NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. ORGANIZATION
KCAP Financial, Inc. (“KCAP”
or the “Company”) is an internally managed, non-diversified closed-end investment company that is 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. Prior to its IPO, the Company did not have material operations. The Company’s IPO of 14,462,000 shares of common
stock raised net proceeds of approximately $200 million. Prior to the IPO, the Company issued 3,484,333 shares to affiliates of
Kohlberg & Co., L.L.C., a leading middle market private equity firm, in exchange for the contribution to the Company of their
ownership interests in Katonah Debt Advisors, L.L.C., and related affiliates (collectively, “Katonah Debt Advisors”)
and in securities issued by collateralized loan obligation (“CLO”) funds (“CLO Funds”) managed by Katonah
Debt Advisors and two other asset managers.
On April 28, 2008, the Company completed
a rights offering that resulted in the issuance of 3.1 million shares of the Company’s common stock, and net proceeds of
$27 million.
On February 29, 2012, the Company purchased
Trimaran Advisors, L.L.C. (“Trimaran Advisors”), an asset manager similar to Katonah Debt Advisors, for total consideration
of $13.0 million in cash and 3,600,000 shares of the Company’s common stock. Contemporaneously with the acquisition of Trimaran
Advisors, the Company acquired from Trimaran Advisors equity interests in certain CLO Funds managed by Trimaran Advisors for an
aggregate purchase price of $12.0 million in cash.
On February 14, 2013, the Company completed
a public offering of 5,232,500 shares of common stock, which included the underwriters’ full exercise of their option to
purchase up to 682,500 shares of common stock, at a price of $9.75 per share, raising approximately $51.0 million in gross proceeds.
In conjunction with this offering, the Company also sold 200,000 shares of common stock to a member of its Board of Directors,
at a price of $9.31125 per share, raising approximately $1.9 million in gross proceeds.
On October 6, 2014, the Company completed
a follow-on public offering of 3.0 million shares of its common stock at a price of $8.02 per share. The offering raised net proceeds
of approximately $23.8 million, after deducting underwriting discounts and offering expenses.
As of June 30, 2018, Katonah Debt Advisors
and Trimaran Advisors, as well as affiliated management companies Katonah 2007-1 Management, L.L.C., Trimaran Advisors Management,
L.L.C. and KCAP Management, L.L.C. (collectively the “Asset Manager Affiliates”), had approximately $2.8 billion of
par value assets under management. Katonah Debt Advisors and Trimaran Advisors are registered under the Investment Advisers Act
of 1940, as amended, and are each managed independently from the Company by a separate management team (however, certain of the
Company’s executive officers also act in similar capacities for one or more of the Asset Manager Affiliates). The Asset Manager
Affiliates provide investment management services to CLO Funds, making day-to-day investment decisions concerning the assets of
the CLO Funds. The Asset Manager Affiliates, either directly or through their subsidiaries, may make investments in the CLO Funds
they manage. In addition, the Company holds investments in a portion of the securities issued by the CLO Funds managed by the Asset
Manager Affiliates.
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 F3C 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 has three principal areas of
investment:
First, the Company originates, structures,
and invests in senior secured term loans and mezzanine debt primarily in privately-held middle market companies (the “Debt
Securities Portfolio”). In addition, from time to time the Company may invest in the equity securities of privately held
middle market companies.
Second, the Company has invested in the
Asset Manager Affiliates, which manage CLO Funds.
Third, the Company invests in debt and
subordinated securities issued by CLO Funds (“CLO Fund Securities”). These CLO Fund Securities are primarily managed
by our Asset Manager Affiliates, but from time-to-time the Company makes investments in CLO Fund Securities managed by other asset
managers. The CLO Funds typically invest in broadly syndicated loans, high-yield bonds and other credit instruments.
The Company may also invest in other investments
such as loans to publicly-traded companies, high-yield bonds, joint venture and distressed debt securities. The Company may also
receive warrants or options to purchase common stock in connection with its debt investments.
The Company has elected to be treated 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 will be 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 7.375% Notes and 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.
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, 2017, 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 KCAP Funding, Kolhberg Capital Funding LLC I, KCAP Senior
Funding I, LLC, KCAP Senior Funding I Holdings, LLC and KCAP Funding I, LLC in its consolidated financial statements as they are
operated solely for investment activities of the Company. The creditors of KCAP Funding I, LLC received security interests in the
assets which owned by KCAP Funding I, LLC and such assets are not intended to be available to the creditors of the Company, or
any other affiliate. All of the borrowings of KCAP Funding, 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 are subject
to Accounting Standards Codification Topic 810, “Consolidation” and although the Company cannot consolidate the financial
statements of portfolio company investments, this guidance impacts the Company’s required disclosures relating to the Asset
Manager Affiliates. The Asset Manager Affiliates qualify 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.
On February 18, 2015, the Financial Accounting
Standards Board (“FASB”) issued Accounting Standards Update 2015-2 (“ASU 2015-2”), which updated consolidation
standards under ASC Topic 810, “Consolidation”. Under this update, a new consolidation analysis is required for variable
interest entities (“VIEs”) and will limit the circumstances in which investment managers and similar entities are required
to consolidate the entities that they manage. The FASB decided to eliminate some of the criteria under which their management fees
are considered a variable interest and limit the circumstances in which variable interests in a VIE held by related parties of
a reporting enterprise require the reporting enterprise to consolidate the VIE. The guidance is effective for public business entities
for annual and interim periods in fiscal years beginning after December 15, 2015. The Asset Manager Affiliates adopted ASU 2015-2
in 2016 which resulted in the deconsolidation of the CLO Funds managed by them.
In addition, in accordance with Regulation
S-X promulgated by the SEC, additional financial information with respect to one of the CLO Funds in which the Company has an investment,
Katonah 2007-I CLO Ltd. (“Katonah 2007-I CLO”), is required to be included in the Company’s SEC filings. The
additional financial information regarding the Asset Manager Affiliates and Katonah 2007-I CLO is set forth in Note 5 to these
consolidated 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 June 30, 2018, the Company provided approximately $61 million to portfolio companies to support their growth
objectives. None of this support was contractually obligated. See also Note 8 – Commitments and Contingencies. As of June
30, 2018, the Company held loans it has made to 48 investee companies with aggregate principal amounts of approximately $171.6
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 six months ended June 30, 2018, the Company did not engage
in any such or similar activities.
Recently adopted accounting pronouncements
FASB issued Accounting Standards Update
2014-09, Revenue from Contracts with Customers, which updated accounting guidance for all revenue recognition arising from contracts
with customers, and also affects entities that enter into contracts to provide goods or services to their customers (unless the
contracts are in the scope of other GAAP requirements). This update provides a model for the measurement and recognition of gains
and losses on the sale of certain nonfinancial assets, such as property and equipment, including real estate. The FASB also issued
ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which deferred the effective date
of the standard for one year. As a result, the guidance is effective for public business entities for annual and interim periods
in fiscal years beginning after December 15, 2017. Management has concluded that the majority of its revenues associated with the
financial instruments are scoped out of ASC 606, and therefore, there was no material impact from adoption.
Pending accounting pronouncements
In March 2017, the Financial Accounting
Standards Board 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. At
this time, management is evaluating the implications of these changes on the 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 U.S. 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.
CLO Fund Securities
. The Company typically
makes a minority investment in the most junior class of securities of CLO Funds raised and managed by the Asset Manager Affiliates
and may selectively invest in securities issued by funds managed by other asset management companies. 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 KCAP Funding I, LLC and/or KCAP Senior 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 June
30, 2018, one of our investments was on non-accrual status, and two of our investments were on partial non-accrual status, whereby
we have recognized income on a portion of contractual PIK amounts due.
Distributions from Asset Manager Affiliates
.
The Company records distributions from our 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 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 our 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 of CLO Funds (typically preferred
shares or subordinated securities) managed by the Asset Manager Affiliates and select investments in securities issued by funds
managed by other asset management companies. 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 KCAP F3C Senior Funding, LLC, interest is earned at a fixed
spread relative to the LIBOR index.
Investment in Joint Venture.
For the three months and six months ended June 30, 2018, the Company recognized $700,000 and $1.4 million in investment
income from its investment in the Joint Venture. As of June 30, 2018 and December 31, 2017, the fair value of the
Company’s investment in the Joint venture was $21.1 million and $21.5 million, respectively. For interim periods, the
Company recognizes investment income on its investment in the Joint Venture based upon its share of the estimated tax-basis
earnings and profits of the Joint Venture. Any distributions in excess of tax-basis earnings and profits are recognized as a
return of capital (adjustment to the Company’s cost basis in the investment). 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 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
. The Company is internally
managed and expenses 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. The Company and the Asset Manager Affiliates share office space and certain other operating expenses. The Company
has entered into an Overhead Allocation Agreement with the Asset Manager Affiliates which provides for the sharing of such expenses
based on an allocation of office lease costs and the ratable usage of other shared resources.
