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Portman Ridge Finance Corp - Quarter Report: 2015 September (Form 10-Q)

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2015

 

¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from          to          

 

Commission File No. 814-00735

 

KCAP Financial, Inc.

(Exact name of Registrant as specified in its charter)

 

 

Delaware   20-5951150
(State or other jurisdiction of   (I.R.S. Employer
Incorporation or organization)   Identification Number)

 

295 Madison Avenue, 6th Floor

New York, New York 10017

(Address of principal executive offices)

 

(212) 455-8300

(Registrant's telephone number, including area code)

 

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes x No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o   Accelerated filer x
         
Non-accelerated filer o (Do not check if a smaller reporting company) Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x

 

The number of outstanding shares of common stock of the registrant as of November 2, 2015 was 37,100,825.

 

 

 

   

 

 

TABLE OF CONTENTS

 

    Page
     
  Part I. Financial Information  
     
Item 1. Consolidated Financial Statements  
     
  Consolidated Balance Sheets as of September 30, 2015 (unaudited) and December 31, 2014 1
     
  Consolidated Statements of Operations (unaudited) for the three and nine months ended September 30, 2015 and 2014 2
     
  Consolidated Statements of Changes in Net Assets (unaudited) for the nine months ended September 30, 2015 and 2014 3
     
  Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2015 and 2014 4
     
  Consolidated Schedules of Investments as of September 30, 2015 (unaudited) and December 31, 2014 5
   
  Consolidated Financial Highlights (unaudited) for the nine months ended September 30, 2015 and 2014 33
     
  Notes to Consolidated Financial Statements (unaudited) 34
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 61
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 79
     
Item 4. Controls and Procedures 80
     
  Part II. Other Information  
     
Item 1. Legal Proceedings 81
     
Item 1A. Risk Factors 81
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 81
     
Item 3. Defaults Upon Senior Securities 81
     
Item 4. Mine Safety Disclosures 81
     
Item 5. Other Information 81
     
Item 6. Exhibits 81
   
Signatures 82

 

   

 

 

KCAP FINANCIAL, INC.

 

CONSOLIDATED BALANCE SHEETS

 

   As of
September 30, 2015
   As of
December 31, 2014
 
   (unaudited)     
ASSETS          
Investments at fair value:          
Money market accounts (cost: 2015 - $3,345,723; 2014 - $1,602,741)  $3,345,723   $1,602,741 
Debt securities (cost: 2015 - $306,613,274; 2014 - $322,884,934)   296,284,441    320,143,170 
CLO Fund securities managed by affiliates (cost: 2015 - $80,790,584; 2014 - $85,355,897)   63,682,491    74,139,696 
CLO Fund securities managed by non-affiliates (cost: 2015 - $5,497,863; 2014 - $5,533,293)   3,038,291    3,375,206 
Equity securities (cost: 2015 - $8,514,487; 2014 - $8,828,812)   6,936,653    8,119,681 
Asset Manager Affiliates (cost: 2015 - $57,189,159; 2014 - $60,292,677)   64,121,000    72,326,000 
Total Investments at Fair Value (cost: 2015 - $461,951,090; 2014 - $484,498,354)   437,408,599    479,706,494 
Cash   1,566,274    1,220,798 
Restricted cash   8,334,124    19,325,550 
Interest receivable   2,229,547    1,748,821 
Due from affiliates   2,634,589    3,027,409 
Other assets   4,735,669    5,417,725 
Total Assets  $456,908,802   $510,446,797 
           
LIABILITIES          
Convertible Notes  $33,647,000   $38,647,000 
7.375% Notes Due 2019   41,400,000    41,400,000 
Notes issued by KCAP Senior Funding I, LLC (net of discount: 2015 - $3,060,315; 2014 - $3,512,407)   144,289,685    143,837,593 
Payable for open trades       18,293,725 
Accounts payable and accrued expenses   1,797,885    2,166,400 
Accrued interest payable   860,939    1,566,255 
Payable to officers and directors       107,750 
Due to affiliates   313,411    31,000 
Shareholder distribution payable       9,080,373 
           
Total Liabilities   222,308,920    255,130,096 
           
COMMITMENTS AND CONTINGENCIES (Note 8)          
           
STOCKHOLDERS' EQUITY          
Common stock, par value $0.01 per share, 100,000,000 common shares authorized; 37,088,923 issued, and 37,052,575 outstanding at September 30, 2015, and 36,775,127 common shares issued and outstanding at December 31, 2014   370,526    367,751 
Capital in excess of par value   364,371,732    362,411,830 
Excess distribution of net investment income   (22,013,276)   (25,579,865)
Accumulated net realized losses   (81,788,040)   (75,512,134)
Net unrealized depreciation on investments   (26,121,123)   (6,370,881)
Treasury stock at cost   (219,937)    
Total Stockholders' Equity   234,599,882    255,316,701 
Total Liabilities and Stockholders' Equity  $456,908,802   $510,446,797 
NET ASSET VALUE PER COMMON SHARE  $6.33   $6.94 

 

See accompanying notes to consolidated financial statements.

 

 1 

 

 

KCAP FINANCIAL, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

 

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
   2015   2014   2015   2014 
                 
Investment Income:                    
Interest from investments in debt securities  $6,302,777   $5,391,997   $18,380,536   $15,812,747 
Interest from cash and time deposits   2,726    831    7,084    2,341 
Investment income on CLO Fund Securities managed by affiliates   3,684,802    3,374,704    11,624,644    9,013,831 
Investment income on CLO Fund Securities managed by non-affiliates   196,965    230,529    821,042    829,203 
Dividends from Asset Manager Affiliates   1,547,069    1,424,415    4,196,483    4,181,347 
Capital structuring service fees   45,009    412,772    263,074    764,971 
Total investment income   11,779,348    10,835,248    35,292,863    30,604,440 
                     
Expenses:                    
Interest and amortization of debt issuance costs   3,007,283    2,891,724    8,965,252    8,775,697 
Compensation   892,119    1,431,825    3,022,393    3,921,913 
Professional fees   762,357    566,320    2,638,931    1,783,443 
Insurance   107,028    112,109    326,561    359,576 
Administrative and other   469,481    315,769    1,459,447    1,183,367 
Total expenses   5,238,268    5,317,747    16,412,584    16,023,996 
                     
Net Investment Income   6,541,080    5,517,501    18,880,279    14,580,444 
Realized And Unrealized Gains (Losses) On Investments:                    
Net realized (losses) from investment transactions   (6,231,759)   (2,141,591)   (6,133,352)   (1,896,806)
Net change in unrealized (depreciation) appreciation on:                    
Debt securities   (6,334,456)   7,420,256    (7,587,070)   7,919,575 
Equity securities   (605,432)   1,215,992    (868,703)   1,435,014 
CLO Fund securities managed by affiliates   (261,695)   (11,986,471)   (5,891,498)   (8,402,287)
CLO Fund securities managed by non-affiliates   (152,980)   3,100,201    (301,488)   3,333,111 
Asset Manager Affiliates investments   (8,863,069)   5,110,585    (5,101,483)   6,961,675 
Total net change in unrealized appreciation (depreciation)   (16,217,632)   4,860,563    (19,750,242)   11,247,088 
Net realized and unrealized appreciation (depreciation) on investments   (22,449,391)   2,718,972    (25,883,594)   9,350,282 
                     
Realized losses on extinguishments of debt   (142,554)       (142,554)    
Net (Decrease) Increase In Stockholders’ Equity Resulting From Operations  $(16,050,865)  $8,236,473   $(7,145,869)  $23,930,726 
Net (Decrease) Increase In Stockholders' Equity Resulting from Operations per Common Share:                    
Basic:  $(0.43)  $0.24   $(0.19)  $0.71 
Diluted:  $(0.43)  $0.23   $(0.19)  $0.68 
Net Investment Income Per Common Share:                    
Basic:  $0.18   $0.16   $0.51   $0.44 
Diluted:  $0.18   $0.16   $0.51   $0.43 
                     
Weighted Average Shares of Common Stock Outstanding—Basic   37,046,906    33,746,159    36,923,212    33,497,934 
Weighted Average Shares of Common Stock Outstanding—Diluted   37,046,906    40,125,660    36,923,212    39,877,326 

 

See accompanying notes to consolidated financial statements.

 

 2 

 

 

KCAP FINANCIAL, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS

(unaudited)

 

   Nine Months Ended
September 30,
 
   2015   2014 
         
Operations:          
Net investment income  $18,880,279   $14,580,444 
Net realized losses from investment transactions   (6,133,352)   (1,896,806)
Realized losses from extinguishments of debt   (142,554)    
Net change in unrealized (depreciation) appreciation on investments   (19,750,242)   11,247,088 
Net (decrease) increase in net assets resulting from operations   (7,145,869)   23,930,726 
           
Stockholder distributions:          
Distribution of ordinary income   (15,313,691)   (16,603,434)
Return of capital   -    - 
Net decrease in net assets resulting from stockholder distributions   (15,313,691)   (16,603,434)
           
Capital transactions:          
(Repurchase) issuance of common stock for:          
Common stock withheld for payroll taxes upon vesting of restricted stock   (220,301)    
Dividend reinvestment plan   811,517    561,662 
Stock based compensation   1,151,525    768,427 
           
Net increase in net assets resulting from capital transactions   1,742,741    1,330,089 
           
Net assets at beginning of period   255,316,701    250,369,693 
           
Net assets at end of period (including undistributed net investment income of $0 in 2015 and $0 in 2014)  $234,599,882   $259,027,074 
           
Net asset value per common share  $6.33   $7.67 
Common shares outstanding at end of period   37,052,575    33,753,672 

 

See accompanying notes to consolidated financial statements.

 

 3 

 

 

KCAP FINANCIAL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

   Nine Months Ended
September 30,
 
   2015   2014 
         
OPERATING ACTIVITIES:          
Net (decrease) increase in stockholder's equity resulting from operations  $(7,145,869)  $23,930,726 
Adjustments to reconcile net (decrease) increase in stockholder’s equity resulting from operations to net cash provided by in operating activities:          
Net realized losses on investment transactions   6,133,352    1,896,806 
Net change in unrealized depreciation (appreciation) on investments   19,750,242    (11,247,086)
Purchases of investments   (100,476,581)   (165,876,071)
Proceeds from sales and redemptions of investments   111,864,151    169,182,675 
Net (accretion) amortization on investments   6,123,977    4,311,245 
Amortization of original issue discount on indebtedness   452,092    328,838 
Amortization of debt issuance costs   897,566    838,726 
Realized losses on extinguishments of debt   142,554     
Payment-in-kind interest income   (1,097,244)   (132,622)
Stock-based compensation    1,151,525    767,101 
Changes in operating assets and liabilities:          
(Decrease) increase in payable for open trades   (18,293,725)   4,282,000 
Increase in interest and dividends receivable   (480,726)   (76,286)
Increase in other assets   (358,065)   (519,467)
Decrease (increase) in due from affiliates   392,820    (24,683)
Increase in due to affiliates   282,411     
(Decrease) in accounts payable and accrued expenses   (1,181,580)   (1,421,978)
Net cash provided by operating activities   18,156,900    26,239,924 
           
FINANCING ACTIVITIES:          
Issuance of restricted shares   1,820    1,326 
Distributions to stockholders   (23,584,369)   (24,374,804)
Repurchase of Convertible Notes   (5,000,000)    
Common Stock withheld for payroll taxes upon vesting of restricted stock   (220,301)    
Decrease (increase) in restricted cash   10,991,426    (1,364,637)
Net cash used in financing activities   (17,811,424)   (25,738,115)
           
CHANGE IN CASH   345,476    501,809 
CASH, BEGINNING OF PERIOD   1,220,798    3,433,675 
CASH, END OF PERIOD  $1,566,274   $3,935,484 
           
Supplemental Information:          
Interest paid during the period  $8,320,809   $8,547,252 
Dividends paid during the period under the dividend reinvestment plan  $811,517   $561,662 

 

See accompanying notes to consolidated financial statements.

 

 4 

 

 

KCAP FINANCIAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS

As of September 30, 2015

 

(unaudited)

 

Debt Securities Portfolio

 

Portfolio Company / Principal Business 

Investment
Interest Rate¹ / Maturity

  Principal   Amortized Cost   Fair Value2 

1A Smart Start LLC9, 10

 Consumer goods: Non-durable

  Senior Secured Loan — Term Loan 5.8% Cash, 1.0% Libor Floor, Due 2/22    $3,000,000   $2,970,355   $2,970,000 
                   

4L Technologies Inc. (fka Clover Holdings, Inc.)9, 10

 Consumer goods: Non-durable

  Senior Secured Loan — Term Loan 5.5% Cash, 1.0% Libor Floor, Due 5/20     2,772,000    2,750,704    2,661,673 
                   

Advanced Lighting Technologies, Inc.9, 10

 Consumer goods: Durable

  First Lien Bond — 10.5% - 06/2019 - 00753CAE2 10.5% Cash, Due 6/19     3,000,000    2,976,651    2,317,500 
                   

Advantage Sales & Marketing Inc.9

 Services: Business

  Junior Secured Loan — Term Loan (Second Lien) 7.5% Cash, 1.0% Libor Floor, Due 7/22     1,000,000    1,002,149    960,000 
                   

Alere Inc. (fka IM US Holdings, LLC)10

 Healthcare & Pharmaceuticals

  Senior Secured Loan — B Term Loan  4.3% Cash, 1.0% Libor Floor, Due 6/22     1,246,875    1,243,869    1,248,627 
                   

American Seafoods Group LLC9, 10

 Beverage, Food and Tobacco

  Senior Secured Loan — Term Loan (First Lien) 6.0% Cash, 1.0% Libor Floor, Due 8/21     4,000,000    3,980,330    3,980,000 
                   

Anaren, Inc.9, 10

 Aerospace and Defense

  Senior Secured Loan — Term Loan (First Lien) 5.5% Cash, 1.0% Libor Floor, Due 2/21     1,965,000    1,949,825    1,931,006 
                   

Aristotle Corporation, The9, 10

 Consumer goods: Non-durable

  Senior Secured Loan — Term Loan 5.5% Cash, 1.0% Libor Floor, Due 6/21     3,990,000    3,970,809    3,970,050 
                   

Asurion, LLC (fka Asurion Corporation)9, 10

 Banking, Finance, Insurance & Real Estate

  Senior Secured Loan — Incremental Tranche B-1 Term Loan 5.0% Cash, 1.3% Libor Floor, Due 5/19     941,254    945,393    900,310 
                   

Asurion, LLC (fka Asurion Corporation)9, 10

 Banking, Finance, Insurance & Real Estate

  Senior Secured Loan — Incremental Tranche B-4 Term Loan 5.0% Cash, 1.0% Libor Floor, Due 8/22     898,299    893,894    851,561 

 

 5 

 

 

Portfolio Company / Principal Business  Investment
Interest Rate¹ / Maturity
  Principal   Amortized Cost   Fair Value2 

Avalign Technologies, Inc.9

 Healthcare & Pharmaceuticals

 

Junior Secured Loan — Initial Term Loan (Second Lien)

9.3% Cash, 1.0% Libor Floor, Due 7/22  

  $1,000,000   $990,282   $990,000 
                   

Avalign Technologies, Inc.9, 10

 Healthcare & Pharmaceuticals

 

Senior Secured Loan — Initial Term Loan (First Lien)

5.5% Cash, 1.0% Libor Floor, Due 7/21  

   3,000,000    2,985,494    2,985,000 
                   

Bankruptcy Management Solutions, Inc.9

 Services: Business

 

Senior Secured Loan — Term B Loan

7.0% Cash, 1.0% Libor Floor, Due 6/18  

   687,043    687,043    670,485 
                   

BarBri, Inc. (Gemini Holdings, Inc.)9, 10

 Services: Consumer

 

Senior Secured Loan — Term Loan

4.5% Cash, 1.0% Libor Floor, Due 7/19  

   2,731,875    2,723,181    2,714,664 
                   

BBB Industries US Holdings, Inc.9, 10

 Automotive

 

Senior Secured Loan — Initial Term Loan (First Lien)

6.0% Cash, 1.0% Libor Floor, Due 11/21  

   2,985,000    2,932,990    2,992,433 
                   

Bellisio Foods, Inc. 9, 10

 Beverage, Food and Tobacco

 

Senior Secured Loan — U.S. Term B Loans

5.3% Cash, 1.0% Libor Floor, Due 8/19  

   1,941,681    1,935,177    1,858,965 
                   

Bestop, Inc.9, 10

 Automotive

 

Senior Secured Loan — Revolving Loan

6.3% Cash, 1.0% Libor Floor, Due 7/20  

   40,000    34,207    39,400 
                   

Bestop, Inc.9, 10

  Automotive

 

Senior Secured Loan — Term Loan

6.3% Cash, 1.0% Libor Floor, Due 7/21  

   1,600,000    1,576,690    1,576,000 
                   

Carolina Beverage Group LLC9

Beverage, Food and Tobacco

 

Senior Secured Bond — 10.625% - 08/2018 - 143818AA0 144A

10.6% Cash, Due 8/18  

   1,500,000    1,511,590    1,481,250 
                   

CCS Intermediate Holdings, LLC9, 10

Healthcare & Pharmaceuticals

 

Senior Secured Loan — Initial Term Loan (First Lien)

5.0% Cash, 1.0% Libor Floor, Due 7/21  

   2,970,000    2,957,569    2,782,890 
                   

Cengage Learning Acquisitions, Inc. (fka TL Acquisitions, Inc.)9, 10

Media: Advertising, Printing & Publishing

 

Senior Secured Loan — Term Loan

7.0% Cash, 1.0% Libor Floor, Due 3/20  

   2,979,950    2,974,213    2,961,325 
                   

Checkout Holding Corp. (fka Catalina Marketing)9, 10

Media: Advertising, Printing & Publishing

 

Senior Secured Loan — Term B Loan (First Lien)

4.5% Cash, 1.0% Libor Floor, Due 4/21  

   987,500    983,596    849,250 

 

 6 

 

 

Portfolio Company / Principal Business  Investment
Interest Rate¹ / Maturity
  Principal   Amortized Cost   Fair Value2 

Consolidated Communications, Inc.10

Telecommunications

 

Senior Secured Loan — Initial Term Loan

4.3% Cash, 1.0% Libor Floor, Due 12/20  

  $2,969,773   $2,979,451   $2,969,179 
                   

CRGT Inc.9, 10

High Tech Industries

 

Senior Secured Loan — Term Loan

7.5% Cash, 1.0% Libor Floor, Due 12/20  

   3,937,421    3,883,316    3,927,577 
                   

Crowley Holdings Preferred, LLC9

Transportation: Cargo

 

Preferred Stock — 12.000% - 12/2049 - Series A Income Preferred Securities

10.0% Cash, 2.0% PIK, Due 12/49  

   10,359,873    10,359,873    10,681,029 
                   

Crowne Group, LLC9, 10

Automotive

 

Senior Secured Loan — Term Loan (First Lien)

6.0% Cash, 1.0% Libor Floor, Due 9/20  

   3,960,000    3,910,360    3,813,876 
                   

CSM Bakery Solutions Limited (fka CSM Bakery Supplies Limited)9

Beverage, Food and Tobacco

 

Junior Secured Loan — Term Loan (Second Lien)

8.8% Cash, 1.0% Libor Floor, Due 7/21  

   3,000,000    3,014,477    2,857,500 
                   

CT Technologies Intermediate Holdings, Inc. (Smart Holdings Corp.) (aka HealthPort)9, 10

Healthcare & Pharmaceuticals

 

Senior Secured Loan — Term Loan

5.3% Cash, 1.0% Libor Floor, Due 11/21  

   2,977,538    2,948,937    2,972,580 
                   

DBI Holding LLC9

Services: Business

 

Senior Unsecured Bond — 13% - 09/2019 – PIK Note

0.0% Cash, 16.0% PIK, Due 9/19  

   3,884,871    3,688,411    3,657,995 
                   

DBI Holding LLC9

Services: Business

 

Senior Subordinated Bond — 13% - 09/2019 - Senior Subordinated Note

12.0% Cash, 4.0% PIK, Due 9/19  

   4,435,792    4,420,467    4,221,543 
                   
Drew Marine Group Inc.9

Transportation: Cargo

 

Junior Secured Loan — Term Loan (Second Lien)

8.0% Cash, 1.0% Libor Floor, Due 5/21  

   2,500,000    2,495,280    2,445,500 
                   

ELO Touch Solutions, Inc.9, 10

High Tech Industries

 

Senior Secured Loan — Term Loan (First Lien)

8.0% Cash, 1.5% Libor Floor, Due 6/18  

   1,586,611    1,545,105    1,582,328 
                   

EWT Holdings III Corp. (fka WTG Holdings III Corp.)9

Environmental Industries

 

Junior Secured Loan — Term Loan (Second Lien)

8.5% Cash, 1.0% Libor Floor, Due 1/22  

   4,000,000    3,984,260    3,798,800 
                   

Fender Musical Instruments Corporation9, 10

Consumer goods: Durable

 

Senior Secured Loan — Initial Loan

5.8% Cash, 1.3% Libor Floor, Due 4/19  

   1,630,443    1,639,197    1,630,443 

 

 7 

 

 

Portfolio Company / Principal Business  Investment
Interest Rate¹ / Maturity
  Principal   Amortized Cost   Fair Value2 

FHC Health Systems, Inc.9, 10

Healthcare & Pharmaceuticals

 

Senior Secured Loan — Initial Term Loan

5.0% Cash, 1.0% Libor Floor, Due 12/21  

  $3,887,607   $3,852,677   $3,841,461 
                   

First American Payment Systems, L.P.9

Banking, Finance, Insurance & Real Estate

 

Junior Secured Loan — Term Loan (Second Lien)

10.8% Cash, 1.3% Libor Floor, Due 4/19  

   2,796,448    2,766,004    2,715,351 
                   

Getty Images, Inc.9, 10

Media: Advertising, Printing & Publishing

 

Senior Secured Loan — Initial Term Loan

4.8% Cash, 1.3% Libor Floor, Due 10/19  

   2,168,441    2,174,087    1,420,784 
                   

GK Holdings, Inc. (aka Global Knowledge)9

Services: Business

 

Junior Secured Loan — Initial Term Loan (Second Lien)

10.5% Cash, 1.0% Libor Floor, Due 1/22  

   1,500,000    1,472,798    1,477,500 
                   

GK Holdings, Inc. (aka Global Knowledge)9, 10

Services: Business

 

Senior Secured Loan — Initial Term Loan (First Lien)

6.5% Cash, 1.0% Libor Floor, Due 1/21  

   2,481,250    2,459,141    2,434,603 
                   

Global Tel*Link Corporation9

Telecommunications

 

Junior Secured Loan — Term Loan (Second Lien)

9.0% Cash, 1.3% Libor Floor, Due 11/20  

   4,000,000    3,943,818    3,768,000 
                   

Gold Standard Baking, Inc.9, 10

Beverage, Food and Tobacco

 

Senior Secured Loan — Term Loan

5.5% Cash, 1.0% Libor Floor, Due 4/21  

   2,493,750    2,482,053    2,469,561 
                   

Grande Communications Networks LLC9, 10

Telecommunications

 

Senior Secured Loan — Initial Term Loan

4.5% Cash, 1.0% Libor Floor, Due 5/20  

   3,910,079    3,914,563    3,909,688 
                   

Grupo HIMA San Pablo, Inc.9

Healthcare & Pharmaceuticals

 

Senior Secured Loan — Term B Loan (First Lien)

8.5% Cash, 1.5% Libor Floor, Due 1/18  

   2,925,000    2,897,657    2,866,500 
                   

Grupo HIMA San Pablo, Inc.9

Healthcare & Pharmaceuticals

 

Junior Secured Loan — Term Loan (Second Lien)

13.8% Cash, Due 7/18  

   7,000,000    6,916,737    6,650,000 
                   

Gymboree Corporation., The9, 10

Retail

 

Senior Secured Loan — Term Loan

5.0% Cash, 1.5% Libor Floor, Due 2/18  

   1,421,105    1,402,760    941,305 
                   

Hargray Communications Group, Inc. (HCP Acquisition LLC)9, 10

Media: Broadcasting & Subscription

 

Senior Secured Loan — Initial Term Loan

5.3% Cash, 1.0% Libor Floor, Due 6/19  

   2,927,271    2,908,947    2,928,442 

 

 8 

 

 

Portfolio Company / Principal Business  Investment
Interest Rate¹ / Maturity
  Principal   Amortized Cost   Fair Value2 

Harland Clarke Holdings Corp. (fka Clarke American Corp.)9, 10

Media: Advertising, Printing & Publishing

 

Senior Secured Loan — Tranche B-3 Term Loan

7.0% Cash, 1.5% Libor Floor, Due 5/18  

  $3,303,125   $3,282,743   $3,302,464 
                   

Harland Clarke Holdings Corp. (fka Clarke American Corp.)9, 10

Media: Advertising, Printing & Publishing

 

Senior Secured Loan — Tranche B-4 Term Loan

6.0% Cash, 1.0% Libor Floor, Due 8/19  

   1,434,375    1,429,354    1,431,506 
                   

Hoffmaster Group, Inc.9

Forest Products & Paper

 

Junior Secured Loan — Initial Term Loan (Second Lien)

10.0% Cash, 1.0% Libor Floor, Due 5/21  

   2,000,000    1,975,937    1,998,600 
                   

Hoffmaster Group, Inc.9, 10

Forest Products & Paper

 

Senior Secured Loan — Initial Term Loan (First Lien)

5.3% Cash, 1.0% Libor Floor, Due 5/20  

   3,950,000    3,919,537    3,946,307 
                   

Hunter Defense Technologies, Inc.9, 10

Aerospace and Defense

 

Senior Secured Loan — Term Loan (First Lien)

6.5% Cash, 1.0% Libor Floor, Due 8/19  

   2,850,000    2,827,819    2,722,605 
                   

Integra Telecom Holdings, Inc.9, 10

Telecommunications

 

Senior Secured Loan — Term B-1 Loan

5.3% Cash, 1.0% Libor Floor, Due 8/20  

   2,969,848    2,959,523    2,967,769 
                   

International Architectural Products, Inc.7, 9

Metals & Mining

 

Senior Secured Loan — Term Loan

0.0% Cash, 3.3% PIK, 2.5% Libor Floor, Due 5/15  

   247,636    228,563    1,000 
                   

Kellermeyer Bergensons Services, LLC9, 10

Services: Business

 

Senior Secured Loan — Initial Term Loan (First Lien)

6.0% Cash, 1.0% Libor Floor, Due 10/21  

   1,985,000    1,967,713    1,960,188 
                   

Key Safety Systems, Inc.9, 10

Automotive

 

Senior Secured Loan — Initial Term Loan

4.8% Cash, 1.0% Libor Floor, Due 8/21  

   1,485,000    1,478,731    1,454,506 
                   

Kinetic Concepts, Inc.9, 10

Healthcare & Pharmaceuticals

 

Senior Secured Loan — Dollar Term E-1 Loan

4.5% Cash, 1.0% Libor Floor, Due 5/18  

   2,969,773    2,963,987    2,966,372 
                   

Landslide Holdings, Inc. (Crimson Acquisition Corp.)9, 10

High Tech Industries

 

Senior Secured Loan — New Term Loan (First Lien)

5.0% Cash, 1.0% Libor Floor, Due 2/20  

   3,430,263    3,437,455    3,313,291 
                   

MB Aerospace ACP Holdings III Corp.9, 10

Aerospace and Defense

 

Senior Secured Loan — Dollar Term Loan

5.0% Cash, 1.0% Libor Floor, Due 5/19  

   3,642,024    3,619,743    3,642,024 

 

 9 

 

 

Portfolio Company / Principal Business  Investment
Interest Rate¹ / Maturity
  Principal   Amortized Cost   Fair Value2 

Medical Specialties Distributors, LLC9, 10

Healthcare & Pharmaceuticals

 

Senior Secured Loan — Term Loan

6.5% Cash, 1.0% Libor Floor, Due 12/19  

  $3,930,000   $3,902,594   $3,823,104 
                   

MGOC, Inc. (fka Media General, Inc.)10

Media: Broadcasting & Subscription

 

Senior Secured Loan — Term B Loan

4.0% Cash, 1.0% Libor Floor, Due 7/20  

   2,717,813    2,720,774    2,700,555 
                   

Millennium Health, LLC (fka Millennium Laboratories, LLC)9

Healthcare & Pharmaceuticals

 

Senior Secured Loan — Tranche B Term Loan

5.3% Cash, 1.0% Libor Floor, Due 4/21  

   2,969,925    2,969,925    954,088 
                   

Nellson Nutraceutical, LLC9, 10

Beverage, Food and Tobacco

 

Senior Secured Loan — Term A-1 Loan (First Lien)

6.0% Cash, 1.0% Libor Floor, Due 12/21  

   2,380,576    2,361,697    2,333,441 
                   

Nellson Nutraceutical, LLC9, 10

Beverage, Food and Tobacco

 

Senior Secured Loan — Term A-2 Loan (First Lien)

6.0% Cash, 1.0% Libor Floor, Due 12/21  

   2,098,176    2,080,808    2,056,633 
                   

Nielsen & Bainbrige, LLC9

Consumer goods: Durable

 

Senior Secured Loan — Term Loan (First Lien)

6.0% Cash, 1.0% Libor Floor, Due 8/20  

   992,502    984,316    961,635 
                   

Nielsen & Bainbrige, LLC9

Consumer goods: Durable

 

Junior Secured Loan — Term Loan (Second Lien)

10.3% Cash, 1.0% Libor Floor, Due 8/21  

   2,091,954    2,064,716    1,924,598 
                   

Nielsen & Bainbrige, LLC9, 10

Consumer goods: Durable

 

Senior Secured Loan — Term Loan (First Lien)

6.0% Cash, 1.0% Libor Floor, Due 8/20  

   3,795,448    3,763,274    3,677,409 
                   
NM Z Parent Inc. (aka Zep, Inc.)9, 10

Chemicals, Plastics and Rubber

 

Senior Secured Loan — Initial Term Loan

5.8% Cash, 1.0% Libor Floor, Due 6/22  

   3,491,250    3,503,317    3,463,669 
                   

Novetta, LLC9

Services: Business

 

Senior Secured Loan — Initial Term Loan

6.0% Cash, 1.0% Libor Floor, Due 10/20  

   2,722,500    2,699,157    2,722,500 
                   

Novitex Acquisition, LLC (fka ARSloane Acquisition, LLC)9, 10

Services: Business

 

Senior Secured Loan — Tranche B-2 Term Loan (First Lien)

7.5% Cash, 1.3% Libor Floor, Due 7/20  

   978,853    971,079    902,698 

 

 10 

 

 

Portfolio Company / Principal Business  Investment
Interest Rate¹ / Maturity
  Principal   Amortized Cost   Fair Value2 

Onex Carestream Finance LP9

Healthcare & Pharmaceuticals

 

Junior Secured Loan — Term Loan (Second Lien)

9.5% Cash, 1.0% Libor Floor, Due 12/19  

  $1,932,311   $1,932,311   $1,901,201 
                   

Onex Carestream Finance LP9, 10

Healthcare & Pharmaceuticals

 

