Item 1. Financial Statements
KKR Financial Holdings LLC and Subsidiaries
Condensed Consolidated Balance Sheets
(Unaudited)
(Amounts in thousands, except share information)
|
|
|
|
|
|
|
|
|
|
June 30, 2016
|
|
December 31, 2015
|
Assets
|
|
|
|
|
|
Cash and cash equivalents
|
$
|
321,984
|
|
|
$
|
320,122
|
|
Restricted cash and cash equivalents
|
815,481
|
|
|
487,374
|
|
Securities, at estimated fair value
|
223,039
|
|
|
417,519
|
|
Corporate loans, at estimated fair value
|
3,891,823
|
|
|
5,188,610
|
|
Equity investments, at estimated fair value
|
218,306
|
|
|
262,946
|
|
Oil and gas properties, net
|
112,545
|
|
|
114,868
|
|
Interests in joint ventures and partnerships, at estimated fair value
|
758,321
|
|
|
888,408
|
|
Derivative assets
|
33,202
|
|
|
40,852
|
|
Interest and principal receivable
|
16,628
|
|
|
22,196
|
|
Receivable for investments sold
|
428,253
|
|
|
19,930
|
|
Other assets
|
11,633
|
|
|
25,570
|
|
Total assets
|
$
|
6,831,215
|
|
|
$
|
7,788,395
|
|
Liabilities
|
|
|
|
|
Collateralized loan obligation secured notes, at estimated fair value
|
$
|
4,055,722
|
|
|
$
|
4,843,746
|
|
Collateralized loan obligation junior secured notes to affiliates, at estimated fair value
|
63,624
|
|
|
—
|
|
Senior notes
|
412,229
|
|
|
413,006
|
|
Junior subordinated notes
|
249,309
|
|
|
248,498
|
|
Payable for investments purchased
|
363,031
|
|
|
220,085
|
|
Accounts payable, accrued expenses and other liabilities
|
29,357
|
|
|
43,667
|
|
Accrued interest payable
|
21,932
|
|
|
20,619
|
|
Related party payable
|
2,195
|
|
|
3,892
|
|
Derivative liabilities
|
63,908
|
|
|
43,892
|
|
Total liabilities
|
5,261,307
|
|
|
5,837,405
|
|
Equity
|
|
|
|
|
|
Preferred shares, no par value, 50,000,000 shares authorized and 14,950,000 issued and outstanding as of both June 30, 2016 and December 31, 2015
|
—
|
|
|
—
|
|
Common shares, no par value, 500,000,000 shares authorized and 100 shares issued and outstanding as of both June 30, 2016 and December 31, 2015
|
—
|
|
|
—
|
|
Paid-in-capital
|
2,764,061
|
|
|
2,764,061
|
|
Accumulated deficit
|
(1,258,416
|
)
|
|
(895,950
|
)
|
Total KKR Financial Holdings LLC and Subsidiaries shareholders’ equity
|
1,505,645
|
|
|
1,868,111
|
|
Noncontrolling interests
|
64,263
|
|
|
82,879
|
|
Total equity
|
1,569,908
|
|
|
1,950,990
|
|
Total liabilities and equity
|
$
|
6,831,215
|
|
|
$
|
7,788,395
|
|
See notes to condensed consolidated financial statements.
KKR Financial Holdings LLC and Subsidiaries
Condensed Consolidated Statements of Operations
(Unaudited)
(Amounts in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months ended June 30, 2016
|
|
For the three months ended June 30, 2015
|
|
For the six months ended June 30, 2016
|
|
For the six months ended June 30, 2015
|
Revenues
|
|
|
|
|
|
|
|
|
Loan interest income
|
$
|
57,526
|
|
|
$
|
72,132
|
|
|
$
|
124,434
|
|
|
$
|
147,460
|
|
Securities interest income
|
6,892
|
|
|
16,258
|
|
|
11,956
|
|
|
31,849
|
|
Oil and gas revenue
|
3,257
|
|
|
6,351
|
|
|
5,898
|
|
|
9,179
|
|
Other
|
1,487
|
|
|
10,950
|
|
|
16,179
|
|
|
14,989
|
|
Total revenues
|
69,162
|
|
|
105,691
|
|
|
158,467
|
|
|
203,477
|
|
Investment costs and expenses
|
|
|
|
|
|
|
|
|
Interest expense
|
54,389
|
|
|
58,322
|
|
|
105,307
|
|
|
114,167
|
|
Interest expense to affiliates
|
1,009
|
|
|
—
|
|
|
1,009
|
|
|
—
|
|
Oil and gas production costs
|
240
|
|
|
298
|
|
|
455
|
|
|
250
|
|
Oil and gas depreciation, depletion and amortization
|
1,258
|
|
|
2,003
|
|
|
2,324
|
|
|
3,005
|
|
Other
|
1,157
|
|
|
1,827
|
|
|
1,956
|
|
|
2,681
|
|
Total investment costs and expenses
|
58,053
|
|
|
62,450
|
|
|
111,051
|
|
|
120,103
|
|
Other income (loss)
|
|
|
|
|
|
|
|
|
Net realized and unrealized gain (loss) on investments
|
30,511
|
|
|
(6,408
|
)
|
|
(107,521
|
)
|
|
13,491
|
|
Net realized and unrealized gain (loss) on derivatives and foreign exchange
|
(3,180
|
)
|
|
15,859
|
|
|
(13,396
|
)
|
|
6,759
|
|
Net realized and unrealized gain (loss) on debt
|
(802
|
)
|
|
(4,977
|
)
|
|
(63,975
|
)
|
|
(88,793
|
)
|
Net realized and unrealized gain (loss) on debt to affiliates
|
(2,984
|
)
|
|
—
|
|
|
(2,984
|
)
|
|
—
|
|
Other income (loss)
|
1,401
|
|
|
3,561
|
|
|
2,940
|
|
|
7,414
|
|
Total other income (loss)
|
24,946
|
|
|
8,035
|
|
|
(184,936
|
)
|
|
(61,129
|
)
|
Other expenses
|
|
|
|
|
|
|
|
|
Related party management compensation
|
6,767
|
|
|
9,817
|
|
|
14,043
|
|
|
20,037
|
|
General, administrative and directors' expenses
|
1,415
|
|
|
1,674
|
|
|
17,191
|
|
|
7,486
|
|
Professional services
|
1,010
|
|
|
778
|
|
|
2,022
|
|
|
1,914
|
|
Total other expenses
|
9,192
|
|
|
12,269
|
|
|
33,256
|
|
|
29,437
|
|
Income (loss) before income taxes
|
26,863
|
|
|
39,007
|
|
|
(170,776
|
)
|
|
(7,192
|
)
|
Income tax expense (benefit)
|
(187
|
)
|
|
729
|
|
|
(127
|
)
|
|
1,076
|
|
Net income (loss)
|
$
|
27,050
|
|
|
$
|
38,278
|
|
|
$
|
(170,649
|
)
|
|
$
|
(8,268
|
)
|
Net income (loss) attributable to noncontrolling interests
|
(1,281
|
)
|
|
(2,705
|
)
|
|
(16,816
|
)
|
|
(8,776
|
)
|
Net income (loss) attributable to KKR Financial Holdings LLC and Subsidiaries
|
28,331
|
|
|
40,983
|
|
|
(153,833
|
)
|
|
508
|
|
Preferred share distributions
|
6,891
|
|
|
6,891
|
|
|
13,782
|
|
|
13,782
|
|
Net income (loss) available to common shares
|
$
|
21,440
|
|
|
$
|
34,092
|
|
|
$
|
(167,615
|
)
|
|
$
|
(13,274
|
)
|
See notes to condensed consolidated financial statements.
KKR Financial Holdings LLC and Subsidiaries
Condensed Consolidated Statements of Comprehensive Income
(Unaudited)
(Amounts in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months ended June 30, 2016
|
|
For the three months ended June 30, 2015
|
|
For the six months
ended June 30, 2016
|
|
For the six months
ended June 30, 2015
|
Net income (loss)
|
$
|
27,050
|
|
|
$
|
38,278
|
|
|
$
|
(170,649
|
)
|
|
$
|
(8,268
|
)
|
Other comprehensive income (loss):
|
|
|
|
|
|
|
|
|
|
Unrealized gains (losses) on securities available-for-sale
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Unrealized gains (losses) on cash flow hedges
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Total other comprehensive income (loss)
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Comprehensive income (loss)
|
$
|
27,050
|
|
|
$
|
38,278
|
|
|
$
|
(170,649
|
)
|
|
$
|
(8,268
|
)
|
Less: Comprehensive income (loss) attributable to noncontrolling interests
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Comprehensive income (loss) attributable to KKR Financial Holdings LLC and Subsidiaries
|
$
|
27,050
|
|
|
$
|
38,278
|
|
|
$
|
(170,649
|
)
|
|
$
|
(8,268
|
)
|
See notes to condensed consolidated financial statements.
KKR Financial Holdings LLC and Subsidiaries
Condensed Consolidated Statements of Changes in Equity
(Unaudited)
(Amounts in thousands, except share information)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
KKR Financial Holdings LLC and Subsidiaries
|
|
|
|
|
|
Preferred Shares
|
|
Common Shares
|
|
Accumulated
Deficit
|
|
Noncontrolling interests
|
|
Total
Equity
|
|
Shares
|
|
Paid-In
Capital
|
|
Shares
|
|
Paid-In
Capital
|
|
|
|
Balance at January 1, 2015
|
14,950,000
|
|
|
$
|
378,983
|
|
|
100
|
|
|
$
|
2,385,078
|
|
|
$
|
(376,182
|
)
|
|
$
|
100,169
|
|
|
$
|
2,488,048
|
|
Cumulative effect adjustment from adoption of accounting guidance
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(1,877
|
)
|
|
—
|
|
|
(1,877
|
)
|
Capital contributions
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
2,455
|
|
|
2,455
|
|
Net income (loss)
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
508
|
|
|
(8,776
|
)
|
|
(8,268
|
)
|
Distributions declared on preferred shares
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(13,782
|
)
|
|
—
|
|
|
(13,782
|
)
|
Distributions to Parent
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(89,453
|
)
|
|
—
|
|
|
(89,453
|
)
|
Balance at June 30, 2015
|
14,950,000
|
|
|
$
|
378,983
|
|
|
100
|
|
|
$
|
2,385,078
|
|
|
$
|
(480,786
|
)
|
|
$
|
93,848
|
|
|
$
|
2,377,123
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
KKR Financial Holdings LLC and Subsidiaries
|
|
|
|
|
|
Preferred Shares
|
|
Common Shares
|
|
Accumulated
Deficit
|
|
Noncontrolling interests
|
|
Total
Equity
|
|
Shares
|
|
Paid-In
Capital
|
|
Shares
|
|
Paid-In
Capital
|
|
|
|
Balance at January 1, 2016
|
14,950,000
|
|
|
$
|
378,983
|
|
|
100
|
|
|
$
|
2,385,078
|
|
|
$
|
(895,950
|
)
|
|
$
|
82,879
|
|
|
$
|
1,950,990
|
|
Capital contributions
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
5,049
|
|
|
5,049
|
|
Capital distributions
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(6,849
|
)
|
|
(6,849
|
)
|
Net income (loss)
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(153,833
|
)
|
|
(16,816
|
)
|
|
(170,649
|
)
|
Distributions declared on preferred shares
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(13,782
|
)
|
|
—
|
|
|
(13,782
|
)
|
Distributions to Parent
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(194,851
|
)
|
|
—
|
|
|
(194,851
|
)
|
As of June 30, 2016
|
14,950,000
|
|
|
$
|
378,983
|
|
|
100
|
|
|
$
|
2,385,078
|
|
|
$
|
(1,258,416
|
)
|
|
$
|
64,263
|
|
|
$
|
1,569,908
|
|
See notes to condensed consolidated financial statements.
KKR Financial Holdings LLC and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(Amounts in thousands)
|
|
|
|
|
|
|
|
|
|
For the six months ended June 30, 2016
|
|
For the six months ended June 30, 2015
|
Cash flows from operating activities
|
|
|
|
|
Net income (loss)
|
$
|
(170,649
|
)
|
|
$
|
(8,268
|
)
|
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
|
|
|
|
|
Net realized and unrealized (gain) loss on derivatives and foreign exchange
|
13,396
|
|
|
(6,759
|
)
|
Unrealized (depreciation) appreciation on investments allocable to noncontrolling interests
|
(16,816
|
)
|
|
(8,776
|
)
|
Net realized and unrealized (gain) loss on investments
|
124,337
|
|
|
(4,715
|
)
|
Depreciation and net amortization
|
26,483
|
|
|
14,632
|
|
Net realized and unrealized (gain) loss on debt
|
63,975
|
|
|
88,793
|
|
Net realized and unrealized (gain) loss on debt to affiliates
|
2,984
|
|
|
—
|
|
Changes in assets and liabilities:
|
|
|
|
Interest receivable
|
6,397
|
|
|
19,676
|
|
Other assets
|
(9,599
|
)
|
|
(23,241
|
)
|
Related party payable
|
(1,697
|
)
|
|
(571
|
)
|
Accounts payable, accrued expenses and other liabilities
|
(15,117
|
)
|
|
(4,731
|
)
|
Accrued interest payable
|
1,313
|
|
|
7,805
|
|
Net cash provided by (used in) operating activities
|
25,007
|
|
|
73,845
|
|
Cash flows from investing activities
|
|
|
|
|
Principal payments from corporate loans
|
767,143
|
|
|
835,195
|
|
Principal payments from securities
|
25,034
|
|
|
7,961
|
|
Proceeds from sales of corporate loans
|
915,725
|
|
|
879,010
|
|
Proceeds from sales of securities
|
115,464
|
|
|
137,617
|
|
Proceeds from equity and other investments
|
105,263
|
|
|
11,869
|
|
Purchases of corporate loans
|
(649,320
|
)
|
|
(953,586
|
)
|
Purchases of securities
|
(5,068
|
)
|
|
(9,387
|
)
|
Purchases of equity and other investments
|
(60,278
|
)
|
|
(49,706
|
)
|
Net change in proceeds, purchases and settlements of derivatives
|
17,233
|
|
|
8,711
|
|
Net change in restricted cash and cash equivalents
|
(328,107
|
)
|
|
(456,140
|
)
|
Net cash provided by (used in) investing activities
|
903,089
|
|
|
411,544
|
|
Cash flows from financing activities
|
|
|
|
|
Issuance of collateralized loan obligation secured notes
|
—
|
|
|
539,746
|
|
Retirement of collateralized loan obligation secured notes
|
(847,764
|
)
|
|
(743,048
|
)
|
Proceeds from collateralized loan obligation warehouse facility
|
—
|
|
|
190,000
|
|
Repayment of collateralized loan obligation warehouse facility
|
—
|
|
|
(190,000
|
)
|
Distributions on common shares
|
(62,888
|
)
|
|
(89,453
|
)
|
Distributions on preferred shares
|
(13,782
|
)
|
|
(13,782
|
)
|
Capital distributions to noncontrolling interests
|
(6,849
|
)
|
|
—
|
|
Capital contributions from noncontrolling interests
|
5,049
|
|
|
2,455
|
|
Other capitalized costs
|
—
|
|
|
(3,914
|
)
|
Net cash provided by (used in) financing activities
|
(926,234
|
)
|
|
(307,996
|
)
|
Net increase (decrease) in cash and cash equivalents
|
1,862
|
|
|
177,393
|
|
Cash and cash equivalents at beginning of period
|
320,122
|
|
|
163,405
|
|
Cash and cash equivalents at end of period
|
$
|
321,984
|
|
|
$
|
340,798
|
|
Supplemental cash flow information
|
|
|
|
|
Cash paid for interest
|
$
|
87,614
|
|
|
$
|
83,937
|
|
Net cash paid (refunded) for income taxes
|
$
|
23
|
|
|
$
|
103
|
|
Non-cash investing and financing activities
|
|
|
|
|
Assets distributed to Parent
|
$
|
(131,963
|
)
|
|
$
|
—
|
|
Redemption of CLO 2007-A subordinated notes
|
$
|
(15,587
|
)
|
|
$
|
—
|
|
Preferred share distributions declared, not yet paid
|
$
|
6,891
|
|
|
$
|
6,891
|
|
See notes to condensed consolidated financial statements.
KKR FINANCIAL HOLDINGS LLC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. ORGANIZATION
KKR Financial Holdings LLC together with its subsidiaries (the “Company” or “KFN”) is a specialty finance company with expertise in a range of asset classes. The Company’s core business strategy is to leverage the proprietary resources of KKR Financial Advisors LLC (the “Manager”) with the objective of generating current income. The Company’s holdings primarily consist of below investment grade syndicated corporate loans, also known as leveraged loans, high yield debt securities and interests in joint ventures and partnerships. The corporate loans that the Company holds are typically purchased via assignment or participation in the primary or secondary market.
The majority of the Company’s holdings consist of corporate loans and high yield debt securities held in collateralized loan obligation (“CLO”) transactions that are structured as on‑balance sheet securitizations and are used as long term financing for the Company’s investments in corporate debt. The senior secured debt issued by the CLO transactions is primarily owned by unaffiliated third party investors and the Company owns the majority of the subordinated notes in the CLO transactions. The Company executes its core business strategy through its majority‑owned subsidiaries, including CLOs.
The Company is a subsidiary of KKR & Co. L.P. (“KKR & Co.”). KKR Fund Holdings L.P. (“KKR Fund Holdings”), a subsidiary of KKR & Co., is the sole holder of all of the outstanding common shares of the Company and is the parent of the Company (the “Parent”). The Manager, a wholly‑owned subsidiary of KKR Credit Advisors (US) LLC, manages the Company pursuant to an amended and restated management agreement (as amended the “Management Agreement”). KKR Credit Advisors (US) LLC is a wholly‑owned subsidiary of Kohlberg Kravis Roberts & Co. L.P. (“KKR”), which is a subsidiary of KKR & Co.
The Company’s
7.375%
Series A LLC Preferred Shares (“Series A LLC Preferred Shares”) and senior notes are traded on the New York Stock Exchange ("NYSE").
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The majority of the Company's significant accounting policies have remained unchanged from the Company's Annual Report on Form 10-K filed with the SEC on March 29, 2015 ("2015 Annual Report"). As such, in addition to the below, refer to the Company's 2015 Annual Report for further discussion.
Basis of Presentation
The accompanying condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). The unaudited condensed consolidated financial statements reflect all normal recurring adjustments, which are, in the opinion of management, necessary for the fair presentation of the Company’s results for the interim periods presented. The condensed consolidated financial statements include the accounts of the Company and entities established to complete secured financing transactions that are considered to be variable interest entities (“VIEs”) and for which the Company is the primary beneficiary. Also included in the condensed consolidated financial statements are the financial results of certain entities, which are not considered VIEs, but in which the Company is presumed to have control. The ownership interests held by third parties are reflected as noncontrolling interests in the accompanying financial statements.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The Company uses historical experience and various other assumptions and information that are believed to be reasonable under the circumstances in developing its estimates and judgments. Estimates and assumptions about future events and their effects cannot be predicted with certainty and, accordingly, these estimates may change as new events occur, as more experience is acquired, as additional information is obtained and as the Company’s operating environment changes. While the Company believes that the estimates and assumptions used in the preparation of the condensed consolidated financial statements are appropriate, actual results could differ from those estimates.
Consolidation
KKR Financial CLO 2007‑1, Ltd. (“CLO 2007‑1”), KKR Financial CLO 2012‑1, Ltd. (“CLO 2012‑1”), KKR Financial CLO 2013‑1, Ltd. (“CLO 2013‑1”), KKR Financial CLO 2013‑2, Ltd. (“CLO 2013‑2”), KKR CLO 9, Ltd. (“CLO 9”), KKR CLO 10, Ltd. (“CLO 10”), KKR CLO 11, Ltd ("CLO 11") and KKR CLO 13, Ltd ("CLO 13") (collectively the “Cash Flow CLOs”) are entities established to complete secured financing transactions. During 2016, the Company called KKR Financial CLO 2011‑1, Ltd. (“CLO 2011‑1”) and during 2015, the Company called KKR Financial CLO 2005‑2, Ltd. (“CLO 2005‑2”), KKR Financial CLO 2005‑1, Ltd. (“CLO 2005‑1”) and KKR Financial CLO 2006-1, Ltd ("CLO 2006-1"), whereby the Company repaid all senior and mezzanine notes outstanding. These entities are VIEs which the Company consolidates as the Company has determined it has the power to direct the activities that most significantly impact these entities’ economic performance and the Company has both the obligation to absorb losses of these entities and the right to receive benefits from these entities that could potentially be significant to these entities. In CLO transactions, subordinated notes have the first risk of loss and conversely, the residual value upside of the transactions.
The Company finances the majority of its corporate debt investments through its CLOs. As of
June 30, 2016
, the Company’s CLOs held
$3.8 billion
par amount, or
$3.7 billion
estimated fair value, of corporate debt investments. As of December 31, 2015, the Company's CLOs held
$5.5 billion
par amount, or
$5.1 billion
estimated fair value, of corporate debt investments. The assets in each CLO can be used only to settle the debt of the related CLO. As of
June 30, 2016
and December 31, 2015, the aggregate par amount of CLO debt to unaffiliated and affiliated parties totaled
$4.1 billion
and
$4.9 billion
, respectively.
The Company consolidates all non‑VIEs in which it holds a greater than
50 percent
voting interest. Specifically, the Company consolidates majority owned entities for which the Company is presumed to have control. The ownership interests of these entities held by third parties are reflected as noncontrolling interests in the accompanying financial statements. The Company began consolidating a majority of these non‑VIE entities as a result of the asset contributions from its Parent during the second half of 2014. For certain of these entities, the Company previously held a percentage ownership, but following the incremental contributions from its Parent, were presumed to have control.
In addition, the Company has noncontrolling interests in joint ventures and partnerships that do not qualify as VIEs and do not meet the control requirements for consolidation as defined by GAAP.
All inter‑company balances and transactions have been eliminated in consolidation.
Recent Accounting Pronouncements
Consolidation
In February 2015, the FASB issued guidance which eliminates the presumption that a general partner should consolidate a limited partnership and also eliminates the consolidation model specific to limited partnerships. The amendments also clarify how to treat fees paid to an asset manager or other entity that makes the decisions for the investment vehicle and whether such fees should be considered in determining when a variable interest entity should be reported on an asset manager's balance sheet. The guidance is effective for reporting periods starting after December 15, 2015 and for interim periods within the fiscal year. Early adoption is permitted, and a full retrospective or modified retrospective approach is required. The adoption of this guidance did not have a material impact on the Company's condensed consolidated financial statements.
Financial Instruments
In January 2016, the FASB issued amended guidance that (i) requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; (ii) eliminates the requirement to disclose the method(s) and significant assumptions used to estimate the fair value that is currently required to be disclosed for financial instruments measured at fair value; (iii) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments and (iv) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements. This guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years and should be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amended guidance related to equity securities without readily determinable fair values (including the disclosure requirements) should be applied
prospectively to equity investments that exist as of the date of adoption. The Company is currently evaluating the impact on its financial statements.
NOTE 3. SECURITIES
The Company accounts for all of its securities, including RMBS, at estimated fair value. The following table summarizes the Company’s securities as of
June 30, 2016
and December 31, 2015 (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2016
|
|
December 31, 2015
|
|
|
Par
|
|
Amortized
Cost
|
|
Estimated
Fair Value
|
|
Par
|
|
Amortized
Cost
|
|
Estimated
Fair Value
|
|
Securities, at estimated fair value
|
$
|
370,729
|
|
|
$
|
313,976
|
|
|
$
|
223,039
|
|
|
$
|
520,135
|
|
|
$
|
474,201
|
|
|
$
|
417,519
|
|
|
Total
|
$
|
370,729
|
|
|
$
|
313,976
|
|
|
$
|
223,039
|
|
|
$
|
520,135
|
|
|
$
|
474,201
|
|
|
$
|
417,519
|
|
|
Net Realized and Unrealized Gains (Losses)
Realized gains or losses are measured by the difference between the net proceeds from the repayment or sale and the amortized cost basis of the asset without regard to unrealized gains or losses previously recognized. Unrealized gains or losses are computed as the difference between the estimated fair value of the asset and the amortized cost basis of such asset. Unrealized gains or losses primarily reflect the change in asset values, including the reversal of previously recorded unrealized gains or losses when gains or losses are realized. The following table presents the Company’s realized and unrealized gains (losses) from securities (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended June 30, 2016
|
|
Three months ended June 30, 2015
|
|
Six months ended June 30, 2016
|
|
Six months ended June 30, 2015
|
Net realized gains (losses)
|
$
|
5,779
|
|
|
$
|
(5,374
|
)
|
|
$
|
4,186
|
|
|
$
|
(5,900
|
)
|
Net (increase) decrease in unrealized losses
|
15,030
|
|
|
(6,909
|
)
|
|
(35,096
|
)
|
|
(5,075
|
)
|
Net realized and unrealized gains (losses)
|
$
|
20,809
|
|
|
$
|
(12,283
|
)
|
|
$
|
(30,910
|
)
|
|
$
|
(10,975
|
)
|
Defaulted Securities
As of both
June 30, 2016
and December 31, 2015, no corporate debt securities in the Company's portfolio was in default.
Concentration Risk
The Company’s corporate debt securities portfolio has certain credit risk concentrated in a limited number of issuers. As of
June 30, 2016
, approximately
97%
of the estimated fair value of the Company’s corporate debt securities portfolio was concentrated in
ten
issuers, with the
three
largest concentrations of debt securities in securities issued by LCI Helicopters Limited, Mizuho Bank, Ltd. and Avoca Capital CLO XII Limited which combined represented
$121.5
million, or approximately
69%
of the estimated fair value of the Company’s corporate debt securities. As of December 31, 2015, approximately
89%
of the estimated fair value of the Company’s corporate debt securities portfolio was concentrated in
ten
issuers, with the
three
largest concentrations of debt securities in securities issued by LCI Helicopters Limited, Preferred Proppants LLC and JC Penney Corp. Inc, which combined represented
$192.5 million
, or approximately
52%
of the estimated fair value of the Company’s corporate debt securities.
Pledged Assets
Note 6 to these condensed consolidated financial statements describes the Company’s borrowings under which the Company has pledged assets for borrowings. The following table summarizes the estimated fair value of securities pledged as collateral as of
June 30, 2016
and December 31, 2015 (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
June 30, 2016
|
|
December 31, 2015
|
Pledged as collateral for collateralized loan obligation secured debt
|
$
|
25,211
|
|
|
$
|
170,365
|
|
Total
|
$
|
25,211
|
|
|
$
|
170,365
|
|
NOTE 4. CORPORATE LOANS
The Company accounts for all of its corporate loans at estimated fair value. The following table summarizes the Company’s corporate loans as of
June 30, 2016
and December 31, 2015 (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2016
|
|
December 31, 2015
|
|
Par
|
|
Amortized
Cost
|
|
Estimated
Fair Value
|
|
Par
|
|
Amortized
Cost
|
|
Estimated
Fair Value
|
Corporate loans, at estimated fair value
|
$
|
4,091,360
|
|
|
$
|
4,073,416
|
|
|
$
|
3,891,823
|
|
|
$
|
5,722,646
|
|
|
$
|
5,619,815
|
|
|
$
|
5,188,610
|
|
Total
|
$
|
4,091,360
|
|
|
$
|
4,073,416
|
|
|
$
|
3,891,823
|
|
|
$
|
5,722,646
|
|
|
$
|
5,619,815
|
|
|
$
|
5,188,610
|
|
Net Realized and Unrealized Gains (Losses)
Realized gains or losses are measured by the difference between the net proceeds from the repayment or sale and the amortized cost basis of the asset without regard to unrealized gains or losses previously recognized. Unrealized gains or losses are computed as the difference between the estimated fair value of the asset and the amortized cost basis of such asset. Unrealized gains or losses primarily reflect the change in asset values, including the reversal of previously recorded unrealized gains or losses when gains or losses are realized. The following tables present the Company’s realized and unrealized gains (losses) from corporate loans (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended June 30, 2016
|
|
Three months ended June 30, 2015
|
|
Six months ended June 30, 2016
|
|
Six months ended June 30, 2015
|
|
Net realized gains (losses)
|
$
|
(180,238
|
)
|
|
$
|
(6,079
|
)
|
|
$
|
(210,952
|
)
|
|
$
|
(22,261
|
)
|
|
Net (increase) decrease in unrealized losses
|
190,503
|
|
|
(27,450
|
)
|
|
235,426
|
|
|
54,824
|
|
|
Net realized and unrealized gains (losses)
|
$
|
10,265
|
|
|
$
|
(33,529
|
)
|
|
$
|
24,474
|
|
|
$
|
32,563
|
|
|
For the corporate loans measured at estimated fair value under the fair value option of accounting,
$170.2 million
of net gains and
$27.5 million
of losses were attributable to changes in instrument specific credit risk for the three months ended
June 30, 2016
and June 30, 2015, respectively. For the six months ended
June 30, 2016
and June 30, 2015,
$197.7 million
of net gains and
$14.3 million
of net losses were attributable to changes in instrument specific credit risk, respectively. Gains and losses attributable to changes in instrument specific credit risk were determined by excluding the non-credit components of gains and losses, such as those due to changes in interest rates and general market conditions. In addition, gains and losses attributable to those loans on non-accrual status or specifically identified as more volatile based on financial or operating performance, restructuring or other factors, were considered instrument specific.
