Attached files
| file | filename |
|---|---|
| EX-31.1 - Portman Ridge Finance Corp | v200571_ex31-1.htm |
| EX-31.2 - Portman Ridge Finance Corp | v200571_ex31-2.htm |
| EX-32.2 - Portman Ridge Finance Corp | v200571_ex32-2.htm |
| EX-10.1 - Portman Ridge Finance Corp | v200571_ex10-1.htm |
| EX-32.1 - Portman Ridge Finance Corp | v200571_ex32-1.htm |
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
|
x
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For
the quarterly period ended September 30, 2010
|
¨
|
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
Kohlberg
Capital Corporation
(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 x
No ¨
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such
files). Yes ¨ No x
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
one):
|
Large
accelerated filer
|
¨
|
Accelerated
filer
|
x
|
|
|
Non-accelerated
filer
|
¨
|
(Do
not check if a smaller reporting company)
|
Smaller
reporting
company
|
¨
|
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 22,767,130
was October 31, 2010.
TABLE
OF CONTENTS
|
|
Page
|
||
|
Part I. Financial
Information
|
|||
|
Item 1.
|
Financial
Statements
|
1
|
|
|
Balance Sheets as of September 30, 2010
(unaudited) and December 31, 2009
|
1
|
||
|
Statements of Operations (unaudited) for the three
and nine months ended September 30, 2010 and 2009
|
2
|
||
|
Statements of Changes in Net Assets (unaudited)
for the nine months ended September 30, 2010 and
2009
|
3
|
||
|
Statements of Cash Flows (unaudited) for the nine
months ended September 30, 2010 and 2009
|
4
|
||
|
Schedules of Investments as of September 30,
2010 (unaudited) and December 31, 2009
|
5
|
||
|
Financial Highlights (unaudited) for the nine
months ended September 30, 2010 and 2009
|
26
|
||
|
Notes to Financial Statements
(unaudited)
|
27
|
||
|
Item 2.
|
Management’s Discussion and
Analysis of Financial Condition and Results of
Operations
|
48
|
|
|
Item 3.
|
Quantitative and Qualitative
Disclosures About Market Risk
|
72
|
|
|
Item 4.
|
Controls and
Procedures
|
73
|
|
|
Part II. Other
Information
|
|||
|
Item 1.
|
Legal
Proceedings
|
75
|
|
|
Item 1A.
|
Risk
Factors
|
76
|
|
|
Item 2.
|
Unregistered Sales of Equity
Securities and Use of Proceeds
|
76
|
|
|
Item 3.
|
Defaults Upon Senior
Securities
|
76
|
|
|
Item 4.
|
[Removed and Reserved]
|
76
|
|
|
Item 5.
|
Other
Information
|
76
|
|
|
Item 6.
|
Exhibits
|
76
|
|
|
Signatures
|
|||
BALANCE
SHEETS
|
As
of
September
30, 2010
|
As
of
December
31, 2009
|
|||||||
|
(unaudited)
|
||||||||
|
ASSETS
|
||||||||
|
Investments
at fair value:
|
||||||||
|
Time
deposits (cost: 2010 - $24,529,777; 2009 - $126)
|
$ | 24,529,777 | $ | 126 | ||||
|
Money
market account (cost: 2010 - $212,245; 2009 - $0)
|
212,245 | — | ||||||
|
Debt
securities (cost: 2010 - $229,736,282; 2009 -
$342,056,023)
|
190,908,445 | 297,356,529 | ||||||
|
CLO
fund securities managed by non-affiliates (cost: 2010 - $15,689,717; 2009
- $15,685,858)
|
5,271,000 | 4,021,000 | ||||||
|
CLO
fund securities managed by affiliate (cost: 2010 - $52,568,940; 2009 -
$52,509,191)
|
47,480,000 | 44,950,000 | ||||||
|
Equity
securities (cost: 2010 - $14,216,146; 2009 - $12,365,603)
|
5,989,599 | 4,713,246 | ||||||
|
Asset
manager affiliates (cost: 2010 - $44,219,947; 2009 -
$40,751,511)
|
49,149,581 | 58,064,720 | ||||||
|
Total
Investments at fair value
|
323,540,647 | 409,105,621 | ||||||
|
Cash
|
2,225,116 | 4,140,408 | ||||||
|
Restricted
cash
|
2,239,603 | 18,696,023 | ||||||
|
Interest
and dividends receivable
|
3,083,707 | 3,836,031 | ||||||
|
Receivable
for open trades
|
8,665,186 | 2,953,500 | ||||||
|
Due
from affiliates
|
1,643 | 44,274 | ||||||
|
Other
assets
|
24,290 | 640,200 | ||||||
|
Total
assets
|
$ | 339,780,192 | $ | 439,416,057 | ||||
|
LIABILITIES
|
||||||||
|
Borrowings
|
$ | 137,159,147 | $ | 218,050,363 | ||||
|
Accounts
payable and accrued expenses
|
1,819,730 | 3,057,742 | ||||||
|
Dividend
payable
|
— | 4,412,228 | ||||||
|
Total
liabilities
|
$ | 138,978,877 | $ | 225,520,333 | ||||
|
Commitments
and contingencies (note 8)
|
||||||||
|
STOCKHOLDERS'
EQUITY
|
||||||||
|
Common
stock, par value $0.01 per share, 100,000,000 common shares authorized;
22,708,399 and 22,363,281 common shares issued and outstanding at
September 30, 2010 and December 31, 2009, respectively.
|
$ | 223,687 | $ | 220,611 | ||||
|
Capital
in excess of par value
|
284,975,852 | 283,074,233 | ||||||
|
Accumulated
undistributed net investment income
|
449,558 | 1,326,380 | ||||||
|
Accumulated
net realized losses
|
(27,215,375 | ) | (16,462,808 | ) | ||||
|
Net
unrealized depreciation on investments
|
(57,632,407 | ) | (54,262,692 | ) | ||||
|
Total
stockholders' equity
|
$ | 200,801,315 | $ | 213,895,724 | ||||
|
Total
liabilities and stockholders' equity
|
$ | 339,780,192 | $ | 439,416,057 | ||||
|
NET
ASSET VALUE PER COMMON SHARE
|
$ | 8.84 | $ | 9.56 | ||||
See
accompanying notes to financial statements.
1
KOHLBERG
CAPITAL CORPORATION
STATEMENTS
OF OPERATIONS
(unaudited)
|
Three
Months Ended
|
Nine
Months Ended
|
|||||||||||||||
|
September
30,
|
September
30,
|
|||||||||||||||
|
2010
|
2009
|
2010
|
2009
|
|||||||||||||
|
Investment
Income:
|
||||||||||||||||
|
Interest
from investments in debt securities
|
$ | 3,774,475 | $ | 5,855,051 | $ | 12,019,584 | $ | 18,808,447 | ||||||||
|
Interest
from cash and time deposits
|
3,259 | 5,092 | 15,752 | 14,778 | ||||||||||||
|
Dividends
from investments in CLO fund securities managed by
non-affiliates
|
472,972 | 355,726 | 1,273,619 | 1,174,026 | ||||||||||||
|
Dividends
from investments in CLO fund securities managed by
affiliate
|
2,222,806 | 2,035,789 | 5,935,478 | 6,246,918 | ||||||||||||
|
Dividends
from affiliate asset manager
|
1,500,000 | — | 3,000,000 | — | ||||||||||||
|
Capital
structuring service fees
|
117,704 | (6,814 | ) | 193,415 | 272,401 | |||||||||||
|
Total
investment income
|
8,091,216 | 8,244,844 | 22,437,848 | 26,516,570 | ||||||||||||
|
Expenses:
|
||||||||||||||||
|
Interest
and amortization of debt issuance costs
|
1,623,305 | 3,137,425 | 6,723,587 | 6,223,077 | ||||||||||||
|
Compensation
|
814,584 | 760,759 | 2,418,567 | 2,386,218 | ||||||||||||
|
Professional
fees
|
1,373,552 | 471,191 | 5,325,341 | 1,111,823 | ||||||||||||
|
Insurance
|
105,985 | 95,662 | 306,752 | 273,136 | ||||||||||||
|
Administrative
and other
|
342,520 | 303,175 | 956,638 | 832,724 | ||||||||||||
|
Total
expenses
|
4,259,946 | 4,768,212 | 15,730,885 | 10,826,978 | ||||||||||||
|
Net
Investment Income
|
3,831,270 | 3,476,632 | 6,706,963 | 15,689,592 | ||||||||||||
|
Realized
And Unrealized Gains (Losses) On Investments:
|
||||||||||||||||
|
Net
realized gains (losses) from investment transactions
|
(3,046,761 | ) | (3,769,049 | ) | (10,752,567 | ) | (8,901,941 | ) | ||||||||
|
Net
change in unrealized appreciation (depreciation) on:
|
||||||||||||||||
|
Debt
securities
|
1,334,179 | 8,218,083 | 5,871,658 | 15,800,620 | ||||||||||||
|
Equity
securities
|
(565,094 | ) | (102,710 | ) | (574,190 | ) | (526,590 | ) | ||||||||
|
CLO
fund securities managed by affiliate
|
550,246 | 4,137,840 | 2,470,250 | 11,118,734 | ||||||||||||
|
CLO
fund securities managed by non-affiliate
|
28,720 | 298,886 | 1,246,142 | (842,722 | ) | |||||||||||
|
Affiliate
asset manager investments
|
(5,451,872 | ) | (1,593,871 | ) | (12,383,575 | ) | 205,975 | |||||||||
|
Net
realized and unrealized appreciation (depreciation) on
investments
|
(7,150,582 | ) | 7,189,179 | (14,122,282 | ) | 16,854,076 | ||||||||||
|
Net
Increase (Decrease) In Net Assets Resulting From
Operations
|
$ | (3,319,312 | ) | $ | 10,665,811 | $ | (7,415,319 | ) | $ | 32,543,668 | ||||||
|
Net
Increase (Decrease) In Stockholders' Equity Resulting from Operations per
Common Share—Basic and Diluted
|
$ | (0.15 | ) | $ | 0.48 | $ | (0.33 | ) | $ | 1.48 | ||||||
|
Net
Investment Income Per Common Share—Basic and Diluted
|
$ | 0.17 | $ | 0.16 | $ | 0.30 | $ | 0.71 | ||||||||
|
Net
Investment Income and Net Realized Gains/Losses Per Common Share—Basic and
Diluted
|
$ | 0.03 | $ | (0.01 | ) | $ | (0.18 | ) | $ | 0.31 | ||||||
|
Weighted
Average Shares of Common Stock Outstanding—Basic
|
22,677,428 | 22,194,690 | 22,547,274 | 22,030,517 | ||||||||||||
|
Weighted
Average Shares of Common Stock Outstanding—Diluted
|
22,677,428 | 22,194,695 | 22,547,274 | 22,030,517 | ||||||||||||
See
accompanying notes to financial statements.
2
KOHLBERG
CAPITAL CORPORATION
STATEMENTS
OF CHANGES IN NET ASSETS
(unaudited)
|
Nine
Months Ended
September
30,
|
||||||||
|
2010
|
2009
|
|||||||
|
Operations:
|
||||||||
|
Net
investment income
|
$ | 6,706,963 | $ | 15,689,592 | ||||
|
Net
realized loss from investment transactions
|
(10,752,567 | ) | (8,901,941 | ) | ||||
|
Net
change in unrealized appreciation (depreciation) on
investments
|
(3,369,715 | ) | 25,756,017 | |||||
|
Net
increase (decrease) in net assets resulting from
operations
|
(7,415,319 | ) | 32,543,668 | |||||
|
Stockholder
distributions:
|
||||||||
|
Dividends
from net investment income to common stockholders
|
(6,706,963 | ) | (10,396,721 | ) | ||||
|
Dividends
in excess of net investment income to restricted
stockholders
|
(32,335 | ) | (106,033 | ) | ||||
|
Common
Stock Dividends in excess of net investment income
|
(844,488 | ) | — | |||||
|
Net
decrease in net assets resulting from stockholder
distributions
|
(7,583,786 | ) | (10,502,754 | ) | ||||
|
Capital
transactions:
|
||||||||
|
Issuance
of common stock for dividend reinvestment plan
|
1,216,946 | 1,656,531 | ||||||
|
Vesting
of restricted stock
|
647 | 1,223 | ||||||
|
Stock
based compensation
|
687,104 | 688,727 | ||||||
|
Net
increase in net assets resulting from capital transactions
|
1,904,697 | 2,346,481 | ||||||
|
Net
assets at beginning of period
|
213,895,723 | 196,566,018 | ||||||
|
Net
assets at end of period (including undistributed net investment income of
$449,558 in 2010 and accumulated distributions in excess of net investment
income of $8,052,272 in 2009)
|
$ | 200,801,315 | $ | 220,953,413 | ||||
|
Net
asset value per common share
|
$ | 8.84 | $ | 9.93 | ||||
|
Common
shares outstanding at end of period
|
22,708,399 | 22,255,149 | ||||||
See
accompanying notes to financial statements.
