Notes to Consolidated Financial Statements
(unaudited)
December 31, 2017
Note 1. Organization
CM Finance Inc (“CMFN” or the “Company”),
a Maryland corporation formed in May 2013, is a closed-end, externally managed, non-diversified management investment company that
has elected to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940, as
amended (the “1940 Act”), and has elected to be treated as a regulated investment company (“RIC”) under
Subchapter M of the Internal Revenue Code (the “Code”) for U.S. federal income tax purposes. The Company is an investment
company and accordingly follows the investment company accounting and reporting guidance of the Financial Accounting Standards
Board (“FASB”) Accounting Standard Codification (“ASC”) Topic 946 Financial Services – Investment
Companies.
On February 11, 2014, the Company completed
its initial public offering (the “Offering”), selling 7,666,666 shares of its common stock, par value $0.001, including
the underwriters’ over-allotment, at a price of $15.00 per share with net proceeds of approximately $111.5 million.
CM Finance LLC, a Maryland limited liability
company, commenced operations in March 2012. Immediately prior to the Offering, CM Finance LLC was merged with and into the Company
(the “Merger”). In connection with the Merger, the Company issued 6,000,000 shares of common stock and $39.8 million
in debt to the pre-existing CM Finance LLC investors, consisting of funds managed by Cyrus Capital Partners, L.P. (the “Original
Investors” or the “Cyrus Funds”). The Company had no assets or operations prior to completion of the Merger and,
as a result, the books and records of CM Finance LLC became the books and records of the Company, as the surviving entity. Immediately
after the Merger, the Company issued 2,181,818 shares of its common stock to Stifel Venture Corp. (“Stifel”) in exchange
for $32.7 million in cash. The Company used all of the proceeds of the sale of shares to Stifel to repurchase 2,181,818 shares
of common stock from the Original Investors. Immediately after the completion of the Offering, the Company had 13,666,666 shares
outstanding. The Company used a portion of the net proceeds of the Offering to repay 100% of the debt issued to the Original Investors
in connection with the Merger.
Upon its election to be regulated as a BDC on
February 5, 2014, the Company entered into an investment advisory agreement (the “Advisory Agreement”) and an administrative
agreement with CM Investment Partners LLC (the “Adviser”) as its investment adviser and administrator, respectively.
The Company’s primary investment objective
is to maximize total return to stockholders in the form of current income and capital appreciation by investing directly in debt
and related equity of privately held middle-market companies to help these companies fund organic growth, acquisitions, market
or product expansion, refinancings, and/or recapitalizations. The Company invests primarily in middle-market companies in the form
of unitranche loans and standalone first and second lien loans. The Company may also invest in unsecured debt, bonds and in the
equity of portfolio companies through warrants.
As a BDC, the Company is required to comply
with certain regulatory requirements. For instance, as a BDC, the Company must not acquire any assets other than “qualifying
assets” specified in the 1940 Act unless, at the time the acquisition is made, at least 70% of total assets are qualifying
assets. Qualifying assets include investments in “eligible portfolio companies.” Under the relevant Securities and
Exchange Commission (“SEC”) rules, the term “eligible portfolio company” includes all private operating
companies, operating companies whose securities are not listed on a national securities exchange, and certain public operating
companies that have listed their securities on a national securities exchange and have a market capitalization of less than $250
million, in each case organized and with their principal of business in the United States.
The Company consolidates the operations of its
wholly owned subsidiaries, CM Finance SPV Ltd. (“SPV”) and CM Finance SPV LLC (“LLC”), which are special
purpose vehicles used to finance certain investments.
The Company has formed certain additional taxable subsidiaries (collectively,
the “Taxable Subsidiaries”), which are taxed as corporations for federal income tax purposes. At December 31, 2017,
the Company had four Taxable Subsidiaries: CM Portfolio Companies LLC, Bird Electric Blocker, LLC, U.S. Well Services Blocker,
LLC and Zinc Borrower Blocker, LLC. These Taxable Subsidiaries allow the Company to hold equity securities of portfolio companies
organized as pass-through entities while continuing to satisfy the requirements of a RIC under the Code.
CM Finance Inc and subsidiaries
Notes to Consolidated Financial Statements
(unaudited)
December 31, 2017
Note 2. Significant Accounting Policies
The following is a summary of significant accounting
policies followed by the Company.
a. Basis of Presentation
The accompanying consolidated financial statements
are prepared in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”) and all values are stated
in U.S. dollars, unless noted otherwise. The financial statements reflect all adjustments that are, in the opinion of management,
necessary for a fair presentation of the results for the periods included herein as required by U.S. GAAP. These adjustments are
normal and recurring in nature.
The preparation of consolidated financial statements
in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the fair value of investments and
other amounts reported in the consolidated financial statements and accompanying notes. Management believes that the estimates
utilized in preparing the Company’s consolidated financial statements are reasonable and prudent. Actual results could differ
materially from these estimates. All material inter-company balances and transactions have been eliminated.
b. Revenue Recognition, Security Transactions, and Realized/Unrealized
Gains or Losses
Interest income, adjusted for amortization of
premium and accretion of discount, is recorded on an accrual basis. Origination, closing, commitment, and amendment fees, purchase
and original issue discounts associated with loans to portfolio companies are accreted into interest income over the respective
terms of the applicable loans. Accretion of discounts or premiums is calculated by the effective interest or straight-line method,
as applicable, as of the purchase date and adjusted only for material amendments or prepayments. Upon the prepayment of a loan
or debt security, any prepayment penalties are included in other fee income and unamortized fees and discounts are recorded as
interest income and are non-recurring in nature.
Structuring fees and similar fees are recognized
as income as earned, usually when received. Structuring fees, excess deal deposits, net profits interests and overriding royalty
interests are included in other fee income.
Loans are placed on non-accrual status when
principal or interest payments are past due 90 days or more or when there is reasonable doubt that principal or interest will be
collected. Accrued interest is generally reversed when a loan is placed on non-accrual status. Interest payments received on non-accrual
loans may be recognized as income or applied to principal depending upon management’s judgment about ultimate collectability
of principal. Non-accrual loans are restored to accrual status when past due principal and interest is paid and, in management’s
judgment, are likely to remain current. PIK interest is not accrued if we do not expect the issuer to be able to pay all principal
and interest when due.
Dividend income is recorded on the ex-dividend
date.
Origination, closing, commitment, and
amendment fees, purchase and original issue discounts associated with loans to portfolio companies are accreted into interest
income over the respective terms of the applicable loans. Accretion of discounts or premiums is calculated by the effective
interest or straight-line method, as applicable, as of the purchase date and adjusted only for material amendments or
prepayments. Upon the prepayment of a loan or debt security, any prepayment penalties are included in other fee income and
unamortized fees and discounts are recorded as interest income and are non-recurring in nature. During the three and six
months ended December 31, 2017, $1,218,231 and $1,240,123 of unamortized discounts upon prepayment were recorded as interest
income, respectively. During the three and six months ended December 31, 2016, $2,104,998 and $2,393,949 of prepayment
penalties and unamortized discounts upon prepayment were recorded as interest income, respectively.
Structuring fees and similar fees
are recognized as income as earned, usually when received. Structuring fees, excess deal deposits, net profits interests
and overriding royalty interests are included in other fee income. During the three and six months ended December 31, 2017,
there was no structuring fee income. During the three and six months ended December 31, 2016, there was no structuring fee
income.
Investment transactions are accounted for on
a trade-date basis. Realized gains or losses on investments are determined by calculating the difference between the net proceeds
from the disposition and the amortized cost basis of the investments, without regard to unrealized gains or losses previously recognized.
Realized gains or losses on the sale of investments are calculated using the specific identification method. The Company reports
changes in fair value of investments as a component of the net change in unrealized appreciation (depreciation) on investments
in the Unaudited Consolidated Statements of Operations.
Management reviews all loans that become 90
days or more past due on principal or interest or when there is reasonable doubt that principal or interest will be collected for
possible placement on non-accrual status. Accrued interest is generally reversed when a loan is placed on non-accrual status. Interest
payments received on non-accrual loans may be recognized as income or applied to principal depending upon management’s judgment
regarding collectability. Non-accrual loans are restored to accrual status when past due principal and interest is paid and, in
management’s judgment, are likely to remain current, although management may make exceptions to this general rule if the
loan has sufficient collateral value and is in the process of collection.
The Company may hold debt investments in its
portfolio that contain a payment-in-kind (“PIK”) interest provision. PIK interest, which represents contractually deferred
interest added to the investment balance that is generally due at maturity, is recorded on an accrual basis to the extent that
such amounts are expected to be collected. PIK interest is not accrued if the Company does not expect the issuer to be able to
pay all principal and interest when due. The Company earned PIK interest of $722,039 and $1,014,517 during the three and six months
ended December 31, 2017, respectively. The Company earned no PIK interest during the three and six months ended December 31, 2016,
respectively.
The Company may hold equity investments in its
portfolio that contain a PIK dividend provision. PIK dividends, which represents contractual dividend
payments added to the investment balance, is recorded on an accrual basis to the extent that such amounts are expected to be collected.
The Company earned PIK dividends of $189,583 and $189,583 during the three and six months ended December 31, 2017, respectively.
The Company earned no PIK dividends during the three and six months ended December 31, 2016, respectively.
CM Finance Inc and subsidiaries
Notes to Consolidated Financial Statements
(unaudited)
December 31, 2017
Note 2. Significant Accounting Policies (Continued)
c. Paid In Capital
The Company records the proceeds from the sale
of its common stock to common stock and additional paid-in capital, after all commissions and marketing support fees.
d. Net Increase in Net Assets Resulting from Operations per Share
The net increase in net assets resulting
from operations per share is calculated based upon the weighted average number of shares of common stock outstanding during
the reporting period.
e. Distributions
Dividends and distributions to common stockholders
are recorded on the ex-dividend date. The amount to be paid out as a dividend or distribution is determined by the board of directors
each quarter and is generally based upon the earnings estimated by management. Net realized capital gains, if any, are generally
distributed annually, although the Company may decide to retain such capital gains for investment.
The Company has adopted a dividend
reinvestment plan that provides for reinvestment of any distributions the Company pays in cash on behalf of the
Company’s stockholders, unless a shareholder elects to receive cash. As a result, if the Company’s board of
directors declares, and the Company pays, a cash distribution, then the Company’s stockholders who have not
“opted out” of the Company’s dividend reinvestment plan will have their cash distributions automatically
reinvested in additional shares of the Company’s common stock, rather than receiving the cash distribution.
f. Cash and Restricted Cash
Cash and restricted cash represent cash held
in money market accounts. The Company deposits its cash in financial institutions and, at times, such balance may be in excess
of the Federal Deposit Insurance Corporation insurance limits. All of the Company’s cash deposits are held at large established
high credit quality financial institutions and management believes that the risk of loss associated with any uninsured balances
is remote. Amounts included in restricted cash have restrictions on the uses of the cash held by SPV and LLC based on the terms
of the Notes Payable. For more information on the Notes Payable, see Note 5.
g. Deferred Offering Costs
Deferred offering costs consist of fees
and expenses incurred in connection with the offer and sale of the Company’s common stock and bonds, including legal,
accounting, printing fees, and other related expenses, as well as costs incurred in connection with the filing of a shelf
registration statement. Offering costs are charged to paid-in-capital upon the sale of the shares in an offering. Offering
costs that have not yet been charged to paid-in capital are written off when it is no longer probable that the shares to
which the offering costs relate will be issued in the future.
h. Investment Transactions and Expenses
Purchases of loans, including revolving credit
agreements, are recorded on a fully committed basis until the funded and unfunded portions are known or estimable, which in many
cases may not be until settlement.
