Portman Ridge Finance Corp - Quarter Report: 2017 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended September 30, 2017

¨	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

Incorporation or organization)

(I.R.S. Employer

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 ý 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, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer	¨		Accelerated filer	x

Non-accelerated filer	¨	(Do not check if a smaller reporting company)	Smaller reporting company	¨

Emerging growth company	¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act. ¨

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 1, 2017 was 37,339,224.

TABLE OF CONTENTS

		Page

	Part I. Financial Information

Item 1.	Consolidated Financial Statements	3

	Consolidated Balance Sheets as of September 30, 2017 (unaudited) and December 31, 2016	3

	Consolidated Statements of Operations (unaudited) for the three and nine months ended September 30, 2017 and 2016	4

	Consolidated Statements of Changes in Net Assets (unaudited) for the nine months ended September 30, 2017 and 2016	5

	Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2017 and 2016	6

	Consolidated Schedules of Investments as of September 30, 2017 (unaudited) and December 31, 2016	7

	Consolidated Financial Highlights (unaudited) for the nine months ended September 30, 2017 and 2016	23

	Notes to Consolidated Financial Statements (unaudited)	24

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	55

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	75

Item 4.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	77

Item 5.	Controls and Procedures	77

	Part II. Other Information

Item 1.	Legal Proceedings	78

Item 1A.	Risk Factors	78

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	78

Item 3.	Defaults Upon Senior Securities	78

Item 4.	Mine Safety Disclosures	78

Item 5.	Other Information	78

Item 6.	Exhibits	78

Signatures		79

KCAP FINANCIAL, INC.

CONSOLIDATED BALANCE SHEETS

	As of September 30, 2017			As of December 31, 2016
	(unaudited)
ASSETS
Investments at fair value:
Short-term investments (cost: 2017 - $57,024,828; 2016 - $28,699,269)	$	57,024,828		$	28,699,269
Debt securities (cost: 2017 - $134,031,011; 2016 - $249,520,234)		127,026,829			238,343,330
CLO Fund securities managed by affiliates (cost: 2017 - $73,495,563; 2016 - $71,734,809)		49,973,662			51,908,784
CLO Fund securities managed by non-affiliates (cost: 2017 - $5,049,176; 2016 - $5,116,508)		1,869,682			2,265,566
Equity securities (cost: 2017 - $10,389,008; 2016 - $10,389,007)		4,450,177			5,056,355
Asset Manager Affiliates (cost: 2017 - $53,341,230; 2016 - $55,341,230)		39,679,000			40,198,000
Joint Venture (cost: 2017 - $36,738,873; 2016 - $0)		36,591,122			—
Total Investments at Fair Value (cost: 2017 - $370,069,689; 2016 - $420,801,057)		316,615,300			366,471,304
Cash		1,936,300			1,307,257
Restricted cash		—			8,528,298
Interest receivable		923,344			1,033,917
Receivable for open trades		—			2,950,658
Accounts receivable		2,000,021			—
Due from affiliates		1,159,759			612,854
Other assets		173,185			467,695

Total Assets	$	322,807,909		$	381,371,983

LIABILITIES
Notes issued by KCAP Senior Funding I, LLC (net of discount and offering costs of: 2016 - $2,286,425 and $2,459,156, respectively)	$	—		$	142,604,419
7.375% Notes due 2019 (net of offering costs of: 2017 - $306,073; 2016 - $550,774)		26,693,927			32,980,151
6.125% Notes due 2022 (net of offering costs of: 2017 - $2,757,357)		74,649,843			—
Payable for open trades		34,950,728			7,884,943
Accounts payable and accrued expenses		1,649,529			2,047,405
Accrued interest payable		—			930,086
Due to affiliates		78,438			54

Total Liabilities		138,022,465			186,447,058
COMMITMENTS AND CONTINGENCIES (Note 8)
STOCKHOLDERS' EQUITY
Common stock, par value $0.01 per share, 100,000,000 common shares authorized; 37,485,993 issued, and 37,317,815 outstanding at September 30, 2017, and 37,282,296 issued, and 37,178,294 outstanding at December 31, 2016		373,178			371,783
Capital in excess of par value		354,341,009			353,404,155
Excess distribution of net investment income		(19,589,473	)		(14,630,319	)
Accumulated net realized losses		(95,485,836	)		(88,491,896	)
Net unrealized depreciation on investments		(54,853,434	)		(55,728,798	)

Total Stockholders' Equity		184,785,444			194,924,925

Total Liabilities and Stockholders' Equity	$	322,807,909		$	381,371,983

NET ASSET VALUE PER COMMON SHARE	$	4.95		$	5.24

See accompanying notes to consolidated financial statements.

KCAP FINANCIAL, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2017			2016			2017			2016

Investment Income:
Interest from investments in debt securities	$	2,439,671		$	5,186,745		$	11,764,702		$	16,106,654
Interest from cash and short-term investments		21,043			7,168			51,250			21,521
Investment income on CLO Fund Securities managed by affiliates		2,693,547			3,307,950			8,378,785			9,595,522
Investment income on CLO Fund Securities managed by non-affiliates		99,578			195,182			329,108			503,358
Dividends from Asset Manager Affiliates		180,000			—			180,000			1,400,000
Investment income - Joint Venture		685,000			—			685,000			—
Capital structuring service fees		134,504			321,744			298,629			481,456

Total investment income		6,253,343			9,018,789			21,687,474			28,108,510

Expenses:
Interest and amortization of debt issuance costs		1,371,953			2,122,325			5,790,242			6,960,355
Compensation		1,072,812			1,199,412			3,473,841			3,212,886
Professional fees		802,507			699,607			2,545,195			1,913,722
Insurance		80,794			102,254			256,473			315,307
Administrative and other		395,783			372,164			1,265,317			1,310,424

Total expenses		3,723,849			4,495,762			13,331,068			13,712,694

Net Investment Income		2,529,495			4,523,027			8,356,404			14,395,816
Realized And Unrealized Gains (Losses) On Investments:
Net realized (losses) gains from investment transactions		(1,906,537	)		4,647,841			(2,871,941	)		(6,046,199	)
Net change in unrealized appreciation (depreciation) on:
Debt securities		1,759,152			456,530			4,172,723			2,539,345
Equity securities		(186,368	)		(4,579,566	)		(606,179	)		(4,896,852	)
CLO Fund securities managed by affiliates		(1,590,062	)		(993,011	)		(3,695,876	)		5,890,984
CLO Fund securities managed by non-affiliates		(34,655	)		(137,193	)		(328,552	)		(136,490	)
Asset Manager Affiliates investments		2,922,000			(1,113,000	)		1,481,000			(12,706,000	)
Joint Venture investment		(147,751	)		—			(147,751	)		—
Total net change in unrealized appreciation (depreciation)		2,722,316			(6,366,240	)		875,365			(9,309,013	)

Net realized and unrealized appreciation (depreciation) on investments		815,779			(1,718,399	)		(1,996,576	)		(15,355,212	)

Realized losses on extinguishments of debt		(4,014,723	)		(88,015	)		(4,121,998	)		(159,206	)
Net Increase (Decrease) In Stockholders’ Equity Resulting From Operations	$	(669,449	)	$	2,716,613		$	2,237,830		$	(1,118,601	)

Net Increase (Decrease) In Stockholders' Equity Resulting from Operations per Common Share:
Basic:	$	(0.02	)	$	0.07		$	0.06		$	(0.03	)
Diluted:	$	(0.02	)	$	0.07		$	0.06		$	(0.03	)
Net Investment Income Per Common Share:
Basic:	$	0.07		$	0.12		$	0.23		$	0.39
Diluted:	$	0.07		$	0.12		$	0.23		$	0.39

Weighted Average Shares of Common Stock Outstanding—Basic		37,196,621			37,152,622			37,202,011			37,142,002
Weighted Average Shares of Common Stock Outstanding—Diluted		37,196,621			37,152,622			37,202,011			37,142,002

See accompanying notes to consolidated financial statements.

KCAP FINANCIAL, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS

(unaudited)

	Nine Months Ended September 30,
	2017			2016

Operations:
Net investment income	$	8,356,404		$	14,395,816
Net realized losses from investment transactions		(2,871,941	)		(6,046,199	)
Realized losses from extinguishments of debt		(4,121,998	)		(159,206	)
Net change in unrealized appreciation (depreciation) on investments		875,365			(9,309,013	)
Net increase (decrease) in net assets resulting from operations		2,237,830			(1,118,602	)

Stockholder distributions:		(13,315,561	)		(16,534,320	)

Capital share transactions:
(Repurchase) issuance of common stock for:
Common stock withheld for payroll taxes upon vesting of restricted stock		(224,944	)		(247,926	)
Dividend reinvestment plan		288,192			549,627
Stock based compensation		875,002			1,154,123

Net increase in net assets resulting from capital transactions		938,250			1,455,824

Net assets at beginning of period		194,924,925			216,100,470

Net assets at end of period (including undistributed net investment income of $0 in 2017 and $0 in 2016)	$	184,785,444		$	199,903,372

Net asset value per common share	$	4.95		$	5.38
Common shares outstanding at end of period		37,317,815			37,160,770

See accompanying notes to consolidated financial statements.

KCAP FINANCIAL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

	Nine Months Ended September 30,
	2017			2016

OPERATING ACTIVITIES:
Net increase (decrease) in stockholder's equity resulting from operations	$	2,237,829		$	(1,118,601	)
Adjustments to reconcile net increase (decrease) in stockholder’s equity resulting from operations to net cash provided by in operating activities:
Net realized losses on investment transactions		2,871,941			6,046,199
Net change in unrealized depreciation on investments		(875,365	)		9,309,013
Purchases of investments		(202,774,324	)		(54,437,487	)
Proceeds from sales and redemptions of investments		252,169,877			75,555,567
Net accretion of amortization on investments		(707,654	)		1,859,301
Amortization of original issue discount on indebtedness		352,340			464,320
Amortization of debt issuance costs		557,527			651,298
Realized losses on extinguishments of debt		4,121,998			159,206
Payment-in-kind interest income		(829,774	)		(975,661	)
Stock-based compensation		875,002			1,154,376
Changes in operating assets and liabilities:
Decrease in receivable for open trades		2,950,658			—
Increase in payable for open trades		27,065,785			9,652,500
Decrease in interest receivable		110,574			654,614
(Increase) in accounts receivable		(2,000,021	)		—
Decrease in other assets		294,509			286,607
(Increase) decrease in due from affiliates		(546,905	)		373,558
Increase (decrease) in due to affiliates		78,384			(554,243	)
(Decrease) in accounts payable		(397,876	)		(219,587	)
(Decrease) in accrued interest payable		(930,086	)		(353,444	)

Net cash provided by operating activities		84,624,419			48,507,536

FINANCING ACTIVITIES:
Issuance of 6.125% Notes Due 2022		77,407,200			—
Debt issuance costs		(2,798,940	)		—
Issuance (forfeitures) of restricted shares		1,303			(254	)
Distributions to stockholders		(13,027,367	)		(15,984,693	)
Repayment/repurchase of Senior Funding Notes		(147,350,000	)		(19,299,000	)
Repurchase of 7.375% Notes Due 2019		(6,530,925	)		(7,399,650	)
Common stock withheld for payroll taxes upon vesting of restricted stock		(224,944	)		(247,926	)
Decrease (increase) in restricted cash		—			(3,771,347	)

Net cash used in financing activities		(92,523,674	)		(46,702,870	)

CHANGE IN CASH AND RESTRICTED CASH		(7,899,255	)		1,804,666
CASH AND RESTRICTED CASH, BEGINNING OF PERIOD		9,835,555			—

CASH AND RESTRICTED CASH, END OF PERIOD	$	1,936,300		$	1,804,666

Supplemental Information:
Interest paid during the period	$	5,810,461		$	6,173,626
Dividends paid during the period under the dividend reinvestment plan	$	289,478		$	549,627

See accompanying notes to consolidated financial statements.

KCAP FINANCIAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENS

As of September 30, 2017

(unaudited)

Debt Securities Portfolio

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

Advanced Lighting Technologies, Inc,^(8)(14)(15) Consumer goods: Durable	First Lien Bond — 12.500% - 6/2019 - 00753CAG7 5.3% Cash, 7.3% PIK, Due 6/19	$	3,157,500	$	3,054,337	$	1,063,761

Advantage Sales & Marketing Inc.^(8)(14) Services: Business	Junior Secured Loan — Term Loan (Second Lien) 7.7% Cash, 1 month LIBOR(1.24%) + 6.50%; LIBOR Floor 1.00% , Due 7/22		1,000,000		1,001,518		962,300

Anaren, Inc.⁽⁸⁾ Aerospace and Defense	Senior Secured Loan — Term Loan (First Lien) 5.8% Cash, 3 month LIBOR(1.33%) + 4.50%; LIBOR Floor 1.00% , Due 2/21		1,513,396		1,529,286		1,529,286

Asurion, LLC (fka Asurion Corporation)⁽⁸⁾ Banking, Finance, Insurance & Real Estate	Senior Secured Loan — Replacement B-5 Term Loan 4.2% Cash, 3 month LIBOR(1.24%) + 3.00%; LIBOR Floor 0.00% , Due 11/23		1,994,987		2,007,456		2,007,556

Avalign Technologies, Inc.^(8)(14) Healthcare & Pharmaceuticals	Senior Secured Loan — Initial Term Loan (First Lien) 5.7% Cash, 1 month LIBOR(1.24%) + 4.50%; LIBOR Floor 1.00% , Due 7/21		1,078,170		1,075,612		1,078,170

Avalign Technologies, Inc.^(8)(14) Healthcare & Pharmaceuticals	Junior Secured Loan — Initial Term Loan (Second Lien) 9.7% Cash, 6 month LIBOR(1.46%) + 8.25%; LIBOR Floor 1.00% , Due 7/22		1,500,000		1,488,351		1,479,000

Carolina Beverage Group LLC^(8)(14) Beverage, Food and Tobacco	Senior Secured Bond — 10.625% - 08/2018 - 143818AA0 144A 10.6% Cash, Due 8/18		1,500,000		1,503,404		1,494,600

CSM Bakery Solutions Limited (fka CSM Bakery Supplies Limited)^(8)(14) Beverage, Food and Tobacco	Junior Secured Loan — Term Loan (Second Lien) 9.1% Cash, 3 month LIBOR(1.30%) + 7.75%; LIBOR Floor 1.00% , Due 7/21		3,000,000		3,009,449		2,851,800

CT Technologies Intermediate Holdings, Inc. (Smart Holdings Corp.) (aka HealthPort)⁽⁸⁾ Healthcare & Pharmaceuticals	Senior Secured Loan — New Term Loan Facility 5.5% Cash, 3 month LIBOR(1.24%) + 4.25%; LIBOR Floor 1.00% , Due 12/21		1,994,898		2,004,872		2,004,872

DigiCert Holdings, Inc. ⁽⁸⁾ High Tech Industries	Junior Secured Loan — Term Loan (Second Lien) 9.0% Cash, 3 month LIBOR(1.24%) + 7.76%; LIBOR Floor 1.00% , Due 9/25		1,000,000		995,000		995,000

Drew Marine Group Inc.^(8)(14) Transportation: Cargo	Junior Secured Loan — Term Loan (Second Lien) 8.2% Cash, 1 month LIBOR(1.24%) + 7.00%; LIBOR Floor 1.00% , Due 5/21		2,500,000		2,496,958		2,500,000

See accompanying notes to consolidated financial statements.

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

EagleTree-Carbide Acquisition Corp. (aka Corsair Components, Inc.)⁽⁸⁾ High Tech Industries	Senior Secured Loan — First Lien Term Loan 5.7% Cash, 3 month LIBOR(1.23%) + 4.50%; LIBOR Floor 0.00% , Due 9/24		5,000,000		4,950,000		4,950,000

EagleTree-Carbide Acquisition Corp. (aka Corsair Components, Inc.)⁽⁸⁾ High Tech Industries	Junior Secured Loan — Term Loan (Second Lien) 9.8% Cash, 3 month LIBOR(1.33%) + 8.50%; LIBOR Floor 1.00% , Due 8/25		5,000,000		4,925,000		4,925,000

Eastern Power, LLC (Eastern Covert Midco, LLC) (aka TPF II LC, LLC)⁽⁸⁾ Utilities: Electric	Senior Secured Loan — Term Loan 5.0% Cash, 1 month LIBOR(1.24%) + 3.75%; LIBOR Floor 1.00% , Due 10/23		1,981,386		1,979,983		1,991,015

EWT Holdings III Corp. (fka WTG Holdings III Corp.)⁽⁸⁾ Environmental Industries	Senior Secured Loan — Term Loan (First Lien) 5.1% Cash, 3 month LIBOR(1.33%) + 3.75%; LIBOR Floor 1.00% , Due 1/21		2,992,385		3,037,271		3,037,271

Exela Technologies, Inc.⁽⁸⁾ Services: Business	Senior Secured Loan — Term Loan B 8.8% Cash, 3 month LIBOR(1.30%) + 7.50%; LIBOR Floor 1.00% , Due 6/23		2,000,000		1,961,345		1,986,200

First American Payment Systems, L.P.^(8)(14) Banking, Finance, Insurance & Real Estate	Junior Secured Loan — Term Loan (Second Lien) 11.7% Cash, 1 month LIBOR(1.23%) + 10.50%; LIBOR Floor 1.00% , Due 7/24		1,500,000		1,459,320		1,435,950

Flexera Software LLC (fka Flexera Software, Inc.)⁽⁸⁾ High Tech Industries	Senior Secured Loan — Term Loan (First Lien) 4.8% Cash, 3 month LIBOR(1.33%) + 3.50%; LIBOR Floor 1.00% , Due 4/20		2,000,000		1,995,000		1,995,000

GI Advo Opco, LLC^(8)(14) Healthcare & Pharmaceuticals	Senior Secured Loan — Term Loan 5.8% Cash, 3 month LIBOR(1.33%) + 4.50%; LIBOR Floor 1.00% , Due 11/21		236,732		235,090		236,684

GK Holdings, Inc. (aka Global Knowledge)^(8)(14) Services: Business	Junior Secured Loan — Initial Term Loan (Second Lien) 11.6% Cash, 3 month LIBOR(1.33%) + 10.25%; LIBOR Floor 1.00% , Due 1/22		1,500,000		1,481,433		1,476,600

Global Tel*Link Corporation^(8)(14) Telecommunications	Junior Secured Loan — Term Loan (Second Lien) 9.1% Cash, 3 month LIBOR(1.33%) + 7.75%; LIBOR Floor 1.25% , Due 11/20		4,000,000		3,965,663		3,939,200

Grupo HIMA San Pablo, Inc.^(8)(14) Healthcare & Pharmaceuticals	Senior Secured Loan — Term B Loan (First Lien) 8.5% Cash, 3 month LIBOR(1.50%) + 7.00%; LIBOR Floor 1.50% , Due 1/18		2,860,000		2,856,176		2,745,600

See accompanying notes to consolidated financial statements.

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

Grupo HIMA San Pablo, Inc.^(8)(14) Healthcare & Pharmaceuticals	Junior Secured Loan — Term Loan (Second Lien) 13.8% Cash, 3 month LIBOR(0.00%) + 13.75%; LIBOR Floor 0.00% , Due 7/18		7,191,667		7,167,268		6,544,417

Harland Clarke Holdings Corp. (fka Clarke American Corp.)⁽⁸⁾ Media: Advertising, Printing & Publishing	Senior Secured Loan — Tranche B-6 Term Loan 6.8% Cash, 3 month LIBOR(1.33%) + 5.50%; LIBOR Floor 1.00% , Due 2/22		3,477,848		3,510,198		3,512,627

Hoffmaster Group, Inc.^(8)(14) Forest Products & Paper	Junior Secured Loan — Initial Term Loan (Second Lien) 10.8% Cash, 3 month LIBOR(1.33%) + 9.50%; LIBOR Floor 1.00% , Due 11/24		1,600,000		1,557,040		1,600,960

Industrial Services Acquisition, LLC (aka Evergreen / NAIC)^(8)(14) Environmental Industries	Senior Secured Loan — Term Loan 6.3% Cash, 1 month LIBOR(1.25%) + 5.00%; LIBOR Floor 1.00% , Due 6/22		1,183,955		1,189,840		1,183,955

Ivanti Software, Inc. (fka LANDesk Group, Inc.)^(8)(14) High Tech Industries	Junior Secured Loan — Loan (Second Lien) 10.2% Cash, 1 month LIBOR(1.24%) + 9.00%; LIBOR Floor 1.00% , Due 1/25		3,228,619		3,228,619		3,186,970

MB Aerospace ACP Holdings II Corp.⁽⁸⁾ Aerospace and Defense	Senior Secured Loan — Initial Term Loan 6.8% Cash, 1 month LIBOR(1.25%) + 5.50%; LIBOR Floor 1.00% , Due 12/22		982,500		983,720		993,602

National Home Health Care Corp.^(8)(14) Healthcare & Pharmaceuticals	Junior Secured Loan — Term Loan (Second Lien) 10.2% Cash, 1 month LIBOR(1.23%) + 9.00%; LIBOR Floor 1.00% , Due 12/22		1,500,728		1,481,090		1,469,813

Onex Carestream Finance LP^(8)(14) Healthcare & Pharmaceuticals	Junior Secured Loan — Term Loan (Second Lien) 9.8% Cash, 3 month LIBOR(1.33%) + 8.50%; LIBOR Floor 1.00% , Due 12/19		1,704,810		1,704,810		1,685,205

Playpower, Inc.⁽⁸⁾ Construction & Building	Senior Secured Loan — Initial Term Loan (First Lien) 6.1% Cash, 3 month LIBOR(1.33%) + 4.75%; LIBOR Floor 1.00% , Due 6/21		997,449		1,007,336		1,007,423

Roscoe Medical, Inc.^(8)(14) Healthcare & Pharmaceuticals	Junior Secured Loan — Term Loan (Second Lien) 11.3% Cash, 3 month LIBOR(0.00%) + 11.25%; LIBOR Floor 0.00% , Due 9/19		6,700,000		6,675,833		6,492,300

SCSG EA Acquisition Company, Inc.⁽⁸⁾ Healthcare & Pharmaceuticals	Senior Secured Loan — Initial Term Loan (First Lien) 5.5% Cash, 3 month LIBOR(1.24%) + 4.25%; LIBOR Floor 1.00% , Due 9/23		4,000,000		3,980,220		3,980,000

See accompanying notes to consolidated financial statements.

