Question-and-Answer Session
Operator
[Operator Instructions]. And our first question comes from the line of Sanjay Sakhrani of KBW. Please go ahead.
Sanjay Sakhrani – Keefe, Bruyette & Woods
Hi. Thanks for taking my question. Just a quick question on the ’08 dividend guidance, how much of the dividends are expected to be paid out of ’08 capital gains?
Malon Wilkus – Chairman, Chief Executive Officer and President
The ’08 dividend?
Sanjay Sakhrani – Keefe, Bruyette & Woods
Yes.
Malon Wilkus – Chairman, Chief Executive Officer and President
Well, you could see that our ordinary taxable income has doing? been doing a superb job of covering our dividend and we don’t see any reason why that won’t continues. So, but on the other hand since we are spilling over the capital gains and we can only do that for so long. We will have to use a chunk of the capital gains to pay the dividend. We will report that but we will spill over then the net operating income over in 2009. So we expect to have outstanding coverage by our taxable income of our dividend in ’08.
John Erickson – Executive Vice President and Chief Financial Officer
Yes. I mean, we didn’t give detailed guidance on this but you’ll be able to see that our ’07 capital gains that are been spilled over are significant. So, based on the? where we set the dividend if we pay the level that we’ve set. You could really see with the numbers that is not an easy any of the ’08 capital gains to pay that level of dividend. I mean, what is been happening is over the past the three years, we’ve been distributing less then our realized earnings as I think Malon mentioned on the call. You know the realized earnings have been running 26% higher than our dividend and so I think that if you look we grew the dividend from ’06 to ’07 12% without using capital gains and you could in fact look at this increase of 13% as being modest of not over flowing capital gains and they are not really relying heavily on future capital gains because of just increase of the growth rate by 1% to some extent with the modest if your similar earnings can change to grow next year they have this year. So there is really not a reliance in looking out towards ’08. We feel like with the spill over and we start spilling our rate is probably two years ago. We’ve already built up over two quarters pushing with this spilling over the capital gains. We’ve got plenty of push into cover that the dividend forecast without having to really rely on ’08 capital gains.
Sanjay Sakhrani – Keefe, Bruyette & Woods
Okay, okay. That’s what I was getting at and just to clarify Malon, to the extent that you guys have realized losses that would hit up against sort of the spill over. Is that right?
Malon Wilkus – Chairman, Chief Executive Officer and President
No. I think that the spill over is going to get locked in and then the realized losses would hit against future capital gains. So and if you look at the portfolio in total, we have plenty of unrealized appreciation to buffer us. So, obviously we will have realized losses but total we are projecting the realized gains will be positive net which is? if you look at portfolio there in terms where it is valued, that is a pretty easy assumption to make.
Sanjay Sakhrani – Keefe, Bruyette & Woods
Okay. Got it. Just second question, just on the asset management initiative, I mean are there any other funds that? or I guess what are the other funds that are imminent? I guess what I’m getting that is sort of what the yield drag is from the non-core assets that are being incubated?
Malon Wilkus – Chairman, Chief Executive Officer and President
We did a extensive analysis of that and we really aren’t having much of the drag on the NOIs as result of the development of our funds under management, in part because it’s really integrated very much into our capital raising capabilities. So our finance department is? has for many years been meaning to raise capital quite periodically and really the capital or the asset management strategy is simply a capital raising concept and so this is? our department there is a permanent department. It is substantial. We are continuing to hire there, so we can tap into all sorts of capital around the world and not just the public markets and you can see the result of that is that we’ve been rolling out a wonderful set of funds under management and if you look at the slide 49, you can see that we now have 6 funds under management. They all are earning us fee income and to the most part they all have carried? some kind of carried interest that gives us some upside. We think for most part, most of these upside will occur down the road but the fee income is helping to produce some wonderful asset management fee income that is highly steady, predictable and growing.
John Erickson – Executive Vice President and Chief Financial Officer
And one other thing if there always a drag related with growth whether it is creating a fund in hiring a team that helps generating assets or whether it is just opening another office just putting assets on American Capital’s books. We’ve had that drag essentially for 10 years in our numbers and we don’t expect that drag to go away. So trying to kind of separate or isolate it is a very difficult task but essentially any time we open a new office or any time we decide to go into a new vertical and hire a team that is dedicated to or any time we decide to set up a fund and hire a team that is going to be dedicated as funds. There is some absolute drag that you experience but that’s really been baked into our numbers for 10 years and as long as you assume that then we are going to continue to grow. We would continue to have a similar kind of drag in the numbers because we? there is no question that at any point in time, we have employees that have been hired but are not yet generating revenues or are fully accretive in terms of the ROEs they are generating. So we want to reduce and to put some asset on the books. It takes a while for the ROE to get up to the level that American Capital overall is enjoying.
Malon Wilkus – Chairman, Chief Executive Officer and President
And I guess where I was getting at is the core sort of middle market investments or debt investments are probably generating a higher yield than let’s say the CMBS portfolio.
Sanjay Sakhrani – Keefe, Bruyette & Woods
No. I mean if you were to isolate those investments. I mean, I would think that there would be a drag on the yield, right?
Malon Wilkus – Chairman, Chief Executive Officer and President
Yes. That was probably true up until we did the CDO and up until we remarked the CMBS assets but at this point in time certainly based on fair value that’s not true and even based on historical cost. We are generating a fairly positive yield. So really that dynamic changed effective with the CDO transaction. It really helped us get the yield to where we wanted it to be plus I guess, we talked about in the second quarter, we started changing the pricing on the CMBS as early as April and that’s already starting to flow through though the price increases continue all the way in through August. So, starting in April, we are raising prices and even as we did? CMBS transactions in July and August, so prices continue to widen out and today we think that we are essentially indifferent to whether we put in a CMBS transaction or to put a sub debt transaction because your CMBS transactions on current yield basis are in the mid teens.
Sanjay Sakhrani – Keefe, Bruyette & Woods
Okay. Great. Thank you very much.