Expenses are accrued as incurred.
Deferred debt issuance costs, incurred in connection
with the Company’s Notes Payable, are amortized using the straight line method over the life of the notes.
Offering costs were charged to paid-in capital
upon the sale of shares in the Offering.
i. Investment Valuation
The Company applies fair value accounting to
all of its financial instruments in accordance with the 1940 Act and ASC Topic 820 – Fair Value Measurements and Disclosures
(“ASC 820”). ASC 820 defines fair value, establishes a framework used to measure fair value and requires disclosures
for fair value measurements. In accordance with ASC 820, the Company has categorized its investments and financial instruments
carried at fair value, based on the priority of the valuation technique, into a three-level fair value hierarchy as discussed in
Note 4. Fair value is a market-based measure considered from the perspective of the market participant who holds the financial
instrument rather than an entity specific measure. Therefore, when market assumptions are not readily available, the Company’s
own assumptions are set to reflect those that management believes market participants would use in pricing the financial instrument
at the measurement date.
CM Finance Inc and subsidiaries
Notes to Consolidated Financial Statements
(unaudited)
December 31, 2017
Note 2. Significant Accounting Policies (Continued)
Fair value is defined as the price that would
be received upon a sale of an asset in an orderly transaction between market participants at the measurement date. Market participants
are buyers and sellers in the principal (or most advantageous) market for the asset that (a) are independent of us, (b) are knowledgeable,
having a reasonable understanding about the asset based on all available information (including information that might be obtained
through due diligence efforts that are usual and customary), (c) are able to transact for the asset, and (d) are willing to transact
for the asset or liability (that is, they are motivated but not forced or otherwise compelled to do so).
Securities that are traded on securities exchanges
(including such securities traded in the afterhour’s market) are valued on the basis of the closing price on the valuation
date (if such prices are available). Securities that are traded on more than one securities exchange are valued at the closing
price on the primary securities exchange on which such securities are traded on the valuation date (or if reported on the consolidated
tape, then their last sales price on the consolidated tape). Listed options for which the last sales price falls between the last
“bid” and “ask” prices for such options are valued at their last sales price on the date of the valuation
on the primary securities exchange on which such options are traded. Options for which the last sales price on the valuation date
does not fall between the last “bid” and “ask” prices are valued at the average of the last “bid”
and “ask” prices for such options on that date. To the extent these securities are actively traded, and valuation adjustments
are not applied, they are categorized in Level 1 of the fair value hierarchy. The Company did not hold any Level 1 investments
as of December 31, 2017 or June 30, 2017.
Investments that are not traded on securities
exchanges but are traded on the over-the-counter (“OTC”) markets (such as term loans, notes and warrants) are valued
using various techniques, which may consider recently executed transactions in securities of the issuer or comparable issuers,
market price quotations (when observable) and fundamental data relating to the issuer. These investments are categorized in Level
2 of the fair value hierarchy, or in instances when lower relative weight is placed on transaction prices, quotations, or similar
observable inputs, they are categorized in Level 3.
The embedded derivative in the Term Notes
and the 2017 Revolving Notes (as defined in Note 5) payable from SPV to UBS AG, London Branch (together with its affiliates
“UBS”) and total return swaps referencing the terms of the Term Notes payable and the total return of the 2017
Revolving Notes (as defined in Note 5) referencing the 2017 Revolving Notes (together, the “TRS”) are valued
based on the change in fair value and the underlying accrued interest of the portfolio of assets held in SPV less the accrued
interest payable on the financing due to the TRS counterparty, UBS. Consideration has been given to counterparty risk. The
Company has assessed the unsecured risk of the counterparty, UBS, in the form of credit ratings and the trading levels of
that risk and has determined that the counterparty risk is minimal. The Company also notes that counterparty risk is further
mitigated by the monthly settlement of both the interest portion of the embedded derivative referencing the Term Notes and
the 2017 Revolving Notes payable and the TRS. If the Company were to determine that counterparty risk were material,
an adjustment to the fair value of the TRS would be made. The embedded derivative in the Term Notes and the 2017 Revolving
Notes payable and the TRS have been categorized in Level 3 of the fair value hierarchy. See Note 4 and Note 5 for more
detail.
Investments for which market quotations are
not readily available or may be considered unreliable are fair valued, in good faith, using a method determined to be appropriate
in the given circumstances. The valuation methods used include the Cost Approach, the Market Approach and the Income Approach.
Inputs used in these approaches may include, but are not limited to, interest rate yield curves, credit spreads, recovery rates,
comparable company transactions, trading multiples, and volatilities. The valuation method of the Company may change as changes
in the underlying company dictates, such as moving from the Cost Approach to Market Approach when underlying conditions change
at the company. Because of the inherent uncertainty of valuation in these circumstances, the fair values for the aforementioned
investments may differ significantly from values that would have been used had a ready and liquid market for such investments existed
or from the amounts that might ultimately be realized, and such differences could be material.
The Company’s valuation policies and procedures
are developed by the Adviser, which is also responsible for ensuring that the valuation policies and procedures are consistently
applied across all investments of the Company, and approved by the Company’s board of directors. The valuations are continuously
monitored and the valuation process for Level 3 investments is completed on a quarterly basis and is designed to subject the valuation
of Level 3 investments to an appropriate level of consistency, oversight and review. The valuation process begins with each portfolio
company or investment being initially valued by the investment professionals of the Adviser responsible for the portfolio investment.
These investment professionals prepare the preliminary valuations based on their evaluation of financial and operating data, company
specific developments, market valuations of comparable securities from the same company or that of comparable companies as well
as any other relevant factors including recent purchases and sales that may have occurred preceding month-end.
CM Finance Inc and subsidiaries
Notes to Consolidated Financial Statements
(unaudited)
December 31, 2017
Note 2. Significant Accounting Policies (Continued)
Valuation models are typically calibrated upon
initial funding, and are re-calibrated as necessary upon subsequent material events (including, but not limited to additional financing
activity, changes in comparable companies, and recent trades). The preliminary valuation conclusions are then documented and discussed
with senior management of the Adviser. On a periodic basis and at least once annually, independent valuation firm(s) engaged by
the Company conduct independent appraisals and review the Adviser’s preliminary valuations and make their own independent
assessment. The Valuation Committee of the Company’s board of directors then reviews the preliminary valuations of the Adviser
and that of the independent valuation firms. The Valuation Committee discusses the valuations and makes a recommendation to the
Company’s board of directors regarding the fair value of each investment in good faith based on the input of the Adviser
and the independent valuation firms. Upon recommendation by the Valuation Committee and a review of the valuation materials of
the Adviser and the third party independent valuation firms, the board of directors of the Company determines, in good faith, the
fair value of each investment.
For more information on the classification of
the Company’s investments by major categories, see Note 4.
The fair value of the Company’s assets
and liabilities that qualify as financial instruments under U.S. GAAP approximates the carrying amounts presented in the Unaudited
Consolidated Statements of Assets and Liabilities.
j. Income Taxes
The Company has elected to be treated, for U.S.
federal income tax purposes, as a RIC under Subchapter M of the Code. To qualify and maintain qualification as a RIC, the Company
must, among other things, meet certain source of income and asset diversification requirements and distribute to stockholders,
for each taxable year, at least 90% of the Company’s “investment company taxable income,’’ which is generally
the Company’s net ordinary income plus the excess, if any, of realized net short-term capital gains over realized net long-term
capital losses. If the Company continues to qualify as a RIC and continues to satisfy the annual distribution requirement, the
Company will not have to pay corporate level federal income taxes on any income that the Company distributes to its stockholders.
The Company intends to make distributions in an amount sufficient to maintain its RIC status each year and to avoid paying any
federal income taxes on income. The Company will also be subject to nondeductible federal excise taxes if the Company does not
distribute to its stockholders at least 98% of net ordinary income, 98.2% of capital gains, if any, and any recognized and undistributed
income from prior years for which it paid no federal income taxes.
Book and tax basis differences that are permanent
differences are reclassified among the Company’s capital accounts, as appropriate at year-end. Additionally, the tax character
of distributions is determined in accordance with the Code, which differs from U.S. GAAP. During the three and six months ended
December 31, 2017, the Company recorded distributions of $3.4 million and $6.8 million, respectively. During the three and six
months ended December 31, 2016, the Company recorded distributions of $4.8 million and $9.6 million, respectively. The tax character
of a portion of these distributions may be return of capital.
U.S. GAAP 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. Tax positions not deemed to meet a more-likely-than-not
threshold would be recorded as a tax expense in the current year. The Company’s policy is to recognize accrued interest and
penalties associated with uncertain tax positions as part of the tax provision.
The Company has analyzed such tax positions
and has concluded that no unrecognized tax benefits should be recorded for uncertain tax positions for any tax year since inception.
Each of the tax years since inception remains subject to examination by taxing authorities. This conclusion may be subject to review
and adjustment at a later date based on factors, including but not limited to, ongoing analysis and changes to laws, regulations,
and interpretations thereof.
Permanent differences between investment company
taxable income and net investment income for financial reporting purposes are reclassified among capital accounts in the financial
statements to reflect their tax character. Differences in classification may also result from the treatment of short-term gains
as ordinary income for tax purposes. During the year ended June 30, 2017, the Company reclassified for book purposes amounts arising
from permanent book/tax differences related to the different tax treatment of paydown gains and losses, and income/(loss) from
wholly owned subsidiaries as follows:
|
|
|
As of
June 30, 2017
|
|
Additional paid-in capital
|
|
$
|
(742,700
|
)
|
Distributions in excess of net investment income
|
|
|
165,192
|
|
Accumulated net realized gain (loss)
|
|
|
577,508
|
|
The tax character of all distributions paid
by the Company during the year ended June 30, 2017 was ordinary income.
At June 30, 2017, the components of distributable
earnings on a tax basis detailed below differ from the amounts reflected in the Company’s Consolidated Statement of Assets
and Liabilities by temporary and other book/tax differences, primarily relating to the tax treatment of dividends payable and non-deductible
incentive fee income unvested, as follows:
|
|
As of
June 30, 2017
|
|
Undistributed net investment income
|
|
$
|
1,314,066
|
|
Accumulated capital gains (losses)
|
|
|
—
|
|
Capital loss carryover
|
|
|
(11,231,827
|
)
|
Unrealized appreciation (depreciation)
|
|
|
(17,062,588
|
)
|
Distributions payable
|
|
|
(3,422,307
|
)
|
Components of tax distributable earnings at year end
|
|
$
|
(30,402,656
|
)
|
In addition, as of June 30, 2017, the LLC recorded a deferred tax asset and a corresponding valuation allowance of approximately $557,059.