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 and six months ended
June 30, 2018 and 2017:
|
|
(unaudited)
|
|
|
(unaudited)
|
|
|
|
Three Months Ended June 30,
|
|
|
Six Months Ended June 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (decrease) increase in net assets resulting from operations
|
|
$
|
(1,311,772
|
)
|
|
$
|
2,521,727
|
|
|
$
|
1,297,622
|
|
|
$
|
2,907,276
|
|
Net (decrease) increase in net assets allocated to unvested share awards
|
|
|
10,438
|
|
|
|
(21,340
|
)
|
|
|
(10,035
|
)
|
|
|
(28,258
|
)
|
Net (decrease) increase in net assets available to common stockholders
|
|
$
|
(1,301,334
|
)
|
|
$
|
2,500,387
|
|
|
|
1,287,587
|
|
|
|
2,879,018
|
|
Weighted average number of common and common stock equivalent shares outstanding for diluted shares computation
|
|
|
37,363,038
|
|
|
|
37,206,487
|
|
|
|
37,356,759
|
|
|
|
37,204,751
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (decrease) increase in net assets per basic common shares:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (decrease) increase in net assets from operations
|
|
$
|
(0.04
|
)
|
|
$
|
0.07
|
|
|
$
|
0.03
|
|
|
$
|
0.08
|
|
Net (decrease) increase in net assets per diluted shares:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (decrease) increase in net assets from operations
|
|
$
|
(0.03
|
)
|
|
$
|
0.07
|
|
|
$
|
0.03
|
|
|
$
|
0.08
|
|
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 50,000 options to purchase
shares of common stock considered for the computation of the diluted per share information for the three and six months ended June
30, 2018 and 2017. Since the effects are anti-dilutive for both periods, the options were not included in the computation.
4. INVESTMENTS
The following table shows the Company’s
portfolio by security type at June 30, 2018 and December 31, 2017:
|
|
June 30, 2018 (unaudited)
|
|
|
December 31, 2017
|
|
Security Type
|
|
Cost/
Amortized
Cost
|
|
|
Fair Value
|
|
|
%
1
|
|
|
Cost/
Amortized
Cost
|
|
|
Fair Value
|
|
|
%
1
|
|
Short-term investments
2
|
|
$
|
11,454,078
|
|
|
$
|
11,454,078
|
|
|
|
4
|
|
|
$
|
77,300,320
|
|
|
$
|
77,300,320
|
|
|
|
26
|
|
Senior Secured Loan
|
|
|
62,122,920
|
|
|
|
58,324,196
|
|
|
|
21
|
|
|
|
48,337,900
|
|
|
|
44,960,146
|
|
|
|
14
|
|
Junior Secured Loan
|
|
|
78,346,396
|
|
|
|
74,037,768
|
|
|
|
27
|
|
|
|
62,561,913
|
|
|
|
58,941,300
|
|
|
|
19
|
|
Senior Unsecured Loan
|
|
|
29,777,282
|
|
|
|
29,777,282
|
|
|
|
11
|
|
|
|
12,777,283
|
|
|
|
12,777,283
|
|
|
|
4
|
|
Senior Secured Bond
|
|
|
—
|
|
|
|
—
|
|
|
|
-
|
|
|
|
1,502,374
|
|
|
|
1,518,750
|
|
|
|
-
|
|
CLO Fund Securities
|
|
|
59,446,300
|
|
|
|
37,972,985
|
|
|
|
14
|
|
|
|
72,339,032
|
|
|
|
51,678,673
|
|
|
|
17
|
|
Equity Securities
|
|
|
10,571,007
|
|
|
|
4,251,111
|
|
|
|
2
|
|
|
|
10,571,007
|
|
|
|
4,414,684
|
|
|
|
1
|
|
Asset Manager Affiliates
3
|
|
|
51,591,230
|
|
|
|
36,853,000
|
|
|
|
13
|
|
|
|
52,591,230
|
|
|
|
38,849,000
|
|
|
|
12
|
|
Joint Venture
|
|
|
24,914,858
|
|
|
|
21,091,494
|
|
|
|
8
|
|
|
|
24,914,858
|
|
|
|
21,516,000
|
|
|
|
7
|
|
Total
|
|
$
|
328,224,071
|
|
|
$
|
273,761,914
|
|
|
|
100
|
%
|
|
$
|
362,895,917
|
|
|
$
|
311,956,156
|
|
|
|
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 June 30, 2018 and December 31, 2017, were as follows:
|
June 30, 2018 (unaudited)
|
|
December 31, 2017
|
Industry Classification
|
|
Cost/
Amortized
Cost
|
|
|
Fair Value
|
|
|
%
1
|
|
|
Cost/
Amortized
Cost
|
|
|
Fair Value
|
|
|
%
|
|
Aerospace and Defense
|
|
$
|
5,423,072
|
|
|
$
|
4,876,425
|
|
|
|
2
|
%
|
|
$
|
5,636,056
|
|
|
$
|
4,115,487
|
|
|
|
1
|
%
|
Asset Management Company
2
|
|
|
51,591,230
|
|
|
|
36,853,000
|
|
|
|
13
|
|
|
|
52,591,230
|
|
|
|
38,849,000
|
|
|
|
12
|
|
Banking, Finance, Insurance & Real Estate
|
|
|
4,447,205
|
|
|
|
4,395,587
|
|
|
|
2
|
|
|
|
4,458,962
|
|
|
|
4,418,391
|
|
|
|
1
|
|
Beverage, Food and Tobacco
|
|
|
5,978,372
|
|
|
|
5,877,619
|
|
|
|
2
|
|
|
|
7,496,438
|
|
|
|
7,435,050
|
|
|
|
2
|
|
Capital Equipment
|
|
|
9,423,335
|
|
|
|
8,555,748
|
|
|
|
3
|
|
|
|
5,454,621
|
|
|
|
4,680,821
|
|
|
|
2
|
|
Chemicals, Plastics and Rubber
|
|
|
6,652,974
|
|
|
|
6,619,400
|
|
|
|
2
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
CLO Fund Securities
|
|
|
59,446,300
|
|
|
|
37,972,985
|
|
|
|
14
|
|
|
|
72,339,032
|
|
|
|
51,678,673
|
|
|
|
17
|
|
Construction & Building
|
|
|
997,633
|
|
|
|
989,895
|
|
|
|
—
|
|
|
|
1,004,093
|
|
|
|
999,872
|
|
|
|
-
|
|
Consumer goods: Durable
|
|
|
1,093,572
|
|
|
|
839,450
|
|
|
|
1
|
|
|
|
1,071,340
|
|
|
|
805,607
|
|
|
|
-
|
|
Consumer goods: Non-durable
|
|
|
599,752
|
|
|
|
602,344
|
|
|
|
—
|
|
|
|
691,234
|
|
|
|
694,662
|
|
|
|
-
|
|
Energy: Oil & Gas
|
|
|
17,222,218
|
|
|
|
12,499,467
|
|
|
|
5
|
|
|
|
14,932,542
|
|
|
|
11,433,777
|
|
|
|
4
|
|
Environmental Industries
|
|
|
8,466,453
|
|
|
|
7,423,009
|
|
|
|
3
|
|
|
|
6,330,630
|
|
|
|
5,766,437
|
|
|
|
2
|
|
Forest Products & Paper
|
|
|
1,561,553
|
|
|
|
1,600,960
|
|
|
|
1
|
|
|
|
1,558,556
|
|
|
|
1,600,960
|
|
|
|
1
|
|
Healthcare & Pharmaceuticals
|
|
|
41,248,780
|
|
|
|
36,188,183
|
|
|
|
13
|
|
|
|
30,367,449
|
|
|
|
25,512,654
|
|
|
|
8
|
|
High Tech Industries
|
|
|
14,132,583
|
|
|
|
14,030,079
|
|
|
|
5
|
|
|
|
18,229,229
|
|
|
|
18,260,577
|
|
|
|
6
|
|
Hotel, Gaming & Leisure
|
|
|
400,000
|
|
|
|
1,000
|
|
|
|
—
|
|
|
|
400,000
|
|
|
|
1,000
|
|
|
|
-
|
|
Joint Venture
|
|
|
24,914,858
|
|
|
|
21,091,494
|
|
|
|
8
|
|
|
|
24,914,858
|
|
|
|
21,516,000
|
|
|
|
7
|
|
Media: Advertising, Printing & Publishing
|
|
|
3,283,670
|
|
|
|
3,230,850
|
|
|
|
1
|
|
|
|
3,371,086
|
|
|
|
3,318,296
|
|
|
|
1
|
|
Related Party Loans
|
|
|
29,777,283
|
|
|
|
29,777,283
|
|
|
|
11
|
|
|
|
12,777,283
|
|
|
|
12,777,283
|
|
|
|
4
|
|
Services: Business
|
|
|
9,479,862
|
|
|
|
8,299,523
|
|
|
|
3
|
|
|
|
3,563,574
|
|
|
|
2,366,400
|
|
|
|
1
|
|
Telecommunications
|
|
|
6,444,954
|
|
|
|
6,419,200
|
|
|
|
2
|
|
|
|
6,455,489
|
|
|
|
6,466,949
|
|
|
|
2
|
|
Textiles and Leather
|
|
|
10,183,566
|
|
|
|
10,162,735
|
|
|
|
4
|
|
|
|
7,950,994
|
|
|
|
7,947,940
|
|
|
|
3
|
|
Money Market Accounts
|
|
|
11,454,078
|
|
|
|
11,454,078
|
|
|
|
4
|
|
|
|
52,293,570
|
|
|
|
52,293,570
|
|
|
|
17
|
|
Transportation: Cargo
|
|
|
4,000,768
|
|
|
|
4,001,600
|
|
|
|
1
|
|
|
|
4,000,901
|
|
|
|
4,010,000
|
|
|
|
1
|
|
U.S. Government Obligations
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
25,006,750
|
|
|
|
25,006,750
|
|
|
|
8
|
|
Total
|
|
$
|
328,224,071
|
|
|
$
|
273,761,914
|
|
|
|
100
|
%
|
|
$
|
362,895,917
|
|
|
$
|
311,956,156
|
|
|
|
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 June 30, 2018 and December 31, 2017, the
total amount of non-qualifying assets was approximately 22% and 23% of total assets, respectively. The majority of non-qualifying
assets were foreign investments which were approximately 14% and 16%, 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 14%
and 16% of its total assets on such dates, respectively).
Investments in CLO Fund Securities
The Company typically makes a minority investment
in the most junior class of securities (typically preferred shares or subordinated securities) of CLO Funds managed by the Asset
Manager Affiliates and may selectively invest in securities issued by CLO funds managed by other asset management companies. 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 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.