Non-Accrual Loans
A loan is considered past due if any required principal and interest payments have not been received as of the date such payments were required to be made under the terms of the loan agreement. A loan may be placed on non-accrual status regardless of whether or not such loan is considered past due. As of
June 30, 2016
, the Company held a total par value and estimated fair value of
$90.1 million
and
$37.4 million
, respectively, of non-accrual loans carried at estimated fair value. As of December 31, 2015, the Company held a total par value and estimated fair value of
$435.2
million and
$127.5
million, respectively, of non-accrual loans. As of both June 30, 2016 and December 31, 2015, there were no corporate loans past due 90 or more days and still accruing.
Defaulted Loans
As of
June 30, 2016
, the Company held
one
corporate loan that was in default with a total estimated fair value of
$6.3 million
from
one
issuer. As of December 31, 2015, the Company held
one
corporate loan that was in default with a total estimated fair value of
$113.6 million
from
one
issuer.
Concentration Risk
The Company’s corporate loan portfolio has certain credit risk concentrated in a limited number of issuers. As of
June 30, 2016
, approximately
21%
of the total estimated fair value of the Company’s corporate loan portfolio was concentrated in
twenty
issuers, with the
three
largest concentrations of corporate loans in loans issued by Infor (US) Inc., iPayment Investors L.P. and Dell Inc., which combined represented
$159.9 million
, or approximately
4%
of the aggregate estimated fair value of
the Company’s corporate loans. As of December 31, 2015, approximately
31%
of the total estimated fair value of the Company’s corporate loan portfolio was concentrated in
twenty
issuers, with the
three
largest concentrations of corporate loans in loans issued by U.S. Foods Inc., Texas Competitive Electric Holdings Company LLC and PQ Corp, which combined represented
$434.6 million
, or approximately
8%
of the aggregate estimated fair value of the Company’s corporate loans.
Pledged Assets
Note 6 to these condensed consolidated financial statements describes the Company’s borrowings under which the Company has pledged assets for borrowings. The following table summarizes the corporate loans, at estimated fair value, pledged as collateral as of
June 30, 2016
and December 31, 2015 (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
June 30, 2016
|
|
December 31, 2015
|
Pledged as collateral for collateralized loan obligation secured debt
|
$
|
3,639,211
|
|
|
$
|
4,917,123
|
|
Total
|
$
|
3,639,211
|
|
|
$
|
4,917,123
|
|
NOTE 5. EQUITY INVESTMENTS AND INTERESTS IN JOINT VENTURES AND PARTNERSHIPS
The Company holds interests in joint ventures and partnerships, certain of which (i) the Company participates alongside KKR and its affiliates through which the Company contributes capital for assets, including development projects related to commercial real estate and specialty lending focused businesses or (ii) are held as interests in private or public funds managed by KKR and its affiliates. Refer to Note 10 to these condensed consolidated financial statements for further discussion. As of
June 30, 2016
and December 31, 2015, the Company held
$758.3 million
and
$888.4 million
, respectively, of interests in joint ventures and partnerships carried at estimated fair value.
In addition, as of
June 30, 2016
and December 31, 2015, the Company held
$218.3 million
and
$262.9 million
, respectively, of equity investments, which were carried at estimated fair value and comprised primarily of common and preferred stock.
Net Realized and Unrealized Gains (Losses)
The following tables present the Company’s realized and unrealized gains (losses), which are accounted for similarly to securities and loans, from equity investments and interests in joint ventures and partnerships (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended
June 30, 2016
|
|
Three months ended
June 30, 2015
|
|
Six months ended
June 30, 2016
|
|
Six months ended
June 30, 2015
|
|
Equity Investments
|
|
Interests in Joint Ventures and Partnerships(1)
|
|
Equity Investments
|
|
Interests in Joint Ventures and Partnerships(1)
|
|
Equity Investments
|
|
Interests in Joint Ventures and Partnerships (1)
|
|
Equity Investments
|
|
Interests in Joint Ventures and Partnerships (1)
|
|
Net realized gains (losses)
|
$
|
(4,496
|
)
|
|
$
|
9,736
|
|
|
$
|
(58
|
)
|
|
$
|
—
|
|
|
$
|
(3,771
|
)
|
|
$
|
7,574
|
|
|
$
|
1,366
|
|
|
$
|
—
|
|
|
Net (increase) decrease in unrealized losses
|
(457
|
)
|
|
(5,346
|
)
|
|
29,799
|
|
|
9,026
|
|
|
(16,449
|
)
|
|
(88,439
|
)
|
|
7,373
|
|
|
(17,473
|
)
|
|
Net realized and unrealized gains (losses)
|
$
|
(4,953
|
)
|
|
$
|
4,390
|
|
|
$
|
29,741
|
|
|
$
|
9,026
|
|
|
$
|
(20,220
|
)
|
|
$
|
(80,865
|
)
|
|
$
|
8,739
|
|
|
$
|
(17,473
|
)
|
|
(1) Includes net loss attributable to noncontrolling interests of
$1.3 million
and
$16.8 million
for the three and six months ended
June 30, 2016
, respectively, and
$2.7 million
and
$8.8 million
for the three and six months ended
June 30, 2015
, respectively.
Equity Method Investments
The Company holds certain investments where the Company does not control the investee and where the Company is not the primary beneficiary, but can exert significant influence over the financial and operating policies of the investee. Significant influence typically exists if the Company has a 20% to 50% ownership interest in the investee unless predominant evidence to the contrary exists.
Under the equity method of accounting, the Company records its proportionate share of net income or loss based on the investee’s financial results. Given that the Company elected the fair value option to account for these equity method investments, the Company’s share of the investee’s underlying net income or loss predominantly represents fair value adjustments in the investments. Changes in estimated fair value are recorded in net realized and unrealized gain (loss) on investments in the condensed consolidated statements of operations.
As of
June 30, 2016
and December 31, 2015, the Company had equity method investments, at estimated fair value, totaling
$410.7 million
and
$506.5 million
, respectively. The Company's equity method investments are comprised primarily of the following issuers with the respective ownership percentages: (i) Maritime Finance Company, which the Company holds approximately
31%
through its ownership of KKR Nautilus Aggregator Limited, (ii) LCI Helicopters Limited, which the Company holds approximately
33%
common equity interest in and (iii) Mineral Acquisition Company, which the Company holds approximately
70%
through its ownership of KKR Royalty Aggregator LLC. KKR Royalty Aggregator LLC is an investment company for accounting purposes and accordingly, does not consolidate Mineral Acquisition Company, which it wholly-owns. The Company consolidates both KKR Nautilus Aggregator Limited and KKR Royalty Aggregator LLC and reflects all ownership interests held by third parties as noncontrolling interests in its financial statements.
Pledged Assets
Note 6 to these condensed consolidated financial statements describes the Company’s borrowings under which the Company has pledged assets for borrowings. The following table summarizes the equity investments, at estimated fair value, pledged as collateral as of
June 30, 2016
and December 31, 2015 (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
June 30, 2016
|
|
December 31, 2015
|
Pledged as collateral for collateralized loan obligation secured debt
|
$
|
46,350
|
|
|
$
|
82,430
|
|
Total
|
$
|
46,350
|
|
|
$
|
82,430
|
|
NOTE 6. BORROWINGS
The Company accounts for its collateralized loan obligation secured notes at estimated fair value, with changes in estimated fair value recorded in the condensed consolidated statements of operations, and all of its other borrowings at amortized cost. As of January 1, 2015, the Company adopted the measurement alternative issued by the FASB whereby the financial liabilities of its consolidated CLOs were measured using the fair value of the financial assets of its consolidated CLOs, which was determined to be more observable.
Certain information with respect to the Company’s borrowings as of
June 30, 2016
is summarized in the following table (dollar amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Par
|
|
Carrying
Value(1)
|
|
Weighted
Average
Borrowing
Rate
|
|
Weighted
Average
Remaining
Maturity
(in days)
|
|
Collateral(2)
|
CLO 2007-1 secured notes(3)
|
$
|
945,569
|
|
|
$
|
1,035,937
|
|
|
3.20
|
%
|
|
1780
|
|
$
|
535,323
|
|
CLO 2007-1 subordinated notes(3)(4)
|
134,468
|
|
|
82,810
|
|
|
5.01
|
|
|
1780
|
|
76,128
|
|
CLO 2012-1 secured notes
|
367,500
|
|
|
372,505
|
|
|
2.72
|
|
|
3090
|
|
377,522
|
|
CLO 2012-1 subordinated notes(4)
|
18,000
|
|
|
10,144
|
|
|
14.57
|
|
|
3090
|
|
18,491
|
|
CLO 2013-1 secured notes
|
458,500
|
|
|
462,907
|
|
|
2.35
|
|
|
3302
|
|
498,787
|
|
CLO 2013-2 secured notes
|
339,250
|
|
|
342,571
|
|
|
2.82
|
|
|
3494
|
|
364,242
|
|
CLO 9 secured notes
|
463,750
|
|
|
463,705
|
|
|
2.64
|
|
|
3759
|
|
460,057
|
|
CLO 9 subordinated notes(4)
|
15,000
|
|
|
9,581
|
|
|
15.18
|
|
|
3759
|
|
14,881
|
|
CLO 9 subordinated notes to affiliates(4)
|
25,572
|
|
|
16,333
|
|
|
—
|
|
|
3759
|
|
25,368
|
|
CLO 10 secured notes
|
368,000
|
|
|
372,535
|
|
|
2.89
|
|
|
3455
|
|
357,439
|
|
CLO 10 subordinated notes to affiliates(4)
|
29,948
|
|
|
16,279
|
|
|
13.48
|
|
|
3455
|
|
29,089
|
|
CLO 11 secured notes
|
507,750
|
|
|
502,493
|
|
|
2.68
|
|
|
3941
|
|
504,540
|
|
CLO 11 subordinated notes(4)
|
28,250
|
|
|
21,925
|
|
|
17.16
|
|
|
3941
|
|
28,071
|
|
CLO 11 subordinated notes to affiliates(4)
|
19,362
|
|
|
15,027
|
|
|
—
|
|
|
3941
|
|
19,240
|
|
CLO 13 secured notes
|
370,000
|
|
|
375,654
|
|
|
2.87
|
|
|
4217
|
|
375,573
|
|
CLO 13 subordinated notes(4)
|
4,000
|
|
|
2,955
|
|
|
—
|
|
|
4217
|
|
4,060
|
|
CLO 13 subordinated notes to affiliates(4)
|
21,636
|
|
|
15,985
|
|
|
—
|
|
|
4217
|
|
21,962
|
|
Total collateralized loan obligation secured debt
|
4,116,555
|
|
|
4,119,346
|
|
|
|
|
|
|
|
3,710,773
|
|
8.375% Senior notes
|
258,750
|
|
|
289,041
|
|
|
8.38
|
|
|
9269
|
|
—
|
|
7.500% Senior notes
|
115,043
|
|
|
123,188
|
|
|
7.50
|
|
|
9394
|
|
—
|
|
Junior subordinated notes
|
283,517
|
|
|
249,309
|
|
|
4.78
|
|
|
7402
|
|
—
|
|
Total borrowings
|
$
|
4,773,865
|
|
|
$
|
4,780,884
|
|
|
|
|
|
|
|
$
|
3,710,773
|
|
|
|
(1)
|
Carrying value represents estimated fair value for the collateralized loan obligation secured debt and amortized cost for all other borrowings.
|
|
|
(2)
|
Collateral for borrowings consists of the estimated fair value of certain corporate loans, securities and equity investments at estimated fair value. For purposes of this table, collateral for CLO secured and subordinated notes are calculated pro rata based on the par amount for each respective CLO.
|
|
|
(3)
|
In addition to the amounts presented in the table, CLO 2007-1 collateral includes restricted cash of
$523.4 million
as of June 30, 2016.
|
|
|
(4)
|
Subordinated notes to unaffiliated and affiliated parties do not have a contractual coupon rate, but instead receive a pro rata amount of the net distributions from each respective CLO. Accordingly, weighted average borrowing rates for the subordinated notes were calculated based on annualized cash distributions during the year, if any.
|
Certain information with respect to the Company’s borrowings as of December 31, 2015 is summarized in the following table (dollar amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Par
|
|
Carrying
Value(1)
|
|
Weighted
Average
Borrowing
Rate
|
|
Weighted
Average
Remaining
Maturity
(in days)
|
|
Collateral(2)
|
CLO 2007-1 secured notes
|
$
|
1,544,032
|
|
|
$
|
1,630,293
|
|
|
2.10
|
%
|
|
1962
|
|
$
|
1,732,855
|
|
CLO 2007-1 subordinated notes(3)
|
134,468
|
|
|
74,954
|
|
|
11.66
|
|
|
1962
|
|
150,912
|
|
CLO 2007-A subordinated notes(3)
|
15,096
|
|
|
17,060
|
|
|
14.49
|
|
|
654
|
|
48,856
|
|
CLO 2011-1 senior debt
|
249,301
|
|
|
249,301
|
|
|
1.67
|
|
|
1689
|
|
310,498
|
|
CLO 2012-1 secured notes
|
367,500
|
|
|
365,383
|
|
|
2.59
|
|
|
3272
|
|
361,684
|
|
CLO 2012-1 subordinated notes(3)
|
18,000
|
|
|
10,845
|
|
|
15.82
|
|
|
3272
|
|
17,715
|
|
CLO 2013-1 secured notes
|
458,500
|
|
|
450,280
|
|
|
2.05
|
|
|
3484
|
|
479,391
|
|
CLO 2013-2 secured notes
|
339,250
|
|
|
334,187
|
|
|
2.52
|
|
|
3676
|
|
347,989
|
|
CLO 9 secured notes
|
463,750
|
|
|
454,103
|
|
|
2.33
|
|
|
3941
|
|
463,574
|
|
CLO 9 subordinated notes(3)
|
15,000
|
|
|
9,972
|
|
|
15.92
|
|
|
3941
|
|
14,994
|
|
CLO 10 secured notes
|
368,000
|
|
|
363,977
|
|
|
2.75
|
|
|
3637
|
|
384,991
|
|
CLO 11 secured notes
|
507,750
|
|
|
491,699
|
|
|
2.38
|
|
|
4123
|
|
501,286
|
|
CLO 11 subordinated notes(3)
|
28,250
|
|
|
23,306
|
|
|
5.28
|
|
|
4123
|
|
27,890
|
|
CLO 13 secured notes
|
370,000
|
|
|
364,986
|
|
|
2.84
|
|
|
4399
|
|
323,781
|
|
CLO 13 subordinated notes(3)
|
4,000
|
|
|
3,400
|
|
|
—
|
|
|
4399
|
|
3,500
|
|
Total collateralized loan obligation secured debt
|
4,882,897
|
|
|
4,843,746
|
|
|
|
|
|
|
5,169,916
|
|
8.375% Senior notes
|
258,750
|
|
|
289,660
|
|
|
8.38
|
|
|
9451
|
|
—
|
|
7.500% Senior notes
|
115,043
|
|
|
123,346
|
|
|
7.50
|
|
|
9576
|
|
—
|
|
Junior subordinated notes
|
283,517
|
|
|
248,498
|
|
|
5.43
|
|
|
7584
|
|
—
|
|
Total borrowings
|
$
|
5,540,207
|
|
|
$
|
5,505,250
|
|
|
|
|
|
|
|
$
|
5,169,916
|
|
|
|
(1)
|
Carrying value represents estimated fair value for the collateralized loan obligation secured debt and amortized cost for all other borrowings.
|
|
|
(2)
|
Collateral for borrowings consists of the estimated fair value of certain corporate loans, securities and equity investments at estimated fair value. For purposes of this table, collateral for CLO secured and subordinated notes are calculated pro rata based on the par amount for each respective CLO.
|
|
|
(3)
|
Subordinated notes do not have a contractual coupon rate, but instead receive a pro rata amount of the net distributions from each respective CLO. Accordingly, weighted average borrowing rates for the subordinated notes were calculated based on annualized cash distributions during the year, if any.
|
CLO Debt
For the CLO secured notes, which the Company measured based on the estimated fair value of the financial assets of its CLOs as of January 1, 2015, there were
no
gains (losses) attributable to changes in instrument specific credit risk for the three and six months ended
June 30, 2016
and 2015.
The indentures governing the Company’s CLO transactions stipulate the reinvestment period during which the collateral manager, which is an affiliate of the Company’s Manager, can generally sell or buy assets at its discretion and can reinvest principal proceeds into new assets. As of
June 30, 2016
, CLO 2007‑1 was no longer in its reinvestment period and as a result, principal proceeds from the assets held in this transaction are generally used to amortize the outstanding balance of the senior notes outstanding. CLO 2012-1, CLO 2013-1, CLO 2013-2, CLO 9, CLO 10, CLO 11 and CLO 13 will end their reinvestment periods during December 2016, July 2017, January 2018, October 2018, December 2018, April 2019 and January 2020, respectively.
Pursuant to the terms of the indentures governing our CLO transactions, the Company has the ability to call its CLO transactions after the end of the respective non-call periods. During November 2015, the Company called CLO 2005-2 and
repaid all senior and mezzanine notes totaling
$140.2 million
par amount. During July 2015, the Company called CLO 2005-1 and repaid all senior and mezzanine notes totaling
$142.4 million
par amount. In addition, during February 2015, the Company called CLO 2006-1 and repaid aggregate senior and mezzanine notes totaling
$181.8 million
par amount. As described below in Note 7 to these condensed consolidated financial statements, the Company used a pay-fixed, receive-variable interest rate swap to hedge interest rate risk associated with CLO 2006-1. In connection with the repayment of CLO 2006-1 notes, the related interest rate swap, with a contractual notional amount of
$84.0 million
, was terminated.
During the three and six months ended
June 30, 2016
,
$486.3 million
and
$598.5 million
par amount, respectively, of original CLO 2007-1 senior notes were repaid. During the three and six months ended June 30, 2015,
$375.6 million
and
$545.4 million
par amount, respectively, of original CLO 2005-1, CLO 2005-2 and CLO 2007-1 senior notes were repaid. CLO 2011-1 does not have a reinvestment period and all principal proceeds from holdings in CLO 2011-1 are used to amortize the transaction. During March 2016, the Company called CLO 2011-1 and repaid all senior notes totaling
$249.3 million
par amount. During the three and six months ended June 30, 2015,
$29.3 million
and
$30.8 million
par amount, respectively, of original CLO 2011-1 senior notes were repaid.
During May 2016, the Company distributed an aggregate
$96.5 million
par amount of CLO 9, CLO 10, CLO 11 and CLO 13 subordinated notes to its Parent. These notes were previously owned by the Company and eliminated in consolidation. Following the distribution, the subordinated notes were held by an affiliate of KKR and reflected as collateralized loan obligation junior secured notes to affiliates, at estimated fair value, on the Company's condensed consolidated balance sheets.
During April 2016, the remaining
$15.1 million
par amount of CLO 2007-A subordinated notes owned by third parties were deemed repaid in full, whereby the Company distributed assets held as collateral in CLO 2007-A to the subordinated noteholders.
On December 16, 2015, the Company closed CLO 13, a
$412.0 million
secured financing transaction maturing on January 16, 2028. The Company issued
$370.0 million
par amount of senior secured notes to unaffiliated investors,
$350.0 million
of which was floating rate with a weighted-average coupon of three-month LIBOR plus
2.19%
and
$20.0 million
of which was fixed rate with a weighted-average coupon of
3.83%
. The Company also issued
$4.0 million
par amount of subordinated notes to unaffiliated investors. The investments that are owned by CLO 13 collateralize the CLO 13 debt, and as a result, those investments are not available to the Company, its creditors or shareholders.
During June 2015, the Company issued
$15.0 million
par amount of CLO 2005-2 class E notes for proceeds of
$15.1 million
and
$35.0 million
par amount of CLO 2007-1 class D and E notes for proceeds of
$35.1 million
. Subsequently, in July 2015, the Company issued
$15.0 million
par amount of CLO 2005-2 class E notes for proceeds of
$15.1 million
.
On
May 7, 2015
, the Company closed CLO 11, a
$564.5 million
secured financing transaction maturing on
April 15, 2027
. The Company issued
$507.8 million
par amount of senior secured notes to unaffiliated investors, all of which was floating rate with a weighted-average coupon of three-month LIBOR plus
2.06%
. The Company also issued
$28.3 million
par amount of subordinated notes to unaffiliated investors. The investments that are owned by CLO 11 collateralize the CLO 11 debt, and as a result, those investments are not available to the Company, its creditors or shareholders.
CLO Warehouse Facility
On March 2, 2015, CLO 11 entered into a $
570.0
million CLO warehouse facility ("CLO 11 Warehouse"), which matured upon the closing of CLO 11 on May 7, 2015. The CLO 11 Warehouse was used to purchase assets for the CLO transaction in advance of its closing date upon which the proceeds of the CLO closing were used to repay the CLO 11 Warehouse in full. Debt issued under the CLO 11 Warehouse was non-recourse to the Company beyond the assets of CLO 11 and bore interest at rates ranging from
LIBOR
plus
1.25%
to
1.75%
. Upon the closing of CLO 11 on May 7, 2015, the aggregate amount outstanding under the CLO 11 Warehouse was repaid.
On July 22, 2015, CLO 13 entered into a
$350.0 million
CLO warehouse facility ("CLO 13 Warehouse"), which matured upon the closing of CLO 13 on December 16, 2015. The CLO 13 Warehouse was used to purchase assets for the CLO transaction in advance of its closing date upon which the proceeds of the CLO closing will be used to repay the CLO 13 Warehouse in full. Debt issued under the CLO 13 Warehouse was non-recourse to the Company beyond the assets of CLO 13 and bore interest at rates ranging from
LIBOR
plus
1.50%
to
2.25%
. Upon the closing of CLO 13 on December 16, 2015, the aggregate amount outstanding under the CLO 13 Warehouse was repaid.
NOTE 7. DERIVATIVE INSTRUMENTS
The Company enters into derivative transactions in order to hedge its interest rate and foreign currency exposure to the effects of interest rate and foreign currency changes. Additionally, the Company enters into derivative transactions in the course of its portfolio management activities. The counterparties to the Company’s derivative agreements are major financial institutions with which the Company and its affiliates may also have other financial relationships. In the event of nonperformance by the counterparties, the Company is potentially exposed to losses. The counterparties to the Company’s derivative agreements are major financial institutions and, as a result, the Company does not anticipate that any of the counterparties will fail to fulfill their obligations.
The table below summarizes the aggregate notional amount and estimated net fair value of the derivative instruments as of
June 30, 2016
and December 31, 2015 (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of June 30, 2016
|
|
As of December 31, 2015
|
|
Notional
|
|
Estimated
Fair Value
|
|
Notional
|
|
Estimated
Fair Value
|
Free-Standing Derivatives:
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate swaps
|
$
|
267,333
|
|
|
$
|
(59,063
|
)
|
|
$
|
297,667
|
|
|
$
|
(41,743
|
)
|
Foreign exchange forward contracts and options
|
(319,771
|
)
|
|
24,125
|
|
|
(375,524
|
)
|
|
38,608
|
|
Common stock warrants
|
—
|
|
|
2,120
|
|
|
—
|
|
|
—
|
|
Options
|
—
|
|
|
2,112
|
|
|
—
|
|
|
95
|
|
Total
|
|
|
|
$
|
(30,706
|
)
|
|
|
|
|
$
|
(3,040
|
)
|
Free-Standing Derivatives
Free-standing derivatives are derivatives that the Company has entered into in conjunction with its investment and risk management activities, but for which the Company has not designated the derivative contract as a hedging instrument for accounting purposes. Such derivative contracts may include interest rate swaps, commodity derivatives, credit default swaps and foreign exchange contracts and options. Free-standing derivatives also include investment financing arrangements (total rate of return swaps) whereby the Company receives the sum of all interest, fees and any positive change in fair value amounts from a reference asset with a specified notional amount and pays interest on such notional amount plus any negative change in fair value amounts from such reference asset.
Gains and losses on free-standing derivatives are reported in net realized and unrealized gain (loss) on derivatives and foreign exchange in the condensed consolidated statements of operations. Unrealized gains (losses) represent the change in fair value of the derivative instruments and are noncash items.
Interest Rate Swaps
The Company uses interest rate swaps to hedge a portion of the interest rate risk associated with its CLOs as well as certain of its floating rate junior subordinated notes. As of
June 30, 2016
and December 31, 2015, the Company had interest rate swaps with a notional amount of
$267.3 million
and
$297.7
million, respectively.
Foreign Exchange Derivatives
The Company holds certain positions that are denominated in a foreign currency, whereby movements in foreign currency exchange rates may impact earnings if the United States dollar significantly strengthens or weakens against foreign currencies. In an effort to minimize the effects of these fluctuations on earnings, the Company will from time to time enter into foreign exchange options or foreign exchange forward contracts related to the assets denominated in a foreign currency. As of
June 30, 2016
and December 31, 2015, the net contractual notional balance of our foreign exchange options and forward contract liabilities totaled
$319.8 million
and
$375.5 million
, respectively, the majority of which related to certain of our foreign currency denominated assets.
Free-Standing Derivatives Gain (Loss)
The following table presents the amounts recorded in net realized and unrealized gain (loss) on derivatives and foreign exchange on the condensed consolidated statements of operations (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, 2016
|
|
Three Months Ended June 30, 2015
|
|
Realized
gains
(losses)
|
|
Unrealized
gains
(losses)
|
|
Total
|
|
Realized
gains
(losses)
|
|
Unrealized
gains
(losses)
|
|
Total
|
Interest rate swaps
|
$
|
—
|
|
|
$
|
(5,934
|
)
|
|
$
|
(5,934
|
)
|
|
$
|
—
|
|
|
$
|
14,657
|
|
|
$
|
14,657
|
|
Foreign exchange forward contracts and options(1)
|
6,400
|
|
|
(5,095
|
)
|
|
1,305
|
|
|
14,220
|
|
|
(12,129
|
)
|
|
2,091
|
|
Common stock warrants
|
—
|
|
|
(165
|
)
|
|
(165
|
)
|
|
—
|
|
|
(110
|
)
|
|
(110
|
)
|
Total rate of return swaps
|
—
|
|
|
—
|
|
|
—
|
|
|
469
|
|
|
151
|
|
|
620
|
|
Options
|
—
|
|
|
1,614
|
|
|
1,614
|
|
|
—
|
|
|
(1,399
|
)
|
|
(1,399
|
)
|
Net realized and unrealized gains (losses)
|
$
|
6,400
|
|
|
$
|
(9,580
|
)
|
|
$
|
(3,180
|
)
|
|
$
|
14,689
|
|
|
$
|
1,170
|
|
|
$
|
15,859
|
|
|
|
(1)
|
Net of foreign exchange remeasurement gain or loss on foreign denominated assets.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, 2016
|
|
Six Months Ended June 30, 2015
|
|
Realized
gains
(losses)
|
|
Unrealized
gains
(losses)
|
|
Total
|
|
Realized
gains
(losses)
|
|
Unrealized
gains
(losses)
|
|
Total
|
Interest rate swaps
|
$
|
—
|
|
|
$
|
(17,665
|
)
|
|
$
|
(17,665
|
)
|
|
$
|
(5,297
|
)
|
|
$
|
14,413
|
|
|
$
|
9,116
|
|
Foreign exchange forward contracts and options(1)
|
17,612
|
|
|
(15,337
|
)
|
|
2,275
|
|
|
14,235
|
|
|
(12,723
|
)
|
|
1,512
|
|
Common stock warrants
|
142
|
|
|
(165
|
)
|
|
(23
|
)
|
|
—
|
|
|
(2,001
|
)
|
|
(2,001
|
)
|
Total rate of return swaps
|
—
|
|
|
—
|
|
|
—
|
|
|
304
|
|
|
130
|
|
|
434
|
|
Options
|
—
|
|
|
2,017
|
|
|
2,017
|
|
|
—
|
|
|
(2,302
|
)
|
|
(2,302
|
)
|
Net realized and unrealized gains (losses)
|
$
|
17,754
|
|
|
$
|
(31,150
|
)
|
|
$
|
(13,396
|
)
|
|
$
|
9,242
|
|
|
$
|
(2,483
|
)
|
|
$
|
6,759
|
|
|
|
(1)
|
Net of foreign exchange remeasurement gain or loss on foreign denominated assets.
|
A master netting arrangement may allow each counterparty to net settle amounts owed between the Company and the counterparty as a result of multiple, separate derivative transactions. The Company has International Swaps and Derivatives Association ("ISDA") agreements or similar agreements with certain financial institutions which contain netting provisions. While these derivative instruments are eligible to be offset in accordance with applicable accounting guidance, the Company has elected to present derivative assets and liabilities on a gross basis in its condensed consolidated balance sheets. As of
June 30, 2016
, if the Company had elected to offset the asset and liability balances of its derivative instruments, the net positions would total the following with its respective financial institution counterparties: (i)
$2.7 million
net asset, including
$0.1 million
collateral held, (ii)
$2.1 million
net asset, net of
$2.0 million
collateral posted and (iii)
$7.1 million
net asset, including
$37.4 million
collateral held. Comparatively, as of December 31, 2015, if the Company had elected to offset the asset and liability balances of its derivative instruments, the net positions would total the following with its respective financial institution counterparties: (i)
$2.4 million
net asset, net of
$20.7 million
collateral posted, (ii)
$1.6 million
net asset, including
$0.1 million
collateral held and (iii)
$9.1 million
net asset, including
$23.6 million
collateral held.