CM Finance Inc and subsidiaries
Notes to Consolidated Financial Statements
(unaudited)
December 31, 2017
Note 2. Significant Accounting Policies (Continued)
k. Capital Gains Incentive Fee
Under U.S. GAAP, the Company calculates the
capital gains incentive fee payable to the Adviser as if the Company had realized all investments at their fair values as of the
reporting date. Accordingly, the Company accrues a provisional capital gains incentive fee taking into account any unrealized gains
or losses. As the provisional capital gains incentive fee is subject to the performance of investments until there is a realization
event, the amount of provisional capital gains incentive fee accrued at a reporting date may vary from the incentive fee that is
ultimately realized and the differences could be material.
The cost basis used to compute gains and losses
for the purpose of determining incentive fees is the fair value of the Company’s investments on February 5, 2014, at the
time the Company priced the Offering.
As of December 31, 2017 and June 30, 2017, there
was no capital gains incentive fee payable to the Adviser under the Advisory Agreement.
Note 3. New Accounting Pronouncements
From time to time, new accounting pronouncements
are issued by the FASB or other standards setting bodies that are adopted by the Company as of the specified effective date. The
Company believes that the impact of recently issued standards that are not yet effective will not have a material impact on its
financial statements upon adoption.
In August 2016, the FASB issued Accounting Standards
Update (“ASU”) 2016-15, Statement of Cash Flows (Topic 230),
Classification of Certain Cash Receipts and Cash Payments
(“ASU 2016-15”), which is intended to reduce the existing diversity in practice in how certain cash receipts and cash
payments are presented and classified in the statement of cash flows. The guidance is effective for annual periods beginning after
December 15, 2017, and interim periods therein. Early adoption is permitted. Management is currently evaluating the impact ASU
2016-15 will have on the Company’s consolidated financial statements and disclosures.
In May 2014, the FASB issued ASU 2014-09,
Revenue
from Contracts with Customers
(Topic 606), which supersedes the revenue recognition requirements in Revenue Recognition (Topic
605). In 2016, the FASB issued additional guidance which clarified, amended, and technically corrected prior guidance. Under the
new guidance, an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount
that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In May 2016,
ASU 2016-12 amended ASU 2014-09 and deferred the effective period to annual periods beginning after December 15, 2017, and interim
periods therein. Early adoption is permitted. Management is currently evaluating the impact these changes will have on the Company’s
consolidated financial statements and disclosures.
Note 4. Investments
The Company’s investments, at any time,
may include securities and other financial instruments, including, without limitation, corporate and government bonds, convertible
securities, collateralized loan obligations, term loans, trade claims, equity securities, privately negotiated securities, direct
placements, working interests, warrants and investment derivatives (such as credit default swaps, recovery swaps, total return
swaps, options, forward contracts, and futures) (all of the foregoing collectively referred to in these financial statements as
“investments”).
a. Certain Risk Factors
In the ordinary course of business, the Company
manages a variety of risks including market risk, liquidity risk and credit risk. The Company identifies, measures and monitors
risk through various control mechanisms, including trading limits and diversifying exposures and activities across a variety of
instruments, markets and counterparties.
Market risk is the risk of potential adverse
changes to the value of financial instruments because of changes in market conditions, including as a result of changes in the
credit quality of a particular issuer, credit spreads, interest rates, and other movements and volatility in security prices or
commodities. In particular, the Company may invest in issuers that are experiencing or have experienced financial or business difficulties
(including difficulties resulting from the initiation or prospect of significant litigation or bankruptcy proceedings), which involves
significant risks. The Company manages its exposure to market risk through the use of risk management strategies and various analytical
monitoring techniques.
The Company’s assets may, at any time,
include securities and other financial instruments or obligations that are illiquid or thinly traded, making purchase or sale of
such securities and financial instruments at desired prices or in desired quantities difficult. Furthermore, the sale of any such
investments may be possible only at substantial discounts, and it may be extremely difficult to value any such investments accurately.
Credit risk is the potential loss the Company
may incur from a failure of an issuer to make payments according to the terms of a contract. The Company is subject to credit risk
because of its strategy of investing in the debt of leveraged companies and its involvement in derivative instruments. The Company’s
exposure to credit risk on its investments is limited to the fair value of the investments. The Company’s TRS contracts are
executed pursuant to an International Swaps and Derivatives Association (“ISDA”) master agreement (the “ISDA
Agreement”) that the Company currently has in place with UBS. At December 31, 2017 and June 30, 2017, the Company had all
of its counterparty credit risk associated with non-performance for swaps with UBS. With regard to derivatives, the Company attempts
to limit its credit risk by considering its counterparty’s (or its guarantor’s) credit rating. The Company’s
policy is to not hold counterparty collateral on ISDA Agreements, but would do so if the exposure were material.
b. Investments
Investment purchases, sales and principal payments/paydowns
are summarized below for the three and six months ended December 31, 2017 and December 31, 2016, respectively. These purchase and
sale amounts exclude derivative instruments.
|
|
Three Months Ended December 31,
|
|
|
Six Months Ended December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Investment purchases, at cost (including PIK interest)
|
|
$
|
35,996,034
|
|
|
$
|
24,702,624
|
|
|
$
|
83,054,878
|
|
|
$
|
48,982,799
|
|
Investment sales and repayments
|
|
|
23,997,051
|
|
|
|
47,904,900
|
|
|
|
54,842,377
|
|
|
|
81,125,266
|
|
CM Finance Inc and subsidiaries
Notes to Consolidated Financial Statements
(unaudited)
December 31, 2017
Note 4. Investments (Continued)
The composition of the Company’s investments
as of December 31, 2017, as a percentage of the total portfolio, at amortized cost and fair value, are as follows:
|
|
Investment at
Amortized Cost
|
|
|
Percentage
|
|
|
Investments at
Fair Value
|
|
|
Percentage
|
|
Senior Secured First Lien Debt Investments
|
|
$
|
140,270,686
|
|
|
|
47.76
|
%
|
|
$
|
143,581,917
|
|
|
|
50.11
|
%
|
Senior Secured Second Lien Debt Investment
|
|
|
142,394,747
|
|
|
|
48.49
|
|
|
|
128,582,008
|
|
|
|
44.87
|
|
Unsecured Debt Investments
|
|
|
—
|
|
|
|
—
|
|
|
|
823,695
|
|
|
|
0.29
|
|
Equity, Warrants and Other Investments
|
|
|
11,005,015
|
|
|
|
3.75
|
|
|
|
13,543,548
|
|
|
|
4.73
|
|
Embedded derivative— Notes Payable
|
|
|
—
|
|
|
|
—
|
|
|
|
615,887
|
|
|
|
0.21
|
|
Total Return Swap
|
|
|
—
|
|
|
|
—
|
|
|
|
(615,887
|
)
|
|
|
(0.21
|
)
|
Total
|
|
$
|
293,670,448
|
|
|
|
100.00
|
%
|
|
$
|
286,531,168
|
|
|
|
100.00
|
%
|
The composition of the Company’s investments
as of June 30, 2017, as a percentage of the total portfolio, at amortized cost and fair value, are as follows:
|
|
Investment at
Amortized Cost
|
|
|
Percentage
|
|
|
Investments at
Fair Value
|
|
|
Percentage
|
|
Senior Secured First Lien Debt Investments
|
|
$
|
123,501,005
|
|
|
|
45.66
|
%
|
|
$
|
127,103,981
|
|
|
|
49.86
|
%
|
Senior Secured Second Lien Debt Investments
|
|
|
144,211,470
|
|
|
|
53.32
|
|
|
|
126,593,792
|
|
|
|
49.66
|
|
Equity, Warrants and Other Investments
|
|
|
2,755,265
|
|
|
|
1.02
|
|
|
|
1,209,398
|
|
|
|
0.48
|
|
Embedded derivative - Notes Payable
|
|
|
—
|
|
|
|
—
|
|
|
|
5,830,501
|
|
|
|
2.29
|
|
Total Return Swap
|
|
|
—
|
|
|
|
—
|
|
|
|
(5,830,501
|
)
|
|
|
(2.29
|
)
|
Total
|
|
$
|
270,467,740
|
|
|
|
100.00
|
%
|
|
$
|
254,907,171
|
|
|
|
100.00
|
%
|
The following table shows the portfolio composition
by industry grouping at fair value at December 31, 2017:
|
|
Investments at
Fair Value
|
|
|
Percentage of
Total Portfolio
|
|
Business Services
|
|
$
|
67,382,865
|
|
|
|
23.52
|
%
|
Entertainment and Leisure
|
|
|
40,736,304
|
|
|
|
14.22
|
|
Oilfield Services
|
|
|
32,356,421
|
|
|
|
11.29
|
|
Oil and Gas
|
|
|
22,880,001
|
|
|
|
7.99
|
|
Healthcare-Products/Services
|
|
|
22,817,063
|
|
|
|
7.96
|
|
Environmental Services
|
|
|
19,600,000
|
|
|
|
6.84
|
|
Media
|
|
|
19,000,000
|
|
|
|
6.63
|
|
Telecommunications
|
|
|
16,866,650
|
|
|
|
5.89
|
|
Metals and Mining
|
|
|
10,241,140
|
|
|
|
3.57
|
|
Trucking and Leasing
|
|
|
9,490,724
|
|
|
|
3.31
|
|
Construction & Building
|
|
|
8,712,000
|
|
|
|
3.04
|
|
Utilities
|
|
|
8,500,000
|
|
|
|
2.97
|
|
Chemicals
|
|
|
7,948,000
|
|
|
|
2.77
|
|
Total
|
|
$
|
286,531,168
|
|
|
|
100.00
|
%
|
CM Finance Inc and subsidiaries
Notes to Consolidated Financial Statements
(unaudited)
December 31, 2017
Note 4. Investments (Continued)
The following table shows the portfolio composition by industry
grouping at fair value at June 30, 2017:
|
|
Investments at
Fair Value
|
|
|
|
Percentage of
Total Portfolio
|
|
Business Services
|
|
$
|
42,602,231
|
|
|
|
16.71
|
%
|
Entertainment and Leisure
|
|
|
38,187,821
|
|
|
|
14.98
|
|
Telecommunications
|
|
|
30,593,524
|
|
|
|
12.00
|
|
Healthcare-Products/Services
|
|
|
28,470,063
|
|
|
|
11.17
|
|
Trucking and Leasing
|
|
|
23,001,112
|
|
|
|
9.02
|
|
Oil and Gas
|
|
|
22,100,080
|
|
|
|
8.67
|
|
Oilfield Services
|
|
|
17,594,035
|
|
|
|
6.90
|
|
Media
|
|
|
15,400,000
|
|
|
|
6.04
|
|
Metals and Mining
|
|
|
11,057,055
|
|
|
|
4.34
|
|
Construction & Building
|
|
|
9,950,000
|
|
|
|
3.91
|
|
Utilities
|
|
|
7,518,750
|
|
|
|
2.95
|
|
Retail
|
|
|
7,437,500
|
|
|
|
2.92
|
|
Consumer Products
|
|
|
995,000
|
|
|
|
0.39
|
|
Total
|
|
$
|
254,907,171
|
|
|
|
100.00
|
%
|
The following table shows the portfolio composition by geographic
grouping at fair value at December 31, 2017:
|
|
Fair Value
|
|
|
Percentage of Total Investments
|
|
U.S. West
|
|
$
|
77,770,541
|
|
|
|
27.14
|
%
|
U.S. Southeast
|
|
|
57,658,265
|
|
|
|
20.12
|
|
U.S. Northeast
|
|
|
50,333,961
|
|
|
|
17.57
|
|
U.S. Southwest
|
|
|
39,396,588
|
|
|
|
13.75
|
|
U.S. Midwest
|
|
|
30,997,250
|
|
|
|
10.82
|
|
Europe
|
|
|
19,000,000
|
|
|
|
6.63
|
|
U.S. Mid-Atlantic
|
|
|
11,374,563
|
|
|
|
3.97
|
|
Total
|
|
$
|
286,531,168
|
|
|
|
100.00
|
%
|
The following table shows the portfolio composition by geographic
grouping at fair value at June 30, 2017:
|
|
|
|
Fair Value
|
|
|
Percentage Total Portfolio
|
|
U.S. West
|
|
$
|
56,376,504
|
|
|
|
22.12
|
%
|
U.S. Southeast
|
|
|
48,867,831
|
|
|
|
19.17
|
|
U.S. Northeast
|
|
|
44,044,876
|
|
|
|
17.28
|
|
U.S. Southwest
|
|
|
32,844,487
|
|
|
|
12.88
|
|
U.S. Mid-Atlantic
|
|
|
32,157,987
|
|
|
|
12.62
|
|
U.S. Midwest
|
|
|
25,215,486
|
|
|
|
9.89
|
|
Europe
|
|
|
15,400,000
|
|
|
|
6.04
|
|
Total
|
|
$
|
254,907,171
|
|
|
|
100.00
|
%
|
CM Finance Inc and subsidiaries
Notes to Consolidated Financial Statements
(unaudited)
December 31, 2017
Note 4. Investments (Continued)
The Company’s primary investment objective
is to maximize total return to stockholders in the form of current income and capital appreciation by investing directly in debt
and related equity of privately held middle-market companies to help these companies fund organic growth, acquisitions, market
product expansion, refinancings and/or recapitalizations. During the six months ended December 31, 2017, the Company made investments
in five new portfolio companies of approximately $62.7 million to which it was not previously contractually committed to provide
financial support. During the six months ended December 31, 2017, the Company did not make investments in companies to which it
was previously committed to provide financial support. The details of the Company’s investments have been disclosed on the
Unaudited Consolidated Schedule of Investments.