Malon Wilkus – Chairman, Chief Executive Officer and President
You’re welcome and just to point out on the slide 49, we have a whole variety of additional funds and development to the? continue to expand our alternative asset management business.
Sanjay Sakhrani – Keefe, Bruyette & Woods
Hey, great.
Malon Wilkus – Chairman, Chief Executive Officer and President
Thank you.
Operator
Okay. Thank you. And the next question comes from the line of James Shanahan of Wachovia. Please go ahead.
James Shanahan – Wachovia Securities
Thank you very much. Good morning.
Malon Wilkus – Chairman, Chief Executive Officer and President
Good morning.
James Shanahan – Wachovia Securities
My first question I guess from your earlier response, it doesn’t sound like you are willing to provide the exact dollar value or retained long term capital gains at sub 30 that’s available to support the dividend.
Malon Wilkus – Chairman, Chief Executive Officer and President
Well, I think the? we will have a number in the queue. It’s going to be at about $140 million. I just don’t want to give an exact number at this time but Rich said this at the press release 142 million is what we're spilling it over at this time.
James Shanahan - Wachovia Securities
And regarding ACAS equity, you sold a 70% interest in all your equities investments and that was at a 3% discount to, I think you said the June 30 carrying value. Now this was announced in October but in this market value comp or level 1 input if you will be impacted the fair value of any of your equity investments for the September quarter?
Malon Wilkus - Chairman, Chief Executive Officer, and President
If you look at the slide. Let’s turn to that slide. That shows the individual assets and composition of the depreciation and net gains. We had wonderful gains on the portfolio so he third line there of $92 million of gains for the portfolio. In Q3, but then we had all of $10 million of portfolio company depreciation. So if there was modest changes to the portfolio company's and it is those, it is the equity in those company's which would be sold in that transaction and so I think we are in great shape it’s nowhere near that $10 million is virtually zero on that volume of assets.
John R. Erickson - Executive Vice President and Chief Financial Officer
I think we could exit at those level 3 data and I think it played a roll in the evaluations yet, in looking at how that transaction was negotiated they were working on Q2 portfolio company data and they were pricing the transaction in the August, September time period. I think the price had been essentially kind of agreed to early in September and they did not have third quarter portfolio company performance data so we had to consider that in our valuation but obviously we also what data they were working on and what the time frame was that they were making that assessment. So when you? certainly during the third quarter I think everyone in the middle of the quarter thought that the quarter would end with public companies being weighed down. But indeed that’s what happened and the public comps were generally quite solid from the beginning of the quarter to the end and in fact our data in the aggregate from our entire portfolio shows revenues and EBITDA increasing. So we think the structure an excellent transaction with respect to American Capital and equity too
Malon Wilkus - Chairman, Chief Executive Officer, and President
One other point. We didn’t sell 100% free and clear interest in those portfolio company's because in essence we retained a management agreement that paid us 2% up to a 30 % carry and so the way GAAP will account for that, it was a fourth quarter transaction the way GAAP will account for that is they will? GAAP will require us to put some value on the management contract retained which will be addition proceeds and the 3% discount does not take into account then the value of the management contract received which will be additional proceeds so when we're done with the fourth quarter valuation and with valuing those proceeds we’ll give a detail break out in Q4 what the actual realized gain or loss for that transaction would be. I mean like we expect at this point to be a realized gain.
John R. Erickson - Executive Vice President and Chief Financial Officer
Yes. Keep in mind that, I think we announced there’s $10 million of revenues flow into the asset management company as a result of the transaction on an annual basis. So the combining that together with the discount frankly it’s a superb transaction for our shareholders.
James Shanahan - Wachovia Securities
Currently Ecast evaluation I appreciate that your generosity with your time. The Ecast valuation, it has deteriorated further since September and should I understand that to mean that any incremental further weakening in the share price of Ecast offset by an increase or improvement in the currency translation would basically be accrued to the control premium?
Malon Wilkus - Chairman, Chief Executive Officer, and President
That remains to be seen. We will have to value that at the end of each quarter obviously. But I think what is occurring is from a control perspective one opportunity of the control investor is the ability to liquidate the assets and that’s something that a minority investor doesn’t have the advantage of but it’s certainly in the power of the control investor. And so the net asset value of European Capital does represent a very powerful indicator of value.
John R. Erickson - Executive Vice President and Chief Financial Officer
Yes. I would say that we spend a tremendous amount of time on that valuation this quarter also consulting with numerous advisors including obviously consulting with national people at Earnest and Young consulting Houlihan Lokey and also consulting with the FAS 157 advisor that we had engaged previously and as you know the FAS. We spending a lot of time providing some guidance insights on 157 right now so I don’t know that we want to give any color on what may happen in the future and I think there’s still some flux around 157 how that, what kind of ultimate guidance that may come out. But, for this quarter suffice it to say we spend extensive amounts of time with our advisors concluding on the valuation methodology and it just depends on what ends up coming out of 157as to how that might impact in the future.
James Shanahan - Wachovia Securities
Thank you.
Malon Wilkus - Chairman, Chief Executive Officer, and President
You're welcome. Thank you. Next question please.
Operator
Thank you and the next question comes from the line of Carl Drake of SunTrust, Robinson, Humphrey. Please go ahead.
Carl Drake - SunTrust Robinson Humphrey
Thank you. Good afternoon. A couple of questions. In the quarter there was a reduction in fee income that came I believe tied to origination volume and also operating expenses that declined nicely with that. Maybe you could touch on little bit of the break out, what happened there and also the breakout of the $44 million in the fee income.
Malon Wilkus - Chairman, President, and Chief Executive Officer
Yes. Ira, why don’t you speak to that.