Senior Secured Loan — Term Loan (First Lien 2013)

5.0% Cash, 1.0% Libor Floor, Due 6/19  

   1,882,721    1,888,026    1,809,765 
                   

Otter Products, LLC (OtterBox Holdings, Inc.)9, 10

Consumer goods: Durable

 

Senior Secured Loan — Term B Loan

5.8% Cash, 1.0% Libor Floor, Due 6/20  

   2,754,168    2,735,107    2,663,280 
                   

Ozburn-Hessey Holding Company LLC9, 10

Transportation: Cargo

 

Senior Secured Loan — Term Loan

6.8% Cash, 1.3% Libor Floor, Due 5/19  

   3,485,681    3,479,849    3,477,316 
                   

PGX Holdings, Inc.9, 10

Services: Consumer

 

Senior Secured Loan — Initial Term Loan (First Lien)

5.8% Cash, 1.0% Libor Floor, Due 9/20  

   3,828,571    3,796,579    3,724,051 
                   

Playpower, Inc.9, 10

Construction & Building

 

Senior Secured Loan — Initial Term Loan (First Lien)

5.8% Cash, 1.0% Libor Floor, Due 6/21  

   1,995,000    1,980,681    1,982,831 
                   

PSC Industrial Holdings Corp.9, 10

Environmental Industries

 

Senior Secured Loan — Term Loan (First Lien)

5.8% Cash, 1.0% Libor Floor, Due 12/20  

   1,985,000    1,967,757    1,928,825 
                   

Quad-C JH Holdings Inc. (aka Joerns Healthcare)9, 10

Healthcare & Pharmaceuticals

 

Senior Secured Loan — Term Loan A

6.2% Cash, 1.0% Libor Floor, Due 5/20  

   3,950,013    3,927,029    3,859,558 
                   

Ravn Air Group, Inc.9, 10

Transportation: Consumer

 

Senior Secured Loan — Initial Term Loan

5.5% Cash, 1.0% Libor Floor, Due 7/21  

   2,500,000    2,487,820    2,487,500 
                   

Reynolds Group Holdings Inc.9, 10

Containers, Packaging and Glass

 

Senior Secured Loan — Incremental U.S. Term Loan

4.5% Cash, 1.0% Libor Floor, Due 12/18  

   2,916,649    2,916,649    2,921,622 
                   

Roscoe Medical, Inc.9

Healthcare & Pharmaceuticals

 

Junior Secured Loan — Term Loan (Second Lien)

11.3% Cash, Due 9/19  

   6,700,000    6,651,467    6,391,130 

 

 11 

 

 

Portfolio Company / Principal Business  Investment
Interest Rate¹ / Maturity
  Principal   Amortized Cost   Fair Value2 

Rovi Solutions Corporation / Rovi Guides, Inc.10

High Tech Industries

 

Senior Secured Loan — Term B Loan

3.8% Cash, 0.8% Libor Floor, Due 7/21  

  $2,969,925   $2,936,592   $2,829,447 
                   

Sandy Creek Energy Associates, L.P.9, 10

Utilities: Electric

 

Senior Secured Loan — Term Loan

5.0% Cash, 1.0% Libor Floor, Due 11/20  

   2,729,107    2,719,110    2,415,260 
                   

SGF Produce Holding Corp.(Frozsun, Inc.)9

Beverage, Food and Tobacco

 

Senior Secured Loan — Term Loan

6.5% Cash, 1.0% Libor Floor, Due 3/19  

   2,174,827    2,162,053    2,174,827 
                   

SGF Produce Holding Corp.(Frozsun, Inc.)9, 10

Beverage, Food and Tobacco

 

Senior Secured Loan — Term Loan

6.5% Cash, 1.0% Libor Floor, Due 3/19  

   4,907,181    4,910,983    4,907,181 
                   

Stafford Logistics, Inc.(dba Custom Ecology, Inc.)9, 10

Environmental Industries

 

Senior Secured Loan — Term Loan

7.5% Cash, 1.3% Libor Floor, Due 6/19  

   2,861,935    2,844,078    2,833,316 
                   

Sun Products Corporation, The (fka Huish Detergents Inc.)9, 10

Consumer goods: Non-durable

 

Senior Secured Loan — Tranche B Term Loan

5.5% Cash, 1.3% Libor Floor, Due 3/20  

   3,882,654    3,862,633    3,672,350 
                   

Tank Partners Holdings, LLC9

Energy: Oil & Gas

 

Senior Secured Loan — Loan

6.6% Cash, 3.5% PIK, 3.0% Libor Floor, Due 8/19  

   10,665,282    10,520,547    8,939,640 
                   

TPF II Power, LLC (TPF II Covert Midco, LLC)9, 10

Utilities: Electric

 

Senior Secured Loan — Term Loan

5.5% Cash, 1.0% Libor Floor, Due 10/21  

   2,958,405    2,982,024    2,931,483 
                   

Trimaran Advisors, L.L.C.9

Related Party Loan

 

Senior Unsecured Loan — Revolving Credit Facility

9.0% Cash, Due 11/17  

   23,000,000    23,000,000    23,000,000 
                   

TRSO I, Inc.9

Energy: Oil & Gas

 

Junior Secured Loan — Term Loan (Second Lien)

11.0% Cash, 1.0% Libor Floor, Due 12/17  

   1,000,000    991,092    961,500 
                   

TWCC Holding Corp.9

Media: Broadcasting & Subscription

 

Junior Secured Loan — Term Loan (Second Lien)

7.0% Cash, 1.0% Libor Floor, Due 6/20  

   1,000,000    1,003,459    956,300 

 

 12 

 

 

Portfolio Company / Principal Business  Investment
Interest Rate¹ / Maturity
  Principal   Amortized Cost   Fair Value2 

TWCC Holding Corp.9, 10

Media: Broadcasting & Subscription

 

Senior Secured Loan — Term B-1 Loan

5.8% Cash, 0.8% Libor Floor, Due 2/20  

  $824,541   $826,440   $814,317 
                   

U.S. Shipping Corp (fka U.S. Shipping Partners LP)9, 10

Transportation: Cargo

 

Senior Secured Loan — Tranche B-2 Term Loan

5.3% Cash, 1.0% Libor Floor, Due 6/21  

   1,496,250    1,495,078    1,496,699 
                   

USJ-IMECO Holding Company, LLC9, 10

Transportation: Cargo

 

Senior Secured Loan — Term Loan

7.0% Cash, 1.0% Libor Floor, Due 4/20  

   3,940,000    3,924,953    3,940,000 
                   

Vantiv, LLC (fka Fifth Third Processing Solutions, LLC)10

Banking, Finance, Insurance & Real Estate

 

Senior Secured Loan — Term B Loan

3.8% Cash, 0.8% Libor Floor, Due 6/21  

   1,693,520    1,697,226    1,698,456 
                   

Verdesian Life Sciences, LLC9

Environmental Industries

 

Senior Secured Loan — Initial Term Loan

6.0% Cash, 1.0% Libor Floor, Due 7/20  

   937,550    926,367    909,329 
                   

Verdesian Life Sciences, LLC9, 10

Environmental Industries

 

Senior Secured Loan — Initial Term Loan

6.0% Cash, 1.0% Libor Floor, Due 7/20  

   3,097,474    3,061,567    3,004,240 
                   

Vestcom International, Inc. (fka Vector Investment Holdings, Inc.)9, 10

Retail

 

Senior Secured Loan — Term Loan

5.3% Cash, 1.0% Libor Floor, Due 9/21  

   2,997,400    2,987,671    2,929,359 
                   

Weiman Products, LLC9

Consumer goods: Non-durable

 

Senior Secured Loan — Term Loan

6.3% Cash, 1.0% Libor Floor, Due 11/18  

   2,949,755    2,930,768    2,949,755 

 

Portfolio Company / Principal Business  Investment
Interest Rate¹ / Maturity
  Principal   Amortized Cost   Value2 

Weiman Products, LLC9, 10

Consumer goods: Non-durable

 

Senior Secured Loan — Term Loan

6.3% Cash, 1.0% Libor Floor, Due 11/18  

  $3,933,007    3,908,280    3,933,007 
                   

WireCo WorldGroup Inc. 9

Capital Equipment

 

Senior Unsecured Bond — 9.000% - 05/2017

9.0% Cash, Due 5/17  

   5,000,000    5,006,206    4,337,500 
                   

WireCo WorldGroup Inc. 9, 10

Capital Equipment

 

Senior Unsecured Bond — 9.000% - 05/2017

9.0% Cash, Due 5/17  

   3,000,000    3,003,723    2,602,500 
                   
Total Investment in Debt Securities
(126% of net asset value at fair value)
     $308,374,718   $306,613,274   $296,284,441 

 

 13 

 

 

Equity Securities Portfolio

 

Portfolio Company / Principal Business  Investment  Percentage
Ownership/Shares
   Amortized Cost   Fair Value2 

Aerostructures Holdings L.P.5, 9

Aerospace and Defense

  Partnership Interests     1.2%  $1,000,000   $1,000 
                   

Aerostructures Holdings L.P.5, 9

Aerospace and Defense

  Series A Preferred Interests     1.2%   250,960    772,631 
                   

Caribe Media Inc. (fka Caribe Information Investments Incorporated)5, 9

Media: Advertising, Printing & Publishing

  Common     1.3%   359,765    609,478 
                   

DBI Holding LLC5, 9

Services: Business

  Class A Warrants     3.2%   258,940    1,504,844 
                   

eInstruction Acquisition, LLC5, 9

Services: Business

  Membership Units     1.1%   1,079,617    1,000 
                   

FP WRCA Coinvestment Fund VII, Ltd.3, 5,

Capital Equipment

  Class A Shares     1,500    1,500,000    1,497,999 
                   

Perseus Holding Corp.5, 9

Hotel, Gaming & Leisure

  Common     0.2%   400,000    1,000 
                   

Roscoe Investors, LLC5, 9

Healthcare & Pharmaceuticals

  Class A Units     1.6%   1,000,000    940,700 
                   

Tank Partners Holdings, LLC5, 9, 12

Energy: Oil & Gas

  Unit     5.8%   980,000    300,976 
                   

Tank Partners Holdings, LLC5, 9

Energy: Oil & Gas

  Warrants     1.3%   185,205    89,462 
                   

TRSO II, Inc.5, 9, 12

Energy: Oil & Gas

  Common Stock     5.4%   1,500,000    1,217,563 
                   
Total Investment in Equity Securities                  
 (3% of net asset value at fair value)          $8,514,487   $6,936,653 

 

 14 

 

 

CLO Fund Securities

 

CLO Subordinated Investments

 

Portfolio Company  Investment14  Percentage
Ownership
   Amortized Cost   Fair Value2 
Grant Grove CLO, Ltd.3  Subordinated Securities, effective interest 12.0%, 1/21 maturity     22.2%  $2,488,323   $362,691 
Katonah III, Ltd.3,14  Preferred Shares, effective interest N/M, 5/15 maturity     23.1%   1,366,357    385,000 
Katonah IX CLO Ltd3, 6, 14  Preferred Shares, effective interest 2.2%, 1/19 maturity     6.9%   1,172,498    100,000 
Katonah X CLO Ltd 3, 6, 14  Subordinated Securities, effective interest 17.7%, 4/20 maturity     33.3%   9,074,951    2,600,000 
Katonah 2007-I CLO Ltd.3, 6  Preferred Shares, effective interest 27.5%, 4/22 maturity     100.0%   23,975,870    23,233,837 
Trimaran CLO VII, Ltd.3, 6  Income Notes, effective interest 46.0%, 6/21 maturity     10.5%   1,349,606    2,024,945 
Catamaran CLO 2012-1 Ltd.3, 6  Subordinated Notes, effective interest 4.0%, 12/23 maturity     24.9%   7,154,268    4,295,666 
Catamaran CLO 2013- 1 Ltd.3, 6  Subordinated Notes, effective interest 12.9%, 1/25 maturity     23.5%   6,559,985    6,561,900 
Catamaran CLO 2014-1 Ltd.3, 6  Subordinated Notes, effective interest 7.6%, 4/26 maturity     24.9%   9,264,284    7,251,390 
Dryden 30 Senior Loan Fund3  Subordinated Notes, effective interest 28.7.%, 11/25 maturity     7.5%   1,643,183    2,290,600 
Catamaran CLO 2014-2 Ltd.3, 6  Subordinated Notes, effective interest 5.9%, 10/26 maturity     24.9%   8,374,214    6,932,673 
Catamaran CLO 2015-1 Ltd.3, 6  Subordinated Notes, effective interest 9.9%, 4/27 maturity     24.0%   12,439,015    9,442,080 
                   
Total Investment in CLO Subordinated Securities          $84,862,554   $65,480,782 

 

 15 

 

 

CLO Rated-Note Investment

 

Portfolio Company   Investment   Percentage
Ownership
   Amortized Cost   Fair Value2 
Catamaran CLO 2014-1 Ltd.3, 6 

Float - 04/2026 - E - 14889FAC7

Par Value of $1,525,000

Due 4/26  

   15.1%   1,425,893    1,240,000 
                   
Total Investment in CLO Rated-Note          $1,425,893   $1,240,000 
                   
Total Investment in CLO Fund Securities   
(28% of net asset value at fair value)
          $86,288,447   $66,720,782 

 

Asset Manager Affiliates

 

Portfolio Company / Principal Business   Investment   Percentage
Ownership
   Cost   Fair Value2 
Asset Manager Affiliates9, 11  Asset Management Company     100.0%  $57,189,159   $64,121,000 
                   
Total Investment in Asset Manager Affiliates   
(27% of net asset value at fair value)
          $57,189,159   $64,121,000 

 

Time Deposits and Money Market Account

 

Time Deposit and Money Market Accounts   Investment   Yield   Par /Amortized Cost   Fair Value2 
JP Morgan Business Money Market
Account8, 9
  Money Market Account     0.10%  $249,216   $249,216 
                   
US Bank Money Market Account9  Money Market Account     0.02%   3,096,507    3,096,507 
                   
Total Investment in Time Deposit and Money Market Accounts   
(1% of net asset value at fair value)
          $3,345,723   $3,345,723 
                   
Total Investments4
(186% of net asset value at fair value)
          $461,951,090   $437,408,599 

 

See accompanying notes to consolidated financial statements.

 

 16 

 

 

1

 

A majority of the variable rate loans in the Company’s investment portfolio bear interest at a rate that may be determined by reference to either LIBOR or an alternate Base Rate (commonly based on the Federal Funds Rate or the Prime Rate), which typically resets semi-annually, quarterly, or monthly at the borrower’s option. The Borrower may also elect to have multiple interest reset periods for each loan. For each such loan, the Company has provided the weighted average annual stated interest rate in effect at September 30, 2015. As noted in the table above, 78% (based on par) of debt securities contain LIBOR floors which range between .75% and 3.00%.
2 Reflects the fair market value of all investments as of September 30, 2015, as determined by the Company’s Board of Directors.
3 Non-U.S. company or principal place of business outside the U.S.
4 The aggregate cost of investments for federal income tax purposes is approximately $480 million. The aggregate gross unrealized appreciation is approximately $9.7 million, the aggregate gross unrealized depreciation is approximately $52.7 million, and the net unrealized depreciation is approximately $43.0 million.
5 Non-income producing.
6 An affiliate CLO Fund managed by an Asset Manager Affiliate (as such term is defined in the notes to the consolidated financial statements).
7 Loan or debt security is on non-accrual status and therefore is considered non-income producing.
8 Money market account holding restricted cash and security deposits for employee benefit plans.
9 Qualified asset for purposes of section 55(a) of the Investment Company Act of 1940.
10 As of September 30, 2015, this investment is owned by KCAP Senior Funding I, LLC and was pledged to secure KCAP Senior Funding I, LLC’s obligation.
11 Other than the Asset Manager Affiliate, which we are deemed to “control”, we do not “control” and are not an “affiliate” of any of our portfolio companies, each as defined in the Investment Company Act of 1940 (the “1940 Act”). In general, under the 1940 Act, we would be presumed to “control” a portfolio company if we owned 25% or more of its voting securities and would be an “affiliate” of a portfolio company if we owned 5% or more of its voting securities.
12 Non-voting.
13 CLO Subordinated Investments are entitled to periodic distributions which are generally equal to the remaining cash flow of the payments made by the underlying fund’s investments less contractual payments to debt holders and fund expenses. The estimated annualized effective yield indicated is based upon a current projection of the amount and timing of these distributions. Such projections are updated on a quarterly basis and the estimated effective yield is adjusted prospectively.
14 Notice of redemption has been received for this transaction.

 

 17 

 

KCAP FINANCIAL, INC.

SCHEDULE OF INVESTMENTS

As of December 31, 2014

 

Debt Securities Portfolio

 

Portfolio Company / Principal Business 

Investment

Interest Rate¹ / Maturity

  Principal   Amortized Cost   Fair Value2 

4L Technologies Inc. (fka Clover Holdings, Inc.)9, 11

Consumer goods: Non-durable

  Senior Secured Loan — Term Loan
5.5% Cash, 1.0% Libor Floor, Due 5/20
  $2,793,000   $2,768,057   $2,723,175 
                   

Advanced Lighting Technologies, Inc.9, 11

Consumer goods: Durable

  First Lien Bond —
10.5% Cash, Due 6/19
   3,000,000    2,962,507    2,580,000 
                    

Advantage Sales & Marketing Inc.9

Services: Business

  Junior Secured Loan — Term Loan (Second Lien)
7.5% Cash, 1.0% Libor Floor, Due 7/22
   1,000,000    1,002,384    992,000 
                   

Alaska Communications Systems Holdings, Inc.9, 11

Telecommunications

  Senior Secured Loan — Term Loan
6.3% Cash, 1.5% Libor Floor, Due 10/16
   5,200,227    5,193,935    5,200,227 
                   

Alere Inc. (fka IM US Holdings, LLC)11

Healthcare & Pharmaceuticals

  Senior Secured Loan — B Term Loan
4.3% Cash, 1.0% Libor Floor, Due 6/17
   2,992,277    2,988,629    2,972,947 
                   

AmSurg Corp.11

Healthcare & Pharmaceuticals

  Senior Secured Loan — Initial Term Loan
3.8% Cash, 0.8% Libor Floor, Due 7/21
   2,992,481    2,992,481    2,975,020 
                   

Anaren, Inc.9, 11

Aerospace and Defense

  Senior Secured Loan — Term Loan (First Lien)
5.5% Cash, 1.0% Libor Floor, Due 2/21
   1,980,000    1,962,587    1,955,250 
                   

Asurion, LLC (fka Asurion Corporation)9, 11

Banking, Finance, Insurance & Real Estate

  Senior Secured Loan — Incremental Tranche B-1 Term Loan
5.0% Cash, 1.3% Libor Floor, Due 5/19
   1,917,430    1,932,331    1,896,549 
                   

AZ Chem US Inc.9, 11

Chemicals, Plastics and Rubber

  Senior Secured Loan — Initial Term Loan (First Lien)
4.5% Cash, 1.0% Libor Floor, Due 6/21
   467,123    464,966    457,977 
                   

Bankruptcy Management Solutions, Inc.9

Services: Business

  Senior Secured Loan — Term B Loan
7.0% Cash, 1.0% Libor Floor, Due 6/18
   700,227    700,227    624,463 

 

 18 

 

 

Portfolio Company / Principal Business 

Investment

Interest Rate¹ / Maturity

  Principal   Amortized Cost   Fair Value2 

BarBri, Inc. (Gemini Holdings, Inc.)9, 11

Services: Consumer

  Senior Secured Loan — Term Loan
4.5% Cash, 1.0% Libor Floor, Due 7/19
  $2,872,500   $2,861,557   $2,835,158 
                   

BBB Industries US Holdings, Inc.9, 11

Automotive

  Senior Secured Loan — Initial Term Loan (First Lien)
6.0% Cash, 1.0% Libor Floor, Due 11/21
   3,000,000    2,941,316    2,985,000 
                   

Bellisio Foods, Inc. 9, 11

Beverage, Food and Tobacco

  Senior Secured Loan — U.S. Term B Loans
5.3% Cash, 1.0% Libor Floor, Due 8/19
   2,239,551    2,230,586    2,235,071 
                   

Blue Coat Systems, Inc.9, 11

High Tech Industries

  Senior Secured Loan — New Term Loan
4.0% Cash, 1.0% Libor Floor, Due 5/19
   467,636    468,971    456,530 
                   

Carolina Beverage Group LLC9

Beverage, Food and Tobacco

  Senior Secured Bond —
10.6% Cash, Due 8/18
   1,500,000    1,515,584    1,552,500 
                   

CCS Intermediate Holdings, LLC9, 11

Healthcare & Pharmaceuticals

  Senior Secured Loan — Initial Term Loan (First Lien)
5.0% Cash, 1.0% Libor Floor, Due 7/21
   2,992,500    2,978,364    2,940,131 
                   

Cengage Learning Acquisitions, Inc. (fka TL Acquisitions, Inc.)9, 11

Media: Advertising, Printing & Publishing

  Senior Secured Loan — Term Loan
7.0% Cash, 1.0% Libor Floor, Due 3/20
   2,987,475    2,980,768    2,963,829 
                   

Charter Communications Operating, LLC (aka CCO Safari LLC)11

Media: Broadcasting & Subscription

  Senior Secured Loan — Term G Loan
4.3% Cash, 0.8% Libor Floor, Due 9/21
   3,000,000    3,022,408    3,022,980 
                   

Checkout Holding Corp.9, 11

Media: Advertising, Printing & Publishing

  Senior Secured Loan — Term B Loan (First Lien)
4.5% Cash, 1.0% Libor Floor, Due 4/21
   995,000    990,534    951,474 
                   

Consolidated Communications, Inc.11

Telecommunications

  Senior Secured Loan — Initial Term Loan
4.3% Cash, 1.0% Libor Floor, Due 12/20
   2,992,443    3,003,588    2,976,538 
                   

CRGT Inc.9, 11

High Tech Industries

  Senior Secured Loan — Term Loan
7.5% Cash, 1.0% Libor Floor, Due 12/20
   3,000,000    2,940,000    2,955,000 
                   

Crowley Holdings Preferred, LLC9

Transportation: Cargo

  Preferred Stock —
10.0% Cash, 2.0% PIK, Due 12/49
   10,206,016    10,206,016    10,418,302 

 

 19 

 

 

Portfolio Company / Principal Business 

Investment

Interest Rate¹ / Maturity

  Principal   Amortized Cost   Fair Value2 

Crowne Group, LLC9, 11

Automotive

  Senior Secured Loan — Term Loan (First Lien)
6.0% Cash, 1.0% Libor Floor, Due 9/20
  $3,990,000   $3,932,506   $3,838,779 
                   

CSM Bakery Solutions Limited (fka CSM Bakery Supplies Limited)9

Beverage, Food and Tobacco

  Junior Secured Loan — Term Loan (Second Lien)
8.8% Cash, 1.0% Libor Floor, Due 7/21
   3,000,000    3,016,357    2,910,000 
                   

CSM Bakery Solutions Limited (fka CSM Bakery Supplies Limited)9, 11

Beverage, Food and Tobacco

  Senior Secured Loan — Term Loan (First Lien)
5.0% Cash, 1.0% Libor Floor, Due 7/20
   2,623,371    2,622,454    2,570,903 
                   

CT Technologies Intermediate Holdings, Inc. (Smart Holdings Corp.)9, 11

Healthcare & Pharmaceuticals

  Senior Secured Loan — Initial Term Loan
6.0% Cash, 1.0% Libor Floor, Due 12/21
   3,000,000    2,970,271    2,988,750 
                   

DBI Holding LLC9

Services: Business

  Senior Unsecured Bond —
13.0% PIK, Due 9/19
   3,457,795    3,221,771    3,386,218 
                   

DBI Holding LLC9

Services: Business

  Senior Subordinated Bond —
12.0% Cash, 1.0% PIK, Due 9/19
   4,314,949    4,295,544    4,240,301 
                   

DJO Finance LLC (ReAble Therapeutics Fin LLC)9, 11

Healthcare & Pharmaceuticals

  Senior Secured Loan — New Tranche B Term Loan
4.3% Cash, 1.0% Libor Floor, Due 9/17
   2,063,574    2,063,574    2,022,303 
                   

Drew Marine Group Inc.9

Transportation: Cargo

  Junior Secured Loan — Term Loan (Second Lien)
8.0% Cash, 1.0% Libor Floor, Due 5/21
   2,500,000    2,494,654    2,523,250 
                   

ELO Touch Solutions, Inc.9, 11

High Tech Industries

  Senior Secured Loan — Term Loan (First Lien)
8.0% Cash, 1.5% Libor Floor, Due 6/18
   1,726,036    1,677,698    1,642,496 
                   

EWT Holdings III Corp. (fka WTG Holdings III Corp.)9

Environmental Industries

  Junior Secured Loan — Term Loan (Second Lien)
8.5% Cash, 1.0% Libor Floor, Due 1/22
   4,000,000    3,982,390    4,033,200 
                   

Fender Musical Instruments Corporation9, 11

Consumer goods: Durable

  Senior Secured Loan — Initial Loan
5.8% Cash, 1.3% Libor Floor, Due 4/19
   2,002,536    2,012,321    1,982,110 
                   

FHC Health Systems, Inc.9, 11

Healthcare & Pharmaceuticals

  Senior Secured Loan — Initial Term Loan
5.0% Cash, 1.0% Libor Floor, Due 12/21
   3,407,143    3,373,191    3,381,589 

 

 20 

 

 

Portfolio Company / Principal Business 

Investment

Interest Rate¹ / Maturity

  Principal   Amortized Cost   Fair Value2 

First American Payment Systems, L.P.9

Banking, Finance, Insurance & Real Estate

  Junior Secured Loan — Term Loan (Second Lien)
10.8% Cash, 1.3% Libor Floor, Due 4/19
  $2,796,448   $2,759,556   $2,782,466 
                   

First Data Corporation9, 11

Banking, Finance, Insurance & Real Estate

  Senior Secured Loan — 2018 New Dollar Term Loan
3.7% Cash, Due 3/18
   1,000,000    968,906    982,190 
                   

Getty Images, Inc.9, 11

Media: Advertising, Printing & Publishing

  Senior Secured Loan — Initial Term Loan
4.8% Cash, 1.3% Libor Floor, Due 10/19
   2,185,164    2,187,551    2,012,165 
                   

Global Tel*Link Corporation9

Telecommunications

  Junior Secured Loan — Term Loan (Second Lien)
9.0% Cash, 1.3% Libor Floor, Due 11/20
   4,000,000    3,935,659    3,889,200 
                   

Grande Communications Networks LLC9, 11

Telecommunications

  Senior Secured Loan — Initial Term Loan
4.5% Cash, 1.0% Libor Floor, Due 5/20
   3,940,040    3,944,690    3,938,464 
                   

Grifols Worldwide Operations Limited11

Healthcare & Pharmaceuticals

  Senior Secured Loan — U.S. Tranche B Term Loam
3.2% Cash, Due 2/21
   2,992,462    2,970,236    2,956,298 
                   

Grupo HIMA San Pablo, Inc.9

Healthcare & Pharmaceuticals

  Senior Secured Loan — Term B Loan (First Lien)
8.5% Cash, 1.5% Libor Floor, Due 1/18
   2,947,500    2,911,129    2,947,500 
                   

Grupo HIMA San Pablo, Inc.9

Healthcare & Pharmaceuticals

  Junior Secured Loan — Term Loan (Second Lien)
13.8% Cash, Due 7/18
   7,000,000    6,894,754    7,105,000 
                   

Gymboree Corporation., The9, 11

Retail

  Senior Secured Loan — Term Loan
5.0% Cash, 1.5% Libor Floor, Due 2/18
   1,421,105    1,390,786    935,563 
                   

Hargray Communications Group, Inc. (HCP Acquisition LLC)9, 11

Media: Broadcasting & Subscription

  Senior Secured Loan — Initial Term Loan
5.3% Cash, 1.0% Libor Floor, Due 6/19
   2,930,662    2,908,645    2,928,611 
                   

Harland Clarke Holdings Corp. (fka Clarke American Corp.)9, 11

Media: Advertising, Printing & Publishing

  Senior Secured Loan — Tranche B-3 Term Loan
7.0% Cash, 1.5% Libor Floor, Due 5/18
   3,368,750    3,343,813    3,385,594 
                   

Harland Clarke Holdings Corp. (fka Clarke American Corp.)9, 11

Media: Advertising, Printing & Publishing

  Senior Secured Loan — Tranche B-4 Term Loan
6.0% Cash, 1.0% Libor Floor, Due 8/19
   1,462,500    1,456,384    1,458,661 

 

 21 

 

 

Portfolio Company / Principal Business 

Investment

Interest Rate¹ / Maturity

  Principal   Amortized Cost   Fair Value2 

Hoffmaster Group, Inc.9

Forest Products & Paper

  Junior Secured Loan — Initial Term Loan (Second Lien)
10.0% Cash, 1.0% Libor Floor, Due 5/21
  $2,000,000   $1,972,727   $1,999,000 
                   

Hoffmaster Group, Inc.9, 11

Forest Products & Paper

  Senior Secured Loan — Initial Term Loan (First Lien)
5.3% Cash, 1.0% Libor Floor, Due 5/20
   3,980,000    3,944,324    3,943,523 
                   

Hunter Defense Technologies, Inc.9, 11

Aerospace and Defense

  Senior Secured Loan — Term Loan (First Lien)
6.5% Cash, 1.0% Libor Floor, Due 8/19
   2,962,500    2,934,961    2,988,866 
                   

Integra Telecom Holdings, Inc.9, 11

Telecommunications

  Senior Secured Loan — Term B Loan
5.3% Cash, 1.3% Libor Floor, Due 2/19
   2,992,386    2,981,164    2,919,461 
                   

International Architectural Products, Inc.7, 9

Metals & Mining

  Senior Secured Loan — Term Loan
Due 5/15
   247,636    228,563    1,000 
                   

Kellermeyer Bergensons Services, LLC9

Services: Business

  Senior Secured Loan — Initial Term Loan (First Lien)
6.0% Cash, 1.0% Libor Floor, Due 10/21
   2,000,000    1,980,432    1,990,000 
                   

Key Safety Systems, Inc.9, 11

Automotive

  Senior Secured Loan — Initial Term Loan
4.8% Cash, 1.0% Libor Floor, Due 8/21
   1,496,250    1,489,134    1,488,769 
                   

Kinetic Concepts, Inc.9, 11

Healthcare & Pharmaceuticals

  Senior Secured Loan — Dollar Term E-1 Loan
4.0% Cash, 1.0% Libor Floor, Due 5/18
   2,992,443    2,984,962    2,956,279 
                   

Landslide Holdings, Inc. (Crimson Acquisition Corp.)9, 11

High Tech Industries

  Senior Secured Loan — New Term Loan (First Lien)
5.0% Cash, 1.0% Libor Floor, Due 2/20
   3,456,381    3,464,859    3,451,197 
                   

MB Aerospace ACP Holdings III Corp.9, 11

Aerospace and Defense

  Senior Secured Loan — Dollar Term Loan
5.0% Cash, 1.0% Libor Floor, Due 5/19
   3,940,000    3,910,979    3,939,212 
                   