In June 2016, the Company sold $7.0 million
par value of the Subordinated Notes of Catamaran 2015-1 for $4.2 million.
In December 2016, the Company purchased $10.1
million of the par value of the Subordinated Notes of Catamaran 2016-1 CLO (“Catamaran 2016-1”) managed by Trimaran
Advisors.
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.
Except for Katonah 2007-1 CLO
Ltd, (“Katonah 2007-1”), Trimaran VII CLO Ltd, and Catamaran 2012-1 CLO, Ltd, all of which have been called, CLO Funds
managed by the Asset Manager Affiliates are currently making quarterly distributions to the Company with respect to its
interests in the CLO Funds and are paying all senior and subordinate management fees to the Asset Manager Affiliates. With
the exception of Katonah III, Ltd. and Grant Grove CLO, Ltd. (both of which have been called), the remaining third-party
managed CLO Fund is making distributions to the Company.
On December 19, 2017, the Company, in its
capacity as the holder of all of the outstanding preferred shares of 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. As of June
30, 2018, Katonah 2007-1 had paid off all of its outstanding indebtedness and had approximately $319,000 in total assets. It is
expected that Katonah 2007-1 will be fully liquidated and dissolved in 2018. The Company received approximately $10.5 million on
its investment in Katonah 2007-1 during the first quarter of 2018 in connection with the continuing liquidation of Katonah 2007-1.
The Company expects to record a realized loss during 2018 of approximately $10 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.
In January 2018, the trustees of Catamaran
CLO 2012-1, Ltd received notice that the holders of a majority of the income notes issued by Catamaran CLO 2012-1, Ltd had exercised
their right of optional redemption.
Affiliate Investments
The following table details investments
in affiliates at June 30, 2018 (unaudited) and December 31, 2017:
|
|
Industry
Classification
|
|
Fair
Value at of
December 31,
2017
|
|
|
Purchases
/(Sales) of
or
Advances
/(Distributions)
|
|
|
Net
Accretion
|
|
|
Unrealized
Gain/(Loss)
|
|
|
Realized
Gain/(Loss)
|
|
|
Fair
Value at
of June 30,
2018 (unaudited)
|
|
|
Interest
Income
|
|
|
Dividend
Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset Manager Affiliates
(4)(5)(6)
|
|
Asset Management Company
|
|
$
|
38,849,000
|
|
|
$
|
(1,000,000
|
)
|
|
|
-
|
|
|
|
(996,000
|
)
|
|
$
|
-
|
|
|
$
|
36,853,000
|
|
|
$
|
|
|
|
$
|
620,000
|
|
Trimaran Advisors, LLC Revolving Credit Facility
(4)(5)(6)
|
|
Related Party Loans
|
|
|
-
|
|
|
|
23,000,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
23,000,000
|
|
|
|
638,631
|
|
|
|
-
|
|
Trimaran Advisors, LLC Related Party Loan
(4)(5)(6)
|
|
Related Party Loans
|
|
|
8,359,051
|
|
|
|
(1,581,769
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
6,777,282
|
|
|
|
439,904
|
|
|
|
|
|
Trimaran Advisors, LLC Related Party Loan
(4)(5)(6)
|
|
Related Party Loans
|
|
|
4,418,232
|
|
|
|
(4,418,232
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
229,380
|
|
|
|
|
|
Katonah 2007-I CLO, Ltd.
(1)(2)(3)(4)
|
|
CLO Fund Securities
|
|
|
10,770,487
|
|
|
|
(10,487,425
|
)
|
|
|
271,656
|
|
|
|
(354,719
|
)
|
|
|
-
|
|
|
|
199,999
|
|
|
|
271,658
|
|
|
|
-
|
|
Trimaran CLO VII, Ltd.
(1)(2)(3)(4)
|
|
CLO Fund Securities
|
|
|
10,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
10,000
|
|
|
|
-
|
|
|
|
-
|
|
Catamaran CLO 2012-1, Ltd.
(1)(2)(3)(4)
|
|
CLO Fund Securities
|
|
|
2,320,783
|
|
|
|
(2,543,968
|
)
|
|
|
264,746
|
|
|
|
8,437
|
|
|
|
-
|
|
|
|
49,998
|
|
|
|
264,746
|
|
|
|
-
|
|
Catamaran CLO 2013-1, Ltd.
(1)(2)(4)
|
|
CLO Fund Securities
|
|
|
6,923,700
|
|
|
|
(756,859
|
)
|
|
|
678,261
|
|
|
|
(870,117
|
)
|
|
|
-
|
|
|
|
5,974,985
|
|
|
|
678,262
|
|
|
|
-
|
|
Catamaran CLO 2014-1, Ltd.
(1)(2)(4)
|
|
CLO Fund Securities
|
|
|
8,230,177
|
|
|
|
(704,498
|
)
|
|
|
685,011
|
|
|
|
1,233,354
|
|
|
|
-
|
|
|
|
9,444,044
|
|
|
|
685,011
|
|
|
|
-
|
|
Catamaran CLO 2014-2, Ltd.
(1)(2)(4)
|
|
CLO Fund Securities
|
|
|
4,500,962
|
|
|
|
(518,472
|
)
|
|
|
364,447
|
|
|
|
(325,754
|
)
|
|
|
-
|
|
|
|
4,021,183
|
|
|
|
364,447
|
|
|
|
-
|
|
Catamaran CLO 2015-1, Ltd.
(1)(2)(4)
|
|
CLO Fund Securities
|
|
|
3,569,603
|
|
|
|
(229,757
|
)
|
|
|
266,574
|
|
|
|
(299,229
|
)
|
|
|
-
|
|
|
|
3,307,191
|
|
|
|
266,574
|
|
|
|
-
|
|
Catamaran CLO 2016-1, Ltd.
(1)(2)(4)
|
|
CLO Fund Securities
|
|
|
8,530,684
|
|
|
|
(647,232
|
)
|
|
|
472,734
|
|
|
|
(505,966
|
)
|
|
|
-
|
|
|
|
7,850,220
|
|
|
|
472,734
|
|
|
|
-
|
|
KCAP F3C Senior Funding Rated Notes
(2)(4)(7)
|
|
CLO Fund Securities
|
|
|
4,632,001
|
|
|
|
-
|
|
|
|
18,496
|
|
|
|
37,347
|
|
|
|
-
|
|
|
|
4,687,844
|
|
|
|
236,243
|
|
|
|
|
|
KCAP Freedom 3 LLC
(4)(7)
|
|
Joint Venture
|
|
|
21,516,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(424,506
|
)
|
|
|
-
|
|
|
|
21,091,494
|
|
|
|
-
|
|
|
|
1,400,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Affiliated Investments
|
|
|
|
$
|
122,630,680
|
|
|
$
|
111,788
|
|
|
$
|
3,021,925
|
|
|
$
|
(2,497,153
|
)
|
|
$
|
-
|
|
|
$
|
123,267,240
|
|
|
$
|
4,547,590
|
|
|
$
|
2,020,000
|
|
|
|
Industry
Classification
|
|
Fair
Value at
December 31,
2016
|
|
|
Purchases/
(Sales) of
or
Advances/
(Distributions)
|
|
|
Net
Accretion
|
|
|
Unrealized
Gain/(Loss)
|
|
|
Realized
Gain/(Loss)
|
|
|
Fair
Value at
of December 31,
2017
|
|
|
Interest
Income
|
|
|
Dividend
Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset Manager Affiliates
(4)(5)(6)
|
|
Asset Management Company
|
|
$
|
40,198,000
|
|
|
$
|
(2,750,000
|
)
|
|
$
|
-
|
|
|
$
|
1,401,000
|
|
|
$
|
-
|
|
|
$
|
38,849,000
|
|
|
$
|
-
|
|
|
$
|
460,000
|
|
Trimaran Advisors, LLC Revolving Credit Facility
(4)(5)(6)
|
|
Related Party Loans
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
916,765
|
|
|
|
-
|
|
Trimaran Advisors, LLC Related Party Loan
(4)(5)(6)
|
|
Related Party Loans
|
|
|
-
|
|
|
|
8,359,051
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8,359,051
|
|
|
|
148,721
|
|
|
|
|
|
Trimaran Advisors, LLC Related Party Loan
(4)(5)(6)
|
|
Related Party Loans
|
|
|
-
|
|
|
|
4,418,232
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,418,232
|
|
|
|
16,752
|
|
|
|
|
|
Katonah 2007-I CLO, Ltd.
(1)(2)(3)(4)
|
|
CLO Fund Securities
|
|
|
20,453,099
|
|
|
|
(13,157,760
|
)
|
|
|
5,660,026
|
|
|
|
(2,184,878
|
)
|
|
|
-
|
|
|
|
10,770,486
|
|
|
|
5,660,026
|
|
|
|
-
|
|
Trimaran CLO VII, Ltd.
(1)(2)(3)(4)
|
|
CLO Fund Securities
|
|
|
1,195,152
|
|
|
|
(1,264,090
|
)
|
|
|
-
|
|
|
|
78,938
|
|
|
|
-
|
|
|
|
10,000
|
|
|
|
-
|
|
|
|
-
|
|
Catamaran CLO 2012-1, Ltd.
(1)(2)(4)
|
|
CLO Fund Securities
|
|
|
2,819,412
|
|
|
|
(771,743
|
)
|
|
|
699,611
|
|
|
|
(426,497
|
)
|
|
|
-
|
|
|
|
2,320,783
|
|
|
|
699,611
|
|
|
|
-
|
|
Catamaran CLO 2013-1, Ltd.
