NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Portman Ridge Finance Corporation (“Portman
Ridge” or the “Company”), formerly known as KCAP Financial, Inc., is an externally managed, non-diversified closed-end
investment company that has elected to be regulated as a business development company (“BDC”) under the Investment
Company Act of 1940, as amended (the “1940 Act”). The Company was formed as a Delaware limited liability company on
August 8, 2006 and, prior to the issuance of shares of the Company’s common stock in its initial public offering (“IPO”),
converted to a corporation incorporated in Delaware on December 11, 2006.
During the third quarter of 2017, the Company
formed a joint venture with Freedom 3 Opportunities LLC (“Freedom 3 Opportunities”), an affiliate of Freedom 3 Capital
LLC, to create KCAP Freedom 3 LLC (the "Joint Venture"). The Company and Freedom 3 Opportunities LLC contributed approximately
$37 million and $25 million, respectively, in assets to the Joint Venture, which in turn used the assets to capitalize a new fund
(KCAP FC3 Senior Funding, L.L.C. or the "Fund") managed by KCAP Management, LLC, one of the Company's indirectly wholly-owned
Asset Manager Affiliate subsidiaries. In addition, the Fund used cash on hand and borrowings under a credit facility to purchase
approximately $184 million of loans from the Company and the Company used the proceeds from such sale to redeem approximately $147
million in debt issued by KCAP Senior Funding. The Joint Venture may originate loans from time to time and sell them to the Fund.
During the fourth quarter of 2017, the Fund
was refinanced through the issuance of senior and subordinated notes. The Joint Venture purchased 100% of the subordinated notes
issued by the Fund. In connection with the refinancing, the Company received a cash distribution of $12.6 million, $11.8
million of which was a return of capital.
The Company originates, structures, and invests
in secured term loans, bonds or notes and mezzanine debt primarily in privately-held middle market companies but may also invest
in other investments such as loans to publicly-traded companies, high-yield bonds, and distressed debt securities (collectively
the “Debt Securities Portfolio”). The Company also invests in joint ventures and debt and subordinated securities issued
by collateralized loan obligation funds (“CLO Fund Securities”). In addition, from time to time the Company may invest
in the equity securities of privately held middle market companies and may also receive warrants or options to purchase common
stock in connection with its debt investments.
The Company has elected to be treated
and intends to continue to qualify as a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue
Code of 1986, as amended (the “Code”). To qualify as a RIC, the Company must, among other things, meet certain source-of-income,
and asset diversification and annual distribution requirements. As a RIC, the Company generally will not have to pay corporate-level
U.S. federal income taxes on any income that it distributes in a timely manner to its stockholders.
On
March 29, 2018, the Company’s Board of Directors, including a “required majority” (as such term is defined
in Section 57(o) of the 1940 Act) of the Board, approved the modified asset coverage requirements set forth in
Section 61(a)(2) of the 1940 Act, as amended by the Small Business Credit Availability Act (“SBCA”). As a
result, the Company’s asset coverage requirement for senior securities changed from 200% to 150%, effective as of March
29, 2019. However, despite the SBCA, we will continue to be prohibited by the indentures governing our 6.125% Notes (each, as
defined and discussed in Note 6 - “Borrowings” below) from making distributions on our common stock if our asset
coverage, as defined in the 1940 Act, falls below 200%. In any such event, we would be prohibited from making distributions
required in order to maintain our status as a RIC.
LibreMax Transaction
On November 8, 2018, the Company entered
into an agreement with LibreMax Intermediate Holdings, LP (“LibreMax”) under which Commodore Holdings, LLC (“Commodore”),
a wholly-owned subsidiary of the Company, sold the Company’s wholly-owned asset manager subsidiaries Katonah Debt Advisors,
LLC (“Katonah Debt Advisors”), Trimaran Advisors, L.L.C. (“Trimaran Advisors”), and Trimaran Advisors Management,
L.L.C. (“Trimaran Advisors Management” and, together with Katonah Debt Advisors and Trimaran Advisors, the “Disposed
Manager Affiliates”), for a cash purchase price of approximately $37.9 million (the “LibreMax Transaction”).
The LibreMax Transaction closed on December 31, 2018. As of March 31, 2019, the Company’s remaining wholly-owned asset management
subsidiaries (the “Asset Manager Affiliates”) were comprised of Commodore, Katonah Management Holdings, LLC, Katonah
X Management LLC, Katonah 2007-1 Management, LLC and KCAP Management, LLC. Prior to their sale in the LibreMax Transaction, the
Disposed Manager Affiliates represented substantially all of the Company’s investment in the Asset Manager Affiliates.
The Externalization Agreement
On December 14, 2018, the Company entered
into a stock purchase and transaction agreement (the “Externalization Agreement”) with BC Partners Advisors L.P. (“BCP”),
an affiliate of BC Partners, through which Sierra Crest Investment Management LLC (the “Adviser”), an affiliate of
BC Partners LLP (“BC Partners”), became the Company’s investment adviser pursuant to an investment advisory Agreement
(the “Advisory Agreement”) with the Company. At a special meeting of the Company’s stockholders (the “Special
Meeting”) held on February 19, 2019, the Company’s stockholders approved the Advisory Agreement. The transactions contemplated
by the Externalization Agreement closed on April 1, 2019 (the “Closing”), and the Company commenced operations as an
externally managed BDC managed by the Adviser on that date.
Pursuant to the Externalization Agreement
with BCP, the Adviser became the Company’s investment adviser in exchange for a cash payment from BCP, or its affiliate,
of $25 million, or $0.669672 per share of the Company’s common stock, directly to the Company’s stockholders. In addition,
the Adviser (or its affiliate) will use up to $10 million of the incentive fee actually paid to the Adviser prior to the second
anniversary of the Closing to buy newly issued shares of the Company’s common stock at the most recently determined net asset
value per share of the Company’s common stock at the time of such purchase. For the period of one year from the first day
of the first quarter following the quarter in which the Closing occurred, the Adviser will permanently forego up to the full amount
of the incentive fees earned by the Adviser without recourse against or reimbursement by the Company, to the extent necessary in
order to achieve aggregate net investment income per common share of the Company for such one-year period to be at least equal
to $0.40 per share, subject to certain adjustments.
On the date of the Closing, the Company
changed its name from KCAP Financial, Inc. to Portman Ridge Finance Corporation and on April 2, 2019, began trading on the NASDAQ
Global Select Market under the symbol “PTMN.”
On April 1, 2019, in connection with the Closing, all of the
Company’s then-current directors resigned from their positions on the Board, with the exceptions of Dean Kehler and Christopher
Lacovara. Prior to their resignations, the Board approved an increase in the size of the Board from seven members to eight members
and appointed the following new individuals to serve on the Board: Graeme Dell; Alexander Duka; Ted Goldthorpe; George Grunebaum;
David Moffitt; and Robert Warshauer. Additionally, in connection with the Closing all of the Company’s then-current officers
resigned from their positions with the exceptions of Edward Gilpin and Daniel Gilligan. Effective as of the Closing, Ted Goldthorpe
was appointed as President and Chief Executive Officer and Patrick Schafer was appointed as Chief Investment Officer of the Company.
About the Adviser
The Adviser is an affiliate of BC Partners.
LibreMax owns a minority stake in the Adviser. Subject to the overall supervision of the Board, the Adviser is responsible for
managing the Company’s business and activities, including sourcing investment opportunities, conducting research, performing
diligence on potential investments, structuring the Company’s investments, and monitoring the Company’s portfolio companies
on an ongoing basis through a team of investment professionals.
The Adviser seeks to invest on behalf of
the Company in performing, well-established middle market businesses that operate across a wide range of industries (i.e., no concentration
in any one industry). The Adviser employs fundamental credit analysis, targeting investments in businesses with relatively low
levels of cyclicality and operating risk. The holding size of each position will generally be dependent upon a number of factors
including total facility size, pricing and structure, and the number of other lenders in the facility. The Adviser has experience
managing levered vehicles, both public and private, and seeks to enhance the Company’s returns through the use of leverage
with a prudent approach that prioritizes capital preservation. The Adviser believes this strategy and approach offers attractive
risk/return with lower volatility given the potential for fewer defaults and greater resilience through market cycles.
The Adviser is affiliated with BC Partners,
a leading buyout firm with a 30-year history investing across Europe and North America which has more than $24 billion in assets
under management in private equity, private credit and real estate strategies. The assets under management for BC Partners are
based on actively managed commitments of its managed funds and relevant vehicles formed for the purpose of co-investing alongside
such funds. BC Partners operates a private equity investment platform (“BCP PE”) a credit investment platform (“BCP
Credit”) and a real estate investment platform (“BCP RE”) as fully integrated businesses. The investment activity
of the Company will take place primarily within the BCP Credit platform. Integration with the broader BC Partners platform allows
BCP Credit to leverage a team of investment professionals across its private equity platform including its operations team. The
BCP Credit Investment Team (the “Investment Team”) is led by Ted Goldthorpe who sits on both the BCP Credit and BCP
PE investment committees. BCP Credit currently manages a private fund in the BCP Credit platform along with several separate managed
accounts focused on credit investments and BC Partners Lending Corporation, a private BDC.
Advisory Agreement
The Adviser provides
management services to the Company pursuant to the Advisory Agreement. Under the terms of the Advisory Agreement, the Adviser is
responsible for the following:
|
•
|
managing the Company’s
assets in accordance with our investment objective, policies and restrictions;
|
|
•
|
determining the composition
of the Company’s portfolio, the nature and timing of the changes to the portfolio and the manner of implementing such changes;
|
|
•
|
identifying, evaluating
and negotiating the structure of the Company’s investments;
|
|
•
|
monitoring the Company’s
investments;
|
|
•
|
determining the securities
and other assets that the Company will purchase, retain or sell;
|
|
•
|
assisting the Board with
its valuation of the Company’s assets;
|
|
•
|
directing investment professionals
of the Adviser to provide managerial assistance to the Company’s portfolio companies;
|
|
•
|
performing due diligence
on prospective portfolio companies;
|
|
•
|
exercising voting rights
in respect of portfolio securities and other investments for the Company;
|
|
•
|
serving on, and exercising
observer rights for, boards of directors and similar committees of our portfolio companies; and
|
|
•
|
providing the Company with
such other investment advisory, research and related services as we may, from time to time, reasonably require for the investment
of capital.
|
The Adviser’s
services under the Advisory Agreement are not exclusive, and it is free to furnish similar services to other entities so long as
its services to us are not impaired.
Term
On April 1,
2019, the Company entered into the Advisory Agreement with the Adviser. Unless earlier terminated as described below, the Investment
Advisory Agreement will remain in effect until April 1, 2021, a period of two years from the date it first became effective
and will remain in effect from year-to-year thereafter if approved annually by a majority of the Board or by the
holders of a majority of the outstanding shares, and, in each case, a majority of the independent directors.
The Advisory
Agreement will automatically terminate within the meaning of the 1940 Act and related Securities and Exchange Commission (“SEC”)
guidance and interpretations in the event of its assignment. In accordance with the 1940 Act, without payment of any penalty, we
may terminate the Advisory Agreement with the Adviser upon 60 days’ written notice. The decision to terminate the agreement
may be made by a majority of the Board or the stockholders holding a majority of the outstanding shares of our common stock. See “Advisory
Agreement—Removal of Adviser” below. In addition, without payment of any penalty, the Adviser may generally
terminate the Advisory Agreement upon 60 days’ written notice and, in certain circumstances, the Adviser may only be able
to terminate the Advisory Agreement upon 120 days’ written notice.
Removal
of Adviser
The Adviser may
be removed by the Board or by the affirmative vote of a Majority of the Outstanding Shares. “Majority of the Outstanding
Shares” means the lesser of (1) 67% or more of the outstanding shares of our common stock present at a meeting, if the holders
of more than 50% of the outstanding shares of our common stock are present or represented by proxy or (2) a majority of outstanding
shares of our common stock.
Compensation
of Adviser
Pursuant
to the terms of the Advisory Agreement, the Company pays the Adviser (i) a base management fee (the “
Base
Management Fee
”) and (ii) an incentive fee (the “
Incentive Fee
”).
For the period from the date of the Advisory Agreement (the “
Effective Date
”)
through the end of the first calendar quarter after the Effective Date, the Base Management Fee will be calculated at an annual
rate of 1.50% of the Company’s gross assets, excluding cash and cash equivalents, but including assets purchased with borrowed
amounts, as of the end of such calendar quarter. Subsequently, the Base Management Fee will be 1.50% of the Company’s
average gross assets, excluding cash and cash equivalents, but including assets purchased with borrowed amounts, at the end of
the two most recently completed calendar quarters; provided, however, that the Base Management Fee will be 1.00% of the Company’s
average gross assets, excluding cash and cash equivalents, but including assets purchased with borrowed amounts, that exceed the
product of (i) 200% and (ii) the value of the Company’s net asset value at the end of the most recently completed calendar
quarter. The Incentive Fee consists of two parts: (1) a portion based on the Company’s pre-incentive fee net investment
income (the “Income-Based Fee”) and (2) a portion based on the net capital gains received on the Company’s
portfolio of securities on a cumulative basis for each calendar year, net of all realized capital losses and all unrealized capital
depreciation on a cumulative basis, in each case calculated from the Effective Date, less the aggregate amount of any previously
paid capital gains Incentive Fee (the “Capital Gains Fee”). The Income-Based Fee is 17.50% of pre-incentive fee net
investment income with a 7.00% hurdle rate. The Capital Gains Fee is 17.50%.
Pre-incentive fee net
investment income means dividends (including reinvested dividends), interest and fee income accrued by the Company during the calendar
quarter, minus operating expenses for the quarter (including the management fee, expenses payable under the administration agreement,
and any interest expense and dividends paid on any issued and outstanding preferred stock, but excluding the incentive fee). Pre-incentive fee
net investment income includes, in the case of investments with a deferred interest feature (such as original issue discount, debt
instruments with payment-in-kind(“PIK”) interest and zero coupon securities), accrued income that the Company
may not have received in cash. The Adviser is not obligated to return the incentive fee it receives on PIK interest that is later
determined to be uncollectible in cash. Pre-incentive fee
net investment income does not include any realized capital gains, realized capital losses or unrealized capital appreciation or
depreciation.
To determine
the income incentive fee, pre-incentive fee net investment income is expressed as a rate of return on the value
of our net assets at the end of the immediately preceding calendar quarter. Because of the structure of the incentive fee, it is
possible that
the Company
may pay an incentive fee in a calendar quarter in which
the Company
incurs a loss. For example, if the Company receives pre-incentive fee net
investment income in excess of the quarterly hurdle rate, the Company will pay the applicable incentive fee even if the Company
has incurred a loss in that calendar quarter due to realized capital losses and unrealized capital depreciation. In addition, because
the quarterly hurdle rate is calculated based on our net assets, decreases in the Company’s net assets due to realized capital
losses or unrealized capital depreciation in any given calendar quarter may increase the likelihood that the hurdle rate is reached
and therefore the likelihood of
the Company
paying an incentive fee for the subsequent
quarter.
The Company’s
net investment income used to calculate this component
of the incentive fee is also included in the amount of the Company’s gross assets used to calculate the management fee because
gross assets are total assets (including cash received) before deducting liabilities (such as declared dividend payments).
The second component
of the incentive fee, the capital gains incentive fee, payable at the end of each calendar year in arrears, equals 17.50% of cumulative
realized capital gains through the end of such calendar year commencing with the calendar year ending December 31, 2019, computed
net of all realized capital losses and unrealized capital depreciation on a cumulative basis, in each case calculated from the
Effective Date, less the aggregate amount of any previously paid capital gains incentive fee for prior periods.
The
Company
will accrue, but will not pay, a capital gains incentive fee with respect to unrealized appreciation because a capital
gains incentive fee would be owed to the Adviser if
the Company
were to sell the relevant
investment and realize a capital gain. In no event will the capital gains incentive fee payable pursuant to the Investment Advisory
Agreement be in excess of the amount permitted by the Investment Advisers Act of 1940, as amended (the “Advisers Act”)
including Section 205 thereof.
The fees that
are payable under the Investment Advisory Agreement for any partial period will be appropriately prorated.
Limitations
of Liability and Indemnification
Under the Advisory
Agreement, the Adviser, its officers, managers, partners, agents, employees, controlling persons, members and any other person
or entity affiliated with the Adviser, including without limitation its managing member, will not be liable to
the
Company
for acts or omissions performed in accordance with and pursuant to the Advisory Agreement, except those resulting
from acts constituting criminal conduct, gross negligence, willful misfeasance, bad faith or reckless disregard of the duties that
the Adviser owes to
the Company
under the Advisory Agreement. In addition, as part
of the Advisory Agreement,
the Company
has agreed to indemnify the Adviser and each
of its officers, managers, partners, agents, employees, controlling persons, members and any other person or entity affiliated
with the Adviser, including without limitation its general partner, and the Administrator from and against any damages, liabilities,
costs and expenses, including reasonable legal fees and other expenses reasonably incurred, in or by reason of any pending, threatened
or completed action, suit, investigation or other proceeding (including an action or suit by or in the right of the Company or
its security holders) arising out of or otherwise based upon the performance of any of the Adviser’s duties or obligations
under the Advisory Agreement or otherwise as an investment adviser of the Company, except where attributable to criminal conduct,
gross negligence, willful misfeasance, bad faith or reckless disregard of such person’s duties under the Advisory Agreement.