Media General, Inc.11

Media: Broadcasting & Subscription

  Senior Secured Loan — Term B Loan
4.3% Cash, 1.0% Libor Floor, Due 7/20
   3,000,000    3,003,750    2,972,805 
                   

Medical Specialties Distributors, LLC9, 11

Healthcare & Pharmaceuticals

  Senior Secured Loan — Term Loan
6.5% Cash, 1.0% Libor Floor, Due 12/19
   3,960,000    3,927,435    3,804,372 

 

 22 

 

 

Portfolio Company / Principal Business 

Investment

Interest Rate¹ / Maturity

  Principal   Amortized Cost   Fair Value2 

Millennium Health, LLC (fka Millennium Laboratories, LLC)9, 11

Healthcare & Pharmaceuticals

  Senior Secured Loan — Tranche B Term Loan
5.3% Cash, 1.0% Libor Floor, Due 4/21
  $2,992,481   $2,992,481   $2,985,000 
                   

Nielsen & Bainbrige, LLC9

Consumer goods: Durable

  Senior Secured Loan — Term Loan (First Lien)
6.0% Cash, 1.0% Libor Floor, Due 8/20
   1,000,000    990,487    963,200 
                   

Nielsen & Bainbrige, LLC9

Consumer goods: Durable

  Junior Secured Loan — Term Loan (Second Lien)
10.3% Cash, 1.0% Libor Floor, Due 8/21
   2,000,000    1,971,249    1,920,000 
                   

Nielsen & Bainbrige, LLC9, 11

Consumer goods: Durable

  Senior Secured Loan — Term Loan (First Lien)
6.0% Cash, 1.0% Libor Floor, Due 8/20
   3,000,000    2,971,460    2,889,600 
                   

Novetta, LLC9

Services: Business

  Senior Secured Loan — Initial Term Loan
6.0% Cash, 1.0% Libor Floor, Due 10/20
   2,743,125    2,716,093    2,743,125 
                   

Novitex Acquisition, LLC (fka ARSloane Acquisition, LLC)9, 11

Services: Business

  Senior Secured Loan — Tranche B-2 Term Loan (First Lien)
7.5% Cash, 1.3% Libor Floor, Due 7/20
   990,019    980,923    950,418 
                   

Onex Carestream Finance LP9

Healthcare & Pharmaceuticals

  Junior Secured Loan — Term Loan (Second Lien)
9.5% Cash, 1.0% Libor Floor, Due 12/19
   2,000,000    2,000,000    1,992,920 
                   

Onex Carestream Finance LP9, 11

Healthcare & Pharmaceuticals

  Senior Secured Loan — Term Loan (First Lien 2013)
5.0% Cash, 1.0% Libor Floor, Due 6/19
   1,973,333    1,980,022    1,969,219 
                   

Orbitz Worldwide, Inc.11

Hotel, Gaming & Leisure

  Senior Secured Loan — Tranche C Term Loan
4.5% Cash, 1.0% Libor Floor, Due 4/21
   2,992,481    2,992,481    2,961,315 
                   

Otter Products, LLC (OtterBox Holdings, Inc.)9, 11

Consumer goods: Durable

  Senior Secured Loan — Term B Loan
5.8% Cash, 1.0% Libor Floor, Due 6/20
   2,992,481    2,968,458    2,966,297 
                   

Ozburn-Hessey Holding Company LLC9, 11

Transportation: Cargo

  Senior Secured Loan — Term Loan
6.8% Cash, 1.3% Libor Floor, Due 5/19
   3,512,426    3,503,687    3,544,389 

 

 23 

 

 

Portfolio Company / Principal Business 

Investment

Interest Rate¹ / Maturity

  Principal   Amortized Cost   Fair Value2 

PGX Holdings, Inc.9, 11

Services: Consumer

  Senior Secured Loan — Initial Term Loan (First Lien)
6.3% Cash, 1.0% Libor Floor, Due 9/20
  $3,975,000    3,936,815    3,917,363 
                   

Post Holdings, Inc.11

Beverage, Food and Tobacco

  Senior Secured Loan — Series A Incremental Term Loan
3.8% Cash, 0.8% Libor Floor, Due 6/21
   2,992,481    2,985,129    2,983,130 
                   

PQ Corporation9, 11

Chemicals, Plastics and Rubber

  Senior Secured Loan — 2014 Term Loan
4.0% Cash, 1.0% Libor Floor, Due 8/17
   2,992,366    2,992,366    2,943,740 
                   

PSC Industrial Holdings Corp.9, 11

Environmental Industries

  Senior Secured Loan — Term Loan (First Lien)
7.0% Cash, 1.0% Libor Floor, Due 12/20
   2,000,000    1,980,119    1,980,000 
                   

Puerto Rico Cable Acquisition Company Inc. (D/B/A Choice TV)9

Media: Broadcasting & Subscription

  Senior Secured Loan — Initial Term Loan
5.5% Cash, 1.0% Libor Floor, Due 7/18
   909,069    910,287    909,069 
                   

Puerto Rico Cable Acquisition Company Inc. (D/B/A Choice TV)9, 11

Media: Broadcasting & Subscription

  Senior Secured Loan — Initial Term Loan
5.5% Cash, 1.0% Libor Floor, Due 7/18
   2,727,206    2,717,359    2,727,206 
                   

QoL Meds, LLC9, 11

Healthcare & Pharmaceuticals

  Senior Secured Loan — Term Loan
5.5% Cash, 1.0% Libor Floor, Due 7/20
   498,750    496,449    480,296 
                   

Quad-C JH Holdings Inc. (aka Joerns Healthcare)9, 11

Healthcare & Pharmaceuticals

  Senior Secured Loan — Term Loan A
6.0% Cash, 1.0% Libor Floor, Due 5/20
   3,980,000    3,953,083    3,786,174 
                   

Restorix Health, Inc.9

Healthcare & Pharmaceuticals

  Senior Unsecured Loan — Delayed Draw
10.0% Cash, 1.5% PIK, Due 6/18
   2,003,587    2,003,587    2,003,587 
                   

Restorix Health, Inc.9

Healthcare & Pharmaceuticals

  Senior Unsecured Loan — Subordinated Term Loan
10.0% Cash, 1.5% PIK, Due 6/18
   8,063,397    8,063,397    8,063,397 
                   

Reynolds Group Holdings Inc.9, 11

Containers, Packaging and Glass

  Senior Secured Loan — Incremental U.S. Term Loan
4.0% Cash, 1.0% Libor Floor, Due 12/18
   2,992,443    2,992,443    2,946,734 

 

 24 

 

 

Portfolio Company / Principal Business 

Investment

Interest Rate¹ / Maturity

  Principal   Amortized Cost   Fair Value2 

Roscoe Medical, Inc.9

Healthcare & Pharmaceuticals

  Junior Secured Loan — Term Loan (Second Lien)
11.3% Cash, Due 9/19
  $6,700,000    6,642,367    6,499,000 
                   

Rovi Solutions Corporation / Rovi Guides, Inc.11

High Tech Industries

  Senior Secured Loan — Term B Loan
3.8% Cash, 0.8% Libor Floor, Due 7/21
   2,992,481    2,954,531    2,936,387 
                   

Safenet, Inc.9, 11

High Tech Industries

  Senior Secured Loan — Initial Term Loan (First Lien)
6.8% Cash, 1.0% Libor Floor, Due 3/20
   2,977,500    2,951,435    2,977,500 
                   

Sandy Creek Energy Associates, L.P.9, 11

Utilities: Electric

  Senior Secured Loan — Term Loan
5.0% Cash, 1.0% Libor Floor, Due 11/20
   2,844,544    2,832,599    2,794,053 
                   

SGF Produce Holding Corp.(Frozsun, Inc.)9

Beverage, Food and Tobacco

  Senior Secured Loan — Term Loan
5.5% Cash, 1.0% Libor Floor, Due 3/19
   2,191,289    2,175,642    2,191,289 
                   

SGF Produce Holding Corp.(Frozsun, Inc.)9, 11

Beverage, Food and Tobacco

  Senior Secured Loan — Term Loan
5.5% Cash, 1.0% Libor Floor, Due 3/19
   3,440,528    3,429,224    3,440,528 
                   

Stafford Logistics, Inc.(dba Custom Ecology, Inc.)9, 11

Environmental Industries

  Senior Secured Loan — Term Loan
6.8% Cash, 1.3% Libor Floor, Due 6/19
   2,861,935    2,840,504    2,858,501 
                   

Sun Products Corporation, The (fka Huish Detergents Inc.)9, 11

Consumer goods: Non-durable

  Senior Secured Loan — Tranche B Term Loan
5.5% Cash, 1.3% Libor Floor, Due 3/20
   3,910,711    3,887,178    3,656,515 

 

 25 

 

 

Portfolio Company / Principal Business 

Investment

Interest Rate¹ / Maturity

  Principal   Amortized Cost   Fair Value2 

Tank Partners Holdings, LLC9

Energy: Oil & Gas

  Senior Secured Loan — Loan
9.8% Cash, 3.5% PIK, 3.0% Libor Floor, Due 8/19
  $10,385,331    10,212,907    9,866,065 
                   

TPF II Power, LLC (TPF II Covert Midco, LLC)9, 11

Utilities: Electric

  Senior Secured Loan — Term Loan
5.5% Cash, 1.0% Libor Floor, Due 10/21
   3,000,000    3,026,933    3,009,375 
                   

Trimaran Advisors, L.L.C.9, 12

Portfolio Company Loan

  Senior Unsecured Loan — Revolving Credit Facility
9.0% Cash, Due 11/17
   23,000,000    23,000,000    23,000,000 
                   

TRSO I, Inc.9

Energy: Oil & Gas

  Junior Secured Loan — Term Loan (Second Lien)
11.0% Cash, 1.0% Libor Floor, Due 12/17
   1,000,000    988,097    961,300 
                   

TWCC Holding Corp.9

Media: Broadcasting & Subscription

  Junior Secured Loan — Term Loan (Second Lien)
7.0% Cash, 1.0% Libor Floor, Due 6/20
   1,000,000    1,004,005    961,670 
                   

TWCC Holding Corp.9, 11

Media: Broadcasting & Subscription

  Senior Secured Loan — Term Loan
3.5% Cash, 0.8% Libor Floor, Due 2/17
   906,653    910,624    887,060 
                   

Univar Inc.9, 11

Chemicals, Plastics and Rubber

  Senior Secured Loan — Term B Loan
5.0% Cash, 1.5% Libor Floor, Due 6/17
   2,894,577    2,890,893    2,808,536 
                   

USJ-IMECO Holding Company, LLC9, 11

Transportation: Cargo

  Senior Secured Loan — Term Loan
7.0% Cash, 1.0% Libor Floor, Due 4/20
   3,970,000    3,952,343    3,970,000 

 

 26 

 

 

Portfolio Company / Principal Business 

Investment

Interest Rate¹ / Maturity

  Principal   Amortized Cost   Fair Value2 

Vantiv, LLC (fka Fifth Third Processing Solutions, LLC)11

Banking, Finance, Insurance & Real Estate

  Senior Secured Loan — Term B Loan
3.8% Cash, 0.8% Libor Floor, Due 6/21
  $1,994,987    1,999,927    1,978,160 
                   

Verdesian Life Sciences, LLC9

Environmental Industries

  Senior Secured Loan — Initial Term Loan
6.0% Cash, 1.0% Libor Floor, Due 7/20
   975,012    961,553    938,547 
                   

Verdesian Life Sciences, LLC9, 11

Environmental Industries

  Senior Secured Loan — Initial Term Loan
6.0% Cash, 1.0% Libor Floor, Due 7/20
   3,221,243    3,178,026    3,100,769 
                   

Vestcom International, Inc. (fka Vector Investment Holdings, Inc.)9, 11

Retail

  Senior Secured Loan — Term Loan
5.3% Cash, 1.0% Libor Floor, Due 9/21
   2,866,953    2,843,300    2,838,284 
                   

Weiman Products, LLC9

Consumer goods: Non-durable

  Senior Secured Loan — Term Loan
6.3% Cash, 1.0% Libor Floor, Due 11/18
   2,972,255    2,948,574    2,972,255 
                   

Weiman Products, LLC9, 11

Consumer goods: Non-durable

  Senior Secured Loan — Term Loan
6.3% Cash, 1.0% Libor Floor, Due 11/18
   3,963,007    3,932,167    3,963,007 
                   

WideOpenWest Finance, LLC9

Telecommunications

  Senior Secured Loan — Term B Loan
4.8% Cash, 1.0% Libor Floor, Due 4/19
   2,954,887    2,971,397    2,941,974 
                   

WireCo WorldGroup Inc. 9

Capital Equipment

  Senior Unsecured Bond —
9.0% Cash, Due 5/17
   5,000,000    4,991,504    5,000,000 
                   

WireCo WorldGroup Inc. 9, 11

Capital Equipment

  Senior Unsecured Bond —
9.0% Cash, Due 5/17
   3,000,000    2,994,903    3,000,000 
                   

Total Investment in Debt Securities

(125% of net asset value at fair value)

  $324,808,055   $322,884,934   $320,143,170 

 

 27 

 

 

Equity Securities Portfolio

 

Portfolio Company / Principal Business  Investment 

Percentage

Ownership/Shares

   Amortized Cost   Fair Value2 

Aerostructures Holdings L.P.5, 9

Aerospace and Defense

  Partnership Interests   1.2%  $1,000,000   $1,000 
                   

Aerostructures Holdings L.P.5, 9

Aerospace and Defense

  Series A Preferred Interests   1.2%   250,961    648,764 
                   

Bankruptcy Management Solutions, Inc.5, 9

Services: Business

  Class A Warrants   1.7%   -    - 
                   

Bankruptcy Management Solutions, Inc.5, 9

Services: Business

  Class B Warrants   1.7%   -    - 
                   

Bankruptcy Management Solutions, Inc.5, 9

Services: Business

  Class C Warrants   1.7%   -    - 
                   

Bankruptcy Management Solutions, Inc.5, 9

Services: Business

  Common Stock 2013   0.8%   314,325    391,932 
                   

Caribe Media Inc. (fka Caribe Information Investments Incorporated)5, 9

Media: Advertising, Printing & Publishing

  Common   1.3%   359,765    624,304 
                   

DBI Holding LLC5, 9

Services: Business

  Class A Warrants   3.2%   258,940    746,964 
                   

eInstruction Acquisition, LLC5, 9

Services: Business

  Membership Units   1.1%   1,079,617    1,000 
                   

FP WRCA Coinvestment Fund VII, Ltd.3, 5,

Capital Equipment

  Class A Shares   1,500    1,500,000    2,351,329 
                   

Perseus Holding Corp.5, 9

Hotel, Gaming & Leisure

  Common   0.2%   400,000    1,000 

 

 28 

 

 

Portfolio Company / Principal Business  Investment 

Percentage

Ownership/Shares

   Amortized Cost   Fair Value2 

Roscoe Investors, LLC5, 9

Healthcare & Pharmaceuticals

  Class A Units   1.6%  $1,000,000   $891,000 
                   

Tank Partners Holdings, LLC5, 9

Energy: Oil & Gas

  Unit   5.8%   980,000    573,750 
                   

Tank Partners Holdings, LLC5, 9

Energy: Oil & Gas

  Warrants   1.3%   185,204    99,752 
                   

TRSO II, Inc.5, 9

Energy: Oil & Gas

  Common Stock   5.4%   1,500,000    1,788,886 
                   

Total Investment in Equity Securities

(3% of net asset value at fair value)

          $8,828,812   $8,119,681 

 

 29 

 

 

CLO Fund Securities

 

CLO Subordinated Securities, Preferred

Shares and Income Notes Investments

 

Portfolio Company  Investment 

Percentage

Ownership

   Amortized Cost   Fair Value2 
Grant Grove CLO, Ltd.3  Subordinated Securities   22.2%  $2,254,638   $469,131 
Katonah III, Ltd.3, 10  Preferred Shares   23.1%   1,015,334    400,000 
Katonah VII CLO Ltd.3, 6  Subordinated Securities   16.4%   3,563,252    1,000 
Katonah VIII CLO Ltd3, 6  Subordinated Securities   10.3%   2,755,267    100,000 
Katonah IX CLO Ltd3, 6  Preferred Shares   6.9%   1,262,496    594,989 
Katonah X CLO Ltd 3, 6  Subordinated Securities   33.3%   8,910,471    4,863,001 
Katonah 2007-I CLO Ltd.3, 6  Preferred Shares   100.0%   23,471,779    25,191,782 
Trimaran CLO IV, Ltd.3, 6  Preferred Shares   19.0%   11,094    900,000 
Trimaran CLO V, Ltd.3, 6  Subordinated Notes   20.8%   1,292,698    1,657,020 
Trimaran CLO VI, Ltd.3, 6  Income Notes   16.2%   1,531,142    1,950,000 
Trimaran CLO VII, Ltd.3, 6  Income Notes   10.5%   1,399,074    2,084,394 
Catamaran CLO 2012-1 Ltd.3, 6  Subordinated Notes   24.9%   7,994,677    5,793,924 
Catamaran CLO 2013- 1 Ltd.3, 6  Subordinated Notes   23.5%   7,492,702    7,874,910 
Catamaran CLO 2014-1 Ltd.3, 6  Subordinated Notes   24.9%   10,473,628    8,867,176 
Dryden 30 Senior Loan Fund3  Subordinated Notes   7.5%   2,263,321    2,506,075 
Catamaran CLO 2014-2 Ltd.3, 6  Subordinated Notes   24.9%   9,862,799    8,761,500 
                    
Total Investment in CLO Subordinated Securities, Preferred Shares and Income Notes       $85,554,372   $72,014,902 

 

 30 

 

 

CLO Rated-Note Investments

 

Portfolio Company  Investment 

Percentage

Ownership

   Amortized Cost   Fair Value2 
Catamaran CLO 2012-1 Ltd.3, 6  Class F Notes
Par Value of $4,500,000
Due 12/23
   42.9%  $3,917,442   $4,160,000 
Catamaran CLO 2014-1 Ltd.3, 6  Class E Notes
Par Value of $1,525,000
Due 4/26
   15.1%   1,417,376    1,340,000 
                    
Total Investment in CLO Rated-Note       $5,334,818   $5,500,000 
                    
Total Investment in CLO Fund Securities
(30% of net asset value at fair value)
       $90,889,190   $77,514,902 

 

Asset Manager Affiliates

 

Portfolio Company / Principal Business  Investment 

Percentage

Ownership

   Cost   Fair Value2 
Asset Manager Affiliates9  Asset Management Company   100.0%  $60,292,677   $72,326,000 
                    
Total Investment in Asset Manager Affiliates
(28% of net asset value at fair value)
       $60,292,677   $72,326,000 

 

Time Deposits and Money Market Account

 

Time Deposit and Money Market Accounts  Investment  Yield   Par / Amortized
Cost
   Fair Value2 
JP Morgan Business Money Market Account8, 9  Money Market Account   0.10%  $249,105   $249,105 
US Bank Money Market Account9  Money Market Account   0.02%   1,353,636    1,353,636 
                   
Total Investment in Time Deposit and Money Market Accounts
(1% of net asset value at fair value)
       $1,602,741   $1,602,741 
                   
Total Investments4
(188% of net asset value at fair value)
       $484,498,354   $479,706,494 

 

See accompanying notes to financial statements.

 

 31 

 

 

1A majority of the variable rate loans in the Company’s investment portfolio bear interest at a rate that may be determined by reference to either LIBOR or an alternate Base Rate (commonly based on the Federal Funds Rate or the Prime Rate), which typically resets semi-annually, quarterly, or monthly at the borrower’s option. The Borrower may also elect to have multiple interest reset periods for each loan. For each such loan, the Company has provided the weighted average annual stated interest rate in effect at December 31, 2014. As noted in the table above, 75% (based on par) of debt securities contain LIBOR floors which range between 0.75% and 3.00%.
2Reflects the fair market value of all investments as of December 31, 2014, as determined by the Company’s Board of Directors.
3Non-U.S. company or principal place of business outside the U.S.
4The aggregate cost of investments for federal income tax purposes is approximately $502 million. The aggregate gross unrealized appreciation is approximately $15.7 million, the aggregate gross unrealized depreciation is approximately $37.7 million, and the net unrealized depreciation is approximately $22 million.
5Non-income producing.
6An affiliate CLO Fund managed by an Asset Manager Affiliate (as such term is defined in the notes to the consolidated financial statements).
7Loan or debt security is on non-accrual status and therefore is considered non-income producing.
8Money market account holding restricted cash and security deposits for employee benefit plans.
9Qualified asset for purposes of section 55(a) of the Investment Company Act of 1940.
10As of December 31, 2014, this CLO Fund Security was not providing a taxable distribution.
11As of December 31, 2014, investment was owned by KCAP Senior Funding I, LLC and has been pledged to secure KCAP Senior Funding I, LLC’s obligations.

 

 32 

 

 

KCAP FINANCIAL, INC.

CONSOLIDATED FINANCIAL HIGHLIGHTS

(unaudited)

 

  

Nine Months Ended

September 30,

 
   2015   2014 
         
Per Share Data:          
Net asset value, at beginning of period  $6.94   $7.51 
Net investment income1   0.51    0.44 
Net realized (losses) from investments1   (0.17)   (0.06)
Net change in unrealized (depreciation) appreciation on investments1   (0.53)   0.33 
Net (decrease) increase in net assets resulting from operations   (0.19)   0.71 
Net decrease in net assets resulting from distributions:          
Distribution of ordinary income   (0.41)   (0.50)
Return of capital   -    - 
Net decrease in net assets resulting from distributions   (0.41)   (0.50)
Net (decrease) in net assets relating to stock-based transactions:          
Stock based compensation   (0.01)   (0.05)
Net decrease in net assets relating to stock-based transactions   (0.01)   (0.05)
           
Net asset value, end of period  $6.33   $7.67 
Total net asset value return2   (2.8)%   8.8%
           
Ratio/Supplemental Data:          
Per share market value at beginning of period  $6.82   $8.07 
Per share market value at end of period  $4.51   $8.31 
Total market return3   (27.8)%   9.2%
Shares outstanding at end of period   37,052,575    33,753,672 
Net assets at end of period  $234,599,882   $259,027,074 
Portfolio turnover rate4   24.0%   37.4%
Average par debt outstanding  $227,250,480   $195,658,000 
Asset coverage ratio   205%   231%
Ratio of net investment income to average net assets5   9.9%   7.6%
Ratio of total expenses to average net assets5   8.6%   8.4%
Ratio of interest expense to average net assets5   4.7%   4.6%
Ratio of non-interest expenses to average net assets5   3.9%   3.8%

 

 

1Based on weighted average number of common shares outstanding-basic for the period.
2Total net asset value return (not annualized) equals the change in the net asset value per share over the beginning of period net asset value per share plus distributions (including any return of capital), divided by the beginning net asset value per share.
3Total market return equals the change in the ending market price over the beginning of period price per share plus distributions (including any return of capital), divided by the beginning price.
4Not annualized. Portfolio turnover rate equals the year-to-date sales and paydowns over the average of the invested assets at fair value.
5Annualized

 

See accompanying notes to consolidated financial statements.

 

 33 

 

 

KCAP FINANCIAL, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

1. ORGANIZATION

 

KCAP Financial, Inc. (“KCAP” or the “Company”) is an internally managed, non-diversified closed-end investment company that is regulated as a business development company (“BDC”) under the Investment Company Act of 1940 (the “1940 Act”). The Company was formed as a Delaware limited liability company on August 8, 2006 and, prior to the issuance of shares of the Company’s common stock in its initial public offering (“IPO”), converted to a corporation incorporated in Delaware on December 11, 2006. Prior to its IPO, the Company did not have material operations. The Company’s IPO of 14,462,000 shares of common stock raised net proceeds of approximately $200 million. Prior to the IPO, the Company issued 3,484,333 shares to affiliates of Kohlberg & Co., L.L.C., a leading middle market private equity firm, in exchange for the contribution to the Company of their ownership interests in Katonah Debt Advisors, L.L.C., and related affiliates controlled by the Company (collectively, “Katonah Debt Advisors”) and in securities issued by collateralized loan obligation funds (“CLO Funds”) managed by Katonah Debt Advisors and two other asset managers.

 

On April 28, 2008, the Company completed a rights offering that resulted in the issuance of 3.1 million shares of our common stock, and net proceeds of $27 million.

 

On February 29, 2012, the Company purchased Trimaran Advisors, L.L.C. (“Trimaran Advisors”), a CLO manager similar to Katonah Debt Advisors with assets under management of approximately $1.5 billion, for total consideration of $13.0 million in cash and 3,600,000 shares of the Company’s common stock. Contemporaneously with the acquisition of Trimaran Advisors, the Company acquired from Trimaran Advisors equity interests in certain CLO Funds managed by Trimaran Advisors for an aggregate purchase price of $12.0 million in cash.

 

On February 14, 2013, the Company completed a public offering of 5,232,500 shares of common stock, which included the underwriters’ full exercise of their option to purchase up to 682,500 shares of common stock, at a price of $9.75 per share, raising approximately $51.0 million in gross proceeds. In conjunction with this offering, the Company also sold 200,000 shares of common stock to a member of its Board of Directors, at a price of $9.31 per share, raising approximately $1.9 million in gross proceeds.

 

On October 6, 2014, the Company completed a follow-on public offering of 3.0 million shares of its common stock at a price of $8.02 per share. The offering raised net proceeds of approximately $23.8 million, after deducting underwriting discounts and offering expenses.

 

As of September 30, 2015, Katonah Debt Advisors and Trimaran Advisors, as well as affiliated management companies Katonah 2007-1 Management, L.L.C., Katonah X Management, L.L.C. and Trimaran Advisors Management, L.L.C. (collectively the “Asset Manager Affiliates”), had approximately $2.7 billion of par value assets under management. The Asset Manager Affiliates are each managed independently from KCAP by a separate management team (however, certain of the Company’s executive officers also act in similar capacities for one or both of the Asset Manager Affiliates). The Asset Manager Affiliates provide investment management services to CLO Funds, making day-to-day investment decisions concerning the assets of the CLO Funds. The Asset Manager Affiliates do not have an investment interest in the CLO Funds they manage; however, KCAP holds investments in a portion of the securities issued by the CLO Funds managed by the Asset Manager Affiliates.

 

The Company has three principal areas of investment:

 

First, the Company originates, structures, and invests in senior secured term loans and mezzanine debt primarily in privately-held middle market companies (the “Debt Securities Portfolio”). In addition, from time to time the Company may invest in the equity securities of privately held middle market companies.

 

 34 

 

 

Second, the Company has invested in the Asset Manager Affiliates, which manage CLO Funds.

 

Third, the Company invests in debt and subordinated securities issued by CLOs (“CLO Fund Securities”). These CLO Fund Securities are primarily managed by our Asset Manager Affiliates, but from time-to-time the Company makes investments in CLO Fund Securities managed by other asset managers. The CLO Funds typically invest in broadly syndicated loans, high-yield bonds and other credit instruments.

 

The Company may also invest in other investments such as loans to larger, publicly-traded companies, high-yield bonds and distressed debt securities. The Company may also receive warrants or options to purchase common stock in connection with its debt investments.

 

The Company has elected to be treated as a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”). To qualify as a RIC, the Company must, among other things, meet certain source-of-income, and asset diversification and annual distribution requirements. As a RIC, the Company generally will not have to pay corporate-level U.S. federal income taxes on any income that it distributes in a timely manner to its stockholders.

 

2. SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared on the accrual basis of accounting in conformity with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information. Accordingly, they do not include all of the information and footnotes required for annual consolidated financial statements. The unaudited interim consolidated financial statements and notes thereto should be read in conjunction with the financial statements and notes thereto in the Company’s Form 10-K for the year ended December 31, 2014, as filed with the U.S. Securities and Exchange Commission (the “Commission” or the “SEC”).

 

The consolidated financial statements reflect all adjustments, both normal and recurring which, in the opinion of management, are necessary for the fair presentation of the Company’s results of operations and financial condition for the periods presented. Furthermore, the preparation of the consolidated financial statements requires the Company to make significant estimates and assumptions including with respect to the fair value of investments that do not have a readily available market value. Actual results could differ from those estimates, and the differences could be material. The results of operations for the interim periods presented are not necessarily indicative of the operating results to be expected for the full year. Certain prior period amounts have been reclassified to conform to the current year presentation.

 

The Company consolidates the financial statements of its wholly-owned special purpose financing subsidiaries KCAP Funding, Kolhberg Capital Funding LLC I, KCAP Senior Funding I, LLC and KCAP Senior Funding I Holdings, LLC in its consolidated financial statements as they are operated solely for investment activities of the Company. The creditors of KCAP Senior Funding I, LLC have received security interests in the assets owned by KCAP Senior Funding I, LLC and such assets are not intended to be available to the creditors of KCAP Financial, Inc., or any other affiliate.

 

In accordance with Article 6 of Regulation S-X under the Securities Act of 1933, as amended (the “Securities Act”), and the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the Company does not consolidate portfolio company investments, including those in which it has a controlling interest (e.g., the Asset Manager Affiliates), unless the portfolio company is another investment company.

 

The Asset Manager Affiliates are subject to Accounting Standards Codification Topic 810, “Consolidation” and although the Company cannot consolidate the financial statements of portfolio company investments, this guidance impacts the required disclosures relating to the Asset Manager Affiliates, as it requires the Asset Manager Affiliates to consolidate the financial statements of managed CLO Funds. As a result of the consolidation of the financial statements of the CLOs into the financial statements of the Asset Manager Affiliates, the Asset Manager Affiliates qualify as a “significant subsidiary” and, as a result, the Company is required to include additional financial information regarding the Asset Manager Affiliates in its filings with the SEC. This additional financial information regarding the Asset Manager Affiliates does not directly impact the financial position or results of operations of the Company.

 

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In addition, in accordance with Rule 3-09 of Regulation S-X promulgated by the SEC, additional financial information with respect to one of the CLO Funds in which the Company has an investment, Katonah 2007-I CLO Ltd. (“Katonah 2007-I CLO”), is required to be included in the Company’s SEC filings. The additional financial information regarding the Asset Manager Affiliates and Katonah 2007-I CLO (pursuant to Rule 3-09) is set forth in Note 5 to these consolidated financial statements.

 

Stockholder distributions on the Statement of Changes in Net Assets reflect the estimated allocation, between net investment income and return of capital, of distributions made during the reporting period, excluding the distribution declared in a quarter with a record date occurring after the quarter-end. The determination of the tax character of distributions is made on an annual (full calendar-year) basis at the end of the year based upon our taxable income for the full year and the distributions paid during the full year. Therefore, an estimate of tax attributes made on a quarterly basis may not be representative of the actual tax attributes of distributions for a full year.

 

It is the Company’s primary investment objective to generate current income and capital appreciation by lending directly to privately-held middle market companies. During the nine months ended September 30, 2015, the Company provided $69 million to portfolio companies to support their growth objectives. None of this support was contractually obligated. See also Note 8 – Commitments and Contingencies. As of September 30, 2015, the Company holds loans it has made to 80 investee companies with aggregate principal amounts of $277 million. The details of such loans have been disclosed on the consolidated schedule of investments as well as in Note 4 – Investments. In addition to providing loans to investee companies, from time to time the Company assists investee companies in securing financing from other sources by introducing such investee companies to sponsors or by leading a syndicate of lenders to provide the investee companies with financing. During the nine-month-period ended September 30, 2015, the Company did not make any such introductions or lead any syndicates.