c. Derivatives
Derivative contracts include total return
swaps and embedded derivatives in Notes Payable. The Company may enter into derivative contracts as part of its investment
strategies.
In connection with the TRS transactions, the
Company entered into an ISDA Agreement with UBS. The ISDA Agreement includes provisions for general obligations, representations,
collateral and events of default or termination. Under an ISDA Agreement, the Company typically may offset with the counterparty
certain derivative payable and/or receivable with collateral held and/or posted and create one single net payment (close-out netting)
in the event of default or termination.
The Company’s ISDA Agreement may contain
provisions for early termination of OTC derivative transactions in the event the net assets of the Company decline below specific
levels (“net asset contingent features”). If these levels are triggered, the Company’s counterparty has the right
to terminate such transaction and require the Company to pay or receive a settlement amount in connection with the terminated transaction.
The Company has determined that the Term Notes
payable from SPV to UBS related to the Term Financing (discussed further in Note 5) contains an embedded derivative. SPV is obligated
to pay UBS the net appreciation (depreciation) of the SPV Assets, as defined below, as well as pay any income generated by the
SPV Assets until maturity. Therefore, amounts required for the future satisfaction of the note may be greater or less than the
amount recorded. Realized and change in unrealized gains and losses on the embedded derivative is included in the net realized
gain or loss on derivatives, and net change in unrealized appreciation (depreciation) on derivative in the Unaudited Consolidated
Statements of Operations.
The following table reflects the fair value
and notional amount or number of contracts of the Company’s derivative contracts, none of which were designated as hedging
instruments under U.S. GAAP, which are presented on a gross basis, at December 31, 2017.
|
|
Assets
|
|
|
Liabilities
|
|
Notional
|
|
|
Contracts
|
|
Credit Risk:
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Return Swaps
|
|
$
|
—
|
|
|
$
|
615,887
|
|
|
$
|
152,000,000
|
|
|
|
2
|
|
Embedded derivatives:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notes Payable
|
|
|
615,887
|
|
|
|
—
|
|
|
|
152,000,000
|
|
|
|
2
|
|
Gross fair value of derivative contracts
|
|
$
|
615,887
|
|
|
$
|
615,887
|
|
|
|
|
|
|
|
|
|
Counterparty netting
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Net fair value of derivative contracts
|
|
$
|
615,887
|
|
|
$
|
615,887
|
|
|
|
|
|
|
|
|
|
Collateral not offset
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Net amount
|
|
$
|
615,887
|
|
|
$
|
615,887
|
|
|
|
|
|
|
|
|
|
CM Finance Inc and subsidiaries
Notes to Consolidated Financial Statements
(unaudited)
December 31, 2017
Note 4. Investments (Continued)
The following table reflects the fair value
and notional amount or number of contracts of the Company’s derivative contracts, none of which were designated as hedging
instruments under U.S. GAAP, which are presented on a gross basis, at June 30, 2017.
|
|
Assets
|
|
|
Liabilities
|
|
|
Notional
|
|
|
Contracts
|
|
Credit Risk:
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Return Swaps
|
|
$
|
—
|
|
|
$
|
5,830,501
|
|
|
$
|
102,000,000
|
|
|
|
1
|
|
Embedded derivatives:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notes Payable
|
|
|
5,830,501
|
|
|
|
—
|
|
|
|
102,000,000
|
|
|
|
1
|
|
Gross fair value of derivative contracts
|
|
$
|
5,830,501
|
|
|
$
|
5,830,501
|
|
|
|
|
|
|
|
|
|
Counterparty netting
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Net fair value of derivative contracts
|
|
$
|
5,830,501
|
|
|
$
|
5,830,501
|
|
|
|
|
|
|
|
|
|
Collateral not offset
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Net amount
|
|
$
|
5,830,501
|
|
|
$
|
5,830,501
|
|
|
|
|
|
|
|
|
|
The following table reflects the amount of
gains (losses) on derivatives included in the Unaudited Consolidated Statements of Operations for the three and six months ended
December 31, 2017 and December 31, 2016, respectively. None of the derivatives were designated as hedging instruments under U.S.
GAAP.
|
|
Included in net change in unrealized appreciation (depreciation) on
investments and derivatives
|
|
|
|
Three Months Ended December 31,
|
|
|
Six Months Ended December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Investment purchases, at cost (including PIK interest)
|
|
$
|
5,934,561
|
|
|
$
|
2,375,799
|
|
|
$
|
5,214,614
|
|
|
$
|
2,588,326
|
|
Investment sales and repayments
|
|
|
(5,934,561
|
)
|
|
|
(2,375,799
|
)
|
|
|
(5,214,614
|
)
|
|
|
2,588,326
|
|
Total
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
d. Fair Value Measurements
ASC 820 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. ASC 820 also establishes a framework for measuring fair value and a valuation hierarchy that prioritizes the
inputs used in the valuation of an asset or liability based upon their transparency. The valuation hierarchy gives the highest
priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to
unobservable inputs (Level 3). Classification within the hierarchy is based upon the lowest level of input that is significant
to the fair value measurement. The Company’s assets and liabilities measured at fair value have been classified in the following
three categories:
Level 1 – valuation is based on unadjusted quoted prices in
active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.
Level 2 – valuation is based on inputs other than quoted prices
included within Level 1 that are observable for the asset or liability, either directly or indirectly, such as (a) quoted prices
for similar assets or liabilities in active markets; (b) quoted prices for identical or similar assets or liabilities in markets
that are not active, that is, markets in which there are few transactions for the asset or liability, the prices are not current,
or price quotations vary substantially either over time or among market makers, or in which little information is released publicly;
(c) inputs other than quoted prices that are observable for the asset or liability; or (d) inputs that are derived principally
from or corroborated by observable market data by correlation or other means.
Level 3 – valuation is based on unobservable inputs for the
asset or liability. Unobservable inputs are used to measure fair value to the extent that observable inputs are not available,
thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement
date. However, the fair value measurement objective remains the same, that is, an exit price from the perspective of a market participant
that holds the asset or owes the liability. Therefore, unobservable inputs reflect the Company’s own assumptions about the
assumptions that market participants would use in pricing the asset or liability, including assumptions about risk. Unobservable
inputs are developed based on the best information available under the circumstances, which might include the Company’s own
data. The Company’s own data used to develop unobservable inputs is adjusted if information is reasonably available without
undue cost and effort that indicates that market participants would use different assumptions.
The availability of observable inputs can vary
from security to security and is affected by a wide variety of factors, including, for example, the type of security, whether the
security is new and not yet established in the marketplace, the liquidity of the market and other characteristics particular to
the security. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market,
the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised in determining fair value
is greatest for instruments categorized in Level 3.
CM Finance Inc and subsidiaries
Notes to Consolidated Financial Statements
(unaudited)
December 31, 2017
Note 4. Investments (Continued)
Estimates of fair value for cash and restricted
cash are measured using observable, quoted market prices, or Level 1 inputs. All other fair value significant estimates are measured
using unobservable inputs, or Level 3 inputs.