Ira J. Wagner - Executive Vice President and Chief Operating Officer
Sure. As we've said many times in the past. The fee income is lumpy quarter-to-quarter. Predominantly tied to the volumes of ACAS buyouts business. And the buyouts business is inherently lumpy quarter-to-quarter of the second quarter of this year was very robust and I think we did five transactions or five or six in the second quarter of the year and the third quarter was significant lower in a couple of transactions which you saw on slide 23 at $586 million and a large part of the fee income is tied to that buyouts business, so that’s why it’s lumpy quarter-to-quarter related to the buyouts business.
Carl Drake - SunTrust Robinson Humphrey
And the operating expense are also tied somewhat to that?
Malon Wilkus - Chairman, Chief Executive Officer, and President
It’s a pretty good decline quarter-to-quarter.
John R. Erickson - Executive Vice President and Chief Financial Officer
The relationship between compensation but there are, some elements are certainly tied to it for example. Write offs for dead deals and that sort of thing that varies from quarter-to-quarter depends on what you're working on and what happens.
Malon Wilkus - Chairman, Chief Executive Officer, and President
That would be the bulk of our business. Now that M&A market has dropped off, but not nearly to the extent that the big LBO transactions have dropped off. So we are continuing to see a very robust deal flow in the middle markets for both the buyouts side of the business as well as sponsored finance side of the business. In fact on the sponsored finance side of the businesses the deal flow is picking up as some other investors have dropped out of the market and its investors like ourselves who are the long-term investors that are? That the other private equity funds are turning to, to fund the transactions that they have. So the middle market contributions to be very active. There’s still plenty of transactions in the marketplace. It’s really the big LBO business that you've seen the really dramatic fall-off and that’s a very, very small part of our business.
John R. Erickson - Executive Vice President and Chief Financial Officer
I think, it’s worth pointing out there’s been a lot of commentary that the M&A business is going to drop off and therefore we won’t be able to do a lot of new buyouts and we won’t be able to sell a lot of companies that we have been doing in the past and we're just not seeing that, there is, quarter-over-quarter the second quarter was an extraordinarily high quarter in volume of M&A activity and yes, we're down from that. But, year-over-year it’s still dramatically up. There’s great opportunities out there. We do think it’s harder for some buyout firms to do deals because it’s harder to get debt financing but it’s not impossible and of course our one stop financing that we offer to other private equity firms is in great demand right now. And then our one stop buyout has tremendous power in this environment where everybody wants more confidence of getting to a closing. Because some of the big buyout firms, weren’t able to provide confidence. I mean they failed in being able to perform, when they had committed to a buy out. We, our one stop buyout capability really eliminates that risk and it gives us great opportunities. But we think we will have still an excellent environment. It certainly is, from what we see in the next quarter, what we're seeing right now and what we would anticipate in the next quarter that we will have substantial M&A volume of opportunities. Now opportunities are one thing, closing is another. We closed up 1.5% I think this last quarter of the deals that we looked at so that’s why it can be so lumpy. And then two, is that we have a number of company's for sale and we quite often just think that they will be sold and with a great outcome. So we think a lot of the speculation about some substantial declines is not appropriate.
Carl Drake - SunTrust Robinson Humphrey
So, your view of the economy, taking those comments is pretty optimistic looking out into 08 in terms of multiples steady on, in terms of purchase multiples despite the credit crunch?
Malon Wilkus - Chairman, Chief Executive Officer, and President
Well the data we've been looking at quite a bit of data on this both our own internal data as well as outside data and if you strip out the large deals and just pay attention to the middle market. Spreads been widening on senior debts. Spreads have widened on sub-debt materially, but purchase multiples have not really changed and that would imply that returns to equity is probably a little lower? the likely returns to equity probably have dropped a little bit. But keep in mind, returns on equity, in the world of private equity, at least, for the top quartile, private equity has been extraordinary. And we have proven that and you can see it from our numbers with extraordinary returns on our equity. Now if those were 2 percentage points less, I don't think it would impact our ability to raise capital, nor I don't think that would be the case for the top quartile of private equity. So, there is still a lot of capital out there for private equity to buy companies, and of course, keep in mind, private equity represents maybe only 40% of the buyers out there or 30% worldwide most of the buyers are strategic buyers.
John R. Erickson - Executive Vice President and Chief Financial Officer
Yes, and I would also say that the return of equities have only dropped if you assume that the cost of financing is going to remain over the next five or six years where it is today. If you assume that it’s going to? will get out of this credit cycle and the fancy market gets a little tightened up some? I backed it some of the equity sponsors are assuming that they can refinance later on a lower cost to debt capital and really not probably impact directly returns that much.
Carl Drake - SunTrust Robinson Humphrey
Okay. I appreciate the discussion.
Malon Wilkus - Chairman, Chief Executive Officer, and President
Yes, that’s not our view. That’s not what we are doing, but that's’ what I think?
John R. Erickson - Executive Vice President and Chief Financial Officer
One of the reasons you are not seeing the equity multiples or the equity changing much in value.
Carl Drake - SunTrust Robinson Humphrey
Okay. Thank you.
Malon Wilkus - Chairman, Chief Executive Officer, and President
You’re welcome.
Operator
Okay. Thank you. And the next question comes from the line of Vernon Plack of BB&T Capital Markets. Please go ahead,
Vernon Plack - BB&T Capital Markets
Yes. Thanks. The? debt to equity ratio at the end of the quarter is? was substantially lower than it has been for quite some time. I am curious in terms of thoughts on managing that going forward, should we expect you to leverage back up or what are your thoughts?
John R. Erickson - Executive Vice President and Chief Financial Officer
Yes, I think that we will certainly leverage back up. I think we had very active quarter for capital rising and for capital coming back. If you added up the slides Malon covered in terms of repayment and capital raises, that's almost $4 billion that we had of liquidity in the quarter on $11 plus billion invest on the balance sheet. So, that's quite substantial. And that was not unintentional. Obviously, in a market of credit disruption, we want to be a little more conservative and really raise some capital ahead of needs, and so, I think that puts our balance sheet in a great position to be opportunistic in this market.
Vernon Plack - BB&T Capital Markets
John, you all were actually coming closer to 0.9 to 1. Do you expect to migrate up to that? Or is a lower number probably more appropriate at this time?