3
KOHLBERG
CAPITAL CORPORATION
STATEMENTS
OF CASH FLOWS
(unaudited)
|
Nine
Months Ended
September
30,
|
||||||||
|
2010
|
2009
|
|||||||
|
OPERATING
ACTIVITIES:
|
||||||||
|
Net
increase (decrease) in stockholders’ equity resulting from
operations
|
$ | (7,415,319 | ) | $ | 32,543,668 | |||
|
Adjustments
to reconcile net increase (decrease) in stockholders’ equity resulting
from operations to net cash provided by operations:
|
||||||||
|
Net
realized losses on investment transactions
|
10,752,567 | 8,901,941 | ||||||
|
Net
change in unrealized (appreciation) depreciation on
investments
|
3,369,715 | (25,756,017 | ) | |||||
|
Net
accretion of discount on securities and loans
|
(371,110 | ) | (1,504,703 | ) | ||||
|
Amortization
of debt issuance cost
|
561,251 | 618,520 | ||||||
|
Purchases
of investments
|
(33,790,481 | ) | (4,597,657 | ) | ||||
|
Capital
contribution to affiliate asset manager
|
(3,468,436 | ) | (3,600,016 | ) | ||||
|
Payment-in-kind
interest income
|
(323,418 | ) | (3,801 | ) | ||||
|
Proceeds
from sale and redemption of investments
|
103,683,805 | 38,417,685 | ||||||
|
Stock
based compensation expense
|
687,104 | 688,725 | ||||||
|
Changes
in operating assets and liabilities:
|
||||||||
|
Decrease
in interest and dividends receivable
|
752,324 | 531,968 | ||||||
|
Decrease
in other assets
|
54,660 | 165,840 | ||||||
|
Decrease
in due from affiliates
|
42,631 | 389,251 | ||||||
|
Increase
(decrease) in accounts payable and accrued expenses
|
(1,238,012 | ) | 38,185 | |||||
|
Net
cash provided by operating activities
|
73,297,281 | 46,833,589 | ||||||
|
FINANCING
ACTIVITIES:
|
||||||||
|
Issuance
of stock (net of offering costs)
|
647 | 1,223 | ||||||
|
Dividends
paid in cash
|
(10,778,426 | ) | (14,725,882 | ) | ||||
|
Cash
paid on repayment of debt
|
(80,891,214 | ) | (33,826,651 | ) | ||||
|
Decrease
in restricted cash
|
16,456,420 | 1,582,794 | ||||||
|
Net
cash used in financing activities
|
(75,212,573 | ) | (46,968,516 | ) | ||||
|
CHANGE
IN CASH
|
(1,915,292 | ) | (134,927 | ) | ||||
|
CASH,
BEGINNING OF PERIOD
|
4,140,408 | 251,412 | ||||||
|
CASH,
END OF PERIOD
|
$ | 2,225,116 | $ | 116,485 | ||||
|
Supplemental
Information:
|
||||||||
|
Interest
paid during the period
|
$ | 6,658,492 | $ | 5,436,585 | ||||
|
Non-cash
dividends paid during the period under the dividend reinvestment
plan
|
$ | 1,216,946 | $ | 1,656,532 | ||||
See
accompanying notes to financial statements.
4
KOHLBERG CAPITAL
CORPORATION
SCHEDULE OF
INVESTMENTS
As
of September 30, 2010
(unaudited)
Debt
Securities Portfolio
|
Portfolio
Company / Principal Business
|
Investment
Interest
Rate¹ / Maturity
|
Principal
|
Cost
|
Value2
|
||||||||||
|
Advanced
Lighting Technologies, Inc.
Home
and Office Furnishings, Housewares, and Durable Consumer
Products
|
Senior
Secured Loan — Revolving Loan
4.0%,
Due 6/13
|
$ | 320,000 | $ | 315,520 | $ | 317,760 | |||||||
|
Advanced
Lighting Technologies, Inc.6
Home
and Office Furnishings, Housewares, and Durable Consumer
Products
|
Senior
Secured Loan — Deferred Draw Term Loan (First Lien)
3.1%,
Due 6/13
|
321,125 | 321,125 | 318,877 | ||||||||||
|
Advanced
Lighting Technologies, Inc.6
Home
and Office Furnishings, Housewares, and Durable Consumer
Products
|
Junior
Secured Loan — Second Lien Term Loan Note
6.3%,
Due 6/14
|
5,000,000 | 5,000,000 | 5,000,000 | ||||||||||
|
Advanced
Lighting Technologies, Inc.6
Home
and Office Furnishings, Housewares, and Durable Consumer
Products
|
Senior
Secured Loan — Term Loan (First Lien)
3.1%,
Due 6/13
|
1,568,392 | 1,568,392 | 1,557,414 | ||||||||||
|
Aero
Products International, Inc.6
Personal
and Non Durable Consumer Products (Mfg. Only)
|
Senior
Secured Loan — Term Loan
9.5%,
Due 4/12
|
2,968,560 | 2,968,560 | 2,968,560 | ||||||||||
|
Aerostructures
Acquisition LLC6
Aerospace
and Defense
|
Senior
Secured Loan — Delayed Draw Term Loan
7.3%,
Due 3/13
|
318,191 | 318,191 | 318,191 | ||||||||||
|
Aerostructures
Acquisition LLC6
Aerospace
and Defense
|
Senior
Secured Loan — Term Loan
7.3%,
Due 3/13
|
4,018,058 | 4,018,058 | 4,018,058 | ||||||||||
|
AGS
LLC6
Hotels,
Motels, Inns, and Gaming
|
Senior
Secured Loan — Delayed Draw Term Loan
3.3%,
Due 5/13
|
405,171 | 402,298 | 369,111 | ||||||||||
|
AGS
LLC6
Hotels,
Motels, Inns, and Gaming
|
Senior
Secured Loan — Initial Term Loan
3.3%,
Due 5/13
|
2,895,981 | 2,875,443 | 2,638,239 | ||||||||||
|
AmerCable
Incorporated6
Machinery
(Non-Agriculture, Non-Construction, Non-Electronic)
|
Senior
Secured Loan — Initial Term Loan
3.8%,
Due 6/14
|
5,575,973 | 5,575,973 | 5,481,182 | ||||||||||
5
|
Portfolio
Company / Principal Business
|
Investment
Interest
Rate¹ / Maturity
|
Principal
|
Cost
|
Value2
|
||||||||||
|
Astoria
Generating Company Acquisitions, L.L.C.6
Utilities
|
Junior
Secured Loan — Term C
4.0%,
Due 8/13
|
$ | 4,000,000 | $ | 4,025,351 | $ | 3,924,000 | |||||||
|
Aurora
Diagnostics, LLC
Healthcare,
Education and Childcare
|
Senior
Secured Loan — Tranche B Term Loan
6.3%,
Due 5/16
|
997,500 | 983,353 | 997,500 | ||||||||||
|
Awesome
Acquisition Company (CiCi's Pizza)6
Personal,
Food and Miscellaneous Services
|
Junior
Secured Loan — Term Loan (Second Lien)
5.3%,
Due 6/14
|
4,000,000 | 3,984,813 | 3,944,000 | ||||||||||
|
AZ
Chem US Inc.6
Chemicals,
Plastics and Rubber
|
Junior
Secured Loan — Second Lien Term Loan
5.8%,
Due 2/14
|
4,000,000 | 3,975,956 | 4,000,000 | ||||||||||
|
Bankruptcy
Management Solutions, Inc.6,
9
Diversified/Conglomerate
Service
|
Junior
Secured Loan — Loan (Second Lien)
6.6%,
Due 7/13
|
2,406,250 | 2,424,498 | 517,344 | ||||||||||
|
Bankruptcy
Management Solutions, Inc.6
Diversified/Conglomerate
Service
|
Senior
Secured Loan — Term Loan (First Lien)
6.3%,
Due 7/12
|
1,870,497 | 1,875,068 | 1,221,434 | ||||||||||
|
Bicent
Power LLC6
Utilities
|
Junior
Secured Loan — Advance (Second Lien)
4.3%,
Due 12/14
|
4,000,000 | 4,000,000 | 3,152,000 | ||||||||||
|
BP
Metals, LLC (fka Constellation Enterprises) 6
Mining,
Steel, Iron and Non-Precious Metals
|
Senior
Secured Loan — Term Loan
10.0%,
Due 6/13
|
4,096,939 | 4,096,939 | 4,096,939 | ||||||||||
|
Caribe
Information Investments Incorporated6
Printing
and Publishing
|
Senior
Secured Loan — Term Loan
2.6%,
Due 3/13
|
1,611,045 | 1,607,681 | 1,427,386 | ||||||||||
|
Charlie
Acquisition Corp.9
Personal,
Food and Miscellaneous Services
|
Mezzanine
Investment — Senior Subordinated Notes
15.5%,
Due 6/13
|
14,261,996 | 10,744,496 | 250,000 | ||||||||||
|
CoActive
Technologies LLC (fka CoActive Technologies, Inc.)6
Machinery
(Non-Agriculture, Non-Construction, Non-Electronic)
|
Senior
Secured Loan — Term Loan (First Lien)
3.3%,
Due 7/14
|
3,881,804 | 3,871,081 | 3,357,761 | ||||||||||
|
CoActive
Technologies LLC (fka CoActive Technologies, Inc.)6
Machinery
(Non-Agriculture, Non-Construction, Non-Electronic)
|
Junior
Secured Loan — Term Loan (Second Lien)
7.0%,
Due 1/15
|
2,000,000 | 1,976,315 | 1,214,000 | ||||||||||
6
|
Portfolio
Company / Principal Business
|
Investment
Interest
Rate¹ / Maturity
|
Principal
|
Cost
|
Value2
|
||||||||||
|
Delta
Educational Systems, Inc.6
Healthcare,
Education and Childcare
|
Senior
Secured Loan — Term Loan
6.0%,
Due 6/12
|
$ | 2,301,996 | $ | 2,301,996 | $ | 2,301,996 | |||||||
|
Dex
Media West LLC
Printing
and Publishing
|
Senior
Secured Loan — New Term Loan
7.0%,
Due 10/14
|
3,196,857 | 2,976,183 | 2,805,242 | ||||||||||
|
Dresser,
Inc.6
Machinery
(Non-Agriculture, Non-Construction, Non-Electronic)
|
Junior
Secured Loan — Term Loan (Second Lien)
6.1%,
Due 5/15
|
3,000,000 | 2,974,379 | 2,967,000 | ||||||||||
|
DRI
Holdings, Inc.6
Healthcare,
Education and Childcare
|
Junior
Secured Loan — US Term Loan (Second Lien)
6.7%,
Due 7/15
|
6,000,000 | 5,569,864 | 6,000,000 | ||||||||||
|
eInstruction
Corporation6
Healthcare,
Education and Childcare
|
Senior
Secured Loan — Initial Term Loan
4.3%,
Due 7/13
|
3,091,218 | 3,091,218 | 3,026,302 | ||||||||||
|
|
||||||||||||||
|
eInstruction
Corporation6
Healthcare,
Education and Childcare
|
Junior
Secured Loan — Term Loan (Second Lien)
7.8%,
Due 7/14
|
10,000,000 | 10,000,000 | 10,000,000 | ||||||||||
|
Fasteners
For Retail, Inc.6
Diversified/Conglomerate
Manufacturing
|
Senior
Secured Loan — Term Loan
4.9%,
Due 12/12
|
3,259,011 | 3,261,663 | 3,259,011 | ||||||||||
|
First
American Payment Systems, L.P.6
Finance
|
Senior
Secured Loan — Term Loan
5.3%,
Due 10/13
|
2,806,000 | 2,806,000 | 2,806,000 | ||||||||||
|
First
Data Corporation
Finance
|
Senior
Secured Loan — Initial Tranche B-2 Term Loan
3.0%,
Due 9/14
|
896,947 | 841,725 | 791,108 | ||||||||||
|
Freescale
Semiconductor, Inc.