Board Approval
of the Advisory Agreement
On December 12,
2018, the then-current Board of the Company held an in-person meeting to consider and approve the Advisory
Agreement and related matters. The Board of Directors was provided the information required to consider the Advisory Agreement,
including: (a) the nature, quality and extent of the advisory and other services to be provided to
the
Company
by the Adviser; (b) comparative data with respect to advisory fees or similar expenses paid by other BDCs with
similar investment objectives; (c)
the Company
projected operating expenses and
expense ratio compared to BDCs with similar investment objectives; (d) any existing and potential sources of indirect income
to the Adviser from its relationship with
the Company
and the profitability of that
relationship; (e) information about the services to be performed and the personnel performing such services under the Advisory
Agreement; (f) the organizational capability and financial condition of the Adviser and its affiliates; (g) the Adviser’s
practices regarding the selection and compensation of brokers that may execute our portfolio transactions and the brokers’
provision of brokerage and research services to the Adviser; and (h) the possibility of obtaining similar services from other
third-party service providers or continuing to operate as an internally managed BDC.
The Board of
Directors, including a majority of independent directors, will oversee and monitor
the Company’s
investment performance and, beginning with the second anniversary of the effective date of the Advisory Agreement, will annually
review the compensation we pay to the Adviser.
Administration Agreement
Under the terms
of the administration agreement (the “Administration Agreement”) between the Company and BC Partners Management LLC
(the “Administrator”), the Administrator will perform, or oversee the performance of, required administrative services,
which includes providing office space, equipment and office services, maintaining financial records, preparing reports to stockholders
and reports filed with the SEC, and managing the payment of expenses and the performance of administrative and professional services
rendered by others.
The Company
will reimburse the Administrator for services performed
for us pursuant to the terms of the Administration Agreement. In addition, pursuant to the terms of the Administration Agreement,
the Administrator may delegate its obligations under the Administration Agreement to an affiliate or to a third party and
the
Company
will reimburse the Administrator for any services performed for it by such affiliate or third party.
Payments under
the Administration Agreement are equal to an amount that reimburses the Administrator for its costs and expenses in performing
its obligations and providing personnel and facilities (including rent, office equipment and utilities) for the Company’s
use under the Administration Agreement, including an allocable portion of the compensation paid to
the
Company’s
chief compliance officer and chief financial officer and their respective staff who provide services to
the Company
. The Board, including the independent directors, will review the general
nature of the services provided by the Administrator as well as the related cost to the Company for those services and consider
whether the cost is reasonable in light of the services provided.
On April 1,
2019, the Board approved the Administration Agreement with the Administrator. Unless earlier terminated as described below, the
Administration Agreement will remain in effect until April 1, 2021, a period of two years from the date it first became effective
and will remain in effect from year-to-year thereafter if approved annually by a majority of the Board or by
the holders of a Majority of the Outstanding Shares, and, in each case, a majority of the independent directors.
The
Company
may terminate the Administration Agreement, without payment of any penalty, upon 60 days’ written notice.
The decision to terminate the agreement may be made by a majority of the Board or the stockholders holding a Majority of the Outstanding
Shares. In addition, the Adviser may terminate the Administration Agreement, without payment of any penalty, upon 60 days’
written notice.
Payment of Our Expenses under the
Advisory and Administration Agreements
Except as specifically
provided below,
the Company
anticipates that all investment professionals and staffs
of the Adviser, when and to the extent engaged in providing investment advisory and management services to
the
Company
, and the compensation and routine overhead expenses (including rent, office equipment and utilities), of such personnel
allocable to such services, will be provided and paid for by the Adviser.
The Company
will bear an allocable portion of the compensation paid by the Adviser (or its affiliates) to the Company’s chief compliance
officer and chief financial officer and their respective staffs (based on a percentage of time such individuals devote, on an estimated
basis, to our business affairs).
The Company
will also bear all other costs and expenses
of our operations, administration and transactions, including, but not limited to (i) investment advisory fees, including
management fees and incentive fees, to the Adviser, pursuant to the Advisory Agreement; (ii) an allocable portion of overhead
and other expenses incurred by the Adviser (or its affiliates) in performing its administrative obligations under the Advisory
Agreement, and (iii) all other expenses of our operations and transactions including, without limitation, those relating to:
|
•
|
the cost of calculating
the Company’s
net asset value, including the cost of any third-party valuation
services;
|
|
•
|
the cost of effecting any
sales and repurchases of
the Company’s
common stock and other securities;
|
|
•
|
fees and expenses payable
under any dealer manager or placement agent agreements, if any;
|
|
•
|
administration fees payable
under the Administration Agreement and any sub-administration agreements, including related expenses;
|
|
•
|
debt service and other
costs of borrowings or other financing arrangements;
|
|
•
|
expenses, including travel
expense, incurred by the Adviser, or members of the investment team, or payable to third parties, performing due diligence on
prospective portfolio companies and, if necessary, enforcing our rights;
|
|
•
|
transfer agent and custodial
fees;
|
|
•
|
fees and expenses associated
with marketing efforts;
|
|
•
|
federal and state registration
fees, any stock exchange listing fees and fees payable to rating agencies;
|
|
•
|
federal, state and local
taxes;
|
|
•
|
independent directors’
fees and expenses including certain travel expenses;
|
|
•
|
costs of preparing financial
statements and maintaining books and records and filing reports or other documents with the SEC (or other regulatory bodies) and
other reporting and compliance costs, including registration and listing fees, and the compensation of professionals responsible
for the preparation of the foregoing;
|
|
•
|
the costs of any reports,
proxy statements or other notices to stockholders (including printing and mailing costs), the costs of any stockholder or director
meetings and the compensation of personnel responsible for the preparation of the foregoing and related matters;
|
|
•
|
commissions and other compensation
payable to brokers or dealers;
|
|
•
|
research and market data;
|
|
•
|
fidelity bond, directors
and officers errors and omissions liability insurance and other insurance premiums;
|
|
•
|
direct costs and expenses
of administration, including printing, mailing, long distance telephone and staff;
|
|
•
|
fees and expenses associated
with independent audits, outside legal and consulting costs;
|
|
•
|
costs of winding up our
affairs;
|
|
•
|
costs incurred by either
the Administrator or us in connection with administering our business, including payments under the Administration Agreement;
|
|
•
|
extraordinary expenses
(such as litigation or indemnification); and
|
|
•
|
costs associated with reporting
and compliance obligations under the 1940 Act and applicable federal and state securities laws.
|
|
2.
|
SIGNIFICANT ACCOUNTING POLICIES
|
Basis of Presentation
The accompanying unaudited consolidated financial
statements have been prepared on the accrual basis of accounting in conformity with U.S. generally accepted accounting principles
(“GAAP”) for interim financial information. Accordingly, they do not include all of the information and footnotes required
for annual consolidated financial statements. The unaudited interim consolidated financial statements and notes thereto should
be read in conjunction with the financial statements and notes thereto in the Company’s Form 10-K for the year ended December
31, 2018, as filed with the U.S. Securities and Exchange Commission (the “Commission” or the “SEC”).
The consolidated financial statements reflect
all adjustments, both normal and recurring which, in the opinion of management, are necessary for the fair presentation of the
Company’s results of operations and financial condition for the periods presented. Furthermore, the preparation of the consolidated
financial statements requires the Company to make significant estimates and assumptions including with respect to the fair value
of investments that do not have a readily available market value. Actual results could differ from those estimates, and the differences
could be material. The results of operations for the interim periods presented are not necessarily indicative of the operating
results to be expected for the full year. Certain prior period amounts have been reclassified to conform to the current year presentation.
The Company consolidates the financial
statements of its wholly-owned special purpose financing subsidiaries Great Lakes KCAP Funding I LLC, Kolhberg Capital Funding
LLC I, KCAP Senior Funding I, LLC and KCAP Funding I Holdings, LLC in its consolidated financial statements as they are operated
solely for investment activities of the Company. The creditors of KCAP Senior Funding I, LLC received security interests in the
assets which are owned by Great Lakes KCAP Funding I, LLC and such assets are not intended to be available to the creditors of
KCAP Financial, Inc., or any other affiliate. All of the borrowings of Kolhberg Capital Funding LLC I, and KCAP Senior Funding
I, LLC have been fully repaid.
In accordance with Article 6 of Regulation
S-X under the Securities Act of 1933, as amended (the “Securities Act”), and the Securities Exchange Act of 1934,
as amended (the “Exchange Act”), the Company does not consolidate portfolio company investments, including those in
which it has a controlling interest (e.g., the Asset Manager Affiliates), unless the portfolio company is another investment company.
The Asset Manager Affiliates
previously qualified as a “significant subsidiary” and, as a result, the Company is required to include
additional financial information regarding the Asset Manager Affiliates in its filings with the SEC. This additional
financial information regarding the Asset Manager Affiliates does not directly impact the financial position or results of
operations of the Company. Summarized financial information regarding the Asset Manager Affiliates is set forth in Note 5 to
these financial statements.
The determination of the tax character of
distributions is made on an annual (full calendar-year) basis at the end of the year based upon our taxable income for the full
year and the distributions paid during the full year. Therefore, an estimate of tax attributes made on a quarterly basis may not
be representative of the actual tax attributes of distributions for a full year.
It is the Company’s primary investment
objective to generate current income and capital appreciation by lending directly to privately-held middle market companies. During
the quarter ended March 31, 2019, the Company provided approximately $35.2 million to portfolio companies to support their growth
objectives. Approximately $2.7 million of this support was contractually obligated. See also Note 8 – Commitments and Contingencies.
As of March 31, 2019, the Company held loans it has made to 51 investee companies with aggregate principal amounts of approximately
$165.7 million. The details of such loans have been disclosed on the consolidated schedule of investments as well as in Note 4
– Investments. In addition to providing loans to investee companies, from time to time the Company assists investee companies
in securing financing from other sources by introducing such investee companies to sponsors or by, among other things, leading
a syndicate of lenders to provide the investee companies with financing. During the three months month period ended March 31, 2019,
the Company did not engage in any such or similar activities.
Recently adopted accounting pronouncements
In March 2017, the FASB issued an Accounting
Standards Update, ASU 2017-08, Receivables — Nonrefundable Fees and Other Costs (Subtopic 310-20), Premium Amortization on
Purchased Callable Debt Securities (“ASU 2017-08”) which amends the amortization period for certain purchased callable
debt securities held at a premium, shortening such period to the earliest call date. ASU 2017-08 does not require any accounting
change for debt securities held at a discount; the discount continues to be amortized to maturity. ASU 2017-08 is effective for
fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The adoption of ASU 2017-08 did
not have a material impact on the financial position or results of operations of the Company.
In February 2016, the FASB issued ASU 2016-02,
Leases, and several amendments (collectively, “ASU 2016-02”), which requires lessees to recognize assets and liabilities
arising from most operating leases on the consolidated statements of financial condition. For operating leases, a lessee is required
to do the following: (a) recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease
payments, in the statement of financial condition; (b) recognize a single lease cost, calculated so that the cost of the lease
is allocated over the lease term on a generally straight-line basis and (c) classify all cash payments within operating activities
in the statement of cash flows. The guidance is effective for fiscal periods beginning after December 15, 2018. Early application
is permitted. The Company recorded a right of use asset (net of previously deferred rent expense) of approximately $3.3 million
and a lease liability of approximately $3.7 million upon adoption of this standard.
Pending Accounting Pronouncements
In August 2018, the FASB issued Accounting
Standards Update 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements
for Fair Value Measurement (“ASU 2018-13”)
.
The standard will modify the disclosure requirements for fair
value measurements by removing, modifying, or adding certain disclosures. ASU 2018-13 is effective for annual reporting periods
beginning after December 15, 2019, including interim periods within that reporting period. Early adoption is permitted upon issuance
of this ASU 2018-13. We are permitted to early adopt any removed or modified disclosures upon issuance of ASU 2018-13 and delay
adoption of the additional disclosures until their effective date. We are currently evaluating the impact of adopting ASU 2018-13
on our consolidated financial statements.
Investments
Investment transactions are recorded on the
applicable trade date. Realized gains or losses are determined using the specific identification method.
Valuation of Portfolio Investments
.
The Company’s Board of Directors is ultimately and solely responsible for making a good faith determination of the fair value
of portfolio investments on a quarterly basis. Debt and equity securities for which market quotations are readily available are
generally valued at such market quotations. Debt and equity securities that are not publicly traded or whose market price is not
readily available are valued by the Board of Directors based on detailed analyses prepared by management and, in certain circumstances,
third parties with valuation expertise. Valuations are conducted by management on 100% of the investment portfolio at the end of
each quarter. The Company follows the provisions of ASC 820: Fair Value Measurements and Disclosures (“ASC 820: Fair Value”).
This standard defines fair value, establishes a framework for measuring fair value, and expands disclosures about assets and liabilities
measured at fair value. ASC 820: Fair Value defines “fair value” as the price that would be received to sell an asset
or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
The Company utilizes an independent valuation
firm to provide third party valuation consulting services. Each quarter the independent valuation firm will perform
third party valuations of the Company’s investments in material illiquid securities such that they are reviewed at least
once during a trailing 12-month period. These third party valuation estimates are considered as one of the relevant
data points in the Company’s determination of fair value. The Company intends to continue to engage an independent valuation
firm in the future to provide certain valuation services, including the review of certain portfolio assets, as part of the quarterly
and annual year-end valuation process.
The Board of Directors may consider other
methods of valuation than those set forth below to determine the fair value of Level III investments as appropriate in conformity
with GAAP. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market
value, the fair value of the Company’s investments may differ materially from the values that would have been used had a
readily available market existed for such investments. Further, such investments may be generally subject to legal and other restrictions
on resale or otherwise be less liquid than publicly traded securities. In addition, changes in the market environment and other
events may occur over the life of the investments that may cause the value realized on such investments to be different from the
currently assigned valuations.
The majority of the Company’s investment
portfolio is composed of debt and equity securities with unique contract terms and conditions and/or complexity that requires a
valuation of each individual investment that considers multiple levels of market and asset specific inputs, which may include historical
and forecasted financial and operational performance of the individual investment, projected cash flows, market multiples, comparable
market transactions, the priority of the security compared with those of other securities for such issuers, credit risk, interest
rates, and independent valuations and reviews.
Debt Securities.
To the extent that
the Company’s investments are exchange traded and are priced or have sufficient price indications from normal course trading
at or around the valuation date (financial reporting date), such pricing will be used to determine the fair value of the investments.
Valuations from third party pricing services may be used as an indication of fair value, depending on the volume and reliability
of the valuation, sufficient and reasonable correlation of bid and ask quotes, and, most importantly, the level of actual trading
activity. However, if the Company has been unable to identify directly comparable market indices or other market guidance that
correlate directly to the types of investments the Company owns, the Company will determine fair value using alternative methodologies
such as available market data, as adjusted, to reflect the types of assets the Company owns, their structure, qualitative and credit
attributes and other asset-specific characteristics.
The Company derives fair value for its illiquid
investments that do not have indicative fair values based upon active trades primarily by using a present value technique that
discounts the estimated contractual cash flows for the subject assets with discount rates imputed by broad market indices, bond
spreads and yields for comparable issuers relative to the subject assets (the “Income Approach”). The Company also
considers, among other things, recent loan amendments or other activity specific to the subject asset. Discount rates applied to
estimated contractual cash flows for an underlying asset vary by specific investment, industry, priority and nature of the debt
security (such as the seniority or security interest of the debt security) and are assessed relative to two indices, a leveraged
loan index and a high-yield bond index, at the valuation date. The Company has identified these two indices as benchmarks for broad
market information related to its loan and debt securities. Because the Company has not identified any market index that directly
correlates to the loan and debt securities held by the Company and therefore uses these benchmark indices, these market indices
may require significant adjustment to better correlate such market data for the calculation of fair value of the investment under
the Income Approach. Such adjustments require judgment and may be material to the calculation of fair value. Further adjustments
to the discount rate may be applied to reflect other market conditions or the perceived credit risk of the borrower. When broad
market indices are used as part of the valuation methodology, their use is subject to adjustment for many factors, including priority,
collateral used as security, structure, performance and other quantitative and qualitative attributes of the asset being valued.
The resulting present value determination is then weighted along with any quotes from observable transactions and broker/pricing
quotes. If such quotes are indicative of actual transactions with reasonable trading volume at or near the valuation date that
are not liquidation or distressed sales, relatively more reliance will be put on such quotes to determine fair value. If such quotes
are not indicative of market transactions or are insufficient as to volume, reliability, consistency or other relevant factors,
such quotes will be compared with other fair value indications and given relatively less weight based on their relevancy. Other
significant assumptions, such as coupon and maturity, are asset-specific and are noted for each investment in the Consolidated
Schedules of Investments.
Equity Securities
. The Company’s
equity securities in portfolio companies for which there is no liquid public market are carried at fair value based on the enterprise
value of the portfolio company, which is determined using various factors, including EBITDA (earnings before interest, taxes, depreciation
and amortization) and discounted cash flows from operations, less capital expenditures and other pertinent factors, such as recent
offers to purchase a portfolio company’s securities or other liquidation events. The determined fair values are generally
discounted to account for restrictions on resale and minority ownership positions. In the event market quotations are readily available
for the Company’s equity securities in public companies, those investments may be valued using the Market Approach (as defined
below). In cases where the Company receives warrants to purchase equity securities, a market standard Black-Scholes model is utilized.
The significant inputs used to determine
the fair value of equity securities include prices, EBITDA and cash flows after capital expenditures for similar peer comparables
and the investment entity itself. Equity securities are classified as Level III, when there is limited activity or less transparency
around inputs to the valuation given the lack of information related to such equity investments held in nonpublic companies. Significant
assumptions observed for comparable companies are applied to relevant financial data for the specific investment. Such assumptions,
such as model discount rates or price/earnings multiples, vary by the specific investment, equity position and industry and incorporate
adjustments for risk premiums, liquidity and company specific attributes. Such adjustments require judgment and may be material
to the calculation of fair value.
Asset Manager Affiliates.