NOTE 8. FAIR VALUE OF FINANCIAL INSTRUMENTS
Financial Instruments Not Carried at Estimated Fair Value
The Company accounts for its investments, as well as its collateralized loan obligation secured notes at estimated fair value. The following table presents the carrying value and estimated fair value, as well as the respective hierarchy classifications, of the Company’s financial assets and liabilities that are not carried at estimated fair value on a recurring basis as of
June 30, 2016
(amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of June 30, 2016
|
|
Fair Value Hierarchy
|
|
Carrying
Amount
|
|
Estimated
Fair Value
|
|
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
|
|
Significant Other
Observable
Inputs (Level 2)
|
|
Significant
Unobservable
Inputs
(Level 3)
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash, restricted cash, and cash equivalents
|
$
|
1,137,465
|
|
|
$
|
1,137,465
|
|
|
$
|
1,137,465
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Senior notes
|
412,229
|
|
|
393,113
|
|
|
393,113
|
|
|
—
|
|
|
—
|
|
Junior subordinated notes
|
249,309
|
|
|
193,300
|
|
|
—
|
|
|
—
|
|
|
193,300
|
|
The following table presents the carrying value and estimated fair value, as well as the respective hierarchy classifications, of the Company’s financial assets and liabilities that are not carried at estimated fair value on a recurring basis as of December 31, 2015 (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2015
|
|
Fair Value Hierarchy
|
|
Carrying
Amount
|
|
Estimated
Fair Value
|
|
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
|
|
Significant Other
Observable
Inputs (Level 2)
|
|
Significant
Unobservable
Inputs
(Level 3)
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash, restricted cash, and cash equivalents
|
$
|
807,496
|
|
|
$
|
807,496
|
|
|
$
|
807,496
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Senior notes
|
413,006
|
|
|
394,390
|
|
|
394,390
|
|
|
—
|
|
|
—
|
|
Junior subordinated notes
|
248,498
|
|
|
216,757
|
|
|
—
|
|
|
—
|
|
|
216,757
|
|
Fair Value Measurements
The following table presents information about the Company’s assets and liabilities measured at fair value on a recurring basis as of
June 30, 2016
, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
|
|
Significant
Other
Observable
Inputs (Level 2)
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
Balance as of
June 30, 2016
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
Securities:
|
|
|
|
|
|
|
|
|
|
|
|
Corporate debt securities
|
$
|
—
|
|
|
$
|
27,867
|
|
|
$
|
149,372
|
|
|
$
|
177,239
|
|
Residential mortgage-backed securities
|
—
|
|
|
—
|
|
|
45,800
|
|
|
45,800
|
|
Total securities
|
—
|
|
|
27,867
|
|
|
195,172
|
|
|
223,039
|
|
Corporate loans
|
—
|
|
|
3,690,982
|
|
|
200,841
|
|
|
3,891,823
|
|
Equity investments, at estimated fair value
|
43,047
|
|
|
51,885
|
|
|
123,374
|
|
|
218,306
|
|
Interests in joint ventures and partnerships, at estimated fair value
|
—
|
|
|
—
|
|
|
758,321
|
|
|
758,321
|
|
Derivatives:
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange forward contracts and options
|
—
|
|
|
26,781
|
|
|
2,189
|
|
|
28,970
|
|
Warrants
|
—
|
|
|
—
|
|
|
2,120
|
|
|
2,120
|
|
Options
|
—
|
|
|
—
|
|
|
2,112
|
|
|
2,112
|
|
Total derivatives
|
—
|
|
|
26,781
|
|
|
6,421
|
|
|
33,202
|
|
Total
|
$
|
43,047
|
|
|
$
|
3,797,515
|
|
|
$
|
1,284,129
|
|
|
$
|
5,124,691
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
Collateralized loan obligation secured notes
|
$
|
—
|
|
|
$
|
4,055,722
|
|
|
$
|
—
|
|
|
$
|
4,055,722
|
|
Collateralized loan obligation secured notes to affiliates
|
—
|
|
|
63,624
|
|
|
—
|
|
|
63,624
|
|
Derivatives:
|
|
|
|
|
|
|
|
|
|
|
Interest rate swaps
|
—
|
|
|
59,063
|
|
|
—
|
|
|
59,063
|
|
Foreign exchange forward contracts and options
|
—
|
|
|
4,308
|
|
|
537
|
|
|
4,845
|
|
Total derivatives
|
—
|
|
|
63,371
|
|
|
537
|
|
|
63,908
|
|
Total
|
$
|
—
|
|
|
$
|
4,182,717
|
|
|
$
|
537
|
|
|
$
|
4,183,254
|
|
The following table presents information about the Company’s assets and liabilities measured at fair value on a recurring basis as of December 31, 2015, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
|
|
Significant
Other
Observable
Inputs (Level 2)
|
|
Significant
Unobservable Inputs
(Level 3)
|
|
Balance as of
December 31,
2015
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
Securities:
|
|
|
|
|
|
|
|
|
|
|
|
Corporate debt securities
|
$
|
—
|
|
|
$
|
172,912
|
|
|
$
|
194,986
|
|
|
$
|
367,898
|
|
Residential mortgage-backed securities
|
—
|
|
|
—
|
|
|
49,621
|
|
|
49,621
|
|
Total securities
|
—
|
|
|
172,912
|
|
|
244,607
|
|
|
417,519
|
|
Corporate loans
|
—
|
|
|
4,889,876
|
|
|
298,734
|
|
|
5,188,610
|
|
Equity investments, at estimated fair value
|
40,765
|
|
|
75,533
|
|
|
146,648
|
|
|
262,946
|
|
Interests in joint ventures and partnerships, at estimated fair value
|
—
|
|
|
—
|
|
|
888,408
|
|
|
888,408
|
|
Derivatives:
|
|
|
|
|
|
|
|
|
|
0
|
|
Foreign exchange forward contracts and options
|
—
|
|
|
37,120
|
|
|
3,637
|
|
|
40,757
|
|
Options
|
—
|
|
|
—
|
|
|
95
|
|
|
95
|
|
Total derivatives
|
—
|
|
|
37,120
|
|
|
3,732
|
|
|
40,852
|
|
Total
|
$
|
40,765
|
|
|
$
|
5,175,441
|
|
|
$
|
1,582,129
|
|
|
$
|
6,798,335
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
Collateralized loan obligation secured notes
|
$
|
—
|
|
|
$
|
4,843,746
|
|
|
$
|
—
|
|
|
$
|
4,843,746
|
|
Derivatives:
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate swaps
|
—
|
|
|
41,743
|
|
|
—
|
|
|
41,743
|
|
Foreign exchange forward contracts and options
|
—
|
|
|
1,399
|
|
|
750
|
|
|
2,149
|
|
Total derivatives
|
—
|
|
|
43,142
|
|
|
750
|
|
|
43,892
|
|
Total
|
$
|
—
|
|
|
$
|
4,886,888
|
|
|
$
|
750
|
|
|
$
|
4,887,638
|
|
Level 3 Fair Value Rollforward
The following table presents additional information about assets and liabilities, including derivatives that are measured at fair value on a recurring basis for which the Company has utilized Level 3 inputs to determine fair value, for the three months ended
June 30, 2016
(amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
Corporate
Debt
Securities
|
|
Residential
Mortgage-
Backed
Securities
|
|
Corporate
Loans
|
|
Equity
Investments,
at Estimated
Fair Value
|
|
Interests in
Joint
Ventures and
Partnerships
|
|
Foreign Exchange Options, Net
|
|
Warrants
|
|
Options
|
Beginning balance as of April 1, 2016
|
$
|
150,068
|
|
|
$
|
47,714
|
|
|
$
|
296,982
|
|
|
$
|
138,563
|
|
|
$
|
748,329
|
|
|
$
|
1,841
|
|
|
$
|
—
|
|
|
$
|
498
|
|
Total gains or losses (for the period):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Included in earnings(1)
|
(667
|
)
|
|
748
|
|
|
(44,943
|
)
|
|
(17,377
|
)
|
|
947
|
|
|
(189
|
)
|
|
(165
|
)
|
|
1,614
|
|
Transfers into Level 3
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
|
—
|
|
Transfers out of Level 3
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
|
—
|
|
Purchases
|
—
|
|
|
—
|
|
|
997
|
|
|
—
|
|
|
45,756
|
|
|
—
|
|
|
|
|
—
|
|
Sales
|
|
|
|
—
|
|
|
(26,685
|
)
|
|
(5,130
|
)
|
|
—
|
|
|
—
|
|
|
|
|
—
|
|
Settlements
|
(29
|
)
|
|
(2,662
|
)
|
|
(25,510
|
)
|
|
7,318
|
|
|
(36,711
|
)
|
|
—
|
|
|
2,285
|
|
|
—
|
|
Ending balance as of June 30, 2016
|
$
|
149,372
|
|
|
$
|
45,800
|
|
|
$
|
200,841
|
|
|
$
|
123,374
|
|
|
$
|
758,321
|
|
|
$
|
1,652
|
|
|
$
|
2,120
|
|
|
$
|
2,112
|
|
Change in unrealized gains or losses for the period included in earnings for assets held at the end of the reporting period(1)
|
$
|
(667
|
)
|
|
$
|
748
|
|
|
$
|
(44,943
|
)
|
|
$
|
(17,377
|
)
|
|
$
|
947
|
|
|
$
|
(189
|
)
|
|
$
|
(165
|
)
|
|
$
|
1,614
|
|
|
|
(1)
|
Amounts are included in net realized and unrealized gain (loss) on investments or net realized and unrealized gain (loss) on derivatives and foreign exchange in the condensed consolidated statements of operations.
|
The following table presents additional information about assets and liabilities, including derivatives that are measured at fair value on a recurring basis for which the Company has utilized Level 3 inputs to determine fair value, for the six months ended
June 30, 2016
(amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
Corporate
Debt
Securities
|
|
Residential
Mortgage-
Backed
Securities
|
|
Corporate
Loans
|
|
Equity
Investments,
at Estimated
Fair Value
|
|
Interests in
Joint
Ventures and
Partnerships
|
|
Foreign Exchange Options, Net
|
|
Warrants
|
|
Options
|
Beginning balance as of January 1, 2016
|
$
|
194,986
|
|
|
$
|
49,621
|
|
|
$
|
298,734
|
|
|
$
|
146,648
|
|
|
$
|
888,408
|
|
|
$
|
2,887
|
|
|
$
|
—
|
|
|
$
|
95
|
|
Total gains or losses (for the period):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Included in earnings(1)
|
(45,549
|
)
|
|
1,080
|
|
|
(51,770
|
)
|
|
(25,462
|
)
|
|
(79,748
|
)
|
|
(1,235
|
)
|
|
(165
|
)
|
|
2,017
|
|
Transfers into Level 3
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
|
—
|
|
Transfers out of Level 3
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
|
—
|
|
Purchases
|
—
|
|
|
—
|
|
|
3,303
|
|
|
—
|
|
|
59,823
|
|
|
—
|
|
|
|
|
—
|
|
Sales
|
|
|
—
|
|
|
(26,685
|
)
|
|
(5,130
|
)
|
|
—
|
|
|
—
|
|
|
|
|
—
|
|
Settlements
|
(65
|
)
|
|
(4,901
|
)
|
|
(22,741
|
)
|
|
7,318
|
|
|
(110,162
|
)
|
|
—
|
|
|
2,285
|
|
|
—
|
|
Ending balance as of June 30, 2016
|
$
|
149,372
|
|
|
$
|
45,800
|
|
|
$
|
200,841
|
|
|
$
|
123,374
|
|
|
$
|
758,321
|
|
|
$
|
1,652
|
|
|
$
|
2,120
|
|
|
$
|
2,112
|
|
Change in unrealized gains or losses for the period included in earnings for assets held at the end of the reporting period(1)
|
$
|
(45,549
|
)
|
|
$
|
1,076
|
|
|
$
|
(51,770
|
)
|
|
$
|
(25,462
|
)
|
|
$
|
(79,748
|
)
|
|
$
|
(1,235
|
)
|
|
$
|
(165
|
)
|
|
$
|
2,017
|
|
|
|
(1)
|
Amounts are included in net realized and unrealized gain (loss) on investments or net realized and unrealized gain (loss) on derivatives and foreign exchange in the condensed consolidated statements of operations.
|
The following table presents additional information about assets and liabilities, including derivatives, that are measured at fair value on a recurring basis for which the Company has utilized Level 3 inputs to determine fair value, for the three months ended June 30, 2015 (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
Corporate
Debt
Securities
|
|
Residential
Mortgage-
Backed
Securities
|
|
Corporate
Loans
|
|
Equity
Investments,
at Estimated
Fair Value
|
|
Interests in
Joint
Ventures and
Partnerships
|
|
Warrants
|
|
Options
|
Beginning balance as of April 1, 2015
|
$
|
307,911
|
|
|
$
|
53,935
|
|
|
$
|
336,186
|
|
|
$
|
103,319
|
|
|
$
|
719,290
|
|
|
$
|
521
|
|
|
$
|
4,309
|
|
Total gains or losses (for the period):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Included in earnings(1)
|
(7,763
|
)
|
|
1,239
|
|
|
(2,278
|
)
|
|
2,213
|
|
|
12,204
|
|
|
(110
|
)
|
|
(1,399
|
)
|
Transfers into Level 3
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Transfers out of Level 3
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Purchases
|
—
|
|
|
—
|
|
|
10,999
|
|
|
—
|
|
|
13,830
|
|
|
—
|
|
|
—
|
|
Sales
|
(76,366
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Settlements
|
2,109
|
|
|
(2,785
|
)
|
|
(3,860
|
)
|
|
61,347
|
|
|
(5,727
|
)
|
|
—
|
|
|
—
|
|
Ending balance as of June 30, 2015
|
$
|
225,891
|
|
|
$
|
52,389
|
|
|
$
|
341,047
|
|
|
$
|
166,879
|
|
|
$
|
739,597
|
|
|
$
|
411
|
|
|
$
|
2,910
|
|
Change in unrealized gains or losses for the period included in earnings for assets held at the end of the reporting period(1)
|
$
|
(11,907
|
)
|
|
$
|
43
|
|
|
$
|
(2,374
|
)
|
|
$
|
2,213
|
|
|
$
|
12,204
|
|
|
$
|
(110
|
)
|
|
$
|
(1,399
|
)
|
|
|
(1)
|
Amounts are included in net realized and unrealized gain (loss) on investments or net realized and unrealized gain (loss) on derivatives and foreign exchange in the condensed consolidated statements of operations.
|
The following table presents additional information about assets and liabilities, including derivatives, that are measured at fair value on a recurring basis for which the Company has utilized Level 3 inputs to determine fair value, for the six months ended June 30, 2015 (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
Liabilities
|
|
Corporate
Debt
Securities
|
|
Residential
Mortgage-
Backed
Securities
|
|
Corporate
Loans
|
|
Equity
Investments,
at Estimated
Fair Value
|
|
Interests in
Joint
Ventures and
Partnerships
|
|
Warrants
|
|
Options
|
|
Collateralized
Loan
Obligation
Secured Notes
|
Beginning balance as of January 1, 2015
|
$
|
317,034
|
|
|
$
|
55,184
|
|
|
$
|
347,077
|
|
|
$
|
81,719
|
|
|
$
|
718,772
|
|
|
$
|
—
|
|
|
$
|
5,212
|
|
|
$
|
5,501,099
|
|
Total gains or losses (for the period):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Included in earnings(1)
|
(11,759
|
)
|
|
3,015
|
|
|
(58,048
|
)
|
|
(21,114
|
)
|
|
(20,158
|
)
|
|
(2,001
|
)
|
|
(2,302
|
)
|
|
—
|
|
Transfers into Level 3
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Transfers out of Level 3(2)
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(5,501,099
|
)
|
Purchases
|
—
|
|
|
—
|
|
|
12,307
|
|
|
—
|
|
|
49,367
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Sales
|
(80,579
|
)
|
|
—
|
|
|
(25,511
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Settlements
|
1,195
|
|
|
(5,810
|
)
|
|
65,222
|
|
|
106,274
|
|
|
(8,384
|
)
|
|
2,412
|
|
|
—
|
|
|
—
|
|
Ending balance as of June 30, 2015
|
$
|
225,891
|
|
|
$
|
52,389
|
|
|
$
|
341,047
|
|
|
$
|
166,879
|
|
|
$
|
739,597
|
|
|
$
|
411
|
|
|
$
|
2,910
|
|
|
$
|
—
|
|
Change in unrealized gains or losses for the period included in earnings for assets held at the end of the reporting period(1)
|
$
|
(14,418
|
)
|
|
$
|
196
|
|
|
$
|
(57,161
|
)
|
|
$
|
(20,418
|
)
|
|
$
|
(19,982
|
)
|
|
$
|
(2,001
|
)
|
|
$
|
(2,302
|
)
|
|
$
|
—
|
|
|
|
(1)
|
Amounts are included in net realized and unrealized gain (loss) on investments or net realized and unrealized gain (loss) on derivatives and foreign exchange in the condensed consolidated statements of operations. Amounts for collateralized loan obligation secured notes, which represent liabilities measured at fair value, are included in net realized and unrealized loss on debt in the condensed consolidated statements of operations.
|
|
|
(2)
|
CLO secured notes were transferred out of Level 3 due to the adoption of accounting guidance effective January 1, 2015, whereby the debt obligations of the Company's consolidated CLOs were measured on the basis of the estimated fair value of the financial assets of the CLOs. As such, as of June 30, 2015, these debt obligations were classified as Level 2. Refer to Note 2 to these condensed consolidated financial statements for further discussion.
|
There were
no
transfers between Level 1 and Level 2 for the Company’s financial assets and liabilities measured at fair value on a recurring and non-recurring basis for the three and six months ended
June 30, 2016
and 2015.
Valuation Techniques and Inputs for Level 3 Fair Value Measurements
The following table presents additional information about valuation techniques and inputs used for assets and liabilities, including derivatives, that are measured at fair value and categorized within Level 3 as of
June 30, 2016
(dollar amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of June 30, 2016
|
|
Valuation
Techniques(1)
|
|
Unobservable
Inputs(2)
|
|
Weighted
Average(3)
|
|
Range
|
|
Impact to
Valuation
from an
Increase in
Input(4)
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate debt securities
|
$
|
149,372
|
|
|
Yield analysis
|
|
Yield
|
|
12%
|
|
7% - 14%
|
|
Decrease
|
|
|
|
|
|
|
|
Net leverage
|
|
10x
|
|
9x-10x
|
|
Decrease
|
|
|
|
|
|
|
EBITDA multiple
|
|
8x
|
|
7x - 9x
|
|
Increase
|
|
|
|
|
|
|
Discount margin
|
|
1250
|
|
1250bps
|
|
Decrease
|
|
|
|
|
Market comparables
|
|
LTM EBITDA multiple
|
|
6x
|
|
6x
|
|
Increase
|
|
Residential mortgage – backed securities
|
$
|
45,800
|
|
|
Discounted cash flows
|
|
Probability of default
|
|
1%
|
|
0% - 2%
|
|
Decrease
|
|
|
|
|
|
|
|
Loss severity
|
|
43%
|
|
35% - 50%
|
|
Decrease
|
|
|
|
|
|
|
|
Constant prepayment rate
|
|
16%
|
|
12% - 20%
|
|
(5
|
)
|
Corporate loans
|
$
|
200,841
|
|
|
Yield Analysis
|
|
Yield
|
|
20%
|
|
4% - 198%
|
|
Decrease
|
|
|
|
|
|
|
|
Net leverage
|
|
9x
|
|
1x - 18x
|
|
Decrease
|
|
|
|
|
|
|
|
EBITDA multiple
|
|
9x
|
|
7x - 12x
|
|
Increase
|
|
Equity investments, at estimated fair value(6)
|
$
|
123,374
|
|
|
Inputs to both market comparables and
discounted cash flow
|
|
Illiquidity discount
|
|
11%
|
|
0% - 15%
|
|
Decrease
|
|
|
|
|
|
|
Weight ascribed to market comparables
|
|
25%
|
|
0% - 100%
|
|
(7
|
)
|
|
|
|
|
|
|
Weight ascribed to discounted cash flows
|
|
75%
|
|
0% - 100%
|
|
(8
|
)
|
|
|
|
|
Market comparables
|
|
LTM EBITDA multiple
|
|
9x
|
|
0x - 13x
|
|
Increase
|
|
|
|
|
|
|
|
Forward EBITDA multiple
|
|
7x
|
|
3x - 11x
|
|
Increase
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Discounted cash flows
|
|
Weighted average cost of capital
|
|
9%
|
|
7% - 14%
|
|
Decrease
|
|
|
|
|
|
|
|
LTM EBITDA exit multiple
|
|
9x
|
|
2x - 10x
|
|
Increase
|
|
Interests in joint ventures and partnerships(9)
|
$
|
758,321
|
|
|
Inputs to both market comparables and discounted cash flow
|
|
Weight ascribed to market comparables
|
|
37%
|
|
0% - 100%
|
|
(7
|
)
|
|
|
|
|
|
|
Weight ascribed to discounted cash flows
|
|
63%
|
|
0% - 100%
|
|
(8
|
)
|
|
|
|
Market comparables
|
|
LTM EBITDA multiple
|
|
5x
|
|
1x- 9x
|
|
Increase
|
|
|
|
|
|
|
Capitalization Rate
|
|
7%
|
|
6% - 12%
|
|
Decrease
|
|
|
|
|
|
Discounted cash flows
|
|
Weighted average cost of capital
|
|
10%
|
|
7% - 24%
|
|
Decrease
|
|
|
|
|
|
|
LTM EBITDA exit multiple
|
|
10x
|
|
10x
|
|
|
|
|
|
|
|
Average price per BOE(10)
|
|
$25.06
|
|
$16.07-$33.15
|
|
Increase
|
|
|
|
|
Yield analysis
|
|
Yield
|
|
15%
|
|
15%
|
|
Decrease
|
|
|
|
|
|
|
Net leverage
|
|
2x
|
|
2x
|
|
Decrease
|
|
|
|
|
|
|
EBITDA multiple
|
|
7x
|
|
7x
|
|
Increase
|
|
Foreign exchange options, net
|
$
|
1,652
|
|
|
Option pricing model
|
|
Forward and spot rates
|
|
11,500
|
|
6 - 13,500
|
|
(11
|
)
|
Options(12)
|
$
|
2,112
|
|
|
Inputs to both market comparables and discounted cash flow
|
|
Illiquidity discount
|
|
10%
|
|
10%
|
|
Decrease
|
|
|
|
|
|
|
|
Weight ascribed to market comparables
|
|
50%
|
|
50%
|
|
(7
|
)
|
|
|
|
|
|
Weight ascribed to discounted cash flows
|
|
50%
|
|
50%
|
|
(8
|
)
|
|
,
|
|
|
Market comparables
|
|
LTM EBITDA multiple
|
|
11x
|
|
11x
|
|
Increase
|
|
|
|
|
|
|
Forward EBITDA multiple
|
|
8x
|
|
8x
|
|
Increase
|
|
|
|
|
|
Discounted cash flows
|
|
Weighted average cost of capital
|
|
15%
|
|
15%
|
|
Decrease
|
|
|
|
|
|
|
|
LTM EBITDA exit multiple
|
|
5x
|
|
5x
|
|
Increase
|
|
|
|
(1)
|
For the assets that have more than one valuation technique, the Company may rely on the techniques individually or in aggregate based on a weight ascribed to each one ranging from
0
-
100%
. When determining the weighting ascribed to each valuation methodology, the Company considers, among other factors, the availability of direct market comparables, the applicability of a discounted cash flow analysis and the expected hold period and manner of realization for the investment. These factors can result in different weightings among the investments and in certain instances, may result in up to a
100%
weighting to a single methodology. Broker quotes obtained for valuation purposes are reviewed by the Company through other valuation techniques.
|
|
|
(2)
|
In determining certain of these inputs, management evaluates a variety of factors including economic conditions, industry and market developments; market valuations of comparable companies; and company specific developments including exit strategies and realization opportunities.
|
|
|
(3)
|
Weighted average amounts are based on the estimated fair values.
|
|
|
(4)
|
Unless otherwise noted, this column represents the directional change in the fair value of the Level 3 investments that would result from an increase to the corresponding unobservable input. A decrease to the unobservable input would have the opposite effect. Significant increases and decreases in these inputs in isolation could result in significantly higher or lower fair value measurements.
|
|
|
(5)
|
The impact of changes in prepayment speeds may have differing impacts depending on the seniority of the instrument. Generally, an increase in the constant prepayment speed will positively impact the overall valuation of traditional mortgage assets. In contrast, an increase in the constant prepayment rate will negatively impact the overall valuation of interest-only strips.
|
|
|
(6)
|
When determining the illiquidity discount to be applied to equity investments, at estimated fair value, the Company seeks to take a uniform approach across its portfolio and generally applies a minimum
5%
discount to all private equity investments carried at estimated fair value. The Company then evaluates such investments to determine if factors exist that could make it more challenging to monetize the investment and, therefore, justify applying a higher illiquidity discount. These factors generally include the salability of the investment, whether the issuer is undergoing significant restructuring activity or similar factors, as well as characteristics about the issuer including its size and/or whether it is experiencing, or expected to experience, a significant decline in earnings. Depending on the applicability of these factors, the Company determines the amount of any incremental illiquidity discount to be applied above the
5%
minimum, and during the time the Company holds the investment, the illiquidity discount may be increased or decreased, from time to time, based on changes to these factors. The amount of illiquidity discount applied at any time requires considerable judgment about what a market participant would consider and is based on the facts and circumstances of each individual investment. Accordingly, the illiquidity discount ultimately considered by a market participant upon the realization of any investment may be higher or lower than that estimated by the Company in its valuations. Of the total equity investments, at estimated fair value,
$47.8 million
was valued solely using a market comparables technique.
|
|
|
(7)
|
The directional change from an increase in the weight ascribed to the market comparables approach would increase the fair value of the Level 3 investments if the market comparables approach results in a higher valuation than the discounted cash flow approach. The opposite would be true if the market comparables approach results in a lower valuation than the discounted cash flow approach.
|
|
|
(8)
|
The directional change from an increase in the weight ascribed to the discounted cash flow approach would increase the fair value of the Level 3 investments if the discounted cash flow approach results in a higher valuation than the market comparables approach. The opposite would be true if the discounted cash flow approach results in a lower valuation than the market comparables approach.
|
|
|
(9)
|
Inputs exclude an asset that was valued using an independent third party valuation firm. Of the total interest in joint ventures and partnerships,
$59.6 million
was valued solely using a discounted cash flow technique, while
$7.8 million
was valued solely using a market comparables technique and
$21.4 million
was valued solely using a yield analysis.
|
|
|
(10)
|
Natural resources assets with an estimated fair value of
$98.4 million
as of June 30, 2016 were valued using commodity prices. Commodity prices may be measured using a common volumetric equivalent where one barrel of oil equivalent (‘‘BOE’’) is determined using the ratio of six thousand cubic feet of natural gas to one barrel of oil, condensate or natural gas liquids. The price per BOE is provided to show the aggregate of all price inputs for these investments over a common volumetric equivalent although the valuations for specific investments may use price inputs specific to the asset for purposes of our valuations. The discounted cash flows include forecasted production of liquids (oil, condensate, and natural gas liquids) and natural gas with a forecasted revenue ratio of approximately
45%
liquids and
55%
natural gas.
|
|
|
(11)
|
Inputs include forward rates for investments in Chinese Yuan and Indian Rupees.
|
|
|
(12)
|
The total options were valued using
50%
a discount cash flow technique and
50%
a market comparables technique.
|
The table above excludes warrants of
$2.1 million
, comprised of equity-like securities in a company that were valued using an independent third party valuation firm primarily based on the contractual agreement and public disclosures of the expected sale value.
