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 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 September 30, 2017, 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. The Asset Manager Affiliates are each managed independently from KCAP by a separate management
team (however, certain of the Company’s executive officers also act in similar capacities for one or both 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 do not have any investments in the CLO Funds they manage;
however, KCAP 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 (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.
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 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.
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 accounting principles generally accepted in
the United States of America (“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, 2016, 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 and KCAP Senior Funding I Holdings, LLC in its consolidated financial statements as they are operated solely for investment
activities of the Company. The creditors of KCAP Senior Funding I, LLC have received security interests in the assets owned by
KCAP Senior Funding I, LLC and such assets are not intended to be available to the creditors of KCAP Financial, Inc., or any other
affiliate.
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.
Stockholder distributions on the Statement
of Changes in Net Assets reflect the distributions made during the reporting period, excluding the distribution declared in a quarter
with a record date occurring after the quarter-end. 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 nine months ended September 30, 2017, the Company provided approximately $17 million to portfolio companies to support their
growth objectives, none of which was contractually obligated. See also Note 8 – Commitments and Contingencies. As of September
30, 2017, the Company held loans it made to 38 investee companies with aggregate principal amounts of $135 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 nine months ended September 30, 2017, the Company did not engage in any such
or similar activities.
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 US 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 financial instruments are scoped out of ASC
606. Management is evaluating the impact of the standard on certain fees earned by the Company.
In March 2016, the FASB issued ASU 2016-09 Compensation
— Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). The
amendments in ASU 2016-09 affect all entities that issue share-based payment awards to their employees and involve multiple aspects
of the accounting for share-based payment transactions, including income tax consequences, classification of awards as either equity
or liabilities, and classification on the statement of cash flows. For public business entities, ASU 2016-09 is effective for annual
periods beginning after December 15 2016, and interim periods within those annual periods. Early adoption is permitted. We adopted
2016-09 during the first quarter of 2017 and there was no impact from adoption.
In November 2016, the FASB issued Accounting
Standards Update 2016-18, Restricted Cash (“ASU 2016-18”) which requires entities to show the changes in the total
cash, cash equivalents, restricted cash and restricted cash equivalents in the statement of cash flows. The guidance is effective
for fiscal years beginning after December 15, 2017, and interim periods within those years. Early adoption is permitted, and entities
will be required to apply the guidance retrospectively when adopted. We have early adopted ASU 2016-18 retrospectively during the
first quarter of 2017 and earlier periods were restated. The following table depicts the retroactive application of ASU 2016-18:
Consolidated Statements of Cash Flows
|
|
Nine Months Ended
September 30, 2016
|
|
|
|
|
|
Net cash (used in) financing activities as reported
|
|
$
|
(46,702,870
|
)
|
Impact of Adoption
|
|
|
3,771,347
|
|
|
|
|
|
|
Net cash (used in) financing activities after adoption
|
|
$
|
(42,931,523
|
)
|
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. Subsequent to the
adoption of ASC 820: Fair Value, the FASB has issued various staff positions clarifying the initial standard as noted below.
The FASB issued guidance that clarified and required
disclosures about fair value measurements. These include requirements to disclose the amounts and reasons for significant transfers
between Level I and Level II, as well as significant transfers in and out of Level III of the fair value hierarchy (see Note 4
– “Investments – Fair Value Measurements” for further information relating to Level I, Level II and Level
III). The guidance also required that purchases, sales, issuances and settlements be presented gross in the Level III reconciliation.
ASC 820: Fair Value requires the disclosure in
interim and annual periods of the inputs and valuation techniques used to measure fair value and a discussion of changes in valuation
techniques and related inputs, if any, during the period.
The Company utilizes an independent valuation
firm to provide an annual third-party review of the Company’s CLO Securities fair value model relative to its functionality,
model inputs and calculations as a reasonable method to determine fair values of CLO Securities, in the absence of Level I or Level
II trading activity or observable market inputs. The independent valuation firm’s 2016 annual review concluded that the Company’s
model appropriately factors in all the necessary inputs required to build an equity cash flow model for CLO Securities for fair
value purposes and that the inputs were being employed correctly.
The Company utilizes an independent valuation
firm to provide third party valuation consulting services. Each quarter the independent valuation firm will perform third party
valuations of the Company’s investments in material illiquid securities such that they are reviewed at least once during
a trailing 12-month period. These third party valuation estimates are considered as one of the relevant data points in the Company’s
determination of fair value. The Company intends to continue to engage an independent valuation firm in the future to provide certain
valuation services, including the review of certain portfolio assets, as part of the quarterly and annual year-end valuation process.
The Board of Directors may consider other methods
of valuation than those set forth below to determine the fair value of Level III investments as appropriate in conformity with
GAAP. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market
value, the fair value of the Company’s investments may differ materially from the values that would have been used had a
readily available market existed for such investments. Further, such investments may be generally subject to legal and other restrictions
on resale or otherwise be less liquid than publicly traded securities. In addition, changes in the market environment and other
events may occur over the life of the investments that may cause the value realized on such investments to be different from the
currently assigned valuations.
The majority of the Company’s investment
portfolio is composed of debt and equity securities with unique contract terms and conditions and/or complexity that requires a
valuation of each individual investment that considers multiple levels of market and asset specific inputs, which may include historical
and forecasted financial and operational performance of the individual investment, projected cash flows, market multiples, comparable
market transactions, the priority of the security compared with those of other securities for such issuers, credit risk, interest
rates, and independent valuations and reviews.
Debt Securities
. To the extent that the
Company’s investments are exchange traded and are priced or have sufficient price indications from normal course trading
at or around the valuation date (financial reporting date), such pricing will be used to determine the fair value of the investments.
Valuations from third party pricing services may be used as an indication of fair value, depending on the volume and reliability
of the valuation, sufficient and reasonable correlation of bid and ask quotes, and, most importantly, the level of actual trading
activity. However, if the Company has been unable to identify directly comparable market indices or other market guidance that
correlate directly to the types of investments the Company owns, the Company will determine fair value using alternative methodologies
such as available market data, as adjusted, to reflect the types of assets the Company owns, their structure, qualitative and credit
attributes and other asset-specific characteristics.
The Company derives fair value for its illiquid
investments that do not have indicative fair values based upon active trades primarily by using a present value technique that
discounts the estimated contractual cash flows for the subject assets with discount rates imputed by broad market indices, bond
spreads and yields for comparable issuers relative to the subject assets (the “Income Approach”). The Company also
considers, among other things, recent loan amendments or other activity specific to the subject asset. Discount rates applied to
estimated contractual cash flows for an underlying asset vary by specific investment, industry, priority and nature of the debt
security (such as the seniority or security interest of the debt security) and are assessed relative to two indices, a leveraged
loan index and a high-yield bond index, at the valuation date. The Company has identified these two indices as benchmarks for broad
market information related to its loan and debt securities. Because the Company has not identified any market index that directly
correlates to the loan and debt securities held by the Company and therefore uses these benchmark indices, these market indices
may require significant adjustment to better correlate such market data for the calculation of fair value of the investment under
the Income Approach. Such adjustments require judgment and may be material to the calculation of fair value. Further adjustments
to the discount rate may be applied to reflect other market conditions or the perceived credit risk of the borrower. When broad
market indices are used as part of the valuation methodology, their use is subject to adjustment for many factors, including priority,
collateral used as security, structure, performance and other quantitative and qualitative attributes of the asset being valued.
The resulting present value determination is then weighted along with any quotes from observable transactions and broker/pricing
quotes. If such quotes are indicative of actual transactions with reasonable trading volume at or near the valuation date that
are not liquidation or distressed sales, relatively more reliance will be put on such quotes to determine fair value. If such quotes
are not indicative of market transactions or are insufficient as to volume, reliability, consistency or other relevant factors,
such quotes will be compared with other fair value indications and given relatively less weight based on their relevancy. Other
significant assumptions, such as coupon and maturity, are asset-specific and are noted for each investment in the 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 (as defined below), 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’s investment in KCAP Freedom 3 LLC (“Joint Venture”), is a joint venture with Freedom
3 Opportunities. 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 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, 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 cash 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. Non-accrual loans 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 September 30, 2017, two issuers representing
1% of the Company’s total investments at fair value were on a non-accrual status, and one of our investments, representing
2% of the Company’s investments at fair value, was on partial non-accrual status, whereby we have recognized income on a
portion of contractual payment-in-kind (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 Catamaran CLO 2014-1, interest is earned at a fixed spread relative
to the LIBOR index.
Joint Venture
. 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 of the year based upon
taxable income and distributions for the full year. Therefore, any estimate of tax attributes of distributions made on an interim
basis may not be representative of the actual tax attributes of distributions for the full year.
Capital Structuring Service Fees
. The
Company may earn ancillary structuring and other fees related to the origination, investment, disposition or liquidation of debt
and investment securities. Generally, the Company will capitalize loan origination fees, then amortize these fees into interest
income over the term of the loan using the effective interest rate method, recognize prepayment and liquidation fees upon receipt
and equity structuring fees as earned, which generally occurs when an investment transaction closes.
Debt Issuance Costs
. Debt issuance costs
represent fees and other direct costs incurred in connection with the Company’s borrowings. These amounts are capitalized
and amortized using the effective interest method over the expected term of the borrowing.
