Fifth Street Asset Management Inc’s (FSAM) Q3 2014 Earnings Call Transcript

Below is the Fifth Street Asset Management Inc (NASDAQ:FSAM) earnings call transcript. Fifth Street Asset Management Inc (NASDAQ:FSAM) reported earnings for the quarter ended September 30, 2014, after the financial markets close in New York on Monday, December 15, 2014.

Fifth Street Asset Management Inc. (NASDAQ:FSAM) is a rapidly growing credit-focused asset manager. The firm has nearly $6 billion of assets under management across two publicly-traded business development companies, Fifth Street Finance Corp. (NASDAQ:FSC) and Fifth Street Senior Floating Rate Corp. (NASDAQ:FSFR), as well as multiple private investment vehicles.

Participants:

Leonard M. Tannenbaum, CFA, Chairman, Chief Executive Officer.

Bernard D. Berman, Co-President, Chief Compliance Officer.

Todd G. Owens, Co-President.

Ivelin M. Dimitrov, CFA, Chief Investment Officer.

Operator (Tia):

Good day ladies and gentleman and welcome to the Q3 2014 Fifth Street Asset Management call. My name is Tia and I’ll be your operator for today. At this time, all participants are in listen only mode. We will conduct the questions and answers session towards the end of this conference. If at any time you require operator assistance press the 0 and the operator will be happy to assist you. I will now transfer the call to your host for today, Miss Robin Freeman, please proceed.

Miss Robin Freeman:

Thank you Tia, good morning and welcome to Fifth Street Asset Management Inc. first conference call to discuss our third quarter 2014 earnings. I am joined this morning by Leonard Tannenbaum Chief Executive Officer, Todd Owens co president and Alexander Frank Chief Financial Officer, in addition Bernard Berman Co President and Ivelin Dimitrov Chief Investment Officer, are on the call today and are available for question.

Before we begin, I would like to note that this call is being recorded, replay information is included in our November 13^th 2014 press release and is posted on the investors relation section of Fifth Street Asset Management Inc. website which can be found at fsam.Fifthstreetfinance.com. Please note that this call is the property of Fifth Street Asset Management Inc. Any unauthorized rebroadcast of this call in any form is strictly prohibited.

Todays’ conference call may include forward looking statements and projections. We ask that you refer to our most recent file link with the SCC from foreign factors that could cause actual results to differ materially from the forward looking statements and projections. We do not undertake to update our forward looking statements a must required by law. To obtain copies of our latest SCC file links please visit our website or call investor relations at 2036813720. The format for today’s call is as follows:

Len will provide introductory remarks and an overview of our results. Todd will discuss the market environment and Alex will summarize the financials then we will open the line for q and a. I will now turn the call over to our Chief Executive Officer Len Tannenbaum.

Len Tannenbaum:

Thank you Robin, welcome to Fifth street asset management first quarterly earning conference call. I would like to thank our current shareholders, prospective shareholders and analyst for joining us today. We look forward to providing consistent updates as we continue to expand our asset management platform, although we were not public during the 3^rd quarter of 2014 we decided to have a call to discuss this quarter’s results because we believe it’s important to have open communication with investors and analysts prior to reporting our 4^th quarter numbers  early next year.  Additionally, I would like to thank our employees which now total almost a hundred individuals for all their hard work and contributions as we continue to grow ourselves.

I am very excited and proud to be here today as FSAM’s Chief Executive Officer, after taking the company that I started public at the end of October. Before we begin I would like to take a minute to introduce the other four members of our management committee. I am joined today by Todd, Alex, Bernie and Ivelyn. Bernie Burman our co president one of Fifth street co-founders has been with the company for over 10 years. Todd Owens our other Co-President joined us after 24 years at Golden Facts, where he was a partner and held various activities during his 10 years including head of the west coast financial institutions group. Ivelyn Demetrov chief investment officer has almost been with Fifth street for almost 10 years and leads our investment profits including our credit underwriting, risk management and credit approvals. Lastly but not leastly Alex Frank our chief financial officer was the CFO of  Children investment company, has spent 22 years of mortgage sternly where he served in variety of capacities including as global head of institutional operations.