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

SCSG EA Acquisition Company, Inc.⁽⁸⁾ Healthcare & Pharmaceuticals	Junior Secured Loan — Initial Term Loan (Second Lien) 9.5% Cash, 3 month LIBOR(1.24%) + 8.25%; LIBOR Floor 1.00% , Due 9/24		5,000,000		4,950,470		4,950,000

Stafford Logistics, Inc. (dba Custom Ecology, Inc.)^(8)(14)(15) Environmental Industries	Senior Secured Loan — Term Loan 9.8% Cash, 3 month LIBOR(4.25%) + 5.50%; LIBOR Floor 1.00% , Due 8/21		2,709,639		2,695,841		1,935,225

Tank Partners Holdings, LLC^(8)(13)(14) Energy: Oil & Gas	Senior Secured Loan — Loan 14.3% Cash, 4.0% Cash, 10.25% PIK, 1 month Prime Rate 4.0%		11,640,915		11,255,256		8,220,814

Tex-Tech Industries, Inc.⁽⁸⁾ Textiles and Leather	Junior Secured Loan — Term Loan (Second Lien) 10.2% Cash, 1 month LIBOR(1.24%) + 9.00%; LIBOR Floor 1.00% , Due 8/24		8,008,000		7,948,833		7,847,840

Time Manufacturing Acquisition, LLC⁽⁸⁾ Capital Equipment	Senior Secured Loan — Term Loan 6.4% Cash, 3 month LIBOR(1.38%) + 5.00%; LIBOR Floor 1.00% , Due 2/23		997,494		995,017		995,000

Trimaran Advisors, L.L.C.⁽⁸⁾⁽⁹⁾ Related Party Loan	Senior Unsecured Loan — Revolving Credit Facility 9.0% Cash, 3 month LIBOR(0.00%) + 7.89%; LIBOR Floor 0.00% , Due 11/17		20,000,000		20,000,000		20,000,000

TRSO I, Inc.^(8)(14) Energy: Oil & Gas	Junior Secured Loan — Term Loan (Second Lien) 14.0% Cash, 3 month LIBOR(1.00%) + 13.00%; LIBOR Floor 1.00% , Due 12/19		1,000,000		993,631		1,000,000

Weiman Products, LLC^(8)(14) Consumer goods: Non-durable	Senior Secured Loan — Term Loan (2013) 5.8% Cash, 3 month LIBOR(1.33%) + 4.50%; LIBOR Floor 1.00% , Due 11/18		734,613		732,896		734,613

WireCo WorldGroup Inc. ^(8)(14) Capital Equipment	Junior Secured Loan — Initial Term Loan (Second Lien) 10.3% Cash, 3 month LIBOR(1.32%) + 9.00%; LIBOR Floor 1.00% , Due 9/24		3,000,000		2,960,569		3,001,200

Total Investment in Debt Securities (69% of net asset value at fair value)		$	134,967,691	$	134,031,011	$	127,026,829

See accompanying notes to consolidated financial statements.

Equity Securities Portfolio

Portfolio Company / Principal Business	Investment	Percentage Ownership/Shares			Amortized Cost		Fair Value²
Advanced Lighting Technologies, Inc,^(5)(8)(14) Consumer goods: Durable	Preferred Stock Series C		1.8	%	$	1	$	1,000

Aerostructures Holdings L.P.^(5)(8)(14) Aerospace and Defense	Partnership Interests		1.2	%		1,000,000		1,000

Aerostructures Holdings L.P.^(5)(8)(14) Aerospace and Defense	Series A Preferred Interests		1.2	%		250,961		742,902

Caribe Media Inc. (fka Caribe Information Investments Incorporated)^(5)(8)(14) Media: Advertising, Printing & Publishing	Common		1.3	%		359,765		362,411

DBI Holding LLC^(5)(8)(14) Services: Business	Class A Warrants		3.2	%		1		1,000

eInstruction Acquisition, LLC^(5)(8)(14) Services: Business	Membership Units		1.1	%		1,079,617		1,000

FP WRCA Coinvestment Fund VII, Ltd.^(3)(5)(14) Capital Equipment	Class A Shares		1,500			1,500,000		747,940

Perseus Holding Corp.^(5)(8)(14) Hotel, Gaming & Leisure	Common		0.2	%		400,000		1,000

Roscoe Investors, LLC^(5)(8)(14) Healthcare & Pharmaceuticals	Class A Units		1.6	%		1,000,000		1,234,000

Tank Partners Holdings, LLC^{(5)(8)(10)(14)} Aerospace and Defense	Class B Units		5.8	%		980,000		1,000

Tank Partners Holdings, LLC^(5)(8)(14) Aerospace and Defense	Warrants		1.3	%		185,205		1,000

TRSO II, Inc.^(5)(8)(14) Energy: Oil & Gas	Common Stock		5.4	%		1,680,158		1,354,924

New Millennium Holdco, Inc. (Millennium Health, LLC)^(5)(8)(14) Healthcare & Pharmaceuticals	Common		0.2	%		1,953,299		1,000

Total Investment in Equity Securities (2% of net asset value at fair value)					$	10,389,007	$	4,450,177

See accompanying notes to consolidated financial statements.

CLO Fund Securities

CLO Subordinated Investments
Portfolio Company	Investment⁽¹¹⁾	Percentage Ownership			Amortized Cost		Fair Value
Grant Grove CLO, Ltd.^(3)(12)(14)	Subordinated Securities, effective interest N/M, 1/21 maturity		22.2	%	$	2,485,886	$	1,000
Katonah III, Ltd.^(3)(12)(14)	Subordinated Securities, effective interest N/M, 5/15 maturity		23.1	%		1,287,155		369,000
Katonah 2007-I CLO Ltd.^(3)(6)(14)	Subordinated Securities, effective interest 20.8%, 4/22 maturity		100.0	%		31,123,451		21,447,386
Trimaran CLO VII, Ltd.^{(3)(6)(13)(14)}	Subordinated Securities, effective interest N/M, 6/21 maturity		10.5	%		379,830		10,000
Catamaran CLO 2012-1 Ltd.^(3)(6)(14)	Subordinated Securities, effective interest 17.1%, 12/23 maturity		24.9	%		5,759,981		2,239,810
Catamaran CLO 2013- 1 Ltd.^(3)(6)(14)	Subordinated Securities, effective interest 14.1%, 1/25 maturity		23.5	%		4,786,050		3,806,100
Catamaran CLO 2014-1 Ltd.^(3)(6)(14)	Subordinated Securities, effective interest 10.2%, 4/26 maturity		32.4	%		8,681,740		4,847,620
Dryden 30 Senior Loan Fund^(3)(14)	Subordinated Securities, effective interest 31.0%, 11/25 maturity		7.5	%		1,276,135		1,499,682
Catamaran CLO 2014-2 Ltd.^(3)(6)(14)	Subordinated Securities, effective interest 12.8%, 10/26 maturity		24.9	%		6,699,877		4,484,009
Catamaran CLO 2015-1 Ltd.^(3)(6)(14)	Subordinated Securities, effective interest 9.2%, 4/27 maturity		9.9	%		4,416,694		3,033,719
Catamaran CLO 2016-1 Ltd.^(3)(6)(14)	Subordinated Securities, effective interest 6.8%, 1/29 maturity		24.9	%		10,196,554		8,585,018

Total Investment in CLO Subordinated Securities					$	77,093,353	$	50,323,344

CLO Rated-Note Investment
Portfolio Company	Investment	Percentage Ownership			Amortized Cost		Fair Value
Catamaran CLO 2014-1 Ltd.^(3)(6)(14)	Float - 04/2026 - E - 14889FAC7, Par Value of $1,525,000, 7.1% cash, 4/26 maturity		15.1	%		1,451,386		1,520,000

Total Investment in CLO Rated-Note					$	1,451,386	$	1,520,000

Total Investment in CLO Fund Securities (28% of net asset value at fair value)					$	78,544,739	$	51,843,344

See accompanying notes to consolidated financial statements.

Asset Manager Affiliates
Portfolio Company / Principal Business	Investment	Percentage Ownership			Cost		Fair Value²
Asset Manager Affiliates^(8)(9)(14)	Asset Management Company		100	%	$	53,341,230	$	39,679,000

Total Investment in Asset Manager Affiliates (21% of net asset value at fair value)					$	53,341,230	$	39,679,000

Joint Ventures

Portfolio Company / Principal Business	Investment	Percentage Ownership			Cost		Fair Value
KCAP Freedom 3 LLC⁽¹⁴⁾	Joint Venture		60	%	$	36,738,873	$	36,591,122

Total Investment in Joint Ventures (20% of net asset value at fair value)					$	36,738,873	$	36,591,122

Short-term Investments

Short-term Investments	Investment	Yield			Par /Amortized Cost		Fair Value²
JP Morgan Business Money Market Account⁽⁷⁾⁽⁸⁾	Money Market Account		0.10	%	$	14,269	$	14,269

US Bank Money Market Account⁽⁷⁾⁽⁸⁾	Money Market Account		0.10	%		32,001,559		32,001,559
U.S Treasury Bills⁽⁸⁾	U.S Treasury Bills, 912796LY3,10/19/17 maturity		0.883	%		15,007,000		15,007,000
U.S Treasury Bills⁽⁸⁾	U.S Treasury Bills, 912796KR9, 10/12/17 maturity		0.801	%		10,002,000		10,002,000

Total Short-term Investments (31% of net asset value at fair value)					$	57,024,828	$	57,024,828
Total Investments⁴					$	370,069,689	$	316,615,300

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, 2017. As noted in the table above, 83% (based on par) of debt securities contain LIBOR floors which range between 1.00% and 3.0%.

²	Reflects the fair market value of all investments as of September 30, 2017, 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 $377 million. The aggregate gross unrealized appreciation is approximately $0.9 million, the aggregate gross unrealized depreciation is approximately $61.2 million, and the net unrealized depreciation is approximately $60.3 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	Money market account holding cash.

See accompanying notes to consolidated financial statements.

⁸	Qualified asset for purposes of section 55(a) of the Investment Company Act of 1940.

⁹	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.

¹⁰	Non-voting.

¹¹	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.

¹²	Notice of redemption has been received for this security.

¹³	Loan or security was on partial nonaccrual status, whereby we have recognized income on a portion of contractual PIK amounts due.

¹⁴	Fair value of this investment was determined using significant unobservable inputs.

¹⁵	Loan or debt security is on non-accrual status and is therefore considered non-income producing.

See accompanying notes to consolidated financial statements.

KCAP FINANCIAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS
As of December 31, 2016

Debt Securities Portfolio

Portfolio Company/Principal Business	Investment Interest Rate⁽¹⁾/Maturity	Principal		Amortized Cost		Fair Value⁽²⁾
1A Smart Start LLC^{(8), (9)} Consumer goods: Non-durable	Senior Secured Loan — Initial Term Loan (First Lien) 5.8% Cash, 1.0% Libor Floor, Due 2/22	$	2,970,000	$	2,946,408	$	2,919,807
4L Technologies Inc. (fka Clover Holdings, Inc.)^{(8), (9)} Consumer goods: Non-durable	Senior Secured Loan — Term Loan 5.5% Cash, 1.0% Libor Floor, Due 5/20		2,720,465		2,705,259		2,606,194
Advanced Lighting Technologies, Inc,^{(8), (9), (14)} Consumer goods: Durable	First Lien Bond — 12.500% – 6/2019 — 00753CAG7 5.3% Cash, 7.3% PIK, Due 6/19		3,060,919		3,060,919		1,089,338
Advantage Sales & Marketing Inc.⁽⁸⁾ Services: Business	Junior Secured Loan — Term Loan (Second Lien) 7.5% Cash, 1.0% Libor Floor, Due 7/22		1,000,000		1,001,753		995,300
Alere Inc. (fka IM US Holdings, LLC)⁽⁹⁾ Healthcare & Pharmaceuticals	Senior Secured Loan — B Term Loan 4.3% Cash, 1.0% Libor Floor, Due 6/22		3,030,277		3,024,429		3,034,489
American Seafoods Group LLC^{(8), (9)} Beverage, Food and Tobacco	Senior Secured Loan — Term Loan (First Lien) 6.0% Cash, 1.0% Libor Floor, Due 8/21		3,853,704		3,838,792		3,874,899
Anaren, Inc.^{(8), (9)} Aerospace and Defense	Senior Secured Loan — Term Loan (First Lien) 5.5% Cash, 1.0% Libor Floor, Due 2/21		1,871,912		1,860,822		1,864,237
Apco Holdings, Inc.^{(8), (9)} Services: Business	Senior Secured Loan — Initial Term Loan 7.0% Cash, 1.0% Libor Floor, Due 1/22		3,867,838		3,769,454		3,900,714
API Technologies Corp.^{(8), (9)} High Tech Industries	Senior Secured Loan — Initial Term Loan 7.5% Cash, 1.0% Libor Floor, Due 4/22		3,482,500		3,420,642		3,480,759
Aristotle Corporation, The^{(8), (9)} Consumer goods: Non-durable	Senior Secured Loan — Term Loan 5.5% Cash, 1.0% Libor Floor, Due 6/21		3,665,860		3,652,075		3,604,274
Asurion, LLC (fka Asurion Corporation)^{(8), (9)} Banking, Finance, Insurance & Real Estate	Senior Secured Loan — Incremental Tranche B-4 Term Loan 5.0% Cash, 1.0% Libor Floor, Due 8/22		876,911		873,399		889,736
Asurion, LLC (fka Asurion Corporation)^{(8), (9)} Banking, Finance, Insurance & Real Estate	Senior Secured Loan — Replacement B-2 Term Loan 4.0% Cash, 0.8% Libor Floor, Due 7/20		187,812		188,275		189,719
Avalign Technologies, Inc.⁽⁸⁾ Healthcare & Pharmaceuticals	Junior Secured Loan — Initial Term Loan (Second Lien) 9.5% Cash, 1.0% Libor Floor, Due 7/22		1,000,000		992,078		985,000
Avalign Technologies, Inc.^{(8), (9)} Healthcare & Pharmaceuticals	Senior Secured Loan — Initial Term Loan (First Lien) 5.5% Cash, 1.0% Libor Floor, Due 7/21		2,925,000		2,913,921		2,915,640
Bankruptcy Management Solutions, Inc.⁽⁸⁾ Services: Business	Senior Secured Loan — Term B Loan 7.0% Cash, 1.0% Libor Floor, Due 6/18		665,654		665,654		655,935
BarBri, Inc. (Gemini Holdings, Inc.)^{(8), (9)} Services: Consumer	Senior Secured Loan — Term Loan 4.5% Cash, 1.0% Libor Floor, Due 7/19		2,619,636		2,614,056		2,578,508
BBB Industries US Holdings, Inc.^{(8), (9)} Automotive	Senior Secured Loan — Initial Term Loan (First Lien) 6.0% Cash, 1.0% Libor Floor, Due 11/21		2,947,500		2,906,715		2,800,125
Bestop, Inc.^{(8), (9)} Automotive	Senior Secured Loan — Delayed Draw Term Loan 6.3% Cash, 1.0% Libor Floor, Due 7/21		34,660		32,776		34,466
Bestop, Inc.^{(8), (9)} Automotive	Senior Secured Loan — First Amendment Term Loan 6.3% Cash, 1.0% Libor Floor, Due 7/21		500,000		495,290		497,200

See accompanying notes to financial statements.

Portfolio Company/Principal Business	Investment Interest Rate⁽¹⁾/Maturity	Principal		Amortized Cost		Fair Value⁽²⁾
Bestop, Inc.^{(8), (9)} Automotive	Senior Secured Loan — Term Loan 6.3% Cash, 1.0% Libor Floor, Due 7/21	$	1,520,000	$	1,498,330	$	1,452,512
Carolina Beverage Group LLC⁽⁸⁾ Beverage, Food and Tobacco	Senior Secured Bond — 10.625% – 08/2018 – 143818AA0 144A 10.6% Cash, Due 8/18		1,500,000		1,506,461		1,487,400
CCS Intermediate Holdings, LLC^{(8), (9)} Healthcare & Pharmaceuticals	Senior Secured Loan — Initial Term Loan (First Lien) 5.0% Cash, 1.0% Libor Floor, Due 7/21		2,932,500		2,922,875		2,470,338
Cengage Learning, Inc.^{(8), (9)} Media: Advertising, Printing & Publishing	Senior Secured Loan — 2016 Refinancing Term Loan 5.3% Cash, 1.0% Libor Floor, Due 6/23		3,793,913		3,788,981		3,702,043
Checkout Holding Corp. (fka Catalina Marketing)^{(8), (9)} Media: Advertising, Printing & Publishing	Senior Secured Loan — Term B Loan (First Lien) 4.5% Cash, 1.0% Libor Floor, Due 4/21		975,000		972,021		853,125
CHS/Community Health Systems, Inc.⁽⁹⁾ Healthcare & Pharmaceuticals	Senior Secured Loan — Incremental 2021 Term H Loan 4.0% Cash, 1.0% Libor Floor, Due 1/21		2,878,621		2,853,070		2,796,465
Consolidated Communications, Inc.⁽⁹⁾ Telecommunications	Senior Secured Loan — Initial Term Loan 4.0% Cash, 1.0% Libor Floor, Due 10/23		2,067,444		2,062,450		2,067,444
CRGT Inc.^{(8), (9)} High Tech Industries	Senior Secured Loan — Term Loan 7.5% Cash, 1.0% Libor Floor, Due 12/20		3,224,017		3,190,360		3,224,339
CSM Bakery Solutions Limited (fka CSM Bakery Supplies Limited)⁽⁸⁾ Beverage, Food and Tobacco	Junior Secured Loan — Term Loan (Second Lien) 8.8% Cash, 1.0% Libor Floor, Due 7/21		3,000,000		3,011,328		2,463,000
CT Technologies Intermediate Holdings, Inc. (Smart Holdings Corp.) (aka HealthPort)^{(8), (9)} Healthcare & Pharmaceuticals	Senior Secured Loan — New Term Loan Facility 5.3% Cash, 1.0% Libor Floor, Due 12/21		2,940,225		2,917,719		2,818,941
Drew Marine Group Inc.⁽⁸⁾ Transportation: Cargo	Junior Secured Loan — Term Loan (Second Lien) 8.0% Cash, 1.0% Libor Floor, Due 5/21		2,500,000		2,496,331		2,380,000
Eastern Power, LLC (Eastern Covert Midco, LLC) (aka TPF II LC, LLC)^{(8), (9)} Utilities: Electric	Senior Secured Loan — Term Loan 5.0% Cash, 1.0% Libor Floor, Due 10/21		2,796,756		2,814,422		2,826,122
Electric Lightwave Holdings, Inc. (f.k.a. Integra Telecom Holdings, Inc.)^{(8), (9)} Telecommunications	Senior Secured Loan — Term B-1 Loan 5.3% Cash, 1.0% Libor Floor, Due 8/20		2,932,538		2,924,968		2,945,734
ELO Touch Solutions, Inc.^{(8), (9)} High Tech Industries	Senior Secured Loan — Term Loan (First Lien) 8.5% Cash, 1.5% Libor Floor, Due 6/18		1,420,897		1,397,046		1,380,544
Empower Payments Acquisition, Inc^{(8), (9)} Services: Business	Senior Secured Loan — Term Loan 6.5% Cash, 1.0% Libor Floor, Due 11/23		3,000,000		2,940,565		2,940,000
EWT Holdings III Corp. (fka WTG Holdings III Corp.)^{(8), (9)} Ecological	Senior Secured Loan — Term Loan (First Lien) 4.8% Cash, 1.0% Libor Floor, Due 1/21		1,745,501		1,741,292		1,760,783
Fender Musical Instruments Corporation^{(8), (9)} Consumer goods: Durable	Senior Secured Loan — Initial Loan 5.8% Cash, 1.3% Libor Floor, Due 4/19		1,339,534		1,345,751		1,322,254
FHC Health Systems, Inc.^{(8), (9)} Healthcare & Pharmaceuticals	Senior Secured Loan — Initial Term Loan 5.0% Cash, 1.0% Libor Floor, Due 12/21		3,838,768		3,811,221		3,742,799
First American Payment Systems, L.P.⁽⁸⁾ Banking, Finance, Insurance & Real Estate	Junior Secured Loan — Term Loan (Second Lien) 10.8% Cash, 1.3% Libor Floor, Due 4/19		1,796,448		1,783,840		1,742,555
Getty Images, Inc.^{(8), (9)} Media: Advertising, Printing & Publishing	Senior Secured Loan — Initial Term Loan 4.8% Cash, 1.3% Libor Floor, Due 10/19		2,140,569		2,147,692		1,874,775
GI Advo Opco, LLC⁽⁸⁾ Healthcare & Pharmaceuticals	Senior Secured Loan — Term Loan 5.5% Cash, 1.0% Libor Floor, Due 11/21		247,500		245,474		223,913

See accompanying notes to financial statements.

Portfolio Company/Principal Business	Investment Interest Rate⁽¹⁾/Maturity	Principal		Amortized Cost		Fair Value⁽²⁾
GI Advo Opco, LLC^{(8), (9)} Healthcare & Pharmaceuticals	Senior Secured Loan — Term Loan 5.5% Cash, 1.0% Libor Floor, Due 11/21	$	2,722,500	$	2,700,224	$	2,463,046
GK Holdings, Inc. (aka Global Knowledge)⁽⁸⁾ Services: Business	Junior Secured Loan — Initial Term Loan (Second Lien) 10.5% Cash, 1.0% Libor Floor, Due 1/22		1,500,000		1,478,209		1,465,650
GK Holdings, Inc. (aka Global Knowledge)^{(8), (9)} Services: Business	Senior Secured Loan — Initial Term Loan (First Lien) 6.5% Cash, 1.0% Libor Floor, Due 1/21		2,450,000		2,433,329		2,446,080
Global TelLink Corporation⁽⁸⁾ Telecommunications*	Junior Secured Loan — Term Loan (Second Lien) 9.0% Cash, 1.3% Libor Floor, Due 11/20		4,000,000		3,957,505		3,894,500
Gold Standard Baking, Inc.^{(8), (9)} Beverage, Food and Tobacco	Senior Secured Loan — Term Loan 5.3% Cash, 1.0% Libor Floor, Due 4/21		2,462,500		2,453,554		2,461,269
Grande Communications Networks LLC^{(8), (9)} Telecommunications	Senior Secured Loan — Initial Term Loan 4.5% Cash, 1.0% Libor Floor, Due 5/20		3,860,145		3,864,877		3,860,145
Grupo HIMA San Pablo, Inc.⁽⁸⁾ Healthcare & Pharmaceuticals	Senior Secured Loan — Term B Loan (First Lien) 8.5% Cash, 1.5% Libor Floor, Due 1/18		2,887,500		2,875,001		2,743,125
Grupo HIMA San Pablo, Inc.⁽⁸⁾ Healthcare & Pharmaceuticals	Junior Secured Loan — Term Loan (Second Lien) 13.8% Cash, Due 7/18		7,000,000		6,953,618		6,370,000
Gymboree Corporation., The^{(8), (9)} Retail	Senior Secured Loan — Term Loan 5.0% Cash, 1.5% Libor Floor, Due 2/18		1,421,105		1,415,457		759,581
Hargray Communications Group, Inc. (HCP Acquisition LLC)^{(8), (9)} Media: Broadcasting & Subscription	Senior Secured Loan — Term B-1 Loan 4.8% Cash, 1.0% Libor Floor, Due 6/19		2,887,075		2,860,733		2,926,166
Harland Clarke Holdings Corp. (fka Clarke American Corp.)^{(8), (9)} Media: Advertising, Printing & Publishing	Senior Secured Loan — Tranche B-3 Term Loan 7.0% Cash, 1.5% Libor Floor, Due 5/18		1,697,272		1,690,708		1,703,637
Harland Clarke Holdings Corp. (fka Clarke American Corp.)^{(8), (9)} Media: Advertising, Printing & Publishing	Senior Secured Loan — Tranche B-4 Term Loan 7.0% Cash, 1.0% Libor Floor, Due 8/19		1,387,500		1,384,229		1,391,545
Harland Clarke Holdings Corp. (fka Clarke American Corp.)^{(8), (9)} Media: Advertising, Printing & Publishing	Senior Secured Loan — Tranche B-5 Term Loan 7.0% Cash, 1.0% Libor Floor, Due 12/19		1,385,417		1,369,287		1,395,980
Highland Acquisition Holdings, LLC (aka HealthSun Health Plans, Inc.)^{(8), (9)} Healthcare & Pharmaceuticals	Senior Secured Loan — Term Loan B 6.5% Cash, 1.0% Libor Floor, Due 11/22		2,000,000		1,903,216		1,910,000
Hoffmaster Group, Inc.⁽⁸⁾ Forest Products & Paper	Junior Secured Loan — Initial Term Loan (Second Lien) 10.5% Cash, 1.0% Libor Floor, Due 11/24		1,600,000		1,552,544		1,524,640
Hoffmaster Group, Inc.^{(8), (9)} Forest Products & Paper	Senior Secured Loan — Initial Term Loan (First Lien) 5.5% Cash, 1.0% Libor Floor, Due 11/23		2,666,667		2,640,345		2,668,267
Industrial Services Acquisition, LLC (aka Evergreen/NAIC)^{(8), (9)} Environmental Industries	Senior Secured Loan — Term Loan 6.0% Cash, 1.0% Libor Floor, Due 6/22		2,925,000		2,898,235		2,925,000
Kellermeyer Bergensons Services, LLC^{(8), (9)} Services: Business	Senior Secured Loan — Initial Term Loan (First Lien) 6.0% Cash, 1.0% Libor Floor, Due 10/21		1,950,120		1,936,641		1,943,100
Key Safety Systems, Inc.^{(8), (9)} Automotive	Senior Secured Loan — Initial Term Loan 5.5% Cash, 1.0% Libor Floor, Due 8/21		1,394,077		1,389,440		1,411,851
Landslide Holdings, Inc.^{(8), (9)} High Tech Industries	Senior Secured Loan — Term Loan (First Lien) 5.5% Cash, 1.0% Libor Floor, Due 9/22		1,850,467		1,846,044		1,850,467
MB Aerospace ACP Holdings II Corp.^{(8), (9)} Aerospace and Defense	Senior Secured Loan — Initial Term Loan 6.5% Cash, 1.0% Libor Floor, Due 12/22		1,342,500		1,331,454		1,342,366

See accompanying notes to financial statements.