The Company’s
investments in its wholly-owned asset management companies, the Asset Manager Affiliates, are carried at fair value, which is primarily
determined utilizing the discounted cash flow approach, which incorporates different levels of discount rates depending on the
hierarchy of fees earned (including the likelihood of realization of senior, subordinate and incentive fees) and prospective modeled
performance. Such valuation takes into consideration an analysis of comparable asset management companies and the amount of assets
under management. The Asset Manager Affiliates are classified as a Level III investment. Any change in value from period to period
is recognized as net change in unrealized appreciation or depreciation. The Company sold substantially all of its investment in
the Asset Manager Affiliates on December 31, 2018.
CLO Fund Securities.
The Company
typically makes a minority investment in the most junior class of securities of CLO Funds. The investments held by CLO Funds generally
relate to non-investment grade credit instruments issued by corporations.
The Company’s investments in CLO Fund
Securities are carried at fair value, which is based either on (i) the present value of the net expected cash inflows for
interest income and principal repayments from underlying assets and cash outflows for interest expense, debt pay-down and other
fund costs for the CLO Funds that are approaching or past the end of their reinvestment period and therefore are selling assets
and/or using principal repayments to pay down CLO Fund debt (or will begin to do so shortly), and for which there continue to be
net cash distributions to the class of securities owned by the Company, a Discounted Cash Flow approach, (ii) a discounted cash
flow model that utilizes prepayment and loss assumptions based on historical experience and projected performance, economic factors,
the characteristics of the underlying cash flow and comparable yields for similar securities or preferred shares to those in which
the Company has invested, or (iii) indicative prices provided by the underwriters or brokers who arrange CLO Funds, a Market Approach.
The Company recognizes unrealized appreciation or depreciation on the Company’s investments in CLO Fund Securities as comparable
yields in the market change and/or based on changes in net asset values or estimated cash flows resulting from changes in prepayment
or loss assumptions in the underlying collateral pool. As each investment in CLO Fund Securities ages, the expected amount of losses
and the expected timing of recognition of such losses in the underlying collateral pool are updated and the revised cash flows
are used in determining the fair value of the CLO Fund investment. The Company determines the fair value of its investments in
CLO Fund Securities on a security-by-security basis.
Due to the individual attributes of each
CLO Fund Security, they are classified as a Level III investment unless specific trading activity can be identified at or near
the valuation date. When available, observable market information will be identified, evaluated and weighted accordingly in the
application of such data to the present value models and fair value determination. Significant assumptions to the present value
calculations include default rates, recovery rates, prepayment rates, investment/reinvestment rates and spreads and the discount
rate by which to value the resulting underlying cash flows. Such assumptions can vary significantly, depending on market data sources
which often vary in depth and level of analysis, understanding of the CLO market, detailed or broad characterization of the CLO
market and the application of such data to an appropriate framework for analysis. The application of data points are based on the
specific attributes of each individual CLO Fund Security’s underlying assets, historic, current and prospective performance,
vintage, and other quantitative and qualitative factors that would be evaluated by market participants. The Company evaluates the
source of market data for reliability as an indicative market input, consistency amongst other inputs and results and also the
context in which such data is presented.
For rated note tranches of CLO Fund Securities
(those above the junior class) without transactions to support a fair value for the specific CLO Fund and tranche, fair value is
based on discounting estimated bond payments at current market yields, which may reflect the adjusted yield on the leveraged loan
index for similarly rated tranches, as well as prices for similar tranches for other CLO Funds and also other factors such as indicative
prices provided by underwriters or brokers who arrange CLO Funds, and the default and recovery rates of underlying assets in the
CLO Fund, as may be applicable. Such model assumptions may vary and incorporate adjustments for risk premiums and CLO Fund specific
attributes.
Joint Venture
. The Company carries
investments in joint ventures at fair value based upon the fair value of the investments held by the joint venture. See Note 4
below, for more information regarding the Joint Venture.
Cash
. The Company defines cash as
demand deposits. The Company places its cash with financial institutions and, at times, cash held in checking accounts may exceed
the Federal Deposit Insurance Corporation insured limit.
Restricted Cash
. Restricted cash
and cash equivalents (e.g., money market funds) consists of cash held for reinvestment and quarterly interest and principal distribution
(if any) to holders of notes issued by Great Lakes KCAP Funding I, LLC.
Short-term investments
. Short-term
investments are generally comprised of money market accounts, time deposits, and U.S. treasury bills.
Interest Income
. Interest income,
including the amortization of premium and accretion of discount and accrual of payment-in-kind (“PIK”) interest, is
recorded on the accrual basis to the extent that such amounts are expected to be collected. The Company generally places a loan
or security on non-accrual status and ceases recognizing interest income on such loan or security when a loan or security becomes
90 days or more past due or if the Company otherwise does not expect the debtor to be able to service its debt obligations. For
investments with PIK interest, which represents contractual interest accrued and added to the principal balance that generally
becomes due at maturity, we will not accrue PIK interest if the portfolio company valuation indicates that the PIK interest is
not collectible (i.e. via a partial or full non-accrual). Loans which are on partial or full non-accrual remain in such status
until the borrower has demonstrated the ability and intent to pay contractual amounts due or such loans become current. As of March
31, 2019, six of our investments were on non-accrual status.
Distributions from Asset Manager Affiliates.
The Company records distributions from the Asset Manager Affiliates on the declaration date, which represents the ex-dividend date.
Distributions in excess of tax-basis earnings and profits of the distributing affiliate company are recognized as tax-basis return
of capital. For interim periods, the Company estimates the tax attributes of any distributions as being either from tax-basis earnings
and profits (i.e., dividend income) or return of capital (i.e., adjustment to the Company’s cost basis in the Asset Manager
Affiliates). The final determination of the tax attributes of distributions from the Asset Manager Affiliates is made on an annual
(full calendar year) basis at the end of the year based upon taxable income and distributions for the full-year. Therefore, any
estimate of tax attributes of distributions made on a quarterly basis may not be representative of the actual tax attributes of
distributions for a full year.
Investment Income on CLO Fund Securities
.
The Company generates investment income from its investments in the most junior class of securities issued by CLO Funds (typically
preferred shares or subordinated securities). The Company’s CLO Fund junior class securities are subordinated to senior note
holders who typically receive a stated interest rate of return based on a floating rate index, such as the London Interbank Offered
Rate (“LIBOR”) on their investment. The CLO Funds are leveraged funds and any excess cash flow or “excess spread”
(interest earned by the underlying securities in the fund less payments made to senior note holders and less fund expenses and
management fees) is paid to the holders of the CLO Fund’s subordinated securities or preferred shares.
GAAP-basis investment income on CLO equity
investments is recorded using the effective interest method in accordance with the provisions of ASC 325-40, based on the anticipated
yield and the estimated cash flows over the projected life of the investment. Yields are revised when there are changes in actual
or estimated projected future cash flows due to changes in prepayments and/or re-investments, credit losses or asset pricing. Changes
in estimated yield are recognized as an adjustment to the estimated yield prospectively over the remaining life of the investment
from the date the estimated yield was changed. Accordingly, investment income recognized on CLO equity securities in the GAAP statement
of operations differs from both the tax–basis investment income and from the cash distributions actually received by the
Company during the period.
For non-junior class CLO Fund Securities,
such as the Company’s investment in the Class E Notes of the Great Lakes KCAP F3C Senior, LLC, (formerly known as KCAP F3C
Senior Funding, L.L.C.), interest is earned at a fixed spread relative to the LIBOR index.
Investment in Joint Venture
. For
three months ended March 31, 2019 and 2018, the Company recognized $950,000 and $700,000 in investment income from its investment
in the Joint Venture. As of March 31, 2019 and December 31, 2018, the fair value of the Company’s investment in the Joint
Venture was approximately $23.7 million and $18.4 million, respectively. The Company recognizes investment income on its investment
in the Joint Venture based upon its share of the estimated earnings and profits of the Joint Venture. The final determination of
the tax attributes of distributions from the Joint Venture is made on an annual (full calendar year) basis at year-end of the year
based upon taxable income and distributions for the full year. Therefore, any estimate of tax attributes of distributions made
on an interim basis may not be representative of the actual tax attributes of distributions for the full year.
Capital Structuring Service Fees
.
The Company may earn ancillary structuring and other fees related to the origination, investment, disposition or liquidation of
debt and investment securities. Generally, the Company will capitalize loan origination fees, then amortize these fees into interest
income over the term of the loan using the effective interest rate method, recognize prepayment and liquidation fees upon receipt
and equity structuring fees as earned, which generally occurs when an investment transaction closes.
Debt Issuance Costs
. Debt
issuance costs represent fees and other direct costs incurred in connection with the Company’s borrowings. These amounts
are capitalized and amortized using the effective interest method over the expected term of the borrowing.
Extinguishment of debt
. The Company
must derecognize a liability if and only if it has been extinguished through delivery of cash, delivery of other financial assets,
delivery of goods or services, or reacquisition by the Company of its outstanding debt securities whether the securities are cancelled
or held. If the debt contains a cash conversion option, the Company must allocate the consideration transferred and transaction
costs incurred to the extinguishment of the liability component and the reacquisition of the equity component and recognize a gain
or loss in the statement of operations.
Expenses
. During the reporting period
the Company was internally managed and expensed costs, as incurred, with regard to the running of its operations. Primary operating
expenses include employee salaries and benefits, the costs of identifying, evaluating, negotiating, closing, monitoring and servicing
the Company’s investments and related overhead charges and expenses, including rental expense, and any interest expense incurred
in connection with borrowings. Through December 31, 2018, the Company and the Asset Manager Affiliates shared office space and
certain other operating expenses. The Company entered into an Overhead Allocation Agreement with the Asset Manager Affiliates which
provided for the sharing of such expenses based on an allocation of office lease costs and the ratable usage of other shared resources.
Following the Closing, the Company will continue to bear the costs associated with the office lease entered into by the Company
prior to the Closing.
Shareholder Distributions
. Distributions
to common stockholders are recorded on the ex-dividend date. The amount of distributions, if any, is determined by the Board of
Directors each quarter.
The Company has adopted a dividend reinvestment
plan (the DRIP) that provides for reinvestment of its distributions on behalf of its stockholders, unless a stockholder “opts
out” of the DRIP to receive cash in lieu of having their cash distributions automatically reinvested in additional shares
of the Company’s common stock.
|
3.
|
EARNINGS (LOSSES) PER SHARE
|
In accordance with the provisions of ASC 260, “Earnings
per Share” (“ASC 260”), basic earnings per share is computed by dividing earnings available to common shareholders
by the weighted average number of shares outstanding during the period. Other potentially dilutive common shares, and the related
impact to earnings, are considered when calculating earnings per share on a diluted basis.
The following information sets forth the computation of basic
and diluted net increase (decrease) in stockholders’ equity per share for the three months ended March 31, 2019 and 2018:
|
|
(unaudited)
|
|
|
|
Three Months Ended March 31,
|
|
|
|
2019
|
|
|
2018
|
|
|
|
|
|
|
|
|
Net (decrease) increase in net assets resulting from operations
|
|
$
|
(10,917,572
|
)
|
|
$
|
2,609,393
|
|
Net increase in net assets allocated to unvested share awards
|
|
|
—
|
|
|
|
(20,773
|
)
|
|
|
|
|
|
|
|
|
|
Net (decrease) increase in net assets available to common stockholders
|
|
$
|
(10,917,572
|
)
|
|
$
|
2,588,620
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of common and common stock equivalent shares outstanding for diluted shares computation
|
|
|
37,335,094
|
|
|
|
37,350,411
|
|
|
|
|
|
|
|
|
|
|
Net (decrease) increase in net assets per basic common shares:
|
|
|
|
|
|
|
|
|
Net (decrease) increase in net assets from operations
|
|
$
|
(0.29
|
)
|
|
$
|
0.07
|
|
Net (decrease) increase in net assets per diluted shares:
|
|
|
|
|
|
|
|
|
Net (decrease) increase in net assets from operations
|
|
$
|
(0.29
|
)
|
|
$
|
0.07
|
|
Share-based awards that contain non-forfeitable
rights to dividends or dividend equivalents, whether paid or unpaid, are participating securities and included in the computation
of both basic and diluted earnings per share. Grants of restricted stock awards to the Company’s employees and directors
are considered participating securities when there are earnings in the period and the earnings per share calculations include outstanding
unvested restricted stock awards in the basic weighted average shares outstanding calculation.
There were 30,000 and 35,000 options to purchase
shares of common stock considered for the computation of the diluted per share information for the three months ended March 31,
2019 and 2018. Since the effects are anti-dilutive for both periods, the options were not included in the computation. These stock
options were cancelled in connection with the Externalization.
The following table shows the Company’s
portfolio by security type at March 31, 2019 and December 31, 2018:
|
|
March 31, 2019 (unaudited)
|
|
|
December 31, 2018
|
|
Security Type
|
|
Cost/Amortized
Cost
|
|
|
Fair Value
|
|
|
%¹
|
|
|
Cost/Amortized
Cost
|
|
|
Fair Value
|
|
|
%¹
|
|
Short-term investments²
|
|
$
|
44,120,648
|
|
|
$
|
44,120,648
|
|
|
|
16
|
|
|
$
|
44,756,478
|
|
|
$
|
44,756,478
|
|
|
|
17
|
|
Senior Secured Loan
|
|
|
75,534,527
|
|
|
|
73,489,758
|
|
|
|
26
|
|
|
|
86,040,921
|
|
|
|
77,616,209
|
|
|
|
28
|
|
Junior Secured Loan
|
|
|
88,707,755
|
|
|
|
78,249,650
|
|
|
|
28
|
|
|
|
76,223,561
|
|
|
|
70,245,535
|
|
|
|
26
|
|
Senior Unsecured Bond
|
|
|
456,974
|
|
|
|
456,974
|
|
|
|
-
|
|
|
|
|
|
|
|
—
|
|
|
|
—
|
|
CLO Fund Securities
|
|
|
54,299,958
|
|
|
|
45,605,015
|
|
|
|
16
|
|
|
|
55,480,626
|
|
|
|
44,325,000
|
|
|
|
16
|
|
Equity Securities
|
|
|
29,326,114
|
|
|
|
16,835,340
|
|
|
|
6
|
|
|
|
21,944,430
|
|
|
|
14,504,687
|
|
|
|
5
|
|
Asset Manager Affiliates³
|
|
|
17,791,230
|
|
|
|
—
|
|
|
|
—
|
|
|
|
17,791,230
|
|
|
|
3,470,000
|
|
|
|
1
|
|
Joint Venture
|
|
|
24,914,858
|
|
|
|
23,707,969
|
|
|
|
8
|
|
|
|
24,914,858
|
|
|
|
18,390,440
|
|
|
|
7
|
|
Total
|
|
$
|
335,152,064
|
|
|
$
|
282,465,354
|
|
|
|
100
|
%
|
|
$
|
327,152,104
|
|
|
$
|
273,308,349
|
|
|
|
100
|
%
|
|
¹
|
Represents percentage of total portfolio at fair value.
|
|
²
|
Includes money market accounts and U.S. treasury bills.
|
|
³
|
Represents the equity investment in the Asset Manager
Affiliates.