The public offering of FSAM in late October has already had a positive impact in our business, the increased transparency and improved capitalization of operating as a public asset manager has accelerated our conversations with institutional investors and we are increasingly confident in our ability to grow our institutional business. Traditionally the IPO is perfectly valuable has been pursuing strategy to develop an  institutional business in Japan which may anticipate to include to opening in Tokyo office in 2015. Further we have seen an increase in hiring opportunities as well as acquisition flow which we believe is partially due to our public currency. Lastly, as we discuss on our road trip the IPL has allowed us to source a 176 million dollars 5 year syndicated senior unsecured revolving credit facility that is attractively priced at libor + 200. The credit facility should provide us with the necessary financial flexibility support for our continued expansion. For the quarter ended at September 30^th of 2014, FSAM generated 24 cents which is just net income per share which is principally driven by AUM  and earnings increase in our 2 business development companies Fifth Street Finance Corp and Fifth Street Senior Floating Rate Corp.

Despite not being public during the September quarter we’re reporting net adjusted income per share for a former basis at the end of the September quarter FSAM had total asset under management of just over 6 billion dollars and feat earning AUM of 4.8 billion dollars with 90% of total AUM in permanent capital vehicles. FSAM is currently operating with the wind at our backs and now have opportunity to take advantage of the favorable market trends to continue growing our business. Our senior loan fund business continues to gain momentum, we’re evaluating options regarding the securitization of senior loan fund 1, continue to ramp senior load fund 2 and in the process of raising our 3^rd senior load fund 3. Our hedge fund, Fifth street opportunities fund only which started taking money from outside investors the beginning of this year has 60 million dollars in AUM as of December 1^st 2014  and continues to receive interest  from multiple potential  investors due to its’ strong returns and unique office strategy.

Along with continuing to grow our investing vehicles we are also excited about diversifying the asset management platform through the launch of new funds. We expect from launch an aircraft leasing funds in the near term which will lever the expertise and experience of our aircraft team as we stayed on the  road show. I and other members of management intend to use personal capital to re seed new products. The aircraft fund will be seeded with 20 million dollars of capital from management primarily myself in the form of GP investment. Additionally we have identified several attractive aircrafts that we anticipate temporarily warehousing in the management company credit facility prior to the funds first close.

Another initiative we are actively pursuing is possibly expanding Fifth street into Japan to take advantage of  the attractive market opportunities that we feel will be presented there. Todd and I just returned from a week-long trip to Japan where we met with potential investors and potential partners including importantly SMBC. The opportunity in Japan remains very attractive and we look forward to continuing to work with SMBC and other partners to develop our products to Japanese market which we expect to launch by the end of 2015 and won’t have material impact in operations till 2016.

In the prospectus we say that we expect the dividend to be 30 cents for the 4^th quarter, the board of directors continues to expect that it will declare their dividend of 30 cents per share to the quarter ending December 31^st 2014. Based on current market conditions including the fact that our 2 BDCs are trading substantially below book value we believe that 30 cent dividend will represent a dividend payout ratio greater than 100% of managed adjusted net income per share in the 4^th quarter which exceeds our long term targeted 80-90% payout ratio as stated in our prospectus. Furthermore we believe that a continuing 30 cent quarterly dividend per share on an annualized basis may exceed 90% of our 2015 estimated adjusted net income per share. We expect our boards dividend declaration policy will be in lined with our peers and we anticipate declaring our quarterly dividend as set by the board when we report earnings for that quarter with the exception of this 4^th quarter dividend.

Management expects to communicate the 4^th quarter dividend as declared by the board the week of January 19, 2015 as a reminder our dividend will be a qualified dividend which is favorable for investors with tax standpoint and since we’re seek corp we will not be providing k1s investors. We look forward to providing frequent updates as we continue to grow our existing vehicles and expand the asset management platform into new products and geographies. I would now like to turn the call over to our co president Todd Owens.

Todd Owens:

Thank you Ben, Fifth Street is one of a handful of leading market sponsored focus origination platforms that has been built over the past 16 years by investments in technologies infrastructure and employees. The size and scale of Fifth street provide us with significant competitive advantages including the ability to source, underwrite and manage almost all transactions in our portfolio as well as the ability to leverage our core focus and credit to develop complimentary product lines. We have a team of almost a hundred professionals located in Brinage, Chicago, Palo Alto and Dallas.

As one of the leading middle market lenders we see a tremendous amount of deal flow and we selectively invest in opportunity with favorable risk adjusted returns. During the September quarter, we received an exemptive order from the SCC to invest across multiple funds within the Fifth street platform. We can now hold up to 250 million dollars per transaction across the platform which is a key differentiating factor in the middle market. The sharing of deal flow should allow Fifth street to deploy capital effectively and efficiently while enhancing portfolio diversification and optimizing individual investment sizes within each of our vehicles. Our 2 BDCs provide a source of permanent capital accounting for over 90 % of our revenue and generated a consistent and predictable income stream for FSAM. Over the course of the fall stock prices of our BDCs declined and did many of their peers and trade well below book value.