The following table presents additional information about valuation techniques and inputs used for assets, including derivatives, that are measured at fair value and categorized within Level 3 as of December 31, 2015 (dollar amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of
December 31, 2015
|
|
Valuation
Techniques(1)
|
|
Unobservable
Inputs(2)
|
|
Weighted
Average(3)
|
|
Range
|
|
Impact to
Valuation
from an
Increase in
Input(4)
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate debt securities
|
$
|
194,986
|
|
|
Yield analysis
|
|
Yield
|
|
23%
|
|
6% - 31%
|
|
Decrease
|
|
|
|
|
|
|
|
Net leverage
|
|
10x
|
|
10x-12x
|
|
Decrease
|
|
|
|
|
|
|
EBITDA multiple
|
|
7x
|
|
7x - 10x
|
|
Increase
|
|
|
|
|
|
|
Discount margin
|
|
750
|
|
750bps
|
|
Decrease
|
|
Residential mortgage – backed securities
|
$
|
49,621
|
|
|
Discounted cash flows
|
|
Probability of default
|
|
1%
|
|
0% - 3%
|
|
Decrease
|
|
|
|
|
|
|
|
Loss severity
|
|
40%
|
|
35% - 45%
|
|
Decrease
|
|
|
|
|
|
|
|
Constant prepayment rate
|
|
15%
|
|
12% - 18%
|
|
(5
|
)
|
Corporate loans
|
$
|
298,734
|
|
|
Yield Analysis
|
|
Yield
|
|
11%
|
|
3% - 18%
|
|
Decrease
|
|
|
|
|
|
|
|
Net leverage
|
|
7x
|
|
1x - 19x
|
|
Decrease
|
|
|
|
|
|
|
|
EBITDA multiple
|
|
9x
|
|
6x - 15x
|
|
Increase
|
|
Equity investments, at estimated fair value(6)
|
$
|
146,648
|
|
|
Inputs to market comparables, discounted cash flow and broker quotes
|
|
Illiquidity discount
|
|
11%
|
|
0% - 15%
|
|
Decrease
|
|
|
|
|
|
|
Weight ascribed to market comparables
|
|
52%
|
|
0% - 100%
|
|
(7
|
)
|
|
|
|
|
|
|
Weight ascribed to discounted cash flows
|
|
42%
|
|
0% - 100%
|
|
(8
|
)
|
|
|
|
|
|
Weight ascribed to broker quotes
|
|
6%
|
|
0% - 100%
|
|
(9
|
)
|
|
|
|
|
Market comparables
|
|
LTM EBITDA multiple
|
|
8x
|
|
4x - 13x
|
|
Increase
|
|
|
|
|
|
|
|
Forward EBITDA multiple
|
|
8x
|
|
3x - 11x
|
|
Increase
|
|
|
|
|
|
Discounted cash flows
|
|
Weighted average cost of capital
|
|
9%
|
|
7% - 14%
|
|
Decrease
|
|
|
|
|
|
|
|
LTM EBITDA exit multiple
|
|
8x
|
|
0x - 9x
|
|
Increase
|
|
|
|
|
Broker quotes
|
|
Offered quotes
|
|
4
|
|
0 - 5
|
|
Increase
|
|
Interests in joint ventures and partnerships(10)
|
$
|
888,408
|
|
|
Inputs to both market comparables and discounted cash flow
|
|
Weight ascribed to market comparables
|
|
43%
|
|
0% - 100%
|
|
(7
|
)
|
|
|
|
|
|
|
Weight ascribed to discounted cash flows
|
|
57%
|
|
0% - 100%
|
|
(8
|
)
|
|
|
|
|
Market comparables
|
|
LTM EBITDA multiple
|
|
5x
|
|
1x - 9x
|
|
Decrease
|
|
|
|
|
|
Discounted cash flows
|
|
Weighted average cost of capital
|
|
8%
|
|
6% - 20%
|
|
Decrease
|
|
|
|
|
|
|
Average price per BOE(11)
|
|
$20.61
|
|
$14.33 - $23.22
|
|
Increase
|
|
|
|
|
Yield analysis
|
|
Yield
|
|
16%
|
|
16%
|
|
Decrease
|
|
|
|
|
|
|
Net leverage
|
|
2x
|
|
2x
|
|
Decrease
|
|
|
|
|
|
|
EBITDA multiple
|
|
8x
|
|
8x
|
|
Increase
|
|
Foreign exchange options, net
|
$
|
2,887
|
|
|
Option pricing model
|
|
Forward and spot rates
|
|
11,500
|
|
6 -14,000
|
|
(12
|
)
|
Options(13)
|
$
|
95
|
|
|
Inputs to both market comparables and discounted cash flow
|
|
Illiquidity discount
|
|
10%
|
|
10%
|
|
Decrease
|
|
|
|
|
|
|
|
Weight ascribed to market comparables
|
|
50%
|
|
50%
|
|
(7
|
)
|
|
|
|
|
|
Weight ascribed to discounted cash flows
|
|
50%
|
|
50%
|
|
(8
|
)
|
|
,
|
|
|
Market comparables
|
|
LTM EBITDA multiple
|
|
9x
|
|
9x
|
|
Increase
|
|
|
|
|
|
|
Forward EBITDA multiple
|
|
8x
|
|
8x
|
|
Increase
|
|
|
|
|
|
Discounted cash flows
|
|
Weighted average cost of capital
|
|
14%
|
|
14%
|
|
Decrease
|
|
|
|
|
|
|
|
LTM EBITDA exit multiple
|
|
8x
|
|
8x
|
|
Increase
|
|
|
|
(1)
|
For the assets that have more than one valuation technique, the Company may rely on the techniques individually or in aggregate based on a weight ascribed to each one ranging from
0
-
100%
. When determining the weighting ascribed to each valuation methodology, the Company considers, among other factors, the availability of direct market comparables, the applicability of a discounted cash flow analysis and the expected hold period and manner of realization for the investment. These factors can result in different weightings among the investments and in certain instances, may result in up to a
100%
weighting to a single methodology. Broker quotes obtained for valuation purposes are reviewed by the Company through other valuation techniques.
|
|
|
(2)
|
In determining certain of these inputs, management evaluates a variety of factors including economic conditions, industry and market developments; market valuations of comparable companies; and company specific developments including exit strategies and realization opportunities.
|
|
|
(3)
|
Weighted average amounts are based on the estimated fair values.
|
|
|
(4)
|
Unless otherwise noted, this column represents the directional change in the fair value of the Level 3 investments that would result from an increase to the corresponding unobservable input. A decrease to the unobservable input would have the opposite effect. Significant increases and decreases in these inputs in isolation could result in significantly higher or lower fair value measurements.
|
|
|
(5)
|
The impact of changes in prepayment speeds may have differing impacts depending on the seniority of the instrument. Generally, an increase in the constant prepayment speed will positively impact the overall valuation of traditional mortgage assets. In contrast, an increase in the constant prepayment rate will negatively impact the overall valuation of interest-only strips.
|
|
|
(6)
|
When determining the illiquidity discount to be applied to equity investments, at estimated fair value, the Company seeks to take a uniform approach across its portfolio and generally applies a minimum
5%
discount to all private equity investments carried at estimated fair value. The Company then evaluates such investments to determine if factors exist that could make it more challenging to monetize the investment and, therefore, justify applying a higher illiquidity discount. These factors generally include the salability of the investment, whether the issuer is undergoing significant restructuring activity or similar factors, as well as characteristics about the issuer including its size and/or whether it is experiencing, or expected to experience, a significant decline in earnings. Depending on the applicability of these factors, the Company determines the amount of any incremental illiquidity discount to be applied above the
5%
minimum, and during the time the Company holds the investment, the illiquidity discount may be increased or decreased, from time to time, based on changes to these factors. The amount of illiquidity discount applied at any time requires considerable judgment about what a market participant would consider and is based on the facts and circumstances of each individual investment. Accordingly, the illiquidity discount ultimately considered by a market participant upon the realization of any investment may be higher or lower than that estimated by the Company in its valuations. Of the total equity investments, at estimated fair value,
$6.4 million
was valued solely using broker quotes, while
$11.3 million
was valued solely using a market comparables technique.
|
|
|
(7)
|
The directional change from an increase in the weight ascribed to the market comparables approach would increase the fair value of the Level 3 investments if the market comparables approach results in a higher valuation than the discounted cash flow approach and broker quotes, if applicable. The opposite would be true if the market comparables approach results in a lower valuation than the discounted cash flow approach and broker quotes, if applicable.
|
|
|
(8)
|
The directional change from an increase in the weight ascribed to the discounted cash flow approach would increase the fair value of the Level 3 investments if the discounted cash flow approach results in a higher valuation than the market comparables approach and broker quotes, if applicable. The opposite would be true if the discounted cash flow approach results in a lower valuation than the market comparables approach and broker quotes, if applicable.
|
|
|
(9)
|
The directional change from an increase in the weight ascribed to broker quotes would increase the fair value of the Level 3 investments if the broker quotes results in a higher valuation than the market comparables and discounted cash flow approaches, if applicable. The opposite would be true if the broker quotes results in a lower valuation than the market comparables and discounted cash flow approaches, if applicable.
|
|
|
(10)
|
Inputs exclude an asset that was valued using an independent third party valuation firm. Of the total interest in joint ventures and partnerships,
$164.4 million
was valued solely using a discounted cash flow technique, while
$98.9 million
was valued solely using a market comparables technique and
$17.5 million
was valued solely using a yield analysis.
|
|
|
(11)
|
Natural resources assets with an estimated fair value of
$114.1 million
as of December 31, 2015 were valued using commodity prices. Commodity prices may be measured using a common volumetric equivalent where one barrel of oil equivalent (‘‘BOE’’) is determined using the ratio of six thousand cubic feet of natural gas to one barrel of oil, condensate or natural gas liquids. The price per BOE is provided to show the aggregate of all price inputs for these investments over a common volumetric equivalent although the valuations for specific investments may use price inputs specific to the asset for purposes of our valuations. The discounted cash flows include forecasted production of liquids (oil, condensate, and natural gas liquids) and natural gas with a forecasted revenue ratio of approximately
25%
liquids and
75%
natural gas.
|
|
|
(12)
|
Inputs include forward rates for investments in Chinese Yuan and Indian Rupees.
|
|
|
(13)
|
The total options were valued using
50%
a discount cash flow technique and
50%
a market comparables technique.
|
NOTE 9. COMMITMENTS AND CONTINGENCIES
Commitments
The Company participates in certain contingent financing arrangements, whereby the Company is committed to provide funding of up to a specific predetermined amount at the discretion of the borrower or has entered into an agreement to acquire interests in certain assets. As of
June 30, 2016
and December 31, 2015, the Company had unfunded financing commitments for corporate loans totaling
$2.8 million
and
$8.6 million
, respectively. The Company did not have any significant losses as of
June 30, 2016
, nor does it expect any significant losses related to those assets for which it committed to fund.
The Company participates in joint ventures and partnerships alongside KKR and its affiliates through which the Company contributes capital for assets, including development projects related to the Company’s interests in joint ventures and partnerships that hold commercial real estate and natural resources investments, as well as specialty lending focused
businesses. The Company estimated these future contributions to total approximately
$85.0 million
as of
June 30, 2016
and
$163.0 million
as of December 31, 2015.
Guarantees
The Company had investments, held alongside KKR and its affiliates, in real estate entities that were financed with non-recourse debt totaling approximately
$1.6 billion
as of June 30, 2016 and
$1.6 billion
as of December 31, 2015. Under non-recourse debt, the lender generally does not have recourse against any other assets owned by the borrower or any related parties of the borrower, except for certain specified exceptions listed in the respective loan documents including customary “bad boy” acts and environmental losses. In connection with certain of these investments, joint and several non-recourse carve-out guarantees and environmental indemnities were provided, pursuant to which KFN guarantees losses or the full amount of the applicable loan in the event of specified bad acts or environmental matters. In addition, completion guarantees were provided for certain properties to complete all or portions of development projects, and partial payment guarantees were provided for certain investments. The Company's maximum exposure under these arrangements is unknown as this would involve future claims that may be made against it that have not yet occurred. However, based on prior experience, the Company expects the risk of material loss to be low.
Contingencies
From time to time, the Company is involved in various legal proceedings, lawsuits and claims incidental to the conduct of the Company’s business. The Company’s business is also subject to extensive regulation, which may result in regulatory proceedings against it. It is inherently difficult to predict the ultimate outcome, particularly in cases in which claimants seek substantial or unspecified damages, or where investigations or proceedings are at an early stage and the Company cannot predict with certainty the loss or range of loss that may be incurred; however, it is possible that an adverse outcome in certain matters could, from time to time, have a material effect on the Company’s financial results in any particular period. Based on current discussion and consultation with counsel, management believes that the final resolution of these matters would not have a material impact on the Company’s consolidated financial statements.
NOTE 10. MANAGEMENT AGREEMENT AND RELATED PARTY TRANSACTIONS
The Manager manages the Company’s day-to-day operations, subject to the direction and oversight of the Company’s board of directors. The Management Agreement expires on December 31 of each year, but is automatically renewed for a
1 year
term each December 31 unless terminated upon the affirmative vote of at least two-thirds of the Company’s independent directors, or by a vote of the holders of a majority of the Company’s outstanding common shares, based upon (1) unsatisfactory performance by the Manager that is materially detrimental to the Company or (2) a determination that the management fee payable to the Manager is not fair, subject to the Manager’s right to prevent such a termination under this clause (2) by accepting a mutually acceptable reduction of management fees. The Manager must be provided
180 days
prior notice of any such termination and will be paid a termination fee equal to
four
times the sum of the average annual base management fee and the average annual incentive fee for the
two
12
-month periods immediately preceding the date of termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination.
The Management Agreement contains certain provisions requiring the Company to indemnify the Manager with respect to all losses or damages arising from acts not constituting bad faith, willful misconduct, or gross negligence. The Company has evaluated the impact of these guarantees on its condensed consolidated financial statements and determined that they are not material.
The following table summarizes the components of related party management compensation on the Company’s condensed consolidated statements of operations, which are described in further detail below (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended June 30, 2016
|
|
Three months ended June 30, 2015
|
|
Six months ended June 30, 2016
|
|
Six months ended June 30, 2015
|
Base management fees, net
|
$
|
559
|
|
|
$
|
1,410
|
|
|
$
|
1,588
|
|
|
$
|
5,463
|
|
CLO management fees
|
6,208
|
|
|
8,407
|
|
|
12,455
|
|
|
14,574
|
|
Incentive fees
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Total related party management compensation
|
$
|
6,767
|
|
|
$
|
9,817
|
|
|
$
|
14,043
|
|
|
$
|
20,037
|
|
Base Management Fees
The Company pays its Manager a base management fee quarterly in arrears. During 2016 and 2015, certain related party fees received by affiliates of the Manager were credited to the Company via an offset to the base management fee (“Fee Credits”). Specifically, as described in further detail under “CLO Management Fees” below, a portion of the CLO management fees received by an affiliate of the Manager for certain of the Company’s CLOs were credited to the Company via an offset to the base management fee.
The table below summarizes the aggregate base management fees (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended June 30, 2016
|
|
Three months ended June 30, 2015
|
|
Six months ended June 30, 2016
|
|
Six months ended June 30, 2015
|
Base management fees, gross
|
$
|
5,002
|
|
|
$
|
7,836
|
|
|
$
|
10,785
|
|
|
$
|
16,327
|
|
CLO management fees credit(1)
|
(4,443
|
)
|
|
(6,426
|
)
|
|
(9,197
|
)
|
|
(10,864
|
)
|
Total base management fees, net
|
$
|
559
|
|
|
$
|
1,410
|
|
|
$
|
1,588
|
|
|
$
|
5,463
|
|
|
|
(1)
|
See “CLO Management Fees” for further discussion.
|
CLO Management Fees
An affiliate of the Manager entered into separate management agreements with the respective investment vehicles for all of the Company’s Cash Flow CLOs pursuant to which it is entitled to receive fees for the services it performs as collateral manager for all of these CLOs, except for CLO 2011-1. The collateral manager has the option to waive the fees it earns for providing management services for the CLO.
Fees Waived
The collateral manager waived CLO management fees totaling of
$0.6 million
and
$1.1 million
for CLO 2005-2 during the three and six months ended June 30, 2015, respectively. The Company called CLO 2005-2 in November 2015.
Fees Charged and Fee Credits
The Company recorded management fees expense for the majority of its CLOs during the three and six months ended June 30, 2016 and 2015. The Manager credits the Company for a portion of the CLO management fees received by an affiliate of the Manager from CLO 2007-1, CLO 2012-1, CLO 9, CLO 10, CLO 11 and CLO 13 via an offset to the base management fees payable to the Manager. As the Company owns less than
100%
of the subordinated notes of these CLOs (with the remaining subordinated notes held by affiliated and unaffiliated third parties), the Company received a Fee Credit equal only to the Company’s pro rata share of the aggregate CLO management fees paid by these CLOs. Specifically, the amount of the reimbursement for each of these CLOs was calculated by taking the product of (x) the total CLO management fees received by an affiliate of the Manager during the period for such CLO multiplied by (y) the percentage of the subordinated notes of such CLO held by the Company. The remaining portion of the CLO management fees paid by each of these CLOs was not credited to the Company, but instead resulted in a dollar-for-dollar reduction in the interest expense paid by the Company to the third party holder of the CLO’s subordinated notes. Similarly, the Manager credited the Company the CLO management fees from CLO 2013-1 and CLO 2013-2 based on the Company’s
100%
ownership of the subordinated notes in the CLO.
The table below summarizes the aggregate CLO management fees, including the Fee Credits (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended June 30, 2016
|
|
Three months ended June 30, 2015
|
|
Six months ended June 30, 2016
|
|
Six months ended June 30, 2015
|
Charged and retained CLO management fees(1)
|
$
|
1,765
|
|
|
$
|
1,981
|
|
|
$
|
3,258
|
|
|
$
|
3,710
|
|
CLO management fees credit
|
4,443
|
|
|
6,426
|
|
|
9,197
|
|
|
10,864
|
|
Total CLO management fees
|
$
|
6,208
|
|
|
$
|
8,407
|
|
|
$
|
12,455
|
|
|
$
|
14,574
|
|
|
|
(1)
|
Represents management fees incurred by the senior and subordinated note holders of a CLO, excluding the Fee Credits received by the Company based on its ownership percentage in the CLO.
|
Subordinated note holders in CLOs have the first risk of loss and conversely, the residual value upside of the transactions. When CLO management fees are paid by a CLO, the residual economic interests in the CLO transaction are reduced by an amount commensurate with the CLO management fees paid. The Company records any residual proceeds due to subordinated note holders as interest expense on the condensed consolidated statements of operations. Accordingly, the increase in CLO management fees is directly offset by a decrease in interest expense.
Incentive Fees
The Manager earned incentive fees totaling
zero
for both of the three and six months ended
June 30, 2016
and 2015.
Reimbursable General and Administrative Expenses
Certain general and administrative expenses are incurred by the Company’s Manager on its behalf that are reimbursable to the Manager pursuant to the Management Agreement. The Company incurred reimbursable general and administrative expenses to its Manager totaling
$0.9 million
and
$1.9 million
for the three and six months ended
June 30, 2016
, respectively. The Company incurred reimbursable general and administrative expenses to its Manager totaling
$1.2 million
and
$3.5 million
for the three and six months ended June 30, 2015, respectively. Expenses incurred by the Manager and reimbursed by the Company are reflected in general, administrative and directors expenses on the condensed consolidated statements of operations.
Contributions and Distributions
The Company has made certain cash distributions to its Parent, as the sole holder of its common shares. The Company distributed
$24.6 million
and
$62.9 million
during the three and six months ended
June 30, 2016
, respectively. The Company
distributed
$55.2 million
and
$89.5 million
for the three and six months ended June 30, 2015, respectively.
During the second quarter ended June 30, 2016, certain assets were distributed to the Parent, including CLO subordinated notes, which were previously held by the Company. As the CLO subordinated notes are held by an affiliate of our Parent, refer to Note 6 in these condensed consolidated financial statements for additional details around these notes to affiliates. The table below summarizes the estimated fair value of distributions at the time of transfer (amounts in thousands):
|
|
|
|
|
|
|
Three months ended June 30, 2016
|
|
Loans
|
$
|
45,225
|
|
|
Equity investments, at estimated fair value
|
26,098
|
|
|
CLO subordinated notes
|
60,640
|
|
|
Total distributions to Parent
|
$
|
131,963
|
|
|
Affiliated Investments
The Company has invested in corporate loans, debt securities and other investments of entities that are affiliates of KKR. As of
June 30, 2016
, the aggregate par amount of these affiliated investments totaled
$89.3 million
, or approximately
2%
of the total investment portfolio, and consisted of
4
issuers. The total affiliated investments was comprised of
$80.2 million
of corporate loans and
$9.1 million
of equity investments. As of December 31, 2015, the aggregate par amount of these affiliated investments totaled
$734.3 million
, or approximately
11%
of the total investment portfolio, and consisted of
8
issuers. The total
$734.3 million
in affiliated investments was comprised of
$723.3 million
of corporate loans and
$11.0 million
of equity investments.
In addition, the Company has invested in certain joint ventures and partnerships alongside KKR and its affiliates. As of
June 30, 2016
and December 31, 2015, the estimated fair value of these interests in joint ventures and partnerships totaled
$649.8 million
and
$805.5 million
, respectively.
NOTE 11. SEGMENT REPORTING
Operating segments are defined as components of a company that engage in business activities that may earn revenues and incur expenses for which separate financial information is available and reviewed by the chief operating decision maker or group in determining how to allocate resources and assessing performance. The Company operates its business through the following reportable segments: credit (“Credit”), natural resources (“Natural Resources”) and other (“Other”).
The Company’s reportable segments are differentiated primarily by their investment focuses. The Credit segment consists primarily of below investment grade corporate debt comprised of senior secured and unsecured loans, mezzanine loans, high yield bonds, private and public equity investments, and distressed and stressed debt securities. The Natural Resources segment consists of non-operated working and overriding royalty interests in oil and natural gas properties, as well as interests in joint ventures and partnerships focused on the oil and gas sector. The Other segment includes all other portfolio holdings, consisting solely of commercial real estate. The segments currently reported are consistent with the way decisions regarding the allocation of resources are made, as well as how operating results are reviewed by the Company.
The Company evaluates the performance of its reportable segments based on several net income (loss) components. Net income (loss) includes (i) revenues, (ii) related investment costs and expenses, (iii) other income (loss), which is comprised primarily of unrealized and realized gains and losses on investments, debt and derivatives, and (iv) other expenses, including related party management compensation and general and administrative expenses. Certain corporate assets and expenses that are not directly related to the individual segments, including interest expense and related costs on borrowings, base management fees and professional services are allocated to individual segments based on the investment portfolio balance in each respective segment as of the most recent period-end. Certain other corporate assets and expenses, including prepaid insurance, incentive fees, insurance expenses and directors’ expenses, if any, are not allocated to individual segments in the Company’s assessment of segment performance. Collectively, these items are included as reconciling items between reported segment amounts and consolidated totals.
The following table presents the net income (loss) components of our reportable segments reconciled to amounts reflected in the condensed consolidated statements of operations for the three months ended June 30, 2016 and 2015 (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended June 30,
|
|
Credit
|
|
Natural Resources
|
|
Other
|
|
Reconciling Items
|
|
Total Consolidated
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
Total revenues
|
$
|
65,905
|
|
|
$
|
90,520
|
|
|
$
|
3,257
|
|
|
$
|
6,351
|
|
|
$
|
—
|
|
|
$
|
8,820
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
69,162
|
|
|
$
|
105,691
|
|
Total investment costs and expenses
|
55,665
|
|
|
59,331
|
|
|
1,894
|
|
|
2,706
|
|
|
494
|
|
|
413
|
|
|
—
|
|
|
—
|
|
|
58,053
|
|
|
62,450
|
|
Total other income (loss)
|
18,756
|
|
|
(842
|
)
|
|
8,634
|
|
|
(6,348
|
)
|
|
(2,444
|
)
|
|
15,225
|
|
|
—
|
|
|
—
|
|
|
24,946
|
|
|
8,035
|
|
Total other expenses
|
8,986
|
|
|
12,014
|
|
|
127
|
|
|
176
|
|
|
79
|
|
|
79
|
|
|
—
|
|
|
—
|
|
|
9,192
|
|
|
12,269
|
|
Income tax expense (benefit)
|
(27
|
)
|
|
14
|
|
|
—
|
|
|
—
|
|
|
(160
|
)
|
|
715
|
|
|
—
|
|
|
—
|
|
|
(187
|
)
|
|
729
|
|
Net income (loss)
|
$
|
20,037
|
|
|
$
|
18,319
|
|
|
$
|
9,870
|
|
|
$
|
(2,879
|
)
|
|
$
|
(2,857
|
)
|
|
$
|
22,838
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
27,050
|
|
|
$
|
38,278
|
|
Net income (loss) attributable to noncontrolling interests
|
(1,948
|
)
|
|
182
|
|
|
667
|
|
|
(2,887
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(1,281
|
)
|
|
(2,705
|
)
|
Net income (loss) attributable to KKR Financial Holdings LLC and Subsidiaries
|
$
|
21,985
|
|
|
$
|
18,137
|
|
|
$
|
9,203
|
|
|
$
|
8
|
|
|
$
|
(2,857
|
)
|
|
$
|
22,838
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
28,331
|
|
|
$
|
40,983
|
|
The following table presents the net income (loss) components of our reportable segments reconciled to amounts reflected in the condensed consolidated statements of operations for the six months ended June 30, 2016 and 2015 (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six months ended June 30,
|
|
Credit
|
|
Natural Resources
|
|
Other
|
|
Reconciling Items(1)
|
|
Total Consolidated
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
Total revenues
|
$
|
143,300
|
|
|
$
|
185,478
|
|
|
$
|
5,898
|
|
|
$
|
9,179
|
|
|
$
|
9,269
|
|
|
$
|
8,820
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
158,467
|
|
|
$
|
203,477
|
|
Total investment costs and expenses
|
106,649
|
|
|
115,298
|
|
|
3,508
|
|
|
4,046
|
|
|
894
|
|
|
759
|
|
|
—
|
|
|
—
|
|
|
111,051
|
|
|
120,103
|
|
Total other income (loss)
|
(155,190
|
)
|
|
(66,834
|
)
|
|
(18,608
|
)
|
|
(14,101
|
)
|
|
(11,138
|
)
|
|
19,806
|
|
|
—
|
|
|
—
|
|
|
(184,936
|
)
|
|
(61,129
|
)
|
Total other expenses
|
32,850
|
|
|
28,417
|
|
|
257
|
|
|
686
|
|
|
149
|
|
|
234
|
|
|
—
|
|
|
100
|
|
|
33,256
|
|
|
29,437
|
|
Income tax expense (benefit)
|
(4
|
)
|
|
62
|
|
|
—
|
|
|
—
|
|
|
(123
|
)
|
|
1,014
|
|
|
—
|
|
|
—
|
|
|
(127
|
)
|
|
1,076
|
|
Net income (loss)
|
$
|
(151,385
|
)
|
|
$
|
(25,133
|
)
|
|
$
|
(16,475
|
)
|
|
$
|
(9,654
|
)
|
|
$
|
(2,789
|
)
|
|
$
|
26,619
|
|
|
$
|
—
|
|
|
$
|
(100
|
)
|
|
$
|
(170,649
|
)
|
|
$
|
(8,268
|
)
|
Net income (loss) attributable to noncontrolling interests
|
(11,659
|
)
|
|
(5,676
|
)
|
|
(5,157
|
)
|
|
(3,100
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(16,816
|
)
|
|
(8,776
|
)
|
Net income (loss) attributable to KKR Financial Holdings LLC and Subsidiaries
|
$
|
(139,726
|
)
|
|
$
|
(19,457
|
)
|
|
$
|
(11,318
|
)
|
|
$
|
(6,554
|
)
|
|
$
|
(2,789
|
)
|
|
$
|
26,619
|
|
|
$
|
—
|
|
|
$
|
(100
|
)
|
|
$
|
(153,833
|
)
|
|
$
|
508
|
|
|
|
(1)
|
Consists of insurance and directors’ expenses which are not allocated to individual segments.
|
The following table shows total assets of our reportable segments reconciled to amounts reflected in the condensed consolidated balance sheets as of
June 30, 2016
and December 31, 2015 (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Credit
|
|
Natural Resources
|
|
Other
|
|
Reconciling Items
|
|
Total Consolidated(1)
|
As of
|
June 30, 2016
|
|
December 31,
2015
|
|
June 30, 2016
|
|
December 31,
2015
|
|
June 30, 2016
|
|
December 31,
2015
|
|
June 30, 2016
|
|
December 31,
2015
|
|
June 30, 2016
|
|
December 31,
2015
|
Total assets
|
$
|
6,385,056
|
|
|
$
|
7,303,305
|
|
|
$
|
213,286
|
|
|
$
|
230,815
|
|
|
$
|
232,873
|
|
|
$
|
254,275
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
6,831,215
|
|
|
$
|
7,788,395
|
|
|
|
(1)
|
Total consolidated assets as of
June 30, 2016
included
$64.3 million
of noncontrolling interests, of which
$36.0 million
was related to the Credit segment and
$28.3 million
was related to the Natural Resources segment. Total consolidated assets as of December 31, 2015 included
$82.9 million
of noncontrolling interests, of which
$50.3 million
was related to the Credit segment and
$32.6 million
was related to the Natural Resources segment.
|
NOTE 12. SUBSEQUENT EVENTS
On June 23, 2016, the Company's board of directors declared a cash distribution on its Series A LLC Preferred Shares totaling
$6.9 million
, or
$0.460938
per share. The distribution was paid on July 15, 2016 to preferred shareholders of record as of the close of business on July 8, 2016.
On July 21, 2016, the Company's board of directors declared a cash distribution for the quarter ended June 30, 2016 on its common shares totaling
$17.9 million
, or
$179,230
per common share. The distribution was paid on July 22, 2016 to common shareholders of record as of the close of business on July 21, 2016.