 

In August 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014- 15, “Presentation of Financial Statements — Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern” (“ASU 2014-15”). The standard requires management to evaluate, at each interim and annual reporting period, whether there are conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date the financial statements are issued, and provide related disclosures. ASU 2014- 15 is effective for annual periods ending after December 15, 2016, and for annual and interim periods thereafter, and early adoption is permitted. We do not expect to adopt ASU 2014-15 early, and we do not believe the standard will have a material impact on our financial statements, when adopted.

 

In February 2015, the FASB issued Accounting Standards Update 2015-2, which updated consolidation standards under ASC Topic 810, “Consolidation”. Under this update, a new consolidation analysis is required for variable interest entities (“VIEs”) and will limit the circumstances in which investment managers and similar entities are required to consolidate the entities that they manage. The FASB decided to eliminate some of the criteria under which their fees are considered a variable interest and limit the circumstances in which variable interests in a VIE held by related parties of a reporting enterprise require the reporting enterprise to consolidate the VIE. The guidance is effective for public business entities for annual and interim periods in fiscal years beginning after December 15, 2015. We do not expect the adoption of ASU 2015-2 to have a material impact to the Company’s financial statements.

 

In April 2015, the FASB issued Accounting Standards Update 2015-03, Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. Under this guidance, debt issuance costs related to a recognized debt liability are to be presented as a direct deduction from the debt liability rather than as an asset on the balance sheet, consistent with debt discounts. For public business entities, the final guidance will be effective for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption is permitted. The Company intends to adopt the new guidance beginning the first quarter of 2016.

 

Investments

 

Investment transactions are recorded on the applicable trade date. Realized gains or losses are determined using the specific identification method.

 

Valuation of Portfolio Investments. The Company’s Board of Directors is ultimately and solely responsible for making a good faith determination of the fair value of portfolio investments on a quarterly basis. Debt and equity securities for which market quotations are readily available are generally valued at such market quotations. Debt and equity securities that are not publicly traded or whose market price is not readily available are valued by the Board of Directors based on detailed analyses prepared by management, the Valuation Committee of the Board of Directors, and, in certain circumstances, third parties with valuation expertise. Valuations are conducted by management on 100% of the investment portfolio at the end of each quarter. The Company follows the provisions of ASC 820: Fair Value Measurements and Disclosures (“ASC 820: Fair Value”). This standard defines fair value, establishes a framework for measuring fair value, and expands disclosures about assets and liabilities measured at fair value. ASC 820: Fair Value defines “fair value” as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Subsequent to the adoption of ASC 820: Fair Value, the FASB has issued various staff positions clarifying the initial standard as noted below.

 

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The FASB issued guidance that clarified and required disclosures about fair value measurements. These include requirements to disclose the amounts and reasons for significant transfers between Level I and Level II, as well as significant transfers in and out of Level III of the fair value hierarchy (see Note 4 – “Investments – Fair Value Measurements” for further information relating to Level I, Level II and Level III). The guidance also required that purchases, sales, issuances and settlements be presented gross in the Level III reconciliation.

 

ASC 820: Fair Value requires the disclosure in interim and annual periods of the inputs and valuation techniques used to measure fair value and a discussion of changes in valuation techniques and related inputs, if any, during the period.

 

The Company utilizes an independent valuation firm to provide an annual third-party review of the Company’s CLO fair value model relative to its functionality, model inputs and calculations as a reasonable method to determine CLO fair values, in the absence of Level I or Level II trading activity or observable market inputs. The independent valuation firm’s 2014 annual review concluded that the Company’s CLO model appropriately factors in all the necessary inputs required to build a CLO equity cash flow model for fair value purposes and that the inputs were being employed correctly.

 

The Company utilizes an independent valuation firm to provide third party valuation consulting services. Each quarter the independent valuation firm will perform third party valuations of the Company’s investments in material illiquid securities such that they are reviewed at least once during a trailing 12-month period. These third party valuation estimates are considered as one of the relevant data points in the Company’s determination of fair value. The Company intends to continue to engage an independent valuation firm in the future to provide certain valuation services, including the review of certain portfolio assets, as part of the quarterly and annual year-end valuation process.

 

The Board of Directors may consider other methods of valuation than those set forth below to determine the fair value of Level III investments as appropriate in conformity with GAAP. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of the Company’s investments may differ materially from the values that would have been used had a readily available market existed for such investments. Further, such investments may be generally subject to legal and other restrictions on resale or otherwise be less liquid than publicly traded securities. In addition, changes in the market environment and other events may occur over the life of the investments that may cause the value realized on such investments to be different from the currently assigned valuations.

 

The majority of the Company’s investment portfolio is composed of debt and equity securities with unique contract terms and conditions and/or complexity that requires a valuation of each individual investment that considers multiple levels of market and asset specific inputs, which may include historical and forecasted financial and operational performance of the individual investment, projected cash flows, market multiples, comparable market transactions, the priority of the security compared with those of other securities for such issuers, credit risk, interest rates, and independent valuations and reviews.

 

Debt Securities. To the extent that the Company’s investments are exchange traded and are priced or have sufficient price indications from normal course trading at or around the valuation date (financial reporting date), such pricing will determine fair value. Valuations from third party pricing services may be used as an indication of fair value, depending on the volume and reliability of the valuation, sufficient and reasonable correlation of bid and ask quotes, and, most importantly, the level of actual trading activity. However, if the Company has been unable to identify directly comparable market indices or other market guidance that correlate directly to the types of investments the Company owns, the Company will determine fair value using alternative methodologies such as available market data, as adjusted, to reflect the types of assets the Company owns, their structure, qualitative and credit attributes and other asset-specific characteristics.

 

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The Company derives fair value for its illiquid investments that do not have indicative fair values based upon active trades primarily by using a present value technique that discounts the estimated contractual cash flows for the subject assets with discount rates imputed by broad market indices, bond spreads and yields for comparable issuers relative to the subject assets (the “Income Approach”). The Company also considers, among other things, recent loan amendments or other activity specific to the subject asset. Discount rates applied to estimated contractual cash flows for an underlying asset vary by specific investment, industry, priority and nature of the debt security (such as the seniority or security interest of the debt security) and are assessed relative to two indices, a leveraged loan index and a high-yield bond index, at the valuation date. The Company has identified these two indices as benchmarks for broad market information related to its loan and debt securities. Because the Company has not identified any market index that directly correlates to the loan and debt securities held by the Company and therefore uses these benchmark indices, these market indices may require significant adjustment to better correlate such market data for the calculation of fair value of the investment under the Income Approach. Such adjustments require judgment and may be material to the calculation of fair value. Further adjustments to the discount rate may be applied to reflect other market conditions or the perceived credit risk of the borrower. When broad market indices are used as part of the valuation methodology, their use is subject to adjustment for many factors, including priority, collateral used as security, structure, performance and other quantitative and qualitative attributes of the asset being valued. The resulting present value determination is then weighted along with any quotes from observable transactions and broker/pricing quotes. If such quotes are indicative of actual transactions with reasonable trading volume at or near the valuation date that are not liquidation or distressed sales, relatively more reliance will be put on such quotes to determine fair value. If such quotes are not indicative of market transactions or are insufficient as to volume, reliability, consistency or other relevant factors, such quotes will be compared with other fair value indications and given relatively less weight based on their relevancy. Other significant assumptions, such as coupon and maturity, are asset-specific and are noted for each investment in the Schedules of Investments.

 

Equity Securities. The Company’s equity securities in portfolio companies for which there is no liquid public market are carried at fair value based on the Enterprise Value of the portfolio company, which is determined using various factors, including EBITDA (earnings before interest, taxes, depreciation and amortization) and discounted cash flows from operations, less capital expenditures and other pertinent factors, such as recent offers to purchase a portfolio company’s securities or other liquidation events. The determined fair values are generally discounted to account for restrictions on resale and minority ownership positions. In the event market quotations are readily available for the Company’s equity securities in public companies, those investments may be valued using the Market Approach. In cases where the Company receives warrants to purchase equity securities, a market standard Black-Scholes model is utilized.

 

The significant inputs used to determine the fair value of equity securities include prices, EBITDA and cash flows after capital expenditures for similar peer comparables and the investment entity itself. Equity securities are classified as Level III, when there is limited activity or less transparency around inputs to the valuation given the lack of information related to such equity investments held in nonpublic companies. Significant assumptions observed for comparable companies are applied to relevant financial data for the specific investment. Such assumptions, such as model discount rates or price/earnings multiples, vary by the specific investment, equity position and industry and incorporate adjustments for risk premiums, liquidity and company specific attributes. Such adjustments require judgment and may be material to the calculation of fair value.

 

Asset Manager Affiliates. The Company’s investments in its wholly-owned asset management companies, the Asset Manager Affiliates, are carried at fair value, which is primarily determined utilizing the Discounted Cash Flow approach, which incorporates different levels of discount rates depending on the hierarchy of fees earned (including the likelihood of realization of senior, subordinate and incentive fees) and prospective modeled performance. Such valuation takes into consideration an analysis of comparable asset management companies and a percentage of assets under management. The Asset Manager Affiliates are classified as a Level III investment. Any change in value from period to period is recognized as net change in unrealized appreciation or depreciation.

 

CLO Fund Securities. The Company typically makes a minority investment in the most junior class of securities of CLO Funds raised and managed by the Asset Manager Affiliates and may selectively invest in securities issued by funds managed by other asset management companies. The investments held by CLO Funds generally relate to non-investment grade credit instruments issued by corporations.

 

The Company’s investments in CLO Fund securities are carried at fair value, which is based either on (i) the present value of the net expected cash inflows for interest income and principal repayments from underlying assets and cash outflows for interest expense, debt pay-down and other fund costs for the CLO Funds that are approaching or past the end of their reinvestment period and therefore are selling assets and/or using principal repayments to pay down CLO Fund debt (or will begin to do so shortly), and for which there continue to be net cash distributions to the class of securities owned by the Company, a Discounted Cash Flow approach, (ii) a discounted cash flow model that utilizes prepayment and loss assumptions based on historical experience and projected performance, economic factors, the characteristics of the underlying cash flow and comparable yields for similar securities or preferred shares to those in which the Company has invested, or (iii) indicative prices provided by the underwriters or brokers who arrange CLO Funds, a Market Approach. The Company recognizes unrealized appreciation or depreciation on the Company’s investments in CLO Fund securities as comparable yields in the market change and/or based on changes in net asset values or estimated cash flows resulting from changes in prepayment or loss assumptions in the underlying collateral pool. As each investment in CLO Fund securities ages, the expected amount of losses and the expected timing of recognition of such losses in the underlying collateral pool are updated and the revised cash flows are used in determining the fair value of the CLO Fund investment. The Company determines the fair value of its investments in CLO Fund securities on a security-by-security basis.

 

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Due to the individual attributes of each CLO Fund security, they are classified as a Level III investment unless specific trading activity can be identified at or near the valuation date. When available, observable market information will be identified, evaluated and weighted accordingly in the application of such data to the present value models and fair value determination. Significant assumptions to the present value calculations include default rates, recovery rates, prepayment rates, investment/reinvestment rates and spreads and the discount rate by which to value the resulting underlying cash flows. Such assumptions can vary significantly, depending on market data sources which often vary in depth and level of analysis, understanding of the CLO market, detailed or broad characterization of the CLO market and the application of such data to an appropriate framework for analysis. The application of data points are based on the specific attributes of each individual CLO Fund security’s underlying assets, historic, current and prospective performance, vintage, and other quantitative and qualitative factors that would be evaluated by market participants. The Company evaluates the source of market data for reliability as an indicative market input, consistency amongst other inputs and results and also the context in which such data is presented.

 

For rated note tranches of CLO Fund securities (those above the junior class) without transactions to support a fair value for the specific CLO Fund and tranche, fair value is based on discounting estimated bond payments at current market yields, which may reflect the adjusted yield on the leveraged loan index for similarly rated tranches, as well as prices for similar tranches for other CLO Funds and also other factors such as indicative prices provided by underwriters or brokers who arrange CLO Funds, and the default and recovery rates of underlying assets in the CLO Fund, as may be applicable. Such model assumptions may vary and incorporate adjustments for risk premiums and CLO Fund specific attributes.

 

Cash. The Company defines cash as demand deposits. The Company places its cash with financial institutions and, at times, cash held in checking accounts may exceed the Federal Deposit Insurance Corporation insured limit.

 

Restricted Cash. Restricted cash and cash equivalents (e.g., money market funds) consists of cash held for reinvestment, quarterly interest and principal distribution (if any) to holders of notes issued by KCAP Senior Funding I, LLC.

 

Time Deposits and Money Market Accounts. Time deposits primarily represent investments of cash held in demand deposit accounts. Money market accounts primarily represent short term interest-bearing deposit accounts. Also includes restricted cash held under employee benefit plans.

 

Interest Income. Interest income, including the amortization of premium and accretion of discount, is recorded on the accrual basis to the extent that such amounts are expected to be collected. The Company generally places a loan or security on non-accrual status and ceases recognizing cash interest income on such loan or security when a loan or security becomes 90 days or more past due or if the Company otherwise does not expect the debtor to be able to service its debt obligations. Non-accrual loans remain in such status until the borrower has demonstrated the ability and intent to pay contractual amounts due or such loans become current. As of September 30, 2015, one issuer representing less than 1% of the Company’s total investments at fair value was on a non-accrual status.

 

Distributions from Asset Manager Affiliates. The Company records distributions from our Asset Manager Affiliates on the declaration date, which represents the ex-dividend date. Distributions in excess of tax-basis earnings and profits of the distributing affiliate company are recognized as tax-basis return of capital. For interim periods, the Company estimates the tax attributes of any distributions as being either tax-basis earnings and profits (i.e., dividend income) or return of capital (i.e., adjustment to the Company’s cost basis in the Asset Manager Affiliates). The final determination of the tax attributes of distributions from our Asset Manager Affiliates is made on an annual (full calendar year) basis at the end of the year based upon taxable income and distributions for the full-year. Therefore, any estimate of tax attributes of distributions made on a quarterly basis may not be representative of the actual tax attributes of distributions for a full year.

 

Investment Income on CLO Fund Securities. The Company generates investment income from its investments in the most junior class of securities of CLO Funds (typically preferred shares or subordinated securities) managed by the Asset Manager Affiliates and selective investments in securities issued by funds managed by other asset management companies. The Company’s CLO Fund junior class securities are subordinated to senior note holders who typically receive a stated interest rate of return based on a floating rate index, such as the London Interbank Offered Rate (“LIBOR”) on their investment. The CLO Funds are leveraged funds and any excess cash flow or “excess spread” (interest earned by the underlying securities in the fund less payments made to senior note holders and less fund expenses and management fees) is paid to the holders of the CLO Fund’s subordinated securities or preferred shares.

 

GAAP-basis investment income on CLO equity investments is recorded using the effective interest method in accordance with the provisions of ASC 325-40, based on the anticipated yield and the estimated cash flows over the projected life of the investment. Yields are revised when there are changes in actual or estimated projected future cash flows due to changes in prepayments and/or re-investments, credit losses or asset pricing. Changes in estimated yield are recognized as an adjustment to the estimated yield prospectively over the remaining life of the investment from the date the estimated yield was changed. Accordingly, investment income recognized on CLO equity securities in the GAAP statement of operations differs from both the tax–basis investment income and from the cash distributions actually received by the Company during the period.

 

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For non-junior class CLO Fund securities, such as the Company’s investment in the Class E Notes of the Catamaran 2014-1 CLO, interest is earned at a fixed spread relative to the LIBOR index.

 

Capital Structuring Service Fees. The Company may earn ancillary structuring and other fees related to the origination, investment, disposition or liquidation of debt and investment securities. Generally, the Company will capitalize loan origination fees, then amortize these fees into interest income over the term of the loan using the effective interest rate method, recognize prepayment and liquidation fees upon receipt and equity structuring fees as earned, which generally occurs when an investment transaction closes.

 

Debt Issuance Costs. Debt issuance costs represent fees and other direct costs incurred in connection with the Company’s borrowings. These amounts are capitalized and amortized using the effective interest method over the contractual term of the borrowing.

 

Extinguishment of debt. The Company must derecognize a liability if and only if it has been extinguished through delivery of cash, delivery of other financial assets, delivery of goods or services, or reacquisition by the Company of its outstanding debt securities whether the securities are cancelled or held. If the debt contains a cash conversion option, the Company must allocate the consideration transferred and transaction costs incurred to the extinguishment of the liability component and the reacquisition of the equity component and recognize a gain or loss in the statement of operations.

 

Expenses. The Company is internally managed and expenses costs, as incurred, with regard to the running of its operations. Primary operating expenses include employee salaries and benefits, the costs of identifying, evaluating, negotiating, closing, monitoring and servicing the Company’s investments and related overhead charges and expenses, including rental expense, and any interest expense incurred in connection with borrowings. The Company and the Asset Manager Affiliates share office space and certain other operating expenses. The Company has entered into an Overhead Allocation Agreement with the Asset Manager Affiliates which provides for the sharing of such expenses based on an allocation of office lease costs and the ratable usage of other shared resources.

 

Shareholder Distributions. Distributions to common stockholders are recorded on the ex-dividend date. The amount of distributions, if any, is determined by the Board of Directors each quarter.

 

The Company has adopted a dividend reinvestment plan that provides for reinvestment of its distributions on behalf of its stockholders, unless a stockholder “opts out” of the plan to receive cash in lieu of having their cash distributions automatically reinvested in additional shares of the Company’s common stock.

 

3. EARNINGS PER SHARE

 

In accordance with the provisions of ASC 260,“Earnings per Share” (“ASC 260”), basic earnings per share is computed by dividing earnings available to common shareholders by the weighted average number of shares outstanding during the period. Other potentially dilutive common shares, and the related impact to earnings, are considered when calculating earnings per share on a diluted basis.

 

The following information sets forth the computation of basic and diluted net (decrease) increase in stockholders’ equity per share for the three and nine months ended September 30, 2015 and 2014 (unaudited):

 

   (unaudited)   (unaudited) 
         
   Three Months Ended September 30,   Nine Months Ended September 30, 
   2015   2014   2015   2014 
                 
Net (decrease) increase in net assets resulting from operations  $(16,050,865)  $8,236,473   $(7,145,869)  $23,930,726 
Net decrease (increase) in net assets allocated to unvested share awards   303,869    (151,517)   125,136    (288,671)
Interest on Convertible Notes       1,072,050        3,216,150 
Amortization of Capitalized Costs on Convertible Notes       106,460        313,327 
                      
Net (decrease) increase in net assets available to common stockholders  $(15,746,996)  $9,263,466   $(7,020,733)  $27,171,532 
Weighted average number of common shares outstanding for basic shares computation   37,046,906    33,746,159    36,923,212    33,497,934 
Effect of dilutive securities – stock options       12,058        11,949 
Effect of dilutive Convertible Notes       6,367,443        6,367,443 
                      
Weighted average number of common and common stock equivalent shares outstanding for diluted shares computation   37,046,906    40,125,660    36,923,212    39,877,326 
                      
Net (decrease) increase in net assets per basic common shares:                    
Net (decrease) increase in net assets from operations  $(0.43)  $0.24   $(0.19)  $0.71 
Net (decrease) increase in net assets per diluted shares:                    
Net (decrease) increase in net assets from operations  $(0.43)  $0.23   $(0.19)  $0.68 

 

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Share-based awards that contain non-forfeitable rights to dividends or dividend equivalents, whether paid or unpaid, are participating securities and included in the computation of both basic and diluted earnings per share. Grants of restricted stock awards to the Company’s employees and directors are considered participating securities when there are earnings in the period and the earnings per share calculations include outstanding unvested restricted stock awards in the basic weighted average shares outstanding calculation.

 

There were 50,000 options to purchase shares of common stock outstanding for the three months ended September 30, 2015 and 2014. For the nine months ended September 30, 2015, the company purchased 36,348 shares of common stock in connection with the vesting of employee’s restricted stock, such shares are treated as treasury shares and reduce the weighted average shares outstanding in the computation of earnings per share.

 

The Company’s Convertible Notes are included in the computation of the diluted net increase or decrease in net assets resulting from operations per share by application of the “if-converted method.” Under the if-converted method, interest charges applicable to the convertible notes for the period are added to reported net increase or decrease in net assets resulting from operations and the full amount of shares (pro-rata if not outstanding for the full period) that would be issued are added to weighted average basic shares. Convertible notes are considered anti-dilutive only when its interest per share upon conversion exceeds the basic net increase or decrease in net assets resulting from operations per share. For the three months and nine months ended September 30, 2015, the effects of the convertible notes are anti-dilutive.

 

The if-converted method of computing the dilutive effects on convertible notes assumes a conversion even if the contracted conversion price exceeds the market value of the shares. As of September 30, 2015, the current conversion rate of the Convertible Notes is approximately 134.51 shares of our common stock per $1,000 principal amount of the Convertible Notes, equivalent to a conversion price of approximately $7.43 per share of the Company’s common stock. Upon conversion, the Company may issue the full amount of common stock and retire the full amount of debt outstanding or, at its option, settle the conversion in cash.

 

4. INVESTMENTS

 

The following table shows the Company’s portfolio by security type at September 30, 2015 and December 31, 2014:

 

   September 30, 2015 (unaudited)   December 31, 2014 
Security Type  Cost   Fair Value      Cost   Fair Value    
Money Market Accounts³  $3,345,723   $3,345,723    1   $1,602,741   $1,602,741    1 
Senior Secured Loan   211,441,566    204,189,144    86    220,965,922    218,329,860    86 
Junior Secured Loan   41,204,786    39,795,980    17    38,664,199    38,569,006    15 
Senior Unsecured Loan   23,000,000    23,000,000    10    33,066,984    33,066,984    13 
First Lien Bond   2,976,651    2,317,500    1    2,962,507    2,580,000    1 
Senior Subordinated Bond   4,420,467    4,221,543    2    4,295,544    4,240,301    2 
Senior Unsecured Bond   11,698,340    10,597,995    5    11,208,178    11,386,218    4 
Senior Secured Bond   1,511,590    1,481,250    1    1,515,584    1,552,500    1 
CLO Fund Securities   86,288,448    66,720,782    28    90,889,190    77,514,901    30 
Equity Securities   8,514,487    6,936,653    3    8,828,812    8,119,681    3 
Preferred Securities   10,359,873    10,681,029    5    10,206,016    10,418,302    4 
Asset Manager Affiliates²   57,189,159    64,121,000    27    60,292,677    72,326,000    28 
                               
Total  $461,951,090   $437,408,599    186%  $484,498,354   $479,706,494    188%

 

 

¹Represents percentage of Net Asset Value.
²Represents the equity investment in the Asset Manager Affiliates.
³Includes restricted cash held under employee benefit plans.

 

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The industry concentrations based on the fair value of the Company’s investment portfolio as of September 30, 2015 and December 31, 2014, were as follows:

 

   September 30, 2015 (unaudited)   December 31, 2014 
Industry Classification  Cost   Fair Value   %1   Cost   Fair Value   %1 
Aerospace and Defense  $9,648,347   $9,069,264    4.0%  $10,059,487   $9,533,092    4%
Asset Management Company2   57,189,159    64,121,000    26.0    60,292,677    72,326,000    28 
Related Party Loan   23,000,000    23,000,000    10.0    23,000,000    23,000,000    9 
Automotive   9,932,977    9,876,215    4.0    8,362,956    8,312,548    3 
Banking, Finance, Insurance & Real Estate   6,302,517    6,165,678    3.0    7,660,721    7,639,366    3 
Beverage, Food and Tobacco   24,439,168    24,119,358    10.0    17,974,974    17,883,421    7 
Capital Equipment   9,509,929    8,437,999    4.0    9,486,407    10,351,329    4 
Chemicals, Plastics and Rubber   3,503,317    3,463,669    1.0    6,348,226    6,210,253    2 
CLO Fund Securities   86,288,447    66,720,782    28.0    90,889,190    77,514,901    31 
Construction & Building   1,980,681    1,982,831    1.0    -    -    - 
Consumer goods: Durable   14,163,260    13,174,865    6.0    13,876,482    13,301,207    5 
Consumer goods: Non-durable   20,393,549    20,156,836    9.0    13,535,975    13,314,952    5 
Containers, Packaging and Glass   2,916,649    2,921,622    1.0    2,992,443    2,946,734    1 
Energy: Oil & Gas   14,176,843    11,509,141    5.0    13,866,208    13,289,753    5 
Environmental Industries   12,784,029    12,474,510    5.0    12,942,593    12,911,017    5 
Forest Products & Paper   5,895,474    5,944,907    3.0    5,917,051    5,942,523    2 
Healthcare & Pharmaceuticals   50,028,563    46,982,976    20.0    66,186,412    65,720,782    27 
High Tech Industries   11,802,469    11,652,643    5.0    14,457,495    14,419,110    6 
Hotel, Gaming & Leisure   400,000    1,000    -    3,392,481    2,962,315    1 
Media: Advertising, Printing & Publishing   11,203,758    10,574,807    5.0    11,318,815    11,396,027    4 
Media: Broadcasting & Subscription   7,459,621    7,399,614    3.0    14,477,078    14,409,401    6 
Metals & Mining   228,563    1,000    -    228,563    1,000    - 
Retail   4,390,431    3,870,664    2.0    4,234,086    3,773,847    1 
Services: Business   20,706,513    20,513,356    9.0    16,550,255    16,066,421    6 
Services: Consumer   6,519,760    6,438,715    3.0    6,798,372    6,752,521    3 
Telecommunications   13,797,355    13,614,636    6.0    22,030,434    21,865,864    9 
Time Deposit and Money Market Accounts3   3,345,723    3,345,724    1.0    1,602,741    1,602,741    1 
Transportation: Cargo   21,755,034    22,040,544    9.0    20,156,700    20,455,941    8 
Transportation: Consumer   2,487,820    2,487,500    1.0    -    -    - 
Utilities: Electric   5,701,134    5,346,743    2.0    5,859,532    5,803,428    2 
                               
Total  $461,951,090   $437,408,599    186%  $484,498,354   $479,706,494    188%

 

 

1Calculated as a percentage of Net Asset Value.
2Represents the equity investment in the Asset Manager Affiliates.
3Includes restricted cash held under employee benefit plans.

 

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The Company may invest up to 30% of the investment portfolio in “non-qualifying” opportunistic investments in debt and equity securities of CLO Funds, distressed debt or debt and equity securities of public companies. The Company expects that these public companies generally will have debt that is non-investment grade. Within this 30% of the portfolio, the Company also may invest in debt of middle market companies located outside of the United States.

 

At September 30, 2015 and December 31, 2014, the total amount of non-qualifying assets was approximately 17% and 21%, respectively. The majority of non-qualifying assets were foreign investments which were approximately 15% and 16% of the Company’s total assets, respectively (including the Company’s investments in CLO Funds, which are typically domiciled outside the U.S. and represented approximately 15% and 16% of its total assets on such dates, respectively).

 

The following tables detail the ten largest portfolio investments (at fair value) as of September 30, 2015 and December 31, 2014:

 

   September 30, 2015 (unaudited) 
Investment  Cost/Amortized Cost   Fair Value   % of FMV 
Asset Manager Affiliates  $57,189,159   $64,121,000    15%
Katonah 2007-I CLO Ltd.   23,975,870    23,233,837    5 
Trimaran Credit Facility   23,000,000    23,000,000    5 
Crowley Holdings Preferred, LLC   10,359,873    10,681,029    2 
Catamaran CLO 2015-1 Ltd.   12,439,015    9,442,080    2 
Tank Partners Holdings, LLC   10,520,547    8,939,640    2 
Catamaran CLO 2014-1 Ltd.   9,264,284    7,251,390    2 
Catamaran CLO 2014-2 Ltd.   8,374,214    6,932,673    2 
Grupo HIMA San Pablo, Inc.   6,916,737    6,650,000    2 
Catamaran CLO 2013- 1 Ltd.   6,559,985    6,561,900    1 
                
Total  $168,599,684   $166,813,549    38%

 

   December 31, 2014 
Investment  Cost/Amortized Cost   Fair Value   % of FMV 
Asset Manager Affiliates  $60,292,677   $72,326,000    15%
Katonah 2007-I CLO Ltd.   23,471,779    25,191,782    5 
Trimaran Credit Facility   23,000,000    23,000,000    5 
Crowley Holdings Preferred, LLC   10,206,016    10,418,302    2 
Tank Partners Holdings, LLC   10,212,907    9,866,065    2 
Catamaran CLO 2014-1 Ltd.   10,473,628    8,867,176    2 
Catamaran CLO 2014-2 Ltd.   9,862,799    8,761,500    2 
Restorix Health, Inc.   8,063,397    8,063,397    2 
Catamaran CLO 2013- 1 Ltd.   7,492,702    7,874,910    2 
Grupo HIMA San Pablo, Inc.   6,894,754    7,105,000    1 
                
Total  $169,970,659   $181,474,132    38%

 

Excluding the Asset Manager Affiliates and CLO Fund securities, the Company’s ten largest portfolio companies represented approximately 18% and 17% of the total fair value of the Company’s investments at September 30, 2015 and December 31, 2014, respectively.

 

 43 

 

 

Investments in CLO Fund Securities

 

The Company typically makes a minority investment in the most junior class of securities (typically preferred shares or subordinated securities) of CLO Funds managed by the Asset Manager Affiliates and may selectively invest in securities issued by CLO funds managed by other asset management companies. These securities also are entitled to recurring distributions which generally equal the net remaining cash flow of the payments made by the underlying CLO Fund’s securities less contractual payments to senior bond holders, management fees and CLO Fund expenses. CLO Funds invest primarily in broadly syndicated non-investment grade loans, high-yield bonds and other credit instruments of corporate issuers. The underlying assets in each of the CLO Funds in which the Company has an investment are generally diversified secured or unsecured corporate debt. The CLO Funds are leveraged funds and any excess cash flow or “excess spread” (interest earned by the underlying securities in the fund less payments made to senior bond holders, fund expenses and management fees) is paid to the holders of the CLO Fund’s subordinated securities or preferred shares.

 

Fair Value Measurements

 

The Company follows the provisions of ASC 820: Fair Value, which among other matters, requires enhanced disclosures about investments that are measured and reported at fair value. This standard defines fair value and establishes a hierarchal disclosure framework which prioritizes and ranks the level of market price observability used in measuring investments at fair value and expands disclosures about assets and liabilities measured at fair value. ASC 820: Fair Value defines “fair value” as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. This fair value definition focuses on an exit price in the principal, or most advantageous market, and prioritizes, within a measurement of fair value, the use of market-based inputs (which may be weighted or adjusted for relevance, reliability and specific attributes relative to the subject investment) over entity-specific inputs. Market price observability is affected by a number of factors, including the type of investment and the characteristics specific to the investment. Investments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value. Subsequent to the adoption of ASC 820: Fair Value, the FASB has issued various staff positions clarifying the initial standard (see Note 2 – “Significant Accounting Policies—Investments”).