As we have previously stated we do not intend to issue acuity at either BDC below book value. As a consequence we have not been able to raise equity capital of the 4^th quarter in our ability to raise additional equity capital a future is dependent upon meaningful increases in our BDC stock prices.

Despite current trading values we remain very excited about the market opportunities for both of our BDCs, we are particularly enthusiastic about FSFR or Senior Floating Rate Vehicle because we are seeing very attractive opportunities in the senior secured market. Furthermore with a low 1% management fee we believe that these structures, once of the lowest in the industry become which are very attractive to investors. Finally, our portfolios are a 100% invested in floating rate loans which position the vehicle for any rise in interest rates. For both of our BDCs we believe there’s capacity to grow by utilizing the 30% non-qualifying asset basket to form joined ventures with long standing partners. Each of our BDCs have one JD which provide multiple benefits, the JD has expand each respective BDC  investment capacity to originate and underwrite middle market loans and provide an efficient way to finance assets that enhance returns for our shareholders.

Senior loan fund JD 1 FSCs joint venture a subsidiary of term per corporation was closed in May of 2014. As of September 30 of 2014 the JD had a 186 million dollars of assets including investments in a range of one-stop in senior secured loans to 18 portfolio companies.

In November we announced the formation of FSFR, Glick, JV, LLC, a joint venture with an entity controlled by members of the Glick family. We expect to start allocating assets to the joint venture from FSFR balance sheet in the near term. We have ample capacities about these and other similar joint ventures. Ramping the joint venture at each BDC and forming other similar potential JVs represent an important driver of our future earnings both at FSC and FSFR. I would now like to turn the call over to Alex Frank our CFO to discuss the financial in more detail.

Alex Frank:

Thank you Todd. FSAM completed its’ IPO on November 4^th 2014 issuing 6 million shares of class A common stock at $17 per share. The total proceeds now net of underrating discount we’re $95.9 million. We ended the 3^rd quarter of 2014 with total AUM of $6 billion, a 55.4% increase from the 3^rd quarter of 2013. Fee earning AUM for the quarter ended September 30^th  2014 increased 60.6% to 4.8 billion from the quarter ended September 30^th 2013. Much of the AUM growth in the 3^rd quarter was driven by equity raises at FSC and the FSFR as well as the launch and ramping of senior loan fund 2 which is our 2^nd senior loan fund that we intend to securitize as part of our CLO platform.

Total revenues increased by 44.1% to $25.4 million for the quarter ended September 30^th 2014 as compared to $17.6 million for the quarter ended September 30^th 2013. The growth in total revenues was driven by the increase in year over year fee earning AUM. For the 3 months ended September 30^th 2014, we generated $23.1 million in management fee revenue which accounts for 90.8% of total revenue. After adjusting for non-recurring items, total expenses increased by 31.1% or $2.2 million to $9.4 million for the quarter ended September 30^th 2014 as compared to $7.2 million for the quarter ended September 30^th 2013.

The increases in expenses was due primarily to increases in occupancy cost and other general and administrated expenses. For the quarter ended September 30^th 2014, we generated $16.7 million of pre-tax adjusted net income versus $10.5 million for the quarter ended September 30^th 2013. We generated $11.8 million in dollars of pro formed adjusted net income for the quarter ended September 30^th 2014 vs $9.7 million for quarter ended September 30^th 2013. For the September quarter we generated pro formed adjusted net income per share of 24 cents as compared to 19 cents in the prior year.

Despite not being public during the September quarter we are reporting our adjusted net income per share in a pro forma basis including the impact of pro forma estimated taxes, also in November we closed on a $176 million 5 year syndicated senior unsecured revolving credit facility jointly led by Morgan Stanley and Sumitomo Mitsui. The credit facility was undrawn and closed and has a $100 million accordion feature for total potential capacity of up to $276 million. The credit facility carries a very attractive interest rate in any borrowing facility will initially grew interest at live work plus 200 basis points. We expect to utilize this facility to among other things, facilitate the growth of our existing business clients, provide fee capital to expand complimentary businesses and funs and cover working capital needs. I will now turn back over to Robin.

Robin:

Thank you for joining us on today’s call. Tia please open the line for questions.

Tia:

Ladies and Gentlemen if you would like to ask questions press start 1. If your question has been answered or you wish to withdraw your question press start 2. Questions will be taken in order received. Let us start 1 to begin.

Robin:

The 1^st question comes from Alyna Ken Worrington of JP Morgan please proceed.