(1)(2)(4)
|
|
CLO Fund Securities
|
|
|
4,918,807
|
|
|
|
(1,054,362
|
)
|
|
|
834,448
|
|
|
|
2,224,807
|
|
|
|
-
|
|
|
|
6,923,699
|
|
|
|
834,448
|
|
|
|
-
|
|
Catamaran CLO 2014-1, Ltd.
(1)(2)(4)
|
|
CLO Fund Securities
|
|
|
4,546,682
|
|
|
|
2,319,047
|
|
|
|
1,079,850
|
|
|
|
1,643,907
|
|
|
|
(1,359,309
|
)
|
|
|
8,230,178
|
|
|
|
1,079,850
|
|
|
|
-
|
|
Catamaran CLO 2014-2, Ltd.
(1)(2)(4)
|
|
CLO Fund Securities
|
|
|
5,092,087
|
|
|
|
(1,130,813
|
)
|
|
|
806,058
|
|
|
|
(266,370
|
)
|
|
|
-
|
|
|
|
4,500,962
|
|
|
|
806,058
|
|
|
|
-
|
|
Catamaran CLO 2015-1, Ltd.
(1)(2)(4)
|
|
CLO Fund Securities
|
|
|
3,223,255
|
|
|
|
(571,562
|
)
|
|
|
446,893
|
|
|
|
471,017
|
|
|
|
-
|
|
|
|
3,569,600
|
|
|
|
446,893
|
|
|
|
-
|
|
Catamaran CLO 2016-1, Ltd.
(1)(2)(4)
|
|
CLO Fund Securities
|
|
|
8,350,290
|
|
|
|
(1,146,242
|
)
|
|
|
1,093,043
|
|
|
|
233,593
|
|
|
|
-
|
|
|
|
8,530,685
|
|
|
|
1,093,043
|
|
|
|
-
|
|
CRMN 2014-1A
(1)(2)(4)
|
|
CLO Fund Securities
|
|
|
1,310,000
|
|
|
|
(1,545,506
|
)
|
|
|
9,259
|
|
|
|
131,727
|
|
|
|
94,520
|
|
|
|
-
|
|
|
|
97,885
|
|
|
|
-
|
|
KCAP F3C Senior Funding Rated Notes
(2)(4)(7)
|
|
CLO Fund Securities
|
|
|
-
|
|
|
|
4,346,290
|
|
|
|
89,676
|
|
|
|
196,035
|
|
|
|
|
|
|
|
4,632,000
|
|
|
|
89,676
|
|
|
|
|
|
KCAP Freedom 3 LLC
(4)(7)
|
|
Joint Venture
|
|
|
-
|
|
|
|
24,914,858
|
|
|
|
-
|
|
|
|
(3,398,858
|
)
|
|
|
-
|
|
|
|
21,516,000
|
|
|
|
-
|
|
|
|
949,037
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Affiliated Investments
|
|
|
|
$
|
92,106,784
|
|
|
$
|
20,965,400
|
|
|
$
|
10,718,864
|
|
|
$
|
104,421
|
|
|
$
|
(1,264,789
|
)
|
|
$
|
122,630,676
|
|
|
$
|
11,889,728
|
|
|
$
|
1,409,037
|
|
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 1940 Act.
|
|
|
6
|
The Company is deemed to “Control” and be an “Affiliated
Person” of the Asset Manager Affiliates, each as defined in the 1940 Act, as the Company owns 100% of each Asset Manager
Affiliate’s outstanding voting securities. In general, under the 1940 Act, the Company would be presumed to “Control”
a portfolio company if it owned 25% or more of its voting securities and would be an “Affiliated Person” of a portfolio
company if it owned 5% or more of its voting securities.
|
|
|
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 (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
|
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,
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 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 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 Joint Venture made a cash distribution to the Company of approximately
$12.6 million. The Company expects that approximately $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 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.
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
|
|
|
|
June 30, 2018
(unaudited)
|
|
|
December 31,
2017
|
|
Cash
|
|
$
|
-
|
|
|
$
|
1,717
|
|
Investment at fair value
|
|
|
37,512,496
|
|
|
|
37,080,000
|
|
Total Assets
|
|
$
|
37,512,496
|
|
|
$
|
37,081,717
|
|
|
|
|
|
|
|
|
|
|
Total Liabilities
|
|
$
|
2,360,006
|
|
|
$
|
1,221,916
|
|
Total Equity
|
|
|
35,152,490
|
|
|
|
35,859,801
|
|
Total Liabilities and Equity
|
|
$
|
37,512,496
|
|
|
$
|
37,081,717
|
|
KCAP Freedom 3 LLC
Summarized Statement of Operations
(unaudited)
|
|
For the three
months ended
June 30, 2018
|
|
|
For the three
months ended
June 30, 2017
|
|
|
For the six
months ended
June 30, 2018
|
|
|
For the six
months ended
June 30, 2017
|
|
Investment income
|
|
$
|
1,221,996
|
|
|
$
|
-
|
|
|
$
|
2,417,814
|
|
|
$
|
-
|
|
Operating expenses
|
|
|
31,998
|
|
|
|
-
|
|
|
|
53,761
|
|
|
|
-
|
|
Net investment income
|
|
|
1,189,998
|
|
|
|
-
|
|
|
|
2,364,053
|
|
|
|
-
|
|
Unrealized (depreciation) appreciation on investments
|
|
|
(1,068,857
|
)
|
|
|
-
|
|
|
|
(564,936
|
)
|
|
|
-
|
|
Net income
|
|
$
|
121,141
|
|
|
$
|
-
|
|
|
$
|
1,799,117
|
|
|
$
|
-
|
|
|
|
KCAP Freedom 3 LLC
|
|
|
|
|
|
|
|
|
|
Schedule of Investments
|
|
|
|
|
|
|
|
|
|
June 30, 2018
|
|
|
|
|
|
|
|
|
|
(unaudited)
|
|
|
|
|
|
|
|
Portfolio Company
|
|
Investment
|
|
Percentage
Ownership
by Joint
Venture
|
|
|
Amortized Cost
|
|
|
Fair Value
|
|
KCAP F3C Senior Funding, LLC
(1)(2)
|
|
Subordinated Securities, effective interest 11.4%, 12/29 maturity
|
|
|
100.0
|
%
|
|
$
|
43,140,686
|
|
|
$
|
37,512,496
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Investments
|
|
|
|
|
|
|
|
$
|
43,140,686
|
|
|
$
|
37,512,496
|
|
(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.
|
|
Schedule of Investments
|
|
|
December 31, 2017
|
Portfolio Company
|
|
Investment
|
|
Percentage
Ownership
by Joint
Venture
|
|
|
Amortized Cost
|
|
|
Fair Value
|
|
KCAP F3C Senior Funding, LLC
(1)(2)
|
|
Subordinated Securities, effective interest 12.1%, 12/29 maturity
|
|
|
100.0
|
%
|
|
$
|
42,143,254
|
|
|
$
|
37,080,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Investments
|
|
|
|
|
|
|
|
$
|
42,143,254
|
|
|
$
|
37,080,000
|
|
(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 a third party broker quote.
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 June 30, 2018 (unaudited) and December
31, 2017, respectively:
|
|
As of June 30, 2018 (unaudited)
|
|
|
|
Level I
|
|
|
Level II
|
|
|
Level III
|
|
|
Total
|
|
Short Term investments
|
|
$
|
—
|
|
|
$
|
11,454,078
|
|
|
$
|
—
|
|
|
$
|
11,454,078
|
|
Debt securities
|
|
|
—
|
|
|
|
44,563,587
|
|
|
|
117,575,659
|
|
|
|
162,139,246
|
|
CLO Fund Securities
|
|
|
—
|
|
|
|
—
|
|
|
|
37,972,985
|
|
|
|
37,972,985
|
|
Equity securities
|
|
|
—
|
|
|
|
—
|
|
|
|
4,251,111
|
|
|
|
4,251,111
|
|
Asset Manager Affiliates
|
|
|
—
|
|
|
|
—
|
|
|
|
36,853,000
|
|
|
|
36,853,000
|
|
Joint Venture
|
|
|
—
|
|
|
|
—
|
|
|
|
21,091,494
|
|
|
|
21,091,494
|
|
Total
|
|
$
|
—
|
|
|
$
|
56,017,665
|
|
|
$
|
217,744,249
|
|
|
$
|
273,761,914
|
|
|
|
As of December 31, 2017
|
|
|
|
Level I
|
|
|
Level II
|
|
|
Level III
|
|
|
Total
|
|
Short Term investments
|
|
$
|
25,006,750
|
|
|
$
|
52,293,570
|
|
|
$
|
—
|
|
|
$
|
77,300,320
|
|
Debt securities
|
|
|
—
|
|
|
|
48,312,024
|
|
|
|
69,885,455
|
|
|
|
118,197,479
|
|
CLO Fund Securities
|
|
|
—
|
|
|
|
—
|
|
|
|
51,678,673
|
|
|
|
51,678,673
|
|
Equity securities
|
|
|
—
|
|
|
|
—
|
|
|
|
4,414,684
|
|
|
|
4,414,684
|
|
Asset Manager Affiliates
|
|
|
—
|
|
|
|
—
|
|
|
|
38,849,000
|
|
|
|
38,849,000
|
|
Joint Venture
|
|
|
—
|
|
|
|
—
|
|
|
|
21,516,000
|
|
|
|
21,516,000
|
|
Total
|
|
$
|
25,006,750
|
|
|
$
|
100,605,594
|
|
|
$
|
186,343,812
|
|
|
$
|
311,956,156
|
|
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.