Extinguishment of debt
. The Company must
derecognize a liability if and only if it has been extinguished through delivery of cash, delivery of other financial assets, delivery
of goods or services, or reacquisition by the Company of its outstanding debt securities whether the securities are cancelled or
held. If the debt contains a cash conversion option, the Company must allocate the consideration transferred and transaction costs
incurred to the extinguishment of the liability component and the reacquisition of the equity component and recognize a gain or
loss in the statement of operations.
Expenses
. 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 nine months ended September
30, 2017 and 2016 (unaudited):
|
|
(unaudited)
|
|
|
(unaudited)
|
|
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase (decrease) in net assets resulting from operations
|
|
$
|
(669,449
|
)
|
|
$
|
2,716,613
|
|
|
$
|
2,237,830
|
|
|
$
|
(1,118,600
|
)
|
Net (increase) decrease in net assets allocated to unvested share awards
|
|
|
3,260
|
|
|
|
(30,313
|
)
|
|
|
(18,094
|
)
|
|
|
16,701
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase (decrease) in net assets available to common stockholders
|
|
$
|
(666,189
|
)
|
|
$
|
2,686,300
|
|
|
$
|
2,219,736
|
|
|
$
|
(1,101,900
|
)
|
Weighted average number of common shares outstanding for basic shares computation
|
|
|
37,196,621
|
|
|
|
37,152,622
|
|
|
|
37,202,011
|
|
|
|
37,142,002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of common and common stock equivalent shares outstanding for diluted shares computation
|
|
|
37,196,621
|
|
|
|
37,152,622
|
|
|
|
37,202,011
|
|
|
|
37,142,002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase (decrease) in net assets per basic common shares:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase (decrease) in net assets from operations
|
|
$
|
(0.02
|
)
|
|
$
|
0.07
|
|
|
$
|
0.06
|
|
|
$
|
(0.03
|
)
|
Net increase (decrease) in net assets per diluted shares:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase (decrease) in net assets from operations
|
|
$
|
(0.02
|
)
|
|
$
|
0.07
|
|
|
$
|
0.06
|
|
|
$
|
(0.03
|
)
|
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 50,000 options to purchase shares
of common stock considered for the computation of the diluted per share information for the three months and nine months ended
September 30, 2017 and 2016. Since the effects are anti-dilutive for both periods, the options were not considered in the computation.
For the three months ended September 30, 2017 and 2016, the Company purchased 349 and 309 shares of common stock, respectively.
For the nine months ended September 30, 2017 and 2016 the Company purchased 64,176 and 67,654 shares of common stock, respectively,
in connection with the vesting of employee restricted stock, such shares are treated as treasury shares and reduce the weighted
average shares outstanding in the computation of earnings per share.
The Company’s Convertible Notes were included
in the computation of the diluted net increase or decrease in net assets resulting from operations per share by application of
the “if-converted method” for periods when the Convertible Notes were outstanding. Under the if-converted method, interest
charges applicable to the convertible notes for the period are added to reported net increase or decrease in net assets resulting
from operations and the full amount of shares (pro-rata if not outstanding for the full period) that would be issued are added
to weighted average basic shares. Convertible notes are considered anti-dilutive only when its interest per share upon conversion
exceeds the basic net increase or decrease in net assets resulting from operations per share. For the nine month period ended September
30, 2016, the effects of the convertible notes were anti-dilutive. The Convertible Notes matured and were repaid in March 2016.
4. INVESTMENTS
The following table shows the Company’s
portfolio by security type at September 30, 2017 and December 31, 2016:
|
|
September 30, 2017 (unaudited)
|
|
|
December 31, 2016
|
|
Security Type
|
|
Cost/
Amortized
Cost
|
|
|
Fair Value
|
|
|
%¹
|
|
|
Cost/
Amortized
Cost
|
|
|
Fair Value
|
|
|
%¹
|
|
Short-term Investments²
|
|
|
57,024,828
|
|
|
$
|
57,024,828
|
|
|
|
18
|
|
|
|
28,699,269
|
|
|
$
|
28,699,269
|
|
|
|
8
|
|
Senior Secured Loan
|
|
|
49,982,415
|
|
|
|
46,124,914
|
|
|
|
15
|
|
|
|
207,701,078
|
|
|
|
200,322,152
|
|
|
|
55
|
|
Junior Secured Loan
|
|
|
59,490,855
|
|
|
|
58,343,554
|
|
|
|
18
|
|
|
|
37,251,776
|
|
|
|
35,444,440
|
|
|
|
10
|
|
Senior Unsecured Loan
|
|
|
20,000,000
|
|
|
|
20,000,000
|
|
|
|
6
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
First Lien Bond
|
|
|
3,054,337
|
|
|
|
1,063,762
|
|
|
|
-
|
|
|
|
3,060,919
|
|
|
|
1,089,338
|
|
|
|
-
|
|
Senior Secured Bond
|
|
|
1,503,404
|
|
|
|
1,494,600
|
|
|
|
-
|
|
|
|
1,506,461
|
|
|
|
1,487,400
|
|
|
|
-
|
|
CLO Fund Securities
|
|
|
78,544,739
|
|
|
|
51,843,344
|
|
|
|
16
|
|
|
|
76,851,317
|
|
|
|
54,174,350
|
|
|
|
15
|
|
Equity Securities
|
|
|
10,389,007
|
|
|
|
4,450,177
|
|
|
|
1
|
|
|
|
10,389,007
|
|
|
|
5,056,355
|
|
|
|
1
|
|
Asset Manager Affiliates³
|
|
|
53,341,230
|
|
|
|
39,679,000
|
|
|
|
13
|
|
|
|
55,341,230
|
|
|
|
40,198,000
|
|
|
|
11
|
|
Joint Venture
|
|
|
36,738,873
|
|
|
|
36,591,122
|
|
|
|
13
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
370,069,689
|
|
|
$
|
316,615,300
|
|
|
|
100
|
%
|
|
$
|
420,801,057
|
|
|
$
|
366,471,304
|
|
|
|
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-related information, based on
the fair value of the Company’s investment portfolio as of September 30, 2017 and December 31, 2016, for the Company’s
investment portfolio was as follows:
|
|
September 30, 2017 (unaudited)
|
|
|
December 31, 2016
|
|
Industry Classification
|
|
Cost/
Amortized Cost
|
|
|
Fair Value
|
|
|
%
1
|
|
|
Cost/
Amortized Cost
|
|
|
Fair Value
|
|
|
%
|
|
Aerospace and Defense
|
|
$
|
4,929,171
|
|
|
$
|
3,268,788
|
|
|
|
1
|
%
|
|
$
|
8,394,633
|
|
|
$
|
8,450,106
|
|
|
|
2
|
%
|
Asset Management Company
2
|
|
|
53,341,230
|
|
|
|
39,679,000
|
|
|
|
13
|
|
|
|
55,341,230
|
|
|
|
40,198,000
|
|
|
|
11
|
|
Automotive
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
6,322,551
|
|
|
|
6,196,154
|
|
|
|
2
|
|
Banking, Finance, Insurance & Real Estate
|
|
|
3,466,776
|
|
|
|
3,443,506
|
|
|
|
1
|
|
|
|
6,805,514
|
|
|
|
6,782,010
|
|
|
|
2
|
|
Beverage, Food and Tobacco
|
|
|
4,512,854
|
|
|
|
4,346,400
|
|
|
|
1
|
|
|
|
15,198,830
|
|
|
|
14,703,372
|
|
|
|
4
|
|
Capital Equipment
|
|
|
5,455,586
|
|
|
|
4,744,140
|
|
|
|
1
|
|
|
|
6,185,129
|
|
|
|
5,575,048
|
|
|
|
2
|
|
Chemicals, Plastics and Rubber
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
6,421,909
|
|
|
|
6,444,073
|
|
|
|
2
|
|
CLO Fund Securities
|
|
|
78,544,739
|
|
|
|
51,843,344
|
|
|
|
16
|
|
|
|
76,851,317
|
|
|
|
54,174,350
|
|
|
|
15
|
|
Construction & Building
|
|
|
1,007,336
|
|
|
|
1,007,423
|
|
|
|
-
|
|
|
|
5,919,158
|
|
|
|
5,929,606
|
|
|
|
2
|
|
Consumer goods: Durable
|
|
|
3,054,338
|
|
|
|
1,064,762
|
|
|
|
-
|
|
|
|
12,319,905
|
|
|
|
10,118,736
|
|
|
|
3
|
|
Consumer goods: Non-durable
|
|
|
732,896
|
|
|
|
734,613
|
|
|
|