 Alyna Ken Worrington:

Hi, Good morning first on the environment I think FSAM had fairly robust assumptions for AUM growth in 4^th quarter 2015, given 4 q is seasonally strong and almost over. Can you give us an update on how the lending environment has been in the quarter?

Answer:The opportunities that are presented from the market are pretty great, you have a high yield and the environment for one stop is probably increasing yields by 50 to 100 basis points of course that cuts 2 ways but we’re really excited to invest capital in this quarter. Fortunately for us we have very very little energy exposure in the 2 BDCs and in hedge fund and in PS Ops so we didn’t have impact that some of our peers who have over to 10% exposure, including one of our peers with the largest companies at 6.3%. I mean it’s ’ really cut very differently across the peer group. So we see a lot of opportunity we are able to take advantage of it. Having said that right,We are not able to raise capital at the BDCs, we won’t raise capital below book and because of that some of that was anticipated I think by some of the analysts but we don’t foresee raising capital at either BDCs for quite a while as we are going to wait for them straight above book so in that case, we’ve had to tamper our broke plans at least especially at FSC, as we enter our max leverage range that we really want. FSFR, of course having much opportunity to grow including as an edge, more leverage lines, it will continue to add assets which we seek plenty of.

Question: FSG treating at us at a succession discount NAV, assuming that it continues to trade below NAV for a period of time, how is your plan in resource allocation changed to continue to drive growth at FSAM?

Answer: Well, we always knew that we had to diversify the asset strategy away from the BDCs, you can’t be reliant on the two BDCs to a large extent withheld products because they do have some institutional holders. We feel like we’re being praised successful developing the institutional side of the business, however I think from FSFR, at the ability to invest in senior-senior assets which are terrific in this market and the ability to lever a bit more, and we believe that it will trade very well. FSC may take a little longer, however both of them are very well positioned for the down cycle because we’ve rotated into very senior securities so the good news is we’re very defensively positioned in both, but you’re right to grow FSAM as aggressively as we would like. We’d require FSC which is a large contributor to grow faster and we don’t see that happening in 2015.

Question: Okay great then lastly on accounting, you’re backing out the cost of FSC offering costs. What’s the rationale here and what is the FSAM philosophy about what cost kind of gets included and excluded as we look forward?

Answer: Hi this is Alex. Our general philosophy is that there was one time non-recurring items and our expectation is we generally are not gonna be doing or paying for those kinds of costs in the future so as a matter of consistency when comparing periods, we think it’s appropriate to exclude that.

Question: Is FSG gonna be in the market somewhat regularly raising equity now? Right but we don’t intend as a general matter that the national company is going to pay for the cost of that.

Tia:

The next question comes from the line of (inaudible), please proceed.

Question: Thanks guys, good morning. So first is you’ve just given a positive response to the level of attracting lending opportunities now comes the question: can you comment on your willingness to lever up both BDCs especially because they’re you know, they are quite under-levered today?

Answer: Look, this is the time to use leverage and the reason I say that is because you’re finally getting the right pricing, right risk adjustment returns for senior assets. I can’t believe how fast they’ve glided and so, we really wanted to take advantage of it and fortunately our sourcing really has come up with a lot of good opportunities. I mean fortunately for FSFR shareholders, the have a lot more capacity than the FSC shareholders in order to take advantage of it. It’s just the fact that they are quite relatively under-levered in the environment so we expect to fully lever FSFR by the end of next quarter and be as far-levered as we can this quarter.

Question: Got it and when we think about incremental growth, if we just assume zero for equity capital raises in both BDCs of the next few months, how should we think about the next   earning growth between corporate leverage at the BDC and also enhancing the size of the joint ventures with the Glick and Camper?

Answer: I’m not sure maybe Alex can answer, the cost associate with what you’re saying. I think, look we’re planning on not raising capital on either BDC for the all of next year. We are hopeful that given good performance over time that they will trade back above book, we may be able to access it but that’s not how I’m budgeting my budget. I’m budgeting my expenses and company for zero growth at both BDCs. Having said that, we expect to invest and grow in lots of different other entities and as we talked about aircraft leasing and the hedge fund and the silo business and opening an office in Tokyo, it’s not that we’re not investing in the future and it’s not that we are not gonna add a UM and potentially a UM and another vehicle as we talked in the road show, so of course we’re still exploring the non-traded markets but as you saw, the largest non-traded have some issues. The Wall Street journal even today, that market is still being evaluated of how to do that in an institutional manner.