Portfolio Company/Principal Business	Investment Interest Rate⁽¹⁾/Maturity	Principal		Amortized Cost		Fair Value⁽²⁾
Medrisk, Inc.^{(8), (9)} Healthcare & Pharmaceuticals	Senior Secured Loan — Term Loan 6.3% Cash, 1.0% Libor Floor, Due 2/23	$	1,985,000	$	1,967,461	$	1,985,000
MGOC, Inc. (fka Media General, Inc.)⁽⁹⁾ Media: Broadcasting & Subscription	Senior Secured Loan — Term B Loan 4.0% Cash, 1.0% Libor Floor, Due 7/20		2,417,989		2,419,940		2,417,989
National Home Health Care Corp.⁽⁸⁾ Healthcare & Pharmaceuticals	Junior Secured Loan — Term Loan (Second Lien) 11.8% Cash, 1.0% Libor Floor, Due 12/22		1,500,000		1,477,675		1,477,500
National Home Health Care Corp.^{(8), (9)} Healthcare & Pharmaceuticals	Senior Secured Loan — Term Loan (First Lien) 5.5% Cash, 1.0% Libor Floor, Due 12/21		3,000,000		2,970,280		2,970,000
Nellson Nutraceutical, LLC^{(8), (9)} Beverage, Food and Tobacco	Senior Secured Loan — Term A-1 Loan (First Lien) 6.0% Cash, 1.0% Libor Floor, Due 12/21		2,350,684		2,335,796		2,350,449
Nellson Nutraceutical, LLC^{(8), (9)} Beverage, Food and Tobacco	Senior Secured Loan — Term A-2 Loan (First Lien) 6.0% Cash, 1.0% Libor Floor, Due 12/21		2,066,562		2,052,899		2,066,355
Nielsen & Bainbridge, LLC^{(8), (9)} Consumer goods: Durable	Senior Secured Loan — Term Loan (First Lien) 6.2% Cash, 1.0% Libor Floor, Due 8/20		5,361,360		5,326,136		5,199,447
NM Z Parent Inc. (aka Zep, Inc.)^{(8), (9)} Chemicals, Plastics and Rubber	Senior Secured Loan — 2016 Term Loan 5.0% Cash, 1.0% Libor Floor, Due 6/22		3,447,500		3,459,466		3,481,630
Novitex Acquisition, LLC (fka ARSloane Acquisition, LLC)^{(8), (9)} Services: Business	Senior Secured Loan — Tranche B-2 Term Loan (First Lien) 8.0% Cash, 1.3% Libor Floor, Due 7/20		1,941,336		1,899,875		1,882,707
Onex Carestream Finance LP⁽⁸⁾ 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		1,647,295
Onex Carestream Finance LP^{(8), (9)} Healthcare & Pharmaceuticals	Senior Secured Loan — Term Loan (First Lien 2013) 5.0% Cash, 1.0% Libor Floor, Due 6/19		1,750,135		1,753,387		1,704,920
Otter Products, LLC (OtterBox Holdings, Inc.)^{(8), (9)} Consumer goods: Durable	Senior Secured Loan — Term B Loan 5.8% Cash, 1.0% Libor Floor, Due 6/20		2,600,266		2,587,099		2,507,697
PGX Holdings, Inc.^{(8), (9)} Services: Consumer	Senior Secured Loan — Initial Term Loan (First Lien) 6.3% Cash, 1.0% Libor Floor, Due 9/20		3,620,714		3,598,052		3,626,381
Playpower, Inc.^{(8), (9)} Construction & Building	Senior Secured Loan — Initial Term Loan (First Lien) 5.8% Cash, 1.0% Libor Floor, Due 6/21		1,970,000		1,958,956		1,969,606
PrimeLine Utility Services LLC (fka FR Utility Services LLC)^{(8), (9)} Energy: Electricity	Senior Secured Loan — Initial Term Loan 6.5% Cash, 1.0% Libor Floor, Due 11/22		3,935,672		3,904,453		3,937,247
Priority Payment Systems Holdings, LLC^{(8), (9)} Banking, Finance, Insurance & Real Estate	Senior Secured Loan — Initial Term Loan 7.0% Cash, 1.0% Libor Floor, Due 1/23		4,000,000		3,960,000		3,960,000
PSC Industrial Holdings Corp.^{(8), (9)} Environmental Industries	Senior Secured Loan — Term Loan (First Lien) 5.8% Cash, 1.0% Libor Floor, Due 12/20		2,974,300		2,953,559		2,941,583
Q Holding Company (fka Lexington Precision Corporation)^{(8), (9)} Chemicals, Plastics and Rubber	Senior Secured Loan — Term B Loan 6.0% Cash, 1.0% Libor Floor, Due 12/21		2,992,366		2,962,443		2,962,443
Quad-C JH Holdings Inc. (aka Joerns Healthcare)^{(8), (9)} Healthcare & Pharmaceuticals	Senior Secured Loan — Term Loan A 6.0% Cash, 1.0% Libor Floor, Due 5/20		3,900,079		3,883,565		3,666,075
Ravn Air Group, Inc.^{(8), (9)} Transportation: Consumer	Senior Secured Loan — Initial Term Loan 5.3% Cash, 1.0% Libor Floor, Due 7/21		2,421,875		2,412,614		2,324,516
Roscoe Medical, Inc.⁽⁸⁾ Healthcare & Pharmaceuticals	Junior Secured Loan — Term Loan (Second Lien) 11.3% Cash, Due 9/19		6,700,000		6,666,733		6,499,000
Sandy Creek Energy Associates, L.P.^{(8), (9)} Utilities: Electric	Senior Secured Loan — Term Loan 5.0% Cash, 1.0% Libor Floor, Due 11/20		2,613,239		2,606,016		2,204,921
Stafford Logistics, Inc.(dba Custom Ecology, Inc.)^{(8), (9)} Environmental Industries	Senior Secured Loan — Term Loan 7.5% Cash, 1.0% Libor Floor, Due 8/21	$	2,709,639	$	2,694,201	$	2,677,395

See accompanying notes to financial statements.

Portfolio Company/Principal Business	Investment Interest Rate⁽¹⁾/Maturity	Principal		Amortized Cost		Fair Value⁽²⁾
Tank Partners Holdings, LLC^{(8), (14)} Energy: Oil & Gas	Senior Secured Loan — Loan 10.0% Cash, 4.0% PIK, 3.0% Libor Floor, Due 8/19		10,750,808		10,656,975		6,550,311
Terra Millennium Corporation^{(8), (9)} Construction & Building	Senior Secured Loan — First Out Term Loan 7.3% Cash, 1.0% Libor Floor, Due 10/22		4,000,000		3,960,202		3,960,000
TronAir Parent Inc.^{(8), (9)} Aerospace and Defense	Senior Secured Loan — Initial Term Loan (First Lien) 5.8% Cash, 1.0% Libor Floor, Due 9/23		3,960,000		3,923,893		3,959,208
TRSO I, Inc.⁽⁸⁾ Energy: Oil & Gas	Junior Secured Loan — Term Loan (Second Lien) 14.0% Cash, 1.0% Libor Floor, Due 12/19		1,000,000		991,495		1,000,000
U.S. Shipping Corp (fka U.S. Shipping Partners LP)^{(8), (9)} Transportation: Cargo	Senior Secured Loan — Tranche B-2 Term Loan 5.3% Cash, 1.0% Libor Floor, Due 6/21		1,392,213		1,391,361		1,312,857
USJ-IMECO Holding Company, LLC^{(8), (9)} Transportation: Cargo	Senior Secured Loan — Term Loan 7.0% Cash, 1.0% Libor Floor, Due 4/20		3,679,796		3,669,622		3,497,278
Verdesian Life Sciences, LLC^{(8), (9)} Environmental Industries	Senior Secured Loan — Initial Term Loan 6.0% Cash, 1.0% Libor Floor, Due 7/20		3,766,302		3,733,929		3,641,261
Weiman Products, LLC⁽⁸⁾ Consumer goods: Non-durable	Senior Secured Loan — Term Loan 5.8% Cash, 1.0% Libor Floor, Due 11/18		916,023		912,479		889,000
Weiman Products, LLC^{(8), (9)} Consumer goods: Non-durable	Senior Secured Loan — Term Loan 5.8% Cash, 1.0% Libor Floor, Due 11/18		4,567,552		4,550,168		4,432,809
WideOpenWest Finance, LLC^{(8), (9)} Media: Broadcasting & Subscription	Senior Secured Loan — New Term B Loan 4.5% Cash, 1.0% Libor Floor, Due 8/23		2,992,500		2,992,500		3,028,829
WireCo WorldGroup Inc.⁽⁸⁾ Capital Equipment	Junior Secured Loan — Initial Term Loan (Second Lien) 10.0% Cash, 1.0% Libor Floor, Due 9/24		3,000,000		2,956,358		3,000,000
WireCo WorldGroup Inc. (WireCo WorldGroup Finance LP)^{(8), (9)} Capital Equipment	Senior Secured Loan — Initial Term Loan (First Lien) 6.5% Cash, 1.0% Libor Floor, Due 9/23		1,745,625		1,728,771		1,763,780
Total Investment in Debt Securities (122% of net asset value at fair value)		$	251,222,570	$	249,520,234	$	238,343,330

See accompanying notes to financial statements.

Equity Securities Portfolio

Portfolio Company/Principal Business	Investment	Percentage Interest/Shares			Amortized Cost		Fair Value⁽²⁾
Aerostructures Holdings L.P.^{(5), (8)} Aerospace and Defense	Partnership Interests		1.2	%	$	1,000,000	$	100,549
Aerostructures Holdings L.P.^{(5), (8)} Aerospace and Defense	Series A Preferred Interests		1.2	%		250,960		1,183,746
Caribe Media Inc. (fka Caribe Information Investments Incorporated)^{(5), (8)} Media: Advertising, Printing & Publishing	Common		1.3	%		359,765		532,342
DBI Holding LLC^{(5), (8)} Services: Business	Class A Warrants		3.2	%		1		1,000
eInstruction Acquisition, LLC^{(5), (8)} Healthcare, Education and Childcare	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		811,268
Perseus Holding Corp.^{(5), (8)} Hotel, Gaming & Leisure	Common		0.2	%		400,000		1,000
Roscoe Investors, LLC^{(5), (8)} Healthcare & Pharmaceuticals	Class A Units		1.6	%		1,000,000		1,169,000
Tank Partners Holdings, LLC^{(5), (8), (11)} Energy: Oil & Gas	Unit		5.8	%		980,000		1,000
Tank Partners Holdings, LLC^{(5), (8)} Energy: Oil & Gas	Warrants		1.3	%		185,205		1,000
TRSO II, Inc.^{(5), (8)} Energy: Oil & Gas	Common Stock		5.4	%		1,680,161		1,253,450
New Millennium Holdco, Inc. (Millennium Health, LLC)⁽⁵⁾,⁽⁸⁾ Healthcare & Pharmaceuticals	Common		0.2	%		1,953,299		1,000
Total Investment in Equity Securities (3% of net asset value at fair value)					$	10,389,007	$	5,056,355

See accompanying notes to financial statements.

CLO Fund Securities

CLO Subordinated Securities, Preferred Shares and Income Notes Investments

Portfolio Company	Investment⁽¹²⁾	Percentage Ownership			Amortized Cost		Fair Value⁽²⁾
Grant Grove CLO, Ltd.^{(3), (13)}	Subordinated Securities, effective interest 0.1%, 1/21 maturity		22.2	%	$	2,485,886	$	1,000
Katonah III, Ltd.^{(3), (13)}	Preferred Shares, effective interest 0.1%, 5/15 maturity		23.1	%		1,287,155		369,000
Katonah 2007-I CLO Ltd.^{(3), (6)}	Preferred Shares, effective interest 30.8%, 4/22 maturity		100	%		28,022,646		20,453,099
Trimaran CLO VII, Ltd.^{(3), (6), (13)}	Income Notes, effective interest 47.9%, 6/21 maturity		10.5	%		1,643,920		1,195,152
Catamaran CLO 2012-1 Ltd.^{(3), (6)}	Subordinated Notes, effective interest 3.1%, 12/23 maturity		24.9	%		5,919,933		2,819,412
Catamaran CLO 2013- 1 Ltd.^{(3), (6)}	Subordinated Notes, effective interest 14.9%, 1/25 maturity		23.5	%		5,237,222		4,918,807
Catamaran CLO 2014-1 Ltd.^{(3), (6)}	Subordinated Notes, effective interest 10.0%, 4/26 maturity		24.9	%		7,818,484		4,546,682
Catamaran CLO 2014-2 Ltd.^{(3), (6)}	Subordinated Notes, effective interest 10.9%, 10/26 maturity		24.9	%		6,967,560		5,092,087
Dryden 30 Senior Loan Fund⁽³⁾	Subordinated Notes, effective interest 36.2%, 11/25 maturity		7.5	%		1,343,467		1,895,566
Catamaran CLO 2015-1 Ltd.^{(3), (6)}	Subordinated Notes, effective interest 9.5%, 4/27 maturity		9.9	%		4,543,317		3,223,255
Catamaran CLO 2016-1 Ltd.^{(3), (6)}	Subordinated Notes, effective interest 13.9%, 1/29 maturity		24.9	%		10,140,000		8,350,290
Total Investment in CLO Subordinated Securities					$	75,409,590	$	52,864,350

CLO Rated-Note Investments

Portfolio Company	Investment	Percentage Ownership			Amortized Cost		Fair Value⁽²⁾
CRMN 2014 – 1A^{(3), (6)}	Float – 04/2026 – E – 14889FAC7, 6.6%, 4/26 maturity		15.1	%	$	1,441,727	$	1,310,000
Total Investment in CLO Rated-Note					$	1,441,727	$	1,310,000
Total Investment in CLO Fund Securities (28% of net asset value at fair value)					$	76,851,317	$	54,174,350

Asset Manager Affiliates

Portfolio Company/Principal Business	Investment	Percentage Ownership			Cost		Fair Value⁽²⁾
Asset Manager Affiliates^{(8), (10)}	Asset Management Company		100	%	$	55,341,230	$	40,198,000
Total Investment in Asset Manager Affiliates (21% of net asset value at fair value)					$	55,341,230	$	40,198,000

See accompanying notes to financial statements.

Time Deposits and Money Market Account

Time Deposit and Money Market Accounts	Investment	Yield			Par/Amortized Cost		Fair Value⁽²⁾
JP Morgan Business Money Market Account^{(7), (8)}	Money Market Account		0.1	%	$	14,268	$	14,268
US Bank Money Market Account⁽⁸⁾	Money Market Account		0.1	%		28,685,001		28,685,001
Total Investment in Time Deposit and Money Market Accounts (15% of net asset value at fair value)					$	28,699,269	$	28,699,269
Total Investments⁽⁴⁾ (188% of net asset value at fair value)					$	420,801,057	$	366,471,304

(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 December 31, 2016. As noted in the table above, 93% (based on par) of debt securities contain LIBOR floors which range between 0.75% and 3.0%.

(2)

Reflects the fair market value of all investments as of December 31, 2016, 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 $429 million. The aggregate gross unrealized appreciation is approximately $2.1 million, the aggregate gross unrealized depreciation is approximately $65.0 million, and the net unrealized depreciation is approximately $62.9 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 financial statements).

(7)

Money market account holding restricted cash and security deposits for employee benefit plans.

(8)

Qualified asset for purposes of section 55(a) of the Investment Company Act of 1940.

(9)

As of December 31, 2016, this investment is owned by KCAP Senior Funding I, LLC and was pledged to secure KCAP Senior Funding I, LLC’s obligation.

(10)

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.

(11)

Non-voting.

(12)

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.

(13)

Notice of redemption has been received for this transaction.

(14)

Loan or security was on partial non-accrual status, whereby we have recognized income on a portion of contractual PIK amounts due.

See accompanying notes to financial statements.

KCAP FINANCIAL, INC.

CONSOLIDATED FINANCIAL HIGHLIGHTS

(unaudited)

	Nine Months Ended September 30,
	2017			2016

Per Share Data:
Net asset value, at beginning of period	$	5.24		$	5.82
Net investment income¹		0.23			0.39
Net realized losses from investments¹		(0.08	)		(0.17	)
Realized losses from extinguishment of debt¹		(0.11	)		-
Net change in unrealized depreciation on investments¹		0.02			(0.25	)
Net decrease in net assets resulting from operations		0.06			(0.03	)
Stockholder Distributions		(0.36	)		(0.45	)
Net increase (decrease) in net assets relating to stock-based transactions:
Common stock withheld for payroll taxes upon vesting of restricted stock		(0.01	)		(0.01	)
Dividend reinvestment plan		0.01			0.01
Stock based compensation		-			0.04
Net increase (decrease) in net assets relating to stock-based transactions⁶		-			0.04

Net asset value, end of period	$	4.95		$	5.38
Total net asset value return²		1.3	%		0.2	%

Ratio/Supplemental Data:
Per share market value at beginning of period	$	3.98		$	4.07
Per share market value at end of period	$	3.65		$	4.63
Total market return³		0.7	%		24.8	%
Shares outstanding at end of period		37,317,815			37,160,770
Net assets at end of period	$	184,785,444		$	199,903,373
Portfolio turnover rate⁴		73.8	%		19.3	%
Average par debt outstanding	$	144,298,499		$	192,692,951
Asset coverage ratio		274	%		207	%
Ratio of net investment income to average net assets⁵		5.9	%		9.2	%
Ratio of total expenses to average net assets⁵		9.4	%		8.8	%
Ratio of interest expense to average net assets⁵		4.1	%		4.5	%
Ratio of non-interest expenses to average net assets⁵		5.3	%		4.3	%

Based on weighted average number of common shares outstanding-basic for the period.

Total net asset value return (not annualized) equals the change in the ending of period 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 of period net asset value per share.

Total market return equals the change in the ending of period market price per share over the beginning of period price per share plus distributions (including any return of capital), divided by the beginning of period market price per share.

⁴

Not annualized. Portfolio turnover rate equals the year-to-date sales and paydowns over the average of the invested assets at fair value.

⁵

Annualized

⁶

Totals may not sum due to rounding.

See accompanying notes to consolidated financial statements.

23



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

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

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

On February 14, 2013, the Company completed a public offering of 5,232,500 shares of common stock, which included the underwriters’ full exercise of their option to purchase up to 682,500 shares of common stock, at a price of $9.75 per share, raising approximately $51.0 million in gross proceeds. In conjunction with this offering, the Company also sold 200,000 shares of common stock to a member of its Board of Directors, at a price of $9.31125 per share, raising approximately $1.9 million in gross proceeds.

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

As of September 30, 2017, Katonah Debt Advisors and Trimaran Advisors, as well as affiliated management companies Katonah 2007-1 Management, L.L.C., Trimaran Advisors Management, L.L.C. and KCAP Management L.L.C., (collectively the “Asset Manager Affiliates”), had approximately $2.8 billion of par value assets under management. The Asset Manager Affiliates are each managed independently from KCAP by a separate management team (however, certain of the Company’s executive officers also act in similar capacities for one or both of the Asset Manager Affiliates). The Asset Manager Affiliates provide investment management services to CLO Funds, making day-to-day investment decisions concerning the assets of the CLO Funds. The Asset Manager Affiliates do not have any investments in the CLO Funds they manage; however, KCAP holds investments in a portion of the securities issued by the CLO Funds managed by the Asset Manager Affiliates.

During the third quarter of 2017, the Company formed a joint venture with Freedom 3 Opportunities LLC (“Freedom 3 Opportunities”), an affiliate of Freedom 3 Capital LLC, to create KCAP Freedom 3 LLC (the “Joint Venture”). The Company and Freedom 3 Opportunities LLC contributed approximately $37 million and $25 million, respectively, in assets to the Joint Venture, which in turn used the assets to capitalize a new fund (the "Fund") managed by KCAP Management, LLC, one of the Company's indirectly wholly-owned Asset Manager Affiliate subsidiaries. In addition, the Fund used cash on hand and borrowings under a credit facility to purchase approximately $184 million of loans from the Company and the Company used the proceeds from such sale to redeem approximately $147 million in debt issued by KCAP Senior Funding. The Joint Venture may originate loans from time to time and sell them to the Fund.

24



The Company has three principal areas of investment:

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

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

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

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

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

2. SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared on the accrual basis of accounting in conformity with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information. Accordingly, they do not include all of the information and footnotes required for annual consolidated financial statements. The unaudited interim consolidated financial statements and notes thereto should be read in conjunction with the financial statements and notes thereto in the Company’s Form 10-K for the year ended December 31, 2016, as filed with the U.S. Securities and Exchange Commission (the “Commission” or the “SEC”).

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

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

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

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

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On February 18, 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2015-2 (“ASU 2015-2”), which updated consolidation standards under ASC Topic 810, “Consolidation”. Under this update, a new consolidation analysis is required for variable interest entities (“VIEs”) and will limit the circumstances in which investment managers and similar entities are required to consolidate the entities that they manage. The FASB decided to eliminate some of the criteria under which their management fees are considered a variable interest and limit the circumstances in which variable interests in a VIE held by related parties of a reporting enterprise require the reporting enterprise to consolidate the VIE. The guidance is effective for public business entities for annual and interim periods in fiscal years beginning after December 15, 2015. The Asset Manager Affiliates adopted ASU 2015-2 in 2016 which resulted in the deconsolidation of the CLO Funds managed by them.

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

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

It is the Company’s primary investment objective to generate current income and capital appreciation by lending directly to privately-held middle market companies. During the nine months ended September 30, 2017, the Company provided approximately $17 million to portfolio companies to support their growth objectives, none of which was contractually obligated. See also Note 8 – Commitments and Contingencies. As of September 30, 2017, the Company held loans it made to 38 investee companies with aggregate principal amounts of $135 million. The details of such loans have been disclosed on the consolidated schedule of investments as well as in Note 4 – Investments. In addition to providing loans to investee companies, from time to time the Company assists investee companies in securing financing from other sources by introducing such investee companies to sponsors or by, among other things, leading a syndicate of lenders to provide the investee companies with financing. During the nine months ended September 30, 2017, the Company did not engage in any such or similar activities.