-
|
|
|
|
14,766,390
|
|
|
|
14,452,096
|
|
|
|
4
|
|
Ecological
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,741,292
|
|
|
|
1,760,783
|
|
|
|
-
|
|
Energy: Electricity
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
3,904,453
|
|
|
|
3,937,247
|
|
|
|
1
|
|
Energy: Oil & Gas
|
|
|
13,929,048
|
|
|
|
10,575,738
|
|
|
|
3
|
|
|
|
14,493,835
|
|
|
|
8,805,761
|
|
|
|
2
|
|
Environmental Industries
|
|
|
6,922,952
|
|
|
|
6,156,451
|
|
|
|
2
|
|
|
|
12,279,924
|
|
|
|
12,185,239
|
|
|
|
3
|
|
Forest Products & Paper
|
|
|
1,557,040
|
|
|
|
1,600,960
|
|
|
|
1
|
|
|
|
4,192,889
|
|
|
|
4,192,907
|
|
|
|
1
|
|
Healthcare & Pharmaceuticals
|
|
|
36,573,091
|
|
|
|
33,901,061
|
|
|
|
11
|
|
|
|
58,769,668
|
|
|
|
53,594,534
|
|
|
|
15
|
|
High Tech Industries
|
|
|
16,093,619
|
|
|
|
16,051,970
|
|
|
|
5
|
|
|
|
9,854,093
|
|
|
|
9,936,109
|
|
|
|
3
|
|
Hotel, Gaming & Leisure
|
|
|
400,000
|
|
|
|
1,000
|
|
|
|
-
|
|
|
|
400,000
|
|
|
|
1,000
|
|
|
|
-
|
|
Joint Venture
|
|
|
36,738,873
|
|
|
|
36,591,122
|
|
|
|
12
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Media: Advertising, Printing & Publishing
|
|
|
3,869,962
|
|
|
|
3,875,038
|
|
|
|
1
|
|
|
|
11,712,682
|
|
|
|
11,453,447
|
|
|
|
3
|
|
Media: Broadcasting & Subscription
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
8,273,174
|
|
|
|
8,372,984
|
|
|
|
2
|
|
Related Party Loan
|
|
|
20,000,000
|
|
|
|
20,000,000
|
|
|
|
6
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Retail
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,415,457
|
|
|
|
759,581
|
|
|
|
-
|
|
Services: Business
|
|
|
5,523,913
|
|
|
|
4,427,100
|
|
|
|
1
|
|
|
|
16,125,481
|
|
|
|
16,230,486
|
|
|
|
4
|
|
Services: Consumer
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
6,212,108
|
|
|
|
6,204,889
|
|
|
|
2
|
|
Telecommunications
|
|
|
3,965,663
|
|
|
|
3,939,200
|
|
|
|
1
|
|
|
|
12,809,799
|
|
|
|
12,767,823
|
|
|
|
3
|
|
Textiles and Leather
|
|
|
7,948,833
|
|
|
|
7,847,841
|
|
|
|
3
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Money Market Accounts
|
|
|
32,015,828
|
|
|
|
32,015,828
|
|
|
|
11
|
|
|
|
28,699,269
|
|
|
|
28,699,269
|
|
|
|
8
|
|
Transportation: Cargo
|
|
|
2,496,958
|
|
|
|
2,500,000
|
|
|
|
1
|
|
|
|
7,557,315
|
|
|
|
7,190,135
|
|
|
|
2
|
|
Transportation: Consumer
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2,412,614
|
|
|
|
2,324,516
|
|
|
|
1
|
|
U.S. Government Obligation
|
|
|
25,009,000
|
|
|
|
25,009,000
|
|
|
|
8
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
Utilities: Electric
|
|
|
1,979,983
|
|
|
|
1,991,015
|
|
|
|
1
|
|
|
|
5,420,438
|
|
|
|
5,031,043
|
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
370,069,689
|
|
|
$
|
316,615,300
|
|
|
|
100
|
%
|
|
$
|
420,801,057
|
|
|
$
|
366,471,304
|
|
|
|
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 its total
assets 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%, the Company also may invest in debt
of middle market companies located outside of the United States.
At September 30, 2017 and December 31, 2016,
the total amount of non-qualifying assets was approximately 28% and 17% of the total investment portfolio, respectively. The majority
of non-qualifying assets were foreign investments which were approximately 17% and 14% of the total investment portfolio, respectively
(including the Company’s investments in CLO Funds, which are typically domiciled outside the U.S. and represented approximately
16% and 15% of total assets on such dates, respectively).
The following tables detail the ten largest
portfolio investments (at fair value) as of September 30, 2017 and December 31, 2016:
|
|
September 30, 2017 (unaudited)
|
|
Investment
|
|
Cost/Amortized Cost
|
|
|
Fair Value
|
|
|
% of FMV
|
|
Asset Manager Affiliates
|
|
$
|
53,341,230
|
|
|
$
|
39,679,000
|
|
|
|
13
|
%
|
KCAP Freedom 3 LLC
|
|
|
36,738,873
|
|
|
|
36,591,122
|
|
|
|
12
|
|
US Bank Money Market Account
|
|
|
32,001,559
|
|
|
|
32,001,559
|
|
|
|
10
|
|
Katonah 2007-I CLO Ltd.
|
|
|
31,123,451
|
|
|
|
21,447,386
|
|
|
|
7
|
|
Trimaran Advisors, L.L.C.
|
|
|
20,000,000
|
|
|
|
20,000,000
|
|
|
|
6
|
|
U.S Treasury Bills - CUSIP: 912796LY3
|
|
|
15,007,000
|
|
|
|
15,007,000
|
|
|
|
5
|
|
U.S Treasury Bills - CUSIP: 912796KR9
|
|
|
10,002,000
|
|
|
|
10,002,000
|
|
|
|
3
|
|
Tank Partners Holdings, LLC
|
|
|
12,420,461
|
|
|
|
8,222,814
|
|
|
|
3
|
|
Catamaran CLO 2016-1 Ltd.
|
|
|
10,196,554
|
|
|
|
8,585,018
|
|
|
|
3
|
|
Grupo HIMA San Pablo, Inc.
|
|
|
10,023,444
|
|
|
|
9,290,017
|
|
|
|
3
|
|
Total
|
|
$
|
230,854,572
|
|
|
$
|
200,825,916
|
|
|
|
65
|
%
|
|
|
December 31, 2016
|
|
Investment
|
|
Cost/Amortized Cost
|
|
|
Fair Value
|
|
|
% of FMV
|
|
Asset Manager Affiliates
|
|
$
|
55,341,230
|
|
|
$
|
40,198,000
|
|
|
|
11
|
%
|
US Bank Money Market Account
|
|
|
28,685,001
|
|
|
|
28,685,001
|
|
|
|
8
|
|
Katonah 2007-I CLO Ltd.
|
|
|
28,022,646
|
|
|
|
20,453,099
|
|
|
|
6
|
|
Grupo HIMA San Pablo, Inc.
|
|
|
9,828,619
|
|
|
|
9,113,125
|
|
|
|
2
|
|
Catamaran CLO 2016-1 Ltd.
|
|
|
10,140,000
|
|
|
|
8,350,290
|
|
|
|
2
|
|
Tank Partners Holdings, LLC
|
|
|
11,822,180
|
|
|
|
6,552,311
|
|
|
|
2
|
|
Roscoe Medical, Inc.
|
|
|
6,666,733
|
|
|
|
6,499,000
|
|
|
|
2
|
|
Weiman Products, LLC
|
|
|
5,462,647
|
|
|
|
5,321,809
|
|
|
|
1
|
|
Nielson & Bainbrige, LLC
|
|
|
5,326,136
|
|
|
|
5,199,447
|
|
|
|
1
|
|
Catamaran CLO 2014-2 Ltd.
|
|
|
6,967,560
|
|
|
|
5,092,087
|
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
168,262,752
|
|
|
$
|
135,464,169
|
|
|
|
36
|
%
|
Excluding the Asset Manager Affiliates and CLO
Fund securities, the Company’s ten largest portfolio companies represented approximately 49% and 13% of the total fair value
of the Company’s investments at September 30, 2017 and December 31, 2016, 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.
In December 2016, the Company purchased $10.1
million of the notional value of the Subordinated Notes of Catamaran 2016-1 CLO (“Catamaran 2016-1”) managed by Trimaran
Advisors.
In the third quarter of 2017, the Company purchased
$3.8 million notional value of the Subordinated Notes of Catamaran 2014-1 CLO managed by Trimaran Advisors.
On February 29, 2016, Katonah X CLO Ltd. was
fully liquidated and all of its outstanding obligations were satisfied. The Company received approximately $1.0 million in connection
therewith related to its investment in the subordinated securities issued by Katonah X CLO Ltd. Accordingly, the Company recorded
a realized loss during the first quarter of 2016 of approximately $6.6 million on its investment in Katonah X CLO Ltd. and a corresponding
unrealized gain of the same amount in order to reverse the approximately $6.6 million of previously recorded unrealized depreciation
with respect to the investment.
All 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. In January 2017, the trustees of Trimaran CLO VII, Ltd. (Trimaran
VII) received notice that the holders of a majority of the income notes issued by Trimaran VII had exercised their right of optional
redemption. With the exception of Katonah III, Ltd. and Grant Grove CLO, Ltd. (both of which have been called), all third-party
managed CLO Funds are making distributions to the Company.