Todd G. Owens:

Let me just amplify a little bit on what Glenn just said. In this environment, it’s really hard to anticipate raising equity capital at the BDCs and so what that means is, the growth in those vehicles is really gonna be driven by growing and developing additional JVs. So there will be some asset growth in those off-balance sheet JVs as well as operating those vehicles at an appropriate amount of leverage and when we get to a point of we are able to raise equity capital, then, we will do that if the investment opportunities are there for those vehicles. As we sit here today, we’re seeing lots of investment opportunities for both vehicles. We’re most excited really about the senior secured opportunities which are most appropriate for FSFR but again neither vehicle today is in a position to raise at equity capital.

Question: Got it and I just have one follow-up on Tokyo: Can you layout the potential timeline you have for building out this business? I just wanna see what big events or key events we should be expecting in the next six months or so?  And when shall we actually see meaningful kind of asset growth coming from that business or is that maybe more of a 2016 event?

Todd G. Owens:

It’s Todd again. As Glenn I think mentioned we don’t expect there to be a meaningful contribution to FSAM until 2016 but even to get a contribution in 2016, there are a lot of things that would have to happen this year. Glenn mentioned that we were in Tokyo all of last week. We had 25 or 27 meetings and we came away from that feeling more optimistic that there’s a real opportunity there. I think what you’re gonna see from us by the middle of the year, we hope, is to open up an office in Tokyo, to make some hiring decisions in Tokyo again by midyear, to be in process or perhaps to have achieved some of the licenses we need to operate in Tokyo and we’re hoping that we would be in a position to watch at least one vehicle to raise capital there before the end of the year. But really any material capital raising are likely to be a 2016 event.

Tia:

Thank you for joining us on today’s call. The next question comes from the line of Christopher Nolan with MLV and company. Please proceed.

Christopher Nolan:

Glenn, in your comments you mentioned that you thought that annualyzing the current 30 cents/quarter dividend in 2015 would deliver a pay-out ratio north to 90%, so that sort of indicates defacto EPS guidance in the range of a dollar 20 to a dollar 33, is that a fair way to look at it?

Glenn:

I won’t answer that again (laughs).

Todd G. Owens:

See actually if you do the math, that’s correct. We’re not providing forward guidance for next year’s earnings. We are not forwarding guidance on earnings but as we look out, as we consider where the BDCs are craving today and our ability to raise equity capital there, we’ve had, it was important to point out that that dividend on the annual basis maybe above 90% of our earnings.

Question: Okay then following up on the dividend, is the expectation to try to target a dividend based on a pay-out ratio of 80% or so, you know when the dividend of January should be more in lined closer to an 80% pay-out?

Answer: Look the goal is to do an 80-90% pay-out over the long term. Initially, there’s gonna be some volatility to that percentage range and the board is very obliged to monitoring the situation.

Tia:

The next question comes from the line of Mark Every with Golman sec. Please proceed.

Mark Every:

Great, thanks.

Question: Can you give us an update on the Sirlon fund in SMA build in 2015 just in terms maybe on what the pipeline looks like? I know you’ve hired Rene and I have an opportunity to build that institutional business and I’m curious how that’s gonna progress or you think that’s gonna progress as you look at sort of the opportunity set ready for 2015? Thanks.

Answer: You know we are pretty excited about the initial traction and it’s our first time hiring ahead of institutional sales and building out that function. And there’s a lot of balls in the air, so I hope that since we’re gonna have frequent calls, that we’re gonna have positive things to say on these calls regarding our institutional business. I think it’s a little bit too early to discuss it but I think there’s gonna be another call reporting some of our earnings and we hope to say some positive things about the growth of the institutional business.

Question: Okay and then you know in terms of the 2015 expanse outlook, obviously we’ve got some start-up causative manual with the Tokyo office in 2015, how should we think about as you don’t have capital raises in the BDCs and you have a little bit of pressure against on the top, how much flexibility is there in terms of the expanse plan or should we continue, is there any sort of variable cause structure that we should be thinking about? Thanks.

Answer: You know I think that’s a very good question. I’m in the middle of the budgeting process. Many adorations for next year. Thinking about all those different things, I will point out that several of our business plans, the management company lose money, which is things like the aircraft leasing team, the hedge fund, we’re operating the hedge fund, it’s a billion dollar hedge fund and it’s not a billion dollars, it’s 60 million. So at those scale, you can be able to get some efficiencies there. That will be offset of course by some new lines such as Japan. So from all intents and purposes, I’ve been actually through the budgeting processes, I’m pretty much detailed now, I feel like flat margins are a reasonable assumption.

(Right Alex?, Yeah, I was gonna say the same thing).