John R. Erickson - Executive Vice President and Chief Financial Officer
It depends on closings. We are very active in terms of pursuing transactions and it’s possible that we could up to 0.9 to 1, but it’s also possible that if we don't close on a transaction here or there, we won’t. I think we want to remain well funded, and we are going to make sure that we got plenty of capital to pursue the opportunities.
Vernon Plack - BB&T Capital Markets
Okay. Great. Thanks John.
Operator
Okay. Thank you. The next question comes from the line of Scott Valentin of FBR Capital Markets. Please go ahead.
Scott Valentin - Friedman, Billings, Ramsey & Company
Thanks for taking my question. It has to do with the control premium and just? I am trying to make sure I get the mechanics behind it correct. I guess that the fact that the ACAS is trading below NAV because you own a good chunk of the Company, you have chosen to evaluate at an NAV basically on the assumption that you can liquidate the Company and recover NAV. At some point in the future if things? when things turnaround and ACAS were to trade at a premium would you then be locked in and say, okay, VAV is liquidation value or would then you go with the higher stock price on the assumption you could sell through the open market at a higher price?
John R. Erickson - Executive Vice President and Chief Financial Officer
The methodology is price times quantity plus? one plus the control premium. So, price times quantity is one of the inputs in that equation.
Malon Wilkus - Chairman, Chief Executive Officer, and President
And 157 does require you to look toward the best market to optimize value.
Scott Valentin - Friedman, Billings, Ramsey & Company
Okay. I am just trying to? a handle for forward looking? when we do our estimates and do you think that, just what can we uses kind of a factor, is there a factor use or is it just going to vary from quarter-to-quarter.
John R. Erickson - Executive Vice President and Chief Financial Officer
Scott, if the stock will be trading well north of NAV. We wouldn’t say that likely exit would be to liquidate the Company. We would say we want to build the stock, and that the philosophy. You may see control premium. We reduced over time if the stock is well north of NAV because you are going to be very liquid market for the stock above NAV.
Scott Valentin - Friedman, Billings, Ramsey & Company
Okay. And just a follow-up question. On the dividend policy going forward, the payout on long-term gains, does that eject more volatility into the dividend? I mean if you guys start paying--?
Malon Wilkus - Chairman, Chief Executive Officer, and President
Just the opposite I mean that's the thing I find so interesting. All of a sudden we added more capital to the potential could? that can fund the dividend. So, historically, for 10 years now, we have only funded the dividend with ordinary taxable income. Now we have announced that we are going to add another stream of cash flow of earnings that could fund the dividend and now people are thinking it’s going to become more volatile. Well, that would be the case if we took it to the max, but we have never taken the dividend to the max. We have always have earned dramatically more realized earnings than we have had paid out as dividends. And we intend to continue to do that. We plan to actually have the dividend be more consistent to provide more confidence in the dividend by building up the reserve to the extent that that the tax laws allow, and that's quite meaning full. It’s not? you can’t do it forever, but it’s very, very meaning full amount. We think we can get three maybe four quarters of reserves and then that reserves will go up and down, depending on some lumpiness of our taxable income. And so we just think we’ve up? so keep in mind, our real life return on equity for five years has been 16%, right. 16% and yet our dividend growth is? this quarter? the year was 12%, this year for ’08 we forecasting 13%.
So, we are still reserving our 3% of our return on equity that we are not paying out. Now alternately with this policy, we will have to? if we continue to have 16% return on equity for the next five years, within about a year, we are going to have to go to a 16% payout rate. And? but we will still have a lot of reserves so that if it dipped below 16% ROE that we will have a period? a year, probably a whole year of capacity to absorber that dip. And so, this is? I mean I think folks don't realize how much more we could have paid out as a dividend over the years, if a lot.
John R. Erickson - Executive Vice President and Chief Financial Officer
Just to the excess realized earnings over the dividends for the last three years was like $0.45 in ’05 and $1.10 in ’06 and $0.79 in ’07. And so there’s been substantial earnings. And the other thing is to keep in mind is our portfolio is extremely granular. It's not as though we have three or four companies where we are expecting all of our capital gains to come from and so either you sell or you don't. We have a granular portfolio of equity investments where we have a number of companies that we are planning to put up for sale in the near-term that have good unrealized appreciation and they will be more companies in ’09 and more companies in 2010. So it’s going to be a regular harvest moon. Certainly, we can go through a recession or a tough environment, but that's why two years ago we started the bank the dividend pay in excess tax and that's? we put ourselves in a position to absorb a downturn. So, I would echo Malon's sentiment we have actually been very conservative and have plenty of excess capacity, so that we don't have the? we don’t want to payout a 100% of everything, so you do start to see the dividend having to move up and down with the realized earnings. We are going to it as a conservative level where we’re continue to spillover in banks and then if you do have a negative environment, you get the ability to keep that dividend going at the same rate and eat into the spillover earnings that you would have had for the following year.
Malon Wilkus - Chairman, Chief Executive Officer, and President
Yes one thing I have always been surprised at is that relative to the other BDCs, we have had one of the best coverages of ordinary taxable income to our dividends. And we have managed to that where it seems at least in some cases BDCs have not concentrated on their ordinary income and use gains to make their dividends, but so even? so there’s two? you can think of it there’s two kinds of companies one like finance companies in the BDC world, where all they really have is ordinary taxable income to cover their dividend, we have really been highly competitive with them it terms of how we have covered the dividend plus we have done the banking of our gains. But we have not created a set of assets where we were looking for homeruns from several of our portfolio companies so that we could cover the dividends. We have had very confident, very regular harvesting of gains. And by the way, we have also have taken our lumps as rapidly as we can and we think it’s appropriate and so there’s not a lot of depreciation on our balance sheet relative to other firms out there because we have recognized those deprecations through loses even in this last quarter. We had $92 million of portfolio company net gains if you want to take that chart I don’t quite know the number off the top of my head, but we had significant amount if losses that we recognized and in the third quarter as well. And we keep doing that quarter-after-quarter, so we have a very clean balance sheet today.