Electronics
|
Senior
Subordinated Bond — 10.125%
10.1%,
Due 12/16
|
3,000,000 | 3,006,397 | 2,730,000 | ||||||||||
|
Ginn
LA Conduit Lender, Inc.9
Buildings and Real
Estate4
|
Senior
Secured Loan — First Lien Tranche A Credit-Linked Deposit
7.8%,
Due 6/11
|
1,257,143 | 1,224,101 | 69,143 | ||||||||||
|
Ginn
LA Conduit Lender, Inc.9
Buildings and Real
Estate4
|
Senior
Secured Loan — First Lien Tranche B Term Loan
7.8%,
Due 6/11
|
2,694,857 | 2,624,028 | 148,217 | ||||||||||
|
Ginn
LA Conduit Lender, Inc.9
Buildings and Real
Estate4
|
Junior
Secured Loan — Loan (Second Lien)
11.8%,
Due 6/12
|
3,000,000 | 2,715,997 | 15,000 | ||||||||||
7
|
Portfolio
Company / Principal Business
|
Investment
Interest
Rate¹ / Maturity
|
Principal
|
Cost
|
Value2
|
||||||||||
|
HMSC
Corporation (aka Swett and Crawford)6
Insurance
|
Junior
Secured Loan — Loan (Second Lien)
5.8%,
Due 10/14
|
$ | 5,000,000 | $ | 4,882,962 | $ | 3,840,000 | |||||||
|
Huish
Detergents Inc.6
Personal
and Non Durable Consumer Products (Mfg. Only)
|
Junior
Secured Loan — Loan (Second Lien)
4.5%,
Due 10/14
|
1,000,000 | 1,000,000 | 977,000 | ||||||||||
|
Hunter
Fan Company6
Home
and Office Furnishings, Housewares, and Durable Consumer
Products
|
Senior
Secured Loan — Initial Term Loan (First Lien)
2.8%,
Due 4/14
|
3,690,443 | 3,593,555 | 3,299,256 | ||||||||||
|
Hunter
Fan Company6
Home
and Office Furnishings, Housewares, and Durable Consumer
Products
|
Junior
Secured Loan — Loan (Second Lien)
7.0%,
Due 10/14
|
3,000,000 | 3,000,000 | 2,778,000 | ||||||||||
|
Infiltrator
Systems, Inc.6
Ecological
|
Senior
Secured Loan — Term Loan
8.5%,
Due 9/12
|
2,678,977 | 2,675,508 | 2,678,977 | ||||||||||
|
Inmar,
Inc.6
Retail
Stores
|
Senior
Secured Loan — Term Loan
3%,
Due 4/13
|
3,363,854 | 3,363,854 | 3,239,391 | ||||||||||
|
International
Architectural Products, Inc.6
Mining,
Steel, Iron and Non-Precious Metals
|
Senior
Secured Loan — Term Loan
3%,
Due 5/15
|
959,760 | 959,760 | 959,760 | ||||||||||
|
Intrapac
Corporation/Corona Holdco6
Containers,
Packaging and Glass
|
Senior
Secured Loan — 1st Lien Term Loan
4%,
Due 5/12
|
4,026,082 | 4,032,011 | 3,989,847 | ||||||||||
|
Intrapac
Corporation/Corona Holdco6
Containers,
Packaging and Glass
|
Junior
Secured Loan — Term Loans (Second Lien)
7.8%,
Due 5/13
|
3,000,000 | 3,010,708 | 3,000,000 | ||||||||||
|
Jones
Stephens Corp.6,
9
Buildings and Real
Estate4
|
Senior
Secured Loan — Term Loan
7.8%,
Due 9/12
|
9,541,180 | 9,527,522 | 5,381,225 | ||||||||||
|
KIK
Custom Products Inc.6
Personal
and Non Durable Consumer Products (Mfg. Only)
|
Junior
Secured Loan — Loan (Second Lien)
5.3%,
Due 12/14
|
5,000,000 | 5,000,000 | 3,357,500 | ||||||||||
8
|
Portfolio
Company / Principal Business
|
Investment
Interest
Rate¹ / Maturity
|
Principal
|
Cost
|
Value2
|
||||||||||
|
Las
Vegas Land Holdings, LLC6
Buildings and Real
Estate4
|
Senior
Secured Loan — Loan
5.3%,
Due 3/16
|
$ | 271,097 | $ | 271,097 | $ | 216,878 | |||||||
|
LBREP/L-Suncal
Master I LLC9
Buildings and Real
Estate4
|
Junior
Secured Loan — Term Loan (Third Lien)
15.0%,
Due 2/12
|
2,332,868 | 2,332,868 | 933 | ||||||||||
|
LBREP/L-Suncal
Master I LLC6,
9
Buildings and Real
Estate4
|
Senior
Secured Loan — Term Loan (First Lien)
5.5%,
Due 1/10
|
3,875,156 | 3,875,156 | 58,127 | ||||||||||
|
LBREP/L-Suncal
Master I LLC6,
9
Buildings and Real
Estate4
|
Junior
Secured Loan — Term Loan (Second Lien)
9.5%,
Due 1/11
|
2,000,000 | 1,920,211 | 7,600 | ||||||||||
|
Legacy
Cabinets, Inc.6
Home
and Office Furnishings, Housewares, and Durable Consumer
Products
|
Senior
Secured Loan — Term Loan
7.3%,
Due 5/14
|
456,194 | 456,194 | 91,239 | ||||||||||
|
Levlad,
LLC & Arbonne International, LLC6
Personal
and Non Durable Consumer Products (Mfg. Only)
|
Senior
Secured Loan — Term Loan (Exit)
10.0%,
Due 3/15
|
654,935 | 654,935 | 654,935 | ||||||||||
|
LN
Acquisition Corp. (Lincoln Industrial)6
Machinery
(Non-Agriculture, Non-Construction, Non-Electronic)
|
Junior
Secured Loan — Initial Term Loan (Second Lien)
6.0%,
Due 1/15
|
2,000,000 | 2,000,000 | 2,000,000 | ||||||||||
|
MCCI
Group Holdings, LLC6
Healthcare,
Education and Childcare
|
Senior
Secured Loan — Term Loan (First Lien)
4.7%,
Due 12/12
|
5,229,035 | 5,221,185 | 5,229,035 | ||||||||||
|
MCCI
Group Holdings, LLC6
Healthcare,
Education and Childcare
|
Junior
Secured Loan — Term Loan (Second Lien)
8.0%,
Due 6/13
|
1,000,000 | 1,000,000 | 1,000,000 | ||||||||||
|
PAS
Technologies Inc.
Aerospace
and Defense
|
Senior
Secured Loan — Incremental Term Loan Add On
5.8%,
Due 6/11
|
431,882 | 431,882 | 431,882 | ||||||||||
|
PAS
Technologies Inc.6
Aerospace
and Defense
|
Senior
Secured Loan — Term Loan Retired 10/06/2010
5.8%,
Due 6/11
|
2,135,417 | 2,132,787 | 2,135,417 | ||||||||||
|
Pegasus
Solutions, Inc.
Leisure,
Amusement, Motion Pictures, Entertainment
|
Senior
Subordinated Bond — Senior Subordinated Second Lien PIK Notes
13.0%,
Due 4/14
|
1,234,233 | 1,234,233 | 1,234,233 | ||||||||||
9
|
Portfolio
Company / Principal Business
|
Investment
Interest
Rate¹ / Maturity
|
Principal
|
Cost
|
Value2
|
||||||||||
|
Perseus
Holding Corp.
Leisure,
Amusement, Motion Pictures, Entertainment
|
Preferred
Stock — Preferred Stock
14.0%,
Due 4/14
|
$ | 400,000 | $ | 400,000 | $ | 384,000 | |||||||
|
QA
Direct Holdings, LLC6
Printing
and Publishing
|
Senior
Secured Loan — Term Loan
8.3%,
Due 8/14
|
4,409,153 | 4,383,919 | 4,356,243 | ||||||||||
|
Resco
Products, Inc.
Mining,
Steel, Iron and Non-Precious Metals
|
Junior
Secured Loan — Term Loan (Second Lien)
6.0%,
Due 6/14
|
2,036,889 | 2,036,889 | 2,036,889 | ||||||||||
|
Resco
Products, Inc.6
Mining,
Steel, Iron and Non-Precious Metals
|
Junior
Secured Loan — Term Loan (Second Lien)
12.0%,
Due 6/14
|
7,050,874 | 6,929,164 | 7,050,874 | ||||||||||
|
San
Juan Cable, LLC6
Broadcasting
and Entertainment
|
Junior
Secured Loan — Loan (Second Lien)
5.8%,
Due 10/13
|
3,000,000 | 2,988,898 | 3,000,000 | ||||||||||
|
Schneller
LLC6
Aerospace
and Defense
|
Senior
Secured Loan — Term Loan
3.5%,
Due 6/13
|
4,080,491 | 4,061,197 | 3,876,466 | ||||||||||
|
Seismic
Micro-Technology, Inc. (SMT)6
Electronics
|
Senior
Secured Loan — Term Loan
2.9%,
Due 6/12
|
1,170,721 | 1,169,601 | 1,071,209 | ||||||||||
|
Seismic
Micro-Technology, Inc. (SMT)6
Electronics
|
Senior
Secured Loan — Term Loan
2.9%,
Due 6/12
|
780,480 | 779,734 | 714,140 | ||||||||||
|
Specialized
Technology Resources, Inc.6
Diversified/Conglomerate
Service
|
Junior
Secured Loan — Loan (Second Lien)
7.3%,
Due 12/14
|
7,500,000 | 7,500,000 | 7,500,000 | ||||||||||
|
Specialized
Technology Resources, Inc.6
Diversified/Conglomerate
Service
|
Senior
Secured Loan — Term Loan (First Lien)
2.8%,
Due 6/14
|
3,533,271 | 3,533,271 | 3,533,271 | ||||||||||
|
TUI
University, LLC6
Healthcare,
Education and Childcare
|
Senior
Secured Loan — Term Loan (First Lien)
3.3%,
Due 10/14
|
3,119,818 | 3,028,287 | 2,932,629 | ||||||||||
10
|
Portfolio
Company / Principal Business
|
Investment
Interest
Rate¹ / Maturity
|
Principal
|
Cost
|
Value2
|
||||||||||
|
Twin-Star
International, Inc.6
Home
and Office Furnishings, Housewares, and Durable Consumer
Products
|
Senior
Secured Loan — Term Loan
4.5%,
Due 4/13
|
$ | 3,915,834 | $ | 3,915,834 | $ | 3,915,834 | |||||||
|
Walker
Group Holdings LLC
Cargo
Transport
|
Junior
Secured Loan — Term Loan B
12.5%,
Due 12/12
|
470,643 | 470,643 | 470,643 | ||||||||||
|
Walker
Group Holdings LLC6
Cargo
Transport
|
Junior
Secured Loan — Term Loan B
12.5%,
Due 12/12
|
4,469,539 | 4,469,539 | 4,469,539 | ||||||||||
|
Water
PIK, Inc.6
Personal
and Non Durable Consumer Products (Mfg. Only)
|
Senior
Secured Loan — Loan (First Lien)
3.5%,
Due 6/13
|
600,037 | 598,120 | 600,037 | ||||||||||
|
Wesco
Aircraft Hardware Corp.