FASB issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers, which updated accounting guidance for all revenue recognition arising from contracts with customers, and also affects entities that enter into contracts to provide goods or services to their customers (unless the contracts are in the scope of other US GAAP requirements). This update provides a model for the measurement and recognition of gains and losses on the sale of certain nonfinancial assets, such as property and equipment, including real estate. The FASB also issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which deferred the effective date of the standard for one year. As a result, the guidance is effective for public business entities for annual and interim periods in fiscal years beginning after December 15, 2017. Management has concluded that the majority of its revenues associated with financial instruments are scoped out of ASC 606. Management is evaluating the impact of the standard on certain fees earned by the Company.

In March 2016, the FASB issued ASU 2016-09 Compensation — Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). The amendments in ASU 2016-09 affect all entities that issue share-based payment awards to their employees and involve multiple aspects of the accounting for share-based payment transactions, including income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. For public business entities, ASU 2016-09 is effective for annual periods beginning after December 15 2016, and interim periods within those annual periods. Early adoption is permitted. We adopted 2016-09 during the first quarter of 2017 and there was no impact from adoption.

In November 2016, the FASB issued Accounting Standards Update 2016-18, Restricted Cash (“ASU 2016-18”) which requires entities to show the changes in the total cash, cash equivalents, restricted cash and restricted cash equivalents in the statement of cash flows. The guidance is effective for fiscal years beginning after December 15, 2017, and interim periods within those years. Early adoption is permitted, and entities will be required to apply the guidance retrospectively when adopted. We have early adopted ASU 2016-18 retrospectively during the first quarter of 2017 and earlier periods were restated. The following table depicts the retroactive application of ASU 2016-18:

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Consolidated Statements of Cash Flows

Nine Months Ended
September 30, 2016

Net cash (used in) financing activities as reported $ (46,702,870 )

Impact of Adoption 3,771,347

Net cash (used in) financing activities after adoption $ (42,931,523 )

In March 2017, the Financial Accounting Standards Board issued an Accounting Standards Update, ASU 2017-08, Receivables— Nonrefundable Fees and Other Costs (Subtopic 310-20), Premium Amortization on Purchased Callable Debt Securities (“ASU-2017-08”) which amends the amortization period for certain purchased callable debt securities held at a premium, shortening such period to the earliest call date. ASU-2017-08 does not require any accounting change for debt securities held at a discount; the discount continues to be amortized to maturity. ASU-2017-08 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. At this time, management is evaluating the implications of these changes on the financial statements.

Investments

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

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

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

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

The Company utilizes an independent valuation firm to provide an annual third-party review of the Company’s CLO Securities fair value model relative to its functionality, model inputs and calculations as a reasonable method to determine fair values of CLO Securities, in the absence of Level I or Level II trading activity or observable market inputs. The independent valuation firm’s 2016 annual review concluded that the Company’s model appropriately factors in all the necessary inputs required to build an equity cash flow model for CLO Securities for fair value purposes and that the inputs were being employed correctly.

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

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

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

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

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

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

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

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

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

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

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

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

Joint Venture. The Company’s investment in KCAP Freedom 3 LLC (“Joint Venture”), is a joint venture with Freedom 3 Opportunities. The Company carries investments in joint ventures at fair value based upon the fair value of the investments held by the joint venture. See Note 4 below, for more information regarding the Joint Venture.

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

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

Short-term investments. Short-term investments are generally comprised of money market accounts, time deposits, and U.S. treasury bills.

Interest Income. Interest income, including the amortization of premium and accretion of discount, is recorded on the accrual basis to the extent that such amounts are expected to be collected. The Company generally places a loan or security on non-accrual status and ceases recognizing cash interest income on such loan or security when a loan or security becomes 90 days or more past due or if the Company otherwise does not expect the debtor to be able to service its debt obligations. Non-accrual loans remain in such status until the borrower has demonstrated the ability and intent to pay contractual amounts due or such loans become current. As of September 30, 2017, two issuers representing 1% of the Company’s total investments at fair value were on a non-accrual status, and one of our investments, representing 2% of the Company’s investments at fair value, was on partial non-accrual status, whereby we have recognized income on a portion of contractual payment-in-kind (PIK) amounts due.

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

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

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

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

Joint Venture. For interim periods, the Company recognizes investment income on its investment in the Joint Venture based upon its share of the estimated tax-basis earnings and profits of the Joint Venture. Any distributions in excess of tax-basis earnings and profits are recognized as a return of capital (adjustment to the Company’s cost basis in the investment). The final determination of the tax attributes of distributions from the Joint Venture is made on an annual (full calendar year) basis at year-end of the year based upon taxable income and distributions for the full year. Therefore, any estimate of tax attributes of distributions made on an interim basis may not be representative of the actual tax attributes of distributions for the full year.

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

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

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

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

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

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

3. EARNINGS (LOSSES) PER SHARE

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

The following information sets forth the computation of basic and diluted net increase (decrease) in stockholders’ equity per share for the three and nine months ended September 30, 2017 and 2016 (unaudited):

(unaudited) (unaudited)

Three Months Ended September 30, Nine Months Ended September 30,

2017 2016 2017 2016

Net increase (decrease) in net assets resulting from operations $ (669,449 ) $ 2,716,613 $ 2,237,830 $ (1,118,600 )

Net (increase) decrease in net assets allocated to unvested share awards 3,260 (30,313 ) (18,094 ) 16,701

Net increase (decrease) in net assets available to common stockholders $ (666,189 ) $ 2,686,300 $ 2,219,736 $ (1,101,900 )

Weighted average number of common shares outstanding for basic shares computation 37,196,621 37,152,622 37,202,011 37,142,002

Weighted average number of common and common stock equivalent shares outstanding for diluted shares computation 37,196,621 37,152,622 37,202,011 37,142,002

Net increase (decrease) in net assets per basic common shares:

Net increase (decrease) in net assets from operations $ (0.02 ) $ 0.07 $ 0.06 $ (0.03 )

Net increase (decrease) in net assets per diluted shares:

Net increase (decrease) in net assets from operations $ (0.02 ) $ 0.07 $ 0.06 $ (0.03 )

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

There were 50,000 options to purchase shares of common stock considered for the computation of the diluted per share information for the three months and nine months ended September 30, 2017 and 2016. Since the effects are anti-dilutive for both periods, the options were not considered in the computation. For the three months ended September 30, 2017 and 2016, the Company purchased 349 and 309 shares of common stock, respectively. For the nine months ended September 30, 2017 and 2016 the Company purchased 64,176 and 67,654 shares of common stock, respectively, in connection with the vesting of employee restricted stock, such shares are treated as treasury shares and reduce the weighted average shares outstanding in the computation of earnings per share.

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The Company’s Convertible Notes were included in the computation of the diluted net increase or decrease in net assets resulting from operations per share by application of the “if-converted method” for periods when the Convertible Notes were outstanding. Under the if-converted method, interest charges applicable to the convertible notes for the period are added to reported net increase or decrease in net assets resulting from operations and the full amount of shares (pro-rata if not outstanding for the full period) that would be issued are added to weighted average basic shares. Convertible notes are considered anti-dilutive only when its interest per share upon conversion exceeds the basic net increase or decrease in net assets resulting from operations per share. For the nine month period ended September 30, 2016, the effects of the convertible notes were anti-dilutive. The Convertible Notes matured and were repaid in March 2016.

4. INVESTMENTS

The following table shows the Company’s portfolio by security type at September 30, 2017 and December 31, 2016:

September 30, 2017 (unaudited) December 31, 2016

Security Type
Cost/
Amortized Cost
Fair Value %¹
Cost/
Amortized Cost
Fair Value %¹

Short-term Investments² 57,024,828 $ 57,024,828 18 28,699,269 $ 28,699,269 8

Senior Secured Loan 49,982,415 46,124,914 15 207,701,078 200,322,152 55

Junior Secured Loan 59,490,855 58,343,554 18 37,251,776 35,444,440 10

Senior Unsecured Loan 20,000,000 20,000,000 6 - - -

First Lien Bond 3,054,337 1,063,762 - 3,060,919 1,089,338 -

Senior Secured Bond 1,503,404 1,494,600 - 1,506,461 1,487,400 -

CLO Fund Securities 78,544,739 51,843,344 16 76,851,317 54,174,350 15

Equity Securities 10,389,007 4,450,177 1 10,389,007 5,056,355 1

Asset Manager Affiliates³ 53,341,230 39,679,000 13 55,341,230 40,198,000 11

Joint Venture 36,738,873 36,591,122 13 - - -

Total $ 370,069,689 $ 316,615,300 100 % $ 420,801,057 $ 366,471,304 100 %

¹ Represents percentage of total portfolio at fair value.

² Includes money market accounts and U.S. treasury bills.

³ Represents the equity investment in the Asset Manager Affiliates.

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The industry-related information, based on the fair value of the Company’s investment portfolio as of September 30, 2017 and December 31, 2016, for the Company’s investment portfolio was as follows:

September 30, 2017 (unaudited) December 31, 2016

Industry Classification
Cost/

Amortized Cost
Fair Value %¹
Cost/

Amortized Cost
Fair Value %

Aerospace and Defense $ 4,929,171 $ 3,268,788 1 % $ 8,394,633 $ 8,450,106 2 %

Asset Management Company² 53,341,230 39,679,000 13 55,341,230 40,198,000 11

Automotive - - - 6,322,551 6,196,154 2

Banking, Finance, Insurance & Real Estate 3,466,776 3,443,506 1 6,805,514 6,782,010 2

Beverage, Food and Tobacco 4,512,854 4,346,400 1 15,198,830 14,703,372 4

Capital Equipment 5,455,586 4,744,140 1 6,185,129 5,575,048 2

Chemicals, Plastics and Rubber - - - 6,421,909 6,444,073 2

CLO Fund Securities 78,544,739 51,843,344 16 76,851,317 54,174,350 15

Construction & Building 1,007,336 1,007,423 - 5,919,158 5,929,606 2

Consumer goods: Durable 3,054,338 1,064,762 - 12,319,905 10,118,736 3

Consumer goods: Non-durable 732,896 734,613 - 14,766,390 14,452,096 4

Ecological - - - 1,741,292 1,760,783 -

Energy: Electricity - - - 3,904,453 3,937,247 1

Energy: Oil & Gas 13,929,048 10,575,738 3 14,493,835 8,805,761 2

Environmental Industries 6,922,952 6,156,451 2 12,279,924 12,185,239 3

Forest Products & Paper 1,557,040 1,600,960 1 4,192,889 4,192,907 1

Healthcare & Pharmaceuticals 36,573,091 33,901,061 11 58,769,668 53,594,534 15

High Tech Industries 16,093,619 16,051,970 5 9,854,093 9,936,109 3

Hotel, Gaming & Leisure 400,000 1,000 - 400,000 1,000 -

Joint Venture 36,738,873 36,591,122 12 - - -

Media: Advertising, Printing & Publishing 3,869,962 3,875,038 1 11,712,682 11,453,447 3

Media: Broadcasting & Subscription - - - 8,273,174 8,372,984 2

Related Party Loan 20,000,000 20,000,000 6 - - -

Retail - - - 1,415,457 759,581 -

Services: Business 5,523,913 4,427,100 1 16,125,481 16,230,486 4

Services: Consumer - - - 6,212,108 6,204,889 2

Telecommunications 3,965,663 3,939,200 1 12,809,799 12,767,823 3

Textiles and Leather 7,948,833 7,847,841 3 - - -

Money Market Accounts 32,015,828 32,015,828 11 28,699,269 28,699,269 8

Transportation: Cargo 2,496,958 2,500,000 1 7,557,315 7,190,135 2

Transportation: Consumer - - - 2,412,614 2,324,516 1

U.S. Government Obligation 25,009,000 25,009,000 8 - -

Utilities: Electric 1,979,983 1,991,015 1 5,420,438 5,031,043 1

Total $ 370,069,689 $ 316,615,300 100 % $ 420,801,057 $ 366,471,304 100 %

¹ Calculated as a percentage of total portfolio at fair value.

² Represents the equity investment in the Asset Manager Affiliates.

The Company may invest up to 30% of the its total assets in “non-qualifying” opportunistic investments, including investments in debt and equity securities of CLO Funds, distressed debt or debt and equity securities of large cap public companies. Within this 30%, the Company also may invest in debt of middle market companies located outside of the United States.

At September 30, 2017 and December 31, 2016, the total amount of non-qualifying assets was approximately 28% and 17% of the total investment portfolio, respectively. The majority of non-qualifying assets were foreign investments which were approximately 17% and 14% of the total investment portfolio, respectively (including the Company’s investments in CLO Funds, which are typically domiciled outside the U.S. and represented approximately 16% and 15% of total assets on such dates, respectively).

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The following tables detail the ten largest portfolio investments (at fair value) as of September 30, 2017 and December 31, 2016:

September 30, 2017 (unaudited)

Investment Cost/Amortized Cost Fair Value % of FMV

Asset Manager Affiliates $ 53,341,230 $ 39,679,000 13 %

KCAP Freedom 3 LLC 36,738,873 36,591,122 12

US Bank Money Market Account 32,001,559 32,001,559 10

Katonah 2007-I CLO Ltd. 31,123,451 21,447,386 7

Trimaran Advisors, L.L.C. 20,000,000 20,000,000 6

U.S Treasury Bills - CUSIP: 912796LY3 15,007,000 15,007,000 5

U.S Treasury Bills - CUSIP: 912796KR9 10,002,000 10,002,000 3

Tank Partners Holdings, LLC 12,420,461 8,222,814 3

Catamaran CLO 2016-1 Ltd. 10,196,554 8,585,018 3

Grupo HIMA San Pablo, Inc. 10,023,444 9,290,017 3

Total $ 230,854,572 $ 200,825,916 65 %

December 31, 2016

Investment Cost/Amortized Cost Fair Value % of FMV

Asset Manager Affiliates $ 55,341,230 $ 40,198,000 11 %

US Bank Money Market Account 28,685,001 28,685,001 8

Katonah 2007-I CLO Ltd. 28,022,646 20,453,099 6

Grupo HIMA San Pablo, Inc. 9,828,619 9,113,125 2

Catamaran CLO 2016-1 Ltd. 10,140,000 8,350,290 2

Tank Partners Holdings, LLC 11,822,180 6,552,311 2

Roscoe Medical, Inc. 6,666,733 6,499,000 2

Weiman Products, LLC 5,462,647 5,321,809 1

Nielson & Bainbrige, LLC 5,326,136 5,199,447 1

Catamaran CLO 2014-2 Ltd. 6,967,560 5,092,087 1

Total $ 168,262,752 $ 135,464,169 36 %

Excluding the Asset Manager Affiliates and CLO Fund securities, the Company’s ten largest portfolio companies represented approximately 49% and 13% of the total fair value of the Company’s investments at September 30, 2017 and December 31, 2016, respectively.

Investments in CLO Fund Securities

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

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In December 2016, the Company purchased $10.1 million of the notional value of the Subordinated Notes of Catamaran 2016-1 CLO (“Catamaran 2016-1”) managed by Trimaran Advisors.

In the third quarter of 2017, the Company purchased $3.8 million notional value of the Subordinated Notes of Catamaran 2014-1 CLO managed by Trimaran Advisors.

On February 29, 2016, Katonah X CLO Ltd. was fully liquidated and all of its outstanding obligations were satisfied. The Company received approximately $1.0 million in connection therewith related to its investment in the subordinated securities issued by Katonah X CLO Ltd. Accordingly, the Company recorded a realized loss during the first quarter of 2016 of approximately $6.6 million on its investment in Katonah X CLO Ltd. and a corresponding unrealized gain of the same amount in order to reverse the approximately $6.6 million of previously recorded unrealized depreciation with respect to the investment.

All CLO Funds managed by the Asset Manager Affiliates are currently making quarterly distributions to the Company with respect to its interests in the CLO Funds and are paying all senior and subordinate management fees to the Asset Manager Affiliates. In January 2017, the trustees of Trimaran CLO VII, Ltd. (Trimaran VII) received notice that the holders of a majority of the income notes issued by Trimaran VII had exercised their right of optional redemption. With the exception of Katonah III, Ltd. and Grant Grove CLO, Ltd. (both of which have been called), all third-party managed CLO Funds are making distributions to the Company.

Affiliate Investments

The following table details investments in affiliates:

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Fair Value
at
December
31, 2016 Purchases/(Sales) of or
Advances/(Distributions) Net
Accretion Unrealized
Gain/(Loss) Fair Value
at of
September
30, 2017
(unaudited) Interest
Income Dividend
Income

Asset Manager Affiliates $ 40,198,000 $ (2,000,000 ) $ - $ 1,481,000 $ 39,679,000 $ - $ 180,000

Trimaran Advisors, LLC Related Party Loan - 20,000,000 - - 20,000,000 506,306 -

Katonah 2007-I CLO, Ltd. 20,453,099 (1,841,861 ) 4,942,665 (2,106,519 ) 21,447,386 4,942,665 -

Trimaran CLO VII, Ltd. 1,195,152 (1,264,090 ) - 78,938 10,000 - -

Catamaran CLO 2012-1, Ltd. 2,819,412 (636,377 ) 476,425 (419,650 ) 2,239,810 476,425 -

Catamaran CLO 2013-1, Ltd. 4,918,807 (985,219 ) 534,047 (661,535 ) 3,806,101 534,047 -

Catamaran CLO 2014-1, Ltd. 4,546,682 303,037 560,220 (562,318 ) 4,847,621 560,220 -

Catamaran CLO 2014-2, Ltd. 5,092,087 (880,468 ) 612,786 (340,395 ) 4,484,010 612,786 -

Catamaran CLO 2015-1, Ltd. 3,223,255 (442,803 ) 316,181 (62,913 ) 3,033,719 316,181 -

Catamaran CLO 2016-1, Ltd. 8,350,290 (791,935 ) 848,489 178,174 8,585,018 848,489 -

CRMN 2014-1A 1,310,000 - 9,659 200,341 1,520,000 87,974 -

KCAP Freedom 3, LLC - 36,738,873 - (147,751 ) 36,591,122 - 685,000

Total Affiliated Investments $ 92,106,784 $ 48,199,157 $ 8,300,472 $ (2,362,628 ) $ 146,243,787 $ 8,885,093 $ 865,000

Investment in Joint Venture:

During the third quarter of 2017, the Company and Freedom 3 Opportunities, an affiliate of Freedom 3 Capital LLC, entered into an agreement to create the Joint Venture. The Company and Freedom 3 Opportunities contributed approximately $37 million and $25 million, respectively, in assets to the Joint Venture, which in turn used the assets to capitalize a new fund (the "Fund") managed by KCAP Management, LLC, one of the Company's Asset Manager Affiliates. In addition, the Fund used cash on hand and borrowings under a credit facility to purchase approximately $184 million of loans from the Company and the Company used the proceeds from such sale to redeem approximately $147 million in debt issued by KCAP Senior Funding. The Joint Venture may originate loans from time to time and sell them to the Fund.

The Joint Venture is structured as an unconsolidated Delaware limited liability company. All portfolio and other material decisions regarding the Joint Venture must be submitted to its board of managers, which is comprised of four members, two of whom were selected by the Company and two of whom were selected by Freedom 3 Opportunities, and must be approved by at least one member appointed by the Company and one appointed by Freedom 3 Opportunities. In addition, certain matters may be approved by the Joint Venture’s investment committee, which is comprised of one member appointed by the Company and one member appointed by Freedom 3 Opportunities.

The Company has determined that the Joint Venture is an investment company under ASC 946, however, in accordance with such guidance; the Company will generally not consolidate its investment in a company other than a wholly owned investment company subsidiary or a controlled operating company whose business consists of providing services to the Company. Accordingly, the Company does not consolidate its non-controlling interest in the Joint Venture.

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KCAP Freedom 3 LLC

Summarized Balance Sheet (unaudited)

As of

September 30, 2017

Investment at fair value $ 62,591,610

Total Assets $ 62,591,610

Total Liabilities $ 1,026,962

Total Equity 61,564,648

Total Liabilities and Equity $ 62,591,610

KCAP Freedom 3 LLC

Summarized Statements of Operations Information (unaudited)

For the period from July 20,
2017 (date of inception) to
September 30, 2017

Investment income $ 1,026,962

Operating Expenses 10,000

Net Investment Income 1,016,962

Unrealized appreciation on Investments 79,258

Net Income $ 1,096,220

During the three months ended September 30, 2017, KCAP Management LLC recognized approximately $185 thousand of management fees from the Fund, which is a wholly-owned subsidiary of the Joint Venture. In turn, the Company has recognized dividend income of approximately $180 thousand during the three months ended September 30, 2017 (included in Dividends from Asset Manager Affiliates) related to distributions from KCAP Management, LLC.

Fair Value Measurements

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

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

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

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

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

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

The following table summarizes the fair value of investments by the above ASC 820: Fair Value hierarchy levels as of September 30, 2017 (unaudited) and December 31, 2016, respectively:

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As of September 30, 2017 (unaudited)

Level I Level II Level III Total

Money market accounts $ — $ 32,015,828 $ — $ 32,015,828

U.S. Treasury Bills 25,009,000 — — 25,009,000

Debt securities — 68,707,692 58,319,137 127,026,829

CLO Fund securities — — 51,843,344 51,843,344

Equity securities — — 4,450,177 4,450,177

Asset Manager Affiliates — — 39,679,000 39,679,000

Joint Venture — — 36,591,122 36,591,122

Total $ 25,009,000 $ 100,723,520 $ 190,882,780 $ 316,615,300

As of December 31, 2016

Level I Level II Level III Total

Money market accounts $ — $ 28,699,269 $ — $ 28,699,269

Debt securities — 84,601,585 153,741,745 238,343,330

CLO Fund securities — — 54,174,350 54,174,350

Equity securities — — 5,056,355 5,056,355

Asset Manager Affiliates — — 40,198,000 40,198,000

Total $ — $ 113,300,854 $ 253,170,450 $ 366,471,304

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

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

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

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

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

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Nine Months Ended September 30, 2017 (unaudited)

Debt Securities CLO Fund
Securities Equity
Securities Asset Manager
Affiliate Joint Venture Total

Balance, December 31, 2016 $ 153,741,745 $ 54,174,350 $ 5,056,355 $ 40,198,000 $ — $ 253,170,450

Transfers out of Level III⁽¹⁾ — — — — — —

Transfers into Level III⁽²⁾ 6,372,000 — — — — 6,372,000

Net accretion (amortization) 206,241 443,434 — — — 649,675

Purchases 20,048,575 1,249,988 1 — 36,738,873 58,037,437

Sales/Paydowns/Return of Capital (126,670,826 ) — — (2,000,000 ) — (128,670,826 )

Total realized gain (loss) included in earnings (995,630 ) — — — — (995,630 )

Total unrealized gain (loss) included in earnings 5,617,032 (4,024,428 ) (606,179 ) 1,481,000 (147,751 ) 2,319,674

Balance, September 30, 2017 $ 58,319,137 $ 51,843,344 $ 4,450,177 $ 39,679,000 $ 36,591,122 190,882,780

Changes in unrealized gains (losses) included in earnings related to investments still held at reporting date $ 1,174,559 $ (4,024,428 ) $ (1 ) $ 1,481,000 $ (147,751 ) $ (1,368,870 )

¹Transfers out of Level III represent a transfer of $0 relating to debt and equity securities for which pricing inputs, other than their quoted prices in active markets were observable as of September 30, 2017.

²Transfers into Level III represent a transfer of $6,372,000 relating to debt and equity securities for which pricing inputs, other than their quoted prices in active markets were unobservable as of September 30, 2017.