Scott Valentin - Friedman, Billings, Ramsey & Company
Okay. And just one quick question. You mentioned you are not really seeing the pricing multiples come down on transactions. But have you seen any stress on EBITDA, any of your portfolio companies given I mean the economy had to slowdown I guess the outlook that it may go down, and certain sectors are seeing a slowdown. Have you seen any of it?.
John R. Erickson - Executive Vice President and Chief Financial Officer
Let me Ira to speak to that.
Ira J. Wagner - Executive Vice President and Chief Operating Officer
I think your question has to do with performance of the portfolio and what we have seen in the portfolio, overall, is that we have seen growth in the portfolio both in revenues and in EBITDA year-over-year. So, in general, the portfolio is performing quite well, and we have had a few companies that have predominantly been exposed to the housing and construction industry that have suffered along with the housing industry but that’s a pretty small part of our portfolio. So the predominance of our portfolio is performing quite well.
Malon Wilkus - Chairman, Chief Executive Officer, and President
We did state in the press release that the earnings and EBITDA for the balance of portfolio was up in the third quarter. So it was really that the non-accruals did come from the housing and construction sector.
Scott Valentin - Friedman, Billings, Ramsey & Company
Okay. Thank you.
Operator
Thank you. And the next question comes from the line of Richard Shane of Jefferies. Please go ahead.
Richard Shane - Jefferies & Company
Thanks guys for taking my question. Most of them have been answered. One sort of technical question. Related to the change in the tax policy on the capital gains, is there going to be any credit going forward associated with that. Is some of these gains are re-characterized or is that what is past is past?
John R. Erickson - Executive Vice President and Chief Financial Officer
I’m not sure. Are you talking about 2006 transactions or are you talking about the ’07 year?
Richard Shane - Jefferies & Company
Anything going forward. Is there any anomaly that we should expect in 2008 related to this. I mean I don’t even know necessarily what the change could be but when you make a tax policy change, do you have for example, credits for taxes if the 35% rate that you paid previously?
John R. Erickson - Executive Vice President and Chief Financial Officer
No. I mean, so for 2006, we did have a deemed distribution. We paid the 35%, so in terms of our tax return that’s done and behind us. There is no recapture or there is no way to go back to that, that’s a done item. So this only relates to capital gains earned in the 2007 taxable year.
Richard Shane - Jefferies & Company
Okay. And that is what I was driving at.
John R. Erickson - Executive Vice President and Chief Financial Officer
Yes.
Richard Shane - Jefferies & Company
The second question and again you guys have talked about this a couple of different times and I apologize for not understanding that but you talk about the fact that 80 portfolio companies, equity positions were sold in the fund too. What was excluded, I’m assuming that the equity position at any of your management companies, were excluded and the reason I’m trying to do this I’m just trying to reconcile the equity values on your balance sheet with the implied equity value of the portfolio companies that you transferred.
Malon Wilkus - Chairman, Chief Executive Officer, and President
Yes, Rick, we would have been excluded European capital or investing the management companies. Investments in equity of CDOs and there may be there’s about a handful of just were we were last year, middle market investments that were excluded for variety of tax or legal structuring issues
John R. Erickson - Executive Vice President and Chief Financial Officer
Primarily equities that had been written down to zero already and so for tax reasons and other, we did not transfer that.
Richard Shane - Jefferies & Company
Got it. And so?
Malon Wilkus - Chairman, Chief Executive Officer, and President
Virtually all of our? what you would take if our historically?
John R. Erickson - Executive Vice President and Chief Financial Officer
Private equity same market portfolio.
Richard Shane - Jefferies & Company
Great. Okay. Thank you guys very much.
Malon Wilkus - Chairman, Chief Executive Officer, and President
There was no? just to make it clear, there was no selective picking from our portfolios, none of that.
Richard Shane - Jefferies & Company
Understood and again it looks to me like the big difference is just the management companies and E-caps in your equity positions there.
Malon Wilkus - Chairman, Chief Executive Officer, and President
That’s right, yes.
Richard Shane - Jefferies & Company
Great. Thank you, guys.
Malon Wilkus - Chairman, Chief Executive Officer, and President
You’re welcome.
Operator
Okay. Thank you. And the next question comes from the line of Jim Ballan of Bear Stearns. Please go ahead.
James Ballan - Bear Stearns
Great. Thanks a lot. Just following up on actually a number of questions that have already have been asked. Along with the de-leveraging that we saw sequentially this quarter and if you take out the sort of call it the strategic equity positions, it looks like you are actually equity exposure is also lower. And so, I wanted to get your thoughts on as you re-lever and as you put this always quite a little work that you have raised. What your thoughts in terms of re-opting the private equity portion of portfolio versus what looks like you have done in the last couple of quarter which has been more of emphasis on senior debt and now that your senior debt is how your better spreads are. So, I mean maybe another way of asking it is where in the capital structure do you see the greatest risk reward today on a relative value basis and how does that jive with your thoughts on where credit quality is going, going forward?
Malon Wilkus - Chairman, Chief Executive Officer, and President
That’s such an interesting question. I ask myself, we have investor committee meetings virtually every day of the week and when I look at one investment opportunity to the next keep in mind, we can go up and down the balance sheet. So we are constantly rejecting securities that one level of a respected portfolio company and by accepting it at another level. So, it is a natural day-to-day occurrence for us to be saying this is not a proper risk reward profile but this is and we’ll bid on that and we won’t bid on the other. In within one company, within one industry within one region, within different sectors, we do that between energy and medical products, financial institutions. We are prepared to look wherever the right risk reward is and honestly I can’t say where the patterns are. I’ve been asked this question many times and when I’m done making an investment, at the end of the week we maybe decided on making 10 different investments that week. I’m not sure which one will be better than the other and I generally couldn’t tell you but what I will say is it right now, obviously we demand a lot for any company within housing for anything that’s having been to do with residential construction. We demand dramatically better companies if we think, it’s in a cyclical industry. We’ve always been doing those things and we continue to do it and bidding on where we think the world is and what is happening in our portfolio and the advice that we are getting from our CEO’s of portfolio companies and so forth. We are constantly shifting our views by industry, by companies, by tranche within the company and so forth. Ira, do you want to add something to that?