 

ASC 820: Fair Value establishes the following three-level hierarchy, based upon the transparency of inputs to the fair value measurement of an asset or liability as of the measurement date:

 

Level I – Unadjusted quoted prices are available in active markets for identical investments as of the reporting date. The type of investments included in Level I include listed equities and listed securities. As required by ASC 820: Fair Value, the Company does not adjust the quoted price for these investments, even in situations where the Company holds a large position and a sale could reasonably affect the quoted price.

 

Level II – Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reporting date. Such inputs may be quoted prices for similar assets or liabilities, quoted markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full character of the financial instrument, or inputs that are derived principally from, or corroborated by, observable market information. Investments which are generally included in this category include illiquid debt securities and less liquid, privately held or restricted equity securities for which some level of recent trading activity has been observed.

 

Level III – Pricing inputs are unobservable for the investment and includes situations where there is little, if any, market activity for the investment. The inputs may be based on the Company’s own assumptions about how market participants would price the asset or liability or may use Level II inputs, as adjusted, to reflect specific investment attributes relative to a broader market assumption. These inputs into the determination of fair value may require significant management judgment or estimation. Even if observable market data for comparable performance or valuation measures (earnings multiples, discount rates, other financial/valuation ratios, etc.) are available, such investments are grouped as Level III if any significant data point that is not also market observable (private company earnings, cash flows, etc.) is used in the valuation methodology.

 

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investment’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and the Company considers factors specific to the investment. A majority of the Company’s investments are classified as Level III. The Company evaluates the source of inputs, including any markets in which its investments are trading, in determining fair value. Inputs that are highly correlated to the specific investment being valued and those derived from reliable or knowledgeable sources will tend to have a higher weighting in determining fair value. Ongoing reviews by the Company’s investment analysts, Chief Investment Officer, Valuation Committee and independent valuation firms (if engaged) may include factors such as an assessment of each underlying investment, its current and prospective operating and financial performance, consideration of financing and sale transactions with third parties, expected cash flows and market-based information, including comparable transactions, performance factors, and other investment or industry specific market data, among other factors.

 

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The following table summarizes the fair value of investments by the above ASC 820: Fair Value fair value hierarchy levels as of September 30, 2015 (unaudited) and December 31, 2014, respectively:

 

   As of September 30, 2015 (unaudited) 
   Level I   Level II   Level III   Total 
Money market accounts  $   $3,345,723   $   $3,345,723 
Debt securities       86,392,713    209,891,728    296,284,441 
CLO Fund securities           66,720,782    66,720,782 
Equity securities           6,936,653    6,936,653 
Asset Manager Affiliates           64,121,000    64,121,000 
Total  $   $89,738,436   $347,670,163   $437,408,599 

 

   As of December 31, 2014 
   Level I   Level II   Level III   Total 
Money market accounts  $   $1,602,741   $   $1,602,741 
Debt securities       149,124,827    171,018,343    320,143,170 
CLO Fund securities           77,514,902    77,514,902 
Equity securities           8,119,681    8,119,681 
Asset Manager Affiliates           72,326,000    72,326,000 
Total  $   $150,727,568   $328,978,926   $479,706,494 

 

As a BDC, the Company is required to invest primarily in the debt and equity of non-public companies for which there is little, if any, market-observable information. As a result a significant portion of the Company’s investments at any given time will likely be deemed Level III investments.

 

Investment values derived by a third party pricing service are generally deemed to be Level III values. For those that have observable trades, the Company considers them to be Level II.

 

Values derived for debt and equity securities using comparable public/private companies generally utilize market-observable data from such comparables and specific, non-public and non-observable financial measures (such as earnings or cash flows) for the private, underlying company/issuer. Such non-observable company/issuer data is typically provided on a monthly or quarterly basis, is certified as correct by the management of the company/issuer and/or audited by an independent accounting firm on an annual basis. Since such private company/issuer data is not publicly available it is not deemed market-observable data and, as a result, such investment values are grouped as Level III assets.

 

Values derived for the Asset Manager Affiliates using comparable public/private companies utilize market-observable data and specific, non-public and non-observable financial measures (such as assets under management, historical and prospective earnings) for the Asset Manager Affiliates. The Company recognizes that comparable asset managers may not be fully comparable to the Asset Manager Affiliates and typically identifies a range of performance measures and/or adjustments within the comparable population with which to determine value. Since any such ranges and adjustments are entity specific they are not considered market-observable data and thus require a Level III grouping. Illiquid investments that have values derived through the use of discounted cash flow models and residual enterprise value models are grouped as Level III assets.

 

The Company’s policy for determining transfers between levels is based solely on the previously defined three-level hierarchy for fair value measurement. Transfers between the levels of the fair value hierarchy are separately noted in the tables below and the reason for such transfer described in each table’s respective footnotes. Investments measured at fair value for which the Company has used unobservable inputs to determine fair value are as follows:

 

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    Nine Months Ended September 30, 2015 (unaudited)  
    Debt Securities     CLO Fund
 Securities
    Equity
Securities
    Asset Manager
Affiliate
    Total  
Balance, December 31, 2014   $ 171,018,343     $ 77,514,902     $ 8,119,681     $ 72,326,000     $ 328,978,926  
Transfers out of Level III     (9,960,953 )1                       (9,960,953 )
Transfers into Level III     42,920,972 2                       42,920,972  
Net accretion (amortization)     221,620       (6,433,551 )                 (6,211,931 )
Purchases     53,510,881       11,952,000                   65,462,881  
Sales / Paydowns     (49,362,448 )     (3,872,700 )     (317,340 )     (3,103,517 )     (56,656,005 )
Total realized gain (loss) included in earnings     24,364       (6,246,883 )     3,015             (6,219,504 )
Total unrealized gain (loss) included in earnings     1,518,949       (6,192,986 )     (868,703 )     (5,101,483 )     (10,644,223 )
Balance, September 30, 2015   $ 209,891,728     $ 66,720,782     $ 6,936,653     $ 64,121,000     $ 347,670,163  
                                         
Changes in unrealized gains (losses) included in earnings related to investments still held at reporting date   $ 1,518,949     $ (12,985,600 )   $ (868,704 )   $ (5,101,484 )   $ (17,436,839 )

¹Transfers out of Level III represent a transfer of $9,960,953 relating to debt securities for which pricing inputs, other than their quoted prices in active markets were observable as of September 30, 2015

 

²Transfers into Level III represent a transfer of $42,920,972 relating to debt securities for which pricing inputs, other than their quoted prices in active markets were unobservable as of September 30, 2015

 

   Year Ended December 31, 2014 
   Debt Securities   CLO Fund 
Securities
   Equity
Securities
   Asset Manager
Affiliate
   Total 
Balance, December 31, 2013  $198,097,374   $79,452,220   $11,006,399   $76,148,000   $364,703,993 
Transfers out of Level III   (38,990,152)1               (38,990,152)
Transfers into Level III   1,982,1102               1,982,110 
Net accretion (amortization)   198,600    (11,102,015)           (10,903,415)
Purchases   132,079,152    22,421,847    2,216,847    545,979    157,263,825 
Sales/Paydowns   (121,242,093)   (10,132,500)   (5,007,311)   (6,432,086)   (142,813,990)
Total realized gain (loss) included in earnings   (9,069,550)   5,575,498    (7,136,407)       (10,630,459)
Total unrealized gain (loss) included in earnings   7,962,902    (8,700,148)   7,040,153    2,064,107    8,367,014 
Balance, December 31, 2014  $171,018,343   $77,514,902   $8,119,681   $72,326,000   $328,978,926 
                          
Changes in unrealized gains (losses) included in earnings related to investments still held at reporting date  $(1,448,794)  $(4,908,278)  $424,306   $2,064,107   $(3,868,659)

¹Transfers out of Level III represent a transfer of $2,783,195 relating to debt securities for which pricing inputs, other than their quoted prices in active markets were observable as of December 31, 2013

 

²Transfers into Level III represent a transfer of $34,070,557 relating to debt securities for which pricing inputs, other than their quoted prices in active markets were unobservable as of December 31, 2013.

 

As of September 30, 2015, the Company’s Level II portfolio investments were valued by a third party pricing services for which the prices are not adjusted and for which inputs are observable or can be corroborated by observable market data for substantially the full character of the financial instrument, or by inputs that are derived principally from, or corroborated by, observable market information. The fair value of the Company’s Level II portfolio investments was $89,738,436 as of September 30, 2015.

 

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As of September 30, 2015, the Company’s Level III portfolio investments had the following valuation techniques and significant inputs:

 

Type  Fair Value   Primary Valuation
Methodology
  Unobservable
Inputs
  Range of Inputs
(Weighted Average)
  $25,317,500   Enterprise Value  Average EBITDA Multiple/Qualitative Inputs  7.2x
Debt Securities  $  184,573,228   Income Approach  Implied Discount Rate  2.3% - 21.2% (9.2%)
   $1,000   Options Value  Qualitative Inputs1   
Equity Securities  $6,933,653   Enterprise Value  Average EBITDA Multiple/WAAC  4.3x/6.5% - 13.1x/15.1% (7.2x/12.2%)
   $3,000   Options Value  Qualitative Inputs   
       Discount Rate  12% (12%)
           Probability of Default  2.0% - 2.5% (2.1%)
CLO Fund Securities  $57,278,702   Discounted Cash Flow  Loss Severity  25.0% - 25.9% (25.7%)
           Recovery Rate  74.1% - 75.0% (74.3%)
           Prepayment Rate  7.6% - 33.5% (26.2%)
   $9,442,080   Market Approach  Third Party Quote  79 (79)
Asset Manager Affiliate  $64,121,000   Discounted Cash Flow  Discount Rate  2.11% - 12.0% (7.0%)
Total Level III Investments  $347,670,163          

  

¹ The qualitative inputs used in the fair value measurements of the Debt Securities include estimates of the distressed liquidation value of the pledged collateral.

 

The significant unobservable inputs used in the fair value measurement of the Company’s debt securities may include, among other things, broad market indices, the comparable yields of similar investments in similar industries, effective discount rates, average EBITDA multiples, and weighted average cost of capital. Significant increases or decreases in such comparable yields would result in a significantly lower or higher fair value measurement.

 

The significant unobservable inputs used in the fair value measurement of the Company’s equity securities include the EBITDA multiple of similar investments in similar industries and the weighted average cost of capital. Significant increases or decreases in such inputs would result in a significantly lower or higher fair value measurement.

 

Significant unobservable input used in the fair value measurement of the Company’s CLO Fund securities include default rates, recovery rates, prepayment rates, spreads, and the discount rate by which to value the resulting underlying cash flows. Such assumptions can vary significantly, depending on market data sources which often vary in depth and level of analysis, understanding of the CLO market, detailed or broad characterization of the CLO market and the application of such data to an appropriate framework for analysis. The application of data points are based on the specific attributes of each individual CLO Fund security’s underlying assets, historic, current and prospective performance, vintage, and other quantitative and qualitative factors that would be evaluated by market participants. The Company evaluates the source of market data for reliability as an indicative market input, consistency amongst other inputs and results and also the context in which such data is presented. Significant increases or decreases in probability of default and loss severity inputs in isolation would result in a significantly lower or higher fair value measurement. In general, a change in the assumption of the probability of default is accompanied by a directionally similar change in the assumption used for the loss severity in an event of default. Significant increases or decreases in the discount rate in isolation would result in a significantly lower or higher fair value measurement.

 

 47 

 

 

The significant unobservable inputs used in the fair value measurement of the Asset Manager Affiliates is the discount rate used to present value prospective cash flows. Prospective revenues are generally based on a fixed percentage of the par value of CLO Fund assets under management and are recurring in nature for the term of the CLO Fund so long as the Asset Manager Affiliates manage the fund. As a result, the fees earned by the Asset Manager Affiliates are generally not subject to market value fluctuations in the underlying collateral. The discounted cash flow model incorporates different levels of discount rates depending on the hierarchy of fees earned (including the likelihood of realization of senior, subordinate and incentive fees) and prospective modeled performance. Significant increases or decreases in such discount rate would result in a significantly lower or higher fair value measurement.

 

5. ASSET MANAGER AFFILIATES

 

Wholly-Owned Asset Managers

 

The Asset Manager Affiliates are wholly-owned portfolio companies. The Asset Manager Affiliates manage CLO Funds primarily for third party investors that invest in broadly syndicated loans, high yield bonds and other credit instruments issued by corporations. At September 30, 2015 and December 31, 2014, the Asset Manager Affiliates had approximately $2.7 billion and $3.0 billion, respectively, of par value of assets under management, and the Company’s 100% equity interest in the Asset Manager Affiliates had a fair value of approximately $64 million and $72 million, respectively.

 

As a manager of the CLO Funds, the Asset Manager Affiliates receive contractual and recurring management fees from the CLO Funds for their management and advisory services. The annual fees which the Asset Manager Affiliates receive are generally based on a fixed percentage of assets under management (at par value and not subject to changes in market value), and the Asset Manager Affiliates generate net income equal to the amount by which their fee income exceeds their operating expenses, including compensation of their employees and income taxes. The management fees the Asset Manager Affiliates receive have three components - a senior management fee, a subordinated management fee and an incentive fee. Currently, all CLO Funds managed by the Asset Manager Affiliates are paying both their senior and subordinated management fees on a current basis. Additionally, two managed funds made incentive fee distributions during the quarter ended September 30, 2015.

 

For the three months ended September 30, 2015 and 2014, the Asset Manager Affiliates declared cash distributions of $2.3 million and $3.1 million to the Company, respectively. For the nine months ended September 30, 2015 and 2014, the Asset Manager Affiliates declared cash distributions of $7.3 million and $9.1 million to the Company, respectively. Any distributions from the Asset Manager Affiliates out of the estimated tax-basis earnings and profits are recorded as “Dividends from Asset Manager Affiliates” on the Company’s statement of operations. The Company recognized $1.5 million and $1.4 million, respectively, of Dividends from Asset Manager Affiliates in the Statement of Operations for the three months ended September 30, 2015 and 2014. The difference between cash distributions received and the tax-basis earnings and profits of the distributing affiliate, are recorded as an adjustment to the cost basis in the Asset Manager Affiliate (i.e., tax-basis return of capital). Distributions receivable, if any, are reflected in the Due from Affiliates account on the consolidated balance sheets.

 

The tax attributes of distributions received from the Asset Manager Affiliates are determined on an annual basis. The Company makes an estimate of the tax-basis earnings and profits of the Asset Manager Affiliates on a quarterly basis, and any quarterly distributions received in excess of the estimated earnings and profits are recorded as return of capital (reduction in the cost basis of the investment in Asset Manager Affiliate).

 

The Asset Manager Affiliates’ fair value is determined quarterly. The valuation is primarily determined utilizing a discounted cash flow model. (See Note 2 - “Significant Accounting Policies” and Note 4 - “Investments” for further information relating to the Company’s valuation methodology.)

 

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Effective January 1, 2010, the Asset Manager Affiliates adopted guidance encompassed in Accounting Standards Codification Topic 810, “Consolidation.” The adoption of this new guidance had an impact on the disclosures relating to the Asset Manager Affiliates in the Company’s SEC filings which had previously not been required, as its provisions require the Asset Manager Affiliates to consolidate certain of their managed CLO Funds that were not previously consolidated. As a result of the consolidation of the CLO Funds into the Asset Manager Affiliates, the financial results of the Asset Manager Affiliates indicate that they qualify as a “significant subsidiary” of the Company requiring the following additional disclosures. In addition, Katonah 2007-I CLO qualifies as “significant subsidiaries” of the Company and the Company is also required to make the additional disclosures about it below. These disclosures regarding the Asset Manager Affiliates and Katonah 2007-I CLO do not directly impact the financial position, results of operations, or cash flows of the Company.

 

Asset Manager Affiliates

Summarized Balance Sheet Information (unaudited)

 

   As of   As of 
   September 30,
2015
   December 31,
2014
 
Investments of CLO Funds, at fair value  $2,832,831,349   $2,846,659,635 
Restricted cash of CLO Funds   163,393,198    182,224,205 
Total assets   3,094,809,922    3,092,592,939 
CLO Fund liabilities at fair value   2,930,979,743    2,990,211,629 
Total liabilities   3,026,008,125    3,060,837,388 
Total Asset Manager Affiliates equity   32,851,021    34,780,345 
Appropriated retained earnings (deficit) of consolidated VIEs   35,950,776    (3,024,793)

 

Asset Manager Affiliates

Summarized Statements of Operations Information (unaudited)

 

   For the three months ended   For the nine months ended 
   September 30,   September 30, 
   2015   2014   2015   2014 
Interest income - investments of CLO Funds  $33,864,746   $31,042,540   $97,413,581   $89,607,622 
Total income   34,295,807    32,777,736    101,084,824    94,460,828 
Interest expense of CLO Fund liabilities   33,480,470    25,477,833    112,252,220    74,533,029 
Total expenses   37,563,731    37,468,325    137,696,316    103,677,330 
Net realized and unrealized gains (losses)   (17,200,639)   (40,493,821)   83,216,644    (50,167,488)
Net (loss) income attributable to noncontrolling interests in      consolidated Variable Interest Entities   (24,666,746)   (47,301,969)   38,468,715    (65,558,757)
Net income attributable to Asset Manager Affiliates   2,858,876    1,274,518    5,370,678    3,949,287 

 

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Katonah 2007-I CLO Ltd.

Summarized Balance Sheet Information (unaudited)

 

   As of   As of 
   September 30,
2015
   December 31,
2014
 
Total investments at fair value  $258,104,187   $273,373,948 
Cash   9,325,472    14,939,994 
Total assets   268,022,761    288,945,330 
CLO Debt at fair value   269,401,971    290,699,426 
Total liabilities   269,379,642    292,730,723 
Total Net Assets   (1,356,881)   (3,785,393)

 

Katonah 2007-I CLO Ltd.

Summarized Statements of Operations Information (unaudited)

 

   For the three months ended   For the nine months ended 
   September 30,   September 30, 
   2015   2014   2015   2014 
Interest income from investments  $2,567,295   $2,925,473   $7,644,426   $8,944,967 
Total income   2,645,492    2,554,342    8,029,801    8,938,951 
Interest expense   2,299,222    2,667,429    6,904,401    8,188,894 
Total expenses   2,530,278    2,949,332    7,722,579    9,144,902 
Net realized and unrealized losses   529,390    (2,698,937)   2,121,290    (9,215,396)
Increase (decrease) in net assets resulting from operations   644,604    (3,093,927)   2,428,512    (9,421,347)

 

As separately regarded entities for tax purposes, the Asset Manager Affiliates are taxed at normal corporate rates. In order to maintain the Company’s RIC status, any tax-basis dividends paid by the Asset Manager Affiliates to the Company would generally need to be distributed to the Company’s shareholders. Generally, such tax-basis dividends of the Asset Manager Affiliates’ income which was distributed to the Company’s shareholders will be considered as qualified dividends for tax purposes. The Asset Manager Affiliates’ taxable net income will differ from U.S. GAAP net income because of deferred tax temporary differences and permanent tax adjustments. Deferred tax temporary differences may include differences for the recognition and timing of amortization and depreciation, compensation related expenses, and net loss carryforward, among other things. Permanent differences may include adjustments, limitations or disallowances for meals and entertainment expenses, penalties, tax goodwill amortization and net operating loss carryforward.

 

Goodwill amortization for tax purposes was created upon the purchase of 100% of the equity interests in Katonah Debt Advisors prior to the Company’s IPO in exchange for shares of the Company’s stock valued at $33 million. Although this transaction was a stock transaction rather than an asset purchase and thus no goodwill was recognized for U.S. GAAP purposes, such exchange was considered an asset purchase under Section 351(a) of the Code. At the time of the transfer, Katonah Debt Advisors had equity of approximately $1 million resulting in tax goodwill of approximately $32 million which is being amortized for tax purposes on a straight-line basis over 15 years, which accounts for an annual difference between U.S. GAAP income and taxable income by approximately $2 million per year over such period.

 

Additional goodwill amortization for tax purposes was created upon the purchase of 100% of the equity interests in Trimaran Advisors by one of KCAP’s affiliates, in exchange for shares of the Company’s stock valued at $25.5 million and cash of $13.0 million. The transaction was considered an asset purchase under Section 351(a) of the Code and resulted in tax goodwill of approximately $22.8 million which is being amortized for tax purposes on a straight-line basis over 15 years, which accounts for an annual difference between GAAP income and taxable income of approximately $1.5 million per year over such period. 

 

Related Party Transactions

 

On February 26, 2013, the Company entered into a senior credit agreement (the “Trimaran Credit Facility”) with Trimaran Advisors, pursuant to which Trimaran Advisors may borrow from time to time up to $20 million from the Company in order to provide capital necessary to support one or more of Trimaran Advisors’ warehouse lines of credit and/or working capital in connection with Trimaran Advisors’ warehouse activities. The Trimaran Credit Facility expires on November 20, 2017 and bears interest at an annual rate of 9.0%. Outstanding borrowings on the Trimaran Credit Facility are callable by the Company at any time. On April 15, 2013, the Trimaran Credit Facility was amended and upsized from $20 million to $23 million. At both September 30, 2015 and December 31, 2014, the par value of the outstanding loan was $23 million. For the three months ended September 30, 2015, and 2014, the Company recognized interest income of approximately $395,000 and $491,000, respectively, related to the Trimaran Credit Facility. For the nine months ended September 30, 2015 and 2014, the Company recognized interest income of approximately $1.2 million and $1.7 million, respectively, related Trimaran Credit Facility.

 

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6. BORROWINGS

 

The Company’s debt obligations consist of the following:

 

   As of 
September 30, 2015
(unaudited)
   As of
December 31, 2014
 
         
Convertible Notes, due March 15, 2016  $33,647,000   $38,647,000 
7.375% Notes Due 2019  $41,400,000   $41,400,000 
Notes Issued by KCAP Senior Funding I, LLC (net of discount: 2015 - $3,060,315; 2014 - $3,512,407)  $144,289,685   $143,837,593 

 

The weighted average stated interest rate and weighted average maturity on all our debt outstanding as of September 30, 2015 were 4.37% and 6.71 years, respectively, and as of December 31, 2014 were 4.43% and 7.23 years, respectively.

 

Convertible Notes

 

On March 16, 2011, the Company issued $55 million in aggregate principal amount of unsecured 8.75% convertible notes due March 2016 (“Convertible Notes”). On March 23, 2011, pursuant to an over-allotment option, the Company issued an additional $5 million of such Convertible Notes for a total of $60 million in aggregate principal amount. The net proceeds from the sale of the Convertible Notes, after the payment of underwriting expenses, were approximately $57.7 million. Interest on the Convertible Notes is paid semi-annually in arrears on March 15 and September 15, at a rate of 8.75%, commencing September 15, 2011. The Convertible Notes mature on March 15, 2016 unless converted earlier. The Convertible Notes are senior unsecured obligations of the Company.

 

The Convertible Notes are convertible into shares of Company’s common stock. As of September 30, 2015, the conversion rate was 134.51 shares of common stock per $1,000 principal amount of Convertible Notes, which is equivalent to a conversion price of approximately $7.43 per share of common stock. Upon conversion, the Company would issue the full amount of common stock or settle the conversion in cash, at its option, and retire the full amount of debt outstanding.

 

Upon conversion, unless a holder converts after a record date for an interest payment but prior to the corresponding interest payment date, the holder will receive a separate cash payment with respect to the Convertible Notes surrendered for conversion representing accrued and unpaid interest to, but not including the conversion date. Any such payment will be made on the settlement date applicable to the relevant conversion on the Convertible Notes.

 

No holder of Convertible Notes will be entitled to receive shares of the Company’s common stock upon conversion to the extent (but only to the extent) that such receipt would cause such converting holder to become, directly or indirectly, a beneficial owner (within the meaning of Section 13(d) of the Securities Exchange Act of 1934 and the rules and regulations promulgated thereunder) of more than 5.0% of the shares of the Company’s common stock outstanding at such time. The 5.0% limitation will no longer apply following the effective date of any fundamental change (as defined in the indenture governing the Convertible Notes).

 

Subject to certain exceptions, holders may require us to repurchase, for cash, all or part of their Convertible Notes upon a fundamental change at a price equal to 100% of the principal amount of the Convertible Notes being repurchased plus any accrued and unpaid interest up to, but excluding, the fundamental change repurchase date. In addition, in the case of certain fundamental changes and without duplication of the foregoing amount, the Company will also pay holders an amount in cash (or, in certain circumstances, shares of the Company’s common stock) equal to the present value of the remaining interest payments on such notes through, and including, the maturity date.

 

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In connection with the issuance of the Convertible Notes, the Company incurred approximately $2.4 million of debt offering costs, which are being amortized over the term of the Convertible Notes on an effective yield method, of which approximately $132,000 remains to be amortized, and is included in other assets in the consolidated balance sheets. On April 4, 2013, approximately $9 million of the Company’s 8.75% Convertible Notes were converted at a price basis per share of $8.159 into 1,102,093 shares of KCAP common stock. On September 4, 2013, the Company purchased $2.0 million face value of its own Convertible Notes at $114.50 plus accrued interest. KCAP subsequently surrendered these notes to the Trustee for cancellation effective September 13, 2013. On October 9, 2014, the Company purchased approximately $10.4 million face value of its own Convertible Notes at $114.875 plus accrued interest. On September 23, 2015, the Company purchased $5.0 million face value of its own Convertible Notes at $102.375 plus accrued interest. KCAP subsequently surrendered these notes to the Trustee for cancellation. Due to the cash conversion option embedded in the Convertible Notes, the Company applied the guidance in ASC 470-20-40, Debt with Conversion and Other Options and realized a loss on the extinguishment of this debt. For the nine months ended September 30, 2015, there was approximately a $143,000 loss on the extinguishment of debt. The indenture governing the Convertible Notes contains certain restrictive covenants, including compliance with certain provisions of the 1940 Act and conditions governing the undertaking of new debt.

 

For the three months ended September 30, 2015 and 2014, interest expense related to the Convertible Notes was approximately $842,000 and $1.1 million, respectively. For the nine months ended September 30, 2015 and 2014, interest expense related to the Convertible Notes was approximately $2.5 million and $3.2 million, respectively.

 

The Convertible Notes have been analyzed for any features that would require its accounting to be bifurcated. There are no features that require accounting to be bifurcated, and as a result, they are recorded as a liability at their contractual amounts. At September 30, 2015, the Company was in compliance with all of its debt covenants.

 

Fair Value of Convertible Notes. The Company carries the Convertible Notes at cost. The Convertible Notes were issued in a private placement and there is no active trading of these notes. The estimated fair value of the Company’s outstanding Convertible Notes was approximately $34.4 million at September 30, 2015. The fair value was determined based on an indicative closing price as of September 30, 2015. The Convertible Notes are categorized as Level III following ASC 820: Fair Value.

 

7.375% Notes Due 2019

 

On October 10, 2012, the Company issued $41.4 million in aggregate principal amount of unsecured 7.375% Notes due 2019. The net proceeds for these Notes, after the payment of underwriting expenses, were approximately $39.9 million. Interest on the 7.375% Notes Due 2019 is paid quarterly in arrears on March 30, June 30, September 30 and December 30, at a rate of 7.375%, commencing December 30, 2012. The 7.375% Notes Due 2019 mature on September, 30, 2019 and are unsecured obligations of the Company. The 7.375% Notes Due 2019 are subject to redemption in whole or in part at any time or from time to time, at the option of the Company, on or after September 30, 2015, at a redemption price per security equal to 100% of the outstanding principal amount thereof plus accrued and unpaid interest payments otherwise payable for the then-current quarterly interest period accrued to the date fixed for redemption. In addition, due to the asset coverage test applicable to the Company as a BDC and a covenant that the Company agreed to in connection with the issuance of the 7.375% Notes Due 2019, the Company is limited in its ability to make distributions in certain circumstances. The indenture governing the 7.375% Notes Due 2019 contains certain restrictive covenants, including compliance with certain provisions of the 1940 Act relating to borrowing and dividends. At September 30, 2015, the Company was in compliance with all of its debt covenants.

 

For the three months ended September 30, 2015 and 2014, interest expense related to the 7.375% Notes Due 2019 was approximately $763,000 for both periods. For the nine months ended September 30, 2015 and 2014, interest expense related to the 7.375% Notes Due 2019 was approximately $2.3 million for both periods.

 

In connection with the issuance of the 7.375% Notes Due 2019, the Company incurred approximately $1.5 million of debt offering costs which are being amortized over the term of the facility on an effective yield method, of which approximately $942,000 remains to be amortized, and is recorded on the consolidated balance sheets in other assets.

 

Fair Value of 7.375% Notes Due 2019.  The 7.375% Notes Due 2019 were issued in a public offering on October 10, 2012 and are carried at cost. The fair value of the Company’s outstanding 7.375% Notes Due 2019 was approximately $41.4 million at September 30, 2015. The fair value was determined based on the closing price on September 30, 2015 for the 7.375% Notes Due 2019. The 7.375% Notes Due 2019 are categorized as Level I under the ASC 820 Fair Value.

 

KCAP Senior Funding I, LLC (Debt Securitization)

 

On June 18, 2013, the Company completed the sale of notes in a $140,000,000 debt securitization financing transaction. The notes offered in this transaction (the “KCAP Senior Funding I Notes”) were issued by KCAP Senior Funding I, LLC, a newly formed special purpose vehicle (the “Issuer”), in which KCAP Senior Funding I Holdings, LLC, a wholly-owned subsidiary of the Company (the “Depositor”), owns all of the KCAP Senior Funding I Subordinated Notes (as defined below), and are backed by a diversified portfolio of bank loans. The indenture governing the KCAP Senior Funding I Notes contains an event of default that is triggered in the event that certain coverage tests are not met.

 

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The secured notes (the “KCAP Senior Funding I Secured Notes”) were issued as Class A senior secured floating rate notes which have an initial face amount of $77,250,000, are rated AAA (sf)/Aaa (sf) by Standard & Poor’s Ratings Services and Moody’s Investors Service, Inc., respectively, and bear interest at the three-month LIBOR plus 1.50%, Class B senior secured floating rate notes which have an initial face amount of $9,000,000, are rated AA (sf)/Aa2 (sf) by Standard & Poor’s Ratings Services and Moody’s Investors Service, Inc., respectively, and bear interest at three-month LIBOR plus the 3.25%, Class C secured deferrable floating rate notes which have an initial face amount of $10,000,000, are rated A (sf)/A2 (sf) by Standard & Poor’s Ratings Services and Moody’s Investors Service, Inc., respectively, and bear interest at three-month LIBOR plus 4.25%, and Class D secured deferrable floating rate notes which have an initial face amount of $9,000,000, are rated BBB (sf)/Baa2 (sf) by Standard & Poor’s Ratings Services and Moody’s Investors Service, Inc., respectively, and bear interest at three-month LIBOR plus 5.25%. The Depositor retained all of the subordinated notes of the Issuer (the “KCAP Senior Funding I Subordinated Notes”), which have an initial face amount of $34,750,000. The KCAP Senior Funding I Subordinated Notes do not bear interest and are not rated. Both the KCAP Senior Funding I Secured Notes and the KCAP Senior Funding I Subordinated Notes have a stated maturity on the payment date occurring in July, 2024, and are subject to a two year non-call period. The Issuer has a four year reinvestment period. The stated interest rate re-sets on a quarterly basis based upon the then-current level of the benchmark three-month LIBOR.