Year Ended December 31, 2016

Debt Securities CLO Fund
Securities Equity
Securities Asset Manager
Affiliate Joint Venture Total

Balance, December 31, 2015 $ 183,400,465 $ 55,872,382 $ 9,103,003 $ 57,381,000 $ — $ 305,756,850

Transfers out of Level III (14,855,471 )¹ — — — — (14,855,471 )

Transfers into Level III 22,107,141 ² — 445,485 — — 22,552,626

Net accretion (amortization) 318,999 (2,192,069 ) — — — (1,873,070 )

Purchases 33,641,315 10,140,000 180,161 — — 43,961,476

Sales/Paydowns/Return of Capital (66,559,349 ) (4,200,000 ) (4,743,682 ) (1,250,000 ) — (76,753,031 )

Total realized gain (loss) included in earnings (366,924 ) (10,111,560 ) 4,484,742 — — (5,993,742 )

Total unrealized gain (loss) included in earnings (3,944,431 ) 4,665,597 (4,413,354 ) (15,933,000 ) — (19,625,188 )

Balance, December 31, 2016 $ 153,741,745 $ 54,174,350 $ 5,056,355 $ 40,198,000 $ — 253,170,450

Changes in unrealized gains (losses) included in
earnings related to investments still held at reporting date $ (6,969,509 ) $ 4,665,597 $ (4,413,354 ) $ (15,933,000 ) $ — $ (22,650,266 )

¹Transfers out of Level III represent a transfer of $14,855,471 relating to debt securities for which pricing inputs, other than their quoted prices in active markets were observable as of December 31, 2016.

²Transfers into Level III represent a transfer of $22,107,141 relating to debt securities for which pricing inputs, other than their quoted prices in active markets were unobservable as of December 31, 2016.

As of September 30, 2017, the Company’s Level II portfolio investments were valued by a third party pricing services for which the prices are not adjusted and for which inputs are observable or can be corroborated by observable market data for substantially the full character of the financial instrument, or by inputs that are derived principally from, or corroborated by, observable market information. The fair value of the Company’s Level II portfolio investments was $100,723,520 as of September 30, 2017.

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As of September 30, 2017, the Company’s Level III portfolio investments had the following valuation techniques and significant inputs:

Type Fair Value Primary Valuation
Methodology Unobservable
Inputs Range of Inputs
(Weighted Average)

Debt Securities $   11,219,800 Enterprise Value Average EBITDA Multiple / WACC
5.2x - 6.7x (5.5x)

13.3% - 17.7% (16.8%)

47,099,337 Income Approach Implied Discount Rate 6.0% - 26.4% (13.8%)

Equity Securities 4,442,177 Enterprise Value Average EBITDA Multiple / WACC
4.6x – 16.1x (10.4x)

10.6% - 14.6% (12.2%)

8,000 Options Value Qualitative Inputs⁽¹⁾

CLO Fund Securities 30,395,957 Discounted Cash Flow Discount Rate 12.0%

Probability of Default 2.0%

Loss Severity 25.9%

Recovery Rate 74.1%

Prepayment Rate 25.0%

21,447,386 Liquidation Value Qualitative Inputs⁽²⁾

Asset Manager Affiliate      39,679,000 Discounted Cash Flow Discount Rate 2.5% - 12.0% (6.5%)

Joint Venture 36,591,122 Enterprise Value Qualitative Inputs⁽²⁾

Total Level III Investments $   190,882,780

¹ The qualitative inputs used in the fair value measurements of Equity Securities include estimates of the distressed liquidation value of the pledged collateral. In cases where KCAP’s analysis ascribes no residual value to a portfolio company’s equity, KCAP typically elects to mark its position at a nominal amount to account for the investment’s option value.

² The qualitative inputs used in the fair value measurements include the value of the pledged collateral.

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As of December 31, 2016, the Company’s Level III portfolio investments had the following valuation techniques and significant inputs:

Type Fair Value Primary Valuation
Methodology Unobservable
Inputs Range of Inputs
(Weighted Average)

Debt Securities $       7,639,648 Enterprise Value Average EBITDA Multiple 5.3x

    146,102,097 Income Approach Implied Discount Rate 5.6% - 21.5% (9.15%)

Equity Securities          5,050,355 Enterprise Value Average EBITDA Multiple/WACC 4.8x/7.4% - 14.1x/13.9%
(9.3x/12.0%)

              6,000 Options Value Qualitative Inputs⁽¹⁾

CLO Fund Securities      45,824,060 Discounted Cash Flow Discount Rate 11.3% - 13.0% (13.0%)

Probability of Default 2.0% - 2.5% (2.0%)

Loss Severity 25.0% - 25.9% (25.9%)

Recovery Rate 74.1% - 75.% (74.2%)

Prepayment Rate 25.0% - 29.1% (25.1%)

     8,350,290 Market Approach 3^rd Party Quote 82.35% (82.35%)

Asset Manager Affiliate        40,198,000 Discounted Cash Flow Discount Rate 2.5% - 13.0% (7.6%)

Total Level III Investments $     253,170,450

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

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

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

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

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

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The Company’s investment in the Joint Venture is carried at fair value based upon the fair value of the investments held by the Joint Venture.

5. ASSET MANAGER AFFILIATES

Wholly-Owned Asset Managers

The Asset Manager Affiliates are wholly-owned portfolio companies. The Asset Manager Affiliates manage CLO Funds primarily for third party investors that invest in broadly syndicated loans, high yield bonds and other credit instruments issued by corporations. At September 30, 2017 and December 31, 2016, the Asset Manager Affiliates had approximately $2.8 billion and $3.0 billion of par value of assets under management, respectively, and the Company’s 100% equity interest in the Asset Manager Affiliates had a fair value of approximately $39.7 million and $40.2 million, respectively.

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

For the three months ended September 30, 2017 and 2016, the Asset Manager Affiliates declared cash distributions of $880,000 and $750,000 to the Company, respectively. For the nine months ended September 30, 2017 and 2016, the Asset Manager Affiliates declared cash distributions of approximately $2.2 million and $2.7 million to the Company, respectively. Any distributions from the Asset Manager Affiliates out of their estimated tax-basis earnings and profits are recorded as “Dividends from Asset Manager Affiliates” on the Company’s statement of operations. The Company recognized $180,000 of Dividends from Asset Manager Affiliates in the Statement of Operations for the three months ended September 30, 2017.For the nine months ended September 30, 2017 and 2016, the Company recognized $180,000 and $1.4 million, respectively of Dividends from Asset Manager Affiliates in the Statement of Operations. The difference between cash distributions received and the tax-basis earnings and profits of the distributing affiliate, are recorded as an adjustment to the cost basis in the Asset Manager Affiliate (i.e., tax-basis return of capital). Distributions receivable, if any, are reflected in the Due from Affiliates account on the consolidated balance sheets.

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

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

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On February 18, 2015, the FASB issued Accounting Standards Update 2015-2 (“ASU 2015-2”), which updated consolidation standards under ASC Topic 810, “Consolidation”. Under this update, a new consolidation analysis is required for VIEs and will limit the circumstances in which investment managers and similar entities are required to consolidate the entities that they manage. The FASB decided to eliminate some of the criteria under which their management fees are considered a variable interest and limit the circumstances in which variable interests in a VIE held by related parties of a reporting enterprise require the reporting enterprise to consolidate the VIE. The guidance is effective for public business entities for annual and interim periods in fiscal years beginning after December 15, 2015, early adoption is permitted. The Asset Manager Affiliates adopted ASU 2015-2 in 2016 which resulted in the deconsolidation of the CLO Funds. Prior year amounts have been restated to reflect the retrospective adoption of ASU 2015-2. In addition, in accordance with Regulation S-X, additional financial information with respect to the Asset Manager Affiliates and one of the CLO Funds in which the Company has an investment, Katonah 2007-I CLO, is required to be included in the Company’s SEC Filings. This additional financial information regarding the Asset Manager Affiliates and Katonah 2007-1 CLO does not directly impact the financial position, results of operations, or cash flows of the Company.

Asset Manager Affiliates

Summarized Balance Sheet (unaudited)

As of As of

September 30, 2017 December 31, 2016

Cash $ 14,532,648 $ 3,425,709

Investments 10,000,000 -

Intangible Assets 22,830,000 23,157,541

Other Assets 3,762,880 5,024,174

Total Assets $ 51,125,528 $ 31,607,424

Total Liabilities $ 25,970,228 $ 6,619,619

Total Equity 25,155,300 24,987,805

Total Liabilities and Equity $ 51,125,528 $ 31,607,424

Asset Manager Affiliates

Summarized Statements of Operations Information (unaudited)

For the three months ended For the nine months ended

September 30, September 30,

2017 2016 2017 2016

Fee Revenue $ 3,027,460 $ 3,148,353 $ 12,000,010 $ 9,707,075

Interest Income 25,298 570,865 31,208 1,138,483

Total Income 3,052,758 3,719,218 12,031,218 10,845,558

Operating Expenses 2,547,545 2,789,654 7,852,377 8,618,839

Amortization of Intangibles - 327,541 327,541 982,623

Interest Expense 121,468 485,355 525,034 1,353,135

Total Expenses 2,669,013 3,602,550 8,704,952 10,954,597

Pre-Tax Income (Loss) 383,745 116,668 3,326,266 (109,039 )

Income Tax (Benefit) Expense (79,791 ) (100,862 ) 978,769 (346,447 )

Net Income $ 463,536 $ 217,530 $ 2,347,497 $ 237,408

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Katonah 2007-I CLO Ltd.

Summarized Balance Sheet Information (unaudited)

As of As of

September 30, 2017 December 31, 2016

Total investments at fair value $ 80,158,889 $ 176,684,976

Cash 24,632,168 34,982,770

Total Assets 105,370,828 212,160,163

CLO Debt at fair value 104,216,372 208,812,164

Total liabilities 105,374,980 210,463,954

Total Net Assets (deficit) (4,151 ) 1,696,209

Katonah 2007-I CLO Ltd.

Summarized Statements of Operations Information (unaudited)

For the three months ended For the nine months ended

September 30, September 30,

2017 2016 2017 2016

Interest income from investments $ 1,185,765 $ 2,330,108 $ 4,336,891 $ 7,338,815

Total income 1,203,940 2,373,500 4,392,101 7,683,808

Interest expense 1,275,068 2,184,144 4,289,994 6,724,410

Total expenses 1,401,622 2,400,770 4,885,278 7,497,100

Net realized and unrealized gains (losses) (48,669 ) 1,397,748 (1,207,183 ) 3,783,015

Increase in net assets resulting from operations (246,351 ) 1,370,478 (1,700,360 ) 3,969,723

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

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

Additional goodwill amortization for tax purposes was created upon the purchase of 100% of the equity interests in Trimaran Advisors by one of KCAP’s affiliates, in exchange for shares of the Company’s stock valued at $25.5 million and cash of $13.0 million. The transaction was considered an asset purchase under Section 351(a) of the Code and resulted in tax goodwill of approximately $22.8 million, and tax basis intangible assets of $15.7 million, of both which are being amortized for tax purposes on a straight-line basis over 15 years.

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During the second quarter of 2016, KCAP contributed 100% of its ownership interests in Katonah Debt Advisors and Trimaran Advisors Management to Commodore Holdings, a wholly-owned subsidiary of KCAP. These transactions simplify the tax structure of the AMAs and facilitate the consolidation of tax basis goodwill deductions for the AMAs, which may impact the tax character of distributions from the AMAs.

Related Party Transactions

On February 26, 2013, the Company entered into a senior credit agreement (the “Trimaran Credit Facility”) with Trimaran Advisors, pursuant to which Trimaran Advisors may borrow from time to time up to $20 million from the Company in order to provide capital necessary to support one or more of Trimaran Advisors’ warehouse lines of credit and/or working capital in connection with Trimaran Advisors’ warehouse activities. The Trimaran Credit Facility expires on November 20, 2017 and bears interest at an annual rate of 9.0%. Outstanding borrowings on the Trimaran Credit Facility are callable by the Company at any time. On April 15, 2013, the Trimaran Credit Facility was amended and upsized from $20 million to $23 million. At September 30, 2017 and December 31, 2016, there was $20 million and $0 million, respectively, outstanding under the Trimaran Credit Facility. For the three months ended September 30, 2017 and 2016, the Company recognized interest income of approximately $126,000 and $485,000, respectively, related to the Trimaran Credit Facility. For the nine months ended September 30, 2017 and 2016, the Company recognized interest income of approximately $529,000 and $1.3 million, respectively, related to the Trimaran Credit Facility.

6. BORROWINGS

The Company’s debt obligations consist of the following:

As of

September 30, 2017

(unaudited)

As of

December 31, 2016

Notes issued by KCAP Senior Funding I, LLC (net of discount and offering costs of: 2016 - $2,286,425 and $2,459,156, respectively) $ - $ 142,604,419

7.375 Notes (net of offering costs of: 2017 - $306,073; 2016 - $550,774) 26,693,927 32,980,151

6.125 Notes (net of offering costs of: 2017 - $2,757,357) 74,649,843 -

Total $ 101,343,770 $ 175,584,570

The weighted average stated interest rate and weighted average maturity on all our debt outstanding as of September 30, 2017 were 6.4% and 4.2 years, respectively, and as of December 31, 2016 were 3.9% and 6.7 years, respectively.

KCAP Senior Funding I, LLC (Debt Securitization)

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

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

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

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

The Additional Issuance Offered Securities were issued as Class A-2 senior secured floating rate notes which have an initial face amount of $30,900,000, have a rating of AAA (sf)/Aaa (sf) by Standard & Poor’s Ratings Services and Moody’s Investors Service, Inc., respectively, and bear interest at the three-month LIBOR plus 1.50%, Class B-2 senior secured floating rate notes which have an initial face amount of $3,600,000, a rating of AA (sf)/Aa2 (sf) by Standard & Poor’s Ratings Services and Moody’s Investors Service, Inc., respectively, and bear interest at three-month LIBOR plus 3.25%, Class C-2 secured deferrable floating rate notes which have an initial face amount of $4,000,000, a rating of A (sf)/A2 (sf) by Standard & Poor’s Ratings Services and Moody’s Investors Service, Inc., respectively, and bear interest at three-month LIBOR plus 4.25%, and Class D-2 secured deferrable floating rate notes which have an initial face amount of $3,600,000, a rating of BBB (sf)/Baa2 (sf) by Standard & Poor’s Ratings Services and Moody’s Investors Service, Inc., respectively, and bear interest at three-month LIBOR plus 5.25%. The Depositor retained all of the subordinated Additional Issuance Securities of the Issuer (the “Additional Issuance Subordinated Notes”), which have an initial face amount of $13,900,000. The Additional Issuance Subordinated Notes do not bear interest and are not rated. The Additional Issuance Securities have a stated maturity date of July 20, 2024 and are subject to a non-call period until the payment date on the Additional Issuance Securities occurring in July 2015. The Issuer has a reinvestment period to and including the payment date on the Additional Issuance Securities occurring in July 2017, or such earlier date as is provided in the indenture relating to the Additional Issuance Securities. In connection with the Additional Issuance Offered Securities, the Company incurred issuance costs and OID costs of approximately $584,000 and $896,000, respectively.

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

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

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

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

All of the Class A,B,C and D notes were repaid in the third quarter of 2017. In connection there with, the Company recorded a realized loss from the extinguishment of debt of $4.0 million in the third quarter of 2017.

For the three months ended September 30, 2017, interest expense, including the amortization of deferred debt issuance costs and the OID was approximately $337,000 consisting of stated interest expense of approximately $263,000, accreted discount of approximately $35,000, and deferred debt issuance costs of approximately $38,000. For the nine months ended September 30, 2017, interest expense, including the amortization of deferred debt issuance costs and the discount on the face amount of the notes, was approximately $3.4 million consisting of stated interest expense of approximately $2.7 million, accreted discount of approximately $352,000, and deferred debt issuance costs of approximately $379,000.

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Fair Value of KCAP Senior Funding I.   The Company carried the KCAP Senior Funding I Notes at cost, net of unamortized discount and offering costs. The fair value of the KCAP Senior Funding I Notes was approximately $146.3 million at December 31, 2016. The fair value was determined based on third party indicative values. The KCAP Senior Funding I L.L.C. Notes were categorized as Level III under ASC 820: Fair Value.

7.375% Notes Due 2019

On October 10, 2012, the Company issued $41.4 million in aggregate principal amount of unsecured 7.375% Notes Due 2019 (the “7.375% Notes due 2019”). The net proceeds for these Notes, after the payment of underwriting expenses, were approximately $39.9 million. Interest on the 7.375% Notes Due 2019 is paid quarterly in arrears on March 30, June 30, September 30 and December 30, at a rate of 7.375%, commencing December 30, 2012. The 7.375% Notes Due 2019 mature on September, 30, 2019 and are unsecured obligations of the Company. The 7.375% Notes Due 2019 are subject to redemption in whole or in part at any time or from time to time, at the option of the Company, on or after September 30, 2015, at a redemption price per security equal to 100% of the outstanding principal amount thereof plus accrued and unpaid interest payments otherwise payable for the then-current quarterly interest period accrued to the date fixed for redemption. In addition, due to the asset coverage test applicable to the Company as a BDC and a covenant that the Company agreed to in connection with the issuance of the 7.375% Notes Due 2019, the Company is limited in its ability to make distributions in certain circumstances. The indenture governing the 7.375% Notes Due 2019 contains certain restrictive covenants, including compliance with certain provisions of the 1940 Act relating to borrowing and dividends. At September 30, 2017, the Company was in compliance with all of its debt covenants.

For the three months ended September 30, 2017 and 2016, interest expense related to the 7.375% Notes Due 2019 was approximately $498,000 and $712,000, respectively. For the nine months ended September 30, 2017 and 2016, interest expense related to the 7.375% Notes Due 2019 was approximately $1.7 million and $2.2 million, respectively.

In connection with the issuance of the 7.375% Notes Due 2019, the Company incurred approximately $1.5 million of debt offering costs which are being amortized over the expected term of the facility on an effective yield method, of which approximately $306,000 remains to be amortized, and is included on the consolidated balance sheets as a reduction in the related debt liability.

During the second quarter of 2016, the Company repurchased approximately $2.4 million par value of the 7.375% Notes Due 2019 at a weighted average price of $25.23 per $25.00 note, resulting in a realized loss on extinguishment of $71,190. KCAP subsequently surrendered these notes to the Trustee for cancellation.

During the third quarter of 2016, $5.0 million par value of the 7.375% Notes Due 2019 was redeemed by the Company, resulting in a realized loss on extinguishment of $88,015. KCAP subsequently surrendered these notes to the Trustee for cancellation.

During the fourth quarter of 2016, approximately $469,000 par value of the 7.375% Notes Due 2019 was redeemed by the Company, resulting in a realized loss on extinguishment of $15,006. KCAP subsequently surrendered these notes to the Trustee for cancellation.

During the second quarter of 2017, approximately $6.5 million par value of the 7.375% Notes Due 2019 was redeemed by the Company, resulting in a realized loss on extinguishment of approximately $107,000. KCAP subsequently surrendered these notes to the Trustee for cancellation.

Fair Value of 7.375% Notes Due 2019.  The 7.375% Notes Due 2019 were issued in a public offering on October 10, 2012 and are carried at cost. The fair value of the Company’s outstanding 7.375% Notes Due 2019 was approximately $27.1 million at September 30, 2017. The fair value was determined based on the closing price on September 30, 2017 for the 7.375% Notes Due 2019. The 7.375% Notes Due 2019 are categorized as Level I under the ASC 820 Fair Value.

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6.125% Notes Due 2022

During the third quarter of 2017, the Company issued $77.4 million in aggregate principal amount of unsecured 6.125% Notes due 2022 (“the 6.125 Notes Due 2022”). The net proceeds for these Notes, after the payment of underwriting expenses, were approximately $74.6 million. Interest on the 6.125% Notes Due 2022 is paid quarterly in arrears on March 30, June 30, September 30 and December 30, at a rate of 6.125%, commencing September 30, 2017. The 6.125% Notes Due 2022 mature on September, 30, 2022 and are unsecured obligations of the Company. The 6.125% Notes Due 2022 are subject to redemption in whole or in part at any time or from time to time, at the option of the Company, on or after September 30, 2019, at a redemption price per security equal to 100% of the outstanding principal amount thereof plus accrued and unpaid interest payments otherwise payable for the then-current quarterly interest period accrued to the date fixed for redemption. In addition, Due to the asset coverage test applicable to the Company as a BDC and a covenant that the Company agreed to in connection with the issuance of the 6.125% Notes Due 2022, the Company is limited in its ability to make distributions in certain circumstances. The indenture governing the 6.125% Notes Due 2022 contains certain restrictive covenants, including compliance with certain provisions of the 1940 Act relating to borrowing and dividends. At September 30, 2017, the Company was in compliance with all of its debt covenants.

For the three months and nine months ended September 30, 2017 interest expense related to the 6.125% Notes Due 2022 was approximately $450,000.

In connection with the issuance of the 6.125% Notes Due 2022, the Company incurred approximately $2.8 million of debt offering costs which are being amortized over the expected term of the facility on an effective yield method, of which approximately $2.8 million remains to be amortized as of September 30, 2017, and is included on the consolidated balance sheets as a reduction in the related debt liability.

Fair Value of 6.125% Notes Due 2022. The 6.125% Notes Due 2022 were issued via public offering during the third quarter of 2017 and are carried at cost. The fair value of the Company’s outstanding 6.125% Notes Due 2022 was approximately $77.3 million at September 30, 2017.The fair value was determined based on the closing price on September 30, 2017 for the 6.125% Notes Due 2022. The 6.125% Notes Due 2022 are categorized as Level I under the ASC 820 Fair Value.

Convertible Notes

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

In connection with the issuance of the Convertible Notes, the Company incurred approximately $2.4 million of debt offering costs, which were amortized over the term of the Convertible Notes on an effective yield method. On April 4, 2013, approximately $9 million of the Company’s 8.75% Convertible Notes were converted at a price per share of $8.159 into 1,102,093 shares of KCAP common stock. On September 4, 2013, the Company purchased $2.0 million face value of its own Convertible Notes at a price of $114.50 plus accrued interest. KCAP subsequently surrendered these notes to the Trustee for cancellation effective September 13, 2013. During 2015, the Company repurchased approximately $19.3 million face value of its own Convertible Notes at a price ranging from $101.500 to $102.375. KCAP subsequently surrendered these notes to the Trustee for cancellation. Due to the cash conversion option embedded in the Convertible Notes, the Company applied the guidance in ASC 470-20-40, Debt with Conversion and Other Options and realized a loss on the extinguishment of this debt. The indenture governing the Convertible Notes contains certain restrictive covenants, including compliance with certain provisions of the 1940 Act and conditions governing the undertaking of new debt.

The Convertible Notes matured and were fully repaid on March 15, 2016.

For the nine months ended September 30, 2016, interest expense related to the Convertible Notes was approximately $378,000.

7. DISTRIBUTABLE TAXABLE INCOME

Effective December 11, 2006, the Company elected to be treated as a RIC under the Code and adopted a December 31 tax-calendar year end. As a RIC, the Company is not subject to federal income tax on the portion of its taxable income and gains distributed currently to its stockholders as a dividend. The Company’s quarterly distributions, if any, are determined by the Board of Directors. The Company anticipates distributing substantially all of its taxable income and gains, within the Subchapter M rules, and thus the Company anticipates that it will not incur any federal or state income tax at the RIC level. As a RIC, the Company is also subject to a federal excise tax based on distributive requirements of its taxable income on a calendar year basis (e.g., calendar year 2017). Depending on the level of taxable income earned in a tax year, the Company may choose to carry forward taxable income in excess of current year distributions into the next tax year and pay a 4% excise tax on such income, to the extent required.