Affiliate Investments
The following table details investments in affiliates:
|
|
Fair
Value
at
December
31, 2016
|
|
|
Purchases/(Sales)
of or
Advances/(Distributions)
|
|
|
Net
Accretion
|
|
|
Unrealized
Gain/(Loss)
|
|
|
Fair
Value
at of
September
30, 2017
(unaudited)
|
|
|
Interest
Income
|
|
|
Dividend
Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset Manager Affiliates
|
|
$
|
40,198,000
|
|
|
$
|
(2,000,000
|
)
|
|
$
|
-
|
|
|
$
|
1,481,000
|
|
|
$
|
39,679,000
|
|
|
$
|
-
|
|
|
$
|
180,000
|
|
Trimaran Advisors, LLC Related Party Loan
|
|
|
-
|
|
|
|
20,000,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
20,000,000
|
|
|
|
506,306
|
|
|
|
-
|
|
Katonah 2007-I CLO, Ltd.
|
|
|
20,453,099
|
|
|
|
(1,841,861
|
)
|
|
|
4,942,665
|
|
|
|
(2,106,519
|
)
|
|
|
21,447,386
|
|
|
|
4,942,665
|
|
|
|
-
|
|
Trimaran CLO VII, Ltd.
|
|
|
1,195,152
|
|
|
|
(1,264,090
|
)
|
|
|
-
|
|
|
|
78,938
|
|
|
|
10,000
|
|
|
|
-
|
|
|
|
-
|
|
Catamaran CLO 2012-1, Ltd.
|
|
|
2,819,412
|
|
|
|
(636,377
|
)
|
|
|
476,425
|
|
|
|
(419,650
|
)
|
|
|
2,239,810
|
|
|
|
476,425
|
|
|
|
-
|
|
Catamaran CLO 2013-1, Ltd.
|
|
|
4,918,807
|
|
|
|
(985,219
|
)
|
|
|
534,047
|
|
|
|
(661,535
|
)
|
|
|
3,806,101
|
|
|
|
534,047
|
|
|
|
-
|
|
Catamaran CLO 2014-1, Ltd.
|
|
|
4,546,682
|
|
|
|
303,037
|
|
|
|
560,220
|
|
|
|
(562,318
|
)
|
|
|
4,847,621
|
|
|
|
560,220
|
|
|
|
-
|
|
Catamaran CLO 2014-2, Ltd.
|
|
|
5,092,087
|
|
|
|
(880,468
|
)
|
|
|
612,786
|
|
|
|
(340,395
|
)
|
|
|
4,484,010
|
|
|
|
612,786
|
|
|
|
-
|
|
Catamaran CLO 2015-1, Ltd.
|
|
|
3,223,255
|
|
|
|
(442,803
|
)
|
|
|
316,181
|
|
|
|
(62,913
|
)
|
|
|
3,033,719
|
|
|
|
316,181
|
|
|
|
-
|
|
Catamaran CLO 2016-1, Ltd.
|
|
|
8,350,290
|
|
|
|
(791,935
|
)
|
|
|
848,489
|
|
|
|
178,174
|
|
|
|
8,585,018
|
|
|
|
848,489
|
|
|
|
-
|
|
CRMN 2014-1A
|
|
|
1,310,000
|
|
|
|
-
|
|
|
|
9,659
|
|
|
|
200,341
|
|
|
|
1,520,000
|
|
|
|
87,974
|
|
|
|
-
|
|
KCAP Freedom 3, LLC
|
|
|
-
|
|
|
|
36,738,873
|
|
|
|
-
|
|
|
|
(147,751
|
)
|
|
|
36,591,122
|
|
|
|
-
|
|
|
|
685,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Affiliated Investments
|
|
$
|
92,106,784
|
|
|
$
|
48,199,157
|
|
|
$
|
8,300,472
|
|
|
$
|
(2,362,628
|
)
|
|
$
|
146,243,787
|
|
|
$
|
8,885,093
|
|
|
$
|
865,000
|
|
Investment in Joint Venture:
During the third quarter of 2017, the Company
and Freedom 3 Opportunities, an affiliate of Freedom 3 Capital LLC, entered into an agreement to create 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 (the "Fund") managed by KCAP Management, LLC, one of
the Company's 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. The Joint Venture may originate loans from time to time and sell them to the Fund.
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 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. Accordingly, the Company does not consolidate its non-controlling interest in the
Joint Venture.
KCAP Freedom 3 LLC
Summarized Balance Sheet (unaudited)
|
|
As of
|
|
|
|
September 30, 2017
|
|
Investment at fair value
|
|
$
|
62,591,610
|
|
Total Assets
|
|
$
|
62,591,610
|
|
|
|
|
|
|
Total Liabilities
|
|
$
|
1,026,962
|
|
Total Equity
|
|
|
61,564,648
|
|
Total Liabilities and Equity
|
|
$
|
62,591,610
|
|
KCAP Freedom 3 LLC
Summarized Statements of Operations Information
(unaudited)
|
|
For the period from July 20,
2017 (date of inception) to
September 30, 2017
|
|
Investment income
|
|
$
|
1,026,962
|
|
Operating Expenses
|
|
|
10,000
|
|
Net Investment Income
|
|
|
1,016,962
|
|
Unrealized appreciation on Investments
|
|
|
79,258
|
|
Net Income
|
|
$
|
1,096,220
|
|
During the three months ended September 30,
2017, KCAP Management LLC recognized approximately $185 thousand of management fees from the Fund, which is a wholly-owned subsidiary
of the Joint Venture. In turn, the Company has recognized dividend income of approximately $180 thousand during the three months
ended September 30, 2017 (included in Dividends from Asset Manager Affiliates) related to distributions from KCAP Management, LLC.
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. Subsequent to the adoption of ASC 820: Fair Value, the FASB has issued
various staff positions clarifying the initial standard (see Note 2 – “Significant Accounting Policies—Investments”).
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 hierarchy levels as of September 30, 2017 (unaudited) and December 31, 2016, respectively:
|
|
As of September 30, 2017 (unaudited)
|
|
|
|
Level I
|
|
|
Level II
|
|
|
Level III
|
|
|
Total
|
|
Money market accounts
|
|
$
|
—
|
|
|
$
|
32,015,828
|
|
|
$
|
—
|
|
|
$
|
32,015,828
|
|
U.S. Treasury Bills
|
|
|
25,009,000
|
|
|
|
—
|
|
|
|
—
|
|
|
|
25,009,000
|
|
Debt securities
|
|
|
—
|
|
|
|
68,707,692
|
|
|
|
58,319,137
|
|
|
|
127,026,829
|
|
CLO Fund securities
|
|
|
—
|
|
|
|
—
|
|
|
|
51,843,344
|
|
|
|
51,843,344
|
|
Equity securities
|
|
|
—
|
|
|
|
—
|
|
|
|
4,450,177
|
|
|
|
4,450,177
|
|
Asset Manager Affiliates
|
|
|
—
|
|
|
|
—
|
|
|
|
39,679,000
|
|
|
|
39,679,000
|
|
Joint Venture
|
|
|
—
|
|
|
|
—
|
|
|
|
36,591,122
|
|
|
|
36,591,122
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
25,009,000
|
|
|
$
|
100,723,520
|
|
|
$
|
190,882,780
|
|
|
$
|
316,615,300
|
|
|
|
As of December 31, 2016
|
|
|
|
Level I
|
|
|
Level II
|
|
|
Level III
|
|
|
Total
|
|
Money market accounts
|
|
$
|
—
|
|
|
$
|
28,699,269
|
|
|
$
|
—
|
|
|
$
|
28,699,269
|
|
Debt securities
|
|
|
—
|
|
|
|
84,601,585
|
|
|
|
153,741,745
|
|
|
|
238,343,330
|
|
CLO Fund securities
|
|
|
—
|
|
|
|
—
|
|
|
|
54,174,350
|
|
|
|
54,174,350
|
|
Equity securities
|
|
|
—
|
|
|
|
—
|
|
|
|
5,056,355
|
|
|
|
5,056,355
|
|
Asset Manager Affiliates
|
|
|
—
|
|
|
|
—
|
|
|
|
40,198,000
|
|
|
|
40,198,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
—
|
|
|
$
|
113,300,854
|
|
|
$
|
253,170,450
|
|
|
$
|
366,471,304
|
|
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:
|
|
Nine Months Ended September 30, 2017 (unaudited)
|
|
|
|
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)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Transfers into Level III
(2)
|
|
|
6,372,000
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
6,372,000
|
|
Net accretion (amortization)
|
|
|
206,241
|
|
|
|
443,434
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
649,675
|
|
Purchases
|
|
|
20,048,575
|
|
|
|
1,249,988
|
|
|
|
1
|
|
|
|
—
|
|
|
|
36,738,873
|
|
|
|
58,037,437
|
|
Sales/Paydowns/Return of Capital
|
|
|
(126,670,826
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
(2,000,000
|
)
|
|
|
—
|
|
|
|
(128,670,826
|
)
|
Total realized gain (loss) included in earnings
|
|
|
(995,630
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(995,630
|
)
|
Total unrealized gain (loss) included in earnings
|
|
|
5,617,032
|
|
|
|
(4,024,428
|
)
|
|
|
(606,179
|
)
|
|
|
1,481,000
|
|
|
|
(147,751
|
)
|
|
|
2,319,674
|
|
Balance, September 30, 2017
|
|
$
|
58,319,137
|
|
|
$
|
51,843,344
|
|
|
$
|
4,450,177
|
|
|
$
|
39,679,000
|
|
|
$
|
36,591,122
|
|
|
|
190,882,780
|
|
Changes in unrealized gains (losses) included in earnings related to investments still held at reporting date
|
|
$
|
1,174,559
|
|
|
$
|
(4,024,428
|
)
|
|
$
|
(1
|
)
|
|
$
|
1,481,000
|
|
|
$
|
(147,751
|
)
|
|
$
|
(1,368,870
|
)
|
¹Transfers out of Level III represent a transfer
of $0 relating to debt and equity securities for which pricing inputs, other than their quoted prices in active markets were
observable as of September 30, 2017.