 

On December 8, 2014, the Company completed the sale of additional notes (“Additional Issuance Securities”) in a $56,000,000 increase to the collateralized loan obligation transaction that originally closed on June 18, 2013 (the “Original Closing Date”). The issuance of additional notes was proportional across all existing classes of notes issued on the Original Closing Date.

 

Each class of secured Additional Issuance Securities (all such classes, collectively, the “Additional Issuance Offered Securities”) was issued as a pari passu sub-class of an existing class of notes issued on the Original Closing Date. Accordingly, the ratings given by Standard & Poor’s Ratings Services and Moody’s Investors Service, Inc. to each existing class of notes issued on the Original Closing Date will apply to each class of Additional Issuance Offered Securities that constitutes a related pari passu sub-class of such existing class of notes issued on the Original Closing Date.

 

The Additional Issuance Offered Securities were issued as Class A-2 senior secured floating rate notes which have an initial face amount of $30,900,000, have a rating of AAA (sf)/Aaa (sf) by Standard & Poor’s Ratings Services and Moody’s Investors Service, Inc., respectively, and bear interest at the three-month LIBOR plus 1.50%, Class B-2 senior secured floating rate notes which have an initial face amount of $3,600,000, a rating of AA (sf)/Aa2 (sf) by Standard & Poor’s Ratings Services and Moody’s Investors Service, Inc., respectively, and bear interest at three-month LIBOR plus 3.25%, Class C-2 secured deferrable floating rate notes which have an initial face amount of $4,000,000, a rating of A (sf)/A2 (sf) by Standard & Poor’s Ratings Services and Moody’s Investors Service, Inc., respectively, and bear interest at three-month LIBOR plus 4.25%, and Class D-2 secured deferrable floating rate notes which have an initial face amount of $3,600,000, a rating of BBB (sf)/Baa2 (sf) by Standard & Poor’s Ratings Services and Moody’s Investors Service, Inc., respectively, and bear interest at three-month LIBOR plus 5.25%. The Depositor retained all of the subordinated Additional Issuance Securities of the Issuer (the “Additional Issuance Subordinated Notes”), which have an initial face amount of $13,900,000. The Additional Issuance Subordinated Notes do not bear interest and are not rated. The Additional Issuance Securities have a stated maturity date of July 20, 2024 and are subject to a non-call period until the payment date on the Additional Issuance Securities occurring in July 2015. The Issuer has a reinvestment period to and including the payment date on the Additional Issuance Securities occurring in July 2017, or such earlier date as is provided in the indenture relating to the Additional Issuance Securities. In connection with the Additional Issuance Offered Securities, the Company incurred issuance costs and OID costs of approximately $679,000 and $896,000, respectively, which is included in other assets on the accompanying balance sheet.

 

As part of this transaction, the Company entered into a master loan sale agreement with the Depositor and the Issuer under which the Company sold or contributed certain bank loans to the Depositor, and the Depositor sold such loans to the Issuer in exchange for a combination of cash and the issuance of the KCAP Senior Funding I Subordinated Notes to the Depositor.

 

In connection with the issuance and sale of the KCAP Senior Funding I Notes, the Company has made customary representations, warranties and covenants in the purchase agreement by and between the Company, the Depositor, the Issuer and Guggenheim Securities, LLC, which served as the initial purchaser of the KCAP Senior Funding I Secured Notes. The KCAP Senior Funding I Secured Notes are the secured obligations of the Issuer, and an indenture governing the KCAP Senior Funding I Notes includes customary covenants and events of default. The KCAP Senior Funding I Notes were sold in a private placement transaction and have not been, and will not be, registered under the Securities Act of 1933, as amended, or any state “blue sky” laws and may not be offered or sold in the United States absent registration with the Securities and Exchange Commission or an applicable exemption from registration.

 

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The Company serves as collateral manager to the Issuer under a collateral management agreement, which contains customary representations, warranties and covenants. Under the collateral management agreement, the Company will perform certain investment management functions, including supervising and directing the investment and reinvestment of the Issuer’s assets, as well as perform certain administrative and advisory functions. 

 

In addition, because each of the Issuer and the Depositor are consolidated subsidiaries, the Company did not recognize any gain or loss on the transfer of any of our portfolio assets to such vehicles in connection with the issuance and sale of the KCAP Senior Funding I Notes.

 

As of September 30, 2015, there were 71 investments in portfolio companies with a total fair value of approximately $186 million plus cash of $8.3 million, collateralizing the secured notes of the Issuer. At September 30, 2015, there were unamortized issuance costs of approximately $3.3 million included in other assets, and unamortized original issue discount, (“OID”) costs of approximately $3.1 million included in Notes issued by KCAP Senior Funding I, LLC liabilities in the accompanying consolidated balance sheet. The pool of loans in the securitization must meet certain requirements, including asset mix and concentration, collateral coverage, term, agency rating, minimum coupon, minimum spread and sector diversity requirements.

 

For the three months ended September 30, 2015, interest expense, including the amortization of deferred debt issuance costs and the discount on the face amount of the notes, was approximately $1.3 million consisting of stated interest expense of approximately $947,000, accreted discount of approximately $152,000, and deferred debt issuance costs of approximately $165,000. For the nine months ended September 30, 2015, interest expense, including the amortization of deferred debt issuance costs and the discount on the face amount of the notes, was approximately $3.7 million consisting of stated interest expense of approximately $2.8 million, accreted discount of approximately $452,000, and deferred debt issuance costs of approximately $485,000. As of September 30, 2015, the stated interest charged under the securitization was based on three month LIBOR at the last reset date, which was 0.29%. The classes, stated interest rates, spread over LIBOR, and stated interest expense are as follows:

 

   Stated Interest
Rate (1)
   LIBOR Spread
(basis points)
   Interest Expense 
             
KCAP Senior Funding LLC Class A Notes   1.79%   150   $483,160 
KCAP Senior Funding LLC Class B Notes   3.54%   325    111,416 
KCAP Senior Funding LLC Class C Notes   4.54%   425    158,795 
KCAP Senior Funding LLC Class D Notes   5.54%   525    174,416 
Total            $927,787 

 

(1) Stated Interest Rate (and thus periodic interest expense), will vary based upon prevailing 3 month LIBOR as of the reset date.

 

The amounts, ratings and interest rates (expressed as a spread to LIBOR) of the Class A, B, C, and D are as follows:

 

Description   Class A Notes   Class B Notes   Class C Notes   Class D Notes  
Type   Senior Secured Floating Rate   Senior Secured Floating Rate   Secured Deferrable Floating Rate   Secured Deferrable Floating Rate  
Amount Outstanding   $ 108,150,000   $ 12,600,000   $ 14,000,000   $ 12,600,000  
Moody's Rating (sf)   "Aaa"   "Aa2"   "A2"   "Baa2"  
Standard & Poor's Rating (sf)   "AAA"   "AA"   "A"   "BBB"  
Interest Rate1   LIBOR + 1.50 %   LIBOR + 3.25 %   LIBOR + 4.25 %   LIBOR + 5.25 %  
Stated Maturity   July, 2024   July, 2024   July, 2024   July, 2024  
Junior Classes  

B, C, D

and Subordinated

 

C, D

and Subordinated

 

D and

Subordinated

  Subordinated  

 

 

¹Three month LIBOR, which was 0.29% as of the last reset date

 

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The Company’s outstanding principal amounts, carrying values and fair values of the Class A, B, C and D Notes are as follows:

   As of 
   September 30, 2015 
   (unaudited) 
   Principal Amount   Carrying Value   Fair Value 
             
KCAP Senior Funding I, LLC Class A Notes  $108,150,000   $105,903,831   $106,527,750 
KCAP Senior Funding I, LLC Class B Notes   12,600,000    12,338,310    12,363,750 
KCAP Senior Funding I, LLC Class C Notes   14,000,000    13,709,234    13,545,000 
KCAP Senior Funding I, LLC Class D Notes   12,600,000    12,338,310    11,938,500 
                
Total  $147,350,000   $144,289,685   $144,375,000 

 

Fair Value of KCAP Senior Funding I.   The Company carries the KCAP Senior Funding I Notes at cost, net of unamortized discount of $3,060,315. The fair value of the KCAP Senior Funding I Notes was approximately $144.4 million at September 30, 2015. The fair values were determined based on third party indicative values. The KCAP Senior Funding I L.L.C. Notes are categorized as Level III under ASC 820: Fair Value.

 

7. DISTRIBUTABLE TAXABLE INCOME

 

Effective December 11, 2006, the Company elected to be treated as a RIC under the Code and adopted a December 31 tax-calendar year end. As a RIC, the Company is not subject to federal income tax on the portion of its taxable income and gains distributed currently to its stockholders as a dividend. The Company’s quarterly distributions, if any, are determined by the Board of Directors. The Company anticipates distributing at least 90% of its taxable income and gains, within the Subchapter M rules, and thus the Company anticipates that it will not incur any federal or state income tax at the RIC level. As a RIC, the Company is also subject to a federal excise tax based on distributive requirements of its taxable income on a calendar year basis (e.g., calendar year 2015). Depending on the level of taxable income earned in a tax year, the Company may choose to carry forward taxable income in excess of current year distributions into the next tax year and pay a 4% excise tax on such income, to the extent required. The Company anticipates timely distribution of its taxable income within the tax rules, and the Company anticipates that it will not incur a US federal excise tax for the calendar year 2015.

 

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The following reconciles net increase in net assets resulting from operations to taxable income for the nine months ended September 30, 2015:

 

   Nine Months Ended 
     
Net increase in net assets resulting from operations  $(7,145,869)
Net change in unrealized depreciation from investments   19,750,242 
Net realized (gains) losses    6,275,906 
Book/tax differences on CLO equity investments   1,462,401 
Other book/tax differences   764,244 
      
Taxable income before deductions for distributions  $21,106,924 
      
Taxable income before deductions for distributions per weighted average basic shares for the period  $0.57 

 

Tax-basis taxable income differs from net increase (decrease) in net assets resulting from operations primarily due to: (1) unrealized appreciation (depreciation) on investments, as investment gains and losses are not included in tax-basis taxable income until they are realized; (2) excess of capital losses over capital gains; (3) book-to-tax differences on CLO equity investments; and (4) other non-deductible expenses including stock compensation expense that is not currently deductible for tax purposes.

 

Dividends from Asset Manager Affiliates are recorded based upon a quarterly estimate of tax-basis earnings and profits of each Asset Manager Affiliate. Distributions in excess of the estimated tax-basis quarterly earnings and profits of each distributing Asset Manager Affiliate are recognized as tax-basis return of capital. The actual tax-basis earnings and profits and resulting dividend and/or return of capital for the year will be determined at the end of the tax year for each distributing Asset Manager Affiliate. For the nine months ended September 30, 2015 and 2014, the Asset Manager Affiliates declared cash distributions of $7.3 million and $9.1 million to the Company, respectively. The Company recognized $4.2 million and $4.2 million, respectively, of dividends from Asset Manager Affiliates in the Statement of Operations for the nine months ended September 30, 2015 and 2014. The difference of $3.1 million and $4.9 million, respectively, between cash distributions received and the tax-basis earnings and profits of the distributing affiliate, are recorded as an adjustment to the cost basis in the Asset Manager Affiliate (i.e. tax-basis return of capital), for the nine months ended September 30, 2015 and 2014, respectively.

 

Distributions to shareholders that exceed tax distributable income (tax net investment income and realized gains, if any) are reported as distributions of paid-in capital (i.e. return of capital). The tax character of distributions is made on an annual (full calendar-year) basis. The determination of the tax attributes of our distributions is made at the end of the year based upon our taxable income for the full year and the distributions paid during the full year. Therefore, a determination of tax attributes made on a quarterly basis may not be representative of the actual tax attributes of distributions for a full year.

 

   Nine months ended
September 30,
   Year ended 
December 31,
 
   2015   2014 
Distributions paid from:          
Ordinary income  $15,313,691   $26,807,154 
Return of Capital   -    7,972,633 
Total  $15,313,6911  $34,779,787 

 

(1) Comprised of the first quarter distribution paid in April and the second quarter distribution paid in July.

 

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At September 30, 2015, the Company had a net capital loss carryforward of $82.9 million to offset net capital gains, to the extent provided by federal tax law. Of the net capital loss carryforward, $32.0 million will begin to expire in the tax year ending December 31, 2015. Of the net capital loss carryforward, $50.9 million is not subject to expiration under the RIC Modernization Act of 2010.

 

On September 22, 2015, the Company’s Board of Directors declared a distribution to shareholders of $0.21 per share for a total of $7.6 million. The record date was October 14, 2015 and the distribution was paid on October 27, 2015.

 

The Company adopted Financial Accounting Standards Board ASC Topic 740 Accounting for Uncertainty in Income Taxes (“ASC 740”) as of January 1, 2007. ASC 740 provides guidance for how uncertain tax positions should be recognized, measured, presented, and disclosed in the consolidated financial statements. ASC 740 requires the evaluation of tax positions taken or expected to be taken in the course of preparing the Company’s tax returns to determine whether the tax positions are “more-likely-than-not” of being sustained by the applicable tax authority. The Company recognizes the tax benefits of uncertain tax positions only where the position is “more likely than not” to be sustained assuming examination by tax authorities. Management has analyzed the Company’s tax positions, and has concluded that no liability for unrecognized tax benefits should be recorded related to uncertain tax positions taken on returns filed for open tax years (the last three fiscal years) or expected to be taken in the Company’s current year tax return. The Company identifies its major tax jurisdictions as U.S. Federal and New York State, and the Company is not aware of any tax positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will change materially in the next 12 months. Management’s determinations regarding ASC 740 may be subject to review and adjustment at a later date based upon factors including, but not limited to, an ongoing analysis of tax laws, regulations and interpretations thereof.

 

8. COMMITMENTS AND CONTINGENCIES

 

From time-to-time the Company is a party to financial instruments with off-balance sheet risk in the normal course of business in order to meet the needs of the Company’s investment in portfolio companies. Such instruments include commitments to extend credit and may involve, in varying degrees, elements of credit risk in excess of amounts recognized on the Company’s balance sheet. Prior to extending such credit, the Company attempts to limit its credit risk by conducting extensive due diligence, obtaining collateral where necessary and negotiating appropriate financial covenants. As of September 30, 2015 and December 31, 2014, the Trimaran Credit Facility was fully drawn and there was no remaining unfunded commitment thereunder. As of September 30, 2015, the Company had a commitment to make an investment of $360,000 in a revolving senior secured loan. As of December 31, 2014, the Company had no outstanding commitments to make such investments.

 

9. STOCKHOLDERS’ EQUITY

 

During the nine months ended September 30, 2015 and 2014, the Company issued 127,672 and 69,762 shares, respectively, of common stock under its dividend reinvestment plan. As of September 30, 2015 and December 31, 2014, there were 701,359 and 619,785 shares of unvested restricted shares, respectively. There were 196,166 grants, 10,042 forfeitures, and 104,550 vested shares during the nine months ended September 30, 2015. The total number of shares of the Company’s common stock issued and outstanding as of September 30, 2015 and December 31, 2014 was 37,052,575 and 36,775,127, respectively. During the nine months ended September 30, 2015, the Company repurchased 36,348 shares at an aggregate cost of approximately $220,000 in connection with the vesting of restricted stock awards.

 

10. EQUITY INCENTIVE PLAN

 

The Company has an equity incentive plan, established in 2006 and as amended in 2008, 2014 and most recently in June 2015, (the “Equity Incentive Plan”). The Company reserved 2,000,000 shares of common stock for issuance under the Equity Incentive Plan. The purpose of the Equity Incentive Plan is to provide officers and employees of the Company with additional incentives and align the interests of its employees with those of its shareholders. Options granted under the Equity Incentive Plan are exercisable at a price equal to the fair market value (market closing price) of the shares on the day the option is granted. Restricted stock granted under the Equity Incentive Plan is granted at a price equal to the fair market value (market closing price) of the shares on the day such restricted stock is granted. Vesting of restricted stock awarded under the 2008 amendment of the Equity Incentive Plan will occur in two equal installments of 50%, on each of the third and fourth anniversaries of the grant date; vesting of restricted stock subsequent to the 2014 amendment of the Equity Incentive Plan will vest in four equal installments of 25%, on each of the first four anniversaries of the grant date.

 

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Stock Options

 

On June 20, 2014, the Company’s Board of Directors approved the amended and restated Non-Employee Director Plan (the “Non-Employee Director Plan”), which was approved by shareholders on June 10, 2011. Accordingly, the annual grant of options to non-employee directors has been discontinued and replaced with an annual grant of shares of restricted stock as partial annual compensation for the services of the non-employee directors.

 

Information with respect to options granted, exercised and forfeited under the Equity Incentive Plan for the period January 1, 2014 through September 30, 2015 is as follows:

 

   Shares   Weighted Average
Exercise Price per
Share
   Weighted Average
Contractual
Remaining Term
(years)
   Aggregate
Intrinsic Value
1
 
 Options outstanding at January 1, 2014   50,000   $7.72           
 Granted                  
 Exercised                  
 Forfeited                  
 Options outstanding at December 31, 2014   50,000   $7.72    4.4   $77,600 
 Granted                  
 Exercised                  
 Forfeited                  
 Outstanding at September 30, 2015   50,000   $7.72    3.6   $- 
                     
 Total vested at September 30, 2015   50,000   $7.72    3.6      

 

1 Represents the difference between the market value of shares of the Company and the exercise price of the options.

 

The Company uses a Binary Option Pricing Model (American, call option) to establish the expected value of all stock option grants. For the nine months ended September 30, 2015 and 2014, the Company did not recognize any non-cash compensation expense related to stock options. At September 30, 2015, the Company had no remaining compensation costs related to unvested stock based awards.

 

Restricted Stock

 

Awards of restricted stock granted under the Non-Employee Director Plan vest as follows: 50% of the shares vest on the grant date and the remaining 50% of the shares vest on the earlier of:

 

(i)the first anniversary of such grant, or
(ii)the date immediately preceding the next annual meeting of shareholders.

 

On May 5, 2014, 5,000 shares of restricted stock were awarded to the Company’s Board of Directors.

 

On June 20, 2014, the Company’s Board of Directors approved the grant of 355,289 shares of restricted stock to the employees of the Company as partial compensation for their services. 25% of such awards will vest on each of the first four anniversaries of the grant date.

 

On May 21, 2015, 6,000 shares of restricted stock were awarded to the Company’s Board of Directors.

 

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On June 16, 2015, the Company received exemptive relief to repurchase shares of its common stock from its employees in connection with certain equity compensation plan arrangements. During the nine months ended September 30, 2015, the Company repurchased 36,348 shares of common stock at an aggregate cost of approximately $220,000 in connection with the vesting of employee’s restricted stock, which is reflected as Treasury Stock at cost on the Consolidated Balance Sheet. These shares are not available to be reissued under the Company’s Equity Incentive Plan.

 

On June 23, 2015, the Company’s Board of Directors approved the grant of 190,166 shares, with a fair value of approximately $1.2 million, of restricted stock to the employees of the Company as partial compensation for their services. 25% of such awards will vest on each of the first four anniversaries of the grant date.

 

On June 23, 2015, the Company’s Board of Directors also voted to amend the Equity Incentive Plan to specify that shares repurchased by the Company to satisfy employee tax withholding requirements would not be returned to the plan reserve and could not be reissued under the Company’s Equity Incentive Plan.

 

During the nine months ended September 30, 2015, 104,550 shares of restricted stock vested and 10,042 shares of restricted stock were forfeited. As of September 30, 2015, after giving effect to these restricted stock awards, there were 701,359 shares of restricted stock outstanding. Information with respect to restricted stock granted, exercised and forfeited under the Plan for the period January 1, 2014 through September 30, 2015 is as follows:

 

   Non-vested
Restricted
Shares
 
 Non-vested shares outstanding at January 1, 2014   272,998 
 Granted   360,289 
 Vested   (5,000)
 Forfeited   (8,502)
 Non-vested shares outstanding at December 31, 2014   619,785 
 Granted   196,166 
 Vested   (104,550)
 Forfeited   (10,042)
 Outstanding at September 30, 2015   701,359 

 

For the nine months ended September 30, 2015, non-cash compensation expense related to restricted stock was approximately $1.2 million; of this amount approximately $504,000 was expensed at the Company, and approximately $648,000 was a reimbursable expense allocated to the Asset Manager Affiliates. For the nine months ended September 30, 2014, non-cash compensation expense related to restricted stock was approximately $768,000; of this amount approximately $376,000 was expensed at the Company and approximately $392,000 was a reimbursable expense allocated to the Asset Manager Affiliates.

 

Distributions are paid on all outstanding shares of restricted stock, whether or not vested. In general, shares of unvested restricted stock are forfeited upon the recipient’s termination of employment. As of September 30, 2015, the company had approximately $4.0 million of total unrecognized compensation cost related to non-vested share-based awards. That cost is expected to be recognized over a weighted average period of 2.7 years.

 

11. OTHER EMPLOYEE COMPENSATION

 

The Company adopted a 401(k) plan (“401K Plan”) effective January 1, 2007. The 401K Plan is open to all full time employees. The 401K Plan permits an employee to defer a portion of their total annual compensation up to the Internal Revenue Service annual maximum based on age and eligibility. The Company makes contributions to the 401K Plan of up to 2% of the Internal Revenue Service’s annual maximum eligible compensation, which fully vests at the time of contribution. Approximately $25,000 and $38,000 was expensed during the nine months ended September 30, 2015 and 2014, respectively, related to the 401K Plan.

 

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The Company has also adopted a deferred compensation plan (“Profit-Sharing Plan”) effective January 1, 2007. Employees are eligible for the Profit-Sharing Plan provided that they are employed and working with the Company to participate in at least 100 days during the year and remain employed as of the last day of the year. Employees do not make contributions to the Profit-Sharing Plan. On behalf of the employee, the Company may contribute to the Profit-Sharing Plan 1) up to 8.0% of all compensation up to the Internal Revenue Service annual maximum and 2) up to 5.7% excess contributions on any incremental amounts above the social security wage base limitation and up to the Internal Revenue Service annual maximum. Employees vest 100% in the Profit-Sharing Plan after five years of service. Approximately $98,000 and $184,000 was expensed during the nine months ended September 30, 2015 and 2014, respectively, related to the Profit-Sharing Plan.

 

12. SUBSEQUENT EVENTS

 

On October 13, 2015 and October 14, 2015, the Company purchased approximately $285,000 and $3.5 million face value of its own Convertible Notes at $102.00 and $102.25, respectively, plus accrued interest. KCAP subsequently surrendered these notes to the Trustee for cancellation. The Company will recognize approximately $99,000 in realized losses in connection with this extinguishment of debt in the fourth quarter.

 

The Company has evaluated events and transactions occurring subsequent to the balance sheet date of September 30, 2015 for items that should potentially be recognized or disclosed in these financial statements. Other than described above, management has determined that there are no material subsequent events that would require adjustment to, or disclosure in, these consolidated financial statements.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

In this Quarterly Report on Form 10-Q, “KCAP Financial,” “Company,” “we,” “us,” and “our” refer to KCAP Financial, Inc., and its wholly-owned subsidiaries.

 

The information contained in this section should be read in conjunction with our consolidated financial statements and notes thereto appearing elsewhere in this Quarterly Report and in conjunction with the financial statements and notes thereto in the Company’s Form 10-K for the year ended December 31, 2014, as filed with the U.S. Securities and Exchange Commission (the “Commission” or the “SEC”). In addition, some of the statements in this report constitute forward-looking statements. The matters discussed in this Quarterly Report, as well as in future oral and written statements by management of KCAP Financial, that are forward-looking statements are based on current management expectations that involve substantial risks and uncertainties which could cause actual results to differ materially from the results expressed in, or implied by, these forward-looking statements. Forward-looking statements relate to future events or our future financial performance. We generally identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other similar words. Important assumptions include our ability to originate new investments, achieve certain margins and levels of profitability, the availability of additional sources of capital, the availability of additional capital, and the ability to maintain certain debt to asset ratios. In light of these and other uncertainties, the inclusion of a projection or forward-looking statement in this Quarterly Report should not be regarded as a representation by us that our plans or objectives will be achieved. The forward-looking statements contained in this Quarterly Report include statements as to:

 

our future operating results;

 

our business prospects and the prospects of our existing and prospective portfolio companies;

 

the return or impact of current and future investments;

 

our contractual arrangements and other relationships with third parties;

 

the dependence of our future success on the general economy and its impact on the industries in which we invest;

 

the financial condition and ability of our existing and prospective portfolio companies to achieve their objectives;

 

our expected financings and investments;

 

our regulatory structure and tax treatment;

 

our ability to operate as a business development company and a registered investment company, including the impact of changes in laws or regulations governing our operations, or the operations of our portfolio companies;

 

the adequacy of our cash resources and working capital;

 

the timing of cash flows, if any, from the operations of our portfolio companies;

  

the impact of a protracted decline in the liquidity of credit markets on our business;

 

the impact of fluctuations in interest rates on our business;

 

the valuation of our investments in portfolio companies, particularly those having no liquid trading market;

 

our ability to recover unrealized losses;

 

market conditions and our ability to access additional capital; and

 

the timing, form and amount of any distributions.

 

There are a number of important risks and uncertainties that could cause our actual results to differ materially from those indicated by such forward-looking statements. For a discussion of factors that could cause our actual results to differ from forward-looking statements contained in this Quarterly Report, please see the discussion in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014. You should not place undue reliance on these forward-looking statements. The forward-looking statements made in this Quarterly Report relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances occurring after the date this Quarterly Report is filed with the SEC.

 

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GENERAL

 

We are an internally managed, non-diversified closed-end investment company that is regulated as a Business Development Company, or BDC under the Investment Company Act of 1940 (the “1940 Act”). We have three principal areas of investments:

 

First, the Company originates, structures, and invests in senior secured term loans and mezzanine debt primarily in privately-held middle market companies (the “Debt Securities Portfolio”). In addition, from time to time the Company may invest in the equity securities of privately held middle market companies.

 

Second, the Company has invested in asset management companies (Katonah Debt Advisors and Trimaran Advisors, collectively the “Asset Manager Affiliates”) that manage CLO Funds.

 

Third, the Company invests in debt and subordinated securities issued by CLOs (“CLO Fund Securities”). These CLO Fund Securities are primarily managed by our Asset Manager Affiliates, but from time-to-time the Company makes investments in CLO Fund Securities managed by other asset managers. The CLO Funds typically invest in broadly syndicated loans, high-yield bonds and other credit instruments.

 

The Company may also invest in other investments such as loans to larger, publicly-traded companies, high-yield bonds and distressed debt securities. The Company may also receive warrants or options to purchase common stock in connection with its debt investments.

 

In our Debt Securities Portfolio, our investment objective is to generate current income and, to a lesser extent, capital appreciation from the investments made by our middle market business in senior secured term loans, mezzanine debt and selected equity investments in privately-held middle market companies. We define the middle market as comprising of companies with earnings before interest, taxes, depreciation and amortization (“EBITDA”) of $10 million to $50 million and/or total debt of $25 million to $150 million. We primarily invest in first and second lien term loans which, because of their priority in a company’s capital structure, we expect will have lower default rates and higher rates of recovery of principal if there is a default and which we expect will create a stable stream of interest income. The investments in our Debt Securities Portfolio are all or predominantly below investment grade, and have speculative characteristics with respect to the issuer’s capacity to pay interest and repay principal. While our primary investment focus is on making loans to, and selected equity investments in, privately-held middle market companies, we may also invest in other investments such as loans to smaller companies or larger, publicly-traded companies, high-yield bonds and distressed debt securities. We may also receive warrants or options to purchase common stock in connection with our debt investments.

 

From our Asset Manager Affiliates investment, we expect to receive recurring cash distributions and to generate capital appreciation through the addition of new CLO Funds managed by our Asset Manager Affiliates. The Asset Manager Affiliates manage CLO Funds that invest in broadly syndicated loans, high-yield bonds and other credit instruments. Collectively, the Asset Manager Affiliates have approximately $2.7 billion of par value assets under management as of September 30, 2015. The Asset Manager Affiliates are registered under the Investment Advisers Act of 1940, and are managed independently from the Company by a separate portfolio management team.

 

In addition, our investments in CLO Fund Securities, which are primarily made up of a minority investment in the subordinated securities or preferred stock of CLO Funds raised and managed by our Asset Manager Affiliates, are anticipated to provide the Company with recurring cash distributions and complement the growth of our Asset Manager Affiliates.

 

We intend to grow our entire portfolio of investments by raising additional capital, including through the prudent use of leverage available to us. As a BDC, we are limited in the amount of leverage we can incur under the 1940 Act. We are only allowed to borrow amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% after such borrowing.

 

We have elected to be treated for U.S. federal income tax purposes as a RIC and intend to operate in a manner to maintain our RIC status. As a RIC, we intend to distribute to our stockholders substantially all of our net ordinary taxable income and the excess of realized net short-term capital gains over realized net long-term capital losses, if any, for each year. To qualify as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements. Pursuant to this election, we generally will not have to pay corporate-level U.S. federal income taxes on any income that we timely distribute to our stockholders.

 

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PORTFOLIO AND INVESTMENT ACTIVITY

 

Our primary investments are: (1) lending to and investing in middle-market businesses through investments in senior secured loans, junior secured loans, subordinated/mezzanine debt investments, and other equity investments, which may include warrants, (2) our investments in our Asset Manager Affiliates, which manage portfolios of broadly syndicated loans, high-yield bonds and other credit instruments, and (3) CLO Fund Securities.

 

Total portfolio investment activity (excluding activity in time deposit and money market investments) for the nine months ended September 30, 2015 (unaudited) and for the year ended December 31, 2014 was as follows:

 

   Debt Securities   CLO Fund
Securities
   Equity Securities   Asset Manager
Affiliates
   Total Portfolio 
Fair Value at December 31, 2013  $266,830,427   $79,452,220   $11,006,398   $76,148,000   $433,437,045 
2014 Activity:                         
Purchases / originations /draws   224,513,503    22,421,847    2,216,847    545,979    249,698,176 
Pay-downs / pay-offs / sales   (168,429,374)   (10,132,500)   (5,007,311)   (6,432,086)   (190,001,271)
Net accretion (amortization)   410,718    (11,102,015)           (10,691,297)
Net realized (losses) gains   (8,823,507)   5,575,498    (7,136,408)       (10,384,417)
Net increase (decrease) in fair value   5,641,403    (8,700,148)   7,040,155    2,064,107    6,045,517 
                          
Fair Value at December 31, 2014   320,143,170    77,514,902    8,119,681    72,326,000    478,103,753 
Year to Date 2015 Activity:                         
Purchases / originations /draws   87,878,844    11,952,000            99,830,844 
Pay-downs / pay-offs / sales   (104,570,594)   (3,872,700)   (317,340)   (3,103,517)   (111,864,151)
Net accretion (amortization)   309,574    (6,433,551)           (6,123,977)
Net realized gains (losses)   110,517    (6,246,883)   3,015        (6,133,351)
Net (decrease) in fair value   (7,587,070)   (6,192,986)   (868,703)   (5,101,483)   (19,750,242)
                          
Fair Value at September 30, 2015  $296,284,441   $66,720,782   $6,936,653   $64,121,000   $434,062,876 

 

The level of investment activity for investments funded and principal repayments for our investments can vary substantially from period to period depending on the number and size of investments that we invest in or divest of, and many other factors, including the amount and competition for the debt and equity securities available to middle market companies, the level of merger and acquisition activity for such companies and the general economic environment.