The following table summarizes the classifications
within the fair value hierarchy of the Company’s assets and liabilities measured at fair value as of December 31, 2017:
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investments
|
|
|
|
|
|
|
|
|
|
|
|
|
Senior Secured First Lien Debt Investments
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
143,581,917
|
|
|
$
|
143,581,917
|
|
Senior Secured Second Lien Debt Investments
|
|
|
—
|
|
|
|
—
|
|
|
|
128,582,008
|
|
|
|
128,582,008
|
|
Unsecured Debt Investment
|
|
|
—
|
|
|
|
—
|
|
|
|
823,695
|
|
|
|
823,695
|
|
Equity, Warrants and Other Investments
|
|
|
—
|
|
|
|
—
|
|
|
|
13,543,548
|
|
|
|
13,543,548
|
|
Total Investments
|
|
|
—
|
|
|
|
—
|
|
|
|
286,531,168
|
|
|
|
286,531,168
|
|
Derivatives
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Embedded Derivative Notes Payable
|
|
|
—
|
|
|
|
—
|
|
|
|
615,887
|
|
|
|
615,887
|
|
Total Derivatives
|
|
|
—
|
|
|
|
—
|
|
|
|
615,887
|
|
|
|
615,887
|
|
Total Assets
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
287,147,055
|
|
|
$
|
287,147,055
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivatives
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Return Swaps
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
615,887
|
|
|
$
|
615,887
|
|
Total Derivatives
|
|
|
—
|
|
|
|
—
|
|
|
|
615,887
|
|
|
|
615,887
|
|
Total Liabilities
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
615,887
|
|
|
$
|
615,887
|
|
The following table summarizes the classifications
within the fair value hierarchy of the Company’s assets and liabilities measured at fair value as of June 30, 2017:
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Total
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
Investments
|
|
|
|
|
|
|
|
|
|
|
|
|
Senior Secured First Lien Debt Investments
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
127,103,981
|
|
|
$
|
127,103,981
|
|
Senior Secured Second Lien Debt Investments
|
|
|
—
|
|
|
|
—
|
|
|
|
126,593,792
|
|
|
|
126,593,792
|
|
Equity, Warrants and Other Investments
|
|
|
—
|
|
|
|
—
|
|
|
|
1,209,398
|
|
|
|
1,209,398
|
|
Total Investments
|
|
|
—
|
|
|
|
—
|
|
|
|
254,907,171
|
|
|
|
254,907,171
|
|
Derivatives
|
|
Embedded derivative Notes Payable
|
|
|
—
|
|
|
|
—
|
|
|
|
5,830,501
|
|
|
|
5,830,501
|
|
Total Derivatives
|
|
|
—
|
|
|
|
—
|
|
|
|
5,830,501
|
|
|
|
5,830,501
|
|
Total Assets
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
260,737,672
|
|
|
$
|
260,737,672
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivatives
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Return Swaps
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
5,830,501
|
|
|
$
|
5,830,501
|
|
Total Derivatives
|
|
|
—
|
|
|
|
—
|
|
|
|
5,830,501
|
|
|
|
5,830,501
|
|
Total Liabilities
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
5,830,501
|
|
|
$
|
5,830,501
|
|
CM Finance Inc and subsidiaries
Notes to Consolidated Financial Statements
(unaudited)
December 31, 2017
Note 4. Investments (Continued)
The following table provides a reconciliation
of the beginning and ending balances for investments that use Level 3 inputs for the six months ended December 31, 2017:
|
|
Senior Secured
First Lien
Debt Investments
|
|
|
Senior Secured
Second Lien
Debt Investments
|
|
|
Unsecured Debt Investment
|
|
|
Equity, Warrants
and Other
Investments
|
|
|
Total
Investments
|
|
Balance as of June 30, 2017
|
|
$
|
127,103,981
|
|
|
$
|
126,593,792
|
|
|
$
|
-
|
|
|
$
|
1,209,398
|
|
|
$
|
254,907,171
|
|
Purchases (including PIK interest)
|
|
|
55,071,877
|
|
|
|
27,460,000
|
|
|
|
-
|
|
|
|
523,000
|
|
|
|
83,054,877
|
|
Sales
|
|
|
(39,749,453
|
)
|
|
|
(15,092,924
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(54,842,377
|
)
|
Amortization
|
|
|
1,520,813
|
|
|
|
599,125
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2,119,938
|
|
Net realized gains (losses)
|
|
|
(69,579
|
)
|
|
|
(7,311,111
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(7,380,690
|
)
|
Transfers in
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
7,518,750
|
|
|
|
7,518,750
|
|
Transfers out
|
|
|
-
|
|
|
|
(7,518,750
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(7,518,750
|
)
|
Net change in unrealized (depreciation) appreciation
|
|
|
(295,722
|
)
|
|
|
3,851,876
|
|
|
|
823,695
|
|
|
|
4,292,400
|
|
|
|
8,672,249
|
|
Balance as of December 31, 2017
|
|
$
|
143,581,917
|
|
|
$
|
128,582,008
|
|
|
$
|
823,695
|
|
|
$
|
13,543,548
|
|
|
$
|
286,531,168
|
|
Change in unrealized gains (losses) relating to assets and liabilities still held as of December 31, 2017
|
|
$
|
(99,761
|
)
|
|
$
|
(8,230,453
|
)
|
|
$
|
823,695
|
|
|
$
|
4,292,399
|
|
|
$
|
(3,214,120
|
)
|
|
|
Total Return Swaps
|
|
|
Embedded derivatives-
Notes Payable
|
|
|
Total Derivatives
|
|
Balance as of June 30, 2017
|
|
$
|
(5,830,501
|
)
|
|
$
|
5,830,501
|
|
|
$
|
—
|
|
Net change in unrealized (depreciation) appreciation
|
|
|
5,214,614
|
|
|
|
(5,214,614
|
)
|
|
|
—
|
|
Balance as of December 31, 2017
|
|
$
|
(615,887
|
)
|
|
$
|
615,887
|
|
|
$
|
—
|
|
Change in unrealized gains (losses) relating to assets and liabilities still held as of December 31, 2017
|
|
$
|
5,214,614
|
|
|
$
|
5,214,614
|
|
|
$
|
—
|
|
The following table provides a reconciliation
of the beginning and ending balances for investments that use Level 3 inputs for the six months ended December 31, 2016:
|
|
Senior Secured
First Lien
Debt Investments
|
|
|
Senior Secured
Second Lien
Debt Investments
|
|
|
Equity, Warrants
and Other
Investments
|
|
|
Total
Investments
|
|
Balance as of June 30, 2016
|
|
$
|
157,088,252
|
|
|
$
|
114,871,040
|
|
|
$
|
154,872
|
|
|
$
|
272,114,164
|
|
Purchases (including PIK interest)
|
|
|
44,182,799
|
|
|
|
4,800,000
|
|
|
|
—
|
|
|
|
48,982,799
|
|
Sales
|
|
|
(62,970,243
|
)
|
|
|
(18,000,000
|
)
|
|
|
(155,023)
|
|
|
|
(81,125,266
|
)
|
Amortization
|
|
|
1,094,689
|
|
|
|
316,242
|
|
|
|
—
|
|
|
|
1,410,931
|
|
Net realized gains (losses)
|
|
|
(6,737,729
|
)
|
|
|
—
|
|
|
|
(1,251,058
|
)
|
|
|
(7,988,787
|
)
|
Transfers in
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Transfers out
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Net change in unrealized (depreciation) appreciation
|
|
|
7,798,232
|
|
|
|
2,955,584
|
|
|
|
1,251,211
|
|
|
|
12,005,027
|
|
Balance as of December 31, 2016
|
|
$
|
140,456,000
|
|
|
$
|
104,942,866
|
|
|
$
|
2
|
|
|
$
|
245,398,868
|
|
Change in unrealized gains (losses) relating to assets and liabilities still held as of December 31, 2016
|
|
$
|
813,392
|
|
|
$
|
2,944,421
|
|
|
$
|
1
|
|
|
$
|
3,757,814
|
|
CM Finance Inc and subsidiaries
Notes to Consolidated Financial Statements
(unaudited)
December 31, 2017
Note 4. Investments (Continued)
|
|
Total
Return
Swaps
|
|
|
Embedded
derivatives -
Notes
Payable
|
|
|
Total
Derivatives
|
|
Balance as of June 30, 2016
|
|
$
|
(9,071,659
|
)
|
|
$
|
9,071,659
|
|
|
$
|
—
|
|
Net change in unrealized (depreciation) appreciation
|
|
|
2,588,326
|
|
|
|
(2,588,326
|
)
|
|
|
—
|
|
Balance as of December 31, 2016
|
|
$
|
(6,483,333
|
)
|
|
$
|
6,483,333
|
|
|
$
|
—
|
|
Change in unrealized gains (losses) relating to assets and liabilities still held as of December 31, 2016
|
|
$
|
2,588,326
|
|
|
$
|
(2,588,326
|
)
|
|
$
|
—
|
|
Transfers into Level 3 during or at the end
of the reporting period are reported under Level 1 or Level 2 as of the beginning of the period. Transfers out of Level 3 during
or at the end of the reporting period are reported under Level 3 as of the beginning of the period. Changes in unrealized gains
(losses) relating to Level 3 instruments are included in net change in unrealized (depreciation) appreciation on investments and
derivatives on the Unaudited Consolidated Statements of Operations.
During the six months ended December 31, 2017
and December 31, 2016, the Company did not transfer any investments among Levels 1, 2 and 3.
The following tables present the ranges of significant
unobservable inputs used to value the Company’s Level 3 investments as of December 31, 2017 and June 30, 2017. These ranges
represent the significant unobservable inputs that were used in the valuation of each type of investment. These inputs are not
representative of the inputs that could have been used in the valuation of any one investment. For example, the highest market
yield presented in the table for senior secured notes is appropriate for valuing a specific investment but may not be appropriate
for valuing any other investment. Accordingly, the ranges of inputs presented below do not represent uncertainty in, or possible
ranges of, fair value measurements of the Company’s Level 3 investments.