|
The industry concentrations based on the
fair value of the Company’s investment portfolio as of March 31, 2019 and December 31, 2018, were as follows:
|
|
March 31, 2019 (unaudited)
|
|
|
December 31, 2018
|
|
Industry Classification
|
|
Cost/Amortized
Cost
|
|
|
Fair Value
|
|
|
%
1
|
|
|
Cost/Amortized
Cost
|
|
|
Fair Value
|
|
|
%
1
|
|
Aerospace and Defense
|
|
$
|
4,237,732
|
|
|
$
|
4,085,483
|
|
|
|
1
|
%
|
|
$
|
5,434,927
|
|
|
$
|
4,049,940
|
|
|
|
1
|
%
|
Asset Management Company
2
|
|
|
17,791,230
|
|
|
|
—
|
|
|
|
—
|
|
|
|
17,791,230
|
|
|
|
3,470,000
|
|
|
|
1
|
|
Banking, Finance, Insurance & Real Estate
|
|
|
5,878,184
|
|
|
|
5,795,824
|
|
|
|
2
|
|
|
|
8,831,841
|
|
|
|
8,733,933
|
|
|
|
3
|
|
Beverage, Food and Tobacco
|
|
|
5,955,812
|
|
|
|
5,760,262
|
|
|
|
2
|
|
|
|
5,963,334
|
|
|
|
5,796,506
|
|
|
|
2
|
|
Capital Equipment
|
|
|
10,881,878
|
|
|
|
9,712,562
|
|
|
|
3
|
|
|
|
10,888,431
|
|
|
|
9,831,391
|
|
|
|
3
|
|
Chemicals, Plastics and Rubber
|
|
|
4,846,678
|
|
|
|
4,745,681
|
|
|
|
2
|
|
|
|
4,862,063
|
|
|
|
4,801,645
|
|
|
|
1
|
|
CLO Fund Securities
|
|
|
54,299,958
|
|
|
|
45,605,015
|
|
|
|
16
|
|
|
|
55,480,626
|
|
|
|
44,325,000
|
|
|
|
16
|
|
Construction & Building
|
|
|
1,529,905
|
|
|
|
1,524,392
|
|
|
|
1
|
|
|
|
1,400,223
|
|
|
|
1,394,163
|
|
|
|
1
|
|
Consumer goods: Durable
|
|
|
1,189,062
|
|
|
|
4,474
|
|
|
|
—
|
|
|
|
1,140,499
|
|
|
|
364,239
|
|
|
|
—
|
|
Consumer goods: Non-durable
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
1,434,568
|
|
|
|
1,440,525
|
|
|
|
1
|
|
Electronics
|
|
|
6,633,298
|
|
|
|
6,566,000
|
|
|
|
2
|
|
|
|
3,007,500
|
|
|
|
3,007,500
|
|
|
|
1
|
|
Energy: Oil & Gas
|
|
|
9,363,046
|
|
|
|
2,535,933
|
|
|
|
1
|
|
|
|
16,827,204
|
|
|
|
8,946,568
|
|
|
|
3
|
|
Environmental Industries
|
|
|
8,373,619
|
|
|
|
5,840,004
|
|
|
|
2
|
|
|
|
8,371,180
|
|
|
|
6,939,794
|
|
|
|
3
|
|
Forest Products & Paper
|
|
|
1,566,064
|
|
|
|
1,554,077
|
|
|
|
1
|
|
|
|
1,564,583
|
|
|
|
1,553,920
|
|
|
|
1
|
|
Healthcare & Pharmaceuticals
|
|
|
47,334,370
|
|
|
|
37,115,328
|
|
|
|
13
|
|
|
|
38,638,822
|
|
|
|
32,287,288
|
|
|
|
12
|
|
High Tech Industries
|
|
|
24,470,324
|
|
|
|
24,193,533
|
|
|
|
9
|
|
|
|
23,971,434
|
|
|
|
23,662,459
|
|
|
|
9
|
|
Hotel, Gaming & Leisure
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
400,000
|
|
|
|
1,000
|
|
|
|
—
|
|
Joint Venture
|
|
|
24,914,858
|
|
|
|
23,707,969
|
|
|
|
8
|
|
|
|
24,914,858
|
|
|
|
18,390,440
|
|
|
|
7
|
|
Limited Partnership
|
|
|
15,185,556
|
|
|
|
14,966,706
|
|
|
|
5
|
|
|
|
12,466,667
|
|
|
|
12,466,667
|
|
|
|
5
|
|
Media: Advertising, Printing & Publishing
|
|
|
3,152,760
|
|
|
|
2,647,664
|
|
|
|
1
|
|
|
|
6,113,852
|
|
|
|
5,590,863
|
|
|
|
2
|
|
Services: Business
|
|
|
10,325,983
|
|
|
|
9,119,357
|
|
|
|
2
|
|
|
|
10,398,713
|
|
|
|
9,213,417
|
|
|
|
3
|
|
Services: Consumer
|
|
|
10,605,382
|
|
|
|
10,603,568
|
|
|
|
4
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Telecommunications
|
|
|
8,351,914
|
|
|
|
8,322,151
|
|
|
|
3
|
|
|
|
8,351,775
|
|
|
|
8,343,919
|
|
|
|
3
|
|
Textiles and Leather
|
|
|
10,143,234
|
|
|
|
9,938,322
|
|
|
|
4
|
|
|
|
10,140,662
|
|
|
|
9,940,294
|
|
|
|
4
|
|
Money Market Accounts
|
|
|
24,121,903
|
|
|
|
24,121,903
|
|
|
|
9
|
|
|
|
34,757,129
|
|
|
|
34,757,129
|
|
|
|
13
|
|
Transportation: Cargo
|
|
|
4,000,568
|
|
|
|
4,000,400
|
|
|
|
1
|
|
|
|
4,000,634
|
|
|
|
4,000,400
|
|
|
|
1
|
|
U.S. Government Obligations
|
|
|
19,998,746
|
|
|
|
19,998,746
|
|
|
|
7
|
|
|
|
9,999,349
|
|
|
|
9,999,349
|
|
|
|
4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
335,152,064
|
|
|
$
|
282,465,354
|
|
|
|
100
|
%
|
|
$
|
327,152,104
|
|
|
$
|
273,308,349
|
|
|
|
100
|
%
|
|
1
|
Calculated as a percentage of total portfolio at fair value.
|
|
2
|
Represents the equity investment in the Asset Manager Affiliates.
|
The Company may invest up to 30% of the investment
portfolio in “non-qualifying” opportunistic investments, including investments in debt and equity securities of CLO
Funds, distressed debt or debt and equity securities of large cap public companies. Within this 30% of the portfolio, the Company
also may invest in debt of middle market companies located outside of the United States.
At March 31, 2019 and December 31, 2018,
the total amount of non-qualifying assets was approximately 29.7% and 28.0% of total assets, respectively. The majority of non-qualifying
assets were foreign investments which were approximately 16.5% and 16.5%, respectively, of the Company’s total assets (including
the Company’s investments in CLO Funds, which are typically domiciled outside the U.S. and represented approximately 15.6%
and 15.5% of its total assets on such dates, respectively).
Investments in CLO Fund Securities
The Company has made minority investments
in the most junior class of securities (typically preferred shares or subordinated securities) of CLO Funds. These securities also
are entitled to recurring distributions which generally equal the net remaining cash flow of the payments made by the underlying
CLO Fund’s securities less contractual payments to senior bond holders, management fees and CLO Fund expenses. CLO Funds
invest primarily in broadly syndicated non-investment grade loans, high-yield bonds and other credit instruments of corporate issuers.
The underlying assets in each of the CLO Funds in which the Company has an investment are generally diversified secured or unsecured
corporate debt. The CLO Funds are leveraged funds and any excess cash flow or “excess spread” (interest earned by the
underlying securities in the fund less payments made to senior bond holders, fund expenses and management fees) is paid to the
holders of the CLO Fund’s subordinated securities or preferred shares.
On October 31, 2017, the Company purchased
an additional $4.3 million of notional amount of Subordinated Notes issued by Catamaran CLO 2014-1 at a cost of $5.4 million.
In December 2017, the Company purchased
an additional $201,000 of notional amount of Subordinated Notes issued by Catamaran CLO 2013-1 at a cost of $201,000.
In December 2017, the Company sold $5.0 million
par value of the Subordinated Notes of Catamaran CLO 2014-1 for $3.0 million.
In September 2018, the Company purchased
$10 million par value of the Subordinated Notes of Catamaran CLO 2018-1 at a cost of approximately $9.5 million.
In December 2018, the Company received $2.5
million of notional amount of subordinated notes of Catamaran 2013-1 with a fair value of $1.4 million and $3.4 million of notional
amount of subordinated notes of Catamaran 2014-1 with a fair value of $1.9 million, as consideration for the repayment of a portion
of the loans to Trimaran Advisors.
On February 29, 2016, Katonah X CLO Ltd.
was fully liquidated and all of its outstanding obligations were satisfied. The Company received approximately $1.0 million in
connection therewith related to its investment in the subordinated securities issued by Katonah X CLO Ltd. Accordingly, the Company
recorded a realized loss during the first quarter of 2016 of approximately $6.6 million on its investment in Katonah X CLO Ltd.
and a corresponding unrealized gain of the same amount in order to reverse the approximately $6.6 million of previously recorded
unrealized depreciation with respect to the investment.
On December 19, 2017, the Company, in its
capacity as the holder of all of the outstanding preferred shares of Katonah 2007-1 CLO Ltd. (“Katonah 2007-1”), exercised
its right to cause Katonah 2007-1 to redeem all of its outstanding indebtedness through the sale of its investments and otherwise
wind up its business. Katonah 2007-1 was fully liquidated and dissolved in the fourth quarter of 2018. Accordingly, the Company
recorded a realized loss during the fourth quarter of 2018 of approximately $10.1 million on its investment in Katonah 2007-1 and
a corresponding unrealized gain of the same amount in order to reverse the previously recorded unrealized depreciation with respect
to the investment.
Similarly, during the fourth quarter of
2018, each of Grant Grove CLO, Ltd., Trimaran CLO VII, Ltd., and Catamaran CLO 2012-1 Ltd. were fully liquidated and dissolved,
and the Company recorded a realized loss of approximately $6.4 million and a corresponding unrealized gain of the same amount in
order to revere the previously recorded unrealized depreciation with respect to these investments.
In the first quarter of 2019, the Company
sold $2.0 million notional amount of subordinated notes of Catamaran CLO 2014-1 for $800,000.
With the exception of Katonah III,
Ltd., as of December 31, 2018 all of the Company’s investments in CLO Fund securities were making distributions to the
Company.
Affiliate Investments
The following table details investments
in affiliates at March 31, 2019 (unaudited):
|
|
Industry Classification
|
|
Fair Value at
of December
31, 2018
|
|
|
Purchases/
(Sales) of or
Advances/
(Distributions)
|
|
|
Net
Accretion
|
|
|
Transfers
In/(Out) of
Affiliates
|
|
|
Unrealized
Gain/(Loss)
|
|
|
Realized
Gain/(Loss)
|
|
|
Fair Value at
of March 31,
2019
|
|
|
Interest
Income
|
|
|
Dividend
Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset Manager Affiliates
(4)(5)(7)
|
|
Asset Management Company
|
|
$
|
3,470,000
|
|
|
$
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
$
|
(3,470,000
|
)
|
|
$
|
-
|
|
|
$
|
|
|
|
$
|
-
|
|
Great Lakes KCAP F3C Senior, LLC Rated Notes
(2)(4)
|
|
CLO Fund Securities
|
|
|
4,473,840
|
|
|
|
-
|
|
|
|
8,942
|
|
|
|
-
|
|
|
|
(82,569
|
)
|
|
|
-
|
|
|
|
4,400,213
|
|
|
|
123,249
|
|
|
|
|
|
BCP Great Lakes Fund LP
(7)
|
|
Limited Partnership
|
|
|
12,466,667
|
|
|
|
2,718,889
|
|
|
|
.
|
|
|
|
-
|
|
|
|
(218,850
|
)
|
|
|
-
|
|
|
|
14,966,706
|
|
|
|
.
|
|
|
|
-
|
|
KCAP Freedom 3, LLC
(4)(6)
|
|
Joint Venture
|
|
|
18,390,440
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
5,317,529
|
|
|
|
|
|
|
|
23,707,969
|
|
|
|
-
|
|
|
|
950,000
|
|
Tank Partners Holdings, LLC
(4)(5)
|
|
Energy:
Oil & Gas
|
|
|
1,000
|
|
|
|
6,228,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(4,495,095
|
)
|
|
|
(1,165,000
|
)
|
|
|
568,905
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Affiliated Investments
|
|
|
|
$
|
38,801,947
|
|
|
$
|
8,946,889
|
|
|
$
|
8,942
|
|
|
$
|
-
|
|
|
$
|
521
,015
|
|
|
$
|
(4,635,000
|
)
|
|
$
|
43,643,793
|
|
|
$
|
123,249
|
|
|
$
|
950,000
|
|
The following table details investments in affiliates at December
31, 2018:
|
|
Industry Classification
|
|
Fair Value at
of December
31, 2017
|
|
|
Purchases/
(Sales) of or
Advances/
(Distributions)
|
|
|
Net
Accretion
|
|
|
Transfers
In/(Out) of
Affiliates
|
|
|
Unrealized
Gain/(Loss)
|
|
|
Realized
Gain/(Loss)
|
|
|
Fair Value at
of December
31, 2018
|
|
|
Interest
Income
|
|
|
Dividend
Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset Manager Affiliates
(4)(5)(7)
|
|
Asset Management Company
|
|
$
|
38,849,000
|
|
|
$
|
(34,800,000
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(579,000
|
)
|
|
$
|
-
|
|
|
$
|
3,470,000
|
|
|
$
|
|
|
|
$
|
1,246,510
|
|
Trimaran Advisors, LLC Revolving Credit Facility
(4)(5)
|
|
Related Party Loans
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,170,825
|
|
|
|
-
|
|
Trimaran Advisors, LLC Related Party Loan
(4)(5)
|
|
Related Party Loans
|
|
|
8,359,051
|
|
|
|
(8,359,051
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
765,963
|
|
|
|
|
|
Trimaran Advisors, LLC Related Party Loan
(4)(5)
|
|
Related Party Loans
|
|
|
4,418,232
|
|
|
|
(4,418,232
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
229,380
|
|
|
|
|
|
Katonah 2007-I CLO, Ltd.
(1)(2)(3)(4)
|
|
CLO Fund Securities
|
|
|
10,770,486
|
|
|
|
(10,676,556
|
)
|
|
|
271,658
|
|
|
|
-
|
|
|
|
9,754,423
|
|
|
|
(10,120,011
|
)
|
|
|
-
|
|
|
|
271,658
|
|
|
|
-
|
|
Trimaran CLO VII, Ltd.
(1)(2)(3)(4)
|
|
CLO Fund Securities
|
|
|
10,000
|
|
|
|
|
|
|
|
(6,725
|
)
|
|
|
-
|
|
|
|
369,831
|
|
|
|
(373,105
|
)
|
|
|
-
|
|
|
|
(6,725
|
)
|
|
|
-
|
|
Catamaran CLO 2012-1, Ltd.
(1)(2)(3)(4)
|
|
CLO Fund Securities
|
|
|
2,320,783
|
|
|
|
(2,596,571
|
)
|
|
|
264,746
|
|
|
|
-
|
|
|
|
3,527,018
|
|
|
|
(3,515,976
|
)
|
|
|
-
|
|
|
|
264,746
|
|
|
|
-
|
|
Catamaran CLO 2013-1, Ltd.
(1)(2)(4)
|
|
CLO Fund Securities
|
|
|
6,923,699
|
|
|
|
147,497
|
|
|
|
1,213,807
|
|
|
|
(7,016,734
|
)
|
|
|
(1,268,269
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
1,213,807
|
|
|
|
-
|
|
Catamaran CLO 2014-1, Ltd.
(1)(2)(4)
|
|
CLO Fund Securities
|
|
|
8,230,178
|
|
|
|
535,309
|
|
|
|
1,347,240
|
|
|
|
(9,777,251
|
)
|
|
|
(335,476
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
1,347,240
|
|
|
|
-
|
|
Catamaran CLO 2014-2, Ltd.
(1)(2)(4)
|
|
CLO Fund Securities
|
|
|
4,500,962
|
|
|
|
(985,241
|
)
|
|
|
656,919
|
|
|
|
(2,158,200
|
)
|
|
|
(2,014,440
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
656,919
|
|
|
|
-
|
|
Catamaran CLO 2015-1, Ltd.
(1)(2)(4)
|
|
CLO Fund Securities
|
|
|
3,569,600
|
|
|
|
(573,089
|
)
|
|
|
507,789
|
|
|
|
(3,048,696
|
)
|
|
|
(455,604
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
507,789
|
|
|
|
-
|
|
Catamaran CLO 2016-1, Ltd.
(1)(2)(4)
|
|
CLO Fund Securities
|
|
|
8,530,685
|
|
|
|
(1,282,923
|
)
|
|
|
913,272
|
|
|
|
(7,067,073
|
)
|
|
|
(1,093,961
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
913,272
|
|
|
|
-
|
|
Catamaran CLO 2018-1, Ltd.
(1)(2)(4)
|
|
CLO Fund Securities
|
|
|
-
|
|
|
|
9,500,000
|
|
|
|
343,450
|
|
|
|
(8,500,000
|
)
|
|
|
(1,343,450
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
343,450
|
|
|
|
-
|
|
KCAP F3C Senior Funding Rated Notes
(2)(4)
|
|
CLO Fund Securities
|
|
|
4,632,000
|
|
|
|
-
|
|
|
|
37,298
|
|
|
|
-
|
|
|
|
(195,458
|
)
|
|
|
-
|
|
|
|
4,473,840
|
|
|
|
468,755
|
|
|
|
|
|
BCP Great Lakes Fund LP
(7)
|
|
Limited Partnership
|
|
|
-
|
|
|
|
12,466,667
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
12,466,667
|
|
|
|
-
|
|
|
|
-
|
|
KCAP Freedom 3, LLC
(4)(6)
|
|
Joint Venture
|
|
|
21,516,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(3,125,560
|
)
|
|
|
-
|
|
|
|
18,390,440
|
|
|
|
-
|
|
|
|
3,100,000
|
|
Tank Partners Holdings, LLC
(4)(5)
|
|
Unit
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
980,000
|
|
|
|
(979,000
|
)
|
|
|
-
|
|
|
|
1,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Affiliated Investments
|
|
|
|
$
|
122,630,676
|
|
|
$
|
(41,042,190
|
)
|
|
$
|
5,549,454
|
|
|
$
|
(36,587,954
|
)
|
|
$
|
2,261,054
|
|
|
$
|
(14,009,092
|
)
|
|
$
|
38,801,947
|
|
|
$
|
8,147,079
|
|
|
$
|
4,346,510
|
|
|
1
|
Non-U.S. company or principal place of business outside
the U.S.
|
|
2
|
An affiliate CLO Fund managed by an Asset Manager Affiliate
(as such term is defined in the notes to the consolidated financial statements).
|
|
3
|
Notice of redemption has been received for this security.
|
|
4
|
Fair value of this investment was determined using significant
unobservable inputs.
|
|
5
|
Qualified
asset for purposes of section 55(a) of the Investment Company Act of 1940.
|
|
6
|
As
defined in the 1940 Act, the Company is deemed to be both an “Affiliated Person” and has “Control” of
this portfolio company as the Company owns more than 25% of the portfolio company’s outstanding voting securities or has
the power to exercise control over management or policies of such portfolio company (including through a management agreement).
Other than for purposes of the 1940 Act, the Company does not believe that it has control over this portfolio company.
|
|
7
|
As
defined in the 1940 Act, the Company is deemed to be both an “Affiliated Person” and has “Control” of
this portfolio company as the Company owns more than 25% of the portfolio company’s outstanding voting securities or has
the power to exercise control over management or policies of such portfolio company.
|
Investment in Joint Venture:
During the third quarter of 2017, the Company
and Freedom 3 Opportunities LLC (“Freedom 3 Opportunities”), an affiliate of Freedom 3 Capital LLC, entered into an
agreement to create KCAP Freedom 3 LLC (the “Joint Venture”). The Company and Freedom 3 Opportunities contributed approximately
$37 million and $25 million, respectively, in assets to the Joint Venture, which in turn used the assets to capitalize a new fund,
Great Lakes KCAP F3C Senior Funding, L.L.C. (formerly known as KCAP F3C Senior Funding, L.L.C.) (the “Fund”) managed
by KCAP Management, LLC, one of the Asset Manager Affiliates. In addition, the Fund used cash on hand and borrowings under a credit
facility to purchase approximately $184 million of primarily middle-market loans from the Company and the Company used the proceeds
from such sale to redeem approximately $147 million in debt issued by KCAP Senior Funding I, LLC (“KCAP Senior Funding”).
