to 0.8. We were able to lower our leverage to 0.8 -- lower our leverage below 0.8 post quarter on the proceeds from the full realization of Food Holdings and other partial repayments. We continue to manage our leverage level towards the high end of the -- high end of our targeted range as the portfolio turns over, and we use our proceeds to selectively invest in first lien investments in Logan -- in the Logan JV core assets and/or repurchase stock as market conditions warrant. During the second quarter, we repurchased $1.5 million or 200,000 shares at a 15% discount in NAV.

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

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Christopher J. Flynn, THL Credit, Inc. - Co-CEO, Co-CIO and Director [6]

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Thanks, Terry. Before opening up the call to questions, I'd like to mention the successful fund raise of our third private fund, THL Credit Direct Lending Fund III, which had its final close on $511 million of commitments in June exceeding its target. We are very pleased with its global institutional investor base, comprised of leading endowments, foundations, insurance companies, pensions and for THL's family offices who endorse that platform. Fund III has the ability to co-invest with the BDC under our current exempted release and has been actively investing since Q2 of last year.

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

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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 Leslie Vandegrift from Raymond James.

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Leslie Vandegrift, [2]

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One of the new non-accruals was CRS this quarter. And another side, it's also on another BDC's investment schedule. And it seems to be the same first lien loan, but with 2 different maturity dates, just 30 days apart from each other, both of which occurred in June this year. And so kind of wanted some more color on that and why the other one that was due June 1 versus your maturity date of June 30 might not have been nonaccruing where you guys are.

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Terrence W. Olson, THL Credit, Inc. - CFO, COO, Treasurer and Assistant Secretary [3]

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The loan, we have a position. And the first out position have a term loan. The BDC you're referring to owns 2 positions, the first out and the last out component. So that's the first point. The loan matured on June 30. We marked -- put the loan on nonaccrual on June 30 given the value we established with the credit at that point in time. And as Chris mentioned, it's been scored at 5, reflecting the fact that we don't expect to recover on full principal.

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Leslie Vandegrift, [4]

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Okay. So I guess, my question is, since it was maturing anyways, did you receive interest up to that maturity date and then since it has not paid back yet, you'd put it on nonaccrual?

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

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The -- well, again, we accrue -- we record interest income -- the recording interest income with the understanding that full principal is expected to be collected over time. We have a view that anytime, we have the security that's trading what I'd call substantially below $0.70 on the dollar to pick a number. In our view, it's hard to justify accruing income when you expect to realize a principal loss on a transaction. And as we evaluated the value of our security at June 30, we believe that to be the case. Accordingly, we did not accrue any income in June, and do not expect to do so going forward.

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Leslie Vandegrift, [6]

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Okay. But -- okay. So you've still received income, you're just not accruing it because of the markdown?

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Christopher J. Flynn, THL Credit, Inc. - Co-CEO, Co-CIO and Director [7]

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We received the payment at June 30. That was reflective of...

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Terrence W. Olson, THL Credit, Inc. - CFO, COO, Treasurer and Assistant Secretary [8]

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Interest payment, correct.

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Leslie Vandegrift, [9]

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Okay, all right. That was my question on that. And then a lot of the space this quarter has been talking about, obviously, prepayment in this past quarter, but also the outlook towards end of the year and possibly at even. Have you guys seen any change in your prepayment outlook for the second half? Is it -- and if so, is it weighted more third quarter or fourth quarter? Or what are you seeing there?

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Terrence W. Olson, THL Credit, Inc. - CFO, COO, Treasurer and Assistant Secretary [10]

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I'd say -- this is Terry, Leslie. Appreciate the question. It's very difficult to predict prepayment penalties even on a market where it's happening a lot. I mean, everyone's portfolio is a little bit different. If you look at ours, quite frankly, our prepayment penalty fees have been pretty nominal over the last few quarters. And I wouldn't want to suggest that there's going to be a particular uptick again as a result of broader market conditions. So a little bit of TBD, but I would characterize our levels on this front low over the last few quarters.