|
|
Fair Value as of December 31, 2017
|
|
Valuation Methodology
|
Unobservable Input(s)
|
|
Weighted Average
|
|
Range
|
|
Senior Secured First Lien Debt Investments
|
|
$
|
130,349,097
|
|
Yield Analysis
|
Market Yields
|
|
|
9.3
|
%
|
|
5.2% - 18.2
|
%
|
Senior Secured First Lien Debt Investments
|
|
|
13,232,820
|
|
Broker Quoted
|
Market Comparable
|
|
|
101.5
|
%
|
|
101.3% - 101.8
|
%
|
Senior Secured Second Lien Debt Investments
|
|
|
120,722,008
|
|
Yield Analysis
|
Market Yields
|
|
|
15.1
|
%
|
|
9.5% - 49.1
|
%
|
Senior Secured Second Lien Debt Investments
|
|
|
7,860,000
|
|
Recent Purchase
|
Recent Purchase
|
|
|
N/A
|
|
|
N/A
|
|
Equity, Warrants and Other Investments
|
|
|
14,367,243
|
|
EV Multiple
|
EBITDA multiple
|
|
|
1.79
|
x
|
|
1.00x - 2.50
|
x
|
Total Return Swaps
|
|
|
(615,887
|
)
|
Intrinsic Value
|
Intrinsic Value
|
|
|
N/A
|
|
|
N/A
|
|
Embedded Derivatives - Notes Payable
|
|
|
615,887
|
|
Intrinsic Value
|
Intrinsic Value
|
|
|
N/A
|
|
|
N/A
|
|
|
|
Fair Value as of
June 30, 2017
|
|
Valuation
Methodology
|
Unobservable
Input(s)
|
|
Weighted
Average
|
|
Range
|
|
Senior Secured First Lien Debt Investments
|
|
$
|
83,516,160
|
|
Yield Analysis
|
Market Yields
|
|
|
9.7
|
%
|
|
5.2%-17.8
|
%
|
Senior Secured First Lien Debt Investments
|
|
|
43,587,821
|
|
Recent Purchase
|
Recent Purchase
|
|
|
N/A
|
|
|
N/A
|
|
Senior Secured Second Lien Debt Investments
|
|
|
108,536,737
|
|
Yield Analysis
|
Market Yields
|
|
|
14.6
|
%
|
|
7.4%-33.8
|
%
|
Senior Secured Second Lien Debt Investments
|
|
|
18,057,055
|
|
Recent Purchase
|
Recent Purchase
|
|
|
N/A
|
|
|
N/A
|
|
Equity, Warrants and Other Investments
|
|
|
1,209,398
|
|
EV Multiple
|
Revenue
|
|
|
2.0
|
x
|
|
2.0
|
x
|
Total Return Swaps
|
|
|
(5,830,501
|
)
|
Intrinsic Value
|
Intrinsic Value
|
|
|
N/A
|
|
|
N/A
|
|
Embedded derivatives—Note Payable
|
|
|
5,830,501
|
|
Intrinsic Value
|
Intrinsic Value
|
|
|
N/A
|
|
|
N/A
|
|
CM Finance Inc and subsidiaries
Notes to Consolidated Financial Statements
(unaudited)
December 31, 2017
Note 4. Investments (Continued)
Fair value measurements categorized within Level
3 are sensitive to changes in the assumptions or methodology used to determine fair value and such changes could result in a significant
increase or decrease in the fair value. Significant increases in illiquidity discounts, PIK discounts and market yields would result
in significantly lower fair value measurements.
Note 5. Notes Payable
On November 9, 2016, the Company entered into
the $50.0 million Senior Secured Revolving Credit Facility (the “Citi Revolving Financing”) with Citibank, N.A. (“Citibank”),
which was secured by collateral consisting primarily of commercial loans and corporate bonds. There were no upfront costs paid
in the establishment of the Citi Revolving Financing.
Borrowings under the Citi
Revolving Financing generally bore interest at a rate per annum equal to London Interbank Offered Rate (“LIBOR”)
plus 4.85%. The default interest rate was equal to the interest rate then in effect plus 2.00%. The Citi Revolving
Financing required the payment of an unused fee of 2.85% annually for any undrawn amounts below 75% of the Citi Revolving
Financing, and 0.75% annually for any undrawn amounts above 75% of the Citi Revolving Financing. Borrowings under the Citi
Revolving Financing were based on a borrowing base. The Citi Revolving Financing generally required payment of interest on a
quarterly basis and all outstanding principal was due upon maturity. The Citi Revolving Financing also required mandatory
prepayment of interest and principal upon certain events. As of December 31, 2017, there were no borrowings outstanding under
the Citi Revolving Financing.
The Company has repaid in full all
indebtedness, liabilities and other obligations under, and terminated, its Citi Revolving Financing on December 8, 2017. In
accordance with the termination of the Citi Revolving Financing, all liens on collateral securing the Citi Revolving
Financing were released.
On May 23, 2013, as amended on June 6, 2013, December 4, 2013, September
26, 2014, July 20, 2015, August 14, 2015, February 28, 2017 and November 20, 2017, the Company, through SPV, entered into a $102.0
million financing transaction (the “Term Financing”) due December 5, 2020 with UBS. The Term Financing is collateralized
by the portion of the Company’s assets held by SPV (the “SPV Assets”) and pledged as collateral as noted in the
Consolidated Schedule of Investments. Borrowings under the Term Financing bear interest (i) at a rate per annum equal to one-month
LIBOR plus 2.75% through December 4, 2018, and (ii) at a rate per annum equal to one-month LIBOR plus 2.55% from December 5, 2018
through December 5, 2020 (the “Term Financing Rate”). The Company also incurs an annual fee of approximately 1% of
the outstanding borrowings under the Term Financing. As of December 31, 2017 and June 30, 2017, there were $102.0 million and $102.0
million borrowings outstanding under the Term Financing, respectively.
On December 4, 2013, as amended on September
26, 2014 and July 17, 2015, the Company, through SPV, entered into a $50.0 million revolving financing (the “2013 UBS Revolving
Financing”), which expired in accordance with its terms on December 5, 2016. From December 4, 2013 through September 24,
2014, the 2013 UBS Revolving Financing bore interest at a fixed rate of 2.10% per annum on drawn amounts and 0.50% per annum
on any undrawn portion. From September 26, 2014 through December 5, 2016, the 2013 UBS Revolving Financing bore interest at a fixed rate of 2.00% on drawn amounts and 0.50% per annum on any undrawn portion. As of December 31, 2017 and June 30, 2017,
there were no borrowings outstanding under the 2013 UBS Revolving Financing.
The initial financing transaction with UBS was
initially executed in four steps:
First, the Company organized SPV, a consolidated
wholly owned bankruptcy remote special purpose vehicle in the Cayman Islands to purchase the SPV Assets through (i) the issuance
and sale of notes secured by the SPV Assets (the “Term Notes”) to UBS and the Company and (ii) the transfer of cash
to the Company. UBS purchased Term Notes with a face value of $76.5 million, which represent 51% of the Term Notes issued and outstanding,
for $76.5 million in cash. The Company purchased Term Notes with a face value of $73.5 million (which are eliminated in consolidation),
which represent 49% of the Term Notes issued and outstanding. Under the terms of the indenture under which the Term Notes were
issued (the “Indenture”), the holders of the Term Notes are entitled to (i) periodic interest payments equal to their
pro rata portion of the interest collected on the assets held by SPV and (ii) their pro-rata portion of the net appreciation (depreciation)
on the SPV Assets at maturity (the “Total Return of the Term Notes”). This represents the embedded derivative in the
Term Notes payable from SPV to UBS. On September 26, 2014, the Company increased the size of the Term Facility to $102.0 million.
In connection with the upsize, UBS purchased additional Term Notes with a face value of $25.5 million for $25.5 million in cash.
The Company also purchased additional Term Notes with a face value of $24.5 million.
Second, the Company and UBS entered into a TRS
transaction whereby the Company would receive the Total Return of the Term Notes purchased by UBS and pay the Financing Rate.
Third, SPV issued and sold an additional $50.0
million notes (the “2013 Revolving Notes”) secured by the SPV Assets to UBS. Cash was only exchanged when the 2013
Revolving Notes were drawn. Under the terms of the Indenture under which the 2013 Revolving Notes were issued (the “2013
Revolver Indenture”), the holders of the 2013 Revolving Notes were entitled to (i) periodic interest payments equal to their
pro rata portion of the interest collected on the SPV Assets and (ii) their pro-rata portion of the net appreciation (depreciation)
on the SPV Assets at maturity (the “Total Return of the 2013 Revolving Notes”).
Fourth, the Company and UBS entered into another
TRS transaction whereby the Company would receive the Total Return of the Revolving Notes purchased by UBS and pay the revolver
financing rate. On December 5, 2016, the 2013 Revolving Notes matured and the corresponding TRS transaction associated with the
2013 Revolving Notes unwound in unison. On November 20, 2017, the Company and UBS entered into another TRS transaction whereby
the Company will receive the total return of the $50 million notes (the “2017 Revolving Notes) purchased by UBS and pay the
Revolver Financing Rate (defined below).
On November 20, 2017, the Company entered
into a $50 million revolving financing facility (the “2017 UBS Revolving Financing”) with UBS. Borrowings under the
2017 UBS Revolving Financing generally bear interest at a rate per annum equal to one-month LIBOR plus 3.55% (the “Revolver
Financing Rate”). The Company pays a fee on any undrawn amounts of 2.50% per annum; provided that if 50% or less of
the 2017 UBS Revolving Financing is drawn, the fee will be 2.75% per annum. Any amounts borrowed under the 2017 UBS Revolving
Financing will mature, and all accrued and unpaid interest will be due and payable, on December 5, 2019. As of December 31, 2017,
there were $17.8 million in borrowings outstanding under the 2017 UBS Revolving Financing.
CM Finance Inc and subsidiaries
Notes to Consolidated Financial Statements
(unaudited)
December 31, 2017
Note 5. Notes Payable (Continued)
As of December 31, 2017, SPV issued and
sold an additional $50.0 million notes (the “2017 Revolving Notes”) secured by the SPV Assets to UBS. Cash is
only exchanged when the 2017 Revolving Notes are drawn. Under the terms of the Indenture under which the 2017 Revolving Notes
were issued (the “2017 Revolver Indenture”), the holders of the 2017 Revolving Notes are entitled to (i)
periodic interest payments equal to their pro rata portion of the interest collected on the SPV Assets and (ii) their
pro-rata portion of the net appreciation (depreciation) on the SPV Assets at maturity (the “Total Return of the
2017 Revolving Notes”).
The fair value of the Company’s Notes
Payable is estimated based on the rate at which similar facilities would be priced. At December 31, 2017 and June 30, 2017, the
fair value of the Notes Payable was estimated at $119.8 million and $102.0 million, respectively, which the Company concluded was
a Level 3 fair value.
Cash, restricted (as shown on the Unaudited
Consolidated Statements of Assets and Liabilities) is held by the trustee of the Term Financing and the 2017 UBS Revolving Financing,
and the Citi Revolving Financing up until its expiration and is restricted to purchases of investments by SPV and LLC that must
meet certain eligibility criteria identified by the Indenture. As of December 31, 2017, SPV and LLC had aggregate assets of $235.1
million, which included $230.3 million of the Company’s portfolio investments at fair value, $3.1 million of accrued interest
receivable and $1.7 million in cash held by the trustees of the Term Financing and the 2017 UBS Revolving Financing (together,
the “UBS Financing Facility”, and with the Citi Revolving Financing, the “Financing Facilities”). As of
June 30, 2017, SPV and LLC had assets of $203.4 million, which included $180.1 million of the Company’s portfolio investments
at fair value, $1.0 million of accrued interest receivable and $22.3 million in cash held by the trustee of the Term Financing.
For the three and six months ended December 31, 2017, the weighted average outstanding debt balance and the weighted average stated
interest rate under the Financing Facilities was $122.3 million and 4.35%, respectively, and $118.6 million and 4.28%, respectively.
For the three and six months ended December 31, 2016, the weighted average outstanding debt balance and the weighted average stated
interest rate under the Financing Facilities was $114.1 million and 3.61%, respectively, and $118.9 million and 3.39%, respectively.
Note 6. Indemnification, Guarantees, Commitments and Contingencies
In the normal course of business, the Company
enters into contracts that provide a variety of representations and warranties and general indemnifications. Such contracts include
those with certain service providers, brokers and trading counterparties. Any exposure to the Company under these arrangements
is unknown as it would involve future claims that may be made against the Company; however, based on the Company’s experience,
the risk of loss is remote and no such claims are expected to occur. As such, the Company has not accrued any liability in connection
with such indemnifications.