 

The following table shows the Company’s portfolio by security type at September 30, 2015 and December 31, 2014:

 

   September 30, 2015 (unaudited)   December 31, 2014 
Security Type  Cost   Fair Value      Cost   Fair Value    
Money Market Accounts³  $3,345,723   $3,345,723    1   $1,602,741   $1,602,741    1 
Senior Secured Loan   211,441,566    204,189,144    86    220,965,922    218,329,860    86 
Junior Secured Loan   41,204,786    39,795,980    17    38,664,199    38,569,006    15 
Senior Unsecured Loan   23,000,000    23,000,000    10    33,066,984    33,066,984    13 
First Lien Bond   2,976,651    2,317,500    1    2,962,507    2,580,000    1 
Senior Subordinated Bond   4,420,467    4,221,543    2    4,295,544    4,240,301    2 
Senior Unsecured Bond   11,698,340    10,597,995    5    11,208,178    11,386,218    4 
Senior Secured Bond   1,511,590    1,481,250    1    1,515,584    1,552,500    1 
CLO Fund Securities   86,288,448    66,720,782    28    90,889,190    77,514,901    30 
Equity Securities   8,514,487    6,936,653    3    8,828,812    8,119,681    3 
Preferred Securities   10,359,873    10,681,029    5    10,206,016    10,418,302    4 
Asset Manager Affiliates²   57,189,159    64,121,000    27    60,292,677    72,326,000    28 
                               
Total  $461,951,090   $437,408,599    186%  $484,498,354   $479,706,494    188%

 

 

¹ Represents percentage of Net Asset Value.

² Represents the equity investment in the Asset Manager Affiliates.

³ Includes restricted cash held under employee benefit plans.

 

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Debt Securities Portfolio

 

At September 30, 2015 and December 31, 2014, our investments in income producing loans and debt securities, excluding CLO Fund securities, had a weighted average interest rate of approximately 7.4% and 7.3%, respectively.

 

The investment portfolio (excluding the Company’s investment in Asset Manager Affiliates and CLO Funds) at September 30, 2015 was spread across 27 different industries and 92 different entities with an average balance per entity of approximately $3.2 million. As of September 30, 2015, all but one of our portfolio companies were current on their debt service obligations.

 

We may invest up to 30% of our investment portfolio in “Non-qualifying” opportunistic investments such as high-yield bonds, debt and equity securities of CLO Funds, foreign investments, and distressed debt or equity securities of public companies. At September 30, 2015 and December 31, 2014, the total amount of non-qualifying assets was approximately 17% and 21%, respectively. The majority of non-qualifying assets were foreign investments which was approximately 15% and 16% of the Company’s total assets, respectively (including the Company’s investments in CLO Funds, which are typically domiciled outside the U.S. and represented approximately 15% and 16% of its total assets on such dates, respectively). The investments in our Debt Securities Portfolio are all or predominantly below investment grade, and therefore have speculative characteristics with respect to the issuer’s capacity to pay interest and repay principal.

 

The following tables detail the ten largest portfolio companies (at fair value) as of September 30, 2015 and December 31, 2014:

 

   September 30, 2015 (unaudited) 
Investment  Cost   Fair Value   % of FMV 
Asset Manager Affiliates  $57,189,159   $64,121,000    15%
Katonah 2007-I CLO Ltd.   23,975,870    23,233,837    5 
Trimaran Credit Facility   23,000,000    23,000,000    5 
Crowley Holdings Preferred, LLC   10,359,873    10,681,029    2 
Catamaran CLO 2015-1 Ltd.   12,439,015    9,442,080    2 
Tank Partners Holdings, LLC   10,520,547    8,939,640    2 
Catamaran CLO 2014-1 Ltd.   9,264,284    7,251,390    2 
Catamaran CLO 2014-2 Ltd.   8,374,214    6,932,673    2 
Grupo HIMA San Pablo, Inc.   6,916,737    6,650,000    2 
Catamaran CLO 2013- 1 Ltd.   6,559,985    6,561,900    1 
                
Total  $168,599,684   $166,813,549    38%

 

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   December 31, 2014 
Investment  Cost   Fair Value   % of FMV 
Asset Manager Affiliates  $60,292,677   $72,326,000    15%
Katonah 2007-I CLO Ltd.   23,471,779    25,191,782    5 
Trimaran Credit Facility   23,000,000    23,000,000    5 
Crowley Holdings Preferred, LLC   10,206,016    10,418,302    2 
Tank Partners Holdings, LLC   10,212,907    9,866,065    2 
Catamaran CLO 2014-1 Ltd.   10,473,628    8,867,176    2 
Catamaran CLO 2014-2 Ltd.   9,862,799    8,761,500    2 
Restorix Health, Inc.   8,063,397    8,063,397    2 
Catamaran CLO 2013- 1 Ltd.   7,492,702    7,874,910    2 
Grupo HIMA San Pablo, Inc.   6,894,754    7,105,000    1 
                
Total  $169,970,659   $181,474,132    38%

 

Excluding the Asset Manager Affiliates and CLO Fund securities, the Company’s ten largest portfolio companies represented approximately 18% and 17% of the total fair value of the Company’s investments at September 30, 2015 and December 31, 2014, respectively.

 

The industry concentrations based on the fair value of the Company’s investment portfolio as of September 30, 2015 and December 31, 2014, were as follows:

 

   September 30, 2015 (unaudited)   December 31, 2014 
Industry Classification  Cost   Fair Value   %1   Cost   Fair Value   %1 
Aerospace and Defense  $9,648,347   $9,069,264    4.0%  $10,059,487   $9,533,092    4%
Asset Management Company2   57,189,159    64,121,000    26.0    60,292,677    72,326,000    28 
Related Party Loan   23,000,000    23,000,000    10.0    23,000,000    23,000,000    9 
Automotive   9,932,977    9,876,215    4.0    8,362,956    8,312,548    3 
Banking, Finance, Insurance & Real Estate   6,302,517    6,165,678    3.0    7,660,721    7,639,366    3 
Beverage, Food and Tobacco   24,439,168    24,119,358    10.0    17,974,974    17,883,421    7 
Capital Equipment   9,509,929    8,437,999    4.0    9,486,407    10,351,329    4 
Chemicals, Plastics and Rubber   3,503,317    3,463,669    1.0    6,348,226    6,210,253    2 
CLO Fund Securities   86,288,447    66,720,782    28.0    90,889,190    77,514,901    31 
Construction & Building   1,980,681    1,982,831    1.0    -    -    - 
Consumer goods: Durable   14,163,260    13,174,865    6.0    13,876,482    13,301,207    5 
Consumer goods: Non-durable   20,393,549    20,156,836    9.0    13,535,975    13,314,952    5 
Containers, Packaging and Glass   2,916,649    2,921,622    1.0    2,992,443    2,946,734    1 
Energy: Oil & Gas   14,176,843    11,509,141    5.0    13,866,208    13,289,753    5 
Environmental Industries   12,784,029    12,474,510    5.0    12,942,593    12,911,017    5 
Forest Products & Paper   5,895,474    5,944,907    3.0    5,917,051    5,942,523    2 
Healthcare & Pharmaceuticals   50,028,563    46,982,976    20.0    66,186,412    65,720,782    27 
High Tech Industries   11,802,469    11,652,643    5.0    14,457,495    14,419,110    6 
Hotel, Gaming & Leisure   400,000    1,000    -    3,392,481    2,962,315    1 
Media: Advertising, Printing & Publishing   11,203,758    10,574,807    5.0    11,318,815    11,396,027    4 
Media: Broadcasting & Subscription   7,459,621    7,399,614    3.0    14,477,078    14,409,401    6 
Metals & Mining   228,563    1,000    -    228,563    1,000    - 
Retail   4,390,431    3,870,664    2.0    4,234,086    3,773,847    1 
Services: Business   20,706,513    20,513,356    9.0    16,550,255    16,066,421    6 
Services: Consumer   6,519,760    6,438,715    3.0    6,798,372    6,752,521    3 
Telecommunications   13,797,355    13,614,636    6.0    22,030,434    21,865,864    9 
Time Deposit and Money Market Accounts3   3,345,723    3,345,724    1.0    1,602,741    1,602,741    1 
Transportation: Cargo   21,755,034    22,040,544    9.0    20,156,700    20,455,941    8 
Transportation: Consumer   2,487,820    2,487,500    1.0    -    -    - 
Utilities: Electric   5,701,134    5,346,743    2.0    5,859,532    5,803,428    2 
                               
Total  $461,951,090   $437,408,599    186%  $484,498,354   $479,706,494    188%

 

 

1 Calculated as a percentage of Net Asset Value.

2 Represents the equity investment in the Asset Manager Affiliates.

3 Includes restricted cash held under employee benefit plans.

 

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CLO Fund Securities

 

We typically make a minority investment in the subordinated securities or preferred stock of CLO Funds raised and managed by our Asset Manager Affiliates and may selectively invest in securities issued by CLO Funds managed by other asset management companies. As of September 30, 2015, we had approximately $67 million invested in CLO Fund Securities, issued primarily by funds managed by our Asset Manager Affiliates.

 

The CLO Funds invest primarily in broadly syndicated non-investment grade loans, high-yield bonds and other credit instruments of corporate issuers. The underlying assets in each of the CLO Fund Securities in which we have an investment are generally diversified secured or unsecured corporate debt.

 

Our CLO Fund Securities as of September 30, 2015 and December 31, 2014 are as follows:

 

          September 30, 2015   December 31, 2014 
CLO Fund Securities  Investment  %1   Cost   Fair Value   Cost   Fair Value 
Grant Grove CLO, Ltd.  Subordinated Securities   22.2%  $2,488,323   $362,691   $2,254,638   $469,132 
Katonah III, Ltd.3  Preferred Shares   23.1    1,366,357    385,000    1,015,334    400,000 
Katonah VII CLO Ltd.2  Subordinated Securities   -            3,563,252    1,000 
Katonah VIII CLO Ltd.2  Subordinated Securities   -            2,755,267    100,000 
Katonah IX CLO Ltd.2  Preferred Shares   6.9    1,172,498    100,000    1,262,496    594,988 
Katonah X CLO Ltd.2  Subordinated Securities   33.3    9,074,951    2,600,000    8,910,471    4,863,001 
Katonah 2007-I CLO Ltd.2  Preferred Shares   100.0    23,975,870    23,233,837    23,471,779    25,191,782 
Trimaran CLO IV, Ltd.2  Preferred Shares   19.0            11,094    900,000 
Trimaran CLO V, Ltd.2  Subordinated Notes   -            1,292,698    1,657,020 
Trimaran CLO VI, Ltd.2  Income Notes   16.2            1,531,142    1,950,000 
Trimaran CLO VII, Ltd.2  Income Notes   10.5    1,349,606    2,024,945    1,399,074    2,084,394 
Catamaran CLO 2012-1 Ltd.2  Subordinated Notes   24.9    7,154,268    4,295,666    7,994,677    5,793,924 
Catamaran CLO 2012-1 Ltd.2  Class F Notes   -            3,917,442    4,160,000 
Catamaran CLO 2013-1 Ltd.2  Subordinated Notes   23.5    6,559,985    6,561,900    7,492,702    7,874,910 
Dryden 30 Senior Loan Fund  Subordinated Notes   7.5    1,643,183    2,290,600    10,473,628    8,867,176 
Catamaran CLO 2014-1 Ltd.2  Subordinated Notes   24.9    9,264,284    7,251,390    1,417,376    1,340,000 
Catamaran CLO 2014-1 Ltd.2  Class E Notes   15.1    1,425,893    1,240,000    2,263,321    2,506,075 
Catamaran CLO 2014-2 Ltd.2  Subordinated Notes   24.9    8,374,214    6,932,673    9,862,799    8,761,500 
Catamaran CLO 2015-1 Ltd.2  Subordinated Notes   24.0    12,439,015    9,442,080         
Total          $86,288,447   $66,720,782   $90,889,190   $77,514,902 

 

 

¹ Represents percentage of class held.

² A CLO Fund managed by an Asset Manager Affiliate.

³ As of September 30, 2015, this CLO Fund security was not providing a dividend distribution.

 

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Asset Manager Affiliates

 

The Asset Manager Affiliates are our wholly-owned asset management companies that manage CLO Funds that invest in broadly syndicated loans, high yield bonds and other credit instruments. The CLO Funds managed by our Asset Manager Affiliates consist primarily of credit instruments issued by corporations. As of September 30, 2015, our Asset Manager Affiliates had approximately $2.7 billion of par value of assets under management on which they earn management fees, and were valued at approximately $64 million.

 

All CLO Funds managed by the Asset Manager Affiliates are currently paying all senior and subordinate management fees. In addition, during the third quarter of 2015, our Asset Manager Affiliates received incentive fees from two funds.

 

RESULTS OF OPERATIONS

 

The principal measure of our financial performance is the net increase (decrease) in stockholders’ equity resulting from operations, which includes net investment income (loss) and net realized and unrealized appreciation (depreciation). Net investment income (loss) is the difference between our income from interest, distributions, fees, and other investment income and our operating expenses. Net realized gain (loss) on investments, is the difference between the proceeds received from dispositions of portfolio investments and their amortized cost. Net change in unrealized appreciation (depreciation) on investments is the net change in the fair value of our investment portfolio.

 

Set forth below is a discussion of our results of operations for the three and nine months ended September 30, 2015 and 2014.

 

Revenue

 

Revenues consist primarily of investment income from interest and dividends on our investment portfolio and various ancillary fees related to our investment holdings.

 

Interest from Investments in Debt Securities. We generate interest income from our investments in debt securities that consist primarily of senior and junior secured loans. Our debt securities portfolio is spread across multiple industries and geographic locations, and as such, we are broadly exposed to market conditions and business environments. As a result, although our investments are exposed to market risks, we continuously seek to limit concentration of exposure in any particular sector or issuer.

 

Investment Income on Investments in CLO Fund Securities. We generate investment income from our investments in the securities (typically preferred shares or subordinated securities) of CLO Funds managed by our Asset Manager Affiliates and selective investments in securities issued by CLO Funds managed by other asset management companies. CLO Funds managed by our Asset Manager Affiliates and those managed by non-affiliates invest primarily in broadly syndicated non-investment grade loans, high-yield bonds and other credit instruments of corporate issuers. The Company distinguishes CLO Funds managed by its Asset Manager Affiliates as “CLO Fund Securities Managed by Affiliates”, in its financial consolidated statements. The underlying assets in each of the CLO Funds in which we have an investment are generally diversified secured or unsecured corporate debt. Our CLO Fund Securities that are subordinated securities or preferred shares (“junior securities”) are subordinated to senior note holders who typically receive a return on their investment at a fixed spread relative to the LIBOR index. The CLO Funds are leveraged funds and any excess cash flow or “excess spread” (interest earned by the underlying securities in the fund less payments made to senior bond holders and less fund expenses and management fees) is paid to the holders of the CLO Fund’s subordinated securities or preferred shares. The level of excess spread from CLO Fund Securities can be impacted by the timing and level of the resetting of the benchmark interest rate for the underlying assets (which reset at various times throughout the quarter) in the CLO Fund and the related CLO Fund note liabilities (which reset at each quarterly distribution date); in periods of short-term and volatile changes in the benchmark interest rate, the levels of excess spread and resulting cash distributions to us can vary significantly.

 

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Interest income on investments in CLO equity investments is recorded using the effective interest method in accordance with the provisions of ASC 325-40, Beneficial Interests in Securitized Financial Assets (“ASC 325-40”), based on the anticipated yield and the estimated cash flows over the projected life of the investment. Yields are revised when there are changes in actual or estimated projected future cash flows due to changes in prepayments and/or re-investments, credit losses or asset pricing. Changes in estimated yield are recognized as an adjustment to the estimated yield prospectively over the remaining life of the investment from the date the estimated yield was changed. Accordingly, investment income recognized on CLO equity securities in the GAAP statement of operations differs from both the tax–basis investment income and from the cash distributions actually received by the Company during the period. As a RIC, the Company anticipates a timely distribution of its tax-basis taxable income.

 

For non-junior class CLO Fund securities, such as our investment in the Class E notes of Catamaran 2014-1, interest is earned at a fixed spread relative to the LIBOR index.

 

Distributions from Asset Manager Affiliates. We receive cash distributions from our investment in our Asset Manager Affiliates, which are wholly-owned and manage CLO Funds that invest primarily in broadly syndicated non-investment grade loans, high yield bonds and other credit instruments issued by corporations. As managers of CLO Funds, our Asset Manager Affiliates receive contractual and recurring management fees from the CLO Funds for their management and advisory services. In addition, our Asset Manager Affiliates may also earn income related to net interest on assets accumulated for future CLO issuances on which they have taken a first loss position in connection with loan warehouse arrangements for their CLO Funds. The annual management fees that our Asset Manager Affiliates receive are generally based on a fixed percentage of the par value of assets under management and are recurring in nature for the term of the CLO Fund so long as the Asset Manager Affiliates manage the fund. As a result, the annual management fees earned by our Asset Manager Affiliates generally are not subject to market value fluctuations in the underlying collateral. Our Asset Manager Affiliates may receive incentive fees provided such CLO Funds have achieved a minimum investment return to holders of their subordinated securities or preferred shares as per the terms of each CLO Fund management agreement. During the three and nine months ended September 30, 2015, the Asset Manager Affiliates received incentive fees from two and three funds, respectively.

 

The Asset Manager Affiliates are expected to pay future distributions to the Company based upon their after-tax free cash flow, which generally will be dependent upon the maintenance and growth in their assets under management and incentive fees. As a result of tax-basis goodwill amortization and certain other tax-related adjustments, portions of distributions received may be deemed return of capital. As amortizing funds which are paying incentive fees are redeemed, we expect incentive fees available for distribution to diminish. During the three and nine months ended September 30, 2015, two and three CLO Funds have achieved the minimum investment return threshold and are paying the Asset Manager Affiliates incentive fees, respectively. The fair value of our investment in our Asset Manager Affiliates was approximately $64 million at September 30, 2015, with an unrealized loss during the nine months ended September 30, 2015 of approximately $5.1 million. For the three months ended September 30, 2015 and 2014, we recognized dividend income of approximately $1.5 million and $1.4 million from the Asset Manager Affiliates, respectively, while cash distributions received were $2.3 million and $3.1 million for those periods, respectively. For the nine months ended September 30, 2015 and 2014, we recognized dividend income of approximately $4.2 million from the Asset Manager Affiliates, for both periods, while cash distributions received were $7.3 million and $9.1 million for those periods, respectively. The difference between cash distributions received and the tax-basis earnings and profits is recorded as an adjustment to the cost basis of the Asset Manager Affiliates investments. For interim periods, the Company estimates the tax attributes of any distributions as being either tax-basis earnings and profits (i.e. dividend income) or return of capital (i.e. adjustment to the Company’s cost basis in the Asset Manager Affiliates). The final determination of the tax attributes of distributions from our Asset Manager Affiliates is made on an annual (full calendar year) basis at the end of the year based upon taxable income and distributions for the full-year. Therefore, any estimate of tax attributes of distributions made on a quarterly basis may not be representative of the actual tax attributes of distributions for a full year. CLO Funds typically have automatic orderly wind-down features following an initial period of reinvestment. Thus, with all else being equal, as managed CLO Fund portfolios age, projected future assets under management (and associated management fees) will naturally decline, resulting in a reduction in fair value of our Asset Manager Affiliates. On the other hand, mandates to manage new CLO Fund portfolios will generally result in an increase in the fair value of our investment in our Asset Manager Affiliates. The aggregate of par value of assets under management by our Asset Manager Affiliates was $2.7 billion and $3.0 billion as of September 30, 2015 and December 31, 2014, respectively.

 

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Capital Structuring Service Fees. We may earn ancillary structuring and other fees related to the origination, investment, disposition or liquidation of debt and investment securities.

 

Investment Income

 

Investment income for the three months ended September 30, 2015 and 2014 was approximately $11.8 million and $10.8 million, respectively. Of these amounts, approximately $6.3 million and $5.4 million was attributable to interest income on our Debt Securities Portfolio. Increases in interest income from 2014 to 2015 were due to higher average invested assets stemming primarily from capital raising activities.

 

Investment income for the nine months ended September 30, 2015 and 2014 was approximately $35.3 million and $30.6 million, respectively. Of these amounts, approximately $18.4 million and $15.8 million was attributable to interest income on our Debt Securities Portfolio. Increases in interest income from 2014 to 2015 were due to higher average invested assets stemming primarily from capital raising activities.

 

The weighted average yield on debt securities Portfolio was 7.4% and 7.3% as of September 30, 2015 and December 31, 2014, respectively.

 

Investment income is primarily dependent on the composition and credit quality of our investment portfolio. Generally, our Debt Securities Portfolio is expected to generate predictable, recurring interest income in accordance with the contractual terms of each loan. Corporate equity securities may pay a dividend and may increase in value for which a gain may be recognized; generally such dividend payments and gains are less predictable than interest income on our loan portfolio.

 

For the three months ended September 30, 2015 and 2014, approximately $3.9 million and $3.6 million, respectively, of investment income was attributable to investments in CLO Fund securities. For the nine months ended September 30, 2015 and 2014, approximately $12.4 million and $9.8 million, respectively, of investment income was attributable to investments in CLO Fund securities. On a tax-basis, the Company recognized $4.3 million of taxable cash distributions from our CLO Fund Securities during the nine months ended September 30, 2015. Distributions from CLO Fund Securities are dependent on the performance of the underlying assets in each CLO Fund; interest payments, principal amortization and prepayments of the underlying loans in each CLO Fund are primary factors which determine the level of distributions on our CLO Fund Securities. The level of excess spread from CLO Fund Securities can be impacted by the timing and level of the resetting of the benchmark interest rate for the underlying assets (which reset at various times throughout the quarter) in the CLO Fund and the related CLO Fund bond liabilities (which reset at each quarterly distribution date); in periods of short-term and volatile changes in the benchmark interest rate, the levels of excess spread and distributions to us can vary significantly.

 

Expenses

 

Because we are internally managed, we directly incur the cost of management and operations. As a result, we pay no investment management fees or other fees to an external advisor. Our expenses consist primarily of interest expense on outstanding borrowings, compensation expense and general and administrative expenses, including professional fees. Interest and compensation expense are typically our largest expenses each period.

 

Interest and Amortization of Debt Issuance Costs. Interest expense is dependent on the average outstanding balance on our borrowings and, the base index rate for the period. Debt issuance costs represent fees, and other direct costs incurred in connection with the Company’s borrowings. These amounts are capitalized and amortized ratably over the contractual term of the borrowing.

 

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Compensation Expense. Compensation expense includes base salaries, bonuses, stock compensation, employee benefits and employer-related payroll costs. The largest components of total compensation costs are base salaries and bonuses; generally, base salaries are expensed as incurred and annual bonus expenses are estimated and accrued. Our compensation arrangements with our employees contain a profit sharing and/or performance based bonus component. Therefore, as our net revenues increase, our compensation costs may also rise. In addition, our compensation expenses may also increase to reflect increased investment in personnel as we grow our products and businesses.

 

Professional Fees and General and Administrative Expenses. The balance of our expenses includes professional fees (primarily legal, accounting, valuation and other professional services), occupancy costs and general administrative and other costs.

 

Total expenses for the three months ended September 30, 2015 and 2014 were approximately $5.2 million and $5.3 million, respectively. Interest expense and amortization on debt issuance costs for the periods, were approximately $3.0 million and $2.9 million, respectively, on average debt outstanding of $227 million and $198 million, respectively.

 

For the three months ended September 30, 2015 and 2014, approximately $892,000 and $1.4 million, respectively, of expenses were attributable to employee compensation, including salaries, bonuses, employee benefits, payroll taxes and stock-based compensation expense. For the three months ended September 30, 2015 and 2014, respectively, professional fees and insurance expenses totaled approximately $869,000 and $678,000. Administrative costs, which include occupancy expense, technology and other office expenses, totaled approximately $469,000 and $316,000 for the three months ended September 30, 2015 and 2014, respectively.

 

Total expenses for the nine months ended September 30, 2015 and 2014 were approximately $16.4 million and $16.0 million, respectively. Interest expense and amortization on debt issuance costs for the periods, were approximately $9.0 million and $8.8 million, respectively, on average debt outstanding of $227 million and $196 million, respectively.

 

For the nine months ended September 30, 2015 and 2014, approximately $3.0 million and $3.9 million, respectively, of expenses were attributable to employee compensation, including salaries, bonuses, employee benefits, payroll taxes and stock-based compensation expense. For the nine months ended September 30, 2015 and 2014, respectively, professional fees and insurance expenses totaled approximately $3.0 million and $2.1 million. Administrative costs, which include occupancy expense, technology and other office expenses, totaled approximately $1.5 million and $1.2 million for the nine months ended September 30, 2015 and 2014, respectively.

 

Net Investment Income and Net Realized Gains (Losses)

 

Net investment income and net realized gains (losses) represents the stockholder’s equity before net unrealized appreciation or depreciation on investments. For the three months ended September 30, 2015, net investment income and net realized losses were approximately $309,000, or $0.01 per share. For the three months ended September 30, 2014, net investment income and net realized losses were approximately $3.4 million or $0.10 per share. For the nine months ended September 30, 2015, net investment income and net realized losses were approximately $12.7 million, or $0.51 per share. For the nine months ended September 30, 2014, net investment income and net realized losses were approximately $12.7 million or $0.66 per share. Net investment income represents the income earned on our investments less operating and interest expense before net realized gains or losses and unrealized appreciation or depreciation on investments. For the three months ended September 30, 2015, net investment income was approximately $6.5 million, or $0.18 per share. For the nine months ended September 30, 2015, net investment income was approximately $18.9 million, or $0.51 per share.

 

Net Unrealized (Depreciation) Appreciation on Investments

 

During the three months ended September 30, 2015, our total investments had net unrealized depreciation of approximately $16.2 million. During the three months ended September 30, 2014, our total investments had net unrealized appreciation of approximately $4.9 million. For the three months ended September 30, 2015, our Asset Manager Affiliates had net unrealized depreciation of approximately $8.9 million. For the three months ended September 30, 2014, our Asset Manager Affiliates had net unrealized appreciation of approximately $5.1 million. For the three months ended September 30, 2015, our portfolio of debt securities and equity securities had net unrealized depreciation of approximately $6.9 million, compared with net unrealized appreciation of $8.6 million during the third quarter of 2014. For the three months ended September 30, 2015, our CLO Fund securities had net unrealized depreciation of approximately $415,000 compared with net unrealized depreciation of $8.9 million during the third quarter of 2014.

 

During the nine months ended September 30, 2015, our total investments had net unrealized depreciation of approximately $19.8 million. During the nine months ended September 30, 2014, our total investments had net unrealized appreciation of approximately $11.2 million. For the nine months ended September 30, 2015, our Asset Manager Affiliates had net unrealized depreciation of approximately $5.1 million. For the nine months ended September 30, 2014, our Asset Manager Affiliates had net unrealized appreciation of approximately $7.0 million. For the nine months ended September 30, 2015, our portfolio of debt securities and equity securities had net unrealized depreciation of approximately $8.5 million, compared with net unrealized appreciation of $9.4 million during the nine months ended September 30, 2014. For the nine months ended September 30, 2015, our CLO Fund securities had net unrealized depreciation of approximately $6.2 million compared with net unrealized depreciation of $5.1 million during the nine months ended September 30, 2014.

 

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Net Change in Stockholder’s Equity Resulting From Operations

 

The net decrease in stockholders’ equity resulting from operations for the three months ended September 30, 2015 was $16.1 million, or $0.43 per share. Net increase in stockholders’ equity resulting from operations for the three months ended September 30, 2014 was $8.2 million, or $0.24 per share.

 

The net decrease in stockholders’ equity resulting from operations for the nine months ended September 30, 2015 was $7.1 million, or $0.19 per share. Net increase in stockholders’ equity resulting from operations for the nine months ended September 30, 2014 was $23.9 million, or $0.71 per share.

 

FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES

 

Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund and maintain investments, pay distributions to our stockholders and other general business needs. We recognize the need to have funds available for operating our business and to make investments. We seek to have adequate liquidity at all times to cover normal cyclical swings in funding availability and to allow us to meet irregular and unexpected funding requirements. We plan to satisfy our liquidity needs through normal operations with the goal of avoiding unplanned sales of assets or emergency borrowing of funds.

 

As of September 30, 2015 and December 31, 2014 the fair value of investments and cash were as follows:

 

   Investments at Fair Value 
Security Type  September 30, 2015   December 31, 2014 
         
Cash  $1,566,274   $1,220,798 
Money Market Accounts   3,345,723    1,602,741 
Senior Secured Loan   204,189,144    218,329,860 
Junior Secured Loan   39,795,980    38,569,006 
Senior Unsecured Loan   23,000,000    33,066,984 
First Lien Bond   2,317,500    2,580,000 
Senior Subordinated Bond   4,221,543    4,240,301 
Senior Secured Bond   1,481,250    1,552,500 
Senior Unsecured Bond   10,597,995    11,386,218 
CLO Fund Securities   66,720,782    77,514,902 
Equity Securities   6,936,653    8,119,681 
Preferred   10,681,029    10,418,302 
Asset Manager Affiliates   64,121,000    72,326,000 
           
Total  $438,974,873   $480,927,293 

 

We use borrowed funds, known as “leverage,” to make investments and to attempt to increase returns to our shareholders by reducing our overall cost of capital. As a BDC, we are limited in the amount of leverage we can incur under the 1940 Act. We are only allowed to borrow amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% after such borrowing. As of September 30, 2015, we had approximately $222.4 million of par value of outstanding borrowings and our asset coverage ratio of total assets to total borrowings was 205%, compliant with the minimum asset coverage level of 200% generally required for a BDC by the 1940 Act. We may also borrow amounts of up to 5% of the value of our total assets for temporary purposes.

 

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On March 16, 2011, the Company issued $55 million in aggregate principal amount of unsecured 8.75% convertible notes due March 2016 (“Convertible Notes”). On March 23, 2011, pursuant to an over-allotment option, the Company issued an additional $5 million of such Convertible Notes for a total of $60 million in aggregate principal amount. The net proceeds from the sale of the Convertible Notes, following underwriting expenses, were approximately $57.7 million. Interest on the Convertible Notes is paid semi-annually in arrears on March 15 and September 15, at a rate of 8.75%, commencing September 15, 2011. The Convertible Notes mature on March 15, 2016 unless converted earlier. The Convertible Notes are senior unsecured obligations of the Company.