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The following reconciles net increase (decrease) in net assets resulting from operations to taxable income for the nine months ended September 30, 2017 and 2016:

Nine Months Ended September 30,

2017 2016

(unaudited) (unaudited)

Net increase (decrease) in net assets resulting from operations $ 2,237,830 $ (1,118,601 )

Net change in unrealized depreciation from investments (875,365 ) 9,309,013

Excess capital gains over capital losses 6,993,940 6,205,405

Book/tax differences on CLO equity investments (1,697,865 ) 1,050,658

Other book/tax differences 224,785 (673,454 )

Taxable income before deductions for distributions $ 6,883,325 $ 14,773,021

Taxable income before deductions for distributions per weighted average basic shares for the period $ 0.19 $ 0.40

Taxable income before deductions for distributions per weighted average diluted shares for the period $ 0.19 $ 0.40

Dividends from Asset Manager Affiliates are recorded based upon a quarterly estimate of tax-basis earnings and profits of each Asset Manager Affiliate. Distributions in excess of the estimated tax-basis quarterly earnings and profits of each distributing Asset Manager Affiliate are recognized as tax-basis return of capital. The actual tax-basis earnings and profits and resulting dividend and/or return of capital for the year will be determined at the end of the tax year for each distributing Asset Manager Affiliate. For the nine months ended September 30, 2017 and 2016, the Asset Manager Affiliates declared cash distributions of $2.2 million and $2.7 million to the Company, respectively. The Company recognized $1.4 million, respectively, of dividends from Asset Manager Affiliates in the Statement of Operations for the nine months ended September 30, 2016. The difference of $2.0 million and $1.3 million, respectively, between cash distributions received and the tax-basis earnings and profits of the distributing affiliate, are recorded as an adjustment to the cost basis in the Asset Manager Affiliate (i.e. tax-basis return of capital), for the nine months ended September 30, 2017 and 2016, respectively.

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

At September 30, 2017, the Company had a net capital loss carryforward of approximately $98.0 million to offset net capital gains, to the extent provided by federal tax law. Of the net capital loss carryforward, $66.7 million is not subject to expiration under the RIC Modernization Act of 2010.

On September 22, 2017 the Company’s Board of Directors declared a distribution to shareholders of $0.12 per share for a total of approximately $4.4 million. The record date was October 10, 2017 and the distribution was paid on October 26, 2017.

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

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8. COMMITMENTS AND CONTINGENCIES

From time-to-time the Company is a party to financial instruments with off-balance sheet risk in the normal course of business in order to meet the needs of the Company’s investment in portfolio companies. Such instruments include commitments to extend credit and may involve, in varying degrees, elements of credit risk in excess of amounts recognized on the Company’s balance sheet. Prior to extending such credit, the Company attempts to limit its credit risk by conducting extensive due diligence, obtaining collateral where necessary and negotiating appropriate financial covenants. As of September 30, 2017 and December 31, 2016, the Company had approximately $3 million and $565,000 of outstanding commitments to fund investments, respectively.

9. STOCKHOLDERS’ EQUITY

During the nine months ended September 30, 2017 and 2016, the Company issued 75,059 and 153,792 shares, respectively, of common stock under its dividend reinvestment plan. For the nine months ended September 30, 2017, there were 139,620 grants, 10,982 forfeitures, and 242,918 shares vested plan with respect to restricted stock.. On February 14, 2013, the Company completed a public offering of 5,232,500 shares of common stock, which included the underwriters’ full exercise of their option to purchase up to 682,500 shares of common stock, at a price of $9.75 per share. In conjunction with this offering, the Company also sold 200,000 shares of common stock to a member of its Board of Directors, at a price of $9.31125 per share, raising approximately $1.9 million in gross proceeds. On April 4, 2013, approximately $9 million of the Company’s 8.75% Convertible Notes were converted at a price basis per share of $8.159 into 1,102,093 shares of KCAP common stock. On October 6, 2014, the Company priced a follow-on public offering of 3.0 million shares of its common stock at a price of $8.02 per share. The offering raised net proceeds were approximately $23.8 million, after deducting underwriting discounts and offering expenses. The total number of shares of the Company’s common stock outstanding as of September 30, 2017 and December 31, 2016 was 37,317,815 and 37,178,294, respectively. During the nine months ended September 30, 2017 and 2016, the Company repurchased 64,176 and 67,654 shares, respectively, at an aggregate cost of approximately $225,000 and $248,000, respectively, in connection with the vesting of restricted stock awards.

10. EQUITY INCENTIVE PLAN

The Company has an equity incentive plan, established in 2006 and as amended in 2008, 2014, 2015 and most recently in May 2017 (the “Equity Incentive Plan”). The Company reserved 2,000,000 shares of common stock for issuance under the Equity Incentive Plan. The purpose of the Equity Incentive Plan is to provide officers and employees of the Company with additional incentives and align the interests of its employees with those of its shareholders. Options granted under the Equity Incentive Plan are exercisable at a price equal to the fair market value (market closing price) of the shares on the day the option is granted. Restricted stock granted under the Equity Incentive Plan is granted at a price equal to the fair market value (market closing price) of the shares on the day such restricted stock is granted. Vesting of restricted stock awarded under the 2008 amendment of the Equity Incentive Plan will occur in two equal installments of 50%, on each of the third and fourth anniversaries of the grant date; vesting of restricted stock subsequent to the 2014 amendment of the Equity Incentive Plan will vest in four equal installments of 25%, on each of the first four anniversaries of the grant date, except for the grant in September of 2017, which will occur in two equal installments of 50%, on each of the third and fourth anniversaries of the grant date.

Stock Options

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

On March 21, 2017, the Company’s Board of Directors approved the 2017 Non-Employee Director Plan, which extended the term of the 2011 Non-Employee Director Plan (together, the “Non-Employee Director Plan”). The Company’s shareholders approved the Non-Employee Director Plan on May 4, 2017.

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Information with respect to options granted, exercised and forfeited under the Equity Incentive Plan for the period January 1, 2016 through September 30, 2017 is as follows:

Shares Weighted Average
Exercise Price per
Share Weighted Average
Contractual
Remaining Term
(years) Aggregate
Intrinsic Value¹

Options outstanding at January 1, 2016 50,000 $ 7.72 3.4

Granted — —

Exercised — —

Forfeited — —

Options outstanding at December 31, 2016 50,000 $ 7.72 2.4 $ —

Granted — —

Exercised — —

Forfeited — —

Outstanding at September 30, 2017 50,000 $ 7.72 1.6 $ —

Total vested at September 30, 2017 50,000 $ 7.72 1.6

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

The Company uses a Binary Option Pricing Model (American, call option) to establish the expected value of all stock option grants. For the nine months ended September 30, 2017 and 2016, the Company did not recognize any non-cash compensation expense related to stock options. At September 30, 2017, the Company had no remaining compensation costs related to unvested stock option awards.

Restricted Stock

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

(i) the first anniversary of such grant, or

(ii) the date immediately preceding the next annual meeting of shareholders.

On May 5, 2013, the Company’s Board of Directors approved the grant of 240,741 shares of restricted stock to the employees of the Company as partial compensation for their services. 50% of such awards will vest on the third anniversary of the grant date and the remaining 50% of the shares will vest on the fourth anniversary of the grant date.

On June 14, 2013, 5,000 shares of restricted stock were awarded to the Company’s Board of Directors.

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

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

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

On May 3, 2016, 6,000 shares of restricted stock were awarded to the Company’s Board of Directors.

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On May 4, 2017, 6,000 shares of restricted stock were awarded to the Company’s Board of Directors.

On June 16, 2015, the Company received exemptive relief to repurchase shares of its common stock from its employees in connection with certain equity compensation plan arrangements. During the nine months ended September 30, 2017 and 2016, the Company repurchased 64,176 and 67,654 shares, respectively, of common stock at an aggregate cost of approximately $225,000 and $248,000, respectively, in connection with the vesting of employee’s restricted stock, which is reflected as Treasury Stock at cost on the Consolidated Balance Sheet. These shares are not available to be reissued under the Company’s Equity Incentive Plan.

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

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

On September 19, 2017, the Company’s Board of Directors approved the grant of 133,620 shares of restricted stock to the employees of the Company as partial compensation for their services. 50% of such awards will vest on the third anniversary of the grant date and the remaining 50% of the shares will vest on the fourth anniversary of the grant date.

During the nine months ended September 30, 2017, 242,918 shares of restricted stock vested and 10,982 shares of restricted stock were forfeited. As of September 30, 2017, after giving effect to these restricted stock awards, there were 297,199 shares of restricted stock outstanding. Information with respect to restricted stock granted, exercised and forfeited under the Plan for the period January 1, 2016 through September 30, 2017 is as follows:

Non-vested
Restricted Shares

Non-vested shares outstanding at January 1, 2016 700,539

Granted 6,000

Vested (260,607 )

Forfeited (34,453 )

Non-vested shares outstanding at December 31, 2016 411,479

Granted 139,620

Vested (242,918 )

Forfeited (10,982 )

Non-Vested Outstanding at September 30, 2017 297,199

For the three months ended September 30, 2017, non-cash compensation expense related to restricted stock was approximately $226,000 of this amount approximately $83,000 was expensed at the Company, and approximately $143,000 was a reimbursable expense allocated to the Asset Manager Affiliates. For the three months ended September 30, 2016, non-cash compensation expense related to restricted stock was approximately $394,000 of this amount approximately $161,000 was expensed at the Company, and approximately $233,000 was a reimbursable expense allocated to the Asset Manager Affiliates. For the nine months ended September 30, 2017, non-cash compensation expense related to restricted stock was approximately $878,000 of this amount approximately $330,000 was expensed at the Company, and approximately $548,000 was a reimbursable expense allocated to the Asset Manager Affiliates. For the nine months ended September 30, 2016, non-cash compensation expense related to restricted stock was approximately $1.2 million; of this amount approximately $472,000 was expensed at the Company and approximately $682,000 was a reimbursable expense allocated to the Asset Manager Affiliates.

Distributions are paid on all outstanding shares of restricted stock, whether or not vested. In general, shares of unvested restricted stock are forfeited upon the recipient’s termination of employment. As of September 30, 2017, the Company had approximately $1.4 million of total unrecognized compensation cost related to non-vested restricted share awards. That cost is expected to be recognized over the remaining weighted average period of 1.6 years.

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11. OTHER EMPLOYEE COMPENSATION

The Company adopted a 401(k) plan (“401K Plan”) effective January 1, 2007. The 401K Plan is open to all full time employees. The 401K Plan permits an employee to defer a portion of their total annual compensation up to the Internal Revenue Service annual maximum based on age and eligibility. The Company makes contributions to the 401K Plan of up to 2% of the Internal Revenue Service’s annual maximum eligible compensation, which fully vests at the time of contribution. Approximately $1,000 and $1,000 was expensed during the three months ended September 30, 2017 and 2016, respectively, related to the 401K Plan. During the nine months ended September 30, 2017 and 2016, approximately $35,000 and $19,000 was expensed related to the 401K Plan.

The Company has also adopted a deferred compensation plan (“Profit-Sharing Plan”) effective January 1, 2007. Employees are eligible for the Profit-Sharing Plan provided that they are employed and working with the Company to participate in at least 100 days during the year and remain employed as of the last day of the year. Employees do not make contributions to the Profit-Sharing Plan. On behalf of the employee, the Company may contribute to the Profit-Sharing Plan 1) up to 8.0% of all compensation up to the Internal Revenue Service annual maximum and 2) up to 5.7% excess contributions on any incremental amounts above the social security wage base limitation and up to the Internal Revenue Service annual maximum. Employees vest 100% in the Profit-Sharing Plan after five years of service. Approximately $46,000 and $46,000 was expensed during the three months ended September 30, 2017 and 2016, respectively, related to the Profit-Sharing Plan. During the nine months ended September 30, 2017 and 2016, approximately $139,000 and $138,000, respectively, was expensed related to the Profit-Sharing Plan.

12. SUBSEQUENT EVENTS

On October 31, 2017, the Joint Venture made a cash distribution to the Company of approximately $12.6 million. The Company expects that approximately $11.8 million of this distribution will be return of capital, reducing the cost basis of its investment in the JV by that amount. The final determination of the tax attributes of distributions from the Joint Venture is made on an annual (full calendar year) basis at the end of the year, therefore, any estimate of tax attributes of distributions made on an interim basis may not be representative of the actual tax attributes of distributions for the full year.

On October 30, 2017, the Company entered into a new term loan agreement with Trimaran Advisors, one of the Asset Manager Affiliates. Trimaran Advisors borrowed $8.4 million under this agreement, which bears interest at a rate of 10.5% annually, payable quarterly. The loan matures on April 30, 2030, can be repaid at any time, and must be repaid upon the occurrence of certain events.

On October 31, 2017, Trimaran Advisors capitalized Trimaran Risk Retention Holdings, LLC, a newly-formed wholly-owned subsidiary, with $8.4 million of equity capital. In turn, Trimaran Risk Retention Holdings capitalized Trimaran RR I, LLC, a wholly-owned subsidiary of Trimaran Risk Retention Holdings, LLC, with $8.4 million of equity capital. With this equity contribution and other borrowed funds, Trimaran RR I, LLC purchased $34.8 million notional amount of notes issued by Catamaran CLO 2014-1, Ltd. for aggregate consideration of $35.5 million.

On October 31, 2017, the Company purchased an additional $4.3 million of notional amount of Subordinated Notes issued by Catamaran CLO 2014-1 at a cost of $5.4 million.

The Company has evaluated events and transactions occurring subsequent to September 30, 2017 for items that should potentially be recognized or disclosed in these financial statements. Other than as noted above, management has determined that there are no material subsequent events that would require adjustment to, or disclosure in, these consolidated financial statements.

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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, 2016, 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 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 regulated 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, 2016. 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 collateralized loan obligation funds (“CLO Funds”).

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

The structure of CLO Funds, which are highly levered, is extremely complicated. Since we primarily invest in securities representing the residual interests of CLO Funds, our investments are much riskier than the risk profile of the loans by which such CLO Funds are collateralized. Our investments in CLO Funds may be riskier and less transparent to us and our stockholders than direct investments in the underlying loans. The CLO Funds in which we invest have debt that ranks senior to our investment.

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

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 private companies or 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. We may also seek to monetize our investment in the Asset Manager Affiliates if and when business conditions warrant. 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 $2.8 billion of par value assets under management as of September 30, 2017. The Asset Manager Affiliates are registered under the Investment Advisers Act of 1940, and 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).

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 our investment in the Asset Manager Affiliates.

Subject to market conditions, 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.

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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.

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, 2017 (unaudited) and for the year ended December 31, 2016 was as follows:

Debt Securities CLO Fund
Securities Equity
Securities Asset Manager
Affiliates Joint Venture Total Portfolio

Fair Value at December 31, 2015 $ 284,639,244 $ 55,872,382 $ 9,548,488 $ 57,381,000 $ — $ 407,441,114

2016 Activity:

Purchases / originations /draws 74,584,952 10,140,000 — — — 84,724,952

Sales / Pay-downs / Return of Capital (123,240,416 ) (4,200,000 ) (4,563,521 ) (1,250,000 ) — (133,253,937 )

Net accretion (amortization) 407,492 (2,192,071 ) — — — (1,784,579 )

Net realized (losses) gains (540,649 ) (10,111,560 ) 4,484,742 — — (6,167,467 )

Net increase (decrease) in fair value 2,492,707 4,665,599 (4,413,354 ) (15,933,000 ) — (13,188,048 )

Fair Value at December 31, 2016 238,343,330 54,174,350 5,056,355 40,198,000 — 337,772,035

Year to Date 2017 Activity:

Purchases / originations /draws 137,288,374 1,249,988 1 — 36,738,873 175,277,236

Sales / Pay-downs / Return of Capital (250,169,877 ) — — (2,000,000 ) — (252,169,877 )

Net accretion (amortization) 264,220 443,434 — — — 707,654

Net realized gains (losses) (2,871,941 ) — — — — (2,871,941 )

Net increase (decrease) in fair value 4,172,723 (4,024,428 ) (606,179 ) 1,481,000 (147,751 ) 875,365

Fair Value at September 30, 2017 $ 127,026,829 $ 51,843,344 $ 4,450,177 $ 39,679,000 $ 36,591,122 $ 259,590,472

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.

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The following table shows the Company’s portfolio by security type at September 30, 2017 and December 31, 2016:

September 30, 2017 (unaudited) December 31, 2016

Security Type Cost/
Amortized Cost Fair Value %¹ Cost/
Amortized Cost Fair Value %¹

Short-term Investments² 57,024,828 $ 57,024,828 18 28,699,269 $ 28,699,269 8

Senior Secured Loan 49,982,415 46,124,914 15 207,701,078 200,322,152 55

Junior Secured Loan 59,490,855 58,343,554 18 37,251,776 35,444,440 10

Senior Unsecured Loan 20,000,000 20,000,000 6 - - -

First Lien Bond 3,054,337 1,063,762 - 3,060,919 1,089,338 -

Senior Secured Bond 1,503,404 1,494,600 - 1,506,461 1,487,400 -

CLO Fund Securities 78,544,739 51,843,344 16 76,851,317 54,174,350 15

Equity Securities 10,389,007 4,450,177 1 10,389,007 5,056,355 1

Asset Manager Affiliates³ 53,341,230 39,679,000 13 55,341,230 40,198,000 11

Joint Venture 36,738,873 36,591,122 13 - - -

Total $ 370,069,689 $ 316,615,300 100 % $ 420,801,057 $ 366,471,304 100 %

¹ Represents percentage of total portfolio at fair value.

² Includes money market accounts and U.S. treasury bills.

³ Represents the equity investment in the Asset Manager Affiliates.

The industry-related information, based on the fair value of the Company’s investment portfolio as of September 30, 2017 and December 31, 2016, for our investment portfolio were as follows:

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September 30, 2017 (unaudited) December 31, 2016

Industry Classification Cost/
Amortized Cost Fair Value %¹ Cost/
Amortized Cost Fair Value %

Aerospace and Defense $ 4,929,171 $ 3,268,788 1 % $ 8,394,633 $ 8,450,106 2 %

Asset Management Company² 53,341,230 39,679,000 13 55,341,230 40,198,000 11

Automotive - - - 6,322,551 6,196,154 2

Banking, Finance, Insurance & Real Estate 3,466,776 3,443,506 1 6,805,514 6,782,010 2

Beverage, Food and Tobacco 4,512,854 4,346,400 1 15,198,830 14,703,372 4

Capital Equipment 5,455,586 4,744,140 1 6,185,129 5,575,048 2

Chemicals, Plastics and Rubber - - - 6,421,909 6,444,073 2

CLO Fund Securities 78,544,739 51,843,344 16 76,851,317 54,174,350 15

Construction & Building 1,007,336 1,007,423 - 5,919,158 5,929,606 2

Consumer goods: Durable 3,054,338 1,064,762 - 12,319,905 10,118,736 3

Consumer goods: Non-durable 732,896 734,613 - 14,766,390 14,452,096 4

Ecological - - - 1,741,292 1,760,783 -

Energy: Electricity - - - 3,904,453 3,937,247 1

Energy: Oil & Gas 13,929,048 10,575,738 3 14,493,835 8,805,761 2

Environmental Industries 6,922,952 6,156,451 2 12,279,924 12,185,239 3

Forest Products & Paper 1,557,040 1,600,960 1 4,192,889 4,192,907 1

Healthcare & Pharmaceuticals 36,573,091 33,901,061 11 58,769,668 53,594,534 15

High Tech Industries 16,093,619 16,051,970 5 9,854,093 9,936,109 3

Hotel, Gaming & Leisure 400,000 1,000 - 400,000 1,000 -

Joint Venture 36,738,873 36,591,122 12 - - -

Media: Advertising, Printing & Publishing 3,869,962 3,875,038 1 11,712,682 11,453,447 3

Media: Broadcasting & Subscription - - - 8,273,174 8,372,984 2

Related Party Loans 20,000,000 20,000,000 6 - - -

Retail - - - 1,415,457 759,581 -

Services: Business 5,523,913 4,427,100 1 16,125,481 16,230,486 4

Services: Consumer - - - 6,212,108 6,204,889 2

Telecommunications 3,965,663 3,939,200 1 12,809,799 12,767,823 3

Textiles and Leather 7,948,833 7,847,841 3 - - -

Money Market Accounts 32,015,828 32,015,828 11 28,699,269 28,699,269 8

Transportation: Cargo 2,496,958 2,500,000 1 7,557,315 7,190,135 2

Transportation: Consumer - - - 2,412,614 2,324,516 1

U.S. Government Obligation 25,009,000 25,009,000 8 - -

Utilities: Electric 1,979,983 1,991,015 1 5,420,438 5,031,043 1

Total $ 370,069,689 $ 316,615,300 100 % $ 420,801,057 $ 366,471,304 100 %

¹ Calculated as a percentage of total portfolio at fair value.

² Represents the equity investment in the Asset Manager Affiliates.



Debt Securities Portfolio

At September 30, 2017 and December 31, 2016, our investments in income producing debt securities portfolio, excluding CLO Fund securities, had a weighted average interest rate of approximately 9.2% and 7.0%, respectively. For the nine months ended September 30, 2017, our total net asset value return per share was 1.3% and our total market return based on our stock price was 0.7%. For the year ended December 31, 2016, our total net asset value return per share was 0.2% and our total market return based on stock price was 12.3%. Total net asset value return per share and total market return based on stock price do not reflect the sales load paid by stockholders.

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The investment portfolio (excluding the Company’s investment in Asset Manager Affiliates, CLO Fund Securities, the Joint Venture, and Short-term investments) at September 30, 2017 was spread across 19 different industries and 19 different entities with an average balance per entity of approximately $5.3 million. As of September 30, 2017, all but two of our portfolio companies were current on their debt service obligations.

We may invest up to 30% of our total assets 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 large cap public companies. At September 30, 2017 and December 31, 2016, the total amount of non-qualifying assets were approximately 28% and 17% of the total investment portfolio, respectively. The majority of non-qualifying assets were foreign investments which were approximately 16% and 14% of the Company’s total investment portfolio, respectively (including the Company’s investments in CLO Funds, which are typically domiciled outside the U.S. and represented approximately 16% and 14% 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.

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, 2017 and December 31, 2016, our Asset Manager Affiliates had approximately $2.8 billion and $3.0 billion of par value respectively, of assets under management on which they earn management fees, and were valued at approximately $39.7 million and $40.2 million, respectively.

All CLO Funds managed by the Asset Manager Affiliates are currently paying all senior and subordinate management fees. In addition, in the nine months ended September 30, 2017 our Asset Manager Affiliates recognized $3.0 million of incentive fees from one fund.