RESULTS OF OPERATIONS
Consolidated Results
The following tables show data of our reportable segments reconciled to amounts reflected in the condensed consolidated statements of operations for the three and six months ended June 30, 2016 and 2015 (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended June 30,
|
|
Credit
|
|
Natural Resources
|
|
Other
|
|
Reconciling Items(1)
|
|
Total Consolidated
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
Total revenues
|
$
|
65,905
|
|
|
$
|
90,520
|
|
|
$
|
3,257
|
|
|
$
|
6,351
|
|
|
$
|
—
|
|
|
$
|
8,820
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
69,162
|
|
|
$
|
105,691
|
|
Total investment costs and expenses
|
55,665
|
|
|
59,331
|
|
|
1,894
|
|
|
2,706
|
|
|
494
|
|
|
413
|
|
|
—
|
|
|
—
|
|
|
58,053
|
|
|
62,450
|
|
Total other income (loss)
|
18,756
|
|
|
(842
|
)
|
|
8,634
|
|
|
(6,348
|
)
|
|
(2,444
|
)
|
|
15,225
|
|
|
—
|
|
|
—
|
|
|
24,946
|
|
|
8,035
|
|
Total other expenses
|
8,986
|
|
|
12,014
|
|
|
127
|
|
|
176
|
|
|
79
|
|
|
79
|
|
|
—
|
|
|
—
|
|
|
9,192
|
|
|
12,269
|
|
Income tax expense (benefit)
|
(27
|
)
|
|
14
|
|
|
—
|
|
|
—
|
|
|
(160
|
)
|
|
715
|
|
|
—
|
|
|
—
|
|
|
(187
|
)
|
|
729
|
|
Net income (loss)
|
$
|
20,037
|
|
|
$
|
18,319
|
|
|
$
|
9,870
|
|
|
$
|
(2,879
|
)
|
|
$
|
(2,857
|
)
|
|
$
|
22,838
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
27,050
|
|
|
$
|
38,278
|
|
Net income (loss) attributable to noncontrolling interests
|
(1,948
|
)
|
|
182
|
|
|
667
|
|
|
(2,887
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(1,281
|
)
|
|
(2,705
|
)
|
Net income (loss) attributable to KKR Financial Holdings LLC and Subsidiaries
|
$
|
21,985
|
|
|
$
|
18,137
|
|
|
$
|
9,203
|
|
|
$
|
8
|
|
|
$
|
(2,857
|
)
|
|
$
|
22,838
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
28,331
|
|
|
$
|
40,983
|
|
(1) Consists of insurance and directors’ expenses which are not allocated to individual segments, if any.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six months ended June 30,
|
|
Credit
|
|
Natural Resources
|
|
Other
|
|
Reconciling Items(1)
|
|
Total Consolidated
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
Total revenues
|
$
|
143,300
|
|
|
$
|
185,478
|
|
|
$
|
5,898
|
|
|
$
|
9,179
|
|
|
$
|
9,269
|
|
|
$
|
8,820
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
158,467
|
|
|
$
|
203,477
|
|
Total investment costs and expenses
|
106,649
|
|
|
115,298
|
|
|
3,508
|
|
|
4,046
|
|
|
894
|
|
|
759
|
|
|
—
|
|
|
—
|
|
|
111,051
|
|
|
120,103
|
|
Total other income (loss)
|
(155,190
|
)
|
|
(66,834
|
)
|
|
(18,608
|
)
|
|
(14,101
|
)
|
|
(11,138
|
)
|
|
19,806
|
|
|
—
|
|
|
—
|
|
|
(184,936
|
)
|
|
(61,129
|
)
|
Total other expenses
|
32,850
|
|
|
28,417
|
|
|
257
|
|
|
686
|
|
|
149
|
|
|
234
|
|
|
—
|
|
|
100
|
|
|
33,256
|
|
|
29,437
|
|
Income tax expense (benefit)
|
(4
|
)
|
|
62
|
|
|
—
|
|
|
—
|
|
|
(123
|
)
|
|
1,014
|
|
|
—
|
|
|
—
|
|
|
(127
|
)
|
|
1,076
|
|
Net income (loss)
|
$
|
(151,385
|
)
|
|
$
|
(25,133
|
)
|
|
$
|
(16,475
|
)
|
|
$
|
(9,654
|
)
|
|
$
|
(2,789
|
)
|
|
$
|
26,619
|
|
|
$
|
—
|
|
|
$
|
(100
|
)
|
|
$
|
(170,649
|
)
|
|
$
|
(8,268
|
)
|
Net income (loss) attributable to noncontrolling interests
|
(11,659
|
)
|
|
(5,676
|
)
|
|
(5,157
|
)
|
|
(3,100
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(16,816
|
)
|
|
(8,776
|
)
|
Net income (loss) attributable to KKR Financial Holdings LLC and Subsidiaries
|
$
|
(139,726
|
)
|
|
$
|
(19,457
|
)
|
|
$
|
(11,318
|
)
|
|
$
|
(6,554
|
)
|
|
$
|
(2,789
|
)
|
|
$
|
26,619
|
|
|
$
|
—
|
|
|
$
|
(100
|
)
|
|
$
|
(153,833
|
)
|
|
$
|
508
|
|
(1) Consists of insurance and directors’ expenses which are not allocated to individual segments, if any.
Revenues
Revenues consist primarily of interest income and discount accretion from our investment portfolio, and to a lesser extent dividend income primarily from our equity investments and interests in joint ventures and partnerships. In addition, revenues include oil and gas revenue from our overriding royalty interest properties.
For the three months ended June 30, 2016 compared to the three months ended June 30, 2015
Revenues decreased $36.5 million in the second quarter of 2016 compared to the second quarter of 2015. This was primarily due to a $24.0 million decline in interest income earned from our corporate debt portfolio coupled with a $9.5 million decrease in other income.
The decline in interest income was largely due to a smaller portfolio generating recurring income. Specifically, as of June 30, 2016 and 2015, the aggregate par value of our corporate debt portfolio totaled $4.4 billion and $6.6 billion, respectively. This decline was primarily due to the calling of KKR Financial CLO 2005-1, Ltd ("CLO 2005-1"), KKR Financial CLO 2005-2, Ltd. ("CLO 2005-2") and CLO 2011-1 during the second half of 2015 and first half of 2016, and the sale of assets held within the CLOs to repay the CLO notes outstanding. In addition, as CLO 2007-1, our largest CLO, continued to amortize during 2015 and into 2016, the underlying portfolio of assets generating interest income diminished. From June 30, 2015 to June 30, 2016, we repaid approximately $1.8 billion of notes from the sale proceeds of assets held within the CLOs that we issued prior to 2012 ("legacy CLOs"). Of this total amount repaid, approximately $1.1 billion was comprised of CLO 2007-1 senior notes. Refer to "Segment Results-Credit Segment-Revenues" for further discussion.
Other revenues decreased $9.5 million in the second quarter of 2016 compared to the second quarter of 2015. Other revenues was primarily comprised of dividend income, the majority of which was from our interests in joint ventures and partnerships and equity investments. In particular, the second quarter of 2015 included $8.8 million of dividend payments from certain of our commercial real estate assets as compared to zero in the second quarter of 2016.
In contrast to our corporate debt portfolio, which have stated coupon rates, dividends from our interests in joint ventures and partnerships and equity investments are not necessarily contractual in their amounts or timing and may vary depending on investment performance.
For the six months ended June 30, 2016 compared to the six months ended June 30, 2015
Revenues decreased $45.0 million in the first half of 2016 compared to the first half of 2015 primarily due to a $42.9 million decline in interest income earned from our corporate debt portfolio. The decline in interest income was largely due to a smaller portfolio generating recurring income. Specifically, as of June 30, 2016 and 2015, the aggregate par value of our corporate debt portfolio totaled $4.4 billion and $6.6 billion, respectively. This decline was primarily due to the calling of KKR Financial CLO 2006-1, Ltd. ("CLO 2006-1"), CLO 2005-1, CLO 2005-2 and CLO 2011-1 during 2015 and the first half of 2016, and the sale of assets held within the CLOs to repay the CLO notes outstanding. In addition, as CLO 2007-1, our largest CLO, continued to amortize during 2015 and into 2016, the underlying portfolio of assets generating interest income diminished. From June 30, 2015 to June 30, 2016, we repaid approximately $1.8 billion of notes from the sale proceeds of assets held within the legacy CLOs. Of this total amount repaid, approximately $1.1 billion was comprised of CLO 2007-1 senior notes. Refer to "Segment Results-Credit Segment-Revenues" for further discussion.
Investment Costs and Expenses
Investment costs and expenses is comprised of interest expense, oil and gas production costs, depreciation, depletion and amortization expense (“DD&A”) related to our oil and gas properties and other investment expenses.
For the three months ended June 30, 2016 compared to the three months ended June 30, 2015
Total investment costs and expenses decreased $4.4 million in the second quarter of 2016 compared to the second quarter of 2015 largely driven by a decrease in interest expense, specifically on our collateralized loan obligation secured notes. As described above, we called CLO 2005-1, CLO 2005-2 and CLO 2011-1 during the second half of 2015 and first half of 2016. As a result of these calls and overall amortization of our legacy CLOs, the assets held in the CLOs and corresponding debt outstanding have declined significantly. Refer to "Segment Results-Credit Segment-Investment Costs and Expenses" for further discussion. Additionally, DD&A on our oil and natural gas properties declined by $0.7 million in the second quarter of 2016 compared to the second quarter of 2015.
For the six months ended June 30, 2016 compared to the six months ended June 30, 2015
Total investment costs and expenses decreased $9.1 million in the first half of 2016 compared to the first half of 2015 largely driven by a decrease in interest expense, specifically on our collateralized loan obligation secured notes.
As described above, we called CLO 2006-1, CLO 2005-1, CLO 2005-2 and CLO 2011-1 during 2015 and the first half of 2016. As a result of these calls and overall amortization of our legacy CLOs, the assets held in the CLOs and corresponding debt outstanding have declined significantly. Additionally, interest expense related to our interest rate swaps decreased $2.3 million during the first half of 2016 compared to the same prior year period. In conjunction with the calling of CLO 2006-1 in February 2015, we terminated the related interest rate swap and ceased incurring the associated interest expense. Refer to "Segment Results-Credit Segment-Investment Costs and Expenses" for further discussion.
Other Income (Loss)
For the three months ended June 30, 2016 compared to the three months ended June 30, 2015
Other income increased $16.9 million in the second quarter of 2016 compared to the second quarter of 2015 due to the following factors.
Net realized and unrealized gain (loss) on investments favorably changed $36.9 million from a net realized and unrealized loss of $6.4 million in the second quarter of 2015 to a net realized and unrealized gain of $30.5 million in the second quarter of 2016. A majority of this favorable change was related to our corporate debt portfolio which increased in value largely attributable to general market conditions, which impacted our investments in the utility, education, specialty finance and health care sectors. For example, the S&P/LSTA Loan Index returned 2.92% for the three months ended June 30, 2016 compared to 0.69% for the same period in the prior year.
Partially offsetting the above was a $19.0 million unfavorable change in net realized and unrealized gain (loss) on derivatives and foreign exchange from a net realized and unrealized gain of $15.9 million in the second quarter of 2015 to a net realized and unrealized loss of $3.2 million in the second quarter of 2016. A majority of the unfavorable change was attributable to our interest rate swaps which are directly impacted by the 30-year swap rate, which declined from 2.94% to 1.82% as of June 30, 2015 and 2016, respectively. Refer to "Segment Results - Credit Segment - Other Income (Loss)" for further discussion.
For the six months ended June 30, 2016 compared to the six months ended June 30, 2015
Other loss increased $123.8 million in the first half of 2016 compared to the first half of 2015 due to the following factors.
First, net realized and unrealized gain (loss) on investments unfavorably changed $121.0 million from a net realized and unrealized gain of $13.5 million in the first half of 2015 to a net realized and unrealized loss of $107.5 million in the first half of 2016. A majority of this unfavorable change was related to our interests in joint ventures, equity investments and corporate debt securities spanning the marine, specialty finance, diversified financial, consumer and oil and gas sectors. Additionally, our commercial real estate assets held in the other segment, were negatively impacted during the first half of 2016. Refer to "Segment Results-Other Segment-Other Income (Loss)" for further discussion.
Second, net realized and unrealized gain (loss) on derivatives and foreign exchange unfavorably changed $20.2 million from a net unrealized gain of $6.8 million in the first half of 2015 to a net unrealized loss of $13.4 million in the first half of 2016.
The unfavorable changes described above were partially offset by a net $21.8 million decrease in net realized and unrealized loss on debt and net realized and unrealized loss on debt to affiliates in the first half of 2016 compared to the first half of 2015. Beginning January 1, 2015, we measured the financial liabilities of our consolidated CLOs using the fair value of the financial assets of our consolidated CLOs, which was determined to be more observable. Accordingly, these financial assets were measured at fair value and these financial liabilities were measured as: (i) the sum of the fair value of the financial assets and the carrying value of any nonfinancial assets that are incidental to the operations of the CLOs, less (ii) the sum of the fair value of any beneficial interests retained by us. For the six months ended June 30, 2016, net realized and unrealized loss on debt totaled $64.0 million, which included significant realized gains generated on the sale of CLO 2007-1 assets. The proceeds from the sale of assets held within the CLO were used to repay $598.5 million of CLO 2007-1 senior notes during the first half of 2016.
Other Expenses
Other expenses include related party management compensation, general, administrative and directors’ expenses and professional services, if any. Related party management compensation consists of base management fees payable to our Manager pursuant to the Management Agreement, collateral management fees and incentive fees.
Base Management Fees
We pay our Manager a base management fee quarterly in arrears. During 2016 and 2015, certain related party fees received by affiliates of our Manager were credited to us via an offset to the base management fee (“Fee Credits”). Specifically, as described in further detail under “CLO Management Fees” below, a portion of the CLO management fees received by an affiliate of our Manager for certain of our CLOs were credited to us via an offset to the base management fee.
The table below summarizes the aggregate base management fees (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended June 30, 2016
|
|
Three months ended June 30, 2015
|
|
Six months ended June 30, 2016
|
|
Six months ended June 30, 2015
|
Base management fees, gross
|
$
|
5,002
|
|
|
$
|
7,836
|
|
|
$
|
10,785
|
|
|
$
|
16,327
|
|
CLO management fees credit(1)
|
(4,443
|
)
|
|
(6,426
|
)
|
|
(9,197
|
)
|
|
(10,864
|
)
|
Total base management fees, net
|
$
|
559
|
|
|
$
|
1,410
|
|
|
$
|
1,588
|
|
|
$
|
5,463
|
|
|
|
(1)
|
See “CLO Management Fees” for further discussion.
|
CLO Management Fees
An affiliate of our Manager entered into separate management agreements with the respective investment vehicles for all of our Cash Flow CLOs pursuant to which it is entitled to receive fees for the services it performs as collateral manager for all of these CLOs, except for CLO 2011-1. The collateral manager has the option to waive the fees it earns for providing management services for the CLO.
Our Manager credited us for a portion of the CLO management fees received by an affiliate of our Manager from CLO 2007-1, CLO 2012-1, CLO 9, CLO 10, CLO 11 and CLO 13 via an offset to the base management fees payable to our Manager. As we own less than 100% of the subordinated notes of these CLOs (with the remaining subordinated notes held by affiliated and unaffiliated third parties), we received a Fee Credit equal only to our pro rata share of the aggregate CLO management fees paid by these CLOs. Specifically, the amount of the reimbursement for each of these CLOs was calculated by taking the product of (x) the total CLO management fees received by an affiliate of our Manager during the period for such CLO multiplied by (y) the percentage of the subordinated notes of such CLO held by us. The remaining portion of the CLO management fees paid by each of these CLOs was not credited to us, but instead resulted in a dollar‑for‑dollar reduction in the interest expense paid by us to the third party holder of the CLO’s subordinated notes. Similarly, our Manager credited to us the CLO management fees from CLO 2013-1 and CLO 2013-2 based on our 100% ownership of the subordinated notes in the CLO.
The table below summarizes the aggregate CLO management fees, including the Fee Credits (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended June 30, 2016
|
|
Three months ended June 30, 2015
|
|
Six months ended June 30, 2016
|
|
Six months ended June 30, 2015
|
Charged and retained CLO management fees(1)
|
$
|
1,765
|
|
|
$
|
1,981
|
|
|
$
|
3,258
|
|
|
$
|
3,710
|
|
CLO management fees credit
|
4,443
|
|
|
6,426
|
|
|
9,197
|
|
|
10,864
|
|
Total CLO management fees
|
$
|
6,208
|
|
|
$
|
8,407
|
|
|
$
|
12,455
|
|
|
$
|
14,574
|
|
|
|
(1)
|
Represents management fees incurred by the senior and subordinated note holders of a CLO, excluding the Fee Credits received by us based on our ownership percentage in the CLO.
|
Subordinated note holders in CLOs have the first risk of loss and conversely, the residual value upside of the transactions. When CLO management fees are paid by a CLO, the residual economic interests in the CLO transaction are reduced by an amount commensurate with the CLO management fees paid. We record any residual proceeds due to subordinated note holders as interest expense on the consolidated statements of operations. Accordingly, the increase in CLO management fees is directly offset by a decrease in interest expense.
For the three months ended June 30, 2016 compared to the three months ended June 30, 2015
Other expenses decreased $3.1 million in the second quarter of 2016 compared to the second quarter of 2015 predominately due to a $3.1 million decrease in related party management compensation, which includes base management fees and CLO management fees. CLO management fees declined $2.2 million in the second quarter of 2016 compared to the prior year period largely due to relatively higher CLO management fees from CLO 2007-1 and CLO 9 during the second quarter of 2015 compared to the second quarter of 2016. CLO management fees for these two CLOs declined $1.9 million in the second quarter of 2016 compared to the second quarter of 2015 primarily due to: (i) a decline in assets in CLO 2007-1 from which the fee is calculated and (ii) the fact that CLO 9 commenced payment during the second quarter of 2015 and such payment included all amounts due since the CLO closed in September 2014. Our CLOs pay on a quarterly basis except for their first payment, which is typically six months post-closing, in accordance with the respective indentures.
For the six months ended June 30, 2016 compared to the six months ended June 30, 2015
Other expenses increased $3.8 million in the first half of 2016 compared to the first half of 2015. This was primarily due to a $9.7 million increase in general, administrative and directors' expenses during the first half of 2016 as a result of the write-off of costs associated with our CLOs, partially offset by a $6.0 million decrease in related party management compensation, which includes base management fees and CLO management fees. Base management fees declined $3.9 million in the first half of 2016 compared to the prior year period primarily due to a decrease in the gross base management fees as a result of lower overall retained earnings largely from net realized and unrealized losses on investments.
Segment Results
We operate our business through multiple reportable segments, which are differentiated primarily by their investment focuses.
Credit (“Credit”): The Credit segment includes primarily below investment grade corporate debt comprised of senior secured and unsecured loans, mezzanine loans, high yield bonds, private and public equity investments, and distressed and stressed debt securities.
Natural resources (“Natural Resources”): The Natural Resources segment consists of non-operated overriding royalty interests in oil and natural gas properties, as well as interests in joint ventures and partnerships focused on the oil and gas sector.
Other (“Other”): The Other segment includes all other portfolio holdings, consisting solely of commercial real estate.
The segments currently reported are consistent with the way decisions regarding the allocation of resources are made, as well as how operating results are reviewed by our chief operating decision maker.
We evaluate the performance of our reportable segments based on several net income (loss) components. Net income (loss) includes: (i) revenues; (ii) related investment costs and expenses; (iii) other income (loss), which is comprised primarily of unrealized and realized gains and losses on investments, debt and derivatives and (iv) other expenses, including related party management compensation and general and administrative expenses. Certain corporate assets and expenses that are not directly related to the individual segments, including interest expense and related costs on borrowings, base management fees and professional services are allocated to individual segments based on the investment portfolio balance in each respective segment as of the most recent period‑end. Certain other corporate assets and expenses, including prepaid insurance, incentive fees, insurance expenses and directors’ expenses, if any, are not allocated to individual segments in our assessment of segment performance. Collectively, these items are included as reconciling items between reported segment amounts and consolidated totals. For further financial information related to our segments, refer to “Part I-Item 1. Financial Statements-Note 11. Segment Reporting.”
The following discussion and analysis regarding our results of operations is based on our reportable segments.
Credit Segment
The following table presents the net income (loss) components of our Credit segment (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months ended
June 30, 2016
|
|
For the three months ended
June 30, 2015
|
|
For the six
months ended
June 30, 2016
|
|
For the six months ended
June 30, 2015
|
Revenues
|
|
|
|
|
|
|
|
Corporate loans and securities interest income
|
$
|
62,396
|
|
|
$
|
87,034
|
|
|
$
|
133,283
|
|
|
$
|
174,645
|
|
Residential mortgage-backed securities interest income
|
924
|
|
|
1,053
|
|
|
1,606
|
|
|
1,859
|
|
Net discount accretion
|
1,097
|
|
|
304
|
|
|
1,500
|
|
|
2,805
|
|
Dividend income
|
1,123
|
|
|
2,051
|
|
|
6,308
|
|
|
6,058
|
|
Other
|
365
|
|
|
78
|
|
|
603
|
|
|
111
|
|
Total revenues
|
65,905
|
|
|
90,520
|
|
|
143,300
|
|
|
185,478
|
|
Investment costs and expenses
|
|
|
|
|
|
|
|
Interest expense:
|
|
|
|
|
|
|
|
Collateralized loan obligation secured notes
|
40,511
|
|
|
43,248
|
|
|
76,939
|
|
|
83,273
|
|
Collateralized loan obligation junior secured notes to affiliates
|
1,009
|
|
|
—
|
|
|
1,009
|
|
|
—
|
|
Senior notes
|
6,614
|
|
|
6,689
|
|
|
13,345
|
|
|
13,432
|
|
Junior subordinated notes
|
3,667
|
|
|
3,959
|
|
|
7,723
|
|
|
7,928
|
|
Interest rate swaps
|
2,706
|
|
|
3,616
|
|
|
5,679
|
|
|
7,995
|
|
Total interest expense
|
54,507
|
|
|
57,512
|
|
|
104,695
|
|
|
112,628
|
|
Other
|
1,158
|
|
|
1,819
|
|
|
1,954
|
|
|
2,670
|
|
Total investment costs and expenses
|
55,665
|
|
|
59,331
|
|
|
106,649
|
|
|
115,298
|
|
Other income (loss)
|
|
|
|
|
|
|
|
Realized and unrealized gain (loss) on derivatives and foreign exchange:
|
|
|
|
|
|
|
|
Interest rate swap
|
(5,934
|
)
|
|
14,657
|
|
|
(17,665
|
)
|
|
9,116
|
|
Total rate of return swaps
|
—
|
|
|
620
|
|
|
—
|
|
|
434
|
|
Common stock warrants
|
(165
|
)
|
|
(110
|
)
|
|
(23
|
)
|
|
(2,001
|
)
|
Foreign exchange(1)
|
2,140
|
|
|
1,298
|
|
|
2,413
|
|
|
834
|
|
Options
|
1,614
|
|
|
(1,399
|
)
|
|
2,017
|
|
|
(2,302
|
)
|
Total realized and unrealized gain (loss) on derivatives and foreign exchange
|
(2,345
|
)
|
|
15,066
|
|
|
(13,258
|
)
|
|
6,081
|
|
Net realized and unrealized gain (loss) on investments
|
23,486
|
|
|
(14,492
|
)
|
|
(77,913
|
)
|
|
8,464
|
|
Net realized and unrealized gain (loss) on debt
|
(802
|
)
|
|
(4,977
|
)
|
|
(63,975
|
)
|
|
(88,793
|
)
|
Net realized and unrealized gain (loss) on debt to affiliates
|
(2,984
|
)
|
|
—
|
|
|
(2,984
|
)
|
|
—
|
|
Other income
|
1,401
|
|
|
3,561
|
|
|
2,940
|
|
|
7,414
|
|
Total other income (loss)
|
18,756
|
|
|
(842
|
)
|
|
(155,190
|
)
|
|
(66,834
|
)
|
Other expenses
|
|
|
|
|
|
|
|
Related party management compensation:
|
|
|
|
|
|
|
|
Base management fees
|
514
|
|
|
1,309
|
|
|
1,478
|
|
|
5,104
|
|
CLO management fees
|
6,208
|
|
|
8,407
|
|
|
12,455
|
|
|
14,574
|
|
Total related party management compensation
|
6,722
|
|
|
9,716
|
|
|
13,933
|
|
|
19,678
|
|
Professional services
|
930
|
|
|
723
|
|
|
1,878
|
|
|
1,787
|
|
Other general and administrative
|
1,334
|
|
|
1,575
|
|
|
17,039
|
|
|
6,952
|
|
Total other expenses
|
8,986
|
|
|
12,014
|
|
|
32,850
|
|
|
28,417
|
|
Income (loss) before income taxes
|
20,010
|
|
|
18,333
|
|
|
(151,389
|
)
|
|
(25,071
|
)
|
Income tax expense (benefit)
|
(27
|
)
|
|
14
|
|
|
(4
|
)
|
|
62
|
|
Net income (loss)
|
$
|
20,037
|
|
|
$
|
18,319
|
|
|
$
|
(151,385
|
)
|
|
$
|
(25,133
|
)
|
|
|
(1)
|
Includes foreign exchange contracts and foreign exchange remeasurement gain or loss.
|
Revenues
For the three months ended June 30, 2016 compared to the three months ended June 30, 2015
Revenues decreased $24.6 million in the second quarter of 2016 compared to the second quarter of 2015. The decrease was primarily attributable to a $24.6 million decrease in corporate loans and securities interest income. Specifically, interest income related to our corporate loans decreased $16.4 million and interest income related to our corporate debt securities decreased $8.2 million in the second quarter of 2016 compared to the same prior year period.
A large driver of the decrease in corporate loan and security interest income was a decline in the aggregate par value of our corporate loan and debt security portfolios as of June 30, 2016 compared to 2015, slightly offset by an increase in interest rates earned on the assets. The decline in the aggregate par value of our corporate debt portfolio was attributable to the calling of CLO 2005-1, CLO 2005-2 and CLO 2011-1 during the second half of 2015 and first half of 2016, and the sale of assets held within the CLOs to repay the CLO notes outstanding. In addition, as CLO 2007-1, our largest CLO, continued to amortize during 2015 and into 2016, the underlying portfolio of assets generating interest income diminished. From June 30, 2015 to June 30, 2016, we repaid approximately $1.8 billion of notes from the sale proceeds of assets held within the legacy CLOs. Of this total amount repaid, approximately $1.1 billion was comprised of CLO 2007-1 senior notes.
We also closed CLO 11 and CLO 13 during 2015; however, total new assets only partially offset the decline in portfolio from the amortization of legacy CLOs. As of June 30, 2016, our corporate loan portfolio had an aggregate par value of $4.1 billion with a weighted average coupon of 5.3%, while our corporate debt securities portfolio had an aggregate par value of $304.8 million with a weighted average coupon of 12.1%. In comparison, as of June 30, 2015, our corporate loan portfolio had an aggregate par value of $6.1 billion with a weighted average coupon of 4.7%, while our corporate debt securities portfolio had an aggregate par value of $468.1 million with a weighted average coupon of 9.0%.
For the six months ended June 30, 2016 compared to the six months ended June 30, 2015
Revenues decreased $42.2 million in the first half of 2016 compared to the first half of 2015. The decrease was primarily attributable to a $41.4 million decrease in corporate loans and securities interest income. Specifically, interest income related to our corporate loans decreased $24.7 million and interest income related to our corporate debt securities decreased $16.7 million in the first half of 2016 compared to the same prior year period.
A large driver of the decrease in corporate loan and security interest income was a decline in the aggregate par value of our corporate loan and debt security portfolios as of June 30, 2016 compared to 2015, slightly offset by an increase in interest rates earned on the assets. The decline in the aggregate par value of our corporate debt portfolio was attributable to the calling of CLO 2006-1, CLO 2005-1, CLO 2005-2 and CLO 2011-1 during 2015 and the first half of 2016, and the sale of assets held within the CLOs to repay the CLO notes outstanding. In addition, as CLO 2007-1, our largest CLO, continued to amortize during 2015 and into 2016, the underlying portfolio of assets generating interest income diminished. From June 30, 2015 to June 30, 2016, we repaid approximately $1.8 billion of notes from the sale proceeds of assets held within the legacy CLOs. Of this total amount repaid, approximately $1.1 billion was comprised of CLO 2007-1 senior notes.
We also closed CLO 11 and CLO 13 during 2015; however, total new assets only partially offset the decline in portfolio from the amortization of legacy CLOs. As of June 30, 2016, our corporate loan portfolio had an aggregate par value of $4.1 billion with a weighted average coupon of 5.3%, while our corporate debt securities portfolio had an aggregate par value of $304.8 million with a weighted average coupon of 12.1%. In comparison, as of June 30, 2015, our corporate loan portfolio had an aggregate par value of $6.1 billion with a weighted average coupon of 4.7%, while our corporate debt securities portfolio had an aggregate par value of $468.1 million with a weighted average coupon of 9.0%.
Investment Costs and Expenses
For the three months ended June 30, 2016 compared to the three months ended June 30, 2015
Total investment costs and expenses decreased $3.7 million in the second quarter of 2016 compared to the second quarter of 2015 primarily as a result of a $3.0 million decline in total interest expense. The decline was primarily driven by a net $1.7 million decrease in interest expense on our secured and junior secured CLO notes, coupled with a $0.9 million decrease in interest expense related to our interest rate swaps.
Interest expense on our secured and junior secured CLO notes declined by a net $1.7 million in the second quarter of 2016 compared to the second quarter of 2015 primarily due to smaller CLO subordinated note payments. Interest expense on our
CLO subordinated notes to unaffiliated parties totaled $4.7 million compared to $11.5 million for the second quarter of 2016 and 2015, respectively. CLO subordinated note holders receive the residual interest after all other payments have been made. As CLO 2007-1, our largest CLO, continued to amortize during 2015 and into 2016, the underlying portfolio of assets generating interest income diminished, resulting in lower CLO subordinated note payments. For example, CLO 2007-1 repaid approximately $1.1 billion of senior notes from June 30, 2015 to June 30, 2016. This net decline, however, was partially offset by: (i) an increase in CLO senior note interest expense partially related to CLO 11 and CLO 13, which closed in May 2015 and December 2015, respectively, and incurred an additional $4.3 million in interest expense and (ii) $1.0 million interest expense on our CLO junior secured notes to affiliates in the second quarter of 2016 compared to zero in the same period in the prior year. Beginning in the second quarter of 2016, as part of the distribution of $96.5 million par amount of subordinated notes to KKR, we incurred interest expense on these CLO junior secured notes held by affiliates of KKR. For further information, refer to "Part I-Item1. Financial Statements-Note 6. Borrowings."
Additionally, interest expense related to our interest rate swaps decreased $0.9 million during the second quarter of 2016 compared to the same prior year period.
For the six months ended June 30, 2016 compared to the six months ended June 30, 2015
Total investment costs and expenses decreased $8.6 million in the first half of 2016 compared to the first half of 2015 primarily as a result of a $7.9 million decline in total interest expense. The decline was largely attributable to a net $5.3 million decrease in interest expense on our secured and junior secured CLO notes, coupled with a $2.3 million decrease in interest expense related to our interest rate swaps.