Aerospace
and Defense
|
Junior
Secured Loan — Loan (Second Lien)
6.0%,
Due 3/14
|
1,906,667 | 1,858,036 | 1,906,667 | ||||||||||
|
Wesco
Aircraft Hardware Corp.6
Aerospace
and Defense
|
Junior
Secured Loan — Loan (Second Lien)
6.0%,
Due 3/14
|
3,940,019 | 3,957,912 | 3,940,019 | ||||||||||
|
Wolf
Hollow I, LP6
Utilities
|
Senior
Secured Loan — Acquisition Term Loan
2.5%,
Due 6/12
|
761,003 | 756,831 | 725,997 | ||||||||||
|
Wolf
Hollow I, LP6
Utilities
|
Senior
Secured Loan — Synthetic Letter of Credit
2.5%,
Due 6/12
|
668,412 | 664,747 | 637,665 | ||||||||||
|
Wolf
Hollow I, LP6
Utilities
|
Senior
Secured Loan — Synthetic Revolver Deposit
2.5%,
Due 6/12
|
167,103 | 166,187 | 159,416 | ||||||||||
|
Wolf
Hollow I, LP6
Utilities
|
Junior
Secured Loan — Term Loan (Second Lien)
4.8%,
Due 12/12
|
2,683,177 | 2,685,659 | 2,573,166 | ||||||||||
|
X-Rite,
Incorporated6
Electronics
|
Senior
Secured Loan — Term Loan (First Lien)
6.6%,
Due 10/12
|
483,731 | 482,725 | 483,731 | ||||||||||
|
Total
Investment in Debt Securities
|
||||||||||||||
|
(95%
of net asset value at fair value)
|
$ | 235,050,484 | $ | 229,736,282 | $ | 190,908,445 | ||||||||
11
Equity
Portfolio
|
Portfolio
Company / Principal Business
|
Investment
|
Percentage
Interest/Shares
|
Cost
|
Value2
|
||||||||||
|
Aerostructures
Holdings L.P.7
Aerospace
and Defense
|
Partnership
Interests
|
1.2 | % | $ | 1,000,000 | $ | 160,000 | |||||||
|
Aerostructures
Holdings L.P.7
Aerospace
and Defense
|
Series
A Preferred Interests
|
1.2 | % | 250,961 | 250,961 | |||||||||
|
Coastal
Concrete Holding II, LLC7
Buildings and Real
Estate4
|
Class
A Units
|
10.8 | % | 8,625,626 | 250,143 | |||||||||
|
eInstruction
Acquisition, LLC7
Healthcare,
Education and Childcare
|
Membership
Units
|
1.1 | % | 1,079,617 | 1,503,042 | |||||||||
|
FP
WRCA Coinvestment Fund VII, Ltd.3,
7
Machinery
(Non-Agriculture, Non-Construction, Non-Electronic)
|
Class
A Shares
|
1,500 | 1,500,000 | 2,205,000 | ||||||||||
|
Perseus
Holding Corp.7
Leisure,
Amusement, Motion Pictures, Entertainment
|
Common
|
0.2 | % | $ | 400,000 | $ | 400,000 | |||||||
|
Natural
Products Group, Inc.7
Personal
and Non Durable Consumer Products (Mfg. Only)
|
Series
A-1 Common Stock
|
0.4 | % | 687,140 | 546,276 | |||||||||
|
International
Architectural Products, Inc.7
Mining,
Steel, Iron and Non-Precious Metals
|
Common
|
2.5 | % | 292,851 | 296,599 | |||||||||
|
Las
Vegas Land Holdings, LLC7
Buildings and Real
Estate4
|
Common
|
0.5 | % | 264,372 | 264,372 | |||||||||
|
Legacy
Cabinets, Inc.7
Home
and Office Furnishings, Housewares, and Durable Consumer
Products
|
Equity
|
4.0 | % | 115,580 | 113,206 | |||||||||
|
Total
Investment in Equity Securities
|
||||||||||||||
|
(3%
of net asset value at fair value)
|
$ | 14,216,146 | $ | 5,989,599 | ||||||||||
12
CLO
Fund Securities
CLO
Equity Investments
|
Portfolio
Company
|
Investment
|
Percentage
Interest
|
Cost
|
Value2
|
||||||||||
|
Grant
Grove CLO, Ltd.3,
12
|
Subordinated
Securities
|
22.2 | % | $ | 4,719,717 | $ | 3,390,000 | |||||||
|
Katonah
III, Ltd.3,
12
|
Preferred
Shares
|
23.1 | % | 4,500,000 | 810,000 | |||||||||
|
Katonah
IV, Ltd.3, 12,
13
|
Preferred
Shares
|
17.1 | % | 3,150,000 | 1,070,000 | |||||||||
|
Katonah
V, Ltd.3, 12,
13
|
Preferred
Shares
|
26.7 | % | 3,320,000 | 1,000 | |||||||||
|
Katonah
VII CLO Ltd.3, 8, 12,
13
|
Subordinated
Securities
|
16.4 | % | 4,500,000 | 2,280,000 | |||||||||
|
Katonah
VIII CLO Ltd3, 8,
12
|
Subordinated
Securities
|
10.3 | % | 3,400,000 | 1,890,000 | |||||||||
|
Katonah
IX CLO Ltd3, 8,
12
|
Preferred
Shares
|
6.9 | % | 2,000,000 | 1,300,000 | |||||||||
|
Katonah
X CLO Ltd 3, 8,
12
|
Subordinated
Securities
|
33.3 | % | 11,606,522 | 9,110,000 | |||||||||
|
Katonah
2007-I CLO Ltd.3, 8,
12
|
Preferred
Shares
|
100.0 | % | 29,976,188 | 26,260,000 | |||||||||
|
Total
Investment in CLO Equity Securities
|
$ | 67,172,427 | $ | 46,111,000 | ||||||||||
|
CLO
Rated-Note Investment
|
||||||||||||||
|
Portfolio
Company
|
Investment
|
Percentage
Interest
|
Cost
|
Value2
|
||||||||||
|
Katonah
2007-I CLO Ltd.3, 8,
12
|
Class
B-2L Notes
Par
Value of $10,500,000
100.0%,
Due 4/22
|
100.0 | % | $ | 1,086,230 | $ | 6,640,000 | |||||||
|
Total
Investment in CLO Rated-Note
|
$ | 1,086,230 | $ | 6,640,000 | ||||||||||
|
Total
Investment in CLO Fund Securities
|
||||||||||||||
|
(26%
of net asset value at fair value)
|
$ | 68,258,657 | $ | 52,751,000 | ||||||||||
|
Asset
Manager Affiliate
|
||||||||||||||
|
Portfolio
Company / Principal Business
|
Investment
|
Percentage
Interest
|
Cost
|
Value2
|
||||||||||
|
Katonah
Debt Advisors
|
Asset
Management Company
|
100.0 | % | $ | 44,219,947 | $ | 49,149,581 | |||||||
|
Total
Investment in Asset Manager Affiliate
|
$ | 44,219,947 | $ | 49,149,581 | ||||||||||
|
(24%
of net asset value at fair value)
|
||||||||||||||
13
Time
Deposits and Money Market Account
|
Time
Deposits and Money Market Account
|
Investment
|
Yield
|
Par
/ Cost
|
Value2
|
||||||||||
|
US
Bank Eurodollar Sweep CL23,
10
|
Time
Deposit
|
0.1 | % | $ | 24,529,226 | $ | 24,529,226 | |||||||
|
JP
Morgan Asset Account
|
Time
Deposit
|
0.0 | % | 551 | 551 | |||||||||
|
JP
Morgan Business Money Market Account11
|
Money
Market Account
|
0.2 | % | 212,245 | 212,245 | |||||||||
|
Total
Investment in Time Deposit and Money Market Accounts
|
$ | 24,742,022 | $ | 24,742,022 | ||||||||||
|
(12%
of net asset value at fair value)
|
||||||||||||||
|
Total Investments5
|
$ | 381,173,054 | $ | 323,540,647 | ||||||||||
|
(161%
of net asset value at fair value)
|
||||||||||||||
|
See
accompanying notes to financial statements.
|
||||||||||||||
|
1
|
A
majority of the variable rate loans to the Company’s portfolio companies
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. For each such loan, the Company has provided the weighted average
annual stated interest rate in effect at September 30,
2010.
|
|
2
|
Reflects
the fair market value of all existing investments as of September 30,
2010, as determined by the Company’s Board of
Directors.
|
|
3
|
Non-U.S.
company or principal place of business outside the
U.S.
|
|
4
|
Buildings
and real estate relate to real estate ownership, builders, managers and
developers and excludes mortgage debt investments and mortgage lenders or
originators. As of September 30, 2010, the Company had no exposure to
mortgage securities (residential mortgage bonds, commercial mortgage
backed securities, or related asset backed securities), companies
providing mortgage lending or emerging markets investments either directly
or through the Company’s investments in CLO
funds.
|
|
5
|
The
aggregate cost of investments for federal income tax purposes is
approximately $381 million. The aggregate gross unrealized appreciation is
approximately $12 million and the aggregate gross unrealized depreciation
is approximately $70 million.
|
|
6
|
Pledged
as collateral for the secured revolving credit facility (see Note 6 to the
financial statements).
|
|
7
|
Non-income
producing.
|
|
8
|
An
affiliate CLO Fund managed by Katonah Debt Advisors, L.L.C. or its
affiliate.
|
|
9
|
Loan
or debt security is on non-accrual status and therefore is considered
non-income producing.
|
|
10
|
Time
deposit investment partially restricted under terms of the secured credit
facility (see Note 6 to financial
statements).
|
|
11
|
Money
market account holding restricted cash for employee flexible spending
accounts.
|
|
12
|
These
securities were acquired in a transaction that was exempt from the
registration requirements of the Securities Act of 1933, as amended (the
“Securities Act”), pursuant to Rule 144A thereunder. These
securities may be resold only in transactions that are exempt from the
registration requirements of the Securities Act, normally to qualified
institutional buyers.
|
|
13
|
As
of September 30, 2010, these CLO Fund Securities were not providing a
dividend distribution.
|
14
KOHLBERG
CAPITAL CORPORATION
SCHEDULE
OF INVESTMENTS
As
of December 31, 2009
Debt
Securities Portfolio
|
Portfolio Company / Principal
Business
|
Investment
Interest
Rate¹ / Maturity
|
Principal
|
Cost
|
Value2
|
||||||||||
|
Advanced
Lighting Technologies, Inc.
Home
and Office Furnishings, Housewares, and Durable Consumer
Products
|
Senior
Secured Loan — Revolving Loan
5.0%,
Due 6/13
|
$ | 640,000 | $ | 634,264 | $ | 637,440 | |||||||
|
Advanced
Lighting Technologies, Inc.6
Home
and Office Furnishings, Housewares, and Durable Consumer
Products
|
Senior
Secured Loan — Deferred Draw Term Loan (First Lien)
3.0%,
Due 6/13
|
323,595 | 323,595 | 322,301 | ||||||||||
|
Advanced
Lighting Technologies, Inc.6
Home
and Office Furnishings, Housewares, and Durable Consumer
Products
|
Junior
Secured Loan — Second Lien Term Loan Note
6.2%,
Due 6/14
|
5,000,000 | 5,000,000 | 5,000,000 | ||||||||||
|
Advanced
Lighting Technologies, Inc.6
Home
and Office Furnishings, Housewares, and Durable Consumer
Products
|
Senior
Secured Loan — Term Loan (First Lien)
3.0%,
Due 6/13
|
1,580,565 | 1,580,565 | 1,574,242 | ||||||||||
|
Aero
Products International, Inc.6
Personal
and Non Durable Consumer Products (Mfg. Only)
|
Senior
Secured Loan — Term Loan
9.5%,
Due 4/12
|
3,118,560 | 3,118,560 | 1,721,445 | ||||||||||
|
Aerostructures
Acquisition LLC6
Aerospace
and Defense
|
Senior
Secured Loan — Delayed Draw Term Loan
6.8%,
Due 3/13
|
412,667 | 412,667 | 412,667 | ||||||||||
|
Aerostructures
Acquisition LLC6
Aerospace
and Defense
|
Senior
Secured Loan — Term Loan
6.8%,
Due 3/13
|
5,219,471 | 5,219,471 | 5,219,471 | ||||||||||
|
AGA
Medical Corporation6
Healthcare,
Education and Childcare
|
Senior
Secured Loan — Tranche B Term Loan
2.3%,
Due 4/13
|
1,832,209 | 1,831,354 | 1,799,230 | ||||||||||
|
AGS
LLC6
Hotels,
Motels, Inns, and Gaming
|
Senior
Secured Loan — Delayed Draw Term Loan
3.2%,
Due 5/13
|
425,866 | 421,983 | 389,241 | ||||||||||
|
AGS
LLC6
Hotels,
Motels, Inns, and Gaming
|
Senior
Secured Loan — Initial Term Loan
3.2%,
Due 5/13
|
3,043,896 | 3,016,145 | 2,782,121 | ||||||||||
|
AmerCable
Incorporated6
Machinery
(Non-Agriculture, Non-Construction, Non-Electronic)
|
Senior
Secured Loan — Initial Term Loan
3.8%,
Due 6/14
|
5,840,213 | 5,840,213 | 5,606,605 | ||||||||||
|
Astoria
Generating Company Acquisitions, L.L.C.6
Utilities
|
Junior
Secured Loan — Term C
4.0%,
Due 8/13
|
4,000,000 | 4,031,898 | 3,800,000 | ||||||||||
15
|
Portfolio
Company / Principal Business
|
Investment
Interest
Rate¹ / Maturity
|
Principal
|
Cost
|
Value2
|
||||||||||
|
Atlantic
Marine Holding Company6