²Transfers into Level III represent a transfer of $6,372,000
relating to debt and equity securities for which pricing inputs, other than their quoted prices in active markets were unobservable
as of September 30, 2017.
|
|
Year Ended December 31, 2016
|
|
|
|
Debt Securities
|
|
|
CLO Fund
Securities
|
|
|
Equity
Securities
|
|
|
Asset Manager
Affiliate
|
|
|
Joint Venture
|
|
|
Total
|
|
Balance, December 31, 2015
|
|
$
|
183,400,465
|
|
|
$
|
55,872,382
|
|
|
$
|
9,103,003
|
|
|
$
|
57,381,000
|
|
|
$
|
—
|
|
|
$
|
305,756,850
|
|
Transfers out of Level III
|
|
|
(14,855,471
|
)
1
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(14,855,471
|
)
|
Transfers into Level III
|
|
|
22,107,141
|
2
|
|
|
—
|
|
|
|
445,485
|
|
|
|
—
|
|
|
|
—
|
|
|
|
22,552,626
|
|
Net accretion (amortization)
|
|
|
318,999
|
|
|
|
(2,192,069
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(1,873,070
|
)
|
Purchases
|
|
|
33,641,315
|
|
|
|
10,140,000
|
|
|
|
180,161
|
|
|
|
—
|
|
|
|
—
|
|
|
|
43,961,476
|
|
Sales/Paydowns/Return of Capital
|
|
|
(66,559,349
|
)
|
|
|
(4,200,000
|
)
|
|
|
(4,743,682
|
)
|
|
|
(1,250,000
|
)
|
|
|
—
|
|
|
|
(76,753,031
|
)
|
Total realized gain (loss) included in earnings
|
|
|
(366,924
|
)
|
|
|
(10,111,560
|
)
|
|
|
4,484,742
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(5,993,742
|
)
|
Total unrealized gain (loss) included in earnings
|
|
|
(3,944,431
|
)
|
|
|
4,665,597
|
|
|
|
(4,413,354
|
)
|
|
|
(15,933,000
|
)
|
|
|
—
|
|
|
|
(19,625,188
|
)
|
Balance, December 31, 2016
|
|
$
|
153,741,745
|
|
|
$
|
54,174,350
|
|
|
$
|
5,056,355
|
|
|
$
|
40,198,000
|
|
|
$
|
—
|
|
|
|
253,170,450
|
|
Changes in unrealized gains (losses) included in
earnings related to investments still held at reporting date
|
|
$
|
(6,969,509
|
)
|
|
$
|
4,665,597
|
|
|
$
|
(4,413,354
|
)
|
|
$
|
(15,933,000
|
)
|
|
$
|
—
|
|
|
$
|
(22,650,266
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
¹Transfers out of Level III represent a transfer of $14,855,471
relating to debt securities for which pricing inputs, other than their quoted prices in active markets were observable as of December
31, 2016.
²Transfers into Level III represent a transfer of $22,107,141
relating to debt securities for which pricing inputs, other than their quoted prices in active markets were unobservable as of
December 31, 2016.
As of September 30, 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 $100,723,520 as of September 30, 2017.
As of September 30, 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
|
$ 11,219,800
|
Enterprise Value
|
Average EBITDA Multiple / WACC
|
5.2x - 6.7x (5.5x)
13.3% - 17.7% (16.8%)
|
|
47,099,337
|
Income Approach
|
Implied Discount Rate
|
6.0% - 26.4% (13.8%)
|
|
Equity Securities
|
4,442,177
|
Enterprise Value
|
Average EBITDA Multiple / WACC
|
4.6x – 16.1x (10.4x)
10.6% - 14.6% (12.2%)
|
|
8,000
|
Options Value
|
Qualitative Inputs
(1)
|
|
|
CLO Fund Securities
|
30,395,957
|
Discounted Cash Flow
|
Discount Rate
|
12.0%
|
|
Probability of Default
|
2.0%
|
|
Loss Severity
|
25.9%
|
|
Recovery Rate
|
74.1%
|
|
Prepayment Rate
|
25.0%
|
|
21,447,386
|
Liquidation Value
|
Qualitative Inputs
(2)
|
|
|
Asset Manager Affiliate
|
39,679,000
|
Discounted Cash Flow
|
Discount Rate
|
2.5% - 12.0% (6.5%)
|
|
Joint Venture
|
36,591,122
|
Enterprise Value
|
Qualitative Inputs
(2)
|
|
|
Total Level III Investments
|
$ 190,882,780
|
|
|
|
|
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, 2016, 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
|
$ 7,639,648
|
Enterprise Value
|
Average EBITDA Multiple
|
5.3x
|
|
146,102,097
|
Income Approach
|
Implied Discount Rate
|
5.6% - 21.5% (9.15%)
|
|
Equity Securities
|
5,050,355
|
Enterprise Value
|
Average EBITDA Multiple/WACC
|
4.8x/7.4% - 14.1x/13.9%
(9.3x/12.0%)
|
|
6,000
|
Options Value
|
Qualitative Inputs
(1)
|
|
|
CLO Fund Securities
|
45,824,060
|
Discounted Cash Flow
|
Discount Rate
|
11.3% - 13.0% (13.0%)
|
|
Probability of Default
|
2.0% - 2.5% (2.0%)
|
|
Loss Severity
|
25.0% - 25.9% (25.9%)
|
|
Recovery Rate
|
74.1% - 75.% (74.2%)
|
|
Prepayment Rate
|
25.0% - 29.1% (25.1%)
|
|
8,350,290
|
Market Approach
|
3
rd
Party Quote
|
82.35% (82.35%)
|
|
Asset Manager Affiliate
|
40,198,000
|
Discounted Cash Flow
|
Discount Rate
|
2.5% - 13.0% (7.6%)
|
|
Total Level III Investments
|
$ 253,170,450
|
|
|
|
|
¹
The qualitative inputs used in the fair value measurements of the Debt Securities include estimates of the distressed liquidation
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 inputs
used in the fair value measurement of the Asset Manager Affiliates is the discount rate used to present value prospective cash
flows. Prospective revenues are generally based on a fixed percentage of the par value of CLO Fund assets under management and
are recurring in nature for the term of the CLO Fund so long as the Asset Manager Affiliates manage the fund. As a result, the
fees earned by the Asset Manager Affiliates are generally not subject to market value fluctuations in the underlying collateral.
The discounted cash flow model incorporates different levels of discount rates depending on the hierarchy of fees earned (including
the likelihood of realization of senior, subordinate and incentive fees) and prospective modeled performance. Significant increases
or decreases in such discount rate would result in a significantly lower or higher fair value measurement.
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 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 September 30, 2017 and December 31, 2016, 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 $39.7 million and $40.2
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. Currently, all CLO Funds managed by the Asset Manager Affiliates are paying both their senior and subordinated management
fees on a current basis.
For the three months ended September 30, 2017
and 2016, the Asset Manager Affiliates declared cash distributions of $880,000 and $750,000 to the Company, respectively. For the
nine months ended September 30, 2017 and 2016, the Asset Manager Affiliates declared cash distributions of approximately $2.2 million
and $2.7 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 $180,000 of Dividends from Asset Manager Affiliates in the Statement of Operations for the three
months ended September 30, 2017.For the nine months ended September 30, 2017 and 2016, the Company recognized $180,000 and $1.4
million, respectively of Dividends from Asset Manager Affiliates in the Statement of Operations. 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). 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 the 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.