The Fund invests primarily in middle-market loans and the Joint Venture partners may source middle-market loans from time-to-time
for the Fund.
During the fourth quarter of 2017, the
Fund was refinanced through the issuance of senior and subordinated notes. The Joint Venture purchased 100% of the subordinated
notes issued by the Fund. In connection with the refinancing, the Joint Venture made a cash distribution to the Company of approximately
$12.6 million. $11.8 million of this distribution was a return of capital, reducing the cost basis of its investment in the Joint
Venture by that amount. The final determination of the tax attributes of distributions from the Joint Venture is made on an annual
(full calendar year) basis at the end of the year, therefore, any estimate of tax attributes of distributions made on an interim
basis may not be representative of the actual tax attributes of distributions for the full year.
The Company owns a 60% equity investment
in the Joint Venture. The Joint Venture is structured as an unconsolidated Delaware limited liability company. All portfolio and
other material decisions regarding the Joint Venture must be submitted to its board of managers, which is comprised of four members,
two of whom were selected by the Company and two of whom were selected by Freedom 3 Opportunities, and must be approved by at least
one member appointed by the Company and one appointed by Freedom 3 Opportunities. In addition, certain matters may be approved
by the Joint Venture’s investment committee, which is comprised of one member appointed by the Company and one member appointed
by Freedom 3 Opportunities.
In connection with the Externalization,
during the first quarter of 2019, KCAP Management agreed to waive management fees it is otherwise entitled to receive for managing
the Fund. In addition, the Joint Venture was restructured such that the Company is now entitled to receive a preferred distribution
in an amount equal to the fees waived by KCAP Management. The impact of these transactions is a reduction in the fair value of
the Asset Manager Affiliates and increase the fair value of the Company’s investment in the Joint Venture. The reduction
in the fair value of the Asset Manager Affiliates was recognized as a realized loss on the Statement of Operations. The increase
in the fair value of the Company’s investment in the Joint Venture was recognized as an unrealized gain in the Statement
of Operations.
The Company has determined that the Joint
Venture is an investment company under Accounting Standards Codification (“ASC”), Financial Services — Investment
Companies (“ASC 946”), however, in accordance with such guidance, the Company will generally not consolidate its investment
in a company other than a wholly owned investment company subsidiary or a controlled operating company whose business consists
of providing services to the Company. The Company does not consolidate its interest in the Joint Venture because the Company does
not control the Joint Venture due to allocation of the voting rights among the Joint Venture partners.
KCAP Freedom 3 LLC
Summarized Statement of Financial Condition
|
|
As of
|
|
|
As of
|
|
|
|
March 31, 2019
|
|
|
December 31, 2018
|
|
Investment at fair value
|
|
$
|
37,519,094
|
|
|
$
|
32,621,188
|
|
Total Assets
|
|
$
|
37,519,094
|
|
|
$
|
32,621,188
|
|
|
|
|
|
|
|
|
|
|
Total Liabilities
|
|
$
|
1,541,539
|
|
|
$
|
1,970,455
|
|
Total Equity
|
|
|
35,977,555
|
|
|
|
30,650,733
|
|
Total Liabilities and Equity
|
|
$
|
37,519,094
|
|
|
$
|
32,621,188
|
|
KCAP Freedom 3 LLC
Summarized Statement of Operations
|
|
For the three months
ended March 31, 2019
|
|
|
For the three months
ended March 31, 2018
|
|
Investment income
|
|
$
|
1,151,386
|
|
|
$
|
1,195,818
|
|
Operating expenses
|
|
|
17,512
|
|
|
|
21,763
|
|
Net investment income
|
|
|
1,133,874
|
|
|
|
1,174,055
|
|
Unrealized appreciation on investments
|
|
|
5,326,822
|
|
|
|
503,920
|
|
Net income
|
|
$
|
6,460,696
|
|
|
$
|
1,677,975
|
|
KCAP Freedom 3 LLC
Schedule of Investments
March 31, 2019
Portfolio Company
|
|
Investment
|
|
Percentage
Ownership
by Joint
Venture
|
|
|
Amortized Cost
|
|
|
Fair Value
|
|
Great Lakes KCAP F3C Senior, LLC
(1)(2)(3)
|
|
Subordinated Securities, effective interest 11.4%, 12/29 maturity
|
|
|
100.0
|
%
|
|
$
|
42,207,464
|
|
|
$
|
37,519,094
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Investments
|
|
|
|
|
|
|
|
$
|
42,207,464
|
|
|
$
|
37,519,094
|
|
(1) CLO Subordinated Investments are entitled to periodic distributions
which are generally equal to the remaining cash flow of the payments made by the underlying fund’s investments less contractual
payments to debt holders and fund expenses. The estimated annualized effective yield indicated is based upon a current projection
of the amount and timing of these distributions. Such projections are updated on a quarterly basis and the estimated effective
yield is adjusted prospectively.
(2) Fair value of this investment was determined using significant
unobservable inputs, including default rates, prepayment rates, spreads, and the discount rate by which to value the resulting
cash flows.
(3) Formerly known as KCAP F3C Senior Funding, LLC
KCAP Freedom 3 LLC
Schedule of Investments
December 31, 2018
Portfolio Company
|
|
Investment
|
|
Percentage
Ownership
by Joint
Venture
|
|
|
Amortized Cost
|
|
|
Fair Value
|
|
KCAP F3C Senior Funding, LLC
(1)(2)
|
|
Subordinated Securities, effective interest 11.5%, 12/29 maturity
|
|
|
100.0
|
%
|
|
$
|
42,636,380
|
|
|
$
|
32,621,188
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Investments
|
|
|
|
|
|
|
|
$
|
42,636,380
|
|
|
$
|
32,621,188
|
|
(1) CLO Subordinated Investments are entitled to periodic distributions
which are generally equal to the remaining cash flow of the payments made by the underlying fund’s investments less contractual
payments to debt holders and fund expenses. The estimated annualized effective yield indicated is based upon a current projection
of the amount and timing of these distributions. Such projections are updated on a quarterly basis and the estimated effective
yield is adjusted prospectively.
(2) Fair value of this investment was determined using significant
unobservable inputs, including default rates, prepayment rates, spreads, and the discount rate by which to value the resulting
cash flows.
Fair Value Measurements
The Company follows the provisions of
ASC 820: Fair Value, which among other matters, requires enhanced disclosures about investments that are measured and reported
at fair value. This standard defines fair value and establishes a hierarchal disclosure framework which prioritizes and ranks
the level of market price observability used in measuring investments at fair value and expands disclosures about assets and liabilities
measured at fair value. ASC 820: Fair Value defines “fair value” as the price that would be received to sell an asset
or paid to transfer a liability in an orderly transaction between market participants at the measurement date. This fair value
definition focuses on an exit price in the principal, or most advantageous market, and prioritizes, within a measurement of fair
value, the use of market-based inputs (which may be weighted or adjusted for relevance, reliability and specific attributes relative
to the subject investment) over entity-specific inputs. Market price observability is affected by a number of factors, including
the type of investment and the characteristics specific to the investment. Investments with readily available active quoted prices
or for which fair value can be measured from actively quoted prices generally will have a higher degree of market price observability
and a lesser degree of judgment used in measuring fair value.
ASC 820: Fair Value establishes the following
three-level hierarchy, based upon the transparency of inputs to the fair value measurement of an asset or liability as of the measurement
date:
Level I – Unadjusted quoted
prices are available in active markets for identical investments as of the reporting date. The type of investments included in
Level I include listed equities and listed securities. As required by ASC 820: Fair Value, the Company does not adjust the quoted
price for these investments, even in situations where the Company holds a large position and a sale could reasonably affect the
quoted price.
Level II – Pricing inputs
are other than quoted prices in active markets, which are either directly or indirectly observable as of the reporting date. Such
inputs may be quoted prices for similar assets or liabilities, quoted markets that are not active, or other inputs that are observable
or can be corroborated by observable market data for substantially the full character of the financial instrument, or inputs that
are derived principally from, or corroborated by, observable market information. Investments which are generally included in this
category include illiquid debt securities and less liquid, privately held or restricted equity securities for which some level
of recent trading activity has been observed.
Level III – Pricing inputs
are unobservable for the investment and includes situations where there is little, if any, market activity for the investment.
The inputs may be based on the Company’s own assumptions about how market participants would price the asset or liability
or may use Level II inputs, as adjusted, to reflect specific investment attributes relative to a broader market assumption. These
inputs into the determination of fair value may require significant management judgment or estimation. Even if observable market
data for comparable performance or valuation measures (earnings multiples, discount rates, other financial/valuation ratios, etc.)
are available, such investments are grouped as Level III if any significant data point that is not also market observable (private
company earnings, cash flows, etc.) is used in the valuation methodology.
In certain cases, the inputs used to measure
fair value may fall into different levels of the fair value hierarchy. In such cases, an investment’s level within the fair
value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment
of the significance of a particular input to the fair value measurement in its entirety requires judgment, and the Company considers
factors specific to the investment. A majority of the Company’s investments are classified as Level III. The Company evaluates
the source of inputs, including any markets in which its investments are trading, in determining fair value. Inputs that are highly
correlated to the specific investment being valued and those derived from reliable or knowledgeable sources will tend to have a
higher weighting in determining fair value. The Company’s fair value determinations may include factors such as an assessment
of each underlying investment, its current and prospective operating and financial performance, consideration of financing and
sale transactions with third parties, expected cash flows and market-based information, including comparable transactions, performance
factors, and other investment or industry specific market data, among other factors.
The following table summarizes the fair
value of investments by the above ASC 820: Fair Value fair value hierarchy levels as of March 31, 2019 (unaudited) and December
31, 2018, respectively:
|
|
As of March 31, 2019 (unaudited)
|
|
|
|
Level I
|
|
|
Level II
|
|
|
Level III
|
|
|
NAV
|
|
|
Total
|
|
Short Term investments
|
|
$
|
19,998,746
|
|
|
$
|
24,121,902
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
44,120,648
|
|
Debt securities
|
|
|
—
|
|
|
|
36,187,061
|
|
|
|
116,009,321
|
|
|
|
—
|
|
|
|
152,196,382
|
|
CLO Fund securities
|
|
|
—
|
|
|
|
—
|
|
|
|
45,605,015
|
|
|
|
—
|
|
|
|
45,605,015
|
|
Equity securities
|
|
|
—
|
|
|
|
—
|
|
|
|
1,868,634
|
|
|
|
14,966,706
|
|
|
|
16,835,340
|
|
Joint Venture
|
|
|
—
|
|
|
|
—
|
|
|
|
23,707,969
|
|
|
|
—
|
|
|
|
23,707,969
|
|
Total
|
|
$
|
19,998,746
|
|
|
$
|
60,308,963
|
|
|
$
|
187,190,939
|
|
|
$
|
14,966,706
|
|
|
$
|
282,465,354
|
|
|
|
As of December 31, 2018
|
|
|
|
Level I
|
|
|
Level II
|
|
|
Level III
|
|
|
NAV
|
|
|
Total
|
|
Short Term investments
|
|
$
|
9,999,349
|
|
|
$
|
34,757,129
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
44,756,478
|
|
Debt securities
|
|
|
—
|
|
|
|
41,120,073
|
|
|
|
106,741,671
|
|
|
|
—
|
|
|
|
147,861,744
|
|
CLO Fund securities
|
|
|
—
|
|
|
|
—
|
|
|
|
44,325,000
|
|
|
|
—
|
|
|
|
44,325,000
|
|
Equity securities
|
|
|
—
|
|
|
|
—
|
|
|
|
2,038,020
|
|
|
|
12,466,667
|
|
|
|
14,504,687
|
|
Asset Manager Affiliates
|
|
|
—
|
|
|
|
—
|
|
|
|
3,470,000
|
|
|
|
—
|
|
|
|
3,470,000
|
|
Joint Venture
|
|
|
—
|
|
|
|
—
|
|
|
|
18,390,440
|
|
|
|
—
|
|
|
|
18,390,440
|
|
Total
|
|
$
|
9,999,349
|
|
|
$
|
75,877,202
|
|
|
$
|
174,965,131
|
|
|
$
|
12,466,667
|
|
|
$
|
273,308,349
|
|
As a BDC, the Company is required to invest
primarily in the debt and equity of non-public companies for which there is little, if any, market-observable information. As a
result, a significant portion of the Company’s investments at any given time will likely be deemed Level III investments.
Investment values derived by a third party pricing service are generally deemed to be Level III values. For those that have observable
trades, the Company considers them to be Level II.
BCP Great Lakes Partnership LP (the “BCP
Great Lakes Partnership”) has invested in BCP Great Lakes Holdings LP, a vehicle formed as a co-investment vehicle to facilitate
the participation of certain co-investors to invest, directly or indirectly, in Great Lakes Funding LLC. The investment strategy
of BCP Great Lakes Funding, LLC is to underwrite and hold senior, secured unitranche loans made to middle-market companies. The
Company does not pay any advisory fees in connection with its investment in the BCP Great Lakes Partnership.
The fair value of the Company’s investment
in the BCP Great Lakes Partnership at March 31, 2019 and December 31, 2018 was $15.0 million and $12.5 million. Fair value has
been determined utilizing the practical expedient pursuant to ASC 820-10. Pursuant to the terms of the BGP Great Lakes Fund LP
Amended and Restated Exempted Limited Partnership Agreement (the “BCP Great Lakes Partnership Agreement”) , the Company
generally may not sell, exchange, assign, pledge or otherwise transfer its interest, in whole or in part, without the prior written
consent of the General Partner which consent may be given or withheld in its sole and absolute discretion, and may be conditioned
upon repayment of its share of indebtedness incurred by the Partnership.
In March 2019, the Company increased
its aggregate commitment to the BCP Great Lakes Partnership to $50 million, subject to certain limitations (including that
the Company is not obligated to fund capital calls if such funding would cause the Company to be out of compliance with
certain provisions of the Investment Company Act of 1940). As of March 31, 2019 and December 31, 2018, the Company has a
$34.8 million and $12.5 million, respectively unfunded commitment to the BCP Great Lakes Partnership.
Subject to the limitations noted above, values
derived for debt and equity securities using comparable public/private companies generally utilize market-observable data from
such comparables and specific, non-public and non-observable financial measures (such as earnings or cash flows) for the private,
underlying company/issuer. Such non-observable company/issuer data is typically provided on a monthly or quarterly basis, is certified
as correct by the management of the company/issuer and/or audited by an independent accounting firm on an annual basis. Since such
private company/issuer data is not publicly available it is not deemed market-observable data and, as a result, such investment
values are grouped as Level III assets.
Values derived for the Asset Manager Affiliates
using comparable public/private companies utilize market-observable data and specific, non-public and non-observable financial
measures (such as assets under management, historical and prospective earnings) for the Asset Manager Affiliates. The Company recognizes
that comparable asset managers may not be fully comparable to the Asset Manager Affiliates and typically identifies a range of
performance measures and/or adjustments within the comparable population with which to determine value. Since any such ranges and
adjustments are entity specific they are not considered market-observable data and thus require a Level III grouping. Illiquid
investments that have values derived through the use of discounted cash flow models and residual enterprise value models are grouped
as Level III assets.
The Company’s policy for determining
transfers between levels is based solely on the previously defined three-level hierarchy for fair value measurement. Transfers
between the levels of the fair value hierarchy are separately noted in the tables below and the reason for such transfer described
in each table’s respective footnotes. Certain information relating to investments measured at fair value for which the Company
has used unobservable inputs to determine fair value is as follows:
|
|
Year Ended March 31, 2019
|
|
|
|
Debt
Securities
|
|
|
CLO Fund
Securities
|
|
|
Equity
Securities
|
|
|
Asset Manager
Affiliate
|
|
|
Joint
Venture
|
|
|
Total
|
|
Balance, December 31, 2018
|
|
$
|
106,741,671
|
|
|
$
|
44,325,000
|
|
|
$
|
2,038,020
|
|
|
$
|
3,470,000
|
|
|
$
|
18,390,440
|
|
|
$
|
174,965,131
|
|
Transfers out of Level III¹
|
|
|
(6,470,154
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(6,470,154
|
)
|
Transfers into Level III²
|
|
|
27,653,032
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
27,653,032
|
|
Net accretion
|
|
|
34,347
|
|
|
|
1,690,216
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
1,724,563
|
|
Purchases
|
|
|
136,501
|
|
|
|
—
|
|
|
|
6,228,000
|
|
|
|
—
|
|
|
|
—
|
|
|
|
6,364,501
|
|
Sales/Paydowns/Return of Capital
|
|
|
(8,012,847
|
)
|
|
|
(2,282,948
|
)
|
|
|
—
|
|
|
|
|
|
|
|
—
|
|
|
|
(10,295,795
|
)
|
Total realized loss included in earnings
|
|
|
(7,852,198
|
)
|
|
|
(587,936
|
)
|
|
|
(1,565,205
|
)
|
|
|
(3,470,000
|
)
|
|
|
—
|
|
|
|
(13,475,339
|
)
|
Change in unrealized gain (loss) included in earnings
|
|
|
3,778,969
|
|
|
|
2,460,683
|
|
|
|
(4,832,181
|
)
|
|
|
—
|
|
|
|
5,317,529
|
|
|
|
6,725,000
|
|
Balance, March 31, 2019
|
|
$
|
116,009,321
|
|
|
$
|
45,605,015
|
|
|
$
|
1,868,634
|
|
|
$
|
—
|
|
|
$
|
23,707,969
|
|
|
$
|
187,190,939
|
|
Changes in unrealized gains (losses) included in earnings related to investments still held at reporting date
|
|
$
|
(9,306,669
|
)
|
|
$
|
2,460,683
|
|
|
$
|
(4,832,181
|
)
|
|
$
|
—
|
|
|
$
|
5,317,529
|
|
|
$
|
(6,360,638
|
)
|
¹Transfers out of Level III represent a transfer of $6,470,154
relating to debt securities for which pricing inputs, other than their quoted prices in active markets were observable as of March
31, 2019.