Cargo
Transport
|
Senior
Secured Loan — Term Loan
4.6%,
Due 3/14
|
$ | 1,681,287 | $ | 1,688,586 | $ | 1,681,287 | |||||||
|
Aurora
Diagnostics, LLC6
Healthcare,
Education and Childcare
|
Senior
Secured Loan — Tranche A Term Loan (First Lien)
4.5%,
Due 12/12
|
4,017,152 | 3,993,498 | 4,017,152 | ||||||||||
|
Awesome
Acquisition Company (CiCi's Pizza)6
Personal,
Food and Miscellaneous Services
|
Junior
Secured Loan — Term Loan (Second Lien)
5.3%,
Due 6/14
|
4,000,000 | 3,981,723 | 3,924,000 | ||||||||||
|
AZ
Chem US Inc.6
Chemicals,
Plastics and Rubber
|
Junior
Secured Loan — Second Lien Term Loan
5.7%,
Due 2/14
|
4,000,000 | 3,970,688 | 4,000,000 | ||||||||||
|
Bankruptcy
Management Solutions, Inc.6
Diversified/Conglomerate
Service
|
Junior
Secured Loan — Loan (Second Lien)
6.5%,
Due 7/13
|
2,418,750 | 2,441,936 | 1,777,781 | ||||||||||
|
Bankruptcy
Management Solutions, Inc.6
Diversified/Conglomerate
Service
|
Senior
Secured Loan — Term Loan (First Lien)
4.2%,
Due 7/12
|
1,870,497 | 1,876,933 | 1,509,491 | ||||||||||
|
Bicent
Power LLC6
Utilities
|
Junior
Secured Loan — Advance (Second Lien)
4.3%,
Due 12/14
|
4,000,000 | 4,000,000 | 3,528,000 | ||||||||||
|
BP
Metals, LLC (fka Constellation Enterprises) 6
Mining,
Steel, Iron and Non-Precious Metals
|
Senior
Secured Loan — Term Loan
10.0%,
Due 6/13
|
4,383,929 | 4,383,929 | 4,383,929 | ||||||||||
|
Broadlane,
Inc.6
Healthcare,
Education and Childcare
|
Senior
Secured Loan — Term Loan
8.5%,
Due 8/13
|
2,741,832 | 2,711,990 | 2,741,832 | ||||||||||
|
Caribe
Information Investments Incorporated6
Printing
and Publishing
|
Senior
Secured Loan — Term Loan
2.5%,
Due 3/13
|
1,676,743 | 1,672,195 | 1,653,269 | ||||||||||
|
Cast
& Crew Payroll, LLC (Payroll Acquisition)6
Leisure,
Amusement, Motion Pictures, Entertainment
|
Senior
Secured Loan — Initial Term Loan
3.2%,
Due 9/12
|
7,693,290 | 7,709,678 | 7,654,824 | ||||||||||
|
CEI
Holdings, Inc. (Cosmetic Essence)6,
9
Personal
and Non Durable Consumer Products (Mfg. Only)
|
Senior
Secured Loan — Term Loan
8.1%,
Due 3/13
|
1,454,368 | 1,407,135 | 780,116 | ||||||||||
|
Charlie
Acquisition Corp.9
Personal,
Food and Miscellaneous Services
|
Mezzanine
Investment — Senior Subordinated Notes
15.5%,
Due 6/13
|
10,893,401 | 10,777,799 | 635,444 | ||||||||||
|
CoActive
Technologies, Inc.6
Machinery
(Non-Agriculture, Non-Construction, Non-Electronic)
|
Senior
Secured Loan — Term Loan (First Lien)
3.3%,
Due 7/14
|
3,916,722 | 3,903,782 | 2,882,707 | ||||||||||
16
|
Portfolio Company / Principal
Business
|
Investment
Interest Rate¹ / Maturity
|
Principal
|
Cost
|
Value2
|
||||||||
|
CoActive
Technologies, Inc.6
Machinery
(Non-Agriculture, Non-Construction, Non-Electronic)
|
Junior
Secured Loan — Term Loan (Second Lien)
7.0%,
Due 1/15
|
$ | 2,000,000 | $ | 1,972,218 | $ | 1,062,000 | |||||
|
Dealer
Computer Services, Inc. (Reynolds & Reynolds)6
Electronics
|
Junior
Secured Loan — Term Loan (Second Lien)
5.8%,
Due 10/13
|
1,000,000 | 1,006,261 | 1,000,000 | ||||||||
|
Dealer
Computer Services, Inc. (Reynolds & Reynolds)6
Electronics
|
Junior
Secured Loan — Term Loan (Third Lien)
7.8%,
Due 4/14
|
7,700,000 | 7,538,614 | 7,700,000 | ||||||||
|
Delta
Educational Systems, Inc.6
Healthcare,
Education and Childcare
|
Senior
Secured Loan — Term Loan
6.0%,
Due 6/12
|
2,301,996 | 2,301,996 | 2,281,278 | ||||||||
|
Dex
Media West LLC
Printing
and Publishing
|
Senior
Secured Loan — Tranche B Term Loan
7.0%,
Due 10/14
|
4,696,402 | 4,312,579 | 4,348,868 | ||||||||
|
Dresser,
Inc.6
Machinery
(Non-Agriculture, Non-Construction, Non-Electronic)
|
Junior
Secured Loan — Term Loan (Second Lien)
6.0%,
Due 5/15
|
3,000,000 | 2,970,206 | 2,991,000 | ||||||||
|
DRI
Holdings, Inc.6
Healthcare,
Education and Childcare
|
Junior
Secured Loan — US Term Loan (Second Lien)
6.5%,
Due 7/15
|
6,000,000 | 5,502,222 | 5,700,000 | ||||||||
|
Edgestone
CD Acquisition Corp. (Custom Direct)6
Printing
and Publishing
|
Junior
Secured Loan — Loan (Second Lien)
6.3%,
Due 12/14
|
5,000,000 | 5,000,000 | 5,000,000 | ||||||||
|
Edgestone
CD Acquisition Corp. (Custom Direct)6
Printing
and Publishing
|
Senior
Secured Loan — Term Loan (First Lien)
3.1%,
Due 12/13
|
3,982,724 | 3,985,832 | 3,982,724 | ||||||||
|
eInstruction
Corporation6
Healthcare,
Education and Childcare
|
Senior
Secured Loan — Initial Term Loan
4.3%,
Due 7/13
|
4,017,321 | 4,017,321 | 3,969,113 | ||||||||
|
eInstruction
Corporation6
Healthcare,
Education and Childcare
|
Junior
Secured Loan — Term Loan (Second Lien)
7.8%,
Due 7/14
|
10,000,000 | 10,000,000 | 10,000,000 | ||||||||
|
Endeavor
Energy Resources, L.P.6
Oil
and Gas
|
Junior
Secured Loan — Initial Loan (Second Lien)
5.3%,
Due 4/12
|
4,000,000 | 4,000,000 | 4,000,000 | ||||||||
|
Fasteners
For Retail, Inc.6
Diversified/Conglomerate
Manufacturing
|
Senior
Secured Loan — Term Loan
4.8%,
Due 12/12
|
4,042,346 | 4,046,728 | 4,042,346 | ||||||||
|
FD
Alpha Acquisition LLC (Fort Dearborn)6
Printing
and Publishing
|
Senior
Secured Loan — US Term Loan
3.2%,
Due 11/12
|
1,538,635 | 1,462,409 | 1,538,635 | ||||||||
17
|
Portfolio Company / Principal
Business
|
Investment
Interest Rate¹ / Maturity
|
Principal
|
Cost
|
Value2
|
||||||||
|
First
American Payment Systems, L.P.6
Finance
|
Senior
Secured Loan — Term Loan
3.3%,
Due 10/13
|
$ | 3,198,000 | $ | 3,198,000 | $ | 3,198,000 | |||||
|
First
Data Corporation
Finance
|
Senior
Secured Loan — Initial Tranche B-2 Term Loan
3.0%,
Due 9/14
|
2,440,944 | 2,262,445 | 2,174,881 | ||||||||
|
Ford
Motor Company6
Automobile
|
Senior
Secured Loan — Tranche B-1 Term Loan
3.3%,
Due 12/13
|
1,942,429 | 1,940,876 | 1,800,631 | ||||||||
|
Freescale
Semiconductor, Inc.
Electronics
|
Senior
Subordinated Bond —
10.1%,
Due 12/16
|
3,000,000 | 3,007,167 | 2,415,000 | ||||||||
|
Frontier
Drilling USA, Inc.6
Oil
and Gas
|
Senior
Secured Loan — Term B Advance
9.3%,
Due 6/13
|
2,000,000 | 1,998,652 | 2,000,000 | ||||||||
|
Ginn
LA Conduit Lender, Inc.9
Buildings and Real
Estate4
|
Senior
Secured Loan — First Lien Tranche A Credit-Linked Deposit
7.8%,
Due 6/11
|
1,257,143 | 1,224,101 | 89,634 | ||||||||
|
Ginn
LA Conduit Lender, Inc.9
Buildings and Real
Estate4
|
Senior
Secured Loan — First Lien Tranche B Term Loan
7.8%,
Due 6/11
|
2,694,857 | 2,624,028 | 195,377 | ||||||||
|
Ginn
LA Conduit Lender, Inc.9
Buildings and Real
Estate4
|
Junior
Secured Loan — Loan (Second Lien)
11.8%,
Due 6/12
|
3,000,000 | 2,715,997 | 60,000 | ||||||||
|
Harland
Clarke Holdings Corp. (fka Clarke American Corp.)6
Printing
and Publishing
|
Senior
Secured Loan — Tranche B Term Loan
2.7%,
Due 6/14
|
2,925,000 | 2,925,000 | 2,442,375 | ||||||||
|
HMSC
Corporation (aka Swett and Crawford)6
Insurance
|
Junior
Secured Loan — Loan (Second Lien)
5.8%,
Due 10/14
|
5,000,000 | 4,861,123 | 4,490,000 | ||||||||
|
Huish
Detergents Inc.6
Personal
and Non Durable Consumer Products (Mfg. Only)
|
Junior
Secured Loan — Loan (Second Lien)
4.5%,
Due 10/14
|
1,000,000 | 1,000,000 | 1,000,000 | ||||||||
|
Hunter
Fan Company6
Home
and Office Furnishings, Housewares, and Durable Consumer
Products
|
Senior
Secured Loan — Initial Term Loan (First Lien)
2.7%,
Due 4/14
|
3,723,929 | 3,605,519 | 3,239,818 | ||||||||
|
Hunter
Fan Company6
Home
and Office Furnishings, Housewares, and Durable Consumer
Products
|
Junior
Secured Loan — Loan (Second Lien)
7.0%,
Due 10/14
|
3,000,000 | 3,000,000 | 2,550,000 | ||||||||
|
Infiltrator
Systems, Inc.6
Ecological
|
Senior
Secured Loan — Term Loan
8.5%,
Due 9/12
|
2,699,907 | 2,695,103 | 2,699,907 | ||||||||
18
|
Portfolio Company / Principal
Business
|
Investment
Interest Rate¹ / Maturity
|
Principal
|
Cost
|
Value2
|
||||||||||
|
Inmar,
Inc.6
Retail
Stores
|
Senior
Secured Loan — Term Loan
2.5%,
Due 4/13
|
$ | 3,543,046 | $ | 3,543,046 | $ | 3,521,787 | |||||||
|
International
Aluminum Corporation (IAL Acquisition Co.)6,
9
Mining,
Steel, Iron and Non-Precious Metals
|
Senior
Secured Loan — Term Loan
5.0%,
Due 3/13
|
2,973,711 | 2,973,711 | 1,987,926 | ||||||||||
|
Intrapac
Corporation/Corona Holdco6
Containers,
Packaging and Glass
|
Senior
Secured Loan — 1st Lien Term Loan
3.8%,
Due 5/12
|
4,034,281 | 4,042,948 | 3,852,738 | ||||||||||
|
Intrapac
Corporation/Corona Holdco6
Containers,
Packaging and Glass
|
Junior
Secured Loan — Term Loans (Second Lien)
7.8%,
Due 5/13
|
3,000,000 | 3,013,753 | 3,000,000 | ||||||||||
|
Jones
Stephens Corp.6
Buildings and Real
Estate4
|
Senior
Secured Loan — Term Loan
7.8%,
Due 9/12
|
9,541,180 | 9,526,158 | 8,491,650 | ||||||||||
|
KIK
Custom Products Inc.6
Personal
and Non Durable Consumer Products (Mfg. Only)
|
Junior
Secured Loan — Loan (Second Lien)
5.3%,
Due 12/14
|
5,000,000 | 5,000,000 | 3,060,000 | ||||||||||
|
La
Paloma Generating Company, LLC6
Utilities
|
Junior
Secured Loan — Loan (Second Lien)
3.8%,
Due 8/13
|
2,000,000 | 2,011,080 | 1,622,000 | ||||||||||
|
LBREP/L-Suncal
Master I LLC9
Buildings and Real
Estate4
|
Junior
Secured Loan — Term Loan (Third Lien)
15.0%,
Due 2/12
|
2,332,868 | 2,332,868 | 1,000 | ||||||||||
|
LBREP/L-Suncal
Master I LLC6,
9
Buildings and Real
Estate4
|
Senior
Secured Loan — Term Loan (First Lien)
5.5%,
Due 1/10
|
3,875,156 | 3,873,404 | 116,255 | ||||||||||
|
LBREP/L-Suncal
Master I LLC6,
9
Buildings and Real
Estate4
|
Junior
Secured Loan — Term Loan (Second Lien)
9.5%,
Due 1/11
|
2,000,000 | 1,920,211 | 7,500 | ||||||||||
|
Legacy
Cabinets, Inc.6,
9
Home
and Office Furnishings, Housewares, and Durable Consumer
Products
|
Senior
Secured Loan — Term Loan
6.6%,
Due 8/12
|
2,258,184 | 2,258,184 | 537,416 | ||||||||||
|
Levlad,
LLC & Arbonne International, LLC6,
9
Personal
and Non Durable Consumer Products (Mfg. Only)
|
Senior
Secured Loan — Term Loan
7.8%,
Due 3/14
|
2,660,729 | 2,660,729 | 1,341,007 | ||||||||||
|
LN
Acquisition Corp. (Lincoln Industrial)6
Machinery
(Non-Agriculture, Non-Construction, Non-Electronic)
|
Junior
Secured Loan — Initial Term Loan (Second Lien)
6.0%,
Due 1/15
|
2,000,000 | 2,000,000 | 1,978,000 | ||||||||||
|
MCCI
Group Holdings, LLC6
Healthcare,
Education and Childcare
|
Senior
Secured Loan — Term Loan (First Lien)
4.3%,
Due 12/12
|
5,754,849 | 5,743,304 | 5,622,487 | ||||||||||
19
|
Portfolio Company / Principal
Business
|
Investment
Interest Rate¹ / Maturity
|
Principal
|
Cost
|
Value2
|
||||||||||
|
MCCI
Group Holdings, LLC6
Healthcare,
Education and Childcare
|
Junior
Secured Loan — Term Loan (Second Lien)
7.5%,
Due 6/13
|
$ | 1,000,000 | $ | 1,000,000 | $ | 1,000,000 | |||||||
|
National
Interest Security Company, L.L.C.