On February 18, 2015, the 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 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, early
adoption is permitted. The Asset Manager Affiliates adopted ASU 2015-2 in 2016 which resulted in the deconsolidation of the CLO
Funds. Prior year amounts have been restated to reflect the retrospective adoption of ASU 2015-2. In addition, in accordance with
Regulation S-X, additional financial information with respect to the Asset Manager Affiliates and one of the CLO Funds in which
the Company has an investment, Katonah 2007-I CLO, is required to be included in the Company’s SEC Filings. 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
|
|
|
|
September 30, 2017
|
|
|
December 31, 2016
|
|
Cash
|
|
$
|
14,532,648
|
|
|
$
|
3,425,709
|
|
Investments
|
|
|
10,000,000
|
|
|
|
-
|
|
Intangible Assets
|
|
|
22,830,000
|
|
|
|
23,157,541
|
|
Other Assets
|
|
|
3,762,880
|
|
|
|
5,024,174
|
|
Total Assets
|
|
$
|
51,125,528
|
|
|
$
|
31,607,424
|
|
|
|
|
|
|
|
|
|
|
Total Liabilities
|
|
$
|
25,970,228
|
|
|
$
|
6,619,619
|
|
Total Equity
|
|
|
25,155,300
|
|
|
|
24,987,805
|
|
Total Liabilities and Equity
|
|
$
|
51,125,528
|
|
|
$
|
31,607,424
|
|
Asset Manager Affiliates
Summarized Statements of Operations Information
(unaudited)
|
|
For the three months ended
|
|
|
For the nine months ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Fee Revenue
|
|
$
|
3,027,460
|
|
|
$
|
3,148,353
|
|
|
$
|
12,000,010
|
|
|
$
|
9,707,075
|
|
Interest Income
|
|
|
25,298
|
|
|
|
570,865
|
|
|
|
31,208
|
|
|
|
1,138,483
|
|
Total Income
|
|
|
3,052,758
|
|
|
|
3,719,218
|
|
|
|
12,031,218
|
|
|
|
10,845,558
|
|
Operating Expenses
|
|
|
2,547,545
|
|
|
|
2,789,654
|
|
|
|
7,852,377
|
|
|
|
8,618,839
|
|
Amortization of Intangibles
|
|
|
-
|
|
|
|
327,541
|
|
|
|
327,541
|
|
|
|
982,623
|
|
Interest Expense
|
|
|
121,468
|
|
|
|
485,355
|
|
|
|
525,034
|
|
|
|
1,353,135
|
|
Total Expenses
|
|
|
2,669,013
|
|
|
|
3,602,550
|
|
|
|
8,704,952
|
|
|
|
10,954,597
|
|
Pre-Tax Income (Loss)
|
|
|
383,745
|
|
|
|
116,668
|
|
|
|
3,326,266
|
|
|
|
(109,039
|
)
|
Income Tax (Benefit) Expense
|
|
|
(79,791
|
)
|
|
|
(100,862
|
)
|
|
|
978,769
|
|
|
|
(346,447
|
)
|
Net Income
|
|
$
|
463,536
|
|
|
$
|
217,530
|
|
|
$
|
2,347,497
|
|
|
$
|
237,408
|
|
Katonah 2007-I CLO Ltd.
Summarized Balance Sheet Information (unaudited)
|
|
As of
|
|
|
As of
|
|
|
|
September 30, 2017
|
|
|
December 31, 2016
|
|
Total investments at fair value
|
|
$
|
80,158,889
|
|
|
$
|
176,684,976
|
|
Cash
|
|
|
24,632,168
|
|
|
|
34,982,770
|
|
Total Assets
|
|
|
105,370,828
|
|
|
|
212,160,163
|
|
CLO Debt at fair value
|
|
|
104,216,372
|
|
|
|
208,812,164
|
|
Total liabilities
|
|
|
105,374,980
|
|
|
|
210,463,954
|
|
Total Net Assets (deficit)
|
|
|
(4,151
|
)
|
|
|
1,696,209
|
|
Katonah 2007-I CLO Ltd.
Summarized Statements of Operations Information
(unaudited)
|
|
For the three months ended
|
|
|
For the nine months ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Interest income from investments
|
|
$
|
1,185,765
|
|
|
$
|
2,330,108
|
|
|
$
|
4,336,891
|
|
|
$
|
7,338,815
|
|
Total income
|
|
|
1,203,940
|
|
|
|
2,373,500
|
|
|
|
4,392,101
|
|
|
|
7,683,808
|
|
Interest expense
|
|
|
1,275,068
|
|
|
|
2,184,144
|
|
|
|
4,289,994
|
|
|
|
6,724,410
|
|
Total expenses
|
|
|
1,401,622
|
|
|
|
2,400,770
|
|
|
|
4,885,278
|
|
|
|
7,497,100
|
|
Net realized and unrealized gains (losses)
|
|
|
(48,669
|
)
|
|
|
1,397,748
|
|
|
|
(1,207,183
|
)
|
|
|
3,783,015
|
|
Increase in net assets resulting from operations
|
|
|
(246,351
|
)
|
|
|
1,370,478
|
|
|
|
(1,700,360
|
)
|
|
|
3,969,723
|
|
Except for KCAP Management, LLC, which is a designated
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 U.S. 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, of both which are being amortized for tax purposes on a straight-line basis over 15 years.
During the second quarter of 2016, KCAP contributed
100% of its ownership interests in Katonah Debt Advisors and Trimaran Advisors Management to Commodore Holdings, a wholly-owned
subsidiary of KCAP. These transactions simplify the tax structure of the AMAs and facilitate the consolidation of tax basis goodwill
deductions for the AMAs, which may impact the tax character of distributions from the AMAs.
Related Party Transactions
On February 26, 2013, the Company entered into
a senior credit agreement (the “Trimaran Credit Facility”) with Trimaran Advisors, pursuant to which Trimaran Advisors
may borrow from time to time up to $20 million from the Company in order to provide capital necessary to support one or more of
Trimaran Advisors’ warehouse lines of credit and/or working capital in connection with Trimaran Advisors’ warehouse
activities. The Trimaran Credit Facility expires on November 20, 2017 and bears interest at an annual rate of 9.0%. Outstanding
borrowings on the Trimaran Credit Facility are callable by the Company at any time. On April 15, 2013, the Trimaran Credit Facility
was amended and upsized from $20 million to $23 million. At September 30, 2017 and December 31, 2016, there was $20 million and
$0 million, respectively, outstanding under the Trimaran Credit Facility. For the three months ended September 30, 2017 and 2016,
the Company recognized interest income of approximately $126,000 and $485,000, respectively, related to the Trimaran Credit Facility.
For the nine months ended September 30, 2017 and 2016, the Company recognized interest income of approximately $529,000 and $1.3
million, respectively, related to the Trimaran Credit Facility.
6. BORROWINGS
The Company’s debt obligations consist
of the following:
|
|
As of
September 30, 2017
(unaudited)
|
|
|
As of
December 31, 2016
|
|
|
|
|
|
|
|
|
Notes issued by KCAP Senior Funding I, LLC (net of discount and offering costs of: 2016 - $2,286,425 and $2,459,156, respectively)
|
|
$
|
-
|
|
|
$
|
142,604,419
|
|
7.375 Notes (net of offering costs of: 2017 - $306,073; 2016 - $550,774)
|
|
|
26,693,927
|
|
|
|
32,980,151
|
|
6.125 Notes (net of offering costs of: 2017 - $2,757,357)
|
|
|
74,649,843
|
|
|
|
-
|
|
Total
|
|
$
|
101,343,770
|
|
|
$
|
175,584,570
|
|
The weighted average stated interest rate and weighted average maturity
on all our debt outstanding as of September 30, 2017 were 6.4% and 4.2 years, respectively, and as of December 31, 2016 were 3.9%
and 6.7 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.
The secured notes (the “KCAP Senior Funding
I Secured Notes”) were issued as Class A senior secured floating rate notes which have an initial face amount of $77,250,000,
are rated AAA (sf)/Aaa (sf) by Standard & Poor’s Ratings Services and Moody’s Investors Service, Inc., respectively,
and bear interest at the three-month LIBOR plus 1.50%, Class B senior secured floating rate notes which have an initial face amount
of $9,000,000, are rated AA (sf)/Aa2 (sf) by Standard & Poor’s Ratings Services and Moody’s Investors Service,
Inc., respectively, and bear interest at three-month LIBOR plus the 3.25%, Class C secured deferrable floating rate notes which
have an initial face amount of $10,000,000, are rated A (sf)/A2 (sf) by Standard & Poor’s Ratings Services and Moody’s
Investors Service, Inc., respectively, and bear interest at three-month LIBOR plus 4.25%, and Class D secured deferrable floating
rate notes which have an initial face amount of $9,000,000, are rated BBB (sf)/Baa2 (sf) by Standard & Poor’s Ratings
Services and Moody’s Investors Service, Inc., respectively, and bear interest at three-month LIBOR plus 5.25%. The Depositor
retained all of the subordinated notes of the Issuer (the “KCAP Senior Funding I Subordinated Notes”), which have an
initial face amount of $34,750,000. The KCAP Senior Funding I Subordinated Notes do not bear interest and are not rated. Both the
KCAP Senior Funding I Secured Notes and the KCAP Senior Funding I Subordinated Notes have a stated maturity on the payment date
occurring in July, 2024, and are subject to a two year non-call period. The Issuer has a four year reinvestment period. The stated
interest rate re-sets on a quarterly basis based upon the then-current level of the benchmark three-month LIBOR.
On December 8, 2014, the Company completed
the sale of additional notes (“Additional Issuance Securities”) in a $56,000,000 increase to the collateralized loan
obligation transaction that originally closed on June 18, 2013 (the “Original Closing Date”). The issuance of additional
notes was proportional across all existing classes of notes issued on the Original Closing Date.
Each class of secured Additional Issuance Securities
(all such classes, collectively, the “Additional Issuance Offered Securities”) was issued as a pari passu sub-class
of an existing class of notes issued on the Original Closing Date. Accordingly, the ratings given by Standard & Poor’s
Ratings Services and Moody’s Investors Service, Inc. to each existing class of notes issued on the Original Closing Date
will apply to each class of Additional Issuance Offered Securities that constitutes a related pari passu sub-class of such existing
class of notes issued on the Original Closing Date.