Interest expense on our CLO notes is primarily comprised of three main components: interest expense on our CLO senior notes, interest expense on our CLO subordinated notes to unaffiliated and affiliated parties and CLO note discount accretion. During the first half of 2016, we recorded $56.5 million of interest expense on our CLO senior notes, $8.8 million of interest expense on our CLO subordinated notes to unaffiliated and affiliated parties and $11.4 million of CLO note discount accretion. Comparatively, during the first half of 2015, we recorded $47.5 million of interest expense on our CLO senior notes, $21.4 million of interest expense on our CLO subordinated notes to unaffiliated and $14.2 million of CLO note discount accretion.
Interest expense on our CLO subordinated notes to unaffiliated and affiliated parties decreased $12.6 million during the first half of 2016 compared to the same prior year period. CLO subordinated note holders receive the residual interest after all other payments have been made. As CLO 2007-1, our largest CLO, continued to amortize during 2015 and into 2016, the underlying portfolio of assets generating interest income diminished, resulting in lower CLO subordinated note payments. For example, CLO 2007-1 repaid approximately $1.1 billion of senior notes from June 30, 2015 to June 30, 2016. In addition, CLO note discount accretion decreased $2.8 million in the first half of 2016 compared to the first half of 2015 due to $2.3 million of accelerated accretion of debt discount recorded in the first half of 2015 due to the calling of CLO 2006-1 in February 2015. These aggregate declines were partially offset by: (i) an increase in interest expense on our CLO senior notes of $9.0 million in the first half of 2016 compared to the same prior year period primarily due to interest expense on CLO 11 and CLO 13, which closed in May 2015 and December 2015, respectively and (ii) an increase in interest expense on our collateralized loan obligation junior secured notes to affiliates. As mentioned above, beginning in the second quarter of 2016, as part of the distribution of $96.5 million par amount of subordinated notes to KKR, we incurred interest expense on these CLO junior secured notes held by affiliates of KKR. For further information, refer to "Part I-Item1. Financial Statements-Note 6. Borrowings."
Additionally, interest expense related to our interest rate swaps decreased $2.3 million during the first half of 2016 compared to the same prior year period. In conjunction with the calling of CLO 2006-1 in February 2015, we terminated the related interest rate swap and ceased incurring the associated interest expense. For further information, refer to "Part I-Item1. Financial Statements-Note 6. Borrowings."
Other Income (Loss)
Other income (loss) consists of gains and losses that can be highly variable, primarily driven by episodic sales, mark-to-market and foreign currency exchange rates as of each period-end.
For the three months ended June 30, 2016 compared to the three months ended June 30, 2015
Total other income (loss) favorably changed $19.6 million in the second quarter of 2016 compared to the second quarter of 2015 largely attributable to the following factors.
Net realized and unrealized gain (loss) on investments favorably changed $38.0 million in the second quarter of 2016 compared to the same period in the prior year from a net realized and unrealized loss of $14.5 million to a net realized and unrealized gain of $23.5 million in the second quarter of 2015 and 2016, respectively. The most significant changes were in our corporate debt portfolio and and our equity investments.
The table below details the components of net realized and unrealized gain (loss) on investments, which is included in other income (loss), separated by financial instrument for the three months ended June 30, 2016 and 2015 (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months ended
June 30, 2016
|
|
For the three months ended
June 30, 2015
|
|
Unrealized
gains
(losses)
|
|
Realized
gains
(losses)
|
|
Total
|
|
Unrealized
gains
(losses)
|
|
Realized
gains
(losses)
|
|
Total
|
Corporate loans
|
$
|
190,503
|
|
|
$
|
(180,238
|
)
|
|
$
|
10,265
|
|
|
$
|
(27,450
|
)
|
|
$
|
(6,079
|
)
|
|
$
|
(33,529
|
)
|
Corporate debt securities
|
14,978
|
|
|
5,384
|
|
|
20,362
|
|
|
(6,956
|
)
|
|
(5,130
|
)
|
|
(12,086
|
)
|
RMBS
|
52
|
|
|
395
|
|
|
447
|
|
|
48
|
|
|
(246
|
)
|
|
(198
|
)
|
Equity investments, at estimated fair value
|
(457
|
)
|
|
(4,496
|
)
|
|
(4,953
|
)
|
|
29,799
|
|
|
(58
|
)
|
|
29,741
|
|
Interests in joint ventures and partnerships, at estimated fair value and other
|
(12,371
|
)
|
|
9,736
|
|
|
(2,635
|
)
|
|
892
|
|
|
688
|
|
|
1,580
|
|
Total
|
$
|
192,705
|
|
|
$
|
(169,219
|
)
|
|
$
|
23,486
|
|
|
$
|
(3,667
|
)
|
|
$
|
(10,825
|
)
|
|
$
|
(14,492
|
)
|
Net realized and unrealized gains (losses) on our corporate loans favorably changed by $43.8 million in the second quarter of 2016 compared to the same prior year period, from net realized and unrealized losses of $33.5 million in the second quarter of 2015 to net realized and unrealized gains of $10.3 million in the second quarter of 2016. The realized and unrealized gains and losses recorded during the second quarter of 2016 were primarily related to the sale of approximately $343.7 million par amount of Texas Competitive Electric Holding Company LLC ("TXU"), which resulted in realized losses of approximately $16.4 million, net of the reversal of previously recorded unrealized losses. Additionally, one issuer in the education sector had unrealized losses of approximately $22.7 million in the second quarter of 2016 compared to $1.4 million unrealized gains for the second quarter of 2015.
Net realized and unrealized gains (losses) on our corporate debt securities favorably changed $32.4 million in the second quarter of 2016 as compared to the same prior year period, from net realized and unrealized losses of $12.1 million in the second quarter of 2015 to net realized and unrealized gains of $20.4 million in the second quarter of 2016. A majority of the gain was related to one issuer in the specialty finance sector which restructured in the second quarter of 2016.
Net realized and unrealized gains (losses) on equity investments unfavorably changed $34.7 million in the second quarter of 2016 compared to the same prior year period from unrealized gains of $29.7 million in the second quarter of 2015 to unrealized losses of $5.0 million in the second quarter of 2016. Unrealized gains (losses) unfavorably changed by $30.3 million, of which $25.9 million was due to investments in the health care and specialty finance sectors, including one of which restructured during the second quarter of 2016.
The favorable change in net realized and unrealized gain (loss) on investments was partially offset by a $17.4 million unfavorable change in total realized and unrealized gain (loss) on derivatives and foreign exchange which changed from realized and unrealized gains of $15.1 million to realized and unrealized losses of $2.3 million in the second quarter of 2015 and 2016, respectively. A majority of the unfavorable change was related to realized and unrealized gain (loss) on interest rate swaps which unfavorably changed $20.6 million due to a decline in the 30-year swap rate. We use pay-fixed, receive variable interest rate swaps to hedge the interest rate risk associated with a portion of our borrowings which are indexed to the 30-year swap rate; as such, movements in the 30-year swap rate impact total realized and unrealized gain (loss) on derivatives and foreign exchange. The 30-year swap rate declined from 2.94% to 1.82% as of June 30, 2015 and 2016, respectively. The unfavorable change in realized and unrealized gain (loss) on interest rate swaps was partially offset by a favorable change in realized and unrealized gain (loss) on options of $3.0 million.
For the six months ended June 30, 2016 compared to the six months ended June 30, 2015
Total other loss increased $88.4 million in the first half of 2016 compared to the first half of 2015 largely attributable to the following factors.
Net realized and unrealized gain (loss) on investments unfavorably changed $86.4 million in the first half of 2016 compared to the same period in the prior year from a net realized and unrealized gain of $8.5 million to a net realized and unrealized loss of $77.9 million in the first half of 2015 and 2016, respectively. The most significant changes were in our interests in our joint ventures and partnerships, equity investments and corporate debt portfolio.
The table below details the components of net realized and unrealized gain (loss) on investments, which is included in other income (loss), separated by financial instrument for the six months ended June 30, 2016 and 2015 (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the six months ended
June 30, 2016
|
|
For the six months ended
June 30, 2015
|
|
Unrealized
gains
(losses)
|
|
Realized
gains
(losses)
|
|
Total
|
|
Unrealized
gains
(losses)
|
|
Realized
gains
(losses)
|
|
Total
|
Corporate loans
|
$
|
235,426
|
|
|
$
|
(210,952
|
)
|
|
$
|
24,474
|
|
|
$
|
54,824
|
|
|
$
|
(22,261
|
)
|
|
$
|
32,563
|
|
Corporate debt securities
|
(35,167
|
)
|
|
3,257
|
|
|
(31,910
|
)
|
|
(5,276
|
)
|
|
(4,731
|
)
|
|
(10,007
|
)
|
RMBS
|
71
|
|
|
929
|
|
|
1,000
|
|
|
201
|
|
|
(1,170
|
)
|
|
(969
|
)
|
Equity investments, at estimated fair value
|
(16,449
|
)
|
|
(3,771
|
)
|
|
(20,220
|
)
|
|
7,373
|
|
|
1,366
|
|
|
8,739
|
|
Interests in joint ventures and partnerships, at estimated fair value and other
|
(60,823
|
)
|
|
9,566
|
|
|
(51,257
|
)
|
|
(22,550
|
)
|
|
688
|
|
|
(21,862
|
)
|
Total
|
$
|
123,058
|
|
|
$
|
(200,971
|
)
|
|
$
|
(77,913
|
)
|
|
$
|
34,572
|
|
|
$
|
(26,108
|
)
|
|
$
|
8,464
|
|
Net realized and unrealized losses in interests in joint ventures and partnerships increased $29.4 million during the first half of 2016 compared to the same prior year period from a loss of $21.9 million in the first half of 2015 to a loss of $51.3 million in the first half of 2016. A majority of the unfavorable change was due to two investments in the marine and specialty finance sectors.
Net realized and unrealized gains (losses) on equity investments unfavorably changed $29.0 million during the first half of 2016 compared to the same prior year period, from net realized and unrealized gains of $8.7 million in the first half of 2015 to net realized and unrealized losses of $20.2 million in the first half of 2016. A majority of the unfavorable change was due to our equity investments in the diversified financial and consumer sectors.
Net realized and unrealized losses on our corporate debt securities increased $21.9 million for the first half of 2016 as compared to the same prior year period, from a loss of $10.0 million in the first half of 2015 to a loss of $31.9 million in the first half of 2016. A majority of the loss during the first half of 2016 was related to one issuer in the oil and gas sector which had unrealized losses totaling $43.8 million during the period due to a drop in commodity prices. This however was partially offset by unrealized gains totaling $12.9 million for the second half of 2016 related to one issuer in the specialty finance sector which restructured during the period.
Net realized and unrealized gains on our corporate loans decreased $8.1 million for the first half of 2016 as compared to the same prior year period. The realized and unrealized gains and losses recorded during the first half of 2016 were primarily related to the sale of approximately $343.7 million par amount of TXU, which resulted in realized losses of approximately $16.4 million, net of the reversal of previously recorded unrealized losses.
Total realized and unrealized gain (loss) on derivatives and foreign exchange unfavorably changed $19.3 million from total realized and unrealized gains of $6.1 million to total realized and unrealized losses of $13.3 million in the first half of 2015 and 2016, respectively. A majority of the change was related to realized and unrealized gain (loss) on interest rate swaps which unfavorably changed $26.8 million due to a decline in the 30-year swap rate. We use pay-fixed, receive variable interest rate swaps to hedge the interest rate risk associated with a portion of our borrowings which are indexed to the 30-year swap rate; as such, movements in the 30-year swap rate impact total realized and unrealized gain (loss) on derivatives and foreign exchange. The 30-year swap rate declined from 2.94% to 1.82% as of June 30, 2015 and 2016, respectively. The unfavorable change in realized and unrealized gain (loss) on interest rate swaps was partially offset by a favorable change in realized and unrealized gain (loss) on options of $4.3 million.
The unfavorable changes described above were partially offset by a net $21.8 million decrease in net realized and unrealized loss on debt and net realized and unrealized loss on debt to affiliates in the first half of 2016 compared to the first half of 2015. Net realized and unrealized loss on debt and unrealized loss on debt to affiliates represents the change in estimated fair value of our financial liabilities. As discussed above, beginning January 1, 2015, we measured the financial liabilities of our consolidated CLOs using the fair value of the financial assets of our consolidated CLOs, which was determined to be more observable. Accordingly, these financial assets were measured at fair value and these financial liabilities were measured as: (i) the sum of the fair value of the financial assets and the carrying value of any nonfinancial assets that are incidental to the
operations of the CLOs, less (ii) the sum of the fair value of any beneficial interests retained by us. For the six months ended June 30, 2016, net realized and unrealized loss on debt totaled $64.0 million, which included significant realized gains generated on the sale of CLO 2007-1 assets. The proceeds from the sale of assets held within the CLO were used to repay $598.5 million of CLO 2007-1 senior notes during the first half of 2016.
Other Expenses
For the three months ended June 30, 2016 compared to the three months ended June 30, 2015
Other expenses decreased $3.0 million in the second quarter of 2016 compared to the second quarter of 2015 predominately due to a $3.0 million decrease in related party management compensation, which includes base management fees and CLO management fees. CLO management fees declined $2.2 million in the second quarter of 2016 compared to the prior year period largely due to relatively higher CLO management fees from CLO 2007-1 and CLO 9 during the second quarter of 2015. CLO management fees for these two CLOs declined $1.9 million in the second quarter of 2016 compared to the second quarter of 2015 primarily due to: (i) a decline in assets in CLO 2007-1 from which the fee is calculated and (ii) the fact that CLO 9 commenced payment during the second quarter of 2015, representing all amounts due since the CLO closed in September 2014. Our CLOs pay on a quarterly basis except for their first payment, which is typically six months post-closing, in accordance with the respective indentures. Refer to “Consolidated Results-Other Expenses” above for further discussion around CLO management fees.
For the six months ended June 30, 2016 compared to the six months ended June 30, 2015
Other expenses increased $4.4 million in the first half of 2016 compared to the first half of 2015 primarily due to a $10.1 million increase in other general and administrative expenses during the first half of 2016 as a result of the write-off of costs associated with our CLOs, partially offset by a $5.7 million decrease in related party management compensation. Related party management compensation includes base management fees and CLO management fees. Base management fees declined $3.6 million in the first half of 2016 compared to the prior year period primarily due to a decrease in the gross base management fees as a result of lower overall retained earnings largely from net realized and unrealized losses on investments. Refer to “Consolidated Results-Other Expenses” above for further discussion around the base management fees and Fee Credits.
Natural Resources Segment
The following table presents the net income (loss) components of our Natural Resources segment (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months ended June 30, 2016
|
|
For the three months ended
June 30, 2015
|
|
For the six months ended June 30, 2016
|
|
For the six months ended
June 30, 2015
|
Revenues
|
|
|
|
|
|
|
|
|
|
Oil and gas revenue:
|
|
|
|
|
|
|
|
|
|
Natural gas sales
|
$
|
253
|
|
|
$
|
522
|
|
|
$
|
623
|
|
|
$
|
852
|
|
Oil sales
|
2,761
|
|
|
5,343
|
|
|
5,058
|
|
|
7,184
|
|
Natural gas liquids sales
|
243
|
|
|
486
|
|
|
217
|
|
|
1,143
|
|
Total revenues
|
3,257
|
|
|
6,351
|
|
|
5,898
|
|
|
9,179
|
|
Investment costs and expenses
|
|
|
|
|
|
|
|
Oil and gas production costs:
|
|
|
|
|
|
|
|
Severance and ad valorem taxes
|
240
|
|
|
298
|
|
|
455
|
|
|
250
|
|
Total oil and gas production costs
|
240
|
|
|
298
|
|
|
455
|
|
|
250
|
|
Oil and gas depreciation, depletion and amortization
|
1,258
|
|
|
2,003
|
|
|
2,324
|
|
|
3,005
|
|
Interest expense:
|
|
|
|
|
|
|
|
Senior notes
|
254
|
|
|
254
|
|
|
462
|
|
|
497
|
|
Junior subordinated notes
|
142
|
|
|
151
|
|
|
267
|
|
|
294
|
|
Total interest expense
|
396
|
|
|
405
|
|
|
729
|
|
|
791
|
|
Total investment costs and expenses
|
1,894
|
|
|
2,706
|
|
|
3,508
|
|
|
4,046
|
|
Other income (loss)
|
|
|
|
|
|
|
|
Net realized and unrealized gain (loss) on investments
|
8,634
|
|
|
(6,348
|
)
|
|
(18,608
|
)
|
|
(14,101
|
)
|
Total other income (loss)
|
8,634
|
|
|
(6,348
|
)
|
|
(18,608
|
)
|
|
(14,101
|
)
|
Other expenses
|
|
|
|
|
|
|
|
Related party management compensation:
|
|
|
|
|
|
|
|
Base management fees
|
20
|
|
|
50
|
|
|
50
|
|
|
187
|
|
Total related party management compensation
|
20
|
|
|
50
|
|
|
50
|
|
|
187
|
|
Professional services
|
36
|
|
|
27
|
|
|
65
|
|
|
65
|
|
Other general and administrative
|
71
|
|
|
99
|
|
|
142
|
|
|
434
|
|
Total other expenses
|
127
|
|
|
176
|
|
|
257
|
|
|
686
|
|
Income (loss) before income taxes
|
9,870
|
|
|
(2,879
|
)
|
|
(16,475
|
)
|
|
(9,654
|
)
|
Income tax expense (benefit)
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Net income (loss)
|
$
|
9,870
|
|
|
$
|
(2,879
|
)
|
|
$
|
(16,475
|
)
|
|
$
|
(9,654
|
)
|
Our natural resources assets are accounted for and presented on our condensed consolidated balance sheets in one of two ways: (i) at cost net of depreciation, depletion and amortization presented within oil and gas properties, net or (ii) estimated fair value within interests in joint ventures and partnerships, at estimated fair value with net realized and unrealized gains or losses on these holdings recorded in other income (loss) on our condensed consolidated statements of operation.
Revenues
For the three months ended June 30, 2016 compared to the three months ended June 30, 2015
Revenues, which represented sales from oil and gas production on our overriding royalty interest properties, decreased $3.1 million in the second quarter of 2016 compared to the second quarter of 2015, primarily due to a decrease in revenues from oil sales. Furthermore, long-term oil, condensate, natural gas liquids and natural gas prices dropped period over period. For example, the price of WTI crude oil declined from approximately $64 per barrel to $54 per barrel as of June 30, 2015 and 2016, respectively, and the price of natural gas declined from $3.36 per mcf to $3.03 per mcf as of June 30, 2015 and 2016,
respectively. As of June 30, 2016 and 2015, our oil and natural gas properties had carrying amounts of $112.5 million and $117.3 million, respectively.
For the six months ended June 30, 2016 compared to the six months ended June 30, 2015
Revenues, which represented sales from oil and gas production on our overriding royalty interest properties, decreased $3.3 million in the first half of 2016 compared to the first half of 2015 primarily, due to a decrease in revenue from oil sales. Furthermore, long-term oil, condensate, natural gas liquids and natural gas prices dropped period over period. For example, the price of WTI crude oil declined from approximately $64 per barrel to $54 per barrel as of June 30, 2015 and 2016, respectively, and the price of natural gas declined from $3.36 per mcf to $3.03 per mcf as of June 30, 2015 and 2016, respectively. As of June 30, 2016 and 2015, our oil and natural gas properties had carrying amounts of $112.5 million and $117.3 million, respectively.
Investment Costs and Expenses
Investment costs and expenses primarily consist of production costs, DD&A and allocated corporate expenses such as interest expense and related costs on borrowings. DD&A represents recurring charges related to the exhaustion of mineral reserves for our oil and natural gas properties.
For the three months ended June 30, 2016 compared to the three months ended June 30, 2015
Total investment costs and expenses decreased $0.8 million in the second quarter of 2016 compared to the second quarter of 2015, primarily due to a $0.7 million decrease in DD&A on our oil and natural gas properties.
For the six months ended June 30, 2016 compared to the six months ended June 30, 2015
Total investment costs and expenses decreased $0.5 million in the first half of 2016 compared to the first half of 2015. The decrease in total investment costs and expenses was primarily due to a $0.7 million decrease in DD&A on our oil and natural gas properties in the first half of 2016 compared to the same period in the prior year, slightly offset by a $0.2 million increase in oil and gas production costs, specifically in severance and ad valorem taxes.
Other Income (Loss)
Our oil and gas results and estimated fair values depend substantially on natural gas, oil and NGL prices and production levels, as well as drilling and operating costs.
For the three months ended June 30, 2016 compared to the three months ended June 30, 2015
Total other income (loss), comprised solely of net realized and unrealized gain (loss) on investments, favorably changed $15.0 million from other loss of $6.3 million in the second quarter of 2015 to other income of $8.6 million in the second quarter of 2016. Other income in the second quarter of 2016 was largely as a result of a period over period increase in commodity prices. For example, the price of WTI crude oil increased approximately $7 per barrel from $47 per barrel to $54 per barrel as of March 31, 2016 and June 30, 2016, respectively.
For the six months ended June 30, 2016 compared to the six months ended June 30, 2015
Total other loss, comprised solely of net realized and unrealized loss on investments, increased $4.5 million in the first half of 2016 compared to the first half of 2015. Net realized and unrealized losses totaled $18.6 million during the first half of 2016 compared to $14.1 million during the same period in the prior year. The period over period increase in unrealized losses was primarily attributable to a general downward trend in long-term oil, condensate, natural gas liquids and natural gas prices, which began during the fourth quarter of 2014 and continued through the first quarter of 2016. Starting in the second quarter of 2016, commodity prices began to recover, however, they remain low compared to recent historical levels. For example, the price of WTI crude oil declined from approximately $67 per barrel as of December 31, 2014 to approximately $54 per barrel as of June 30, 2016 and the price of natural gas declined from $3.77 per mcf as of December 31, 2014 to $3.03 per mcf as of June 30, 2016.
Other Expenses
For the three months ended June 30, 2016 compared to the three months ended June 30, 2015
Total other expenses decreased less than $0.1 million for the second quarter of 2016 compared to the second quarter of 2015 at approximately $0.1 million and $0.2 million, respectively. Corporate expenses are allocated based on the investment portfolio balance in each respective segment as of period-end. In addition to the diminishing aggregate corporate costs period over period, the carrying value of our natural resources assets, comprised of oil and gas properties and interests in joint ventures and partnerships, declined from $251.1 million, excluding noncontrolling interests, as of June 30, 2015, to $182.7 million, excluding noncontrolling interests, as of June 30, 2016, which resulted in a smaller allocation.
For the six months ended June 30, 2016 compared to the six months ended June 30, 2015
Total other expenses decreased $0.4 million in the first half of 2016 compared to the first half of 2015. As mentioned above, corporate expenses are allocated based on the investment portfolio balance in each respective segment as of period-end. In addition to the diminishing aggregate corporate costs period over period, the carrying value of our natural resources assets, comprised of oil and gas properties and interests in joint ventures and partnerships, declined from $251.1 million, excluding noncontrolling interests, as of June 30, 2015, to $182.7 million, excluding noncontrolling interests, as of June 30, 2016, which resulted in a smaller allocation.
Other Segment
The following table presents the net income (loss) components of our Other segment (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months ended June 30, 2016
|
|
For the three months ended
June 30, 2015
|
|
For the six months ended June 30, 2016
|
|
For the six months ended
June 30, 2015
|
Revenues
|
|
|
|
|
|
|
|
|
Dividend income
|
$
|
—
|
|
|
$
|
8,820
|
|
|
$
|
9,269
|
|
|
$
|
8,820
|
|
Total revenues
|
—
|
|
|
8,820
|
|
|
9,269
|
|
|
8,820
|
|
Investment costs and expenses
|
|
|
|
|
|
|
|
|
Interest expense:
|
|
|
|
|
|
|
|
|
Senior notes
|
318
|
|
|
255
|
|
|
566
|
|
|
471
|
|
Junior subordinated notes
|
176
|
|
|
151
|
|
|
325
|
|
|
278
|
|
Total interest expense
|
494
|
|
|
406
|
|
|
891
|
|
|
749
|
|
Other
|
—
|
|
|
7
|
|
|
3
|
|
|
10
|
|
Total investment costs and expenses
|
494
|
|
|
413
|
|
|
894
|
|
|
759
|
|
Other income (loss)
|
|
|
|
|
|
|
|
|
Net realized and unrealized gain (loss) on derivatives and foreign exchange:
|
|
|
|
|
|
|
|
|
Foreign exchange(1)
|
(835
|
)
|
|
793
|
|
|
(138
|
)
|
|
678
|
|
Total realized and unrealized gain (loss) on derivatives and foreign exchange
|
(835
|
)
|
|
793
|
|
|
(138
|
)
|
|
678
|
|
Net realized and unrealized gain (loss) on investments
|
(1,609
|
)
|
|
14,432
|
|
|
(11,000
|
)
|
|
19,128
|
|
Total other income (loss)
|
(2,444
|
)
|
|
15,225
|
|
|
(11,138
|
)
|
|
19,806
|
|
Other expenses
|
|
|
|
|
|
|
|
Related party management compensation:
|
|
|
|
|
|
|
|
Base management fees
|
25
|
|
|
51
|
|
|
60
|
|
|
172
|
|
Total related party management compensation
|
25
|
|
|
51
|
|
|
60
|
|
|
172
|
|
Professional services
|
44
|
|
|
28
|
|
|
79
|
|
|
62
|
|
Other general and administrative
|
10
|
|
|
—
|
|
|
10
|
|
|
—
|
|
Total other expenses
|
79
|
|
|
79
|
|
|
149
|
|
|
234
|
|
Income before income taxes
|
(3,017
|
)
|
|
23,553
|
|
|
(2,912
|
)
|
|
27,633
|
|
Income tax expense (benefit)
|
(160
|
)
|
|
715
|
|
|
(123
|
)
|
|
1,014
|
|
Net income (loss)
|
$
|
(2,857
|
)
|
|
$
|
22,838
|
|
|
$
|
(2,789
|
)
|
|
$
|
26,619
|
|
|
|
(1)
|
Includes foreign exchange contracts and foreign exchange remeasurement gain or loss.
|
Our commercial real estate assets are carried at estimated fair value and are included within interests in joint ventures and partnerships, at estimated fair value on our condensed consolidated balance sheets. Net realized and unrealized gains or losses on these holdings are recorded in other income (loss) on our condensed consolidated statements of operation.
Revenues
For the three months ended June 30, 2016 compared to the three months ended June 30, 2015
Revenues totaled zero for the second quarter of 2016 compared to $8.8 million for the second quarter of 2015. During the second quarter of 2015, we received dividend payments from certain of our commercial real estate assets acquired during 2012 and 2013. In contrast to our corporate debt portfolio, which typically earns interest at stated coupon rates and frequencies, revenues generated from our commercial real estate assets are often delayed from the date of acquisition and are episodic in their
frequency and amount. As of June 30, 2016 and 2015, our commercial real estate assets had carrying values of $227.5 million and $251.6 million, respectively.
For the six months ended June 30, 2016 compared to the six months ended June 30, 2015
Revenues increased $0.4 million in the first half of 2016 compared to the first half of 2015 and represented dividend income from our commercial real estate investments acquired during 2012 and 2013. As of June 30, 2016 and 2015, our commercial real estate assets had carrying values of $227.5 million and $251.6 million, respectively.
Investment Costs and Expenses
For the three months ended June 30, 2016 compared to the three months ended June 30, 2015
Investment costs and expenses remained relatively flat for the second quarter of 2016 compared to the second quarter of 2015 at $0.5 million and $0.4 million, respectively. Certain corporate assets and expenses that are not directly related to an individual segment, including interest expense and related costs on borrowings, are allocated to individual segments based on the investment portfolio balance in each respective segment as of period-end. As of June 30, 2016 and 2015, our commercial real estate assets had carrying values of $227.5 million and $251.6 million, respectively.
For the six months ended June 30, 2016 compared to the six months ended June 30, 2015
Investment costs and expenses increased $0.1 million in the first half of 2016 compared to the first half of 2015 at $0.9 million and $0.8 million, respectively. Certain corporate assets and expenses that are not directly related to an individual segment, including interest expense and related costs on borrowings, are allocated to individual segments based on the investment portfolio balance in each respective segment as of period-end. As of June 30, 2016 and 2015, our commercial real estate assets had carrying values of $227.5 million and $251.6 million, respectively.
Other Income (Loss)
For the three months ended June 30, 2016 compared to the three months ended June 30, 2015
Other income (loss) unfavorably changed $17.7 million from other income of $15.2 million in the second quarter of 2015 to other loss of $2.4 million in the second quarter of 2016. The unfavorable change was largely attributable to unrealized losses in two of our commercial real estate investments which were acquired during 2012 and had aggregate unrealized gains of $8.7 million during the second quarter of 2015 as compared to aggregate unrealized losses of $3.3 million during the second quarter of 2016. Factors that impact the carrying value of our commercial real estate assets may include overall market conditions, as well as the pace of development, vacancies and ability to rent, and amount of cash distributions made from the individual investments.
For the six months ended June 30, 2016 compared to the six months ended June 30, 2015
Other income (loss) unfavorably changed $30.9 million from other income of $19.8 million in the first half of 2015 to other loss of $11.1 million in the first half of 2016. A majority of the unfavorable change was attributable to three of our commercial real estate investments which were acquired during 2012 and 2013 and had aggregate unrealized gains of $13.0 million in the first half of 2015 compared to aggregate unrealized losses of $11.3 million during the same period in the prior year. Factors that impact the carrying value of our commercial real estate assets may include overall market conditions, as well as the pace of development, vacancies and ability to rent, and amount of cash distributions made from the individual investments.