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:
|
|
Six Months Ended June 30, 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 III
1
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Transfers into Level III
2
|
|
|
24,921,613
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
24,921,613
|
|
Net accretion
|
|
|
61,525
|
|
|
|
3,151,236
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
3,212,761
|
|
Purchases
|
|
|
29,962,022
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
29,962,022
|
|
Sales/Paydowns/Return of Capital
|
|
|
(6,466,548
|
)
|
|
|
(16,043,968
|
)
|
|
|
—
|
|
|
|
(1,000,000
|
)
|
|
|
—
|
|
|
|
(23,510,516
|
)
|
Total realized loss included in earnings
|
|
|
67,835
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
67,835
|
|
Change in unrealized gain (loss) included in earnings
|
|
|
(856,242
|
)
|
|
|
(812,956
|
)
|
|
|
(163,573
|
)
|
|
|
(996,000
|
)
|
|
|
(424,506
|
)
|
|
|
(3,253,277
|
)
|
Balance, June 30, 2018
|
|
$
|
117,575,659
|
|
|
$
|
37,972,985
|
|
|
$
|
4,251,111
|
|
|
$
|
36,853,000
|
|
|
$
|
21,091,494
|
|
|
$
|
217,744,249
|
|
Changes in unrealized gains (losses) included in earnings related to investments still held at reporting date
|
|
$
|
(515,834
|
)
|
|
$
|
(812,956
|
)
|
|
$
|
(163,573
|
)
|
|
$
|
(996,000
|
)
|
|
$
|
(424,506
|
)
|
|
$
|
(2,912,419
|
)
|
1
Transfers out of Level III represent a transfer of $0
relating to debt securities for which pricing inputs, other than their quoted prices in active markets were observable as of June
30, 2018.
2
Transfers into Level III represent a transfer of $24,921,613
relating to debt securities for which pricing inputs, other than their quoted prices in active markets were unobservable as of
June 30, 2018.
|
|
Year Ended December 31, 2017
|
|
|
|
Debt Securities
|
|
|
CLO Fund
Securities
|
|
|
Equity
Securities
|
|
|
Asset Manager
Affiliate
|
|
|
Joint
Venture
|
|
|
Total
|
|
Balance, December 31, 2016
|
|
$
|
153,741,745
|
|
|
$
|
54,174,350
|
|
|
$
|
5,056,355
|
|
|
$
|
40,198,000
|
|
|
$
|
—
|
|
|
$
|
253,170,450
|
|
Transfers out of Level III
1
|
|
|
(3,867,400
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(3,867,400
|
)
|
Transfers into Level III
2
|
|
|
2,477,500
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
2,477,500
|
|
Net accretion
|
|
|
246,238
|
|
|
|
11,139,633
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
11,385,871
|
|
Purchases
|
|
|
53,219,762
|
|
|
|
11,211,368
|
|
|
|
182,000
|
|
|
|
—
|
|
|
|
36,738,873
|
|
|
|
101,352,003
|
|
Sales/Paydowns/Return of Capital
|
|
|
(136,020,685
|
)
|
|
|
(25,598,497
|
)
|
|
|
—
|
|
|
|
(2,750,000
|
)
|
|
|
(11,824,015
|
)
|
|
|
(176,193,197
|
)
|
Total realized gain included in earnings
|
|
|
(2,121,907
|
)
|
|
|
(1,264,789
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(3,386,696
|
)
|
Total unrealized gain (loss) included in earnings
|
|
|
2,210,202
|
|
|
|
2,016,608
|
|
|
|
(823,671
|
)
|
|
|
1,401,000
|
|
|
|
(3,398,858
|
)
|
|
|
1,405,281
|
|
Balance, December 31, 2017
|
|
$
|
69,885,455
|
|
|
$
|
51,678,673
|
|
|
$
|
4,414,684
|
|
|
$
|
38,849,000
|
|
|
$
|
21,516,000
|
|
|
$
|
186,343,812
|
|
Changes in unrealized gains (losses) included in earnings related to investments still held at reporting date
|
|
$
|
(479,087
|
)
|
|
$
|
2,016,608
|
|
|
$
|
(823,671
|
)
|
|
$
|
1,401,000
|
|
|
$
|
(3,398,858
|
)
|
|
$
|
(1,284,008
|
)
|
1
Transfers out of Level III represent a transfer of $3,867,400
relating to debt securities for which pricing inputs, other than their quoted prices in active markets were observable as of December
31, 2017.
2
Transfers into Level III represent a transfer of $2,477,500
relating to debt securities for which pricing inputs, other than their quoted prices in active markets were unobservable as of
December 31, 2017.
As of June 30, 2018 and December 31, 2017, 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 $56,017,665 and $100,605,594 as of June 30, 2018 and December 31, 2017, respectively.
As of June 30, 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
|
$ 15,829,929
|
Enterprise Value
|
Average EBITDA Multiple / WACC
|
5.1x– 6.3x (5.9x)
15.2%-18.2 %( 17.2%)
|
|
101,745,730
|
Income Approach
|
Implied Discount Rate
|
7.1% – 25.1% (11.7%)
|
|
Equity Securities
|
4,241,111
|
Enterprise Value
|
Average EBITDA Multiple / WACC
|
5.3x – 16.0x (9.9x)
11.8%-15.1% (13.1%)
|
|
10,000
|
Options Value
|
Qualitative Inputs
(1)
|
|
|
CLO Fund Securities
|
37,342,705
|
Discounted Cash Flow
|
Discount Rate
|
10.3%-12.0% (11.79%)
|
|
Probability of Default
|
2.0%
|
|
Loss Severity
|
25.9%
|
|
Recovery Rate
|
74.1%
|
|
Prepayment Rate
|
25.0%
|
|
630,280
|
Liquidation Value
|
Qualitative Inputs
(2)
|
|
|
Asset Manager Affiliate
|
36,853,000
|
Discounted Cash Flow
|
Discount Rate
|
3.17% - 9.62% (7.01%)
|
|
Joint Venture
|
21,091,494
|
Enterprise Value
|
Underlying NAV of the CLO
|
|
|
Total Level III Investments
|
$ 217,744,249
|
|
|
|
|
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 KCAP’s
analysis ascribes no residual value to a portfolio company’s equity, KCAP 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, 2017, 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
|
$ 14,059,524
|
Enterprise Value
|
Average EBITDA Multiple / WACC
|
5.1x - 6.1x (5.2x)
15.2% - 18.5% (17.4%)
|
|
$55,825,931
|
Income Approach
|
Implied Discount Rate
|
6.4% - 23.5% (12.0%)
|
|
Equity Securities
|
$4,405,684
|
Enterprise Value
|
Average EBITDA Multiple / WACC
|
4.5x – 15.2x (9.8x)
10.8% - 15.1% (12.2%)
|
|
9,000
|
Options Value
|
Qualitative Inputs
(1)
|
|
|
CLO Fund Securities
|
18,922,030
|
Discounted Cash Flow
|
Discount Rate
|
12.0%
|
|
Probability of Default
|
2.0%
|
|
Loss Severity
|
25.9%
|
|
Recovery Rate
|
74.1%
|
|
Prepayment Rate
|
25.0%
|
|
11,150,766
|
Liquidation Value
|
Qualitative Inputs
(2)
|
|
|
|
21,605,877
|
Market Approach
|
Third Party Quote
|
56.0%-96.5% (69.7%)
|
|
Asset Manager Affiliate
|
38,849,000
|
Discounted Cash Flow
|
Discount Rate
|
2.66% - 12.0% (6.56%)
|
|
Joint Venture
|
21,516,000
|
Market Approach
|
Third Party Quote
|
90%
|
|
Total Level III Investments
|
$ 186,343,812
|
|
|
|
|
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 KCAP’s
analysis ascribes no residual value to a portfolio company’s equity, KCAP 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.
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.
The 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. 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 input 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.
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
The Asset Manager Affiliates are wholly-owned
portfolio companies. The Asset Manager Affiliates manage CLO Funds primarily for third party investors that invest in broadly syndicated
loans, high yield bonds and other credit instruments issued by corporations. At June 30, 2018 and December 31, 2017, the Asset
Manager Affiliates had approximately $2.8 billion and $3.0 billion 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 $36.9 million and $38.8
million, respectively.
As a manager of the CLO Funds, the Asset
Manager Affiliates receive contractual and recurring management fees from the CLO Funds for their management and advisory services.
The annual fees which the Asset Manager Affiliates receive are generally based on a fixed percentage of assets under management
(at par value and not subject to changes in market value), and the Asset Manager Affiliates generate net income equal to the amount
by which their fee income exceeds their operating expenses, including compensation of their employees and income taxes. The management
fees the Asset Manager Affiliates receive have three components - a senior management fee, a subordinated management fee and an
incentive fee. During the first half of 2018, the Asset Manager Affiliates did not recognize any incentive fee revenue. During
the first half of 2017, the Asset Manager Affiliates recognized $2.9 million of incentive fee revenue from Trimaran VII, which
was called in January 2017. Currently, all CLO Funds managed by the Asset Manager Affiliates are paying both their senior and subordinated
management fees on a current basis. As of June 30, 2018, none of the CLO Funds managed by the Asset Manager Affiliates were paying
incentive fees.
Certain investments, and the future management
fees of certain managed CLO Funds, have been pledged by the Asset Manager Affiliates to third-party lenders under borrowing arrangements
undertaken to satisfy the U.S. risk retention rules formerly required by Section 941 of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (the “Dodd-Frank Act”) applicable to asset managers. In addition, certain of the Asset Manager Affiliates
have provided a make-whole guaranty to these lenders in the event that the pledged assets and management fees are insufficient
to satisfy the repayment of these borrowings. So long as the underlying managed CLO Funds’ rated notes are making regular
quarterly distributions, the management fees are available to the Asset Manager Affiliates. A recent court ruling has vacated the
application of the U.S. risk retention rules insofar as they apply to managers of “open market CLOs,” such as the Asset
Manager Affiliates. Please see Note 8 – “Commitments and Contingencies” for further information regarding the
U.S. risk retention rules.