²Transfers into Level III represent a transfer of $27,653,032
relating to debt securities for which pricing inputs, other than their quoted prices in active markets were unobservable as of
March 31, 2019.
|
|
Year Ended December 31, 2018
|
|
|
|
Debt
Securities
|
|
|
CLO Fund
Securities
|
|
|
Equity
Securities
|
|
|
Asset Manager
Affiliate
|
|
|
Joint
Venture
|
|
|
Total
|
|
Balance, December 31, 2017
|
|
$
|
69,885,455
|
|
|
$
|
51,678,673
|
|
|
$
|
4,414,684
|
|
|
$
|
38,849,000
|
|
|
$
|
21,516,000
|
|
|
$
|
186,343,812
|
|
Transfers out of Level III¹
|
|
|
(230,732
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(230,732
|
)
|
Transfers into Level III²
|
|
|
16,474,663
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
16,474,663
|
|
Net accretion
|
|
|
125,614
|
|
|
|
5,878,260
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
6,003,874
|
|
Purchases
|
|
|
38,099,644
|
|
|
|
12,781,528
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
50,881,172
|
|
Sales/Paydowns/Return of Capital
|
|
|
(11,116,360
|
)
|
|
|
(19,033,322
|
)
|
|
|
(1,093,244
|
)
|
|
|
(34,800,000
|
)
|
|
|
—
|
|
|
|
(66,042,926
|
)
|
Total realized gain included in earnings
|
|
|
(51,674
|
)
|
|
|
(16,484,872
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(16,536,546
|
)
|
Total unrealized gain (loss) included in earnings
|
|
|
(6,444,939
|
)
|
|
|
9,504,733
|
|
|
|
(1,283,420
|
)
|
|
|
(579,000
|
)
|
|
|
(3,125,560
|
)
|
|
|
(1,928,186
|
)
|
Balance, December 31, 2018
|
|
$
|
106,741,671
|
|
|
$
|
44,325,000
|
|
|
$
|
2,038,020
|
|
|
$
|
3,470,000
|
|
|
$
|
18,390,440
|
|
|
$
|
174,965,131
|
|
Changes in unrealized gains (losses) included in earnings related to investments still held at reporting date
|
|
$
|
(5,197,940
|
)
|
|
$
|
6,631,424
|
|
|
$
|
(1,283,420
|
)
|
|
$
|
(579,000
|
)
|
|
$
|
(3,125,560
|
)
|
|
$
|
(3,554,496
|
)
|
¹Transfers out of Level III represent a transfer of $230,732
relating to debt securities for which pricing inputs, other than their quoted prices in active markets were observable as of December
31, 2018.
²Transfers into Level III represent a transfer of $16,474,663
relating to debt securities for which pricing inputs, other than their quoted prices in active markets were unobservable as of
December 31, 2018.
As of March 31, 2019 and December 31, 2018, the Company’s
Level II portfolio investments were valued by a third party pricing services for which the prices are not adjusted and for which
inputs are observable or can be corroborated by observable market data for substantially the full character of the financial instrument,
or by inputs that are derived principally from, or corroborated by, observable market information. The fair value of the Company’s
Level II portfolio investments was $60.3 million and $75.9 million as of March 31, 2019 and December 31, 2018, respectively.
As of March 31, 2019, the Company’s
Level III portfolio investments had the following valuation techniques and significant inputs:
Type
|
Fair Value
|
Primary Valuation
Methodology
|
Unobservable
Inputs
|
Range
of Inputs
(Weighted Average)
|
|
|
Debt Securities
|
$ 459,448
|
Enterprise Value
|
Average EBITDA Multiple
|
6.75x (0.04x)
|
|
115,549,873
|
Income Approach
|
Implied Discount Rate
|
6.7% – 27.5% (11.5)%
|
|
Equity Securities
|
1,811,634
|
Enterprise Value
|
Average EBITDA Multiple / WACC
|
3.9x – 8.5x (6.1x)
21.30%
|
|
57,000
|
Options Value
|
Qualitative Inputs
(1)
|
|
|
CLO Fund Securities
|
36,285,735
|
Discounted Cash Flow
|
Discount Rate
|
13.4%-13.9% (13.720%)
|
|
Probability of Default
|
1%-2% (1.5%)
|
|
Loss Severity
|
20%-34% (27.1%)
|
|
Recovery Rate
|
66%-80% (72.9%)
|
|
Prepayment Rate
|
10%-20% (15%)
|
|
369,280
|
Liquidation Value
|
Qualitative Inputs
(2)
|
|
|
8,950,000
|
Market Approach
|
Third Party Quote
|
89.5%
|
|
Joint Venture
|
23,707,969
|
Enterprise Value
|
Underlying NAV of the CLO
|
|
|
Total Level III Investments
|
$ 187,190,939
|
|
|
|
|
¹ The qualitative inputs used in the fair value measurements
of Equity Securities include estimates of the distressed liquidation value of the pledged collateral. In cases where Portman Ridge’s
analysis ascribes no residual value to a portfolio company’s equity, Portman Ridge typically elects to mark its position
at a nominal amount to account for the investment’s option value.
2
The qualitative inputs used in the fair value measurements
include the value of the pledged collateral.
As of December 31, 2018, the Company’s
Level III portfolio investments had the following valuation techniques and significant inputs:
Type
|
Fair Value
|
Primary Valuation
Methodology
|
Unobservable
Inputs
|
Range of Inputs
(Weighted Average)
|
|
|
Debt Securities
|
$ 8,661,114
|
Enterprise Value
|
Average EBITDA
|
5.0x – 8.0x (5.2x)
|
|
Multiple / WACC
|
15.8%
|
|
98,080,557
|
Income Approach
|
Implied Discount Rate
|
6.3% - 26.8% (11.8%)
|
|
Equity Securities
|
1,979,020
|
Enterprise Value
|
Average EBITDA Multiple
|
4.5x – 11.0x (9.5x)
|
|
59,000
|
Options Value
|
Qualitative Inputs
(1)
|
|
|
CLO Fund Securities
|
35,455,720
|
Discounted Cash Flow
|
Discount Rate
|
13.5%-14.0% (13.9%)
|
|
Probability of Default
|
0.75%-2% (1.4%)
|
|
Loss Severity
|
20%-36 % (28.3%)
|
|
Recovery Rate
|
63.5%-80% (71.7%)
|
|
Prepayment Rate
|
10%-20% (15%)
|
|
369,280
|
Liquidation Value
|
Qualitative Inputs
(2)
|
|
|
|
8,500,000
|
Market Approach
|
Third Party Quote
|
85.0%
|
|
Asset Manager Affiliate
|
3,470,000
|
Discounted Cash Flow
|
Discount Rate
|
4.0% - 10.0% (7.77%)
|
|
Joint Venture
|
18,390,440
|
Enterprise Value
|
Underlying NAV of the CLO
|
|
|
Total Level III Investments
|
$ 174,965,131
|
|
|
|
|
¹ The qualitative inputs used in the fair value measurements
of Equity Securities include estimates of the distressed liquidation value of the pledged collateral. In cases where Portman Ridge’s
analysis ascribes no residual value to a portfolio company’s equity, Portman Ridge typically elects to mark its position
at a nominal amount to account for the investment’s option value.
2
The qualitative inputs used in the fair value measurements
include the value of the pledged collateral.
The significant unobservable inputs used
in the fair value measurement of the Company’s debt securities may include, among other things, broad market indices, the
comparable yields of similar investments in similar industries, effective discount rates, average EBITDA multiples, and weighted
average cost of capital. Significant increases or decreases in such comparable yields would result in a significantly lower or
higher fair value measurement, respectively.
The significant unobservable inputs used
in the fair value measurement of the Company’s equity securities include the EBITDA multiple of similar investments in similar
industries and the weighted average cost of capital. Significant increases or decreases in such inputs would result in a significantly
lower or higher fair value measurement.
Significant unobservable input used in
the fair value measurement of the Company’s CLO Fund Securities include default rates, recovery rates, prepayment rates,
spreads, and the discount rate by which to value the resulting underlying cash flows. Such assumptions can vary significantly,
depending on market data sources which often vary in depth and level of analysis, understanding of the CLO market, detailed or
broad characterization of the CLO market and the application of such data to an appropriate framework for analysis. The application
of data points are based on the specific attributes of each individual CLO Fund Security’s underlying assets, historic, current
and prospective performance, vintage, and other quantitative and qualitative factors that would be evaluated by market participants.
The Company evaluates the source of market data for reliability as an indicative market input, consistency amongst other inputs
and results and also the context in which such data is presented. Significant increases or decreases in probability of default
and loss severity inputs in isolation would result in a significantly lower or higher fair value measurement, respectively. In
general, a change in the assumption of the probability of default is accompanied by a directionally similar change in the assumption
used for the loss severity in an event of default. Significant increases or decreases in the discount rate in isolation would result
in a significantly lower or higher fair value measurement.
The significant unobservable inputs used
in the fair value measurement of the Asset Manager Affiliates is the discount rate used to present value prospective cash flows.
Prospective revenues are generally based on a fixed percentage of the par value of CLO Fund assets under management and are recurring
in nature for the term of the CLO Fund so long as the Asset Manager Affiliates manage the fund. As a result, the fees earned by
the Asset Manager Affiliates are generally not subject to market value fluctuations in the underlying collateral. The discounted
cash flow model incorporates different levels of discount rates depending on the hierarchy of fees earned (including the likelihood
of realization of senior, subordinate and incentive fees) and prospective modeled performance. Significant increases or decreases
in such discount rate would result in a significantly lower or higher fair value measurement, respectively.
The Company’s investment in the Joint
Venture is carried at fair value based upon the fair value of the investments held by the Joint Venture.
5. ASSET MANAGER AFFILIATES
Wholly-Owned Asset Managers
On December 31, 2018, the Company’s
wholly-owned subsidiary Commodore Holdings, LLC (“Commodore”) sold its wholly-owned asset management subsidiaries Katonah
Debt Advisors, Trimaran Advisors and Trimaran Advisors Management, representing substantially all of the Company’s investment
in the Asset Manager Affiliates. Commodore received cash proceeds of $37.9 million from the sale and distributed $33.8 million
in cash to the Company. All of this cash distribution was recorded as a return of capital. No realized gain or loss was recognized
due to this transaction.
The Asset Manager Affiliates manage CLO
Funds primarily for third party investors that invest primarily in broadly syndicated loans, high yield bonds and other credit
instruments issued by corporations. At March 31, 2019 and December 31, 2018, the Asset Manager Affiliates had approximately $300
million and $300 million of par value of assets under management, respectively, and the Company’s 100% equity interest in
the Asset Manager Affiliates had a fair value of approximately $0 and $3.5 million, respectively.
Certain investments, and the future management
fees of certain managed CLO Funds, had been pledged by the Asset Manager Affiliates to third-party lenders under borrowing arrangements
undertaken to satisfy the risk retention requirements of the Dodd-Frank Act applicable to asset managers. In addition, certain
of the Asset Manager Affiliates had provided a make-whole guaranty to these lenders in the event that the pledged assets and management
fees were insufficient to satisfy the repayment of these borrowings. These borrowing arrangements were all satisfied prior to the
sale of the Asset Manager Affiliates.
No distributions were declared during the
three months ended March 31, 2019. For the three months ended March 31, 2018, the Asset Manager Affiliates declared cash distributions
of $820,000 to the Company. Any distributions from the Asset Manager Affiliates out of their estimated tax-basis earnings and profits
are recorded as “Dividends from Asset Manager Affiliates” on the Company’s statement of operations. The Company
recognized $320,000 of Dividends from Asset Manager Affiliates, as reflected in the Company’s statement of operations in
the first quarter of 2018, respectively. The difference between cash distributions received and the tax-basis earnings and profits
of the distributing affiliate are recorded as an adjustment to the cost basis in the Asset Manager Affiliate (i.e., tax-basis return
of capital). For the quarter ended March 31, 2018 the difference of $500,000, between cash distributions received and the tax-basis
earnings and profits of the distributing affiliate, were recorded as an adjustment to the cost basis in the Asset Manager Affiliate
(i.e. tax-basis return of capital). Distributions receivable, if any, are reflected in the “due from affiliates” account
on the consolidated balance sheets.
The tax attributes of distributions received
from the Asset Manager Affiliates are determined on an annual basis. The Company makes an estimate of the tax-basis earnings and
profits of the Asset Manager Affiliates on a quarterly basis, and any quarterly distributions received in excess of the estimated
earnings and profits are recorded as return of capital (reduction in the cost basis of the investment in Asset Manager Affiliate).
The Asset Manager Affiliates’ fair
value is determined quarterly. The valuation is primarily determined utilizing a discounted cash flow model. See Note 2 - “Significant
Accounting Policies” and Note 4 - “Investments” for further information relating to the Company’s valuation
methodology.
In accordance with Rules 3-09, Rule 4-08(g)
and 1-02 of Regulation S-X, additional financial information with respect to the Asset Manager Affiliates is required to be included
in the Company’s SEC filings. The additional information regarding the Asset Manager Affiliates is set forth below. This
additional financial information regarding the Asset Manager Affiliates does not directly impact the financial position, results
of operations, or cash flows of the Company.
Asset Manager Affiliates
Summarized Balance Sheet
|
|
As of
|
|
|
As of
|
|
|
|
March 31, 2019
|
|
|
December 31, 2018
|
|
|
|
(unaudited)
|
|
|
|
|
Cash
|
|
$
|
861,980
|
|
|
$
|
1,335,004
|
|
Other Assets
|
|
|
12,680
|
|
|
|
129,880
|
|
Total Assets
|
|
$
|
874,660
|
|
|
$
|
1,464,884
|
|
|
|
|
|
|
|
|
|
|
Other Liabilities
|
|
$
|
443,536
|
|
|
$
|
995,270
|
|
Total Liabilities
|
|
|
443,536
|
|
|
|
995,270
|
|
Total Equity
|
|
|
431,124
|
|
|
|
469,614
|
|
Total Liabilities and Equity
|
|
$
|
874,660
|
|
|
$
|
1,464,884
|
|
Asset Manager Affiliates
Summarized Statements of Operations Information
(unaudited)
|
|
For the three months ended
|
|
|
|
March 31,
|
|
|
|
2019
|
|
|
2018
|
|
Fee Revenue
|
|
$
|
-
|
|
|
$
|
3,059,660
|
|
Interest Income
|
|
|
-
|
|
|
|
686,586
|
|
Total Income
|
|
|
-
|
|
|
|
3,746,246
|
|
Operating Expenses
|
|
|
38,877
|
|
|
|
2,526,085
|
|
Interest Expense
|
|
|
-
|
|
|
|
1,177,518
|
|
Total Expenses
|
|
|
38,877
|
|
|
|
3,703,603
|
|
Income before unrealized gains on investments and income taxes
|
|
|
(38,877
|
)
|
|
|
42,643
|
|
Unrealized gains on investments
|
|
|
-
|
|
|
|
820,270
|
|
(Loss) Income before income taxes
|
|
|
(38,877
|
)
|
|
|
862,913
|
|
Income Tax (Benefit)
|
|
|
-
|
|
|
|
(126,954
|
)
|
Net (Loss) Income
|
|
$
|
(38,877
|
)
|
|
$
|
989,867
|
|
Except for KCAP Management, LLC, which is
a disregarded entity whose tax results are included with the Company’s tax results, as separately regarded entities for tax
purposes, the Asset Manager Affiliates are taxed at normal corporate rates. In order to maintain the Company’s RIC status,
any tax-basis dividends paid by the Asset Manager Affiliates to the Company would generally need to be distributed to the Company’s
shareholders. Generally, such tax-basis dividends of the Asset Manager Affiliates’ income which was distributed to the Company’s
shareholders will be considered as qualified dividends for tax purposes. The Asset Manager Affiliates’ taxable net income
will differ from GAAP net income because of deferred tax temporary differences and permanent tax adjustments. Deferred tax temporary
differences may include differences for the recognition and timing of amortization and depreciation, compensation related expenses,
and net loss carryforward, among other things. Permanent differences may include adjustments, limitations or disallowances for
meals and entertainment expenses, penalties, tax goodwill amortization and net operating loss carryforward.
Goodwill amortization for tax purposes was
created upon the purchase of 100% of the equity interests in Katonah Debt Advisors prior to the Company’s IPO in exchange
for shares of the Company’s stock valued at $33 million. Although this transaction was a stock transaction rather than an
asset purchase and thus no goodwill was recognized for GAAP purposes, such exchange was considered an asset purchase under Section 351(a)
of the Code. At the time of the transfer, Katonah Debt Advisors had equity of approximately $1 million resulting in tax goodwill
of approximately $32 million which was being amortized for tax purposes on a straight-line basis over 15 years.
Additional goodwill amortization for tax
purposes was created upon the purchase of 100% of the equity interests in Trimaran Advisors by one of the Company’s affiliates,
in exchange for shares of the Company’s stock valued at $25.5 million and cash of $13.0 million. The transaction was considered
an asset purchase under Section 351(a) of the Code and resulted in tax goodwill of approximately $22.8 million, and tax basis intangible
assets of $15.7 million, both of which were being amortized for tax purposes on a straight-line basis over 15 years.