Other Expenses
For the three months ended June 30, 2016 compared to the three months ended June 30, 2015
Other expenses remained flat for the second quarter of 2016 compared to the second quarter of 2015. Other expenses are comprised of certain corporate expenses that are not directly related to an individual segment, including base management fees and professional services, and are allocated based on the investment portfolio balance in each respective segment as of period-end. As of June 30, 2016 and 2015, our commercial real estate assets had carrying values of $227.5 million and $251.6 million, respectively.
For the six months ended June 30, 2016 compared to the six months ended June 30, 2015
Other expenses decreased $0.1 million in the first half of 2016 compared to the first half of 2015. As mentioned above, corporate expenses are allocated based on the investment portfolio balance in each respective segment as of period-end. In addition to the decline in carrying value of our commercial real estate assets from $251.6 million as of June 30, 2015 to $227.5 million as of June 30, 2016, which resulted in a smaller allocation, there were diminishing aggregate corporate costs period over period, specifically our base management fees.
Income Tax Provision
We intend to continue to operate so that we qualify, for United States federal income tax purposes, as a partnership and not as an association or publicly traded partnership taxable as a corporation. Therefore, we generally are not subject to United States federal income tax at the entity level, but are subject to limited state and foreign taxes. Holders of our Series A LLC Preferred Shares will be allocated a share of our gross ordinary income for our taxable year ending within or with their taxable year. Holders of our Series A LLC Preferred Shares will not be allocated any gains or losses from the sale of our assets.
We hold equity interests in certain subsidiaries that have elected or intend to elect to be taxed as real estate investment trusts (“REIT subsidiaries”) under the Internal Revenue Code of 1986, as amended (the “Code”). A REIT is not subject to United States federal income tax to the extent that it currently distributes its income and satisfies certain asset, income and ownership tests, and recordkeeping requirements, but it may be subject to some amount of federal, state, local and foreign taxes based on its taxable income.
We have wholly‑owned domestic and foreign subsidiaries that are taxable as corporations for United States federal income tax purposes and thus are not consolidated by us for United States federal income tax purposes. For financial reporting purposes, current and deferred taxes are provided for on the portion of earnings recognized by us with respect to our interest in the domestic taxable corporate subsidiaries, because each is taxed as a regular corporation under the Code. Deferred income tax assets and liabilities are computed based on temporary differences between the GAAP consolidated financial statements and the United States federal income tax basis of assets and liabilities as of each consolidated balance sheet date. The foreign corporate subsidiaries were formed to make certain foreign and domestic investments from time to time. The foreign corporate subsidiaries are organized as exempted companies incorporated with limited liability under the laws of the Cayman Islands, and are anticipated to be exempt from United States federal and state income tax at the corporate entity level because they restrict their activities in the United States to trading in stock and securities for their own account. They generally will not be subject to corporate income tax in our financial statements on their earnings, and no provision for income taxes for the three and six months ended
June 30, 2016
was recorded; however, we will be required to include their current taxable income in our calculation of our gross ordinary income allocable to holders of our Series A LLC Preferred Shares.
CLO 2005‑1, CLO 2005‑2, CLO 2006‑1, CLO 2007‑1, CLO 2007‑A, CLO 2009‑1 and CLO 2011‑1 are our foreign subsidiaries that elected to be treated as disregarded entities or partnerships for United States federal income tax purposes. These subsidiaries were established to facilitate securitization transactions, structured as secured financing transactions.
Our REIT subsidiaries are not expected to incur a federal tax expense, but are subject to limited state and foreign income tax expense related to the 2016 tax year.
For the three and six months ended
June 30, 2016
, we recorded total income tax benefit of $0.2 million and $0.1 million, respectively. Cumulative tax assets and liabilities are included in other assets and accounts payable, accrued expenses and other liabilities, respectively, on our condensed consolidated balance sheets.
Investment Portfolio
Our investment portfolio primarily consists of corporate debt holdings, consisting of corporate loans and corporate debt securities. The details of our corporate debt portfolio are discussed below under “Corporate Debt Portfolio.” Also included in our investment portfolio are our other holdings, including royalty interests in oil and gas properties, equity investments, and interests in joint ventures and partnerships, which are all discussed below under “Other Holdings.”
Corporate Debt Portfolio
Our corporate debt investment portfolio primarily consists of investments in corporate loans and corporate debt securities. Our corporate loans primarily consist of senior secured, second lien and subordinated loans. The corporate loans we invest in are generally below investment grade and are primarily floating rate indexed to three‑month LIBOR. Our investments in corporate debt securities primarily consist of fixed rate investments in below investment grade corporate bonds that are senior
secured, senior unsecured and subordinated. We evaluate and monitor the asset quality of our investment portfolio by performing detailed credit reviews and by monitoring key credit statistics and trends. The key credit statistics and trends we monitor to evaluate the quality of our investments include credit ratings of both our investments and the issuer, financial performance of the issuer including earnings trends, free cash flows of the issuer, debt service coverage ratios of the issuer, financial leverage of the issuer, and industry trends that have or may impact the issuer’s current or future financial performance and debt service ability.
We do not require specific collateral or security to support our corporate loans and debt securities; however, these loans and debt securities are either secured through a first or second lien on the assets of the issuer or are unsecured. We do not have access to any collateral of the issuer of the corporate loans and debt securities, rather the seniority in the capital structure of the loans and debt securities determines the seniority of our investment with respect to prioritization of claims in the event that the issuer defaults on the outstanding debt obligation.
Corporate Loans
Our corporate loan portfolio had an aggregate par value of $4.1 billion as of
June 30, 2016
and $5.7 billion as of December 31, 2015. Our corporate loan portfolio consists of debt obligations of corporations, partnerships and other entities in the form of senior secured loans, second lien loans and subordinated loans. The following table summarizes our corporate loans portfolio stratified by type:
Corporate Loans
(Amounts in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2016
|
|
December 31, 2015
|
|
Par
|
|
Amortized
Cost
|
|
Estimated
Fair Value
|
|
Par
|
|
Amortized
Cost
|
|
Estimated
Fair Value
|
Senior secured
|
$
|
3,905,447
|
|
|
$
|
3,886,471
|
|
|
$
|
3,743,775
|
|
|
$
|
5,513,949
|
|
|
$
|
5,401,562
|
|
|
$
|
4,997,394
|
|
Second lien
|
83,083
|
|
|
81,813
|
|
|
68,522
|
|
|
83,492
|
|
|
81,453
|
|
|
78,267
|
|
Subordinated
|
102,830
|
|
|
105,132
|
|
|
79,526
|
|
|
125,205
|
|
|
136,800
|
|
|
112,949
|
|
Total
|
$
|
4,091,360
|
|
|
$
|
4,073,416
|
|
|
$
|
3,891,823
|
|
|
$
|
5,722,646
|
|
|
$
|
5,619,815
|
|
|
$
|
5,188,610
|
|
As of
June 30, 2016
, $4.0 billion par amount, or 96.9%, of our corporate loan portfolio was floating rate and $125.9 million par amount, or 3.1%, was fixed rate. In addition, as of
June 30, 2016
, $141.6 million par amount, or 3.5%, of our corporate loan portfolio was denominated in foreign currencies, of which 68.7% was denominated in Euros. As of December 31, 2015, $5.6 billion par amount, or 97.5%, of our corporate loan portfolio was floating rate and $142.6 million par amount, or 2.5%, was fixed rate. In addition, as of December 31, 2015, $163.2 million par amount, or 2.9%, of our corporate loan portfolio was denominated in foreign currencies, of which 70.6% was denominated in Euros.
As of
June 30, 2016
, our fixed rate corporate loans had a weighted average coupon of 15.2% and a weighted average years to maturity of 3.6 years, as compared to 15.7% and 4.2 years, respectively, as of December 31, 2015. All of our floating rate corporate loans have index reset frequencies of less than twelve months with the majority resetting at least quarterly. The weighted average coupon on our floating rate corporate loans was 4.8% as of
June 30, 2016
and 4.5% as of December 31, 2015, and the weighted average coupon spread to LIBOR of our floating rate corporate loan portfolio was 3.8% as of
June 30, 2016
and 3.7% as of December 31, 2015. The weighted average years to maturity of our floating rate corporate loans was 4.6 years as of
June 30, 2016
and 4.1 years as of December 31, 2015.
Non‑Accrual Loans
Loans are placed on non‑accrual when there is uncertainty regarding whether future income amounts on the loan will be earned and collected. While on non‑accrual status, interest income is recognized using the cost‑recovery method, cash‑basis method or some combination of the two methods. A loan is placed back on accrual status when the ultimate collectability of the principal and interest is no longer in doubt. When placed on non‑accrual status, previously recognized accrued interest is reversed and charged against current income.
As of
June 30, 2016
, we held a total par value and estimated fair value of non-accrual loans of $90.1 million and $37.4 million, respectively, and $435.2 million and $127.5 million, respectively, as of December 31, 2015. The decline in total non-accrual loans was primarily due to the sale of one asset from a single issuer, which previously comprised the majority of the balance as of December 31, 2015.
Defaulted Loans
Defaulted loans consist of corporate loans that have defaulted under the contractual terms of their loan agreements. As of
June 30, 2016
, we had one corporate loan that was in default with a total estimated fair value of $6.3 million from one issuer. As of December 31, 2015, we had one corporate loan that was in default with a total estimated fair value of $113.6 million from one issuer.
Concentration Risk
Our corporate loan portfolio has certain credit risk concentrated in a limited number of issuers. As of
June 30, 2016
, approximately 21% of the total estimated fair value of the our corporate loan portfolio was concentrated in twenty issuers, with the three largest concentrations of corporate loans in loans issued by Infor (US), Inc., iPayment Investors L.P. and Dell Inc., which combined represented $159.9 million, or approximately 4% of the aggregate estimated fair value of our corporate loans. As of December 31, 2015, approximately 31% of the total estimated fair value of the our corporate loan portfolio was concentrated in twenty issuers, with the three largest concentrations of corporate loans in loans issued by U.S. Foods Inc., TXU and PQ Corp., which combined represented $434.6 million, or approximately 8% of the aggregate estimated fair value of our corporate loans.
Corporate Debt Securities
Our corporate debt securities portfolio had an aggregate par value of $304.8 million and $447.8 million as of
June 30, 2016
and December 31, 2015, respectively. Our corporate debt securities portfolio consists of debt obligations of corporations, partnerships and other entities in the form of senior secured, senior unsecured and subordinated bonds. Our corporate debt securities are included in securities on our consolidated balance sheets. The following table summarizes our corporate debt securities portfolio stratified by type:
Corporate Debt Securities
(Amounts in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2016
|
|
December 31, 2015
|
|
Par
|
|
Amortized
Cost
|
|
Estimated
Fair Value
|
|
Par
|
|
Amortized
Cost
|
|
Estimated
Fair Value
|
Senior secured
|
$
|
153,946
|
|
|
$
|
132,724
|
|
|
$
|
46,019
|
|
|
$
|
178,396
|
|
|
$
|
166,313
|
|
|
$
|
110,406
|
|
Senior unsecured
|
25,280
|
|
|
28,917
|
|
|
30,350
|
|
|
137,634
|
|
|
137,949
|
|
|
142,990
|
|
Subordinated
|
125,617
|
|
|
109,284
|
|
|
100,870
|
|
|
131,720
|
|
|
122,997
|
|
|
114,502
|
|
Total
|
$
|
304,843
|
|
|
$
|
270,925
|
|
|
$
|
177,239
|
|
|
$
|
447,750
|
|
|
$
|
427,259
|
|
|
$
|
367,898
|
|
As of
June 30, 2016
, $155.3 million par amount, or 55.2%, of our corporate debt securities portfolio was fixed rate and $126.2 million par amount, or 44.8%, was floating rate. In addition, we had $23.3 million par amount of other securities that do not have fixed or floating coupons, such as subordinated notes in third‑party‑controlled CLOs. As of December 31, 2015, $307.1 million par amount, or 72.3%, of our corporate debt securities portfolio was fixed rate and $117.9 million par amount, or 27.7%, was floating rate. In addition, we had $22.8 million par amount of other securities that do not have fixed or floating coupons, such as subordinated notes in CLOs.
As of
June 30, 2016
, $26.3 million par amount, or 8.6%, of our corporate debt securities portfolio, was denominated in foreign currencies, of which 88.8% was denominated in Euros. As of December 31, 2015, $26.2 million par amount, or 5.8%, of our corporate debt securities portfolio, was denominated in foreign currencies, of which 87.3% was denominated in Euros.
As of
June 30, 2016
, our fixed rate corporate debt securities had a weighted average coupon of 10.0% and a weighted average years to maturity of 3.7 years, as compared to 8.4% and 2.8 years, respectively, as of December 31, 2015. All of our floating rate corporate debt securities have index reset frequencies of less than twelve months. The weighted average coupon on our floating rate corporate debt securities was 14.7% as of both
June 30, 2016
and December 31, 2015, both of which included a single PIK security earning 15% and excluded other securities such as subordinated notes in third‑party‑ controlled CLOs that do not earn a stated rate. The weighted average coupon spread to LIBOR of our floating rate corporate debt securities was 1.0% as of both
June 30, 2016
and December 31, 2015. The weighted average years to maturity of our floating rate corporate debt securities was 5.3 years and 5.9 years as of
June 30, 2016
and December 31, 2015, respectively.
Defaulted Securities
As of both
June 30, 2016
and December 31, 2015, no corporate debt securities in our portfolio were in default.
Concentration Risk
Our corporate debt securities portfolio has certain credit risk concentrated in a limited number of issuers. As of
June 30, 2016
, approximately 97% of the estimated fair value of our corporate debt securities portfolio was concentrated in ten issuers, with the three largest concentrations of debt securities in securities issued by LCI Helicopters Limited, Mizuho Bank Ltd, and Avoca Capital CLO XII Limited which combined represented $121.5 million, or approximately 69% of the estimated fair value of our corporate debt securities. As of December 31, 2015, approximately 89% of the estimated fair value of our corporate debt securities portfolio was concentrated in ten issuers, with the three largest concentrations of debt securities in securities issued by LCI Helicopters Limited, Preferred Proppants LLC and JC Penney Corp. Inc. which combined represented $192.5 million, or approximately 52% of the estimated fair value of our corporate debt securities.
Other Holdings
Our other holdings primarily consisted of royalty interests in oil and gas properties, equity investments, as well as interests in joint ventures and partnerships.
Natural Resources Holdings
Our natural resources holdings consisted of the following as of
June 30, 2016
and December 31, 2015 (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
As of
June 30, 2016
|
|
As of
December 31, 2015
|
|
Oil and gas properties, net
|
|
$
|
112,545
|
|
|
$
|
114,868
|
|
|
Interests in joint ventures and partnerships(1)
|
|
98,397
|
|
|
114,136
|
|
|
Total
|
|
$
|
210,942
|
|
|
$
|
229,004
|
|
|
_____________________
|
|
(1)
|
Includes $28.3 million and $32.6 million of noncontrolling interests as of
June 30, 2016
and December 31, 2015, respectively. Refer to “Interests in Joint Ventures and Partnerships Holdings” below for further discussion around the aggregate balance of our interests in joint ventures and partnerships.
|
As of
June 30, 2016
and December 31, 2015, our oil and gas properties, net totaled $112.5 million and $114.9 million, respectively, and consisted solely of overriding royalty interests in acreage located in Texas. The overriding royalty interests include producing oil and natural gas properties operated by unaffiliated third parties. We had approximately 980 and 902 gross productive wells as of
June 30, 2016
and December 31, 2015, respectively, in which we own an overriding royalty interest, and the acreage is still under development.
Commodity prices, specifically natural gas and oil, have varied meaningfully over the course of the year. Following a meaningful fall in commodity prices that started in the second half of 2014, the long-term price of WTI crude and natural gas increased approximately 14% and 6%, respectively, during the quarter favorably impacting the value of our natural resources assets. The long-term price of WTI crude oil increased from approximately $47 per barrel to $54 per barrel and the long-term price of natural gas increased from $2.86 per mcf to $3.03 per mcf as of March 31, 2016 and June 30, 2016, respectively. As a result of these price improvements, unrealized gains on our natural resources assets totaled $8.6 million for the three months ended June 30, 2016. However, commodity prices remain low compared to recent historical levels, and if commodity prices remain depressed or decline or if a decline is not offset by other factors, we would expect the value of our natural resources assets to be adversely impacted.
Equity Holdings
As of
June 30, 2016
and December 31, 2015, our equity investments carried at estimated fair value totaled $
218.3 million
and $262.9 million, respectively. The following table summarizes the changes in our equity investments, at estimated fair value (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months ended June 30, 2016
|
|
For the three months ended June 30, 2015
|
|
For the six months ended June 30, 2016
|
|
For the six months ended June 30, 2015
|
Beginning balance
|
|
$
|
244,462
|
|
|
$
|
201,593
|
|
|
$
|
262,946
|
|
|
$
|
181,378
|
|
Additions
|
|
4,160
|
|
|
61,723
|
|
|
10,039
|
|
|
108,075
|
|
Dispositions and paydowns
|
|
(29,670
|
)
|
|
(1,221
|
)
|
|
(38,727
|
)
|
|
(3,175
|
)
|
Unrealized gains (losses)
|
|
(457
|
)
|
|
29,798
|
|
|
(16,449
|
)
|
|
7,373
|
|
Other(1)
|
|
(189
|
)
|
|
437
|
|
|
497
|
|
|
(1,321
|
)
|
Ending balance
|
|
$
|
218,306
|
|
|
$
|
292,330
|
|
|
$
|
218,306
|
|
|
$
|
292,330
|
|
_____________________
(1) Includes foreign exchange translation.
Interests in Joint Ventures and Partnerships Holdings
As of
June 30, 2016
and December 31, 2015, our interests in joint ventures and partnerships, which primarily hold assets related to commercial real estate, natural resources and specialty lending, had an aggregate estimated fair value of $
758.3 million
, which included noncontrolling interests of $
64.3 million
and $888.4 million, which included noncontrolling interests of $82.9 million, respectively. We currently consolidate majority owned entities for which we are presumed to have control. Specifically, we consolidate three entities, all of which are classified as interests in joint ventures and partnerships. Noncontrolling interests represent the ownership interests that certain third parties hold in these entities that are consolidated in our financial results.
Equity
Our total equity at
June 30, 2016
totaled $
1.6 billion
and included $
64.3 million
of noncontrolling interests, which represents the equity component held by third parties. Comparatively, our total equity at December 31, 2015 totaled $2.0 billion and included $82.9 million of noncontrolling interests.
Contributions and Distributions
We received contributions of certain assets, including cash, from our Parent and we made distributions of other assets, including cash, to our Parent in order to consolidate related assets among our Parent's subsidiaries, to achieve a desired allocation of assets among various strategies, and/or to facilitate the management and administration of such assets by us.
On May 25, 2016, our board of directors approved the distribution of certain of our loans, equity investments at estimated fair value and CLO subordinated notes owned by us to our Parent, as the holder of our common shares. The estimated fair value of these distributions totaled approximately $132.0 million and were completed during May 2016. Refer to "Sources of Funds - Cash Flow CLO Transactions" for further details.
On October 26, 2015, our board of directors approved the receipt of a contribution from our Parent of certain general partner interests in an alternative credit fund. The estimated fair value of the contribution totaled approximately $251.7 million at the time of transfer and was completed on October 30, 2015.
Separately, on October 26, 2015, our board of directions also approved the distribution of cash to our Parent totaling $251.7 million, which was paid on October 30, 2015.
Preferred Shareholders
The following table shows the distributions declared on our 14.95 million Series A LLC Preferred Shares outstanding:
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|
|
|
|
|
|
|
|
Declaration Date
|
|
Record Date
|
|
Payment Date
|
|
Cash Distribution Declared
per Preferred Share
|
Year ended December 31, 2016
|
|
|
|
|
|
|
|
March 24, 2016
|
|
April 8, 2016
|
|
April 15, 2016
|
|
$0.460938
|
|
June 23, 2016
|
|
July 8, 2016
|
|
July 15, 2016
|
|
$0.460938
|
Year ended December 31, 2015
|
|
|
|
|
|
|
|
March 26, 2015
|
|
April 8, 2015
|
|
April 15, 2015
|
|
$0.460938
|
|
June 25, 2015
|
|
July 8, 2015
|
|
July 15, 2015
|
|
$0.460938
|
|
September 24, 2015
|
|
October 8, 2015
|
|
October 15, 2015
|
|
$0.460938
|
|
December 23, 2015
|
|
January 8, 2016
|
|
January 15, 2016
|
|
$0.460938
|
Common Shareholders
Our Parent owns 100 common shares, constituting all of our outstanding common shares. The following table shows the distributions declared on our common shares:
|
|
|
|
|
|
|
|
|
|
|
Record and
Declaration Date
|
|
Payment Date
|
|
Cash Distribution
Declared per
Common Share
|
Year ended December 31, 2016
|
|
|
|
|
|
|
|
First Quarter ended March 31, 2016
|
|
May 9, 2016
|
|
May 10, 2016
|
|
$245,741
|
|
Second Quarter ended June 30, 2016
|
|
July 21, 2016
|
|
July 22, 2016
|
|
$179,230
|
Year ended December 31, 2015
|
|
|
|
|
|
|
|
First Quarter ended March 31, 2015
|
|
May 7, 2015
|
|
May 8, 2015
|
|
$342,908
|
|
Second Quarter ended June 30, 2015
|
|
August 6, 2015
|
|
August 7, 2015
|
|
$521,120
|
|
Third Quarter ended September 30, 2015
|
|
November 5, 2015
|
|
November 6, 2015
|
|
$375,155
|
|
Fourth Quarter ended December 31, 2015
|
|
February 25, 2016
|
|
February 26, 2016
|
|
$383,135
|
Distribution amounts and the decision whether or not to declare and pay a regular quarterly distribution to the holders of common shares and Series A LLC Preferred Shares are determined by the executive committee, which was established by the board of directors. Distributions are determined based upon a review of various factors including current market conditions, our liquidity needs, legal and contractual restrictions on the payment of distributions, including those under the terms of our preferred shares which would have impacted our common shareholders, the amount of ordinary taxable income or loss earned by us, gains or losses recognized by us on the disposition of assets and our liquidity needs. For this purpose, we generally determined gains or losses based upon the price we paid for those assets.
Holders of Series A LLC Preferred Shares will not be allocated any gains or losses from any sale of our assets. Shareholders may have taxable income or tax liability attributable to our shares for a taxable year that is greater than our cash distributions for such taxable year. Refer to “Non‑Cash ‘Phantom’ Taxable Income” below for further discussion about taxable income allocable to holders of our shares. We may not declare or pay distributions on our common shares unless all accrued distributions have been declared and paid, or set aside for payment, on our Series A LLC Preferred Shares.
LIQUIDITY AND CAPITAL RESOURCES
We actively manage our liquidity position with the objective of preserving our ability to fund our operations and fulfill our commitments on a timely and cost-effective basis. Although we believe our current sources of liquidity are adequate to preserve our ability to fund our operations and fulfill our commitments, we may evaluate opportunities to issue incremental capital. As of
June 30, 2016
, we had unrestricted cash and cash equivalents totaling
$322.0 million
.
The majority of our investments are held in Cash Flow CLOs. Accordingly, the majority of our cash flows have historically been received from our investments in the secured and subordinated notes of our Cash Flow CLOs. However, during the period in which a Cash Flow CLO is not in compliance with an over-collateralization test (‘‘OC Test’’), as outlined
in its respective indenture, the cash flows we would generally expect to receive from our Cash Flow CLO holdings are paid to the secured note holders of the Cash Flow CLOs. As described in further detail below, as of
June 30, 2016
, all of our Cash Flow CLOs were in compliance with their respective coverage tests (specifically, their OC Tests and interest coverage (‘‘IC’’) tests) and made cash distributions to secured and/or subordinated note holders, including us.
CLO issuances typically increase when the spread between the assets and liabilities generates an attractive return to subordinated note holders. In the case where demand for loans leads to tighter spreads or if interest rates for the liabilities increases, the return to subordinated note holders will be less attractive, and the issuance of CLOs is expected generally to decline. Since April 30, 2014, the date we became a subsidiary of KKR & Co., to June 30, 2016, we have called five CLOs, and as a result, the amount of invested capital in our CLOs has decreased.
Our legacy CLOs were larger in total transaction size relative to those that were issued subsequently. As a result, our interests in the subordinated notes of legacy CLOs were significantly greater compared to our interests in the subordinated notes of those CLOs issued since 2012. Therefore, as our legacy CLOs are called and the assets held within the CLOs are sold to repay the CLO note holders, including us as a subordinated note holder, our capital invested in our CLO portfolio will decline. As of June 30, 2016, all but one of our legacy CLOs were called with all outstanding notes repaid. Unless we change our existing practice, we expect the size of our CLO portfolio to continue to decrease as well as associated interest income and interest expense, as a result of the foregoing, if not offset by new issuances or other opportunities of comparable size and/or amount. Based on the above factors combined with alternative investment opportunities, we may selectively redeploy capital to other assets outside of CLOs and credit.
Sources of Funds
Cash Flow CLO Transactions
In accordance with GAAP, we consolidate each of our CLO subsidiaries, or Cash Flow CLOs, as we have the power to direct the activities of these VIEs, as well as the obligation to absorb losses of the VIEs or the right to receive benefits of the VIEs that could potentially be significant to the VIEs. We utilize CLOs to fund our investments in corporate loans and corporate debt securities.
During May 2016, we distributed an aggregate $96.5 million par amount of CLO 9, CLO 10, CLO 11 and CLO 13 subordinated notes to our Parent. These notes were previously owned by us and eliminated in consolidation. Following the distribution, the subordinated notes were held by an affiliate of KKR and reflected as collateralized loan obligation junior secured notes to affiliates, at estimated fair value, on our condensed consolidated balance sheets.
During April 2016, the remaining $15.1 million of CLO 2007-A subordinated notes owned by third parties were deemed repaid in full, whereby we distributed cash and assets held as collateral in CLO 2007-A to the subordinated noteholers.
On December 16, 2015, we closed CLO 13, a $412.0 million secured financing transaction maturing on January 16, 2028. We issued $370.0 million par amount of senior secured notes to unaffiliated investors, $350.0 million of which was floating rate with a weighted-average coupon of three-month LIBOR plus 2.19% and $20.0 million of which was fixed rate with a weighted-average coupon of 3.83%. The CLO also issued $4.0 million of subordinated notes to unaffiliated investors. The investments that are owned by CLO 13 collateralize the CLO 13 debt, and as a result, those investments are not available to us, our creditors or shareholders.
During June 2015, we issued $15.0 million par amount of CLO 2005-2 class E notes for proceeds of $15.1 million and $35.0 million par amount of CLO 2007-1 class D and E notes for proceeds of $35.1 million. Subsequently, in July 2015, we issued $15.0 million par amount of CLO 2005-2 class E notes for proceeds of $15.1 million.
On May 7, 2015, we closed CLO 11, a $564.5 million secured financing transaction maturing on April 15, 2027. We issued $507.8 million par amount of senior secured notes to unaffiliated investors, all of which was floating rate with a weighted-average coupon of three-month LIBOR plus 2.06%. The CLO also issued $28.3 million of subordinated notes to unaffiliated investors. The investments that are owned by CLO 11 collateralize the CLO 11 debt, and as a result, those investments are not available to us, our creditors or shareholders.
The indentures governing our Cash Flow CLOs include numerous compliance tests, the majority of which relate to the CLO’s portfolio.
In the case of our Cash Flow CLOs, in the event that a portfolio profile test is not met, the indenture places restrictions on the ability of the CLO’s manager to reinvest available principal proceeds generated by the collateral in the CLOs until the specific test has been cured. In addition to the portfolio profile tests, the indentures for these CLOs include OC Tests which set the ratio of the collateral value of the assets in the CLO to the tranches of debt for which the test is being measured, as well as interest coverage tests. For purposes of the calculation, collateral value is the par value of the assets unless an asset is in default, is a discounted obligation, or is a CCC-rated asset in excess of the percentage of CCC-rated asset limit specified for each CLO.
If an asset is in default, the indenture for each CLO transaction defines the value used to determine the collateral value, which value is the lower of the market value of the asset or the recovery value proscribed for the asset based on its type and rating by Standard & Poor’s or Moody’s.
A discount obligation is an asset with a purchase price of less than a particular percentage of par. The discount obligation amounts are specified in each CLO and are generally set at a purchase price of less than 80% of par for corporate loans and 75% of par for corporate debt securities.
The indenture for each CLO specifies a CCC-threshold for the percentage of total assets in the CLO that can be rated CCC. All assets in excess of the CCC threshold specified for the respective CLO are also included in the OC Tests at market value and not par.
Defaults of assets in CLOs, ratings downgrade of assets in CLOs to CCC, price declines of CCC assets in excess of the proscribed CCC threshold amount, and price declines in assets classified as discount obligations may reduce the over-collateralization ratio such that a CLO is not in compliance. If a CLO is not in compliance with an OC Test, cash flows normally payable to the holders of junior classes of notes will be used by the CLO to amortize the most senior class of notes until such point as the OC Test is brought back into compliance. While being out of compliance with an OC Test would
not impact our investment portfolio or results of operations, it would impact our unrestricted cash flows available for operations, new investments and cash distributions. As of
June 30, 2016
, all of our CLOs were in compliance with their respective OC Tests.
An affiliate of our Manager has entered into separate management agreements with our Cash Flow CLOs and is entitled to receive fees for the services performed as collateral manager. The indentures governing the CLO transactions stipulate the reinvestment period during which the collateral manager can generally sell or buy assets at its discretion and can reinvest principal proceeds into new assets. As of
June 30, 2016
, CLO 2007-1 was no longer in its reinvestment period and as a result, principal proceeds from the assets held in this transaction are generally used to amortize the outstanding balance of the senior notes outstanding. CLO 2012-1, CLO 2013-1, CLO 2013-2, CLO 9, CLO 10, CLO 11 and CLO 13 will end their reinvestment periods during December 2016, July 2017, January 2018, October 2018, December 2018, April 2019 and January 2020, respectively.