Aerospace
and Defense
|
Mezzanine
Investment — Mezzanine Facility
15.0%,
Due 6/13
|
3,000,000 | 3,000,000 | 3,300,000 | ||||||||||
|
National
Interest Security Company, L.L.C.
Aerospace
and Defense
|
Junior
Secured Loan — Second Lien Term Loan
15.0%,
Due 6/13
|
1,000,000 | 1,000,000 | 1,100,000 | ||||||||||
|
National
Interest Security Company, L.L.C.6
Aerospace
and Defense
|
Senior
Secured Loan — Term Loan - 1st Lien
7.8%,
Due 12/12
|
7,650,000 | 7,650,000 | 7,650,000 | ||||||||||
|
Northeast
Biofuels, LP6,
9
Farming
and Agriculture
|
Senior
Secured Loan — Construction Term Loan
8.8%,
Due 6/13
|
1,382,120 | 1,383,944 | 208,369 | ||||||||||
|
Northeast
Biofuels, LP6,
9
Farming
and Agriculture
|
Senior
Secured Loan — Synthetic LC Term Loan
8.8%,
Due 6/13
|
57,257 | 57,333 | 8,632 | ||||||||||
|
PAS
Technologies Inc.
Aerospace
and Defense
|
Senior
Secured Loan — Incremental Term Loan Add On
4.3%,
Due 6/11
|
632,022 | 632,022 | 632,022 | ||||||||||
|
PAS
Technologies Inc.6
Aerospace
and Defense
|
Senior
Secured Loan — Term Loan
4.3%,
Due 6/11
|
3,125,000 | 3,117,290 | 3,125,000 | ||||||||||
|
Pegasus
Solutions, Inc.9
Leisure,
Amusement, Motion Pictures, Entertainment
|
Senior
Unsecured Bond —
10.5%,
Due 4/15
|
2,000,000 | 2,000,000 | 1,710,000 | ||||||||||
|
Pegasus
Solutions, Inc.6,
10
Leisure,
Amusement, Motion Pictures, Entertainment
|
Senior
Secured Loan — Term Loan
7.8%,
Due 4/13
|
4,863,083 | 4,863,083 | 4,863,083 | ||||||||||
|
Primus
International Inc.6
Aerospace
and Defense
|
Senior
Secured Loan — Term Loan
2.7%,
Due 6/12
|
1,087,032 | 1,088,240 | 1,060,944 | ||||||||||
|
QA
Direct Holdings, LLC6
Printing
and Publishing
|
Senior
Secured Loan — Term Loan
8.3%,
Due 8/14
|
4,540,186 | 4,509,168 | 4,540,186 | ||||||||||
|
Resco
Products, Inc.6
Mining,
Steel, Iron and Non-Precious Metals
|
Junior
Secured Loan — Term Loan (Second Lien)
20.0%,
Due 6/14
|
6,650,000 | 6,503,858 | 6,650,000 | ||||||||||
|
Rhodes
Companies, LLC, The6,
9
Buildings and Real
Estate4
|
Senior
Secured Loan — First Lien Term Loan
11.8%,
Due 11/10
|
1,685,674 | 1,636,741 | 298,241 | ||||||||||
20
|
Portfolio Company / Principal
Business
|
Investment
Interest Rate¹ / Maturity
|
Principal
|
Cost
|
Value2
|
||||||||||
|
Rhodes
Companies, LLC, The6,
9
Buildings and Real
Estate4
|
Junior
Secured Loan — Second Lien Term Loan
13.0%,
Due 11/11
|
$ | 2,013,977 | $ | 2,019,403 | $ | 12,720 | |||||||
|
San
Juan Cable, LLC6
Broadcasting
and Entertainment
|
Junior
Secured Loan — Loan (Second Lien)
5.8%,
Due 10/13
|
3,000,000 | 2,986,206 | 2,862,000 | ||||||||||
|
Schneller
LLC6
Aerospace
and Defense
|
Senior
Secured Loan — Term Loan
3.7%,
Due 6/13
|
4,304,174 | 4,278,271 | 4,231,003 | ||||||||||
|
Seismic
Micro-Technology, Inc. (SMT)6
Electronics
|
Senior
Secured Loan — Term Loan
3.2%,
Due 6/12
|
838,694 | 837,545 | 829,469 | ||||||||||
|
Seismic
Micro-Technology, Inc. (SMT)6
Electronics
|
Senior
Secured Loan — Term Loan
3.2%,
Due 6/12
|
1,258,041 | 1,256,317 | 1,244,203 | ||||||||||
|
Specialized
Technology Resources, Inc.6
Diversified/Conglomerate
Service
|
Junior
Secured Loan — Loan (Second Lien)
7.2%,
Due 12/14
|
7,500,000 | 7,500,000 | 7,500,000 | ||||||||||
|
Specialized
Technology Resources, Inc.6
Diversified/Conglomerate
Service
|
Senior
Secured Loan — Term Loan (First Lien)
2.7%,
Due 6/14
|
3,563,166 | 3,563,166 | 3,563,166 | ||||||||||
|
Standard
Steel, LLC6
Cargo
Transport
|
Senior
Secured Loan — Delayed Draw Term Loan
8.3%,
Due 7/12
|
738,349 | 741,143 | 738,349 | ||||||||||
|
Standard
Steel, LLC6
Cargo
Transport
|
Senior
Secured Loan — Initial Term Loan
9.0%,
Due 7/12
|
3,663,267 | 3,677,125 | 3,663,267 | ||||||||||
|
Standard
Steel, LLC6
Cargo
Transport
|
Junior
Secured Loan — Loan (Second Lien)
13.8%,
Due 7/13
|
1,750,000 | 1,756,512 | 1,750,000 | ||||||||||
|
TPF
Generation Holdings, LLC6
Utilities
|
Junior
Secured Loan — Loan (Second Lien)
4.5%,
Due 12/14
|
2,000,000 | 2,023,571 | 1,894,000 | ||||||||||
|
TUI
University, LLC6
Healthcare,
Education and Childcare
|
Senior
Secured Loan — Term Loan (First Lien)
3.2%,
Due 10/14
|
3,590,407 | 3,465,781 | 3,590,407 | ||||||||||
|
Twin-Star
International, Inc.6
Home
and Office Furnishings, Housewares, and Durable Consumer
Products
|
Senior
Secured Loan — Term Loan
4.3%,
Due 4/13
|
4,291,879 | 4,291,879 | 4,218,917 | ||||||||||
|
Walker
Group Holdings LLC
Cargo
Transport
|
Junior
Secured Loan — Term Loan B
12.5%,
Due 12/12
|
526,500 | 526,500 | 526,500 | ||||||||||
21
|
Portfolio Company / Principal
Business
|
Investment
Interest Rate¹ / Maturity
|
Principal
|
Cost
|
Value2
|
||||||||||
|
Walker
Group Holdings LLC6
Cargo
Transport
|
Junior
Secured Loan — Term Loan B
12.8%,
Due 12/12
|
$ | 5,000,000 | $ | 5,000,000 | $ | 5,000,000 | |||||||
|
Water
PIK, Inc.6
Personal
and Non Durable Consumer Products (Mfg. Only)
|
Senior
Secured Loan — Loan (First Lien)
3.5%,
Due 6/13
|
1,243,577 | 1,238,507 | 1,243,577 | ||||||||||
|
Wesco
Aircraft Hardware Corp.
Aerospace
and Defense
|
Junior
Secured Loan — Loan (Second Lien)
6.0%,
Due 3/14
|
2,000,000 | 1,938,058 | 2,000,000 | ||||||||||
|
Wesco
Aircraft Hardware Corp.6
Aerospace
and Defense
|
Junior
Secured Loan — Loan (Second Lien)
6.0%,
Due 3/14
|
4,132,887 | 4,155,678 | 4,132,887 | ||||||||||
|
WireCo
WorldGroup Inc. 10
Machinery
(Non-Agriculture, Non-Construction, Non-Electronic)
|
Mezzanine
Investment —
11.0%,
Due 2/15
|
5,000,000 | 4,829,054 | 5,100,000 | ||||||||||
|
WireCo
WorldGroup Inc. 6,
10
Machinery
(Non-Agriculture, Non-Construction, Non-Electronic)
|
Mezzanine
Investment —
11.0%,
Due 2/15
|
10,000,000 | 10,000,000 | 10,200,000 | ||||||||||
|
Wolf
Hollow I, LP6
Utilities
|
Senior
Secured Loan — Acquisition Term Loan
2.5%,
Due 6/12
|
767,269 | 761,240 | 743,484 | ||||||||||
|
Wolf
Hollow I, LP6
Utilities
|
Senior
Secured Loan — Synthetic Letter of Credit
.1%,
Due 6/12
|
668,412 | 663,160 | 647,691 | ||||||||||
|
Wolf
Hollow I, LP6
Utilities
|
Senior
Secured Loan — Synthetic Revolver Deposit
1.2%,
Due 6/12
|
167,103 | 165,790 | 161,923 | ||||||||||
|
Wolf
Hollow I, LP6
Utilities
|
Junior
Secured Loan — Term Loan (Second Lien)
4.8%,
Due 12/12
|
2,683,177 | 2,686,492 | 2,591,949 | ||||||||||
|
X-Rite,
Incorporated6
Electronics
|
Junior
Secured Loan — Loan (Second Lien)
14.4%,
Due 10/13
|
649,162 | 649,162 | 649,162 | ||||||||||
|
X-Rite,
Incorporated6
Electronics
|
Senior
Secured Loan — Term Loan (First Lien)
7.5%,
Due 10/12
|
581,049 | 579,404 | 569,430 | ||||||||||
|
Total
Investment in Debt Securities
|
||||||||||||||
|
(139%
of net asset value at fair value)
|
$ | 344,924,114 | $ | 342,056,023 | $ | 297,356,529 | ||||||||
22
Equity
Portfolio
|
Portfolio Company / Principal
Business
|
Investment
|
Percentage
Interest/Shares
|
Cost
|
Value2
|
|||||||||
|
Aerostructures
Holdings L.P.7
Aerospace
and Defense
|
Partnership
Interests
|
1.2 | % | $ | 1,000,000 | $ | 350,280 | ||||||
|
Aerostructures
Holdings L.P.7
Aerospace
and Defense
|
Series
A Preferred Interests
|
1.2 | % | 160,361 | 202,396 | ||||||||
|
Coastal
Concrete Holding II, LLC7
Buildings and Real
Estate4
|
Class
A Units
|
10.8 | % | 8,625,625 | 568,570 | ||||||||
|
eInstruction
Acquisition, LLC7
Healthcare,
Education and Childcare
|
Membership
Units
|
1.1 | % | 1,079,617 | 1,456,000 | ||||||||
|
FP
WRCA Coinvestment Fund VII, Ltd.3,
7
Machinery
(Non-Agriculture, Non-Construction, Non-Electronic)
|
Class
A Shares
|
15,000 | 1,500,000 | 2,136,000 | |||||||||
|
Total
Investment in Equity Securities
|
|||||||||||||
|
(2%
of net asset value at fair value)
|
$ | 12,365,603 | $ | 4,713,246 | |||||||||
|
CLO
Fund Securities
|
|||||||||||||
|
CLO
Equity Investments
|
|||||||||||||
|
Portfolio Company
|
Investment
|
Percentage
Interest
|
Cost
|
Value2
|
|||||||||
|
Grant
Grove CLO, Ltd.3, 10,
11
|
Subordinated
Securities
|
22.2 | % | $ | 4,715,858 | $ | 2,780,000 | ||||||
|
Katonah
III, Ltd.3,
10
|
Preferred
Shares
|
23.1 | % | 4,500,000 | 950,000 | ||||||||
|
Katonah
IV, Ltd.3, 10,
11
|
Preferred
Shares
|
17.1 | % | 3,150,000 | 290,000 | ||||||||
|
Katonah
V, Ltd.3, 10,
11
|
Preferred
Shares
|
26.7 | % | 3,320,000 | 1,000 | ||||||||
|
Katonah
VII CLO Ltd.3, 8, 10,
11
|
Subordinated
Securities
|
16.4 | % | 4,500,000 | 1,840,000 | ||||||||
|
Katonah
VIII CLO Ltd3, 8, 10,
11
|
Subordinated
Securities
|
10.3 | % | 3,400,000 | 1,760,000 | ||||||||
|
Katonah
IX CLO Ltd3, 8, 10,
11
|
Preferred
Shares
|
6.9 | % | 2,000,000 | 1,560,000 | ||||||||
|
Katonah
X CLO Ltd 3, 8,
10
|
Subordinated
Securities
|
33.3 | % | 11,589,830 | 8,280,000 | ||||||||
|
Katonah
2007-I CLO Ltd.3, 8,
10
|
Preferred
Shares
|
100.0 | % | 29,940,867 | 27,100,000 | ||||||||
|
Total
Investment in CLO Equity Securities
|
$ | 67,116,555 | $ | 44,561,000 | |||||||||
23
CLO
Rated-Note Investment
|
Portfolio Company
|
Investment
|
Percentage
Interest
|
Cost
|
Value2
|
||||||||||
|
Katonah
2007-I CLO Ltd.3, 8,
10
|
Class
B-2L Notes
Par
Value of $10,500,000
5.3%,
Due 4/22
|
100.0 | % | $ | 1,078,494 | $ | 4,410,000 | |||||||
|
Total
Investment in CLO Rated-Note
|
$ | 1,078,494 | $ | 4,410,000 | ||||||||||
|
Total
Investment in CLO Fund Securities
|
||||||||||||||
|
(23%
of net asset value at fair value)
|
$ | 68,195,049 | $ | 48,971,000 | ||||||||||
|
Asset
Manager Affiliate
|
||||||||||||||
|
Portfolio Company / Principal
Business
|
Investment
|
Percentage
Interest
|
Cost
|
Value2
|
||||||||||
|
Katonah
Debt Advisors, L.L.C.