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Leslie Vandegrift, [11]

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Yes, so -- but, I mean, you don't see -- so you don't see a major change for years coming on then?

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

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Look, you -- I can't -- you can't predict when the prepayment..

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Leslie Vandegrift, [13]

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Well, yes.

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Terrence W. Olson, THL Credit, Inc. - CFO, COO, Treasurer and Assistant Secretary [14]

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So I don't want to venture to guess what it will be. I will say that it's -- they've been low the last few quarters.

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Leslie Vandegrift, [15]

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Okay, and then last question for me. On the unitranche first lien out -- or first out positions in the first lien last out positions that you have on your book. Is there -- when you work -- when you've been outlooking in the pipeline for those, has there been increased competition on the size and -- of the companies that you've been doing, looking at unitranches? Or have you seen more opportunity in that pipeline? I know you only have a couple right now. But has that outlook changed in any given -- the wind down completely now of the former GE now as a sell fee fund. So have you guys seen that change there?

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Christopher J. Flynn, THL Credit, Inc. - Co-CEO, Co-CIO and Director [16]

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This is Chris, Leslie. I think from a competitive standpoint, the lower middle market where we're focused at $10 million to $30 million dollars in EBITDA, the competition is safe and stable, which is -- that's been high. But from the GE area's wind down, that size portfolio company was not -- I wouldn't describe as a direct competitor of ours. So I said in March, conditions have been relatively stable since -- over last few quarters.

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Leslie Vandegrift, [17]

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Yes. And I'm sorry, and I guess I missed a little bit there. What I meant was with that finally going down and maybe some of the larger unitranche-focused players moving back into that side, I didn't know if that decreased the competition a bit on your end of the market, just from movement I'd say.

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Christopher J. Flynn, THL Credit, Inc. - Co-CEO, Co-CIO and Director [18]

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I would not say so, no.

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Operator [19]

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And our next question comes from the line of Kyle Joseph from Jefferies.

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Kyle M. Joseph, Jefferies LLC, Research Division - Equity Analyst [20]

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Just Terry, on the other income in the quarter, it looks like it was a little bit elevated this quarter as well as the last -- in the second quarter of 2016. Is there any seasonality there? Or is this a good run rate to use going forward?

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Terrence W. Olson, THL Credit, Inc. - CFO, COO, Treasurer and Assistant Secretary [21]

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No seasonality there, Kyle. A lot of the -- when you have amendments and transactions that generate some fees from a variety of sources, it just happens to be when they close. Probably, a little on -- slightly on the high side this quarter relative to a run rate basis if I had to look at that in general, but certainly no seasonality to it.

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Kyle M. Joseph, Jefferies LLC, Research Division - Equity Analyst [22]

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Got it. And then just on the Logan JV, we've seen it continue to grow, but the yields come down a little bit. Can you just talk about sort of your outlook for the dividend contribution there given those 2 factors?

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Terrence W. Olson, THL Credit, Inc. - CFO, COO, Treasurer and Assistant Secretary [23]

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Sure. I think we can -- we certainly see a little bit of compression as there's been some steady level of refinancings in the Logan portfolio like the yields have come down about 20 basis points in aggregate in the portfolio from Q1. If we continue to keep it fully levered, it's performing extremely strong. If you look at the range of dividend incomes on a -- or looking at just quarterly basis, they've kind of been from 12.5% to 13.5% up to 14%. I think we could -- I think we can comfortably -- assuming credit and there's no crazy level of repayments, I think we're comfortable that a 13-plus percent yield can continue to be achieved on that portfolio. But quarter-to-quarter, it can range from 12.5% to 13.5%.

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Operator [24]

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(Operator Instructions) Our next question comes from the line of Jonathan Bock from Wells Fargo.