Pursuant to the terms of the indentures governing our CLO transactions, we have the ability to call our CLO transactions after the end of their respective non-call periods. During November 2015, we called CLO 2005-2 and repaid all senior and mezzanine notes totaling $140.2 million par amount. During July 2015, we called CLO 2005-1 and repaid all senior and mezzanine notes totaling $142.4 million par amount. In addition, during February 2015, we called CLO 2006-1 and repaid aggregate senior and mezzanine notes totaling $181.8 million par amount. In connection with the repayment of CLO 2006-1 notes, the related pay-fixed, receive-variable interest rate swap to hedge interest rate risk associated with CLO 2006-1, with a contractual notional amount of $84.0 million, was terminated.
During the three and six months ended June 30, 2016, $486.3 million and $598.5 million, respectively, of original CLO 2007-1 senior notes were repaid. During the three and six months ended June 30, 2015, $375.6 million and $545.4 million, respectively, of original CLO 2005-1, CLO 2005-2 and CLO 2007-1 senior notes were repaid. CLO 2011-1 does not have a reinvestment period and all principal proceeds from holdings in CLO 2011-1 are used to amortize the transaction. During March 2016, we called CLO 2011-1 and repaid all senior notes totaling $249.3 million par amount. During the three and six months ended June 30, 2015, $29.3 million and $30.8 million, respectively, of original CLO 2011-1 senior notes were repaid.
CLO Warehouse Facility
On July 22, 2015, CLO 13 entered into a $350.0 million CLO warehouse facility ("CLO 13 Warehouse"), which matured upon the closing of CLO 13 on December 16, 2015. The CLO 13 Warehouse was used to purchase assets for the CLO transaction in advance of its closing date upon which the proceeds of the CLO closing were used to repay the CLO 13 Warehouse in full. Debt issued under the CLO 13 Warehouse was non-recourse to us beyond the assets of CLO 13 and bore
interest at rates ranging from LIBOR plus 1.50% to 2.25%. Upon the closing of CLO 13 on December 16, 2015, the aggregate amount outstanding under the CLO 13 Warehouse was repaid.
On March 2, 2015, CLO 11 entered into a $570.0 million CLO warehouse facility ("CLO 11 Warehouse"), which matured upon the closing of CLO 11 on May 7, 2015. The CLO 11 Warehouse was used to purchase assets for the CLO transaction in advance of its closing date upon which the proceeds of the CLO closing were used to repay the CLO 11 Warehouse in full. Debt issued under the CLO 11 Warehouse was non-recourse to us beyond the assets of CLO 11 and bore interest at rates ranging from LIBOR plus 1.25% to 1.75%. Upon the closing of CLO 11 on May 7, 2015, the aggregate amount outstanding under the CLO 11 Warehouse was repaid.
Off-Balance Sheet Arrangements
We participate in certain contingent financing arrangements, whereby we are committed to provide funding of up to a specific predetermined amount at the discretion of the borrower or have entered into an agreement to acquire interests in certain assets. As of
June 30, 2016
and December 31, 2015, we had unfunded financing commitments for corporate loans totaling
$2.8 million
and
$8.6 million
, respectively.
We participate in joint ventures and partnerships alongside KKR and its affiliates through which we contribute capital for assets, including development projects related to our interests in joint ventures and partnerships that hold commercial real estate and natural resources investments, as well as specialty lending focused businesses. As of
June 30, 2016
, we estimated these future contributions to total approximately
$85.0 million
, whereby approximately 67% was related to our credit segment and 33% was related to our other segment. As of December 31, 2015, we estimated these future contributions to total approximately $163.0 million, whereby approximately 44% was related to our credit segment, 34% was related to our natural resources segment and 22% was related to our other segment.
We had investments, held alongside KKR and its affiliates, in real estate entities that were financed with non-recourse debt totaling approximately $1.6 billion as of both
June 30, 2016
and December 31, 2015. Under non-recourse debt, the lender generally does not have recourse against any other assets owned by the borrower or any related parties of the borrower, except for certain specified exceptions listed in the respective loan documents including customary ‘‘bad boy’’ acts and environmental losses. In connection with certain of these investments, joint and several non-recourse carve-out guarantees and environmental indemnities were provided, pursuant to which KFN guarantees losses or the full amount of the applicable loan in the event of specified bad acts or environmental matters. In addition, completion guarantees were provided for certain properties to complete all or portions of development projects, and partial payment guarantees were provided for certain investments.
PARTNERSHIP TAX MATTERS
Non-Cash “Phantom” Taxable Income
We intend to continue to operate so that we qualify, for United States federal income tax purposes, as a partnership and not as an association or a publicly traded partnership taxable as a corporation. Holders of our Series A LLC Preferred Shares are subject to United States federal income taxation and generally other taxes, such as state, local and foreign income taxes, on their allocable share of our gross ordinary income, regardless of whether or when they receive cash distributions. We generally allocate our gross ordinary income using a monthly convention, which means that we determine our gross ordinary income for the taxable year to be allocated to our Series A LLC Preferred Shares and then prorate that amount on a monthly basis. Our Series A LLC Preferred Shares will receive an allocation of our gross ordinary income. If the amount of cash distributed to our Series A LLC Preferred Shares in any year exceeds our gross ordinary income for such year, additional gross ordinary income will be allocated to the Series A LLC Preferred Shares in future years until such excess is eliminated. Consequently, in some taxable years, holders of our Series A LLC Preferred Shares may recognize taxable income in excess of our cash distributions. Furthermore, even if we did not pay cash distributions with respect to a taxable year, holders of our Series A LLC Preferred Shares may still have a tax liability attributable to their allocation of gross ordinary income from us during such year in the event that cash distributed in a prior year exceeded our gross ordinary income in such year.
Qualifying Income Exception
We intend to continue to operate so that we qualify, for United States federal income tax purposes, as a partnership and not as an association or a publicly traded partnership taxable as a corporation. In general, if a partnership is ‘‘publicly traded’’ (as defined in the Code), it will be treated as a corporation for United States federal income tax purposes. A publicly traded partnership will be taxed as a partnership, however, and not as a corporation, for United States federal income tax purposes so long as it is not required to register under the Investment Company Act and at least 90% of its gross income for
each taxable year constitutes ‘‘qualifying income’’ within the meaning of Section 7704(d) of the Code. We refer to this exception as the ‘‘qualifying income exception.’’ Qualifying income generally includes rents, dividends, interest (to the extent such interest is neither derived from the ‘‘conduct of a financial or insurance business’’ nor based, directly or indirectly, upon ‘‘income or profits’’ of any person), income and gains derived from certain activities related to minerals and natural resources, and capital gains from the sale or other disposition of stocks, bonds and real property. Qualifying income also includes other income derived from the business of investing in, among other things, stocks and securities.
If we fail to satisfy the ‘‘qualifying income exception’’ described above, our gross ordinary income would not pass through to holders of our Series A LLC Preferred Shares and such holders would be treated for United States federal (and certain state and local) income tax purposes as shareholders in a corporation. In such case, we would be required to pay income tax at regular corporate rates on all of our net income. In addition, we would likely be liable for state and local income and/or franchise taxes on all of our income. Distributions to holders of our Series A LLC Preferred Shares would constitute ordinary dividend income taxable to such holders to the extent of our earnings and profits, and these distributions would not be deductible by us. If we were taxable as a corporation, it could result in a material reduction in cash flow and after-tax return for holders of our Series A LLC Preferred Shares and thus could result in a substantial reduction in the value of our Series A LLC Preferred Shares and any other securities we may issue.
Tax Consequences of Investments in Natural Resources and Real Estate
As referenced above, we have made certain investments in natural resources and real estate. It is likely that the income from natural resources investments will be treated as effectively connected with the conduct of a United States trade or business with respect to holders of our Series A LLC Preferred Shares that are not ‘‘United States persons’’ within the meaning of Section 7701(a)(30) of the Code. Furthermore, any notional principal contracts that we enter into, if any, in connection with investments in natural resources likely would generate income that would be treated as effectively connected with the conduct of a United States trade or business. Further, our investments in real estate through pass-through entities may generate operating income that is treated as effectively connected with the conduct of a United States trade or business.
To the extent our income is treated as effectively connected income, a holder who is a non-United States person generally would be required to (i) file a United States federal income tax return for such year reporting its allocable share, if any, of our gross ordinary income effectively connected with such trade or business and (ii) pay United States federal income tax at regular United States tax rates on any such income. Moreover, if such a holder is a corporation, it might be subject to a United States branch profits tax on its allocable share of our effectively connected income. In addition, distributions to such a holder would be subject to withholding at the highest applicable federal income tax rate to the extent of the holder’s allocable share of our effectively connected income. Any amount so withheld would be creditable against such holder’s United States federal income tax liability, and such holder could claim a refund to the extent that the amount withheld exceeded such holder’s United States federal income tax liability for the taxable year.
If we are engaged in a United States trade or business, a portion of any gain recognized by an investor who is a non-United States person on the sale or exchange of its Series A LLC Preferred Shares may be treated for United States federal income tax purposes as effectively connected income, and hence such holder may be subject to United States federal income tax on the sale or exchange. Moreover, if the fair market value of our investments in United States real property interests, which include our investments in natural resources, real estate and REIT subsidiaries that invest primarily in real estate, represent more than 10% of the total fair market value of our assets, our Series A LLC Preferred Shares could be treated as United States real property interests. In such case, gain recognized by an investor who is a non-United States person on the sale or exchange of its Series A LLC Preferred Shares would be treated for United States federal income tax purposes as effectively connected income (unless our Series A LLC Preferred Shares are regularly traded on a securities market and the non-United States person owned 5% or less of the shares of our Series A LLC Preferred Shares during the applicable compliance period). We believe that the fair market value of our investments in United States real property interests represented more than 10% of the total fair market value of our assets during the second quarter of 2016. As a result, although the Treasury regulations are not entirely clear, the Series A LLC Preferred Shares (unless our Series A LLC Preferred Shares are regularly traded on a securities market and the non-United States person owned 5% or less of the shares of our Series A LLC Preferred Shares during the applicable compliance period) could be treated as United States real property interests. Moreover, it is possible that the Internal Revenue Service ("IRS") could take the position that such shares would be treated as United States real property interests for the five years following the last date on which more than 10% of the total fair market value of our assets consisted of United States real property interests. If gain from the sale of our Series A LLC Preferred Shares is treated as effectively connected income, the holder may be subject to United States federal income and/or withholding tax on the sale or exchange.
In addition, all holders of our Series A LLC Preferred Shares will likely have state tax filing obligations in jurisdictions in which we have made investments in natural resources or real estate (other than through a REIT subsidiary). As a
result, holders of our Series A LLC Preferred Shares will likely be required to file state and local income tax returns and pay state and local income taxes in some or all of these various jurisdictions. Further, holders may be subject to penalties if they fail to comply with those requirements. Our current investments may cause our holders to have state tax filing obligations in the following states: Florida, Georgia, Illinois, Kansas, Louisiana, Maryland, Mississippi, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Virginia and West Virginia. We may make investments in other states or non-U.S. jurisdictions in the future.
For holders of our Series A LLC Preferred Shares that are regulated investment companies, to the extent that our income from our investments in natural resources and real estate exceeds 10% of our gross income, then we will likely be treated as a ‘‘qualified publicly traded partnership’’ for purposes of the income and asset diversification tests that apply to regulated investment companies. Although the calculation of our gross income for purposes of this test is not entirely clear, it is possible we may be treated as a ‘‘qualified publicly traded partnership’’ for our 2016 tax year. However, no assurance can be provided that we will or will not be treated as a ‘‘qualified publicly traded partnership’’ in 2016 or any future year.
OUR INVESTMENT COMPANY ACT STATUS
Section 3(a)(1)(A) of the Investment Company Act defines an investment company as any issuer that is, holds itself out as being, or proposes to be, primarily engaged in the business of investing, reinvesting or trading in securities and Section 3(a)(1)(C) of the Investment Company Act defines an investment company as any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire “investment securities” (within the meaning of the Investment Company Act) having a value exceeding 40% of the value of the issuer’s total assets (exclusive of United States government securities and cash items) on an unconsolidated basis (the “40% test”). Excluded from the term “investment securities” are, among others, securities issued by majority‑owned subsidiaries unless the subsidiary is an investment company or relies on the exceptions from the definition of an investment company provided by Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act (a “fund”).
We are organized as a holding company. We conduct our operations primarily through our majority‑owned subsidiaries. Each of our subsidiaries is either outside of the definition of an investment company in Sections 3(a)(1)(A) and 3(a)(1)(C), described above, or excepted from the definition of an investment company under the Investment Company Act. We believe that we are not, and that we do not propose to be, primarily engaged in the business of investing, reinvesting or trading in securities and we do not believe that we have held ourselves out as such. We intend to continue to conduct our operations so that we are not required to register as an investment company under the Investment Company Act.
We monitor our holdings regularly to confirm our continued compliance with the 40% test. In calculating our position under the 40% test, we are responsible for determining whether any of our subsidiaries is majority‑owned. We treat as majority‑owned subsidiaries for purposes of the 40% test entities, including those that issue CLOs, in which we own at least 50% of the outstanding voting securities or that are otherwise structured consistent with applicable SEC staff guidance. Some of our majority‑owned subsidiaries may rely solely on the exceptions from the definition of “investment company” found in Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act. In order for us to satisfy the 40% test, our ownership interests in those subsidiaries or any of our subsidiaries that are not majority‑owned for purposes of the Investment Company Act, together with any other “investment securities” that we may own, may not have a combined value in excess of 40% of the value of our total assets on an unconsolidated basis and exclusive of United States government securities and cash items. However, many of our majority‑owned subsidiaries either fall outside of the general definitions of an investment company or rely on exceptions provided by provisions of, and rules and regulations promulgated under, the Investment Company Act (other than Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act) and, therefore, the securities of those subsidiaries that we own and hold are not investment securities for purposes of the Investment Company Act. In order to conform to these exceptions, these subsidiaries are limited with respect to the assets in which each of them can invest and/or the types of securities each of them may issue. We must, therefore, monitor each subsidiary’s compliance with its applicable exception and our freedom of action relating to such a subsidiary, and that of the subsidiary itself, may be limited as a result. For example, our subsidiaries that issue CLOs generally rely on the exception provided by Rule 3a‑7 under the Investment Company Act, while our real estate subsidiaries, including those that are taxed as REITs for United States federal income tax purposes, generally rely on the exception provided by Section 3(c)(5)(C) of the Investment Company Act. Each of these exceptions requires, among other things that the subsidiary (i) not issue redeemable securities and (ii) engage in the business of holding certain types of assets, consistent with the terms of the exception. Similarly, any subsidiaries engaged in the ownership of oil and gas assets may, depending on the nature of the assets, be outside the definition of an investment company or rely on exceptions provided by Section 3(c)(5)(C) or Section 3(c)(9) of the Investment Company Act. While Section 3(c)(9) of the Investment Company Act does not limit the nature of the securities issued, it does impose business engagement requirements that limit the types of assets that may be held.
We do not treat our interests in majority‑owned subsidiaries that are outside of the general definition of an investment company or that rely on Section 3(c)(5)(A), (B), (C) or Section 3(c)(9) of, or Rule 3a‑7 under, the Investment Company Act as investment securities when calculating our 40% test.
We sometimes refer to our subsidiaries that rely on Rule 3a‑7 under the Investment Company Act as “CLO subsidiaries.” Rule 3a‑7 under the Investment Company Act is available to certain structured financing vehicles that are engaged in the business of holding financial assets that, by their terms, convert into cash within a finite time period and that issue fixed income securities entitling holders to receive payments that depend primarily on the cash flows from these assets, provided that, among other things, the structured finance vehicle does not engage in certain portfolio management practices resembling those employed by management investment companies (e.g., mutual funds). Accordingly, each of these CLO subsidiaries is subject to an indenture (or similar transaction documents) that contains specific guidelines and restrictions limiting the discretion of the CLO subsidiary and its collateral manager. In particular, these guidelines and restrictions prohibit the CLO subsidiary from acquiring and disposing of assets primarily for the purpose of recognizing gains or decreasing losses resulting from market value changes. Thus, a CLO subsidiary cannot acquire or dispose of assets primarily to enhance returns to the owner of the equity in the CLO subsidiary; however, subject to this limitation, sales and purchases of assets may be made so long as doing so does not violate guidelines contained in the CLO subsidiary’s relevant transaction documents. A CLO subsidiary generally can, for example, sell an asset if the collateral manager believes that its credit quality has declined since its acquisition or that the credit profile of the obligor will deteriorate and the proceeds of permitted dispositions may be reinvested in additional collateral, subject to fulfilling the requirements set forth in Rule 3a‑7 under the Investment Company Act and the CLO subsidiary’s relevant transaction documents. As a result of these restrictions, our CLO subsidiaries may suffer losses on their assets and we may suffer losses on our investments in those CLO subsidiaries.
We sometimes refer to our subsidiaries that rely on Section 3(c)(5)(C) of the Investment Company Act, as our “real estate subsidiaries.” Section 3(c)(5)(C) of the Investment Company Act is available to companies that are primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate. While the SEC has not promulgated rules to address precisely what is required for a company to be considered to be “primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate,” the SEC’s Division of Investment Management, or the “Division,” has taken the position, through a series of no‑action and interpretive letters, that a company may rely on Section 3(c)(5)(C) of the Investment Company Act if, among other things, at least 55% of the company’s assets consist of mortgage loans, other assets that are considered the functional equivalent of mortgage loans and certain other interests in real property (collectively, “qualifying real estate assets”), and at least 25% of the company’s assets consist of real estate‑ related assets (reduced by the excess of the company’s qualifying real estate assets over the required 55%), leaving no more than 20% of the company’s assets to be invested in miscellaneous assets. The Division has also provided guidance as to the types of assets that can be considered qualifying real estate assets. Because the Division’s interpretive letters are not binding except as they relate to the companies to whom they are addressed, if the Division were to change its position as to, among other things, what assets might constitute qualifying real estate assets our REIT subsidiaries might be required to change its investment strategy to comply with the changed position. We cannot predict whether such a change would be adverse.
Based on current guidance, our real estate subsidiaries classify investments in mortgage loans as qualifying real estate assets, as long as the loans are “fully secured” by an interest in real estate on which we retain the unilateral right to foreclose. That is, if the loan‑to‑value ratio of the loan is equal to or less than 100%, then the mortgage loan is considered to be a qualifying real estate asset. Mortgage loans with loan‑to‑value ratios in excess of 100% are considered to be only real estate‑related assets. Our real estate subsidiaries consider agency whole pool certificates to be qualifying real estate assets. Examples of agencies that issue whole pool certificates are the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation and the Government National Mortgage Association. An agency whole pool certificate is a certificate issued or guaranteed as to principal and interest by the United States government or by a federally chartered entity, which represents the entire beneficial interest in the underlying pool of mortgage loans. By contrast, an agency certificate that represents less than the entire beneficial interest in the underlying mortgage loans is not considered to be a qualifying real estate asset, but is considered by our real estate subsidiaries to be a real estate‑related asset.
Most non‑agency mortgage‑backed securities do not constitute qualifying real estate assets because they represent less than the entire beneficial interest in the related pool of mortgage loans; however, based on Division guidance, where our real estate subsidiaries’ investment in non‑agency mortgage‑backed securities is the “functional equivalent” of owning the underlying mortgage loans, our real estate subsidiaries may treat those securities as qualifying real estate assets. Moreover, investments in mortgage‑ backed securities that do not constitute qualifying real estate assets are classified by our real estate subsidiaries as real estate‑related assets. Therefore, based upon the specific terms and circumstances related to each non‑agency mortgage‑backed security that our real estate subsidiaries own, our real estate subsidiaries will make a determination of whether that security should be classified as a qualifying real estate asset or as a real estate‑ related asset; and there may be instances where a security is recharacterized from being a qualifying real estate asset to a real estate‑related asset,
or conversely, from being a real estate‑related asset to being a qualifying real estate asset based upon the acquisition or disposition or redemption of related classes of securities from the same securitization trust. If our real estate subsidiaries acquire securities that, collectively, receive all of the principal and interest paid on the related pool of underlying mortgage loans (less fees, such as servicing and trustee fees, and expenses of the securitization), and that subsidiary has unilateral foreclosure rights with respect to those mortgage loans, then our real estate subsidiaries will consider those securities, collectively, to be qualifying real estate assets. If another entity acquires any of the securities that are expected to receive cash flow from the underlying mortgage loans, then our real estate subsidiaries will consider whether it has appropriate foreclosure rights with respect to the underlying loans and whether its investment is a first loss position in deciding whether these securities should be classified as qualifying real estate assets. If our real estate subsidiaries own more than one subordinate class, then, to determine the classification of subordinate classes other than the first loss class, our real estate subsidiaries will consider whether such classes are contiguous with the first loss class (with no other classes absorbing losses after the first loss class and before any other subordinate classes that our real estate subsidiaries own), whether our real estate subsidiaries own the entire amount of each such class and whether our real estate subsidiaries would continue to have appropriate foreclosure rights in connection with each such class if the more subordinate classes were no longer outstanding. If the answers to any of these questions is no, then our real estate subsidiaries would expect not to classify that particular class, or classes senior to that class, as qualifying real estate assets.
We have made or may make oil and gas and other mineral investments that are held through one or more subsidiaries and would refer to those subsidiaries as our “oil and gas subsidiaries”. Depending upon the nature of the oil and gas assets held by an oil and gas subsidiary, such oil and gas subsidiary may rely on Section 3(c)(5)(C) or Section 3(c)(9) of the Investment Company Act or may fall outside of the general definition of an investment company. An oil and gas subsidiary that does not engage primarily, propose to engage primarily or hold itself out as engaging primarily in the business of investing, reinvesting or trading in securities will be outside of the general definition of an investment company provided that it passes the 40% test. This may be the case where an oil and gas subsidiary holds a sufficient amount of oil and gas assets constituting real estate interests together with other assets that are not investment securities such as equipment. Oil and gas subsidiaries that hold oil and gas assets that constitute real property interests, but are unable to pass the 40% test, may rely on Section 3(c)(5)(C), subject to the requirements and restrictions described above. Alternately, an oil and gas subsidiary may rely on Section 3(c)(9) of the Investment Company Act if substantially all of its business consists of owning or holding oil, gas or other mineral royalties or leases, certain fractional interests, or certificates of interest or participations in or investment contracts relating to such royalties, leases or fractional interests. These various restrictions imposed on our oil and gas subsidiaries by the Investment Company Act may have the effect of limiting our freedom of action with respect to oil and gas assets (or other assets) that may be held or acquired by such subsidiary or the manner in which we may deal in such assets.
In addition, we anticipate that one or more of our subsidiaries, will qualify for an exception from registration as an investment company under the 1940 Act pursuant to either Section 3(c)(5)(A) of the 1940 Act, which is available for entities primarily engaged in the business of purchasing or otherwise acquiring notes, drafts, acceptances, open accounts receivable, and other obligations representing part or all of the sales price of merchandise, insurance, and services, and/or Section 3(c)(5)(B) of the 1940 Act, which is available for entities primarily engaged in the business of making loans to manufacturers, wholesalers, and retailers of, and to prospective purchasers of, specified merchandise, insurance, and services and, in each case, the entities are not engaged in the business of issuing redeemable securities, face‑amount certificates of the installment type or periodic payment plan certificates. In order to rely on Sections 3(c)(5)(A) and (B) and be deemed “primarily engaged” in the applicable businesses, at least 55% of an issuer’s assets must represent investments in eligible loans and receivables under those sections. We intend to treat as qualifying assets for purposes of these exceptions the purchases of loans and leases representing part or all of the sales price of equipment and loans where the loan proceeds are specifically provided to finance equipment, services and structural improvements to properties and other facilities and maritime and infrastructure projects or improvements. We intend to rely on guidance published by the SEC or its staff in determining which assets are deemed qualifying assets.
As noted above, if the combined values of the securities issued to us by any non‑majority‑owned subsidiaries and our subsidiaries that must rely on Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act, together with any other investment securities we may own, exceed 40% of the value of our total assets (exclusive of United States government securities and cash items) on an unconsolidated basis, we may be deemed to be an investment company. If we fail to maintain an exception, exemption or other exclusion from the Investment Company Act, we could, among other things, be required either (i) to change substantially the manner in which we conduct our operations to avoid being subject to the Investment Company Act or (ii) to register as an investment company. Either of these would likely have a material adverse effect on us, the type of investments we make, our ability to service our indebtedness and to make distributions on our shares, and on the market price of our shares and any other securities we may issue. If we were required to register as an investment company under the Investment Company Act, we would become subject to substantial regulation with respect to our capital structure (including our ability to use leverage), management, operations, transactions with certain affiliated persons (within the meaning of the
Investment Company Act), portfolio composition (including restrictions with respect to diversification and industry concentration) and other matters. Additionally, our Manager would have the right to terminate our Management Agreement effective the date immediately prior to our becoming an investment company. Moreover, if we were required to register as an investment company, we would no longer be eligible to be treated as a partnership for United States federal income tax purposes. Instead, we would be classified as a corporation for tax purposes and would be able to avoid corporate taxation only to the extent that we were able to elect and qualify as a regulated investment company (“RIC”) under applicable tax rules. Because our eligibility for RIC status would depend on our assets and sources of income at the time that we were required to register as an investment company, there can be no assurance that we would be able to qualify as a RIC. If we were to lose partnership status and fail to qualify as a RIC, we would be taxed as a regular corporation. See “Partnership Tax Matters-Qualifying Income Exception”.
We have not requested approval or guidance from the SEC or its staff with respect to our Investment Company Act determinations, including, in particular: our treatment of any subsidiary as majority‑owned; the compliance of any subsidiary with Section 3(c)(5)(A), (B), (C) or Section 3(c)(9) of, or Rule 3a‑7 under, the Investment Company Act, including any subsidiary’s determinations with respect to the consistency of its assets or operations with the requirements thereof; or whether our interests in one or more subsidiaries constitute investment securities for purposes of the 40% test. If the SEC were to disagree with our treatment of one or more subsidiaries as being majority‑ owned, excepted from the Investment Company Act pursuant to Rule 3a‑7, Section 3(c)(5)(A), (B), (C), Section 3(c)(9) or any other exception, with our determination that one or more of our other holdings do not constitute investment securities for purposes of the 40% test, or with our determinations as to the nature of the business in which we engage or the manner in which we hold ourselves out, we and/or one or more of our subsidiaries would need to adjust our operating strategies or assets in order for us to continue to pass the 40% test or register as an investment company, either of which could have a material adverse effect on us. Moreover, we may be required to adjust our operating strategy and holdings, or to effect sales of our assets in a manner that, or at a time or price at which, we would not otherwise choose, if there are changes in the laws or rules governing our Investment Company Act status or that of our subsidiaries, or if the SEC or its staff provides more specific or different guidance regarding the application of relevant provisions of, and rules under, the Investment Company Act. The SEC published on August 31, 2011 an advance notice of proposed rulemaking to potentially amend the conditions for reliance on Rule 3a‑7 and the treatment of asset‑backed issuers that rely on Rule 3a‑7 under the Investment Company Act (the “3a‑7 Release”).
The SEC, in the 3a‑7 Release, requested public comment on the nature and operation of issuers that rely on Rule 3a‑7 and indicated various steps it may consider taking in connection with Rule 3a‑7, although it did not formally propose any changes to the rule. Among the issues for which the SEC has requested comment in the 3a‑7 Release is whether Rule 3a‑7 should be modified so that parent companies of subsidiaries that rely on Rule 3a‑7 should treat their interests in such subsidiaries as investment securities for purposes of the 40% test. The SEC also published on August 31, 2011 a concept release seeking information about the nature of entities that invest in mortgages and mortgage‑related pools and public comment on how the SEC staff’s interpretive positions in connection with Section 3(c)(5)(C) affect these entities, although it did not propose any new interpretive positions or changes to existing interpretive positions in connection with Section 3(c)(5)(C). Any guidance or action from the SEC or its staff, including changes that the SEC may ultimately propose and adopt to the way Rule 3a‑7 applies to entities or new or modified interpretive positions related to Section 3(c)(5)(C), could further inhibit our ability, or the ability of a subsidiary, to pursue our current or future operating strategies, which could have a material adverse effect on us.
If the SEC or a court of competent jurisdiction were to find that we were required, but failed, to register as an investment company in violation of the Investment Company Act, we may have to cease business activities, we would breach representations and warranties and/or be in default as to certain of our contracts and obligations, civil or criminal actions could be brought against us, our contracts would be unenforceable unless a court were to require enforcement and a court could appoint a receiver to take control of us and liquidate our business, any or all of which would have a material adverse effect on our business.
OTHER REGULATORY ITEMS
In August 2012, the U.S. Commodities Futures Trading Commission (“CFTC”) adopted a series of rules to establish a new regulatory framework for swaps that may cause certain users of swaps to be deemed commodity pools or to register as commodity pool operators. In October 2012, the CFTC delayed the implementation of the relevant rules until December 31, 2012. Although we believe that KKR Financial Holdings LLC is not a commodity pool, we have requested confirmation of this conclusion from the CFTC. To the extent that any of our subsidiaries may be deemed to be a commodity pool, we believe they should satisfy certain exemptions to these rules available to privately offered entities. However, if the CFTC were to take the position that KKR Financial Holdings LLC is a commodity pool, our directors may be required to register as commodity pool
operators. Such registration would add to our operating and compliance costs and could affect the manner in which we use swaps as part of our operating and hedging strategies.