For the three months ended June 30, 2018
and 2017, the Asset Manager Affiliates declared cash distributions of $800,000 and $650,000 to the Company, respectively. For the
six monthsended June 30, 2018 and 2017, the Asset Manager Affiliates declared cash distributions of $1.6 million and $1.3 million
to the Company, respectively. 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 $300,000 and $0 of Dividends from Asset Manager Affiliates, as reflected in the Company’s in the statement
of operations in the second quarter of 2018 and 2017, 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 quarters ended June 30, 2018 and 2017 the difference of $500,000 and $650,000,
respectively, 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 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 and with respect to one
of the CLO Funds in which the Company has an investment, Katonah 2007-I CLO are required to be included in the Company’s
SEC filings. The additional financial information regarding the Asset Manager Affiliates (pursuant to Rule 3-09) and Katonah 2007-I
CLO (pursuant to Rule 4-08(g)) is set forth below. This additional financial information regarding the Asset Manager Affiliates
and Katonah 2007-1 CLO does not directly impact the financial position, results of operations, or cash flows of the Company.
Asset Manager Affiliates
Summarized Balance Sheet (unaudited)
|
|
As of
|
|
|
As of
|
|
|
|
June 30, 2018
|
|
|
December 31, 2017
|
|
Cash
|
|
$
|
3,478,623
|
|
|
$
|
4,655,662
|
|
Investments
|
|
|
46,679,398
|
|
|
|
79,901,209
|
|
Intangible Assets
|
|
|
22,830,000
|
|
|
|
22,830,000
|
|
Other Assets
|
|
|
2,524,449
|
|
|
|
4,471,250
|
|
Total Assets
|
|
$
|
75,512,470
|
|
|
$
|
111,858,121
|
|
|
|
|
|
|
|
|
|
|
Borrowings
|
|
$
|
19,685,000
|
|
|
$
|
69,802,500
|
|
Borrowings from related parties
|
|
|
29,777,282
|
|
|
|
12,792,218
|
|
Other Liabilities
|
|
|
5,203,387
|
|
|
|
6,789,433
|
|
Total Liabilities
|
|
|
54,665,669
|
|
|
|
89,384,151
|
|
Total Equity
|
|
|
20,846,801
|
|
|
|
22,473,970
|
|
Total Liabilities and Equity
|
|
$
|
75,512,470
|
|
|
$
|
111,858,121
|
|
Asset Manager Affiliates
Summarized Statements of Operations Information
(unaudited)
|
|
For the three months ended
|
|
|
For the six months ended
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Fee Revenue
|
|
$
|
2,890,867
|
|
|
$
|
3,088,353
|
|
|
$
|
5,950,527
|
|
|
$
|
8,972,550
|
|
Interest Income
|
|
|
1,582,005
|
|
|
|
3,735
|
|
|
|
2,268,591
|
|
|
|
5,910
|
|
Total Income
|
|
|
4,472,872
|
|
|
|
3,092,088
|
|
|
|
8,219,118
|
|
|
|
8,978,460
|
|
Operating Expenses
|
|
|
2,819,121
|
|
|
|
2,543,378
|
|
|
|
5,345,206
|
|
|
|
5,304,832
|
|
Amortization of Intangibles
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
327,541
|
|
Interest Expense
|
|
|
1,535,588
|
|
|
|
214,715
|
|
|
|
2,713,106
|
|
|
|
403,566
|
|
Total Expenses
|
|
|
4,354,709
|
|
|
|
2,758,093
|
|
|
|
8,058,312
|
|
|
|
6,035,939
|
|
Income before unrealized gains on investments and income taxes
|
|
|
118,163
|
|
|
|
333,995
|
|
|
|
160,806
|
|
|
|
2,942,521
|
|
Net realized and unrealized gains (losses) on investments
|
|
|
(616,810
|
)
|
|
|
-
|
|
|
|
203,461
|
|
|
|
-
|
|
Income before income taxes
|
|
|
(498,647
|
)
|
|
|
333,995
|
|
|
|
364,267
|
|
|
|
2,942,521
|
|
Income Tax (Benefit) Expense
|
|
|
(201,612
|
)
|
|
|
(280,784
|
)
|
|
|
(328,566
|
)
|
|
|
1,058,560
|
|
Net (Loss) Income
|
|
$
|
(297,035
|
)
|
|
$
|
614,779
|
|
|
$
|
692,833
|
|
|
$
|
1,883,961
|
|
Katonah 2007-I CLO Ltd.
Summarized Balance Sheet Information (unaudited)
|
|
As of
|
|
|
As of
|
|
|
|
June 30, 2018
|
|
|
December 31, 2017
|
|
Total Investments at Fair Value
|
|
$
|
49,144
|
|
|
$
|
778,828
|
|
Cash
|
|
|
215,799
|
|
|
|
1,673,789
|
|
Receivable for investments sold
|
|
|
-
|
|
|
|
8,750,934
|
|
Total assets
|
|
|
264,943
|
|
|
|
11,203,551
|
|
CLO Debt at Fair Value
|
|
|
-
|
|
|
|
10,770,486
|
|
Total Liabilities
|
|
|
50,006
|
|
|
|
10,854,495
|
|
Total Net Assets
|
|
|
214,937
|
|
|
|
349,056
|
|
Katonah 2007-I CLO Ltd.
Summarized Statements of Operations Information
(unaudited)
|
|
For the three months ended
|
|
|
For the six months ended
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Interest Income from Investments
|
|
$
|
-
|
|
|
$
|
1,373,010
|
|
|
$
|
-
|
|
|
$
|
3,151,126
|
|
Total Income
|
|
|
-
|
|
|
|
1,344,827
|
|
|
|
6,505
|
|
|
|
3,188,161
|
|
Interest Expense
|
|
|
-
|
|
|
|
1,488,620
|
|
|
|
10,487,425
|
|
|
|
3,014,926
|
|
Total Expenses
|
|
|
4,138
|
|
|
|
1,681,473
|
|
|
|
10,626,914
|
|
|
|
3,483,656
|
|
Net Realized and Unrealized Gains (Losses)
|
|
|
-
|
|
|
|
(530,500
|
)
|
|
|
10,504,641
|
|
|
|
(1,158,514
|
)
|
Increase (Decrease) in net assets resulting from operations
|
|
|
(4,138
|
)
|
|
|
(867,146
|
)
|
|
|
(115,768
|
)
|
|
|
(1,454,009
|
)
|
On December 19, 2017, the Company, in its
capacity as the holder of all of the outstanding preferred shares of 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. As of December
31, 2017, Katonah 2007-1 had paid off all of its outstanding indebtedness and had approximately $10.8 million in total assets.
It is expected that Katonah 2007-1 will be fully liquidated and dissolved in 2018. The Company received approximately $11.3 million
on its investment in Katonah 2007-1 during the fourth quarter of 2017 in connection with the liquidation of Katonah
2007-1, and received an additional $10.5 million in the first half of 2018. Upon receipt of the final liquidating distribution from
Katonah 2007-1, the Company expects to record a realized loss of approximately $10 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.
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.
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 U.S. 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 is 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 KCAP’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 are 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. On April 15, 2013, the Trimaran Credit Facility was amended and upsized from $20 million to $23 million. On November
17, 2017, the Trimaran Credit Facility was amended to extend the maturity date to November 17, 2022 and bears interest at an annual
rate of 9.0%. At June 30, 2018 there was a $23 million loan outstanding and at December 31, 2017, there were no loans outstanding
under the Trimaran Credit Facility. For the three months ended June 30, 2018 and 2017, the Company recognized interest income of
approximately $524,000 and $210,000, respectively, related to the Trimaran Credit Facility. For the six months ended June 30, 2018
and 2017, the Company recognized interest income of approximately $639,000 and $390,000, respectively, 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 bears 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 second quarter of 2018,
$1.6 million of the principal on this loan was repaid by Trimaran. During the three months and six months ended June 30, 2018,
the Company recognized approximately $221,000 and $440,000, respectively, of interest income related to this loan.
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 I, 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. Trimaran Advisors borrowed
$4.4 million, which also bears interest at a rate of 10.5% annually, payable quarterly. The loan matures on January 27, 2028, can
be repaid at any time, and must be repaid upon the occurrence of certain events. During the second quarter of 2018, this loan was
repaid in full by Trimaran. During the three months and six months ended June 30, 2018, the Company recognized approximately $113,000
and $229,000, respectively, of interest income related to this loan.
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 under this agreement million of equity capital to Trimaran RR I. With this equity contribution and other
borrowed funds, Trimaran RR I, LLC purchased $27.4 million notional amount of notes issued by Catamaran CLO 2013-1, Ltd. for aggregate
consideration of $27.4 million.
Section 941 of the Dodd-Frank
Act added a provision to the Exchange Act requiring the seller, sponsor or securitizer of a securitization vehicle to retain no
less than five percent of the credit risk in assets it sells into a securitization and prohibiting such securitizer from directly
or indirectly hedging or otherwise transferring the retained credit risk. The responsible federal agencies adopted final rules
implementing these restrictions on October 22, 2014. The U.S. risk retention rules became effective with respect to CLOs two years
after publication in the Federal Register. Under the final rules, the asset manager of a CLO is considered the sponsor of a securitization
vehicle and is required to retain five percent of the credit risk in the CLO, which may be retained horizontally in the equity
tranche of the CLO or vertically as a five percent interest in each tranche of the securities issued by the CLO.