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Jonathan Gerald Bock, Wells Fargo Securities, LLC, Research Division - MD and Senior Equity Analyst [25]

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Terry, Chris, Sam, so your NAV went down this quarter and you had mentioned that your NOI and the incentive fee had gone down a bit. Yet I believe that instead of taking 20% of pre-incentive fee net investment income, you take 20% of pre-incentive fee net investment income and management fees, which effectively allows you to earn more to the manager, when contrasted with other various shareholder family structures like Golub and Goldman Sachs and others. So can you explain why you're deserving of that premium management fee structure in light of your performance versus others that have more shareholder-friendly arrangements and better performance?

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Terrence W. Olson, THL Credit, Inc. - CFO, COO, Treasurer and Assistant Secretary [26]

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Sure, John. It's Terry. Appreciate the question. At least take a step back. We wrote the incentive fee structure back in April 2010 and alongside Golub who went public I believe the same week as we are drafting our disclosures alongside each other, not realizing when the other was going to go public. So we crafted a structure, and at that point in time, that was most friendly to the market. And the view on management fees was that as we built the construct was management fees are fees that keep the lights on, if you will, at a BDC of our scale. And as such, we elected to treat it as an add-back so as not to penalize ourself against incentive fees what we view to be costs so you'd keep the lights on.

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Jonathan Gerald Bock, Wells Fargo Securities, LLC, Research Division - MD and Senior Equity Analyst [27]

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But you're already receiving that cost to keep the lights on through the base management fee. Why do you need to add it back to the incentive fee?

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Terrence W. Olson, THL Credit, Inc. - CFO, COO, Treasurer and Assistant Secretary [28]

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John, it wasn't -- it was a -- it was something we put in at day 1. If you compare it to others today, it is not as favorable to others today. We understand that the other folks don't have that in. I'm not trying to justify it as better than the rest. But we were the first ones to put in place, and it is what it is today.

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Jonathan Gerald Bock, Wells Fargo Securities, LLC, Research Division - MD and Senior Equity Analyst [29]

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I guess, under the arrangement of it is what it is, are you going to choose to take that tact or are you going to realign it to be best-in-class in light that your performance has been well below your peer group?

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Sam W. Tillinghast, THL Credit, Inc. - Co-CEO, Co-CIO and Director [30]

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Hey, John, it's Sam. We hear your point. It's something that we'll discuss with our board. I can't say on this call what we will do, but we -- you're -- we certainly hear what you're saying John.

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Jonathan Gerald Bock, Wells Fargo Securities, LLC, Research Division - MD and Senior Equity Analyst [31]

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No, I appreciate the mutual respect both ways. It's just an item that I'd imagine that your private investors, when they look at their fund, they clearly would probably have the same types of questions if they were invested in this publicly and found that the fee structures weren't necessarily the same as peers. So thank you for that. It's my question.

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Operator [32]

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And I am currently -- actually just one more came in. Our next question comes from the line of Leslie Vandegrift from Raymond James.

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Leslie Vandegrift, [33]

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Hey, sorry guys. Just one quick follow-up on that. The CRS, obviously, the cash was paid down, but it's on nonaccrual again like you said because of not expecting to get that back. The other nonaccruals, LAI, Tri-Starr, et cetera -- or not -- sorry, not LAI, Tri-Starr, and -- now, I can't find the other one -- specialty brands. Now are you receiving any cash payments on that even though there's no nonaccrual?

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Christopher J. Flynn, THL Credit, Inc. - Co-CEO, Co-CIO and Director [34]

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No, we are not.

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Operator [35]

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And I am showing no further questions. And I would now like to turn the call back to Sam Tillinghast for any closing remarks.

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Sam W. Tillinghast, THL Credit, Inc. - Co-CEO, Co-CIO and Director [36]

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Yes. I just want to thank everybody for their questions, and we'll talk to you again soon. Thank you.

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Operator [37]

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Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program, and you may all disconnect. Everyone, have a good day.