The Additional Issuance Offered Securities
were issued as Class A-2 senior secured floating rate notes which have an initial face amount of $30,900,000, have a rating of
AAA (sf)/Aaa (sf) by Standard & Poor’s Ratings Services and Moody’s Investors Service, Inc., respectively, and
bear interest at the three-month LIBOR plus 1.50%, Class B-2 senior secured floating rate notes which have an initial face amount
of $3,600,000, a rating of AA (sf)/Aa2 (sf) by Standard & Poor’s Ratings Services and Moody’s Investors Service,
Inc., respectively, and bear interest at three-month LIBOR plus 3.25%, Class C-2 secured deferrable floating rate notes which have
an initial face amount of $4,000,000, a rating of A (sf)/A2 (sf) by Standard & Poor’s Ratings Services and Moody’s
Investors Service, Inc., respectively, and bear interest at three-month LIBOR plus 4.25%, and Class D-2 secured deferrable floating
rate notes which have an initial face amount of $3,600,000, a rating of BBB (sf)/Baa2 (sf) by Standard & Poor’s Ratings
Services and Moody’s Investors Service, Inc., respectively, and bear interest at three-month LIBOR plus 5.25%. The Depositor
retained all of the subordinated Additional Issuance Securities of the Issuer (the “Additional Issuance Subordinated Notes”),
which have an initial face amount of $13,900,000. The Additional Issuance Subordinated Notes do not bear interest and are not rated.
The Additional Issuance Securities have a stated maturity date of July 20, 2024 and are subject to a non-call period until the
payment date on the Additional Issuance Securities occurring in July 2015. The Issuer has a reinvestment period to and including
the payment date on the Additional Issuance Securities occurring in July 2017, or such earlier date as is provided in the indenture
relating to the Additional Issuance Securities. In connection with the Additional Issuance Offered Securities, the Company incurred
issuance costs and OID costs of approximately $584,000 and $896,000, respectively.
As part of this transaction, the Company entered
into a master loan sale agreement with the Depositor and the Issuer under which the Company sold or contributed certain bank loans
to the Depositor, and the Depositor sold such loans to the Issuer in exchange for a combination of cash and the issuance of the
KCAP Senior Funding I Subordinated Notes to the Depositor.
In connection with the issuance and sale of
the KCAP Senior Funding I Notes, the Company has made customary representations, warranties and covenants in the purchase agreement
by and between the Company, the Depositor, the Issuer and Guggenheim Securities, LLC, which served as the initial purchaser of
the KCAP Senior Funding I Secured Notes. The KCAP Senior Funding I Secured Notes are the secured obligations of the Issuer, and
an indenture governing the KCAP Senior Funding I Notes includes customary covenants and events of default. The KCAP Senior Funding
I Notes were sold in a private placement transaction and have not been, and will not be, registered under the Securities Act of
1933, as amended, or any state “blue sky” laws and may not be offered or sold in the United States absent registration
with the Securities and Exchange Commission or an applicable exemption from registration.
The Company serves
as collateral manager to the Issuer under a collateral management agreement, which contains customary representations, warranties
and covenants. Under the collateral management agreement, the Company will perform certain investment management functions, including
supervising and directing the investment and reinvestment of the Issuer’s assets, as well as perform certain administrative
and advisory functions.
In addition, because each of the Issuer and
the Depositor are consolidated subsidiaries, the Company did not recognize any gain or loss on the transfer of any of our portfolio
assets to such vehicles in connection with the issuance and sale of the KCAP Senior Funding I Notes.
All of the Class A,B,C and D notes were repaid
in the third quarter of 2017. In connection there with, the Company recorded a realized loss from the extinguishment of debt of
$4.0 million in the third quarter of 2017.
For the three months ended September 30, 2017,
interest expense, including the amortization of deferred debt issuance costs and the OID was approximately $337,000 consisting
of stated interest expense of approximately $263,000, accreted discount of approximately $35,000, and deferred debt issuance costs
of approximately $38,000. For the nine months ended September 30, 2017, interest expense, including the amortization of deferred
debt issuance costs and the discount on the face amount of the notes, was approximately $3.4 million consisting of stated interest
expense of approximately $2.7 million, accreted discount of approximately $352,000, and deferred debt issuance costs of approximately
$379,000.
Fair Value of KCAP Senior Funding I.
The
Company carried the KCAP Senior Funding I Notes at cost, net of unamortized discount and offering costs. The fair value of the
KCAP Senior Funding I Notes was approximately $146.3 million at December 31, 2016. The fair value was determined based on third
party indicative values. The KCAP Senior Funding I L.L.C. Notes were categorized as Level III under ASC 820: Fair Value.
7.375% Notes Due 2019
On October 10, 2012, the Company
issued $41.4 million in aggregate principal amount of unsecured 7.375% Notes Due 2019 (the “7.375% Notes due 2019”). The net
proceeds for these Notes, after the payment of underwriting expenses, were approximately $39.9 million. 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 test applicable to the Company as a
BDC and a covenant that the Company agreed to in connection with the issuance of the 7.375% Notes Due 2019, the Company 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 September 30, 2017, the Company was in compliance with all of its debt covenants.
For the three months ended September 30, 2017
and 2016, interest expense related to the 7.375% Notes Due 2019 was approximately $498,000 and $712,000, respectively. For the
nine months ended September 30, 2017 and 2016, interest expense related to the 7.375% Notes Due 2019 was approximately $1.7 million
and $2.2 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 $306,000 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. KCAP 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.
KCAP 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
$15,006. KCAP 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. KCAP 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. The fair value of the Company’s
outstanding 7.375% Notes Due 2019 was approximately $27.1 million at September 30, 2017. The fair value was determined based on
the closing price on September 30, 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%, commencing
September 30, 2017. The 6.125% Notes Due 2022 mature on September, 30, 2022 and are unsecured obligations of the Company. The 6.125%
Notes Due 2022 are subject to redemption in whole or in part at any time or from time to time, at the option of the Company, on
or after September 30, 2019, at a redemption price per security equal to 100% of the outstanding principal amount thereof plus
accrued and unpaid interest payments otherwise payable for the then-current quarterly interest period accrued to the date fixed
for redemption. In addition, Due to the asset coverage test applicable to the Company as a BDC and a covenant that the Company
agreed to in connection with the issuance of the 6.125% Notes Due 2022, the Company is limited in its ability to make distributions
in certain circumstances. The indenture governing the 6.125% Notes Due 2022 contains certain restrictive covenants, including compliance
with certain provisions of the 1940 Act relating to borrowing and dividends. At September 30, 2017, the Company was in compliance
with all of its debt covenants.
For the three months and nine months ended
September 30, 2017 interest expense related to the 6.125% Notes Due 2022 was approximately $450,000.
In connection with the issuance of the 6.125%
Notes Due 2022, the Company incurred approximately $2.8 million of debt offering costs which are being amortized over the expected
term of the facility on an effective yield method, of which approximately $2.8 million remains to be amortized as of September
30, 2017, 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. The fair value
of the Company’s outstanding 6.125% Notes Due 2022 was approximately $77.3 million at September 30, 2017.The fair value was
determined based on the closing price on September 30, 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.
Convertible Notes
On March 16, 2011, the Company issued $55 million
in aggregate principal amount of unsecured 8.75% convertible notes Due March 2016 (“Convertible Notes”). On March 23,
2011, pursuant to an over-allotment option, the Company issued an additional $5 million of such Convertible Notes for a total of
$60 million in aggregate principal amount. The net proceeds from the sale of the Convertible Notes, after the payment of underwriting
expenses, were approximately $57.7 million. Interest on the Convertible Notes is due semi-annually in arrears on March 15 and September
15, at a rate of 8.75%, commencing September 15, 2011. The Convertible Notes matured and were repaid on March 15, 2016. The Convertible
Notes were senior unsecured obligations of the Company.
In connection with the issuance of the Convertible
Notes, the Company incurred approximately $2.4 million of debt offering costs, which were amortized over the term of the Convertible
Notes on an effective yield method. On April 4, 2013, approximately $9 million of the Company’s 8.75% Convertible Notes were
converted at a price per share of $8.159 into 1,102,093 shares of KCAP common stock. On September 4, 2013, the Company purchased
$2.0 million face value of its own Convertible Notes at a price of $114.50 plus accrued interest. KCAP subsequently surrendered
these notes to the Trustee for cancellation effective September 13, 2013. During 2015, the Company repurchased approximately $19.3
million face value of its own Convertible Notes at a price ranging from $101.500 to $102.375. KCAP subsequently surrendered these
notes to the Trustee for cancellation. Due to the cash conversion option embedded in the Convertible Notes, the Company applied
the guidance in ASC 470-20-40,
Debt with Conversion and Other Options
and realized a loss on the extinguishment of this
debt. The indenture governing the Convertible Notes contains certain restrictive covenants, including compliance with certain provisions
of the 1940 Act and conditions governing the undertaking of new debt.
The Convertible Notes matured and were fully
repaid on March 15, 2016.
For the nine months ended September 30, 2016,
interest expense related to the Convertible Notes was approximately $378,000.