Ira J. Wagner - Executive Vice President and Chief Operating Officer
No. I think it’s very much a deal-by-deal basis and we look at every, we underwrite every transaction and everything that’s on the balance sheet and then we make decisions about where we think we should be invested on that balance sheet and there is a lot of as we’ve said the spreads in the debt markets have gone up. So we are seeing a lot of opportunities in the mezzanine business but we are still seeing a lot of what we consider to be good in equity investments so, its really very much deal-by-deal.
James Ballan - Bear Stearns
Okay. I mean just on? there is a lot of economists out there who are predicting a slow down or possibly recession. I mean can you just? obviously your unique visibility into that. I mean is there anything you point out?
Malon Wilkus - Chairman, Chief Executive Officer, and President
Well, we think two things about it. Number one, we have certainly, we are also are of the view, we are not economists here but we are also of a view that the other recession probably has gone up and believe me we care about that a great deal and we are asking all of our investment teams to assume a worst scenarios for our base case to decide whether to make an investment or not. So we have moved up with on to our most companies that we review. We usually have recessions and forecasts. We move those? in this last year we’ve moved that up to an earlier period and to some degree made them more severe. Now, that’s not true for every company because some companies are actually quite recession resistant we believe but?
John R. Erickson - Executive Vice President and Chief Financial Officer
Well in fact if you look at the bi-ops that we’ve done so far this year, I think we selected some larger companies that we feel like aren’t completely correlated economy that have some stability and lower beta in terms of their earnings, first is what would happen in a recession.
Malon Wilkus - Chairman, Chief Executive Officer, and President
Well also I think it’s interesting. I’m not sure many other firms do this but if we like the company that we think it’s a dramatic, it’s a wonderful company and has tremendous growth and maybe probably has very little exposure to any economic cycles. We may pay a very high multiple for that company, but we might also assume an exit multiple that’s a chunk below, substantially below our entry multiple and not assume that we’ll be in the same kind of multiple environment when its time to exit when we entered. And so we passed our assumptions all the time and put great demands on what we believe we should maybe investing in. Now, keep in mind the reason our volume is so high is we're simply the biggest firm in the world in the middle market and by a very substantial major. We can have our 14 offices and we have the largest deal flow and more importantly we get the cream of the crop. We don’t have to always be the highest bidder, because when you can do a one stop buyout and none of your competitors can. We have the lowest cost of capital in the industry. We have these huge advantages. So the reason our volume? people keep asking why did we do all that volume in the last year ending in the second quarter. Because, we saw fabulous companies. They were great companies and by the way if you? we looked at the assets that we invested in, the investments we made in the first and second quarter of this year and they actually appreciated about $30 million by the end of the third quarter. So those assets are performing for us. They are excellent companies.
James Ballan - Bear Stearns
Okay. Terrific. Thanks a lot.
Malon Wilkus - Chairman, President, and Chief Executive Officer
We just want to be in the enviable roll of seeking the very best opportunities out there.
James Ballan - Bear Stearns
Great. Thanks a lot Malon.
Malon Wilkus - Chairman, President, and Chief Executive Officer
You're welcome.
Operator
Thank you. The next question comes from the line of Chris Brendler of Stifel Nicolaus. Please go ahead.
Christopher Brendler - Stifel Nicolaus & Company,
All right. Thanks. Good afternoon. A couple of questions. A pretty large number of senior debt sales this quarter. Can you just talk about that and do you actually get that gain income when you sell those and where does that show up?
Ira J Wagner - Executive Vice President and Chief Operating Officer
Sure. This is Ira. Let me talk about the large volume of senior debt sales in the third quarter is indicative of the success of our ability to underwrite the senior debt and then syndicate is and sell it off to other investors. So we have been very successful in doing that both within our own buyouts as well as in the in the one stop financing deals that we do for other private equity firms. So our syndications desk in New York has been, we've been extremely good at structuring transactions that will fit the marketplace and then successfully syndicating that paper out to other investors and that almost billion dollars that you saw in the third quarter of senior debt sales is indicative of that. So its, really another example of where the middle market is different then the big LBO business where we've been able to do it quite successfully for our sized transactions as compared to the other people in the big LBO business that had to do much bigger numbers, to much larger numbers of investors. That’s been very difficult environment for them and we've been able to be very successful at it in our, for our middle market space.
John R. Erickson - Executive Vice President and Chief Financial Officer
Going into the accounting for that, there is a small portion that we generate or realize a gain because we have a, some portion of the loan fee is a discount fee of OID on that portion of the loan and see a little bit of realized gain from that portion. But the bulk of the income of the transaction would be, the portion of the loan fees that we actually keep in the syndication process, which would be fee income.
Christopher Brendler - Stifel Nicolaus & Company
Okay. And then Ira is that market still as robust as it was in the third quarter?
Ira J Wagner - Executive Vice President and Chief Operating Officer
No. as I've said earlier. It is off a little bit but its not off very much at all and it still is extremely robust and as Malon said with our market coverage with offices all over the country and all over the world. Our penetration into that market is very high. So it’s a very? remains, continues to be a very large fragmented marketplace even if it’s a little bit off from where it used to be. Even three months ago it is still a very robust with lots of transactions in the marketplace every quarter.
Christopher Brendler - Stifel Nicolaus & Company
And then. A couple of questions related to the CMBS business. In the CRE CDO that you did, do you think you could name all--?