The Company’s Board of Directors declared
the following quarterly distributions:
Declared
|
|
Ex-Date
|
|
Record Date
|
|
Pay Date
|
|
Amount
|
|
|
Fiscal Quarter
|
August 24, 2017
|
|
September 7, 2017
|
|
September 8, 2017
|
|
October 5, 2017
|
|
$
|
0.2500
|
|
|
1st 2018
|
November 7, 2017
|
|
December 14, 2017
|
|
December 15, 2017
|
|
January 4, 2018
|
|
$
|
0.2500
|
|
|
2nd 2018
|
February
6, 2018
|
|
March 14, 2018
|
|
March 15, 2018
|
|
April 5, 2018
|
|
$
|
0.2500
|
|
|
3rd 2018
|
Loans purchased by the Company may include revolving
credit agreements or other financing commitments obligating the Company to advance additional amounts on demand. The Company generally
sets aside sufficient liquid assets to cover its unfunded commitments, if any.
The following table details the unfunded commitments
as of December 31, 2017:
Investments
|
|
Unfunded
Commitment
|
|
|
Annual
Non-use
Fee
|
|
|
|
Expiration Date
|
|
1888 Industrial Services, LLC
|
|
$
|
693,069
|
|
|
|
0.50
|
%
|
|
|
9/30/21
|
|
Bird Electric Enterprises LLC
|
|
|
1,000,000
|
|
|
|
6.00
|
|
|
|
6/14/22
|
|
PR Wireless, Inc.
|
|
|
1,846,478
|
|
|
|
0.35
|
|
|
|
6/27/19
|
|
U.S. Well Services, LLC
|
|
|
215,004
|
|
|
|
0.00
|
|
|
|
1/31/22
|
|
Total Unfunded Commitments
|
|
$
|
3,754,551
|
|
|
|
|
|
|
|
|
|
The following table details the Company’s unfunded commitments
as of June 30, 2017:
Investments
|
|
Unfunded
Commitment
|
|
|
Annual
Non-use
Fee
|
|
|
Expiration Date
|
|
AAR Intermediate Holdings, LLC
|
|
$
|
792,079
|
|
|
|
0.50
|
%
|
|
|
9/30/21
|
|
U.S. Well Services, LLC
|
|
|
413,342
|
|
|
|
0.00
|
|
|
|
1/31/22
|
|
Total Unfunded Commitments
|
|
$
|
1,205,421
|
|
|
|
|
|
|
|
|
|
Note 7. Agreements and Related Party Transactions
Related Party Transactions
In connection with the Offering, the Adviser
paid $3.45 million or 50.0% of the total underwriting costs and offering costs in excess of the $1.2 million paid by Company.
CM Finance Inc and subsidiaries
Notes to Consolidated Financial Statements
(unaudited)
December 31, 2017
Note 7. Agreements and Related Party Transactions (Continued)
Investment Advisory Agreement
Pursuant to the Advisory Agreement, the Company
has agreed to pay to the Adviser a base management fee of 1.75% of gross assets, including assets purchased with borrowed funds
or other forms of leverage and excluding cash and cash equivalents and fair value of derivatives associated with the Company’s
financing, and an incentive fee consisting of two parts.
The first part of the incentive fee, which is
calculated and payable quarterly in arrears, equals 20.0% of the “pre-incentive fee net investment income” (as defined
in the agreement) for the immediately preceding quarter, subject to a hurdle rate of 2.0% per quarter (8.0% annualized), and is
subject to a “catch-up” feature. The incentive fee is subject to a total return requirement, which provides that no
incentive fee in respect of the Company’s pre-incentive fee net investment income will be payable except to the extent 20.0%
of the cumulative net increase in net assets resulting from operations over the then current and 11 preceding quarters exceeds
the cumulative incentive fees accrued and/or paid for the 11 preceding quarters. The net pre-incentive fee investment income used
to calculate this part of the incentive fee is also included in the amount of the Company’s gross assets used to calculate
the 1.75% base management fee.
The second part of the incentive fee is calculated
and payable in arrears as of the end of each calendar year and equals 20.0% of the aggregate cumulative realized capital gains
from inception through the end of each calendar year, computed net of aggregate cumulative realized capital losses and aggregate
cumulative unrealized capital depreciation through the end of such year, less the aggregate amount of any previously paid capital
gain incentive fees.
The Adviser agreed to permanently waive all
or portions of the incentive fee for the calendar year ended December 31, 2016 to the extent required to support an annualized
dividend yield of 9.375% per annum. The Adviser has not contractually agreed to voluntarily waive any fees under the Advisory Agreement
for the calendar year ended December 31, 2017 or thereafter.
For the three and six months ended December
31, 2017, $1,161,353 and $2,315,233 in base management fees were earned by the Adviser, of which $2,315,233 was payable at December
31, 2017. For the three and six months ended December 31, 2016, $1,183,946 and $2,395,481 in base management fees were earned by
the Adviser, of which $2,395,481 was payable at December 31, 2016.
For the three and six months ended
December 31, 2017, the Company incurred $921,782 and $906,758, respectively, of incentive fees related to pre-incentive fee
net investment income of which $0 and $0 was waived, respectively. As of December 31, 2017, $1,162,320 of such incentive fees
are currently payable to the Adviser and $414,939 of pre-incentive fees incurred by the Company were generated from deferred
interest (i.e. PIK and certain discount accretion) and are not payable until such amounts are received in cash. For the three
and six months ended December 31, 2016, the Company incurred $1,095,515 and $1,095,515, respectively, of incentive fees
related to pre-incentive fee net investment income of which $203,242 and $203,242 was waived, respectively. As of December
31, 2016, $904,951 of such incentive fees are currently payable to the Adviser and $262,862 of pre-incentive fees incurred by
the Company were generated from deferred interest (i.e. PIK and certain discount accretion) and are not payable until such
amounts are received in cash.
The capital gains incentive fee consists of
fees related to both realized gains, realized capital losses and unrealized capital depreciation. As of December 31, 2017, there
was no capital gains incentive fee accrued, earned or payable to the Adviser under the Advisory Agreement. As of June 30, 2017,
there was no capital gains incentive fee accrued, earned or payable to the Adviser under the Advisory Agreement.
With respect to the incentive fee expense accrual
relating to the capital gains incentive fee, U.S. GAAP requires that the capital gains incentive fee accrual consider the cumulative
aggregate unrealized appreciation in the calculation, as a capital gains incentive fee would be payable if such unrealized appreciation
were realized, even though such unrealized appreciation is not permitted to be considered in calculating the fee actually payable
under the Advisory Agreement.
The Advisory Agreement provides that, absent
willful misfeasance, bad faith or gross negligence in the performance of its duties or by reason of the reckless disregard of its
duties and obligations under the Advisory Agreement, the Adviser and its officers, managers, partners, agents, employees, controlling
persons and members, and any other person or entity affiliated with it, are entitled to indemnification from the Company for any
damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement)
arising from the rendering of the Adviser’s services under the Advisory Agreement or otherwise as the Adviser.
CM Finance Inc and subsidiaries
Notes to Consolidated Financial Statements
(unaudited)
December 31, 2017
Note 7. Agreements and Related Party Transactions (Continued)
Prior to the Company’s election to be
regulated as a BDC on February 5, 2014, no management or incentive fees were due and payable.
Administration Agreement
The Company entered into an administration
agreement with the Adviser (the “Administration Agreement”) pursuant to which the Adviser furnishes the Company with
office facilities and equipment and will provide the Company with the clerical, bookkeeping, recordkeeping and other administrative
services necessary to conduct day-to-day operations. Under the Administration Agreement, the Adviser performs, or oversees the
performance of the Company’s required administrative services, which includes, among other things, being responsible for
the financial records which it is required to maintain and preparing reports to its stockholders and reports filed with the SEC.
In addition, the Adviser assists the Company in determining and publishing its net asset value, oversees the preparation and filing
of its tax returns and the printing and dissemination of reports and other materials to its stockholders, and generally oversees
the payment of its expenses and the performance of administrative and professional services rendered to it by others. Under the
Administration Agreement, the Adviser also provides managerial assistance on the Company’s behalf to those portfolio companies
that have accepted its offer to provide such assistance. The Adviser has also retained the services of accounting and back office
professionals on an as needed basis through a services agreement with the Cyrus Capital Partners, L.P. to assist the Adviser in
fulfilling certain of its obligations to the Company under the Administration Agreement. The Company incurred costs of $184,561
and $311,790 under the Administration Agreement for the three and six months ended December 31, 2017, respectively. The Company
incurred costs of $148,710 and $416,952 under the Administration Agreement for the three and six months ended December 31, 2016,
respectively.
As of December 31, 2017 and June 30, 2017, the
Company recorded $35,033 and $85,000, respectively, in accrued expenses and other liabilities on its Unaudited Consolidated Statements
of Assets and Liabilities for reimbursement of expenses owed to the Adviser under the Administration Agreement.
License Agreement
The Company has entered into a license agreement
with the Adviser under which the Adviser has agreed to grant the Company a non-exclusive, royalty-free license to use the name
“CM Finance.” Under this agreement, the Company has a right to use the “CM Finance” name for so long as
the Adviser or one of its affiliates remains the Adviser. Other than with respect to this limited license, the Company has no legal
right to the “CM Finance” name.
Stifel Arrangement
In December 2013, the Company entered into
an arrangement pursuant to which Stifel Venture Corp. (“Stifel”) made a capital contribution to the Company on February 5,
2014 and the Company granted Stifel certain rights, such as a right to nominate for election a member of the Company’s
board of directors. Stifel has not exercised its right to nominate for election a member of the Company’s board of
directors. Stifel does not have any rights to exercise a controlling influence over the Company’s day-to-day operations
or the investment management function of the Adviser.
Four of the investment
professionals employed by the Adviser as part of its investment team are also employees of Stifel, Nicolaus & Company,
Incorporated or its affiliates and are members of the Adviser’s investment committee designated by Stifel. Although
these four investment professionals dedicate substantially all of their time to the business and activities of the Adviser,
they are dual employees of both Stifel, Nicolaus & Company, Incorporated or its affiliates and the Adviser, and a member
of the Adviser’s investment committee is an employee of Stifel, Nicolaus & Company, Incorporated or its affiliates
and as a result, may continue to engage in investment advisory activities for Stifel, Nicolaus & Company, Incorporated or
its affiliates. As of December 31, 2017, Stifel owned approximately 16.0% of the Company’s outstanding common stock,
and also holds a 20.0% interest in the Adviser.
Note 8. Directors’ Fees
Each of the Company’s four independent
directors receives (i) an annual fee of $75,000, and (ii) $2,500 plus reimbursement of reasonable out-of-pocket expenses incurred
in connection with attending in person or telephonically each regular board of directors meeting and each special telephonic meeting.