|
Membership
Interests
|
100 | % | $ | 40,751,511 | $ | 58,064,720 | |||||||
|
Total
Investment in Asset Manager Affiliate
(27%
of net asset value at fair value)
|
$ | 40,751,511 | $ | 58,064,720 | ||||||||||
|
Time
Deposits and Money Market Account
|
||||||||||||||
|
Time Deposits and Money Market
Account
|
Investment
|
Yield
|
Par / Cost
|
Value2
|
||||||||||
|
JP
Morgan Asset Account
|
Time
Deposit
|
0.07 | % | 126 | 126 | |||||||||
|
Total
Investment in Time Deposit and Money Market Accounts
(0%
of net asset value at fair value)
|
$ | 126 | $ | 126 | ||||||||||
|
Total
Investments5
(191%
of net asset value at fair value)
|
$ | 463,368,313 | $ | 409,105,621 | ||||||||||
See
accompanying notes to financial statements.
|
1
|
A
majority of the variable rate loans to the Company’s portfolio companies
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. For each such loan, the Company has provided the weighted average
annual stated interest rate in effect at December 31,
2009.
|
24
|
2
|
Reflects
the fair market value of all existing investments as of December 31, 2009,
as determined by the Company’s Board of
Directors.
|
|
3
|
Non-U.S.
company or principal place of business outside the
U.S.
|
|
4
|
Buildings
and real estate relate to real estate ownership, builders, managers and
developers and excludes mortgage debt investments and mortgage lenders or
originators. As of December 31, 2009, the Company had no exposure to
mortgage securities (residential mortgage bonds, commercial mortgage
backed securities, or related asset backed securities), companies
providing mortgage lending or emerging markets investments either directly
or through the Company’s investments in CLO
funds.
|
|
5
|
The
aggregate cost of investments for federal income tax purposes is
approximately $463 million. The aggregate gross unrealized appreciation is
approximately $24 million and the aggregate gross unrealized depreciation
is approximately $78 million.
|
|
6
|
Pledged
as collateral for the secured revolving credit facility (see Note 6 to the
financial statements).
|
|
7
|
Non-income
producing.
|
|
8
|
An
affiliate CLO Fund managed by Katonah Debt Advisors L.L.C. or its
affiliate.
|
|
9
|
Loan
or debt security is on non-accrual status and therefore is considered
non-income producing.
|
|
10
|
These
securities were acquired in a transaction that was exempt from the
registration requirements of the Securities Act of 1933, as amended (the
“Securities Act”), pursuant to Rule 144A thereunder. These
securities may be resold only in transactions that are exempt from the
registration requirements of the Securities Act, normally to qualified
institutional buyers.
|
|
11
|
As
of December 31, 2009, these CLO Fund securities were not providing a
dividend distribution.
|
25
KOHLBERG
CAPITAL CORPORATION
FINANCIAL
HIGHLIGHTS
(unaudited)
($
per share)
|
Nine Months Ended
September 30,
|
||||||||
|
2010
|
2009
|
|||||||
|
(as
restated)
|
||||||||
|
Per
Share Data:
|
||||||||
|
Net
asset value, at beginning of period
|
$ | 9.56 | $ | 9.03 | ||||
|
Net
income (loss)
|
||||||||
|
Net
investment income1
|
0.30 | 0.71 | ||||||
|
Net
realized losses1
|
(0.48 | ) | (0.40 | ) | ||||
|
Net
change in unrealized appreciation/depreciation on investments1
|
(0.29 | ) | 0.97 | |||||
|
Net
income
|
(0.47 | ) | 1.28 | |||||
|
Net
decrease in net assets resulting from distributions
|
||||||||
|
From
net investment income
|
(0.29 | ) | (0.48 | ) | ||||
|
In
excess of net investment income
|
(0.04 | ) | ||||||
|
Net
decrease in net assets resulting from distributions
|
(0.33 | ) | (0.48 | ) | ||||
|
Net
increase in net assets relating to stock-based
transactions
|
||||||||
|
Issuance
of common stock (not including DRIP)
|
- | - | ||||||
|
Issuance
of common stock under dividend reinvestment plan
|
0.05 | 0.07 | ||||||
|
Stock
based compensation expense
|
0.03 | 0.03 | ||||||
|
Net
increase in net assets relating to stock-based
transactions
|
0.08 | 0.10 | ||||||
|
Net
asset value, end of period
|
$ | 8.84 | $ | 9.93 | ||||
|
Total
net asset value return2
|
1.7 | % | 15.2 | % | ||||
|
Ratio/Supplemental
Data:
|
||||||||
|
Per
share market value at beginning of period
|
$ | 4.56 | $ | 3.64 | ||||
|
Per
share market value at end of period
|
$ | 6.69 | $ | 6.03 | ||||
|
Total
market return3
|
54.1 | % | 78.6 | % | ||||
|
Shares
outstanding at end of period
|
22,708,399 | 22,255,149 | ||||||
|
Net
assets at end of period
|
$ | 200,801,315 | $ | 220,953,413 | ||||
|
Portfolio
turnover rate4
|
2.5 | % | 1.0 | % | ||||
|
Average
debt outstanding
|
$ | 171,738,698 | $ | 240,843,511 | ||||
|
Asset
coverage ratio
|
246 | % | 197 | % | ||||
|
Ratio
of net investment income to average net assets5
|
4.3 | % | 10.0 | % | ||||
|
Ratio
of total expenses to average net assets5
|
10.0 | % | 6.9 | % | ||||
|
Ratio
of interest expense to average net assets5
|
4.3 | % | 4.0 | % | ||||
|
Ratio
of non-interest expenses to average net assets5
|
5.7 | % | 2.9 | % | ||||
1 Based on weighted average number of common shares outstanding for the period.
2 Total
net asset value return (not annualized) equals the change in the net asset value
per share over the beginning of period net asset value per share plus dividends,
divided by the beginning net asset value per share.
3 Total
market return (not annualized) equals the change in the ending market price over
the beginning of period price per share plus dividends, divided by the beginning
price.
4 Not
annualized
5 Annualized
See
accompanying notes to financial statements.
26
KOHLBERG
CAPITAL CORPORATION
NOTES
TO FINANCIAL STATEMENTS
(unaudited)
1.
ORGANIZATION
Kohlberg
Capital Corporation (“Kohlberg Capital” or the “Company”) is an internally
managed, non-diversified closed-end investment company that is regulated as a
business development company (“BDC”) under the Investment Company Act of 1940.
The Company originates, structures and invests in senior secured term loans,
mezzanine debt and selected equity securities primarily in privately-held middle
market companies. The Company defines the middle market as comprising 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.
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, converted to a corporation incorporated in Delaware on
December 11, 2006. Prior to its initial public offering (“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., LLC
(“Kohlberg & Co.”), a leading middle market private equity firm, in exchange
for the contribution of their ownership interests in Katonah Debt Advisors,
L.L.C. (collectively with its affiliates, “Katonah Debt Advisors”) and in
securities issued by collateralized loan obligation funds (“CLO Funds”) managed
by Katonah Debt Advisors and two other asset managers to the Company. As of
September 30, 2010, Katonah Debt Advisors had approximately $2.1 billion of
assets under management.
The
Company’s investment objective is to generate current income and capital
appreciation from investments made in senior secured term loans, mezzanine debt
and selected equity investments in privately-held middle market companies. The
Company also expects to continue to receive distributions of recurring fee
income and to generate capital appreciation from its investment in the asset
management business of Katonah Debt Advisors. Katonah Debt Advisors manages CLO
Funds which invest in broadly syndicated loans, high-yield bonds and other
credit instruments. The Company’s investment portfolio as well as the investment
portfolios of the CLO Funds in which it has invested and the investment
portfolios of the CLO Funds managed by Katonah Debt Advisors consist exclusively
of credit instruments and other securities issued by corporations and do not
include any asset-backed securities secured by commercial mortgages, residential
mortgages or other consumer borrowings.
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 requirements. Pursuant to this
election, the Company generally will not have to pay corporate-level taxes on
any income that it distributes to its stockholders.
2.
SIGNIFICANT ACCOUNTING POLICIES
Basis
of Presentation
The
financial statements include the accounts of the Company and the accounts of its
special purpose financing subsidiary, Kohlberg Capital Funding LLC I. In
accordance with Article 6 of Regulation S-X under the Securities Act of 1933 and
Securities Exchange Act of 1934, the Company does not consolidate portfolio
company investments, including those in which it has a controlling interest
(Katonah Debt Advisors, including its affiliates, is currently the only company
in which the Company has a controlling interest).
The
accompanying unaudited 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 financial statements. The unaudited interim 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, 2009,
as filed with the Securities and Exchange Commission (the “Commission” or the
“SEC”).
The
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 financial statements requires
management to make significant estimates and assumptions including 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.
27
Accounting Standards
Codification. In June 2009, the Financial Accounting
Standards Board (“FASB”) issued a pronouncement establishing the FASB Accounting
Standards Codification (“ASC”) as the source of authoritative accounting
principles recognized by the FASB to be applied in the preparation of financial
statements in conformity with GAAP. The ASC reorganized existing U.S. accounting
and reporting standards issued by the FASB and other related private sector
standard setters into a single source of authoritative accounting principles
arranged by topic. The standard explicitly recognizes rules and
interpretive releases of the Commission under federal securities laws as
authoritative GAAP for SEC registrants. The ASC supersedes all existing U.S.
accounting standards; all other accounting literature not included in the ASC
(other than SEC guidance for publicly-traded companies) is considered
non-authoritative. The ASC was effective on a prospective basis for interim
and annual reporting periods ending after September 15, 2009. The
adoption of the ASC changed the Company’s references to U.S. GAAP accounting
standards but did not impact its results of operations, financial position or
liquidity.
Investments
Investment
transactions are recorded on the applicable trade date. Realized gains or losses
are determined using the specific identification method.
Valuation of Portfolio
Investments. The Company’s Board of Directors is ultimately and solely
responsible for making a good faith determination of the fair value of portfolio
investments on a quarterly basis. Debt and equity securities for which market
quotations are readily available are generally valued at such market quotations.
Debt and equity securities that are not publicly traded or whose market price is
not readily available are valued by the Board of Directors based on detailed
analyses prepared by management, the Valuation Committee of the Board of
Directors, and, in certain circumstances, third parties with valuation
expertise. Valuations are conducted by management on 100% of the investment
portfolio at the end of each quarter. The Company follows the provisions of ASC
Fair Value Measurements and Disclosures (“Fair Value Measurements and
Disclosures ”). This standard defines fair value, establishes a framework
for measuring fair value, and expands disclosures about assets and liabilities
measured at fair value. Fair
Value Measurements and Disclosures 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 Fair Value
Measurements and Disclosures, the FASB has issued various staff positions
clarifying the initial standard as noted below.
In
January 2010, the FASB issued guidance that clarifies and requires new
disclosures about fair value measurements. The clarifications and requirement 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, were adopted by the Company in the first quarter of 2010. Note
4 below reflects the amended disclosure requirements. The new guidance also
requires that purchases, sales, issuances and settlements be presented gross in
the Level III reconciliation and that requirement is effective for fiscal years
beginning after December 15, 2010 and for interim periods within those
years. The Company is evaluating the increased disclosure requirements for
implementation by the effective date. Since this new guidance only amends the
disclosures requirements, it did not impact our statements of financial
position, statements of operations, or cash flow statements.