On February 9, 2018, the United States Court
of Appeals for the District of Columbia (the “D.C. Circuit Court”) ruled in favor of an appeal brought by the Loan
Syndications and Trading Association (the “LSTA”) against the SEC and the Board of Governors of the Federal Reserve
System (the “Applicable Governmental Agencies”) that managers of so-called “open market CLOs” are not “securitizers”
under Section 941 of the Dodd-Frank Act and, therefore, are not subject to the requirements of the U.S. risk retention rules (the
"Appellate Court Ruling"). The LSTA was appealing from a judgment entered by the United States District Court for the
District of Columbia (the "D.C. District Court"), which granted summary judgment in favor of the SEC and Federal Reserve
and against the LSTA with respect to its challenges.
On April 5, 2018, the D.C. District Court
entered an order implementing the Appellate Court Ruling and thereby vacated the U.S. risk retention rules insofar as they apply
to CLO managers of “open market CLOs.” In addition, the Applicable Governmental Agencies did not request that the case
be heard by the United States Supreme Court. Since the Applicable Governmental Agencies have not successfully challenged the Appellate
Court Ruling and the D.C. District Court has issued the above described order implementing the Appellate Court Ruling, collateral
managers of open market CLOs are no longer required to comply with the U.S. risk retention rules at this time. As such, it is possible
that some collateral managers of open market CLOs will decide to dispose of the notes constituting the “eligible vertical
interest” or “eligible horizontal interest” they were previously required to retain, or decide to take other
action with respect to such notes that is not otherwise permitted by the U.S. risk retention rules. As a result of this decision,
certain CLO managers of "open market CLOs" will no longer be required to comply with the U.S. risk retention rules solely
because of their roles as managers of "open market CLOs", and there may be no "sponsor" of such securitization
transactions and no party may be required to acquire and retain an economic interest in the credit risk of the securitized assets
of such transactions.
There can be no assurance or representation
that any of the transactions, structures or arrangements currently under consideration by or currently used by CLO market participants
will comply with the U.S. risk retention rules to the extent such rules are reinstated or otherwise become applicable to open market
CLOs. The ultimate impact of the U.S. risk retention rules on the loan securitization market and the leveraged loan market generally
remains uncertain, and any negative impact on secondary market liquidity for securities comprising a CLO may be experienced due
to the effects of the U.S. risk retention rules on market expectations or uncertainty, the relative appeal of other investments
not impacted by the U.S. risk retention rules and other factors.
During the second quarter of 2018, Trimaran RR I sold $31.4 million and $24.9 million, respectively
of notional amount of notes issued by Catamaran CLO 2014-1, Ltd and Catamaran 2013-1, Ltd, respectively.
6. BORROWINGS
The Company’s debt obligations consist
of the following:
|
|
As of
June 30, 2018
(unaudited)
|
|
|
As of
December 31, 2017
|
|
|
|
|
|
|
|
|
6.125% Notes Due 2022 (net of offering costs of: 2018-$2,474,275; 2017 - $2,734,248)
|
|
$
|
74,932,925
|
|
|
$
|
74,672,952
|
|
7.375% Notes Due 2019 (net of offering costs of: 2018 - $40,536; 2017 - $259,635)
|
|
|
6,959,463
|
|
|
|
26,740,365
|
|
KCAP Funding I, LLC Revolving Credit Facility (net of offering costs of: 2018 - $1,265,107)
|
|
|
19,895,080
|
|
|
|
-
|
|
|
|
$
|
101,787,468
|
|
|
$
|
101,413,316
|
|
The weighted average stated interest rate and weighted average
maturity on all our debt outstanding as of June 30, 2018 were 6.1% and 3.9 years, respectively, and as of December 31, 2017 were
6.4% and 3.9 years, respectively.
KCAP Senior Funding I, LLC (Debt Securitization)
On June 18, 2013, the Company completed
the sale of notes in a $140,000,000 debt securitization financing transaction. The notes offered in this transaction (the “KCAP
Senior Funding I Notes”) were issued by KCAP Senior Funding I, LLC, a newly formed special purpose vehicle (the “Issuer”),
in which KCAP Senior Funding I Holdings, LLC, a wholly-owned subsidiary of the Company (the “Depositor”), owns all
of the KCAP Senior Funding I Subordinated Notes (as defined below), and are backed by a diversified portfolio of bank loans. The
indenture governing the KCAP Senior Funding I Notes contains an event of default that is triggered in the event that certain coverage
tests are not met.
For the three months ended June 30, 2017,
interest expense, including the amortization of deferred debt issuance costs and the OID was approximately $1.6 million consisting
of stated interest expense of approximately $1.3 million, accreted discount of approximately $159,000, and deferred debt issuance
costs of approximately $171,000. For the six months ended June 30, 2017, interest expense, including the amortization of deferred
debt issuance costs and the discount on the face amount of the notes, was approximately $3.1 million consisting of stated interest
expense of approximately $2.4 million, accreted discount of approximately $317,000, and deferred debt issuance costs of approximately
$340,000.
All of the KCAP Senior Funding I Class
A, B, C and D notes were repaid in the third quarter of 2017. In connection therewith, the Company recorded a realized loss from
the extinguishment of debt of approximately $4.0 million in the third quarter of 2017.
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. Interest on
the 7.375% Notes Due 2019 is 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 mature on September, 30, 2019 and are unsecured obligations
of the Company. The 7.375% Notes Due 2019 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, 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 requirement 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 is 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. At June
30, 2018, the Company was in compliance with all of its debt covenants.
For the three months ended June 30, 2018
and 2017, interest expense related to the 7.375% Notes Due 2019 was approximately, $129,000 and $609,000, respectively. For the
six months ended June 30, 2018 and 2017, interest expense related to the 7.375% Notes Due 2019 was approximately $565,000 and $1.2
million, respectively.
In connection with the issuance of the
7.375% Notes Due 2019, the Company incurred approximately $1.5 million of debt offering costs which are being amortized over the
expected term of the facility on an effective yield method, of which approximately $40,000 remains to be amortized, and is included
on the consolidated balance sheets as a reduction in the related debt liability.
During the second quarter of 2016, the
Company repurchased approximately $2.4 million par value of the 7.375% Notes Due 2019 at a weighted average price of $25.23 per
$25.00 note, resulting in a realized loss on extinguishment of $71,190. The Company subsequently surrendered these notes to the
Trustee for cancellation.
During the third quarter of 2016, $5.0
million par value of the 7.375% Notes Due 2019 was redeemed by the Company, resulting in a realized loss on extinguishment of $88,015.
The Company subsequently surrendered these notes to the Trustee for cancellation.
During the fourth quarter of 2016, approximately
$469,000 par value of the 7.375% Notes Due 2019 was redeemed by the Company, resulting in a realized loss on extinguishment of
approximately $15,000. The Company subsequently surrendered these notes to the Trustee for cancellation.
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
Fair Value of 7.375% Notes Due 2019.
The 7.375% Notes Due 2019 were issued in a public offering on October 10, 2012 and are carried at cost. As of June
30, 2018 and December 31, 2017, the fair value of the Company’s outstanding 7.375% Notes Due 2019 was approximately $7.1
million and $27.3 million, respectively. The fair value was determined based on the closing price on June 29, 2018 and
December 29, 2017 for the 7.375% Notes Due 2019. The 7.375% Notes Due 2019 are categorized as Level I under the ASC 820 Fair Value.
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 requirement 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 June 30, 2018, the Company was in compliance with all
of its debt covenants.
For the three months ended June 30, 2018
and 2017, interest expense related to the 6.125% Notes Due 2022 was approximately $1.2 million and $0, respectively. For the six
months ended June 30, 2018 and 2017, interest expense related to the 6.125% Notes Due 2022 was approximately $2.4 million and $0,
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 $2.5 million remains to be amortized as of June
30, 2018, 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 $2.7 million at June 30, 2018. The fair value of the Company’s outstanding 6.125% Notes Due 2022 was approximately
$78.3 million and $77.7 million at June 30, 2018 and December 31, 2017. The fair value was determined based on the closing price
on June 29, 2018 and December 29, 2017 for the 6.125% Notes Due 2022. The 6.125% Notes Due 2022 are categorized as Level I under
the ASC 820 Fair Value.
KCAP Funding I, LLC
On March 1, 2018, 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.
The maximum commitment amount of the Revolving
Credit Facility is $50 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 earliest 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 June
30, 2018, Funding was in compliance with all of its debt covenants.
As of June 30, 2018, $21.2 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. Concurrently with any termination of the Revolving Credit Facility
before March 1, 2019, Funding will pay to agent an amount equal to 1% of the Revolver Commitments.
For the three months ended June 30, 2018,
interest expense related to the Revolving Credit Facility was approximately $278,000. For six months ended June 30, 2018, interest
expense related to the Revolving Credit Facility was approximately $350,000.