The Company’s independent directors also receive $1,000 plus reimbursement of reasonable out-of-pocket expenses incurred
in connection with each committee meeting attended in person and each telephonic committee meeting. The chairman of the audit committee
receives an annual fee of $7,500. The chairperson of the valuation committee, the nominating and corporate governance committee
and the compensation committee receives an annual fee of $2,500, $2,500 and $2,500, respectively. The Company has obtained directors’
and officers’ liability insurance on behalf of the Company’s directors and officers. Independent directors have the
option of having their directors’ fees paid in shares of the Company’s common stock issued at a price per share equal
to the greater of net asset value or the market price at the time of payment. For three and six months ended December 31, 2017,
the Company recorded directors’ fees of $99,000 and $198,667, of which $96,746 were payable at December 31, 2017. For three
and six months ended December 31, 2016, the Company recorded directors’ fees of $99,999 and $199,999, of which none were
payable at December 31, 2016.
CM Finance Inc and subsidiaries
Notes to Consolidated Financial Statements
(unaudited)
December 31, 2017
Note 9. Net Change in Net Assets Resulting from Operations Per
Share
Basic earnings per share is computed by dividing
earnings available to common stockholders 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 table sets forth the computation
of the weighted average basic and diluted net increase in net assets per share from operations:
|
|
Basic and Diluted Net Increase (Decrease) in Net Assets Per Share
|
|
|
|
Three Months Ended December 31,
|
|
|
Six Months Ended December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Net increase (decrease) in net assets resulting from operations
|
|
$
|
4,859,147
|
|
|
$
|
8,554,098
|
|
|
$
|
7,994,863
|
|
|
$
|
12,859,055
|
|
Weighted average shares of common stock outstanding
|
|
|
13,690,480
|
|
|
|
13,686,865
|
|
|
|
13,690,182
|
|
|
|
13,683,841
|
|
Basic/diluted net increase (decrease) in net assets from operations per share
|
|
$
|
0.35
|
|
|
$
|
0.62
|
|
|
$
|
0.58
|
|
|
$
|
0.94
|
|
Note 10. Distributions
The following table reflects the cash dividend
distributions per share that the Company declared and/or paid to its stockholders since the Offering in February 2014. Stockholders
of record as of each respective record date were entitled to receive the distribution:
Declaration Date
|
|
Record Date
|
|
Payment Date
|
|
Amount Per Share
|
|
March 14, 2014
|
|
March 24, 2014
|
|
March 31, 2014
|
|
$
|
0.1812
|
|
May 14, 2014
|
|
June 16, 2014
|
|
July 1, 2014
|
|
$
|
0.3375
|
|
September 4, 2014
|
|
September 18, 2014
|
|
October 1, 2014
|
|
$
|
0.3375
|
|
November 6, 2014
|
|
December 18, 2014
|
|
January 5, 2015
|
|
$
|
0.3375
|
|
January 28, 2015
|
|
March 18, 2015
|
|
April 2, 2015
|
|
$
|
0.3469
|
|
May 6, 2015
|
|
June 8, 2015
|
|
July 5, 2015
|
|
$
|
0.3469
|
|
June 10, 2015*
|
|
September 1, 2015
|
|
September 15, 2015
|
|
$
|
0.4300
|
|
June 10, 2015
|
|
September 18, 2015
|
|
October 2, 2015
|
|
$
|
0.3469
|
|
November 3, 2015
|
|
December 18, 2015
|
|
January 5, 2016
|
|
$
|
0.3469
|
|
February 2, 2016
|
|
March 18, 2016
|
|
April 7, 2016
|
|
$
|
0.3516
|
|
April 28, 2016
|
|
June 17, 2016
|
|
July 7, 2016
|
|
$
|
0.3516
|
|
August 25, 2016
|
|
September 16, 2016
|
|
October 6, 2016
|
|
$
|
0.3516
|
|
November 3, 2016
|
|
December 16, 2016
|
|
January 5, 2017
|
|
$
|
0.3516
|
|
November 3, 2016
|
|
March 17, 2017
|
|
April 6, 2017
|
|
$
|
0.2500
|
|
May 2, 2017
|
|
June 16, 2017
|
|
July 6, 2017
|
|
$
|
0.2500
|
|
August 24, 2017
|
|
September 8, 2017
|
|
October 5, 2017
|
|
$
|
0.2500
|
|
November 7, 2017
|
|
December 15, 2017
|
|
January 4, 2018
|
|
$
|
0.2500
|
|
February 6, 2018
|
|
March 15, 2018
|
|
April 5, 2018
|
|
$
|
0.2500
|
|
CM Finance Inc and subsidiaries
Notes to Consolidated Financial Statements
(unaudited)
December 31, 2017
Note 10. Distributions (Continued)
The following table reflects the sources of
the cash distributions that the Company has paid on its common stock during the six months ended December 31, 2017 and December
31, 2016:
|
|
Six months ended December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
Distribution Amount
|
|
|
Percentage
|
|
|
Distribution Amount
|
|
|
Percentage
|
|
Ordinary income and short-term capital gains
|
|
$
|
6,845,051
|
|
|
|
100
|
%
|
|
$
|
9,622,655
|
|
|
|
100
|
%
|
Long-term capital gains
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Total
|
|
$
|
6,845,051
|
|
|
|
100
|
%
|
|
$
|
9,622,655
|
|
|
|
100
|
%
|
Note 11. Share Transactions
The following table summarizes the total shares
issued for the six months ended December 31, 2017 and December 31, 2016.
|
|
Six months ended December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Shares
|
|
|
Amount
|
|
Balance at beginning of period
|
|
|
13,689,221
|
|
|
$
|
200,568,530
|
|
|
|
13,679,686
|
|
|
$
|
200,482,695
|
|
Reinvestments of shareholder distributions
|
|
|
1,259
|
|
|
|
11,813
|
|
|
|
7,594
|
|
|
|
67,768
|
|
Balance at end of period
|
|
|
13,690,480
|
|
|
$
|
200,580,343
|
|
|
|
13,687,280
|
|
|
$
|
200,550,463
|
|
Note 12. Financial Highlights
The following represents the per share data
and the ratios to average net assets for CM Finance Inc:
|
Six months
ended
December 31,
2017
|
|
|
Six months
ended
December 31,
2016
|
|
Per Share Data:
(1)
|
|
|
|
|
|
|
Net asset value, beginning of period
|
$
|
12.41
|
|
|
$
|
11.90
|
|
|
|
|
Net investment income
|
0.49
|
|
|
|
0.64
|
|
Net realized and unrealized gains (losses)
|
0.10
|
|
|
|
0.29
|
|
Net increase in net assets resulting from operations
|
0.59
|
|
|
|
0.93
|
|
|
|
|
Capital transactions
(2)
|
|
|
|
|
|
|
Dividends from net investment income
|
(0.50
|
)
|
|
|
(0.70
|
)
|
Distributions from net realized gains
|
—
|
|
|
|
—
|
|
Net decrease in net assets resulting from capital transactions
|
(0.50
|
)
|
|
|
(0.70
|
)
|
|
|
|
Net asset value, end of period
|
$
|
12.50
|
|
|
$
|
12.13
|
|
Market value per share, end of period
|
$
|
8.15
|
|
|
$
|
9.30
|
|
|
|
|
Total return based on market value
(3)(4)
|
(13.65
|
)%
|
|
|
13.09
|
%
|
|
|
|
Shares outstanding at end of period
|
13,690,480
|
|
|
|
13,687,280
|
|
|
|
|
Ratio/Supplemental Data:
|
|
|
|
|
|
|
Net assets, at end of period
|
$
|
171,109,737
|
|
|
$
|
166,054,051
|
|
Ratio of total expenses to average net assets
(5)
|
9.88
|
%
|
|
|
9.81
|
%
|
Ratio of net expenses to average net assets
(5)
|
9.88
|
%
|
|
|
9.57
|
%
|
Ratio of interest expense and fees and amortization of deferred debt issuance costs to average net assets
(5)
|
3.90
|
%
|
|
|
3.34
|
%
|
Ratio of net investment income before fee waiver to average net assets
(5)
|
7.81
|
%
|
|
|
10.47
|
%
|
Ratio of net investment income after fee waiver to average net assets
(5)
|
7.81
|
%
|
|
|
10.72
|
%
|
Total Notes Payable
|
$
|
119,830,000
|
|
|
$
|
116,332,649
|
|
Asset Coverage Ratio
(6)
|
2.46
|
|
|
|
2.43
|
|
Portfolio Turnover Rate
(4)
|
20
|
%
|
|
|
19
|
%
|
|
(1)
|
The per share data was derived by using the shares outstanding during the period.
|
|
(2)
|
The per share data for dividends and distributions declared reflects the actual amount of the dividends and distributions declared
per share during the period.
|
CM Finance Inc and subsidiaries
Notes to Consolidated Financial Statements
(unaudited)
December 31, 2017
Note 12. Financial Highlights (Continued)
|
(3)
|
Total returns are historical and are calculated by determining the percentage change in the market value with all dividends
and distributions, if any, reinvested. Dividends and distributions are assumed to be reinvested at prices obtained under the company’s
dividend reinvestment plan. Total investment return does not reflect sales load.
|
|
(6)
|
Asset coverage ratio is equal to (i) the sum of (A) net assets at the end of the period and (B) debt outstanding at the end
of the period, divided by (ii) total debt outstanding at the end of the period.
|
Note 13. Other Fee Income
The other fee income consists of structuring
fee income, amendment fee income and royalty income. The following tables summarize the Company’s other fee income for the
three and six months ended December 31, 2017 and December 31, 2016:
|
|
For the three months ended December 31,
|
|
|
For the six months ended December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Loan Structuring Fee
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Loan Amendment/Consent Fee
|
|
|
—
|
|
|
|
359,494
|
|
|
|
9,879
|
|
|
|
575,961
|
|
Royalty Income
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Other Fee Income
|
|
$
|
—
|
|
|
$
|
359,494
|
|
|
$
|
9,879
|
|
|
$
|
575,961
|
|
Note 14. Tax Information
As of December 31, 2017, the Company’s
aggregate investment unrealized appreciation and depreciation based on cost for U.S. federal income tax purposes were as follows:
Tax cost
|
|
$
|
293,670,448
|
|
Gross unrealized appreciation
|
|
|
9,703,467
|
|
Gross unrealized depreciation
|
|
|
(16,842,747
|
)
|
Net unrealized investment depreciation
|
|
$
|
(7,139,280
|
)
|
As of June 30, 2017, the Company’s aggregate
investment unrealized appreciation and depreciation based on cost for U.S. federal income tax purposes were as follows:
Tax cost
|
|
$
|
271,969,759
|
|
Gross unrealized appreciation
|
|
|
3,709,069
|
|
Gross unrealized depreciation
|
|
|
(20,771,657
|
)
|
Net unrealized investment depreciation
|
|
$
|
(17,062,588
|
)
|