 

The Convertible Notes are convertible into shares of the Company’s common stock. As of September 30, 2015, the conversion rate was 134.51 shares of common stock per $1,000 principal amount of Convertible Notes, which is equivalent to a conversion price of approximately $7.43 per share of common stock. The conversion rate is subject to adjustment upon certain events. Upon conversion, the Company would issue the full amount of common stock or settle the conversion in cash, at its option, and retire the full amount of debt outstanding.

 

On April 4, 2013, approximately $9 million of the Company’s 8.75% Convertible Notes were converted at a price per share of $8.159 into 1,102,093 shares of KCAP common stock. On September 4, 2013, the Company purchased $2 million face value of its own Convertible Notes at a price of $114.50, plus accrued interest. KCAP subsequently surrendered these notes to the note trustee for cancellation effective September 13, 2013. On October 9, 2014, the Company purchased approximately $10.4 million face value of its own Convertible Notes at $114.875 plus accrued interest. On September 23, 2015, the Company purchased $5.0 million face value of its own Convertible Notes at $102.375 plus accrued interest. KCAP subsequently surrendered these notes to the trustee for cancellation. Due to the cash conversion option embedded in the Convertible Notes, the Company applied the guidance in ASC 470-40-20, Debt with Conversion and Other Options, and realized a loss on the extinguishment of this debt. For the nine months ended September 30, 2015, there were no realized losses on extinguishment of debt. The indenture governing the Convertible Notes contains certain restrictive covenants, including compliance with certain provisions of the 1940 Act and conditions governing the undertaking of new debt.

 

On October 10, 2012, the Company issued $41.4 million in aggregate principal amount of unsecured 7.375% Notes Due 2019. The net proceeds for the 7.375% Notes Due 2019, following underwriting expenses, were approximately $39.9 million. Interest on the 7.375% Notes Due 2019 is paid quarterly in arrears on March 30, June 30, September 30 and December 30, at a rate of 7.375%, commencing December 30, 2012. The 7.375% Notes Due 2019 mature on September 30, 2019, and are senior unsecured obligations of the Company. In addition, due to the coverage test applicable to the Company as a BDC and a covenant that the Company agreed to in connection with the issuance of the 7.375% Notes Due 2019, the Company is limited in its ability to make distributions if its asset coverage, as defined in the 1940 Act, is below 200% at the time of the declaration of the distribution. At September 30, 2015, the Company was in compliance with all of its debt covenants. The indenture governing the 7.375% Notes Due 2019 contains certain restrictive covenants, including compliance with certain provisions of the 1940 Act relating to borrowing and dividends.

 

On June 18, 2013, KCAP Senior Funding I, LLC, a specialty finance subsidiary of the Company, was capitalized through the issuance of $140 million of notes (the “KCAP Senior Funding I Notes”). The KCAP Senior Funding I Notes are backed by a diversified portfolio of bank loans. The Company invested in the most junior class of the notes, issued in the approximate amount of $35 million, representing the Company’s primary exposure to the performance of the assets acquired from the proceeds of the issuance of the KCAP Senior Funding I Notes. On December 8, 2014, the Company completed the sale of additional KCAP Senior Funding I Notes for $56 million. The issuance of additional notes was pro-rata across all existing classes of notes originally issued. KCAP purchased an additional $13.9 million in the most junior class of notes. These junior notes eliminate in consolidation and the remaining notes with a par value of $105 million, net of $3.1 million of unamortized discount, are reflected on our consolidated balance sheet. The indenture governing the KCAP Senior Funding I Notes contains an event of default that is triggered in the event that certain coverage tests are not met.

 

On October 6, 2014, the Company priced a follow-on public offering of 3.0 million shares of its common stock at a price of $8.02 per share. The offering raised net proceeds were approximately $23.8 million, after deducting underwriting discounts and offering expenses.

 

Subject to prevailing market conditions, we intend to grow our portfolio of assets by raising additional capital, including through the prudent use of leverage available to us. As a result, we may seek to enter into new agreements with other lenders or into other financing arrangements as market conditions permit. From time to time, we may seek to retire, repurchase, or exchange debt securities in open market purchases or by other means dependent on market conditions, liquidity, contractual obligations, and other matters. In addition, we evaluate strategic opportunities available to us and/or the Asset Manager Affiliates, including mergers, divestures, spin-offs, joint ventures and other similar transactions from time to time.

 

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If our common stock trades below our net asset value per share, we will generally not be able to issue additional common stock at the market price unless our shareholders approve such a sale and our Board of Directors makes certain determinations.

 

Stockholder Distributions

 

We intend to continue to make quarterly distributions to our stockholders. To avoid certain excise taxes imposed on RICs, we currently intend to distribute during each calendar year an amount at least equal to the sum of:

 

98% of our ordinary net taxable income for the calendar year;

 

98.2% of our capital gains, if any, in excess of capital losses for the one-year period ending on October 31 of the calendar year; and

 

any net ordinary income and net capital gains for the preceding year that were not distributed during such year.

 

The amount of our declared distributions, as evaluated by management and approved by our Board of Directors, is based primarily on our evaluation of distributable taxable income and after-tax free cash flow from our Asset Manager Affiliates.

 

We will be prohibited by the 1940 Act and the indenture governing our 7.375% Notes from making distributions if our asset coverage, as defined in the 1940 Act, falls below 200%. In any such event, we would be prohibited from making distributions required in order to maintain our status as a RIC.

 

The following table sets forth the quarterly distributions declared by us since 2013.

 

   Distribution   Declaration
Date
  Record
Date
  Pay Date
2015:              
Third quarter   0.21   9/22/2015  10/14/2015  10/27/2015
Second quarter   0.21   6/23/2015  7/6/2015  7/27/2015
First quarter  $0.21   3/24/2015  4/6/2015  4/27/2015
               
Total declared in 2015  $0.63          
               
2014:              
Fourth quarter   0.25   12/17/2014  12/29/2014  1/29/2015
Third quarter   0.25   9/19/2014  10/14/2014  10/29/2014
Second quarter   0.25   6/20/2014  7/3/2014  7/25/2014
First quarter  $0.25   3/21/2014  4/4/2014  4/25/2014
               
Total declared in 2014  $1.00          
               
2013:              
Fourth quarter   0.25   12/13/2013  12/27/2013  1/27/2014
Third quarter   0.25   9/13/2013  10/8/2013  10/29/2013
Second quarter   0.28   6/17/2013  7/5/2013  7/26/2013
First quarter  $0.28   3/15/2013  4/5/2013  4/26/2013
               
Total declared in 2013  $1.06          

  

OFF-BALANCE SHEET ARRANGEMENTS

 

We are a party to financial instruments with off-balance sheet risk in the normal course of business in order to meet the needs of the Company’s investment objectives. Such instruments include commitments to extend credit and may involve, in varying degrees, elements of credit risk in excess of amounts recognized on our balance sheet. Prior to extending such credit, we attempt to limit our credit risk by conducting extensive due diligence, obtaining collateral where necessary and negotiating appropriate financial covenants. As of September 30, 2015, the Company had a commitment to make an investment of $360,000 in a revolving senior secured loan. As of December 31, 2014, the Company had no outstanding commitments to make such investments.

 

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CONTRACTUAL OBLIGATIONS

 

The following table summarizes our contractual cash obligations and other commercial commitments as of September 30, 2015:

 

    Payments Due by Period  
Contractual
Obligations
  Total     Less than one
year
    1 - 3 years     3 - 5 years     More than
5 years
 
Long-term debt obligations1   $ 222,397,000     $ 33,647,000     $     $ 41,400,000     $ 147,350,000  

  

(1)Represents approximately $33.6 million of Convertible Notes due March 16, 2016, $41.4 million of 7.375% Notes Due 2019 and $147.4 of Notes issued by KCAP Senior Funding I, L.L.C.

 

CRITICAL ACCOUNTING POLICIES

 

The consolidated financial statements are based on the selection and application of critical accounting policies, which require management to make significant estimates and assumptions. Critical accounting policies are those that are both important to the presentation of our financial condition and results of operations and require management’s most difficult, complex, or subjective judgments. Our critical accounting policies are those applicable to the basis of presentation, valuation of investments, and certain revenue recognition matters as discussed below. See Note 2 to our consolidated financial statements, contained elsewhere herein: Significant Accounting Policies — Investments.

 

Valuation of Portfolio Investments

 

The most significant estimate inherent in the preparation of our consolidated financial statements is the valuation of investments and the related amounts of unrealized appreciation and depreciation of investments recorded.

 

Value, as defined in Section 2(a)(41) of 1940 Act, is (1) the market price for those securities for which a market quotation is readily available and (2) for all other securities and assets, fair value as determined in good faith by our Board of Directors pursuant to procedures approved by our Board of Directors. Our valuation policy is intended to provide a consistent basis for determining the fair value of the portfolio based on the nature of the security, the market for the security and other considerations including the financial performance and enterprise value of the portfolio company. Because of the inherent uncertainty of valuation, the Board of Directors’ determined values may differ significantly from the values that would have been used had a ready market existed for the investments, and the differences could be material.

 

Pursuant to the AICPA Guide, we reflect our investments on our balance sheet at their estimated fair value with unrealized gains and losses resulting from changes in fair value reflected as a component of unrealized gains or losses on our statements of operations. Fair value is the amount that would be received to sell the investments in an orderly transaction between market participants at the measurement date (i.e., the exit price).

 

See Note 4 to the consolidated financial statements for the additional information about the level of market observability associated with investments carried at fair value.

 

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The Company follows the provisions of ASC 820: Fair Value, which among other matters, requires enhanced disclosures about investments that are measured and reported at fair value. This standard defines fair value and establishes a hierarchal disclosure framework which prioritizes and ranks the level of market price observability used in measuring investments at fair value and expands disclosures about assets and liabilities measured at fair value. ASC 820: Fair Value defines “fair value” as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. This fair value definition focuses on an exit price in the principal, or most advantageous market, and prioritizes, within a measurement of fair value, the use of market-based inputs (which may be weighted or adjusted for relevance, reliability and specific attributes relative to the subject investment) over entity-specific inputs. Market price observability is affected by a number of factors, including the type of investment and the characteristics specific to the investment. Investments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value. Subsequent to the adoption of ASC 820: Fair Value, the FASB has issued various staff positions clarifying the initial standard (see Note 2 to the consolidated financial statements: “Significant Accounting Policies — Investments”).

 

ASC 820: Fair Value establishes the following three-level hierarchy, based upon the transparency of inputs to the fair value measurement of an asset or liability as of the measurement date:

 

    Level I –Unadjusted quoted prices are available in active markets for identical investments as of the reporting date. The type of investments included in Level I include listed equities and listed securities. As required by ASC 820: Fair Value, the Company does not adjust the quoted price for these investments, even in situations where the Company holds a large position and a sale could reasonably affect the quoted price.

 

    Level II –Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reporting date. Such inputs may be quoted prices for similar assets or liabilities, quoted markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full character of the financial instrument, or inputs that are derived principally from, or corroborated by, observable market information. Investments which are generally included in this category include illiquid debt securities and less liquid, privately held or restricted equity securities, for which some level of recent trading activity has been observed.

 

    Level III – Pricing inputs are unobservable for the investment and includes situations where there is little, if any, market activity for the investment. The inputs may be based on the Company’s own assumptions about how market participants would price the asset or liability or may use Level II inputs, as adjusted, to reflect specific investment attributes relative to a broader market assumption. These inputs into the determination of fair value may require significant management judgment or estimation. Even if observable market data for comparable performance or valuation measures (earnings multiples, discount rates, other financial/valuation ratios, etc.) are available, such investments are grouped as Level III if any significant data point that is not also market observable (private company earnings, cash flows, etc.) is used in the valuation methodology.

 

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investment’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and the Company considers factors specific to the investment. A majority all of the Company’s investments are classified as Level III. The Company evaluates the source of inputs, including any markets in which its investments are trading, in determining fair value. Inputs that are backed by actual transactions, those that are highly correlated to the specific investment being valued and those derived from reliable or knowledgeable sources will tend to have a higher weighting in determining fair value. Ongoing reviews by the Company’s investment analysts, Chief Investment Officer, Valuation Committee and independent valuation firms (if engaged) may include factors such as an assessment of each underlying investment, its current and prospective operating and financial performance, consideration of financing and sale transactions with third parties, expected cash flows and market-based information, including comparable transactions, performance factors, and other investment or industry specific market data, among other factors.

 

We have valued our investments, in the absence of observable market prices, using the valuation methodologies described below applied on a consistent basis. For some investments little market activity may exist; management’s determination of fair value is then based on the best information available in the circumstances, and may incorporate management’s own assumptions and involves a significant degree of management’s judgment.

 

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Our investments in CLO Fund Securities are carried at fair value, which is based either on (i) the present value of the net expected cash inflows for interest income and principal repayments from underlying assets and the cash outflows for interest expense, debt paydown and other fund costs for the CLO Funds which are approaching or past the end of their reinvestment period and therefore are selling assets and/or using principal repayments to pay-down CLO Fund debt, and for which there continue to be net cash distributions to the class of we securities own, or (ii) a discounted cash flow model that utilizes prepayment and loss assumptions based on historical experience and projected performance, economic factors, the characteristics of the underlying cash flow and comparable yields for similar securities or preferred shares to those in which the Company has invested, or (iii) indicative prices provided by the underwriters or brokers who arrange CLO Funds. We recognize unrealized appreciation or depreciation on our investments in CLO Fund Securities as comparable yields in the market change and/or based on changes in net asset values or estimated cash flows resulting from changes in prepayment or loss assumptions in the underlying collateral pool. As each investment in CLO Fund Securities ages, the expected amount of losses and the expected timing of recognition of such losses in the underlying collateral pool are updated and the revised cash flows are used in determining the fair value of the CLO Fund Securities. We determine the fair value of our investments in CLO Fund Securities on a security-by-security basis.

 

The Company’s investments in its wholly-owned Asset Manager Affiliates are carried at fair value, which is primarily determined utilizing a discounted cash flow model which incorporates different levels of discount rates depending on the hierarchy of fees earned (including the likelihood of realization of senior, subordinate and incentive fees) and prospective modeled performance (“Discounted Cash Flow”). Such valuation takes into consideration an analysis of comparable asset management companies and a percentage of assets under management. The Asset Manager Affiliates are classified as a Level III investment (as described above). Any change in value from period to period is recognized as net change in unrealized appreciation or depreciation.

 

Fair values of other investments for which market prices are not observable are determined by reference to public market or private transactions or valuations for comparable companies or assets in the relevant asset class and/or industry when such amounts are available. Generally these valuations are derived by multiplying a key performance metric of the investee company or asset (e.g., EBITDA) by the relevant valuation multiple observed for comparable companies or transactions, adjusted by management for differences between the investment and the referenced comparable. Such investments may also be valued at cost for a period of time after an acquisition as the best indicator of fair value. If the fair value of such investments cannot be valued by reference to observable valuation measures for comparable companies, then the primary analytical method used to estimate the fair value is a discounted cash flow method and/or cap rate analysis. A sensitivity analysis is applied to the estimated future cash flows using various factors depending on the investment, including assumed growth rates (in cash flows), capitalization rates (for determining terminal values) and appropriate discount rates to determine a range of reasonable values or to compute projected return on investment.

 

For bond rated note tranches of CLO Fund Securities (those above the junior class) without transactions to support a fair value for the specific CLO Fund and tranche, fair value is based on discounting estimated bond payments at current market yields, which may reflect the adjusted yield on the leveraged loan index for similarly rated tranches, as well as prices for similar tranches for other CLO Funds and also other factors such as indicative prices provided by underwriters or brokers who arrange CLO Funds, and the default and recovery rates of underlying assets in the CLO Fund, as may be applicable. Such model assumptions may vary and incorporate adjustments for risk premiums and CLO Fund specific attributes.

 

We derive fair value for our illiquid loan investments that do not have indicative fair values based upon active trades primarily by using the Income Approach, and also consider recent loan amendments or other activity specific to the subject asset as described above. Other significant assumptions, such as coupon and maturity, are asset-specific and are noted for each investment in the Schedules of Investments.

 

The determination of fair value using this methodology takes into consideration a range of factors, including but not limited to the price at which the investment was acquired, the nature of the investment, local market conditions, trading values on public exchanges for comparable securities, current and projected operating performance and financing transactions subsequent to the acquisition of the investment. This valuation methodology involves a significant degree of management’s judgment.

 

Our Board of Directors may consider other methods of valuation to determine the fair value of investments as appropriate in conformity with GAAP.

 

Interest Income

 

Interest income, including amortization of premium and accretion of discount, is recorded on the accrual basis to the extent that such amounts are expected to be collected. We generally place a loan on non-accrual status and cease recognizing interest income on such loan or security when a loan or security becomes 90 days or more past due or if we otherwise do not expect the debtor to be able to service its debt obligations. Non-accrual loans remain in such status until the borrower has demonstrated the ability and intent to pay contractual amounts due or such loans become current. As of September 30, 2015 and December 31, 2014, there was one issuer (representing less than 1% of our total investments at fair value) on non-accrual status.

 

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Investment Income on CLO Fund Securities

 

We receive distributions from our investments in the most junior class of securities of CLO Funds (typically preferred shares or subordinated securities) managed by the Asset Manager Affiliates and selective investments in securities issued by funds managed by other asset management companies. Our CLO Fund junior class securities are subordinated to senior note holders who typically receive a return on their investment at a fixed spread relative to the LIBOR index. The CLO Funds are leveraged funds and any excess cash flow or “excess spread” (interest earned by the underlying securities in the fund less payments made to senior note holders and less fund expenses and management fees) is paid to the holders of the CLO Fund’s subordinated securities or preferred shares. The level of excess spread from CLO Fund securities can be impacted from the timing and level of the resetting of the benchmark interest rate for the underlying assets (which reset at various times throughout the quarter) in the CLO Fund and the related CLO Fund note liabilities (which reset at each quarterly distribution date); in periods of short-term and volatile changes in the benchmark interest rate, the levels of excess spread and distributions to us can vary significantly. In addition, the failure of CLO Funds in which we invest to comply with certain financial covenants may lead to the temporary suspension or deferral of cash distributions to us.

 

GAAP-basis investment income on CLO equity investments is recorded using the effective interest method in accordance with the provisions of ASC 325-40, based on the anticipated yield and the estimated cash flows over the projected life of the investment. Yields are revised when there are changes in actual or estimated projected future cash flows due to changes in prepayments and/or re-investments, credit losses or asset pricing. Changes in estimated yield are recognized as an adjustment to the estimated yield prospectively over the remaining life of the investment from the date the estimated yield was changed. Accordingly, investment income recognized on CLO equity securities in the GAAP statement of operations differs from both the tax–basis investment income and from the cash distributions actually received by the Company during the period.

 

For non-junior class CLO Fund Securities, such as our investment in the class E notes of Catamaran 2014-1, interest is earned at a fixed spread relative to the LIBOR index.

 

Distributions from Asset Manager Affiliates

 

We record distributions from our Asset Manager Affiliates on the declaration date, which represents the ex-dividend date. Distributions in excess of tax-basis earnings and profits are recorded as tax-basis return of capital. For interim periods, the Company estimates the tax attributes of any distributions as being either tax-basis earnings and profits (i.e. dividend income) or return of capital (i.e. adjustment to the Company’s cost basis in the Asset Manager Affiliates). The final determination of the tax attributes of distributions from our Asset Manager Affiliates is made on an annual (full calendar year) basis at the end of the year based upon taxable income and distributions for the full-year. Therefore, any estimate of tax attributes of distributions made on a quarterly basis may not be representative of the actual tax attributes of distributions for a full year.

 

Payment-in-Kind Interest

 

We may have loans in our portfolio that contain a payment-in-kind (“PIK”) provision. PIK interest, computed at the contractual rate specified in each loan agreement, is added to the principal balance of the loan and recorded as interest income. To maintain our RIC status, this non-cash source of income must be distributed to stockholders in the form of cash dividends, even though the Company has not yet collected any cash.

 

Fee Income

 

Fee income includes fees, if any, for due diligence, structuring, commitment and facility fees, and fees, if any, for transaction services and management services rendered by us to portfolio companies and other third parties. Commitment and facility fees are generally recognized as income over the life of the underlying loan, whereas due diligence, structuring, transaction service and management service fees are generally recognized as income when the services are rendered.

 

Management Compensation

 

We may, from time to time, issue stock options or restricted stock, under the Equity Incentive Plan, to officers and employees for services rendered to us. We follow Accounting Standards Codification 718, Compensation — Stock Compensation, a method by which the fair value of options or restricted stock is determined and expensed.

 

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United States Federal Income Taxes

 

The Company has elected and intends to continue to qualify for the tax treatment applicable to RICs under Subchapter M of the Code and, among other things, intends to make the required distributions to its stockholders as specified therein. In order to qualify as a RIC, the Company is required to timely distribute to its stockholders at least 90% of investment company taxable income, as defined by the Code, for each year. Depending on the level of taxable income earned in a tax year, we may choose to carry forward taxable income in excess of current year distributions into the next tax year and pay a 4% excise tax on such income, to the extent required.

 

Distributions to Shareholders

 

The amount of our declared distributions, as evaluated by management and approved by our Board of Directors, is based primarily on our evaluation of distributable taxable income and after-tax free cash flow from our Asset Manager Affiliates.

 

The following table sets forth the quarterly distributions declared by us since the most recent completed calendar year.

 

   Distribution   Declaration
Date
  Record
Date
  Pay Date
2015:              
Third quarter   0.21   9/22/2015  10/14/2015  10/27/2015
Second quarter   0.21   6/23/2015  7/6/2015  7/27/2015
First quarter  $0.21   3/24/2015  4/6/2015  4/27/2015
               
Total declared in 2015  $0.63          
               
2014:              
Fourth quarter   0.25   12/17/2014  12/29/2014  1/29/2015
Third quarter   0.25   9/19/2014  10/14/2014  10/29/2014
Second quarter   0.25   6/20/2014  7/3/2014  7/25/2014
First quarter  $0.25   3/21/2014  4/4/2014  4/25/2014
               
Total declared in 2014  $1.00          
               
2013:              
Fourth quarter   0.25   12/13/2013  12/27/2013  1/27/2014
Third quarter   0.25   9/13/2013  10/8/2013  10/29/2013
Second quarter   0.28   6/17/2013  7/5/2013  7/26/2013
First quarter  $0.28   3/15/2013  4/5/2013  4/26/2013
               
Total declared in 2013  $1.06          

 

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The following table depicts the composition of shareholder distributions on a per share basis:

 

   Three Months Ended September 30,   Nine Months Ended September 30, 
   2015¹   2014¹   2015¹   2014¹ 
Net investment income  $0.18   $0.16   $0.51   $0.44 
Tax Accounting Difference on CLO Equity Investments   0.01    0.03    0.04    0.14 
Other tax accounting differences    0.02    -    0.02    0.01 
Taxable distributable income   0.21    0.20    0.57    0.59 
Cash distributed to the Company by Asset Manager Affiliates in excess of their taxable earnings   0.02    0.05    0.08    0.15 
Available for distribution²   0.23    0.25    0.66    0.74 
Distributed  $0.21   $0.25   $0.63   $0.75 
Difference  $0.02   $-   $0.03   $(0.01)

 

 

¹Table may not foot due to rounding.
²The "Available for distribution" financial measure is a non-GAAP financial measure that is calculated by including the cash distributed to the Company by the Asset Manager Affiliates in excess of their taxable earnings to the Company's taxable distributable income, which is the most directly comparable GAAP financial measure. In order to reconcile the "Available for distribution financial measure to taxable distributable income per share in accordance with GAAP, the $0.02 and $0.08 per share of cash distributed to the Company by the Asset Manager Affiliates in excess of their taxable earnings is subtracted from the "Available for distribution" financial measure for the three and nine months ended September 30, 2015, respectively. The Company's management believes that the presentation of the non-GAAP "Available for distribution" financial measure provides useful information to investors.

 

 Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

Our business activities contain elements of market risks. We consider our principal market risks to be fluctuations in interest rates and the valuations of our investment portfolio. Managing these risks is essential to our business. Accordingly, we have systems and procedures designed to identify and analyze our risks, to establish appropriate policies and thresholds and to continually monitor these risks and thresholds by means of administrative and information technology systems and other policies and processes.

 

Interest Rate Risk

 

Interest rate risk is defined as the sensitivity of our current and future earnings to interest rate volatility, variability of spread relationships, the difference in re-pricing intervals between our assets and liabilities and the effect that interest rates may have on our cash flows. Changes in the general level of interest rates can affect our net interest income, which is the difference between the interest income earned on interest earning assets and our interest expense incurred in connection with our interest bearing debt and liabilities. Changes in interest rates can also affect, among other things, our ability to acquire and originate loans and securities and the value of our investment portfolio.

 

Our investment income is affected by fluctuations in various interest rates, including LIBOR and prime rates. As of September 30, 2015, approximately 97.7% of our debt securities portfolio were either fixed rate or floating rate with a spread to an interest rate index such as LIBOR or the prime rate. Most of these floating rate loans contain LIBOR floors ranging between 0.75% and 3.00%. We generally expect that future portfolio investments will predominately be floating rate investments. As of September 30, 2015, we had $222.4 million par value of borrowings outstanding at a weighted average rate of 4.37%.

 

Because we borrow money to make investments, our net investment income is dependent upon the difference between our borrowing rate and the rate we earn on the invested proceeds borrowed. In periods of rising or lowering interest rates, the cost of the portion of our debt associated with our Convertible Notes or 7.375% Notes Due 2019 would remain the same at 8.75% and 7.375%, respectively, given that this debt is at a fixed rate. The Notes issued by KCAP Senior Funding are floating rate based upon a LIBOR index plus a spread, which serves as a floor should LIBOR decrease to zero. Accordingly, our interest costs associated with this debt will fluctuate with changes in LIBOR.

 

Generally we would expect that an increase in the base rate index for our floating rate investment assets would increase our gross investment income and that a decrease in the base rate index for such assets would decrease our gross investment income (in either case, such increase/decrease may be limited by interest rate floors/minimums for certain investment assets).

 

We have analyzed the potential impact of changes in interest rates on interest income net of interest expense. Assuming that our balance sheet at September 30, 2015 was to remain constant and no actions were taken to alter the existing interest rate sensitivity, the table below illustrates the impact on net investment income on our Debt Securities Portfolio for various hypothetical increases in interest rates:

 

   Impact on net investment income: 
   1%   2%   3% 
Increase (decrease) in interest rate  $(746,695)  $74,705   $912,268 
                
Decrease in interest rate  $407,701   $407,701   $407,701 

 

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As shown above, net investment income assuming a 1% increase in interest rates would decrease by approximately $747,000 on an annualized basis, reflecting the impact to investments in our portfolio that are either fixed rate or which have embedded floors that would be unaffected by a 1% change in the underlying interest rate while our interest expense would be increasing. However, if the increase in rates was more significant, such as 2% or 3%, the net effect on net investment income would be an increase of approximately $75,000 and $912,000, respectively. Since LIBOR underlying certain investments, as well as certain of our borrowings, is currently very low, it is unlikely that the underlying rate will decrease by 1% or 2% or even 3%. If the underlying rate decreased to 0%, it would result in approximately a $408,000 increase in net investment income.

 

Although management believes that this measure is indicative of sensitivity to interest rate changes on our Debt Securities Portfolio, it does not adjust for potential changes in credit quality, size and composition of the assets on the balance sheet and other business developments that could affect a net change in assets resulting from operations or net income. Accordingly, no assurances can be given that actual results would not materially differ from the potential outcome simulated by this estimate.

 

We did not hold any derivative financial instruments for hedging purposes as of September 30, 2015.

 

Portfolio Valuation

 

We carry our investments at fair value, as determined in good faith by our Board of Directors pursuant to a valuation methodology approved by our Board of Directors. Investments for which market quotations are generally readily available are generally valued at such market quotations. Investments for which there is not a readily available market value are valued at fair value as determined in good faith by our Board of Directors under a valuation policy and consistently applied valuation process. However, due to the inherent uncertainty of determining the fair value of investments that cannot be marked to market, the fair value of our investments may differ materially from the values that would have been used had a ready market existed for such investments. In addition, changes in the market environment and other events that may occur over the life of the investments may cause the value realized on these investments to be different than the valuations that are assigned. The types of factors that we may take into account in fair value pricing of our investments include, as relevant, the nature and realizable value of any collateral, third party valuations, the portfolio company’s ability to make payments and its earnings and discounted cash flow, the markets in which the portfolio company does business, comparison to publicly-traded securities, recent sales of or offers to buy comparable companies, and other relevant factors.

 

The Company has engaged an independent valuation firm to provide third party valuation consulting services to the Company’s Board of Directors. Each quarter, the independent valuation firm will perform third party valuations on the Company’s material investments in illiquid securities such that they are reviewed at least once during a trailing 12 month period. These third party valuation estimates were considered as one of the relevant data inputs in the Company’s determination of fair value. The Company intends to continue to engage an independent valuation firm in the future to provide certain valuation services, including the review of certain portfolio assets, as part of the quarterly and annual year-end valuation process.

 

Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

The Company’s management, under the supervision and with the participation of various members of management, including its Chief Executive Officer (“CEO”) and its Chief Financial Officer (“CFO”), has evaluated the effectiveness of its disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) of the Exchange Act) as of the end of the period covered by this report. Based upon that evaluation, the Company’s CEO and CFO have concluded that the Company’s disclosure controls and procedures are effective as of the end of the period covered by this report.

 

Changes in Internal Control Over Financial Reporting

 

During the quarter ended September 30, 2015, there were no changes in the Company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II. Other Information

 

 Item 1. Legal Proceedings

 

The Company is not currently a party to any material legal proceedings.

 

 Item 1A. Risk Factors

 

There have been no material changes from the risk factors previously disclosed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2014.

 

 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

While we did not engage in any sales of unregistered securities during the three months ended September 30, 2015, we issued a total of 20,059 shares of common stock under our dividend reinvestment plan (“DRIP”). This issuance was not subject to the registration requirements of the Securities Act of 1933. For the three months ended September 30, 2015, the aggregate value of the shares of our common stock issued under our DRIP was approximately $103,099.

 

 Item 3. Defaults Upon Senior Securities

 

None.

 

 Item 4. Mine Safety Disclosures

 

Not Applicable.

 

 Item 5. Other Information

 

None.

 

 Item 6. Exhibits

 

Reference is made to the Exhibit List filed as a part of this report beginning on page E-1. Each of such exhibits is incorporated by reference herein.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.

 

       

KCAP Financial, Inc

       
Date: November 4, 2015       By   /s/ Dayl W. Pearson
                Dayl W. Pearson
                President and Chief Executive Officer
                (Principal Executive Officer)
       
Date: November 4, 2015       By   /s/ Edward U. Gilpin
                Edward U. Gilpin
                Chief Financial Officer
                (Principal Financial and Accounting Officer)

 

* * * * *

 

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Exhibit Index

 

Exhibit

Number

  Description of Document
     
31.1   Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.**
     
31.2   Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.**
     
32.1   Certification of Chief Executive Officer Pursuant to 18 U. S. C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. **
     
32.2   Certification of Chief Financial Officer Pursuant to 18 U. S. C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.**
     
**   Submitted herewith

 

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