The Company incurred approximately $1.4
million of debt offering costs in connection with the issuance of the Revolving Credit Facility, which are being amortized over
the expected term of the Revolving Credit Facility, of which approximately $1.3 million remains to be amortized as of June 30,
2018, 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 June
30, 2018. The fair value of the Revolving Credit Facility borrowings was approximately $21.2 million at June 30, 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. 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 2018). 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 six months ended June 30, 2018:
|
|
Six Months Ended June 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
|
(unaudited)
|
|
|
(unaudited)
|
|
|
|
|
|
|
|
|
Net increase in net assets resulting from operations
|
|
$
|
1,297,622
|
|
|
$
|
2,907,276
|
|
Net change in unrealized depreciation from investments
|
|
|
3,522,396
|
|
|
|
1,846,951
|
|
Excess capital losses over capital gains
|
|
|
169,644
|
|
|
|
1,072,681
|
|
Book/tax differences on CLO equity investments
|
|
|
(188,560
|
)
|
|
|
(1,233,069
|
)
|
Other book/tax differences
|
|
|
556,816
|
|
|
|
(2,586
|
)
|
Taxable income before deductions for distributions
|
|
$
|
5,357,918
|
|
|
$
|
4,591,253
|
|
Taxable income before deductions for distributions per weighted average basic shares for the period
|
|
$
|
0.14
|
|
|
$
|
0.12
|
|
Taxable income before deductions for distributions per weighted average diluted shares for the period
|
|
$
|
0.14
|
|
|
$
|
0.12
|
|
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 six months ended June 30, 2018 and 2017, the Asset Manager Affiliates declared cash distributions of $1.6
million and $1.3 million respectively, to the Company. The Company recognized $620,000 and $0 of dividends from the Asset
Manager Affiliates, as reflected in the Company’s statement of operations in the second quarter of 2018 and 2017,
respectively. For the six months ended June 30, 2018 and 2017 the differences of $1.0 million and $1.3 million, respectively,
between cash distributions received and the estimated tax-basis earnings and profits of the distributing affiliate, are
recorded as adjustments 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 June 30, 2018, the Company had a net
capital loss carryforward of $88.6 million to offset net capital gains, to the extent provided by federal tax law. $13.5 million
of net capital loss carryforward expired in 2017. $17.9 million of net capital loss carryforward is subject to expiration in 2018.
$70.8 million of the net capital loss carryforward is not subject to expiration under the RIC Modernization Act of 2010.
On June 19, 2018 the Company’s
Board of Directors declared a distribution to shareholders of $0.10 per share for a total of approximately $3.7
million. The record date was July 6, 2018 and the distribution was paid on July 26, 2018.
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 June 30, 2018 and December 31, 2017, the Company
had no outstanding commitments, respectively.
9. STOCKHOLDERS’ EQUITY
During the six months ended June 30, 2018
and 2017, the Company issued 31,048 and 56,918 shares, respectively, of common stock under its dividend reinvestment plan. For
the six months ended June 30, 2018, there were 6,000 grants of restricted stock, 7,954 shares were forfeited, and 116,126 shares
vested. The total number of shares of the Company’s common stock outstanding as of June 30, 2018 and December 31, 2017 was
37,341,924 and 37,339,224, respectively. During the six months ended June 30, 2018 and 2017, the Company repurchased 26,394 and
63,827, respectively shares at an aggregate cost of approximately $86,000 and $224,000, respectively, in connection with the vesting
of restricted stock awards.
10. EQUITY COMPENSATION PLANS
The Company has 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. Pursuant to the Equity Incentive Plan and in accordance with the terms of the exemptive relief granted
to the Company in August 2008, the Company aims to provide officers and employees of the Company with additional incentives and
align the interests of its employees with those of its shareholders. Restricted stock granted under the Equity Incentive Plan is
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 are exercisable at a price equal to the fair market value (market closing price)
of the shares on the day the option is granted. Restricted stock granted pursuant to the Equity Incentive Plan in 2013 vested in
two equal installments of 50% on each of the third and the fourth anniversaries of the grant date. Restricted Stock granted pursuant
to the Equity Incentive Plan in 2014 and 2015 vests in four equal installments of 25% on each of the first four anniversaries of
the grant date. Restricted Stock granted pursuant to the Equity Incentive Plan in 2017 will vest in two equal installments of 50%
on each of the third and the fourth anniversaries of the grant date.
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”). Pursuant
to the Non-Employee Director Plan, the Company’s independent directors and other directors who are not officers or employees
of the Company (“Non-Employee Directors”) may be issued restricted stock as a portion of their compensation for service
on the Company’s Board of Directors in accordance with the terms of exemptive relief granted by the SEC in August 2008. Since
implementation of the 2011 Plan, the Company is permitted to issue restricted stock, and is no longer permitted to issue any options
for common stock, of the Company to Non-Employee Directors. Any options outstanding as of the date of the 2011 Annual Shareholder
Meeting are governed in all respects by the terms of the 2008 Plan. Under the Non-Employee Director Plan, the Non-Employee Directors
automatically receive 1,000 shares of restricted stock on the date of each annual meeting of shareholders during the term of the
plan.
Information with respect to options granted,
exercised and forfeited under the Equity Incentive Plan for the period January 1, 2017 through June 30, 2018 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, 2017
|
|
|
50,000
|
|
|
$
|
7.72
|
|
|
|
2.4
|
|
|
$
|
-
|
|
Granted
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Options outstanding at December 31, 2017
|
|
|
50,000
|
|
|
$
|
7.72
|
|
|
|
1.4
|
|
|
$
|
-
|
|
Granted
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Expired Unexercised
|
|
|
(5,000
|
)
|
|
|
11.97
|
|
|
|
|
|
|
|
|
|
Cancelled
|
|
|
(15,000
|
)
|
|
|
11.97
|
|
|
|
|
|
|
|
|
|
Outstanding at June 30, 2018
|
|
|
30,000
|
|
|
$
|
4.88
|
|
|
|
1.5
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total vested at June 30, 2018
|
|
|
30,000
|
|
|
$
|
4.88
|
|
|
|
1.5
|
|
|
|
|
|
|
1
|
Represents the difference between the market value of shares
of the Company on June 30, 2018 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 six months ended June 30, 2018
and 2017, the Company did not recognize any non-cash compensation expense related to stock options. At June 30, 2018, the Company
had no remaining compensation costs related to unvested stock option 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 5, 2013, the Company’s Board
of Directors approved the grant of 240,741 shares of restricted stock to the employees of the Company as partial compensation for
their services. 50% of such awards will vest on the third anniversary of the grant date and the remaining 50% of the shares will
vest on the fourth anniversary of the grant date.
On June 14, 2013, 5,000 shares of restricted
stock were awarded to the Company’s Board of Directors.
On May 5, 2014, 5,000 shares of restricted
stock were awarded to the Company’s Board of Directors.
On June 20, 2014, the Company’s Board
of Directors approved the grant of 355,289 shares 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 May 21, 2015, 6,000 shares of restricted
stock were awarded to the Company’s Board of Directors.
On May 3, 2016, 6,000 shares of restricted
stock were awarded to the Company’s Board of Directors.
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.
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 years ended December 31, 2016 and 2015, the Company repurchased 67,654 and 36,348 shares, respectively,
of common stock at an aggregate cost of approximately $248,000 and $220,000, respectively, in connection with the vesting of employee’s
restricted stock, which is reflected as Treasury Stock at cost on the Consolidated Balance Sheet. 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 June 23, 2015, the Company’s Board
of Directors also voted to amend the Equity Incentive Plan to specify that shares repurchased by the Company to satisfy employee
tax withholding requirements would not be returned to the plan reserve and could not be reissued under the Company’s Equity
Incentive Plan.
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 will vest on the third anniversary of the grant date and the remaining 50% of the shares
will vest on the fourth anniversary of the grant date.
Information with respect to restricted
stock granted, exercised and forfeited under the Plan for the period January 1, 2017 through June 30, 2018 is as follows:
|
|
Non-vested
Restricted
Shares
|
|
Non-vested shares outstanding at January 1, 2017
|
|
|
411,479
|
|
Granted
|
|
|
139,620
|
|
Vested
|
|
|
(242,918
|
)
|
Forfeited
|
|
|
(10,982
|
)
|
Non-vested shares outstanding at December 31, 2017
|
|
|
297,199
|
|
Granted
|
|
|
6,000
|
|
Vested
|
|
|
(122,126
|
)
|
Forfeited
|
|
|
(7,954
|
)
|
Non-Vested Outstanding at June 30, 2018
|
|
|
173,119
|
|
For the three months ended June 30, 2018,
non-cash compensation expense related to restricted stock was approximately $208,000; of this amount approximately $78,000 was
expensed at the Company, and approximately $130,000 was a reimbursable expense allocated to the Asset Manager Affiliates. For the
three months ended June 30, 2017, non-cash compensation expense related to restricted stock was approximately $258,000; of this
amount approximately $88,000 was expensed at the Company, and approximately $170,000 was a reimbursable expense allocated to the
Asset Manager Affiliates. For the six months ended June 30, 2018, non-cash compensation expense related to restricted stock was
approximately $461,000; of this amount approximately $186,000 was expensed at the Company, and approximately $275,000 was a reimbursable
expense allocated to the Asset Manager Affiliates. For the six months ended June 30, 2017, non-cash compensation expense related
to restricted stock was approximately $647,000; of this amount approximately $247,000 was expensed at the Company and approximately
$400,000 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 are forfeited upon the recipient’s
termination of employment. As of June 30, 2018, the Company had approximately $662,000 of total unrecognized compensation cost
related to non-vested restricted share awards, respectively. That cost is expected to be recognized over the remaining weighted
average period of 1.0 years. As of June 30, 2017, the Company had approximately $1.1 million of total unrecognized compensation
cost related to non-vested restricted share awards, respectively.
11. OTHER EMPLOYEE COMPENSATION
The Company adopted a 401(k) plan (“401K
Plan”) effective January 1, 2007. The 401K Plan is 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 makes 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 $10,000 and $17,000 was expensed during the three months ended June
30, 2018 and 2017, respectively, related to the 401K Plan. Approximately $20,000 and $34,000 was expensed during the six months
ended June 30, 2018 and 2017, respectively, related to the 401K Plan.
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
$47,000 and $46,000 was expensed during the three months ended June 30, 2018 and 2017, respectively, related to the Profit-Sharing
Plan. Approximately $72,000 and $92,000 was expensed during the six months ended June 30, 2018 and 2017, respectively, related
to the Profit-Sharing Plan.
12. SUBSEQUENT EVENTS
The Company has evaluated events and transactions
occurring subsequent to June 30, 2018 for items that should potentially be recognized or disclosed in these financial statements.
Management has determined that there are no material subsequent events that would require adjustment to, or disclosure in, these
consolidated financial statements.