Related Party Transactions
On February 26, 2013, the Company entered
into a senior credit agreement (the “Trimaran Credit Facility”) with Trimaran Advisors, pursuant to which Trimaran
Advisors may borrow from time to time up to $20 million from the Company in order to provide capital necessary to support one or
more of Trimaran Advisors’ warehouse lines of credit and/or working capital in connection with Trimaran Advisors’ warehouse
activities. The Trimaran Credit Facility, which expired on November 20, 2017 and bore interest at an annual rate of 9.0%. On April
15, 2013, the Trimaran Credit Facility was amended and upsized from $20 million to $23 million. Outstanding borrowings on the Trimaran
Credit Facility were callable by the Company at any time. The Trimaran Credit Facility was fully repaid and terminated in the fourth
quarter of 2018. At March 31, 2019 and December 31, 2018, there were no loans outstanding under the Trimaran Credit Facility. For
the three months ended March 31, 2018 the Company recognized interest income of approximately $115,000, related to the Trimaran
Credit Facility.
On October 30, 2017, the Company entered
into a new term loan agreement with Trimaran Advisors, one of the Asset Manager Affiliates. Trimaran Advisors borrowed $8.4 million
under this agreement, which bore interest at a rate of 10.5% annually, payable quarterly. The loan matures on April 30, 2030, can
be repaid at any time, and must be repaid upon the occurrence of certain events. During the third quarter 2018 $2.1 million of
the principal on this loan was repaid by Trimaran Advisors. During the fourth quarter of 2018, Trimaran Advisors repaid this loan
in full. Repayment was comprised of $3.0 million of cash and $2.5 million notional amount of subordinated notes of Catamaran 2013-1
with a fair value of $1.4 million and $3.4 million of notional amount of subordinated notes of Catamaran 2014-1 with a fair value
of $1.9 million.
On October 31, 2017, Trimaran Advisors capitalized
Trimaran Risk Retention Holdings, LLC, a newly-formed wholly-owned subsidiary, with $8.4 million of equity capital. In turn, Trimaran
Risk Retention Holdings capitalized Trimaran RR I, LLC, a wholly-owned subsidiary of Trimaran Risk Retention Holdings, LLC, with
$8.4 million of equity capital. With this equity contribution and other borrowed funds, Trimaran RR II, LLC purchased $34.8 million
notional amount of notes issued by Catamaran CLO 2014-1, Ltd. for aggregate consideration of $35.5 million. On December 21, 2017,
the Company entered into another new term loan agreement with Trimaran Advisors, under which Trimaran Advisors borrowed $4.4 million,
which also bore interest at a rate of 10.5% annually, payable quarterly. During the second quarter of 2018, this loan was repaid
in full by Trimaran Advisors.
On December 21,
2017, Trimaran Advisors contributed $4.4 million of equity capital to Trimaran Risk Retention Holdings, LLC. In turn, Trimaran
Risk Retention Holdings contributed $4.4 million of equity capital to Trimaran RR II. With this equity contribution and other borrowed
funds, Trimaran RR I, LLC purchased $27.4 million notional amount of notes issued by Catamaran CLO 2015-1, Ltd. for aggregate consideration
of $27.4 million.
On June 4, 2018,
Trimaran RR I, LLC sold $31.4 million and $24.9 million, of notional amount of notes issued by Catamaran CLO 2014-1, Ltd and Catamaran
2013-1, Ltd, respectively. In December 2018, Trimaran RR I, LLC. distributed to Trimaran $2.5 million notional amount of subordinated
notes issued by Catamaran 2013-1 with a fair value of $1.4 million, and a notional amount of $3.4 million of subordinated notes
issued by Catamaran 2014-1 with a fair value of $1.9 million.
Administration Agreement
On April 1,
2019, the Company entered into the Administration Agreement with the Administrator. Under the terms of the Administration Agreement,
the Administrator will perform the administrative services necessary for the operation of the Company, which includes office facilities,
equipment, bookkeeping and recordkeeping services and such other services as the Administrator, subject to review by the Board,
shall from time to time determine to be necessary or useful to perform its obligations under this Administration Agreement. See
“Organization - Administration Agreement” in Note 1, above, for additional information about the Administration
Agreement.
No person who is an officer, director,
or employee of the Adviser or its affiliates and who serves as a director of the Company receives any compensation from the Company
for his or her services as a director. However, the Company reimburses the Administrator (or its affiliates) for an allocable portion
of the compensation paid by the Administrator (or its affiliates) to the Company’s Chief Compliance Officer and Chief Financial
Officer and their respective staffs (based on a percentage of time such individuals devote, on an estimated basis, to the business
affairs of the Company).
The Administration
Agreement was not in effect during the quarter ended March 31, 2019.
Investment Advisory Agreement
On April 1,
2019, the Company entered into the Advisory Agreement with the Adviser. Under the terms of the Advisory Agreement, the Adviser
is responsible for managing the Company’s business and activities, including sourcing investment opportunities, conducting
research, performing due diligence on potential investments, structuring its investments, monitoring its portfolio companies and
provide managerial assistance to portfolio companies. See “Organization - Advisory Agreement” in Note 1, above,
for additional information about the Advisory Agreement.
The Advisory
Agreement was not in effect during the quarter ended March 31, 2019.
Co-investment Exemptive Relief
As a BDC, the
Company is subject to certain regulatory restrictions in making its investments. For example, BDCs generally are not permitted
to co-invest with certain affiliated entities in transactions originated by the BDC or its affiliates in the absence
of an exemptive order from the SEC. However, BDCs are permitted to, and may, simultaneously co-invest in transactions
where price is the only negotiated term.
On October 23,
2018, the SEC issued an order granting an application for exemptive relief to an affiliate of the Adviser that allows BDCs managed
by the Adviser, including the Company, to co-invest, subject to the satisfaction of certain conditions, in certain private
placement transactions, with other funds managed by the Advisers or its affiliates, including BCP Special Opportunities Fund I
LP, BC Partners Lending Corporation and any future funds that are advised by the Adviser or its affiliated investment advisers.
Under the terms of the exemptive order, in order for the Company to participate in a co-investment transaction a “required
majority” (as defined in Section 57(o) of the 1940 Act) of the Company’s independent directors must conclude that
(i) the terms of the proposed transaction, including the consideration to be paid, are reasonable and fair to the Company
and its stockholders and do not involve overreaching with respect of the Company or its stockholders on the part of any person
concerned, and (ii) the proposed transaction is consistent with the interests of the Company’s stockholders and is consistent
with the Company’s investment objectives and strategies and certain criteria established by the Board.
6. BORROWINGS
The Company’s debt obligations consist
of the following:
|
|
As of
March 31, 2019
(unaudited)
|
|
|
As of
December 31, 2018
|
|
|
|
|
|
|
|
|
6.125% Notes Due 2022 (net of offering costs of: 2019-$2,071,220; 2018 - $2,207,342)
|
|
$
|
75,335,980
|
|
|
$
|
75,199,858
|
|
Great Lakes KCAP Funding I, LLC Revolving Credit Facility (net of offering costs of: 2019 - $1,327,960; 2018 - $1,555,754)
|
|
|
42,543,122
|
|
|
|
25,200,331
|
|
|
|
$
|
117,879,102
|
|
|
$
|
100,400,189
|
|
The weighted average stated interest rate and weighted average
maturity on all our debt outstanding as of March 31, 2019 were 6.0% and 3.3 years, respectively, and as of December 31, 2018 were
6.0% and 3.6 years, respectively.
6.125% Notes Due 2022
During the third quarter of 2017, the Company
issued $77.4 million in aggregate principal amount of unsecured 6.125% Notes due 2022 (the 6.125% “Notes Due 2022”).
The net proceeds for these Notes, after the payment of underwriting expenses, were approximately $74.6 million. Interest on the
6.125% Notes Due 2022 is paid quarterly in arrears on March 30, June 30, September 30 and December 30, at a rate of 6.125%. The
6.125% Notes Due 2022 mature on September 30, 2022 and are unsecured obligations of the Company. The 6.125% Notes Due 2022 are
subject to redemption in whole or in part at any time or from time to time, at the option of the Company, on or after September
30, 2019, at a redemption price per security equal to 100% of the outstanding principal amount thereof plus accrued and unpaid
interest payments otherwise payable for the then-current quarterly interest period accrued to the date fixed for redemption. In
addition, Due to the asset coverage test applicable to the Company as a BDC and a covenant that the Company agreed to in connection
with the issuance of the 6.125% Notes Due 2022, the Company is limited in its ability to make distributions in certain circumstances.
The indenture governing the 6.125% Notes Due 2022 contains certain restrictive covenants, including compliance with certain provisions
of the 1940 Act relating to borrowing and dividends. At March 31, 2019, the Company was in compliance with all of its debt covenants.
For the three months ended March 31, 2019
and 2018, interest expense related to the 6.125% Notes Due 2022 was approximately $1.2 million and $1.2 million, respectively.
In connection with the issuance of the
6.125% Notes Due 2022, the Company incurred approximately $2.9 million of debt offering costs which are being amortized over the
expected term of the facility on an effective yield method, of which approximately $2.1 million and $2.2 million remains to be
amortized as of March 31, 2019 and December 31, 2018, respectively, and is included on the consolidated balance sheets as a reduction
in the related debt liability.
Fair Value of 6.125% Notes Due 2022.
The 6.125% Notes Due 2022 were issued via public offering during the third quarter of 2017 and are carried at cost, net of offering
costs of $2.1 million and $2.2 million at March 31, 2019 and December 31, 2018. The fair value of the Company’s outstanding
6.125% Notes Due 2022 was approximately $78.6 million and $76.6 million at March 31, 2019 and December 31, 2018. The fair value
was determined based on the closing price on March 31, 2019 for the 6.125% Notes Due 2022. The 6.125% Notes Due 2022 are categorized
as Level I under the ASC 820 Fair Value.
Great Lakes KCAP Funding I, LLC
On March 1, 2018, Great Lakes KCAP Funding
I, LLC (“Funding”), a wholly-owned subsidiary of the Company, entered into a senior secured revolving credit facility
(the “Revolving Credit Facility”) with certain institutional lenders, State Bank and Trust Company, as the administrative
agent, lead arranger and bookrunner, CIBC Bank USA, as documentation agent and the Company, as the servicer.
On March 31, 2019, the maximum commitment
amount of the Revolving Credit Facility was increased to $57.5 million, subject to availability under the borrowing base. Borrowings
under the Revolving Credit Facility bear interest at a rate per annum equal to (i) in the case of LIBOR rate loans, an adjusted
LIBOR rate for the applicable interest period plus 3.25% or (ii) in the case of base rate loans, the prime rate plus 3.25%. Funding
will pay a fee on any undrawn amounts of 0.375% per annum; provided that if 50% or less of the Revolving Credit Facility is drawn,
the fee will be 0.50% per annum.
The Company intends to use the proceeds
from borrowings under the Revolving Credit Facility for general corporate purposes, including to acquire certain qualifying loans,
and such other uses as permitted under the Loan and Security Agreement (the “Revolving Credit Agreement”).
The maturity date is the earlier of: (a)
March 1, 2022 and (b) the date upon which all loans shall become due and payable in full, whether by acceleration or otherwise,
as a result of a default by the Company, as defined in the Revolving Credit Facility.
Borrowings under the Revolving Credit Facility
are repayable by the Company at any time.
The Revolving Credit Facility is secured
by all of the assets held by Funding, and the Company has pledged its interests in Funding as collateral to State Bank and Trust
Company, as the administrative agent, to secure the obligations of Funding under the Revolving Credit Facility. The Revolving Credit
Agreement includes customary affirmative and negative covenants, including certain limitations on the incurrence of additional
indebtedness and liens, as well as usual and customary events of default for revolving credit facilities of this nature. At March
31, 2019 and December 31, 2018, Funding was in compliance with all of its debt covenants.
As of March 31, 2019 and December 31, 2018,
$43.9 million and $26.4 million principal amount of borrowings was outstanding under the Revolving Credit Facility.
Interest on borrowings under the Revolving
Credit Facility is paid monthly. Borrowings under the Revolving Credit Facility are subject to redemption in whole or in part at
any time or from time to time, at the option of the Funding.
For the three months ended March 31, 2019
and 2018, interest and fees expense related to the Revolving Credit Facility was approximately $0.4 million and $0.1 million.
The Company incurred approximately $1.7
million of debt offering costs in connection with the Revolving Credit Facility, which are being amortized over the expected term
of the Revolving Credit Facility on an effective yield method, of which approximately $1.3 million remains to be amortized as of
March 31, 2019, and is included on the consolidated balance sheets as a reduction in the related debt liability.
Fair Value of the Revolving Credit Facility.
Borrowings under the Revolving Credit Facility are carried at cost, net of unamortized debt offering costs of $1.3 million at March
31, 2019. The fair value of the Revolving Credit Facility borrowings was approximately $43.9 million and $26.4 million at March
31, 2019 and December 31, 2018. The fair value was determined based on an analysis of the value of the pledged collateral and the
amount of over-collateralization supporting the repayment of these borrowings. The Revolving Credit Facility borrowings are categorized
as Level III under the ASC 820 Fair Value.
7.375% Notes Due 2019
On October 10, 2012, the Company issued
$41.4 million in aggregate principal amount of unsecured 7.375% Notes due 2019 (the “7.375% Notes Due 2019”). The net
proceeds for these Notes, after the payment of underwriting expenses, were approximately $39.9 million. As of December 31,
2018, there were no 7.375% Notes Due 2019 outstanding. Interest on the 7.375% Notes Due 2019 was paid quarterly in arrears
on March 30, June 30, September 30 and December 30, at a rate of 7.375%, commencing December 30, 2012. The 7.375% Notes
Due 2019 had a maturity date of September, 30, 2019 and were unsecured obligations of the Company. The 7.375% Notes Due
2019 were subject to redemption in whole or in part at any time or from time to time, at the option of the Company, on or after
September 30, 2015, at a redemption price per security equal to 100% of the outstanding principal amount thereof plus accrued and
unpaid interest payments otherwise payable for the then-current quarterly interest period accrued to the date fixed for redemption.
In addition, due to the asset coverage test applicable to the Company as a BDC and a covenant that the Company agreed to in connection
with the issuance of the 7.375% Notes Due 2019, the Company was limited in its ability to make distributions in certain circumstances.
The indenture governing the 7.375% Notes Due 2019 contains certain restrictive covenants, including compliance with certain provisions
of the 1940 Act relating to borrowing and dividends.
For the three months ended March 31, 2018,
interest expense related to the 7.375% Notes Due 2019 was approximately, $436,000.
During the second quarter of 2017, approximately
$6.5 million par value of the 7.375% Notes Due 2019 was redeemed by the Company, resulting in a realized loss on extinguishment
of approximately $107,000. The Company subsequently surrendered these notes to the Trustee for cancellation.
During the first quarter of 2018, approximately
$20 million par value of the 7.375% Notes Due 2019 was redeemed by the Company, resulting in a realized loss on extinguishment
of approximately $169,000. The Company subsequently surrendered these notes to the Trustee for cancellation.
During the fourth quarter of 2018, all of the remaining $7 million
par value of the 7.375% Notes Due 2019 was redeemed by the Company, resulting in a realized loss on extinguishment of approximately
$28,000. The Company subsequently surrendered these notes to the Trustee for cancellation.
7. DISTRIBUTABLE TAXABLE INCOME
Effective December 11, 2006, the Company elected to be treated
as a RIC under the Code and adopted a December 31 tax-calendar year end. As a RIC, the Company is not subject to federal income
tax on the portion of its taxable income and gains distributed currently to its stockholders as a dividend. The Company’s
quarterly distributions, if any, are determined by the Board of Directors. The Company anticipates distributing substantially all
of its taxable income and gains, within the Subchapter M rules, and thus the Company anticipates that it will not incur any federal
or state income tax at the RIC level. As a RIC, the Company is also subject to a federal excise tax based on distributive requirements
of its taxable income on a calendar year basis (e.g., calendar year 2019). Depending on the level of taxable income earned in a
tax year, the Company may choose to carry forward taxable income in excess of current year distributions into the next tax year
and pay a 4% excise tax on such income, to the extent required.
The following reconciles net increase in
net assets resulting from operations to taxable income for the three months ended March 31, 2019:
|
|
Three Months Ended March 31,
|
|
|
|
2019
|
|
|
2018
|
|
|
|
(unaudited)
|
|
|
(unaudited)
|
|
|
|
|
|
|
|
|
Net (decrease) increase in net assets resulting from operations
|
|
$
|
(10,917,572
|
)
|
|
$
|
2,609,393
|
|
Net change in unrealized appreciation from investments
|
|
|
(4,627,045
|
)
|
|
|
(314,624
|
)
|
Excess capital losses over capital gains
|
|
|
13,349,430
|
|
|
|
165,973
|
|
Book/tax differences on CLO equity investments
|
|
|
(198,326
|
)
|
|
|
(787,949
|
)
|
Other book/tax differences
|
|
|
663,298
|
|
|
|
457,219
|
|
Taxable (loss) income before deductions for distributions
|
|
$
|
(1,730,215
|
)
|
|
$
|
2,130,012
|
|
Taxable (loss) income before deductions for distributions per weighted average basic shares for
the period
|
|
$
|
(0.05
|
)
|
|
$
|
0.06
|
|
Taxable (loss) income before deductions for distributions per weighted average diluted shares
for the period
|
|
$
|
(0.05
|
)
|
|
$
|
0.06
|
|
Dividends from Asset Manager Affiliates are
recorded based upon a quarterly estimate of tax-basis earnings and profits of each Asset Manager Affiliate. Distributions in excess
of the estimated tax-basis quarterly earnings and profits of each distributing Asset Manager Affiliate are recognized as tax-basis
return of capital. The actual tax-basis earnings and profits and resulting dividend and/or return of capital for the year will
be determined at the end of the tax year for each distributing Asset Manager Affiliate. For the three months ended March 31, 2019
and 2018, the Asset Manager Affiliates declared cash distributions of $0 and $820,000, respectively, to the Company. The Company
recognized $0 and $320,000 of dividends from the Asset Manager Affiliates, as reflected in the Company’s statement of operations
in the first quarter of 2019 and 2018, respectively. For the quarter ended March 31, 2018 the difference of $500,000 between cash
distributions received and the tax-basis earnings and profits of the distributing affiliate, are recorded as an adjustment to the
cost basis in the Asset Manager Affiliate (i.e. tax-basis return of capital).