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 2017). 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 (decrease)
in net assets resulting from operations to taxable income for the nine months ended September 30, 2017 and 2016:
|
|
Nine Months Ended September 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
(unaudited)
|
|
|
(unaudited)
|
|
|
|
|
|
|
|
|
Net increase (decrease) in net assets resulting from operations
|
|
$
|
2,237,830
|
|
|
$
|
(1,118,601
|
)
|
Net change in unrealized depreciation from investments
|
|
|
(875,365
|
)
|
|
|
9,309,013
|
|
Excess capital gains over capital losses
|
|
|
6,993,940
|
|
|
|
6,205,405
|
|
Book/tax differences on CLO equity investments
|
|
|
(1,697,865
|
)
|
|
|
1,050,658
|
|
Other book/tax differences
|
|
|
224,785
|
|
|
|
(673,454
|
)
|
|
|
|
|
|
|
|
|
|
Taxable income before deductions for distributions
|
|
$
|
6,883,325
|
|
|
$
|
14,773,021
|
|
|
|
|
|
|
|
|
|
|
Taxable income before deductions for distributions per weighted average basic shares for the period
|
|
$
|
0.19
|
|
|
$
|
0.40
|
|
Taxable income before deductions for distributions per weighted average diluted shares for the period
|
|
$
|
0.19
|
|
|
$
|
0.40
|
|
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 nine months ended September 30, 2017 and 2016,
the Asset Manager Affiliates declared cash distributions of $2.2 million and $2.7 million to the Company, respectively. The Company
recognized $1.4 million, respectively, of dividends from Asset Manager Affiliates in the Statement of Operations for the nine months
ended September 30, 2016. The difference of $2.0 million and $1.3 million, 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), for the nine months ended September 30, 2017 and 2016, respectively.
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 September 30, 2017, the Company had a net
capital loss carryforward of approximately $98.0 million to offset net capital gains, to the extent provided by federal tax law.
Of the net capital loss carryforward, $66.7 million is not subject to expiration under the RIC Modernization Act of 2010.
On September 22, 2017 the Company’s Board
of Directors declared a distribution to shareholders of $0.12 per share for a total of approximately $4.4 million. The record
date was October 10, 2017 and the distribution was paid on October 26, 2017.
The Company adopted Financial Accounting Standards
Board ASC Topic 740 Accounting for Uncertainty in Income Taxes (“ASC 740”) as of January 1, 2007. 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 September 30, 2017 and December 31, 2016, the Company had approximately $3 million and $565,000 of outstanding
commitments to fund investments, respectively.
9. STOCKHOLDERS’ EQUITY
During the nine months ended September 30,
2017 and 2016, the Company issued 75,059 and 153,792 shares, respectively, of common stock under its dividend reinvestment plan.
For the nine months ended September 30, 2017, there were 139,620 grants, 10,982 forfeitures, and 242,918 shares vested plan with
respect to restricted stock.. 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. 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 April 4, 2013, approximately
$9 million of the Company’s 8.75% Convertible Notes were converted at a price basis per share of $8.159 into 1,102,093 shares
of KCAP common stock. On October 6, 2014, the Company priced 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 were approximately $23.8 million, after deducting underwriting
discounts and offering expenses. The total number of shares of the Company’s common stock outstanding as of September 30,
2017 and December 31, 2016 was 37,317,815 and 37,178,294, respectively. During the nine months ended September 30, 2017 and 2016,
the Company repurchased 64,176 and 67,654 shares, respectively, at an aggregate cost of approximately $225,000 and $248,000, respectively,
in connection with the vesting of restricted stock awards.
10. EQUITY INCENTIVE PLAN
The Company has an equity incentive plan,
established in 2006 and as amended in 2008, 2014, 2015 and most recently in May 2017 (the “Equity Incentive Plan”).
The Company reserved 2,000,000 shares of common stock for issuance under the Equity Incentive Plan. The purpose of the Equity Incentive
Plan is to provide officers and employees of the Company with additional incentives and align the interests of its employees with
those of its shareholders. 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 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. Vesting of restricted stock awarded under the 2008 amendment of the Equity Incentive Plan will occur in two equal installments
of 50%, on each of the third and fourth anniversaries of the grant date; vesting of restricted stock subsequent to the 2014 amendment
of the Equity Incentive Plan will vest in four equal installments of 25%, on each of the first four anniversaries of the grant
date, except for the grant in September of 2017, which will occur in two equal installments of 50%, on each of the third and fourth
anniversaries of the grant date.
Stock Options
On June 20, 2014, the
Company’s Board of Directors approved the amended and restated the 2011 Non-Employee Director Plan, which was approved by shareholders on June 10, 2011. Accordingly, the annual grant
of options to non-employee directors has been discontinued and replaced with an annual grant of shares of restricted stock as
partial annual compensation for the services of the non-employee directors.
On March 21, 2017, the Company’s Board of Directors approved
the 2017 Non-Employee Director Plan, which extended the term of the 2011 Non-Employee Director Plan (together, the “Non-Employee
Director Plan”). The Company’s shareholders approved the Non-Employee Director Plan on May 4, 2017.
Information with respect to options granted,
exercised and forfeited under the Equity Incentive Plan for the period January 1, 2016 through September 30, 2017 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, 2016
|
|
|
50,000
|
|
|
$
|
7.72
|
|
|
|
3.4
|
|
|
|
|
|
Granted
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Options outstanding at December 31, 2016
|
|
|
50,000
|
|
|
$
|
7.72
|
|
|
|
2.4
|
|
|
$
|
—
|
|
Granted
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Outstanding at September 30, 2017
|
|
|
50,000
|
|
|
$
|
7.72
|
|
|
|
1.6
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total vested at September 30, 2017
|
|
|
50,000
|
|
|
$
|
7.72
|
|
|
|
1.6
|
|
|
|
|
|
|
1
|
Represents the difference between the market value of shares
of the Company 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 nine months ended September 30, 2017
and 2016, the Company did not recognize any non-cash compensation expense related to stock options. At September 30, 2017, 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 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 nine months ended September 30, 2017 and 2016, the Company repurchased 64,176 and 67,654 shares, respectively,
of common stock at an aggregate cost of approximately $225,000 and $248,000, 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 Equity Incentive 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.
During the nine months ended September
30, 2017, 242,918 shares of restricted stock vested and 10,982 shares of restricted stock were forfeited. As of September 30, 2017,
after giving effect to these restricted stock awards, there were 297,199 shares of restricted stock outstanding. Information with
respect to restricted stock granted, exercised and forfeited under the Plan for the period January 1, 2016 through September 30,
2017 is as follows:
|
|
Non-vested
Restricted Shares
|
|
Non-vested shares outstanding at January 1, 2016
|
|
|
700,539
|
|
Granted
|
|
|
6,000
|
|
Vested
|
|
|
(260,607
|
)
|
Forfeited
|
|
|
(34,453
|
)
|
Non-vested shares outstanding at December 31, 2016
|
|
|
411,479
|
|
Granted
|
|
|
139,620
|
|
Vested
|
|
|
(242,918
|
)
|
Forfeited
|
|
|
(10,982
|
)
|
Non-Vested Outstanding at September 30, 2017
|
|
|
297,199
|
|
For the three months ended September 30, 2017,
non-cash compensation expense related to restricted stock was approximately $226,000 of this amount approximately $83,000 was expensed
at the Company, and approximately $143,000 was a reimbursable expense allocated to the Asset Manager Affiliates. For the three
months ended September 30, 2016, non-cash compensation expense related to restricted stock was approximately $394,000 of this amount
approximately $161,000 was expensed at the Company, and approximately $233,000 was a reimbursable expense allocated to the Asset
Manager Affiliates. For the nine months ended September 30, 2017, non-cash compensation expense related to restricted stock was
approximately $878,000 of this amount approximately $330,000 was expensed at the Company, and approximately $548,000 was a reimbursable
expense allocated to the Asset Manager Affiliates. For the nine months ended September 30, 2016, non-cash compensation expense
related to restricted stock was approximately $1.2 million; of this amount approximately $472,000 was expensed at the Company and
approximately $682,000 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 September 30, 2017, the Company had approximately $1.4 million of total unrecognized compensation
cost related to non-vested restricted share awards. That cost is expected to be recognized over the remaining weighted average
period of 1.6 years.
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 $1,000 and $1,000 was expensed during the three months ended September
30, 2017 and 2016, respectively, related to the 401K Plan. During the nine months ended September 30, 2017 and 2016, approximately
$35,000 and $19,000 was expensed 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 $46,000
and $46,000 was expensed during the three months ended September 30, 2017 and 2016, respectively, related to the Profit-Sharing
Plan. During the nine months ended September 30, 2017 and 2016, approximately $139,000 and $138,000, respectively, was expensed
related to the Profit-Sharing Plan.
12. SUBSEQUENT EVENTS
On October 31, 2017, 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 will be return of capital, reducing the cost basis of its investment in the JV 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.
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.
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 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.
The Company has evaluated events and transactions
occurring subsequent to September 30, 2017 for items that should potentially be recognized or disclosed in these financial statements.
Other than as noted above, management has determined that there are no material subsequent events that would require adjustment
to, or disclosure in, these consolidated financial statements.