Ira J Wagner - Executive Vice President and Chief Operating Officer
Perhaps I could. Before we move from that I would like to say one more thing about it. Think about this, we're virtually the only firm that syndicates senior assets, that is also investing in the equity of the same company and the sub debt of the same company and in fact holding some of that senior for some of our structured CDO vehicles that we're managing. So everybody else is trying to syndicate those assets are essentially saying I don’t want them. We're saying look we are fighting for you as an equity investor, a sub debt investor and as I, as a firm preparing to sue with you in that senior. And so we have far, there are far more people wanting to buy our senior assets in syndication that there is for other firms out there. We are the perfect firm syndicate senior. The perfect firm to syndicate senior. And keep in mind, if for any reason we can't syndicate it. If all of a sudden the world gets worse somehow and we can't syndicate it. Well we just in our balance sheet. You folks should be happy about that, if that happens you should be writing good things about it.
Christopher Brendler - Stifel Nicolaus & Company
I think it’s wonderful and that’s been a look for a long-time. You originated one stop and get rid of the lower end of the seniors, perfect.
Malon Wilkus - Chairman, Chief Executive Officer, and President
Yes, we have made wonderful fees on that.
Christopher Brendler - Stifel Nicolaus & Company
Any sense of what those fees are?
Malon Wilkus - Chairman, Chief Executive Officer, and President
Yes, there’s a significant fee income from the underwriting to the syndication. It was significant. I think in ’06, it was 10. I would be something North of a 100 basis points on the total number on the senior debt.
John R. Erickson - Executive Vice President and Chief Financial Officer
Right
Christopher Brendler - Stifel Nicolaus & Company
Great. Thanks. On CMBS business can you just talk about what drove the realized loss and I’d like to know just you imagine that superior [inaudible] performance you're seeing in your portfolio but yet we're seeing a pretty heavy sell off in CMBS bonds especially [inaudible] I think about a 300 basis points riding the lower range traunches. How does that impact your thinking and how does it impact your perspective valuation of that portfolio ?
Ira J Wagner - Executive Vice President and Chief Operating Officer
Yes the realized loss Chris is related to the sell of the bonds in [inaudible] into the CDL so we sold [inaudible] loss on the sale based on the expected returns that we were putting on to the underlying retained pieces
Malon Wilkus - Chairman, President, and Chief Executive Officer
Yes and that we announced I guess in July. We did a transaction announced that it was a regular realized loss. I think in terms of the sell off in CMBS. We are an active CMBS investor and part of what we're doing is, I mean when we're looking at the required returns. We're an active buyer of CMBS investments and so we've been very close to the market. And in terms of our experience we saw the? we helped drive the spreads running after from April till August. Since then in terms of where we have been bidding and winning and losing deals we have a very good sense of where the current spreads are. Now, in terms of specific bonds and I don’t think you see a lot of the non-rated tranches out in the market. I think what you are seeing are probably BBB and maybe some BB and other parts of the capital structure so?
Malon Wilkus - Chairman, Chief Executive Officer, and President
Let me go at it another way. The tranches that we are investing in, in the CMBS is the last out of the equity tranche and it’s virtually not traded at all so you can’t look for trading Marks to the terms in the valuation there but we are making new investments and so are our competitors. There’s only a handful? we really only have a handful of competitors in that arena but we know, generally speaking some of the pricing that they are in investing at and so if spreads widen any existing set of CMBS that we have in our portfolio, will get appreciated, almost invariably. And not because we think there has been a change in the risk of with respect to our forecast of loss rates, but simply because the market is requiring a re-pricing? just as off interest rate change and a bond value has been changed. So, keep in mind, we intend to hold those equity stakes to their complete repayment, and those? that in many years and we think we have outstanding IRRs in those, great cash flows, it’s all cash? wonderful cash flowing, there is no non-cash income, there is no equity risk, the way you think of in other equities. So, this is? we think these are great assets, but they are subject to these periodic depreciation or appreciation. That will happen they will go up and down, but as we get closer and closer to their full maturity, they should counted? assuming our forecast on lost rates was correct they will come to zero and all we will have is our income and our income will should be in the mid to high teens. And so, we are with real with these opportunities, in fact, as spreads have widened, we just are happier and happier with this business, we think there is great opportunities there.
Christopher Brendler - Stifel Nicolaus & Company
It’s hard to say you don’t think of the commercial real estate--?
John R. Erickson - Executive Vice President and Chief Financial Officer
I am sorry going back to our data point. The non-rated in the single Bs, we bid on and loss transactions in September and October and we bid on one transactions and I think we are very good data where we think those spreads are clearing the market. And then going back to the double B, there is some is trading data on that and they actually I think widening down in August and we had some other trading days suggesting they maybe tightening up a little bit in September. But we do factor all that in due to our valuations and suffice to say that depending on what that data showing at December 31st, will impact where the markets on these go. But as Malon said we are a long-term investor, we are not holding these on our balance sheet to sell. And so, we would not look? we will not be converting those into a realized loss by selling them, so they may appreciate or depreciate based on where they are in December 31. But today you can assume they are providing very attractive returns for us in terms of new generating the earnings we want for our dividend.
Malon Wilkus - Chairman, Chief Executive Officer, and President
And keep in mind, these? since the cash flows still wonderfully, so steadily, and highly predictable, we can lever these assets, so the mid teens returns that we get on the gross assets we can leverage and really compound those returns. So, where we are we are very much appreciate our? one of the leading positions in the CMBS investing arena.
Christopher Brendler - Stifel Nicolaus & Company
Okay. Thanks.
Operator
Okay. Thank you. [Operator Instructions].
Malon Wilkus - Chairman, Chief Executive Officer, and President
Is there any other questions?
Operator
And the next question comes from the line of John Neff of William Blair. Please go ahead.
John Neff - William Blair & Company
Hi, thanks for taking the question. I’ll be quick. You mentioned in the press release that CMBS and CDOs are about 7% of your portfolio which is sort of around $770 million, the net depreciation on those looks like it was $54 million in Q3, which would be roughly a 7% decline in the value there. Am I thinking about that correctly and does that include CMBS assets sold to the CDO?