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, 2017, we had approximately $52 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, 2017 and December 31, 2016 are as follows:

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September 30, 2017 December 31, 2016

CLO Fund Securities Investment %¹ Cost/Amortized
Cost Fair Value Cost/Amortized
Cost Fair Value

Grant Grove CLO, Ltd.³ Subordinated Securities 22.2 % $ 2,485,886 $ 1,000 $ 2,485,886 $ 1,000

Katonah III, Ltd.³ Preferred Shares 23.1 1,287,155 369,000 1,287,155 369,000

Katonah 2007-I CLO Ltd.² Preferred Shares 100.0 31,123,451 21,447,386 28,022,646 20,453,099

Trimaran CLO VII, Ltd.² Income Notes 10.5 379,830 10,000 1,643,920 1,195,152

Catamaran CLO 2012-1 Ltd.² Subordinated Notes 24.9 5,759,981 2,239,810 5,919,933 2,819,412

Catamaran CLO 2013-1 Ltd.² Subordinated Notes 23.5 4,786,050 3,806,100 5,237,222 4,918,807

Catamaran CLO 2014-1 Ltd.² Subordinated Notes 32.4 8,681,740 4,847,620 7,818,484 4,546,682

Catamaran CLO 2014-1 Ltd.² Class E Notes 15.1 1,451,386 1,520,000 1,441,727 1,310,000

Dryden 30 Senior Loan Fund Subordinated Notes 7.5 1,276,135 1,499,682 1,343,467 1,895,566

Catamaran CLO 2014-2 Ltd.² Subordinated Notes 24.9 6,699,877 4,484,009 6,967,560 5,092,087

Catamaran CLO 2015-1 Ltd.² Subordinated Notes 9.9 4,416,694 3,033,719 4,543,317 3,223,255

Catamaran CLO 2016-1 Ltd.² Subordinated Notes 24.9 10,196,554 8,585,018 10,140,000 8,350,290

Total $ 78,544,739 $ 51,843,344 $ 76,851,317 $ 54,174,350



¹ Represents percentage of class held as of September 30, 2017.

² A CLO Fund managed by an Asset Manager Affiliate.

³ As of September 30, 2017, this CLO Fund security was not providing a distribution.

Investment in Joint Venture:

During the third quarter of 2017, the Company and Freedom 3 Opportunities LLC (“Freedom Opportunities”), an affiliate of Freedom 3 Capital LLC, entered into an agreement to create the Joint Venture. The Company and Freedom 3 Opportunities contributed approximately $37 million and $25 million, respectively, in assets to the Joint Venture, which in turn used the assets to capitalize a new fund (the "Fund") managed by KCAP Management, LLC, one of the Company's Asset Manager Affiliates. In addition, the Fund used cash on hand and borrowings under a credit facility to purchase approximately $184 million of loans from the Company and the Company used the proceeds from such sale to redeem approximately $147 million in debt issued by KCAP Senior Funding. The Joint Venture may originate loans from time to time and sell them to the Fund.

The Joint Venture is structured as an unconsolidated Delaware limited liability company. All portfolio and other material decisions regarding the Joint Venture must be submitted to its board of managers, which is comprised of four members, two of whom were selected by the Company and two of whom were selected by Freedom 3 Opportunities, and must be approved by at least one member appointed by the Company and one appointed by Freedom 3 Opportunities. In addition, certain matters may be approved by the Joint Venture’s investment committee, which is comprised of one member appointed by the Company and one member appointed by Freedom 3 Opportunities.

The Company has determined that the Joint Venture is an investment company under ASC 946, however, in accordance with such guidance, the Company will generally not consolidate its investment in a company other than a wholly owned investment company subsidiary or a controlled operating company whose business consists of providing services to the Company. Accordingly, the Company does not consolidate its non-controlling interest in the Joint Venture.

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The following tables detail the ten largest portfolio companies (at fair value) as of September 30, 2017 and December 31, 2016:

September 30, 2017 (unaudited)

Investment Cost/Amortized Cost Fair Value % of FMV

Asset Manager Affiliates $ 53,341,230 $ 39,679,000 13 %

KCAP Freedom 3 LLC 36,738,873 36,591,122 12

US Bank Money Market Account 32,001,559 32,001,559 10

Katonah 2007-I CLO Ltd. 31,123,451 21,447,386 7

Trimaran Advisors, L.L.C. 20,000,000 20,000,000 6

U.S Treasury Bills - CUSIP: 912796LY3 15,007,000 15,007,000 5

U.S Treasury Bills - CUSIP: 912796KR9 10,002,000 10,002,000 3

Tank Partners Holdings, LLC 12,420,461 8,222,814 3

Catamaran CLO 2016-1 Ltd. 10,196,554 8,585,018 3

Grupo HIMA San Pablo, Inc. 10,023,444 9,290,017 3

Total $ 230,854,572 $ 200,825,916 65 %

December 31, 2016

Investment Cost/Amortized Cost Fair Value % of FMV

Asset Manager Affiliates $ 55,341,230 $ 40,198,000 11 %

US Bank Money Market Account¹ 28,685,001 28,685,001 8

Katonah 2007-I CLO Ltd. 28,022,646 20,453,099 6

Grupo HIMA San Pablo, Inc. 9,828,619 9,113,125 2

Catamaran CLO 2016-1 Ltd. 10,140,000 8,350,290 2

Tank Partners Holdings, LLC 11,822,180 6,552,311 2

Roscoe Medical, Inc. 6,666,733 6,499,000 2

Weiman Products, LLC 5,462,647 5,321,809 1

Nielson & Bainbrige, LLC 5,326,136 5,199,447 1

Catamaran CLO 2014-2 Ltd. 6,967,560 5,092,087 1

Total $ 168,262,752 $ 135,464,169 36 %

Excluding the Asset Manager Affiliates and CLO Fund Securities, the Company’s ten largest portfolio companies represented approximately 49% and 13% of the total fair value of the Company’s investments at September 30, 2017 and December 31, 2016, respectively.

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, 2017 and 2016.

Revenue

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

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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 select 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.

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 CLO 2014-1 Ltd, 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, 2017, the Asset Manager Affiliates received incentive fees from one fund.

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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. The fair value of our investment in our Asset Manager Affiliates was approximately $39.7 million at September 30, 2017, with an unrealized gain during the nine months ended September 30, 2017 of approximately $1.5 million. For the three months ended September 30, 2017 and 2016, we recognized dividend income of approximately $180,000 and $0 from the Asset Manager Affiliates, respectively, while cash distributions received were $880,000 and $750,000 for the three months ended September 30, 2017 and 2016, respectively. For the nine months ended September 30, 2017 and 2016, we recognized dividend income of approximately $180,000 and $1.4 million from the Asset Manager Affiliates, respectively, while cash distributions received were approximately $2.2 million and $2.7 million for the three months ended September 30, 2017 and 2016, 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 $2.8 billion and $3.0 billion as of September 30, 2017 and December 31, 2016, respectively.

Investment in Joint Venture. For the three months ended September 30, 2017, the Company recognized $685,000 in investment income from its investment in the Joint Venture. As of September 30, 2017, the fair value of the Company’s investment in Joint venture was $36.6 million.

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, 2017 and 2016 was approximately $6.3 million and $9.0 million, respectively. Of these amounts, approximately $2.4 million and $5.2 million was attributable to interest income on our Debt Securities Portfolio.

Investment income for the nine months ended September 30, 2017 and 2016 was approximately $21.7 million and $28.1 million, respectively. Of these amounts, approximately $11.8 million and $16.1 million was attributable to interest income on our Debt Securities Portfolio.

The weighted average interest rate on our income producing Debt Securities Portfolio was 9.2% and 7.0% as of September 30, 2017 and December 31, 2016, respectively. For the nine months ended September 30, 2017, our total net asset value return per share was 1.3% and our total market return based on stock price was 0.7%. For the nine months ended September 30, 2016, our total net asset value return per share was 0.2% and our total market return based on stock price was 24.8%. Total net asset value return per share and total market return based on stock price do not reflect the sales load paid by stockholders.

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.

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For the three months ended September 30, 2017 and 2016, approximately $2.8 million and $3.5 million, respectively, of investment income was attributable to investments in CLO Fund Securities. For the nine months ended September 30, 2017 and 2016, approximately $8.7 million and $10.1 million, respectively, of investment income was attributable to investments in CLO Fund Securities. On a tax-basis, the Company recognized $2.3 million and $7.0 million of taxable distributable income on distributions from our CLO Fund Securities during the three and nine months ended September 30, 2017, respectively. 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 expected term of the borrowing.

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, 2017 and 2016 were approximately $3.7 million and $4.5 million, respectively. Interest expense and amortization on debt issuance costs for the periods, were approximately $1.4 million and $2.1 million, respectively, on average debt outstanding of $34 million and $186 million, respectively.

For the three months ended September 30, 2017 and 2016, approximately $1.1 million and $1.2 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, 2017 and 2016, respectively, professional fees and insurance expenses totaled approximately $883,000 and $802,000. Administrative costs, which include occupancy expense, technology and other office expenses, totaled approximately $396,000 and $372,000 for the three months ended September 30, 2017 and 2016, respectively.

Total expenses for the nine months ended September 30, 2017 and 2016 were approximately $13.3 million and $13.7 million, respectively. Interest expense and amortization on debt issuance costs for the periods, were approximately $5.8 million and $7.0 million, respectively, on average debt outstanding of $131 million and $193 million, respectively.

For the nine months ended September 30, 2017 and 2016, approximately $3.5 million and $3.2 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, 2017 and 2016, respectively, professional fees and insurance expenses totaled approximately $2.8 million and $2.2 million. Administrative costs, which include occupancy expense, technology and other office expenses, totaled approximately $1.3 million and $1.3 million for the nine months ended September 30, 2017 and 2016, respectively.

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Net Investment Income and Net Realized Gains (Losses)

Net investment income and net realized gains (losses) represents the net change in stockholder’s equity before net unrealized appreciation or depreciation on investments. For the three months ended September 30, 2017, net investment income and net realized losses were approximately $623,000, or $0.02 per share. For the three months ended September 30, 2016, net investment income and net realized gains were approximately $9.2 million or $0.25 per share. For the nine months ended September 30, 2017, net investment income and net realized losses were approximately $5.5 million, or $0.15 per share. For the nine months ended September 30, 2016, net investment income and net realized losses were approximately $8.3 million or $0.22 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. On February 29, 2016, Katonah X CLO Ltd. was fully liquidated and all of its outstanding obligations were satisfied. The Company received approximately $1.0 million in connection therewith related to its investment in the subordinated securities issued by Katonah X CLO Ltd. Accordingly, the Company recorded a realized loss during the first quarter of 2016 of approximately $6.6 million on its investment in Katonah X CLO Ltd. and a corresponding unrealized gain of the same amount in order to reverse the approximately $6.6 million of previously recorded unrealized depreciation with respect to the investment. For the three months ended September 30, 2017 and 2016, GAAP-basis net investment income was approximately $2.5 million or $0.07 per share, and $4.5 million or $0.12 per share, respectively, while tax-basis distributable income was approximately $2.3 million or $0.07 per share and $4.6 million or $0.12 per share, respectively. For the nine months ended September 30, 2017 and 2016, GAAP-basis net investment income was approximately $8.4 million or $0.23 per share, and $14.4 million or $0.39 per share, respectively, while tax-basis distributable income was approximately $6.9 million or $0.19 per share and $14.9 million or $0.40 per share, respectively.

Net Unrealized (Depreciation) Appreciation on Investments

During the three months ended September 30, 2017, our total investments had net unrealized appreciation of approximately $2.7 million. During the three months ended September 30, 2016, our total investments had net unrealized depreciation of approximately $6.4 million. For the three months ended September 30, 2017, our Asset Manager Affiliates had net unrealized appreciation of approximately $2.9 million. For the three months ended September 30, 2016, our Asset Manager Affiliates had net unrealized depreciation of approximately $1.1 million. For the three months ended September 30, 2017, our portfolio of debt securities and equity securities had net unrealized appreciation of approximately $1.6 million, compared with net unrealized depreciation of $4.1 million during the third quarter of 2016. For the three months ended September 30, 2017, our CLO Fund Securities had net unrealized depreciation of approximately $1.6 million compared with net unrealized depreciation of $1.1 million during the third quarter of 2016. For the three months ended September 30, 2017, our investment in the Joint Venture had net unrealized depreciation of $147,000.

During the nine months ended September 30, 2017, our total investments had net unrealized appreciation of approximately $875,000. During the nine months ended September 30, 2016, our total investments had net unrealized depreciation of approximately $9.3 million. For the nine months ended September 30, 2017, our Asset Manager Affiliates had net unrealized appreciation of approximately $1.5 million. For the nine months ended September 30, 2016, our Asset Manager Affiliates had net unrealized depreciation of approximately $12.7 million. For the nine months ended September 30, 2017, our portfolio of debt securities and equity securities had net unrealized appreciation of approximately $3.6 million, compared with net unrealized depreciation of $2.4 million during the nine months ended September 30, 2016. For the nine months ended September 30, 2017, our CLO Fund Securities had net unrealized depreciation of approximately $4.0 million compared with net unrealized appreciation of $5.8 million during the nine months ended September 30, 2016. For the nine months ended September 30, 2017, our investment in the Joint Venture had net unrealized depreciation of $147,000.

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, 2017 was $669,000, or $0.02 per share. Net decrease in stockholders’ equity resulting from operations for the three months ended September 30, 2016 was $2.7 million, or $0.07 per share.

The net increase in stockholders’ equity resulting from operations for the nine months ended September 30, 2017 was $2.2 million, or $0.08 per share. Net decrease in stockholders’ equity resulting from operations for the nine months ended September 30, 2016 was $1.1 million, or $0.03) 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, 2017 and December 31, 2016 the fair value of investments and cash were as follows:

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Investments at Fair Value

Security Type September 30, 2017 December 31, 2016

Cash $ 1,186,838 $ 1,307,257

Restricted Cash — 8,528,298

Short-term Investments 57,024,828 28,699,269

Senior Secured Loan 46,124,913 200,322,152

Junior Secured Loan 58,343,554 35,444,440

Senior Unsecured Loan 20,000,000 —

First Lien Bond 1,063,762 1,089,338

Senior Secured Bond 1,494,600 1,487,400

CLO Fund Securities 51,843,344 54,174,350

Equity Securities 4,450,177 5,056,355

Asset Manager Affiliates 39,679,000 40,198,000

Joint Venture 36,591,122 —

Total $ 317,802,138 $ 376,306,859

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, 2017, we had approximately $104.4 million of par value of outstanding borrowings and our asset coverage ratio of total assets to total borrowings was 274%, 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.

On March 15, 2016, the Convertible Notes matured and were repaid in full.

On October 10, 2012, the Company issued $41.4 million in aggregate principal amount of unsecured 7.375% Notes Due 2019 (“the 7.375 Notes Due 2019”). The net proceeds for 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, 2017, 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. During the second quarter of 2016, the Company repurchased approximately $2.4 million par value of the 7.375% notes due 2019 at a weighted average price of $25.23 per $25.00 note, resulting in a realized loss on extinguishment of $71,190. During the third quarter of 2016, $5.0 million par value of the 7.375% Notes due 2019 was redeemed by the Company, resulting in a realized loss on extinguishment of $88,015. During the fourth quarter of 2016, $469,000 par value of the 7.375% Notes due 2019 was redeemed by the Company, resulting in a realized loss on extinguishment of $15,000. During the second quarter of 2017, the Company redeemed $6.5 million par value of the 7.375% Notes due 2019 resulting in a realized loss on extinguishment of debt of $107,276. KCAP subsequently surrendered all of these notes to the Trustee for cancellation.

On July 20, 2017 $147.4 million par value of notes issued by KCAP Senior Funding were repaid in full, resulting in a realized loss on extinguishment of debt of $4 million.

During the third quarter of 2017, the company issued $77.4 million aggregate principal amount of 6.125% Notes Due 2022 (“the 6.125 Notes Due 2022”). The net proceeds for these Notes, after the payment of underwriting expenses, were approximately $74.6 million. Interest on the 6.125% Notes Due 2022 is paid quarterly in arrears on March 30, June 30, September 30 and December 30, at a rate of 6.125% commencing September 30, 2017. The 6.125% Notes Due 2022 mature on September 30, 2022, and are 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 6.125% Notes Due 2022, 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, 2017, the Company was in compliance with all of its debt covenants. The indenture governing the 6.125% Notes Due 2022 contains certain restrictive covenants, including compliance with certain provisions of the 1940 Act relating to borrowing and dividends.

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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. However, we may face difficulty in obtaining a new debt and equity financing as a result of current market conditions. In this regard, because our common stock has traded at a price below our current net asset value per share over the last year or so and we are limited in our ability to sell our common stock at a price below net asset value per share without stockholder approval (which we currently do not have), we have been and may continue to be limited in our ability to raise equity capital. 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.

Stockholder Distributions

We intend to continue to make quarterly distributions to our stockholders. To avoid certain excise taxes imposed on RICs, we generally endeavor 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 and on which we do not pay corporate tax.

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.

The amount of our declared distributions, as evaluated by management and approved by our Board of Directors, is based primarily on our evaluation of our distributable taxable income and the 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 on our common stock if our asset coverage, as defined in the 1940 Act, falls below 200%. In any such event, we would be prohibited from making distributions required in order to maintain our status as a RIC.

The following table sets forth the quarterly distributions declared by us since for the two most recently completed fiscal years and the current fiscal year to date.

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Distribution Declaration
Date Record
Date Pay Date

2017:

Third quarter $ 0.12 9/22/2017 10/10/2017 10/26/2017

Second quarter 0.12 6/20/2017 7/7/2017 7/27/2017

First quarter 0.12 3/21/2017 4/7/2017 4/28/2017

Total declared in 2017 $ 0.36

2016:

Fourth quarter $ 0.12 12/14/2016 1/6/2017 ¹ 1/27/2017

Third quarter 0.15 9/20/2016 10/14/2016 10/27/2016

Second quarter 0.15 6/21/2016 7/7/2016 7/28/2016

First quarter 0.15 3/18/2016 4/7/2016 4/28/2016

Total declared in 2016 $ 0.57

2015:

Fourth quarter $ 0.15 12/16/2015 1/6/2016 ¹ 1/28/2016

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 $ 0.78

¹ Since the record date of this distribution is subsequent to year-end, it is a subsequent year tax event.

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, 2017 and December 31, 2016, the Company had approximately $3 million and $565,000 of commitments to make such investments, respectively.

CONTRACTUAL OBLIGATIONS

The following table summarizes our contractual cash obligations and other commercial commitments as of September 30, 2017:

Payments Due by Period

Contractual Obligations Total Less than one
year 1 - 3 years 3 - 5 years More than 5
years

Long-term debt obligations $ 104,407,200 $ — $ 27,000,000 $ 77,407,200 $ —

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.

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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 determined 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.

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.

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• 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. The 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 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. The Company’s fair value determinations may include factors such as an assessment of each underlying investment, its current and prospective operating and financial performance, consideration of financing and sale transactions with third parties, expected cash flows and market-based information, including comparable transactions, performance factors, and other investment or industry specific market data, among other factors.

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.

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 securities we 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.

KCAP carries investments in joint ventures at fair value based upon the fair value of the investments held by the joint venture.

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.

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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, 2017, two issuers representing 1% of the Company’s total investments at fair value were on a non-accrual status, and one of our investments, representing 2% of the Company’s investments at fair value, was on partial non-accrual status, whereby we have recognized income on a portion of contractual payment-in-kind (PIK) amounts due.

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.

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For non-junior class CLO Fund Securities, such as our investment in the class E notes of Catamaran CLO 2014-1 Ltd, 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.

Distributions from Joint Venture

We recognize investment income from our joint venture based on the Company’s share of thr tax-basis earnings and profits on the joint venture entity. 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 Joint Venture). The final determination of the tax attributes of distributions from our Joint Venture 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.

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.

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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

2017 ⁽¹⁾:

Third quarter $ 0.12 9/22/2017 10/10/2017 10/26/2017

Second quarter 0.12 6/20/2017 7/7/2017 7/27/2017

First quarter 0.12 3/21/2017 4/7/2017 4/28/2017

Total declared in 2017 $ 0.36

2016 ⁽²⁾:

Fourth quarter $ 0.12 12/14/2016 1/6/2017 ¹ 1/27/2017

Third quarter 0.15 9/20/2016 10/14/2016 10/27/2016

Second quarter 0.15 6/21/2016 7/7/2016 7/28/2016

First quarter 0.15 3/18/2016 4/7/2016 4/28/2016

Total declared in 2016 $ 0.57

2015 ⁽³⁾ :

Fourth quarter $ 0.15 12/16/2015 1/6/2016 ¹ 1/28/2016

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 $ 0.78

¹ Percentage of distributions representing a return of capital will be determined on a full-year basis for 2017 in early 2018

² Approximately 33.7% of 2016 distributions represented a return of capital.

³ Approximately 0.0% of 2015 distributions represented a return of capital.

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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,

2017¹ 2016¹ 2017¹ 2016¹

Net investment income $ 0.07 $ 0.12 $ 0.23 $ 0.39

Tax Accounting Difference on CLO Equity Investments (0.01 ) - (0.05 ) 0.03

Other tax accounting differences 0.01 - 0.01 (0.02 )

Taxable distributable income 0.06 0.12 0.19 0.40

Cash distributed to the Company by Asset Manager Affiliates in excess of their taxable earnings 0.02 0.02 0.05 0.03

Cash received from CLO Equity Investments in excess of their taxable earnings - - 0.03 -

Available for distribution² 0.08 0.14 0.27 0.43

Distributed 0.12 0.15 0.36 0.45

Difference $ (0.04 ) $ (0.01 ) $ (0.09 ) $ (0.02 )

¹ Table may not foot due to rounding.

² The "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 $0.05 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, 2017, respectively. The Company's management believes that the presentation of the non-GAAP "Available for distribution" financial measure provides useful information to investors.

Recent Developments

On October 31, 2017, the Joint Venture made a cash distribution to the Company of approximately $12.6 million. The Company expects that approximately $11.8 million of this distribution will be return of capital, reducing the cost basis of its investment in the Joint Venture by that amount. The final determination of the tax attributes of distributions from the Joint Venture is made on an annual (full calendar year) basis at the end of the year, therefore, any estimate of tax attributes of distributions made on an interim basis may not be representative of the actual tax attributes of distributions for the full year.

On October 30, 2017, the Company entered into a new term loan agreement with Trimaran Advisors, one of the Asset Manager Affiliates. Trimaran Advisors borrowed $8.4 million under this agreement, which bears interest at a rate of 10.5% annually, payable quarterly. The loan matures on April 30, 2030, can be repaid at any time, and must be repaid upon the occurrence of certain events.

On October 31, 2017, Trimaran Advisors capitalized Trimaran Risk Retention Holdings, LLC, a newly-formed wholly-owned subsidiary, with $8.4 million of equity capital. In turn, Trimaran Risk Retention Holdings capitalized Trimaran RR I, LLC, a wholly-owned subsidiary of Trimaran Risk Retention Holdings, LLC, with $8.4 million of equity capital. With this equity contribution and other borrowed funds, Trimaran RR I, LLC purchased $34.8 million notional amount of notes issued by Catamaran CLO 2014-1, Ltd. for aggregate consideration of $35.5 million.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Our business activities contain elements of market risks. We consider our principal market risk to be fluctuations in interest rates. 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.

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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, 2017, approximately 98.1% 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 1.00% and 3.00%. We generally expect that future portfolio investments will predominately be floating rate investments. As of September 30, 2017, we had $104.4 million of borrowings outstanding at a current weighted average rate of 6.4%.

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 7.375% Notes Due 2019 and 6.125% Notes Due 2022 would remain the same, given that this debt is at a fixed rate.

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, 2017 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 from a change in interest
rates at:

1% 2% 3%

Increase in interest rate $ 864,592 $ 1,700,553 $ 2,536,515

Decrease in interest rate $ (220,059 ) $ (220,059 ) $ (220,059 )

As shown above, net investment income assuming a 1% increase in interest rates would increase by approximately $865,000 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 $1.7 million and $2.5 million, respectively. Since LIBOR underlying certain investments, as well as certain of our borrowings, is currently 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 $220,000 decrease 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, 2017.

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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. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

Item 5. 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

There have been no changes in our internal control over financial reporting during the three months ended September 30, 2017 that have materially affected, or are reasonably likely to materially affect, our 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, 2016.