Distributions to shareholders that exceed
tax-basis distributable income (tax-basis net investment income and realized gains, if any) are reported as distributions of paid-in
capital (i.e. return of capital). The tax character of distributions is made on an annual (full calendar-year) basis. The determination
of the tax attributes of our distributions is made at the end of the year based upon our taxable income for the full year and the
distributions paid during the full year. Therefore, a determination of tax attributes made on a quarterly basis may not be representative
of the actual tax attributes of distributions for a full year.
At March 31, 2019, the Company had a net
capital loss carryforward of $96.6 million to offset net capital gains. This net capital loss carryforward is not subject to expiration.
On March 20, 2019 the Company’s Board
of Directors declared a distribution to shareholders of $0.10 per share for a total of $3.7 million. The record date was April
5, 2019 and the distribution was paid on April 26, 2019.
ASC Topic 740 Accounting for Uncertainty
in Income Taxes (“ASC 740”) provides guidance for how uncertain tax positions should be recognized, measured, presented,
and disclosed in the consolidated financial statements. ASC 740 requires the evaluation of tax positions taken or expected to be
taken in the course of preparing the Company’s tax returns to determine whether the tax positions are “more-likely-than-not”
of being sustained by the applicable tax authority. The Company recognizes the tax benefits of uncertain tax positions only where
the position is “more likely than not” to be sustained assuming examination by tax authorities. Management has analyzed
the Company’s tax positions, and has concluded that no liability for unrecognized tax benefits should be recorded related
to uncertain tax positions taken on returns filed for open tax years (the last three fiscal years) or expected to be taken in the
Company’s current year tax return. The Company identifies its major tax jurisdictions as U.S. Federal and New York State,
and the Company is not aware of any tax positions for which it is reasonably possible that the total amounts of unrecognized tax
benefits will change materially in the next 12 months. Management’s determinations regarding ASC 740 may be subject to review
and adjustment at a later date based upon factors including, but not limited to, an ongoing analysis of tax laws, regulations and
interpretations thereof.
8. COMMITMENTS AND CONTINGENCIES
From time-to-time the Company is a party
to financial instruments with off-balance sheet risk in the normal course of business in order to meet the needs of the Company’s
investment in portfolio companies. Such instruments include commitments to extend credit and may involve, in varying degrees, elements
of credit risk in excess of amounts recognized on the Company’s balance sheet. Prior to extending such credit, the Company
attempts to limit its credit risk by conducting extensive due diligence, obtaining collateral where necessary and negotiating appropriate
financial covenants. As of March 31, 2019 and December 31, 2018, the Company had $35.9 million and $12.9 million outstanding commitments,
respectively.
The Company has made an aggregate
commitment to the BCP Great Lakes Partnership of $50 million, subject to certain limitations (including that the Company is
not obligated to fund capital calls if such funding would cause the Company to be out of compliance with certain provisions
of the Investment Company Act of 1940). As of March 31, 2019 and December 31, 2018, the Company had a $34.8 million and $12.5
million, respectively unfunded commitment to the BCP Great Lakes Partnership, subject to the limitations noted above. In the
fourth quarter of 2018, the Company undertook the commitments under a lease obligation for its office space. Such obligation
was previously with Katonah Debt Advisors. During 2018, the Company and the Asset Manager Affiliates shared the cost of such
lease pursuant to an Overhead Allocation agreement. The Company’s portion of rent expense was approximately $193,000,
and $94,000 for the quarter ended March 31, 2019 and 2018, respectively.
The following table summarizes the future minimum lease payments
as of March 31, 2019:
|
|
Payments Due by Period
|
|
Contractual Obligations
|
|
2019
|
|
|
2020
|
|
|
2021
|
|
|
2022
|
|
|
2023
|
|
|
More than 5
years
|
|
Operating lease obligations
|
|
$
|
590,065
|
|
|
$
|
800,436
|
|
|
$
|
800,436
|
|
|
$
|
800,436
|
|
|
$
|
800,436
|
|
|
$
|
333,515
|
|
9. STOCKHOLDERS’ EQUITY
The following table details the components
of Stockholders’ Equity for the three months ended March 31, 2019 and 2018:
|
|
Three Months Ended March 31, 2019
|
|
|
|
Common Stock
|
|
|
Capital in Excess of
Par Value
|
|
|
Total Distributable
(loss) earnings
|
|
|
Total Stockholders'
Equity
|
|
Balance, January 1, 2019
|
|
$
|
373,268
|
|
|
$
|
306,784,387
|
|
|
$
|
(149,136,644
|
)
|
|
$
|
158,021,011
|
|
Net investment loss
|
|
|
—
|
|
|
|
—
|
|
|
|
(2,195,187
|
)
|
|
|
(2,195,187
|
)
|
Net realized (losses) from investment transactions
|
|
|
—
|
|
|
|
—
|
|
|
|
(13,349,430
|
)
|
|
|
(13,349,430
|
)
|
Net change in unrealized appreciation on investments
|
|
|
—
|
|
|
|
—
|
|
|
|
4,627,045
|
|
|
|
4,627,045
|
|
Distributions to Stockholders
|
|
|
—
|
|
|
|
—
|
|
|
|
(3,732,836
|
)
|
|
|
(3,732,836
|
)
|
Reinvested Dividends
|
|
|
155
|
|
|
|
56,334
|
|
|
|
—
|
|
|
|
56,489
|
|
Stock-based compensation
|
|
|
(106
|
)
|
|
|
259,042
|
|
|
|
—
|
|
|
|
258,936
|
|
Balance, March 31, 2019
|
|
$
|
373,317
|
|
|
$
|
307,099,763
|
|
|
$
|
(163,787,052
|
)
|
|
$
|
143,686,028
|
|
|
|
Three Months Ended March 31, 2018
|
|
|
|
Common Stock
|
|
|
Capital in Excess of
Par Value
|
|
|
Total Distributable
(loss) earnings
|
|
|
Total Stockholders'
Equity
|
|
Balance, January 1, 2018
|
|
$
|
373,392
|
|
|
$
|
329,789,716
|
|
|
$
|
(148,358,532
|
)
|
|
$
|
181,804,576
|
|
Net investment income (loss)
|
|
|
—
|
|
|
|
—
|
|
|
|
2,460,742
|
|
|
|
2,460,742
|
|
Net realized (losses) from investment transactions
|
|
|
—
|
|
|
|
—
|
|
|
|
3,101
|
|
|
|
3,101
|
|
Realized loss from extinguishment of debt
|
|
|
—
|
|
|
|
—
|
|
|
|
(169,074
|
)
|
|
|
(169,074
|
)
|
Net change in unrealized (depreciation) on investments
|
|
|
—
|
|
|
|
—
|
|
|
|
314,624
|
|
|
|
314,624
|
|
Distributions to Stockholders
|
|
|
—
|
|
|
|
—
|
|
|
|
(3,716,297
|
)
|
|
|
(3,716,297
|
)
|
Reinvested Dividends
|
|
|
153
|
|
|
|
51,407
|
|
|
|
—
|
|
|
|
51,560
|
|
Stock-based compensation
|
|
|
—
|
|
|
|
252,855
|
|
|
|
—
|
|
|
|
252,855
|
|
Balance, March 31, 2018
|
|
$
|
373,545
|
|
|
$
|
330,093,978
|
|
|
$
|
(149,465,436
|
)
|
|
$
|
181,002,087
|
|
During the three months ended March 31,
2019 and 2018, the Company issued 15,434 and 15,255 shares, respectively, of common stock under its dividend reinvestment plan.
For the three months ended March 31, 2019, there were no grants of restricted stock, 10,571 shares were forfeited, and 113,382 shares
vested. The total number of shares of the Company’s common stock outstanding as of March 31, 2019 and December 31, 2018 was
37,331,709 and 37,326,846, respectively.
10. EQUITY COMPENSATION PLANS
The Company had an equity incentive plan,
established in 2006 and most recently amended, following approval by the Company’s Board of Directors and shareholders, on
May 4, 2017 (the “Equity Incentive Plan”). The Company reserved 2,000,000 shares of common stock for issuance under
the Equity Incentive Plan. In connection with the Closing, the Company terminated the Equity Incentive Plan and will no longer
make grants pursuant to the plan. Prior to the Closing, restricted stock granted under the Equity Incentive Plan was granted at
a price equal to the fair market value (market closing price) of the shares on the day such restricted stock is granted. Options
granted under the Equity Incentive Plan were exercisable at a price equal to the fair market value (market closing price) of the
shares on the day the option is granted.
Stock Options
The 2008 Non-Employee Director Plan was
originally adopted by the Board and was approved by a vote of the Company’s shareholders at the 2008 Annual Shareholder Meeting
(the “2008 Plan”). Effective June 10, 2011, the 2008 Plan was amended and restated in accordance with a resolution
of the Board and approved by a vote of the Company’s shareholders at the 2011 Annual Shareholder Meeting (the “2011
Plan”). Effective May 4, 2017, the 2011 Plan was amended and restated in accordance with a resolution of the Board and approved
by the Company’s shareholders at the 2017 Annual Shareholder Meeting (the “Non-Employee Director Plan”). In connection
with the Closing, the Company terminated the 2008 Plan and will no longer make grants pursuant to the plan.
Immediately prior to the Closing, by virtue
of the Externalization and subject to the execution of an option cancellation agreement, each option to purchase shares of the
Company’s common stock granted under the 2008 Plan that was outstanding immediately prior to the Externalization was cancelled
in exchange for a payment in cash to the holder thereof.
Information with respect to options granted,
exercised and forfeited under the Equity Incentive Plan for the period January 1, 2018 through March 31, 2019 is as follows:
|
|
Shares
|
|
|
Weighted Average
Exercise Price per Share
|
|
|
Weighted Average
Contractual
Remaining Term
(years)
|
|
|
Aggregate Intrinsic
Value
1
|
|
Options outstanding at January 1, 2018
|
|
|
50,000
|
|
|
$
|
7.72
|
|
|
|
2.4
|
|
|
$
|
-
|
|
Granted
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expired unexercised
|
|
|
(5,000
|
)
|
|
|
11.97
|
|
|
|
|
|
|
|
|
|
Cancelled
|
|
|
(15,000
|
)
|
|
|
11.97
|
|
|
|
|
|
|
|
|
|
Options outstanding at December 31, 2018
|
|
|
30,000
|
|
|
$
|
4.88
|
|
|
|
0.9
|
|
|
$
|
-
|
|
Granted
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Cancelled
|
|
|
(30,000
|
)
|
|
|
4.88
|
|
|
|
0.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at March 31, 2019
|
|
|
—
|
|
|
$
|
—
|
|
|
|
-
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total vested at March 31, 2019
|
|
|
—
|
|
|
$
|
—
|
|
|
|
-
|
|
|
|
|
|
1
|
Represents the difference between the market value of shares of the Company on March 31, 2019 and the exercise price of the options.
|
The Company uses a Binary Option Pricing
Model (American, call option) to establish the expected value of all stock option grants. For the three months ended March 31,
2019 and 2018, the Company did not recognize any non-cash compensation expense related to stock options. At March 31, 2019, the
Company had no remaining compensation costs related to unvested stock based awards.
Restricted Stock
Awards of restricted stock granted under
the Non-Employee Director Plan vest as follows: 50% of the shares vest on the grant date and the remaining 50% of the shares vest
on the earlier of:
(i) the first anniversary of such grant,
or
(ii) the date immediately preceding the
next annual meeting of shareholders.
On May 4, 2017, 6,000 shares of restricted
stock were awarded to the Company’s Board of Directors.
On May 3, 2018, 6,000 shares of restricted
stock were awarded to the Company’s Board of Directors.
Immediately prior to the Closing, 3,000 shares
of restricted stock outstanding and not previously forfeited under the Non-Employee Director Plan, all restrictions with respect
to such restricted stock lapsed, and the holders of such restricted stock became entitled to receive a pro rata share of the payment
due to stockholders of the Company pursuant to the Externalization Agreement.
On June 16, 2015, the
Company received exemptive relief to repurchase shares of its common stock from its employees in connection with certain
equity compensation plan arrangements. During the year ended December 31, 2018, the Company repurchased 26,681 shares, of
common stock at an aggregate cost of approximately $86,000, in connection with the vesting of employee’s restricted
stock, which is reflected as a reduction in Stockholders’ Equity at cost. These shares are not available to be reissued
under the Company’s Equity Incentive Plan.
On June 23, 2015, the Company’s Board
of Directors approved the grant of 190,166 shares, with a fair value of approximately $1.2 million, of restricted stock to the
employees of the Company as partial compensation for their services. 25% of such awards will vest on each of the first four anniversaries
of the grant date.
On September 19, 2017, the Company’s
Board of Directors approved the grant of 133,620 shares of restricted stock to the employees of the Company as partial compensation
for their services. 50% of such awards were scheduled to vest on the third anniversary of the grant date and the remaining 50%
of the shares were scheduled to vest on the fourth anniversary of the grant date.
Immediately prior to the Closing, 110,382
shares of restricted stock outstanding and not previously forfeited under the Equity Incentive Plan and the 2008 Plan (as defined
below) became fully vested, all restrictions with respect to such restricted stock lapsed, and the holders of such restricted stock
became entitled to receive a pro rata share of the payment due to stockholders of the Company pursuant to the Externalization Agreement.
Information with respect to restricted
stock granted, exercised and forfeited under the Plan for the period January 1, 2018 through March 31, 2019 is as follows:
|
|
Non-vested
Restricted
Shares
|
|
Non-vested shares outstanding at January 1, 2018
|
|
|
297,199
|
|
Granted
|
|
|
6,000
|
|
Vested
|
|
|
(122,878
|
)
|
Forfeited
|
|
|
(56,368
|
)
|
Non-vested shares outstanding at December 31, 2018
|
|
|
123,953
|
|
Granted
|
|
|
—
|
|
Vested
|
|
|
(113,382
|
)
|
Forfeited
|
|
|
(10,571
|
)
|
Non-Vested Outstanding at March 31, 2019
|
|
|
—
|
|
On March 31, 2019, all of the remaining restricted
shares vested. For the three months ended March 31, 2019, non-cash compensation expense related to restricted stock was approximately
$259,000; all of which was expensed at the Company. For the three months ended March 31, 2018, non-cash compensation expense related
to restricted stock was approximately $253,000; of this amount approximately $108,000 was expensed at the Company, and approximately
was $145,000 was a reimbursable expense allocated to the Asset Manager Affiliates.
Distributions are paid on all outstanding shares of restricted
stock, whether or not vested. In general, shares of unvested restricted stock were forfeited upon the recipient’s termination
of employment.
11. OTHER EMPLOYEE COMPENSATION
The Company adopted a 401(k) plan (“401K
Plan”) effective January 1, 2007. The 401K Plan was open to all full time employees. The 401K Plan permits an employee
to defer a portion of their total annual compensation up to the Internal Revenue Service annual maximum based on age and eligibility.
The Company made contributions to the 401K Plan of up to 2% of the Internal Revenue Service’s annual maximum eligible compensation,
which fully vests at the time of contribution. Approximately $9,000 and $10,000 was expensed during the three months ended March
31, 2019 and 2018, respectively, related to the 401K Plan. This Plan was terminated effective March 31, 2019.
The Company has also adopted a deferred
compensation plan (“Profit-Sharing Plan”) effective January 1, 2007. Employees are eligible for the Profit-Sharing
Plan provided that they are employed and working with the Company to participate in at least 100 days during the year and remain
employed as of the last day of the year. Employees do not make contributions to the Profit-Sharing Plan. On behalf of the employee,
the Company may contribute to the Profit-Sharing Plan 1) up to 8.0% of all compensation up to the Internal Revenue Service annual
maximum and 2) up to 5.7% excess contributions on any incremental amounts above the social security wage base limitation and up
to the Internal Revenue Service annual maximum. Employees vest 100% in the Profit-Sharing Plan after five years of service. Approximately
$25,000 was expensed during the three months ended March 31, 2018, related to the Profit-Sharing Plan. This Plan was terminated
effective March 31, 2019, and no expense was recognized during the three months ended March 31, 2019.
12. SUBSEQUENT EVENTS
On April 1, 2019, the maximum commitment
amount of the Revolving Credit Facility was increased from $57.5 million to $67.5 million.
On December 14, 2018, the Company entered
into a stock purchase and transaction agreement (the “Externalization Agreement”) with BC Partners Advisors L.P. (“BCP”),
an affiliate of BC Partners, through which Sierra Crest Investment Management LLC (the “Adviser”), an affiliate of
BC Partners LLP (“BC Partners”), became the Company’s investment adviser pursuant to an investment advisory Agreement
(the “Advisory Agreement”) with the Company. At a special meeting of the Company’s stockholders (the “Special
Meeting”) held on February 19, 2019, the Company’s stockholders approved the Advisory Agreement. The transactions contemplated
by the Externalization Agreement closed on April 1, 2019 (the “Closing”), and the Company commenced operations as an
externally managed BDC managed by the Adviser on that date.
The Company has evaluated events and transactions
occurring subsequent to March 31, 2019 for items that should potentially be recognized or disclosed in these financial statements.
Other than described above, management has determined that there are no other material subsequent events that would require adjustment
to, or disclosure in, these consolidated financial statements.