John R. Erickson - Executive Vice President and Chief Financial Officer
Now you also would add to that to realize loss that you had, and that would? I think the CDO transaction, it’s difficult to benchmark in terms of where that was with the NOI CMBS valuations. But that was one transaction, so then, I think if you look at the depreciation of the balance of the CMBS pool as a separate transaction and measure the depreciation you are looking at core based on what’s invested in the CMBS.
Malon Wilkus - Chairman, Chief Executive Officer, and President
Yes, John, to clarify that $27 million on the CDO transaction at the real estate. You would measure that against the $650 million of cost that we sold in, and then you would measure the remaining appreciation, depreciation or the value of the assets that we hold in the same CMBS and CDOs.
John Neff - William Blair & Company
All right. And then I just? little bit more clarification on the dividend policy, I just want to establish is this? you can talk about sort of building a reserve, are you intending to pay the dividend, pay long-term capital gains on a regular basis through the dividend? Or is it? you mentioned getting I think, Malon, three or four quarter kind of a reserve. Is that the intention and you don’t plan on playing long-term capital gains through the dividend only in the event of having to dip into that reserves that you would build up?
Malon Wilkus - Chairman, Chief Executive Officer, and President
We will be compelled to pay first with long-term capital gains. And it will be ordinary taxable income that we will spillover from year-to-year-to-year. And so, you will see our dividend composed more of long-term capital gains, but you need to pay attention to our total ordinary taxable? I am sorry? total taxable income, and you will see that, frankly, we could have paid it with? you will see I believe that we will? we could have paid that future dividend with ordinary taxable income or almost entirely with ordinary taxable income. But it will get reported has been paid from long-term capital gains to some extent and then ordinary taxable income to another extent. And we will try to keep you apprised of how much we are covering the dividend with realized earnings, just as we have been. I don’t? people don’t? they don’t see written very often, but we’ve dramatically covering the dividend with realized earnings and we don’t see that changing upping our growth rate, keep in mind, we grew 12% last year and we up it to 13%. So, we really haven’t up it very much from our prior growth rate, but we’ve? and you can just compare it to the return on equity. The realized return on equity is 16%. So, by definition, we are keeping 3%. If we have 16% return on equity through 2008, then by definition, we kept 3% return on equity as some? some form of retention, either ordinary taxable income or long-term capital gains.
John Neff - William Blair & Company
All right. Thank you very much.
Malon Wilkus - Chairman, Chief Executive Officer, and President
And then just as I said before, we will get to a point where we can’t bank any more ordinary income and we will be compelled to pay at all out. But since we have so much bank, it will be like four quarters banked, we will be able? even if there is a slowing down of our dividend growth, we will be able to? even that out very nicely because we have so much in reserve.
John R. Erickson - Executive Vice President and Chief Financial Officer
We should just take one last question as we work for more than an hour and a half.
Operator
Okay. Thank you. And our last question comes from the line of Joseph Nickerson of [inaudible] Partners. Please go ahead.
Unidentified Analyst
Hi, gentlemen. Thank you for taking my call. I was just wondering what kind of growth rate we can assume in now? in 2008.
Malon Wilkus - Chairman, Chief Executive Officer, and President
While we are not? we haven’t forecast that and I don’t? we certainly are not going to do at top of our heads now. But we? and keep in mind, the? one of the reasons we had some such outstanding growth in our NAV in the past is because the underlying assets have performed so well and we’ve not paid out as much dividend as our return on equity. Our return on equity not? it’s the bottom line return on equity has been 20% some. 21%, I think in the last 12 months? 24% last 12 months, but it’s been 21% last five years I believe. So, if we continue at those level and our assets have been performing at those levels for a long, long time for 10 years now, we should continue to grow the NAV as well as achieved this very high dividend payout.
John R. Erickson - Executive Vice President and Chief Financial Officer
We typically do our guidance in February of the year, that’s when we put the ’07 NAV guidance. So, if we decide to do NAV guidance for ’08, that’s when you can expect to see it.
Unidentified Analyst
Okay. All right. I guess, I was just a little bit concern because it seems like if I look at this quarter, it was about 2% decline quarter-over-quarter. And if I look at the mid point of your estimate for Q4, it’s another 2% decline since. I presume that’s not the run rate that you are assuming for the full year next year.
John R. Erickson - Executive Vice President and Chief Financial Officer
I think the estimate, we have out there has room to appreciate or depreciate. And so, we have got plus or minus and you should not be assuming that we are looking at it a decline rate on NAV.
Malon Wilkus - Chairman, Chief Executive Officer, and President
And I think we have done it. I think, hope, we’ve made this point clear. There are things simply out of our control, which orderly out of control that could cause depreciation to our assets. You saw that at European Capital, totally out of our control, but it is a good investment on our part. We are making very great? new wonderful dividends also of our investments, European Capital. We think ultimately, it will trade at a premium to book? at a nice premium to book as investors get? to enjoy those dividends and continue to grow. And the same we have say CMBS another asset as well. Their interest rate change and you will see some changes in depreciation or appreciation. That is out of our control, and so, we are? we can’t easily predict NAV. But our dividend is, I think keep in mind, we have always growing our dividend and it’s been a best indicator of all of how our underlying assets have been performing.
Unidentified Analyst
Okay.
Malon Wilkus - Chairman, Chief Executive Officer, and President
By the way if you look at that chart about historical performances, you can see about five years we had a 20.1% return on equity.
Malon Wilkus - Chairman, Chief Executive Officer, and President
All right. Thanks everybody. This has been a good call. We appreciate you taking all this time to listen to how we did for the quarter and what we are thinking about the future. And we will talk again with you about three months from now. Take care now.
Operator
Okay. And ladies and gentlemen, this conference will be made available for replay after 9:30 PM Eastern Time today until Wednesday, November 14th at mid night. You may access the AT&T Executive playback service at any time by dialing 1-800-475-6701, entering the access code 889559. International participants dial 1-320-365-3844. And again, that access code is 889559.
And that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.
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