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, 2017, we issued a total of 18,141 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, 2017, the aggregate value of the shares of our common stock issued under our DRIP was approximately $64,000.

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 7, 2017 By /s/ Dayl W. Pearson

Dayl W. Pearson

President and Chief Executive Officer

(Principal Executive Officer)

Date: November 7, 2017 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

2.1 Purchase and Sale Agreement, dated February 29, 2012, by and among Kohlberg Capital Corporation (the “Company”), Commodore Holdings, L.L.C., Trimaran Advisors, L.L.C., HBK Caravelle, L.L.C., Trimaran Fund Management, L.L.C., Jay R. Bloom, and Dean C. Kehler.⁽¹⁾

3.1 Form of Certificate of Incorporation of the Company.⁽²⁾

3.2 Form of Bylaws of the Company, as amended and restated effective February 29, 2012.⁽³⁾

4.1 Form of Dividend Reinvestment Plan.⁽⁴⁾

4.2 Form of Base Indenture between the Company, as Issuer, and U.S. Bank National Association, as Trustee⁽⁵⁾

4.3 Form of First Supplemental Indenture between the Company and U.S. Bank National Association relating to the 7.375% Senior Notes Due 2019⁽⁵⁾

4.4 Form of Note relating to the 7.375% Senior Notes Due 2019 (included as part of Exhibit 4.3)⁽⁵⁾

4.5 Second Supplemental Indenture between the Company and U.S. Bank National Association relating to the 6.125% Notes Due 2022⁽⁶⁾

4.6 Form of 6.125% Notes Due 2022 (included as part of Exhibit 4.5).⁽⁶⁾

11.1 Computation of Per Share Earnings (included in the notes to the unaudited financial statements contained in this report).

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

(1) Incorporated by reference to Exhibit 2.1 of the Current Report on Form 8-K, as filed on March 1, 2012 (File No. 814-00735).

(2) Incorporated by reference to the exhibit included in Pre-Effective Amendment No. 1 on Form N-2, as filed on October 6, 2006 (File No. 333-136714).

(3) Incorporated by reference to Exhibit 3.1 of the Current Report on Form 8-K, as filed on March 1, 2012 (File No. 814-00735).

(4) Incorporated by reference to the exhibit included in Pre-Effective Amendment No. 2 on Form N-2, as filed on November 20, 2006 (File No. 333-136714).

(5) Incorporated by reference to exhibit included in the Registration Statement in Form N-2, as filed on October 3, 2012 (File No. 333-183032).

(6) Incorporated by reference to the exhibit included in Post-Effective Amendment No. 1 on Form N-2, as filed on August 14, 2017 (File No. 333-218596).

80

	Nine Months Ended September 30, 2016

Net cash (used in) financing activities as reported	$	(46,702,870	)
Impact of Adoption		3,771,347

Net cash (used in) financing activities after adoption	$	(42,931,523	)

	(unaudited)						(unaudited)
	Three Months Ended September 30,						Nine Months Ended September 30,
	2017			2016			2017			2016

Net increase (decrease) in net assets resulting from operations	$	(669,449	)	$	2,716,613		$	2,237,830		$	(1,118,600	)
Net (increase) decrease in net assets allocated to unvested share awards		3,260			(30,313	)		(18,094	)		16,701

Net increase (decrease) in net assets available to common stockholders	$	(666,189	)	$	2,686,300		$	2,219,736		$	(1,101,900	)
Weighted average number of common shares outstanding for basic shares computation		37,196,621			37,152,622			37,202,011			37,142,002

Weighted average number of common and common stock equivalent shares outstanding for diluted shares computation		37,196,621			37,152,622			37,202,011			37,142,002

Net increase (decrease) in net assets per basic common shares:
Net increase (decrease) in net assets from operations	$	(0.02	)	$	0.07		$	0.06		$	(0.03	)
Net increase (decrease) in net assets per diluted shares:
Net increase (decrease) in net assets from operations	$	(0.02	)	$	0.07		$	0.06		$	(0.03	)

	September 30, 2017 (unaudited)							December 31, 2016
Security Type	Cost/ Amortized Cost		Fair Value		%¹			Cost/ Amortized Cost		Fair Value		%¹
Short-term Investments²		57,024,828	$	57,024,828		18			28,699,269	$	28,699,269		8
Senior Secured Loan		49,982,415		46,124,914		15			207,701,078		200,322,152		55
Junior Secured Loan		59,490,855		58,343,554		18			37,251,776		35,444,440		10
Senior Unsecured Loan		20,000,000		20,000,000		6			-		-		-
First Lien Bond		3,054,337		1,063,762		-			3,060,919		1,089,338		-
Senior Secured Bond		1,503,404		1,494,600		-			1,506,461		1,487,400		-
CLO Fund Securities		78,544,739		51,843,344		16			76,851,317		54,174,350		15
Equity Securities		10,389,007		4,450,177		1			10,389,007		5,056,355		1
Asset Manager Affiliates³		53,341,230		39,679,000		13			55,341,230		40,198,000		11
Joint Venture		36,738,873		36,591,122		13			-		-		-

Total	$	370,069,689	$	316,615,300		100	%	$	420,801,057	$	366,471,304		100	%

	September 30, 2017 (unaudited)							December 31, 2016
Industry Classification	Cost/ Amortized Cost		Fair Value		%¹			Cost/ Amortized Cost		Fair Value		%
Aerospace and Defense	$	4,929,171	$	3,268,788		1	%	$	8,394,633	$	8,450,106		2	%
Asset Management Company²		53,341,230		39,679,000		13			55,341,230		40,198,000		11
Automotive		-		-		-			6,322,551		6,196,154		2
Banking, Finance, Insurance & Real Estate		3,466,776		3,443,506		1			6,805,514		6,782,010		2
Beverage, Food and Tobacco		4,512,854		4,346,400		1			15,198,830		14,703,372		4
Capital Equipment		5,455,586		4,744,140		1			6,185,129		5,575,048		2
Chemicals, Plastics and Rubber		-		-		-			6,421,909		6,444,073		2
CLO Fund Securities		78,544,739		51,843,344		16			76,851,317		54,174,350		15
Construction & Building		1,007,336		1,007,423		-			5,919,158		5,929,606		2
Consumer goods: Durable		3,054,338		1,064,762		-			12,319,905		10,118,736		3
Consumer goods: Non-durable		732,896		734,613		-			14,766,390		14,452,096		4
Ecological		-		-		-			1,741,292		1,760,783		-
Energy: Electricity		-		-		-			3,904,453		3,937,247		1
Energy: Oil & Gas		13,929,048		10,575,738		3			14,493,835		8,805,761		2
Environmental Industries		6,922,952		6,156,451		2			12,279,924		12,185,239		3
Forest Products & Paper		1,557,040		1,600,960		1			4,192,889		4,192,907		1
Healthcare & Pharmaceuticals		36,573,091		33,901,061		11			58,769,668		53,594,534		15
High Tech Industries		16,093,619		16,051,970		5			9,854,093		9,936,109		3
Hotel, Gaming & Leisure		400,000		1,000		-			400,000		1,000		-
Joint Venture		36,738,873		36,591,122		12			-		-		-
Media: Advertising, Printing & Publishing		3,869,962		3,875,038		1			11,712,682		11,453,447		3
Media: Broadcasting & Subscription		-		-		-			8,273,174		8,372,984		2
Related Party Loan		20,000,000		20,000,000		6			-		-		-
Retail		-		-		-			1,415,457		759,581		-
Services: Business		5,523,913		4,427,100		1			16,125,481		16,230,486		4
Services: Consumer		-		-		-			6,212,108		6,204,889		2
Telecommunications		3,965,663		3,939,200		1			12,809,799		12,767,823		3
Textiles and Leather		7,948,833		7,847,841		3			-		-		-
Money Market Accounts		32,015,828		32,015,828		11			28,699,269		28,699,269		8
Transportation: Cargo		2,496,958		2,500,000		1			7,557,315		7,190,135		2
Transportation: Consumer		-		-		-			2,412,614		2,324,516		1
U.S. Government Obligation		25,009,000		25,009,000		8			-		-
Utilities: Electric		1,979,983		1,991,015		1			5,420,438		5,031,043		1

Total	$	370,069,689	$	316,615,300		100	%	$	420,801,057	$	366,471,304		100	%

	September 30, 2017 (unaudited)
Investment	Cost/Amortized Cost		Fair Value		% of FMV
Asset Manager Affiliates	$	53,341,230	$	39,679,000		13	%
KCAP Freedom 3 LLC		36,738,873		36,591,122		12
US Bank Money Market Account		32,001,559		32,001,559		10
Katonah 2007-I CLO Ltd.		31,123,451		21,447,386		7
Trimaran Advisors, L.L.C.		20,000,000		20,000,000		6
U.S Treasury Bills - CUSIP: 912796LY3		15,007,000		15,007,000		5
U.S Treasury Bills - CUSIP: 912796KR9		10,002,000		10,002,000		3
Tank Partners Holdings, LLC		12,420,461		8,222,814		3
Catamaran CLO 2016-1 Ltd.		10,196,554		8,585,018		3
Grupo HIMA San Pablo, Inc.		10,023,444		9,290,017		3
Total	$	230,854,572	$	200,825,916		65	%

	Fair Value at December 31, 2016		Purchases/(Sales) of or Advances/(Distributions)			Net Accretion		Unrealized Gain/(Loss)			Fair Value at of September 30, 2017 (unaudited)		Interest Income		Dividend Income

Asset Manager Affiliates	$	40,198,000	$	(2,000,000	)	$	-	$	1,481,000		$	39,679,000	$	-	$	180,000
Trimaran Advisors, LLC Related Party Loan		-		20,000,000			-		-			20,000,000		506,306		-
Katonah 2007-I CLO, Ltd.		20,453,099		(1,841,861	)		4,942,665		(2,106,519	)		21,447,386		4,942,665		-
Trimaran CLO VII, Ltd.		1,195,152		(1,264,090	)		-		78,938			10,000		-		-
Catamaran CLO 2012-1, Ltd.		2,819,412		(636,377	)		476,425		(419,650	)		2,239,810		476,425		-
Catamaran CLO 2013-1, Ltd.		4,918,807		(985,219	)		534,047		(661,535	)		3,806,101		534,047		-
Catamaran CLO 2014-1, Ltd.		4,546,682		303,037			560,220		(562,318	)		4,847,621		560,220		-
Catamaran CLO 2014-2, Ltd.		5,092,087		(880,468	)		612,786		(340,395	)		4,484,010		612,786		-
Catamaran CLO 2015-1, Ltd.		3,223,255		(442,803	)		316,181		(62,913	)		3,033,719		316,181		-
Catamaran CLO 2016-1, Ltd.		8,350,290		(791,935	)		848,489		178,174			8,585,018		848,489		-
CRMN 2014-1A		1,310,000		-			9,659		200,341			1,520,000		87,974		-
KCAP Freedom 3, LLC		-		36,738,873			-		(147,751	)		36,591,122		-		685,000

Total Affiliated Investments	$	92,106,784	$	48,199,157		$	8,300,472	$	(2,362,628	)	$	146,243,787	$	8,885,093	$	865,000

	As of
	September 30, 2017
Investment at fair value	$	62,591,610
Total Assets	$	62,591,610

Total Liabilities	$	1,026,962
Total Equity		61,564,648
Total Liabilities and Equity	$	62,591,610

	For the period from July 20, 2017 (date of inception) to September 30, 2017
Investment income	$	1,026,962
Operating Expenses		10,000
Net Investment Income		1,016,962
Unrealized appreciation on Investments		79,258
Net Income	$	1,096,220

	As of September 30, 2017 (unaudited)
	Level I		Level II		Level III		Total
Money market accounts	$	—	$	32,015,828	$	—	$	32,015,828
U.S. Treasury Bills		25,009,000		—		—		25,009,000
Debt securities		—		68,707,692		58,319,137		127,026,829
CLO Fund securities		—		—		51,843,344		51,843,344
Equity securities		—		—		4,450,177		4,450,177
Asset Manager Affiliates		—		—		39,679,000		39,679,000
Joint Venture		—		—		36,591,122		36,591,122

Total	$	25,009,000	$	100,723,520	$	190,882,780	$	316,615,300

	As of December 31, 2016
	Level I		Level II		Level III		Total
Money market accounts	$	—	$	28,699,269	$	—	$	28,699,269
Debt securities		—		84,601,585		153,741,745		238,343,330
CLO Fund securities		—		—		54,174,350		54,174,350
Equity securities		—		—		5,056,355		5,056,355
Asset Manager Affiliates		—		—		40,198,000		40,198,000

Total	$	—	$	113,300,854	$	253,170,450	$	366,471,304

	Nine Months Ended September 30, 2017 (unaudited)
	Debt Securities			CLO Fund Securities			Equity Securities			Asset Manager Affiliate			Joint Venture			Total
Balance, December 31, 2016	$	153,741,745		$	54,174,350		$	5,056,355		$	40,198,000		$	—		$	253,170,450
Transfers out of Level III⁽¹⁾		—			—			—			—			—			—
Transfers into Level III⁽²⁾		6,372,000			—			—			—			—			6,372,000
Net accretion (amortization)		206,241			443,434			—			—			—			649,675
Purchases		20,048,575			1,249,988			1			—			36,738,873			58,037,437
Sales/Paydowns/Return of Capital		(126,670,826	)		—			—			(2,000,000	)		—			(128,670,826	)
Total realized gain (loss) included in earnings		(995,630	)		—			—			—			—			(995,630	)
Total unrealized gain (loss) included in earnings		5,617,032			(4,024,428	)		(606,179	)		1,481,000			(147,751	)		2,319,674
Balance, September 30, 2017	$	58,319,137		$	51,843,344		$	4,450,177		$	39,679,000		$	36,591,122			190,882,780
Changes in unrealized gains (losses) included in earnings related to investments still held at reporting date	$	1,174,559		$	(4,024,428	)	$	(1	)	$	1,481,000		$	(147,751	)	$	(1,368,870	)

	Year Ended December 31, 2016
	Debt Securities			CLO Fund Securities			Equity Securities			Asset Manager Affiliate			Joint Venture		Total
Balance, December 31, 2015	$	183,400,465		$	55,872,382		$	9,103,003		$	57,381,000		$	—	$	305,756,850
Transfers out of Level III		(14,855,471	)¹		—			—			—			—		(14,855,471	)
Transfers into Level III		22,107,141	²		—			445,485			—			—		22,552,626
Net accretion (amortization)		318,999			(2,192,069	)		—			—			—		(1,873,070	)
Purchases		33,641,315			10,140,000			180,161			—			—		43,961,476
Sales/Paydowns/Return of Capital		(66,559,349	)		(4,200,000	)		(4,743,682	)		(1,250,000	)		—		(76,753,031	)
Total realized gain (loss) included in earnings		(366,924	)		(10,111,560	)		4,484,742			—			—		(5,993,742	)
Total unrealized gain (loss) included in earnings		(3,944,431	)		4,665,597			(4,413,354	)		(15,933,000	)		—		(19,625,188	)
Balance, December 31, 2016	$	153,741,745		$	54,174,350		$	5,056,355		$	40,198,000		$	—		253,170,450
Changes in unrealized gains (losses) included in earnings related to investments still held at reporting date	$	(6,969,509	)	$	4,665,597		$	(4,413,354	)	$	(15,933,000	)	$	—	$	(22,650,266	)

Type	Fair Value	Primary Valuation Methodology	Unobservable Inputs	Range of Inputs (Weighted Average)
Type	Fair Value	Primary Valuation Methodology	Unobservable Inputs	Range of Inputs (Weighted Average)
Debt Securities	$ 11,219,800	Enterprise Value	Average EBITDA Multiple / WACC	5.2x - 6.7x (5.5x) 13.3% - 17.7% (16.8%)
Debt Securities	47,099,337	Income Approach	Implied Discount Rate	6.0% - 26.4% (13.8%)
Equity Securities	4,442,177	Enterprise Value	Average EBITDA Multiple / WACC	4.6x – 16.1x (10.4x) 10.6% - 14.6% (12.2%)
Equity Securities	8,000	Options Value	Qualitative Inputs⁽¹⁾
CLO Fund Securities	30,395,957	Discounted Cash Flow	Discount Rate	12.0%
			Probability of Default	2.0%
			Loss Severity	25.9%
			Recovery Rate	74.1%
			Prepayment Rate	25.0%
	21,447,386	Liquidation Value	Qualitative Inputs⁽²⁾
Asset Manager Affiliate	39,679,000	Discounted Cash Flow	Discount Rate	2.5% - 12.0% (6.5%)
Joint Venture	36,591,122	Enterprise Value	Qualitative Inputs⁽²⁾
Total Level III Investments	$ 190,882,780

	For the three months ended						For the nine months ended
	September 30,						September 30,
	2017			2016			2017		2016
Fee Revenue	$	3,027,460		$	3,148,353		$	12,000,010	$	9,707,075
Interest Income		25,298			570,865			31,208		1,138,483
Total Income		3,052,758			3,719,218			12,031,218		10,845,558
Operating Expenses		2,547,545			2,789,654			7,852,377		8,618,839
Amortization of Intangibles		-			327,541			327,541		982,623
Interest Expense		121,468			485,355			525,034		1,353,135
Total Expenses		2,669,013			3,602,550			8,704,952		10,954,597
Pre-Tax Income (Loss)		383,745			116,668			3,326,266		(109,039	)
Income Tax (Benefit) Expense		(79,791	)		(100,862	)		978,769		(346,447	)
Net Income	$	463,536		$	217,530		$	2,347,497	$	237,408

	As of September 30, 2017 (unaudited)		As of December 31, 2016

Notes issued by KCAP Senior Funding I, LLC (net of discount and offering costs of: 2016 - $2,286,425 and $2,459,156, respectively)	$	-	$	142,604,419
7.375 Notes (net of offering costs of: 2017 - $306,073; 2016 - $550,774)		26,693,927		32,980,151
6.125 Notes (net of offering costs of: 2017 - $2,757,357)		74,649,843		-
Total	$	101,343,770	$	175,584,570

	Shares		Weighted Average Exercise Price per Share		Weighted Average Contractual Remaining Term (years)		Aggregate Intrinsic Value¹
Options outstanding at January 1, 2016		50,000	$	7.72		3.4
Granted		—		—
Exercised		—		—
Forfeited		—		—
Options outstanding at December 31, 2016		50,000	$	7.72		2.4	$	—
Granted		—		—
Exercised		—		—
Forfeited		—		—
Outstanding at September 30, 2017		50,000	$	7.72		1.6	$	—

Total vested at September 30, 2017		50,000	$	7.72		1.6

	Non-vested Restricted Shares
Non-vested shares outstanding at January 1, 2016		700,539
Granted		6,000
Vested		(260,607	)
Forfeited		(34,453	)
Non-vested shares outstanding at December 31, 2016		411,479
Granted		139,620
Vested		(242,918	)
Forfeited		(10,982	)
Non-Vested Outstanding at September 30, 2017		297,199

	Investments at Fair Value
Security Type	September 30, 2017		December 31, 2016

Cash	$	1,186,838	$	1,307,257
Restricted Cash		—		8,528,298
Short-term Investments		57,024,828		28,699,269
Senior Secured Loan		46,124,913		200,322,152
Junior Secured Loan		58,343,554		35,444,440
Senior Unsecured Loan		20,000,000		—
First Lien Bond		1,063,762		1,089,338
Senior Secured Bond		1,494,600		1,487,400
CLO Fund Securities		51,843,344		54,174,350
Equity Securities		4,450,177		5,056,355
Asset Manager Affiliates		39,679,000		40,198,000
Joint Venture		36,591,122		—

Total	$	317,802,138	$	376,306,859

	Payments Due by Period
Contractual Obligations	Total		Less than one year		1 - 3 years		3 - 5 years		More than 5 years
Long-term debt obligations	$	104,407,200	$	—	$	27,000,000	$	77,407,200	$	—

	Distribution		Declaration Date	Record Date		Pay Date

2017 ⁽¹⁾:
Third quarter	$	0.12	9/22/2017	10/10/2017		10/26/2017
Second quarter		0.12	6/20/2017	7/7/2017		7/27/2017
First quarter		0.12	3/21/2017	4/7/2017		4/28/2017

Total declared in 2017	$	0.36

2016 ⁽²⁾:
Fourth quarter	$	0.12	12/14/2016	1/6/2017	¹	1/27/2017
Third quarter		0.15	9/20/2016	10/14/2016		10/27/2016
Second quarter		0.15	6/21/2016	7/7/2016		7/28/2016
First quarter		0.15	3/18/2016	4/7/2016		4/28/2016

Total declared in 2016	$	0.57

2015 ⁽³⁾ :
Fourth quarter	$	0.15	12/16/2015	1/6/2016	¹	1/28/2016
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	$	0.78

	Three Months Ended September 30,						Nine Months Ended September 30,
	2017¹			2016¹			2017¹			2016¹
Net investment income	$	0.07		$	0.12		$	0.23		$	0.39
Tax Accounting Difference on CLO Equity Investments		(0.01	)		-			(0.05	)		0.03
Other tax accounting differences		0.01			-			0.01			(0.02	)
Taxable distributable income		0.06			0.12			0.19			0.40
Cash distributed to the Company by Asset Manager Affiliates in excess of their taxable earnings		0.02			0.02			0.05			0.03
Cash received from CLO Equity Investments in excess of their taxable earnings		-			-			0.03			-
Available for distribution²		0.08			0.14			0.27			0.43
Distributed		0.12			0.15			0.36			0.45
Difference	$	(0.04	)	$	(0.01	)	$	(0.09	)	$	(0.02	)

	Impact on net investment income from a change in interest rates at:
	1%			2%			3%
Increase in interest rate	$	864,592		$	1,700,553		$	2,536,515

Decrease in interest rate	$	(220,059	)	$	(220,059	)	$	(220,059	)

	KCAP FINANCIAL, INC.

Date: November 7, 2017	By	/s/ Dayl W. Pearson
		Dayl W. Pearson
		President and Chief Executive Officer
		(Principal Executive Officer)

Date: November 7, 2017	By	/s/ Edward U. Gilpin
		Edward U. Gilpin
		Chief Financial Officer
		(Principal Financial and Accounting Officer)

2.1		Purchase and Sale Agreement, dated February 29, 2012, by and among Kohlberg Capital Corporation (the “Company”), Commodore Holdings, L.L.C., Trimaran Advisors, L.L.C., HBK Caravelle, L.L.C., Trimaran Fund Management, L.L.C., Jay R. Bloom, and Dean C. Kehler.⁽¹⁾

3.1		Form of Certificate of Incorporation of the Company.⁽²⁾

3.2		Form of Bylaws of the Company, as amended and restated effective February 29, 2012.⁽³⁾

4.1		Form of Dividend Reinvestment Plan.⁽⁴⁾

4.2		Form of Base Indenture between the Company, as Issuer, and U.S. Bank National Association, as Trustee⁽⁵⁾

4.3		Form of First Supplemental Indenture between the Company and U.S. Bank National Association relating to the 7.375% Senior Notes Due 2019⁽⁵⁾

4.4		Form of Note relating to the 7.375% Senior Notes Due 2019 (included as part of Exhibit 4.3)⁽⁵⁾

4.5		Second Supplemental Indenture between the Company and U.S. Bank National Association relating to the 6.125% Notes Due 2022⁽⁶⁾

4.6		Form of 6.125% Notes Due 2022 (included as part of Exhibit 4.5).⁽⁶⁾

11.1		Computation of Per Share Earnings (included in the notes to the unaudited financial statements contained in this report).

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.**