Fair Value Measurements and
Disclosures 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 engaged Valuation Research
Corporation (“VRC”), an independent valuation firm, to provide third-party
valuation estimates for approximately 39% of its portfolio at fair value as of
December 31, 2009. VRC’s valuation estimates were considered as
one of the relevant data inputs in the Company’s determination of fair
value. Though the Board of Directors did not engage VRC to
provide valuation estimates for any of the assets in the Company’s portfolio as
of September 30, 2010, the Board of Directors 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 Company’s
annual year end valuation process.
The Board
of Directors may consider other methods of valuation than those set forth above
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 ready 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.
28
The
Company’s valuation methodology and procedures are as follows:
|
1)
|
Each
portfolio company or investment is cross-referenced to an independent
pricing service to determine if a current market quote is available. The
nature and quality of such quote is reviewed to determine reliability and
relevance of the quote. Factors considered in this determination include
whether the quote is from a transaction or is a broker quote, the date and
aging of such quote, whether the transaction is arms-length, whether it is
of a liquidation or distressed nature and certain other factors judged to
be relevant by management within the framework of Fair Value Measurements
and Disclosures.
|
|
2)
|
If
an investment does not have a market quotation on either a broad market
exchange or from an independent pricing service, the investment is
initially valued by the Company’s investment professionals responsible for
the portfolio investment in conjunction with the portfolio management
team.
|
|
3)
|
Preliminary
valuation conclusions are discussed and documented by
management.
|
|
4)
|
Illiquid
loans, junior and mezzanine securities, equity investments, CLO Fund
securities and Katonah Debt Advisors may be selected for review by an
independent valuation firm, which is engaged by the Company’s Board of
Directors. Such independent valuation firm reviews management’s
preliminary valuations and makes their own independent valuation
assessment.
|
|
5)
|
The
Valuation Committee of the Board of Directors reviews the portfolio
valuations, as well as the input and report of such independent valuation
firm, as applicable.
|
|
6)
|
Upon
approval of the investment valuations by the Valuation Committee of the
Board of Directors, the Audit Committee of the Board of Directors reviews
the results for inclusion in the Company’s quarterly and annual financial
statements, as applicable.
|
|
7)
|
The
Board of Directors discusses the valuations and determines in good faith
that the fair values of each investment in the portfolio is reasonable
based upon any applicable independent pricing service, input of
management, estimates from independent valuation firms (if any) and the
recommendations of the Valuation Committee of the Board of
Directors.
|
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, including 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.
Loans and Debt
Securities. To the extent
that the Company’s investments are exchange traded and are priced or have
sufficient price indications from normal course trading at or around the
valuation date (financial reporting date), such pricing will determine fair
value. Pricing service marks from third party pricing services may be used as an
indication of fair value, depending on the volume and reliability of the marks,
sufficient and reasonable correlation of bid and ask quotes, and, most
importantly, the level of actual trading activity. However, most of the
Company’s investments are illiquid investments with little or no trading
activity. Further, 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. As a result, for most of its assets, the Company
determines fair value using alternative methodologies using 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.
29
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
underlying assets with discount rates imputed by broad market indices, bond
spreads and yields for comparable issuers relative to the subject assets (the
“Market Yield Approach”) and also considers 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 investments. Because the Company
has not identified any market index that directly correlates to the loan and
debt investments held by the Company and therefore uses the two 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 Market Yield 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 and Equity-Related
Securities. The Company’s equity and equity-related 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 and 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. The values of the Company’s equity
and equity-related securities in public companies for which market quotations
are readily available are based upon the closing public market prices on the
balance sheet date. Securities that carry certain restrictions on sale are
typically valued at a discount from the public market value of the
security.
The
significant inputs used to determine the fair value of equity and equity-related
securities include prices, earnings, EBITDA and cash flows after capital
expenditures for similar peer comparables and the investment entity itself.
Equity and equity related securities are classified as Level III, as described
in Note 4 below, 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.
Affiliate Asset Manager. The
Company’s investment in its wholly-owned asset management company, Katonah Debt
Advisors, is carried at fair value, which is determined after taking into
consideration a percentage of assets under management and a discounted cash flow
model incorporating 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 includes an analysis of comparable asset management companies. Katonah
Debt Advisors is classified as a Level III investment (as described below). 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 Katonah Debt Advisors and may
selectively invest in securities issued by funds managed by other asset
management companies (collectively “CLO Fund securities”). The Company’s CLO
Fund securities relate exclusively to credit instruments issued by corporations
and do not include any asset-backed securities secured by commercial mortgages,
residential mortgages, or consumer borrowings.
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 paydown 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, or (ii)
a discounted cash flow model for more recent CLO Funds 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. 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 NAVs 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 an individual security-by-security
basis.
30
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 bond
rated 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 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. Such
adjustments require judgment and may be material to the calculation of fair
value.
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 consists mostly of cash held in an operating
account pursuant to the Company’s secured credit facility agreement with its
lender.
Time Deposits and
Money Market Accounts. Time deposits primarily represent overnight
Eurodollar investments of cash held in non-demand deposit accounts. Such
time deposits are partially restricted under terms of the secured credit
facility. The money market account contains restricted cash held for employee
flexible spending accounts.
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, 2010, five issuers representing 2% of total
investments at fair value were considered in default.
Dividends from
Affiliate Asset Manager. The Company records dividend income from its
affiliate asset manager on the declaration date, which represents the
ex-dividend date.
Dividend Income
from CLO Fund Securities. The Company generates dividend income
from its investments in the most junior class of securities of CLO Funds
(typically preferred shares or subordinated securities) managed by Katonah Debt
Advisors and selective investments in securities issued by funds managed by
other asset management companies. The Company’s CLO Fund junior class securities
are subordinated to senior bond holders who typically receive a fixed rate of
return 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 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 Company makes estimated interim accruals of
such dividend income based on recent historical distributions and CLO Fund
performance and adjusts such accruals on a quarterly basis to reflect actual
distributions.
For
non-junior class CLO Fund securities, such as the Company’s investment in the
Class B-2L Notes of the Katonah 2007-1 CLO, interest is earned at a fixed spread
relative to the LIBOR index.
Capital
Structuring Service Fees. The Company may earn ancillary structuring and
other fees related to the origination, investment, disposition or liquidation of
debt and investment securities. Generally, the Company will capitalize loan
origination fees, then amortize these fees into interest income over the term of
the loan using the effective interest rate method , recognizes 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 ratably over the contractual term of the borrowing. At
September 30, 2010, there was an unamortized debt issuance cost of approximately
$57,000 included in other assets in the accompanying balance sheet. Amortization
expense for the nine months ended September 30, 2010 and 2009 was approximately
$561,000 and $619,000, respectively.
31
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 its asset manager
affiliates share office space and certain other operating expenses. The Company
has entered into an Overhead Allocation Agreement with its asset manager
affiliates which provides for the sharing of such expenses based on an equal
sharing of office lease costs and the ratable usage of other shared resources.
The aggregate net payments of such expenses under the Overhead Allocation
Agreement are not material.
Dividends.
Dividends and distributions to common stockholders are recorded on the
ex-dividend date. The amount to be paid out as a dividend is determined by the
Board of Directors each quarter and is generally based upon the earnings
estimated by management for the period and year.
The
Company has adopted a dividend reinvestment plan (“DRIP”) that provides for
reinvestment of its distributions on behalf of its stockholders, unless a
stockholder “opts out” of the plan to receive cash in lieu of having their cash
dividends automatically reinvested in additional shares of the Company’s common
stock.
Recent
Accounting Pronouncements
Improved Disclosures Regarding Fair
Value Measurements. In
January 2010, the FASB issued Accounting Standards Update No. 2010-06,
Fair Value Measurements and
Improving Disclosures About Fair Value Measurements (Topic 820), which
provides for improving disclosures about fair value measurements, primarily
significant transfers in and out of Levels I and II, and activity in Level III
fair value measurements. The new disclosures and clarifications of existing
disclosures are effective for the interim and annual reporting periods beginning
after December 15, 2009, while the disclosures about the purchases, sales,
issuances, and settlements in the roll forward activity in Level 3 fair value
measurements are effective for fiscal years beginning after December 15,
2010 and for the interim periods within those fiscal years. Except for certain
detailed Level III disclosures, which are effective for fiscal years beginning
after December 15, 2010 and interim periods within those years, the new
guidance became effective for the Company’s fiscal 2010 second quarter. The
Company did not have transfers of assets or liabilities in or out of Level I and
Level II fair value measurements. The adoption of this disclosure-only guidance
is included in Note 3 “— Portfolio Investments” and did not have a material
impact on the Company’s financial results.
Fair Value Measurements for
Alternative Investments. In September 2009, the FASB issued
Accounting Standards Update 2009-12, Fair Value Measurements and
Disclosures (Topic 820) — Investments in Certain Entities That Calculate Net
Asset Value per Share (or Its Equivalent), which provides guidance on
estimating the fair value of an alternative investment, amending ASC 820-10. The
amendment is effective for interim and annual periods ending after
December 15, 2009. The adoption of this guidance did not have a material
impact on either the Company’s financial position or results of
operations.
32
3.
EARNINGS PER SHARE
The
following information sets forth the computation of basic and diluted net
increase in stockholders’ equity per share for the three and nine months ended
September 30, 2010 and 2009:
|
Three Months Ended September 30,
|
Nine Months Ended September 30,
|
|||||||||||||||
|
2010
|
2009
|
2010
|
2009
|
|||||||||||||
|
Net
increase (decrease) in net assets from operations
|
$ | (3,319,312 | ) | $ | 10,665,810 | $ | (7,415,319 | ) | $ | 32,543,669 | ||||||
|
Net
increase (decrease) in net assets allocated to non-vested share
awards
|
— | 129,675 | — | 461,696 | ||||||||||||
|
Net
increase (decrease) in net assets available to common
stockholders
|
(3,319,312 | ) | 10,536,135 | (7,415,319 | ) | 32,081,973 | ||||||||||
|
Weighted
average number of common shares outstanding for basic shares
computation
|
22,677,428 | 22,194,690 | 22,547,274 | 22,030,517 | ||||||||||||
|
Effect
of dilutive securities - stock options
|
— | 5 | — | — | ||||||||||||
|
Weighted
average number of common and common stock equivalent shares outstanding
for diluted shares computation
|
22,677,428 | 22,194,695 | 22,547,274 | 22,030,517 | ||||||||||||
|
Basic
and diluted net increase (decrease) in net assets per common
shares:
|
||||||||||||||||
|
Net
increase (decrease) in net assets from operations
|
(0.15 | ) | 0.47 | (0.33 | ) | 1.46 | ||||||||||
|
Net
increase (decrease) in net assets allocated to non-vested share
awards
|
— | 0.01 | — | 0.02 | ||||||||||||
Effective
January 1, 2008, the accounting for unvested share-based payment awards included
in the calculation of earnings per share changed. Share-based awards that
contain nonforfeitable rights to dividends or dividend equivalents, whether paid
or unpaid, are now participating securities and included in the computation of
both basic and diluted earnings per share. Our grants of restricted stock awards
to our employees and directors are considered participating securities when
there are earnings in the period. We have prepared our earnings per share
calculations to include outstanding unvested restricted stock awards in the
basic weighted average shares outstanding calculation.
Options
to purchase 40,000 and 20,000 shares were not included in the computation of
diluted earnings per share for the periods ended September 30, 2010 and 2009,
respectively, because the effect would be antidilutive as the exercise prices
exceeded the average market price of the common shares.
4.
INVESTMENTS
The
Company invests in senior secured loans and mezzanine debt and, to a lesser
extent, equity capital of middle market companies in a variety of industries.
The Company generally targets companies that generate positive cash flows
because the Company looks to cash flows as the primary source for servicing
debt. However, the Company may invest in industries in which it currently has
little or no investment if it is presented with attractive
opportunities.
The
following table shows the Company’s portfolio by security type at September 30,
2010 and December 31, 2009:
|
September 30, 2010
|
December 31, 2009
|
|||||||||||||||||||||||
|
Security Type
|
Cost
|
Fair Value
|
%¹
|
Cost
|
Fair Value
|
%¹
|
||||||||||||||||||
|
Time
Deposits
|
$ | 24,529,777 | $ | 24,529,777 | 12 | % | $ | 126 | $ | 126 | - | % | ||||||||||||
|
Money
Market Account
|
212,245 | 212,245 | - | - | - | - | ||||||||||||||||||
|
Senior
Secured Loan
|
110,660,494 | 95,668,038 | 48 | 179,425,767 | 159,075,586 | 74 | ||||||||||||||||||
|
Junior
Secured Loan
|
103,690,662 | 90,642,174 | 45 | 129,016,237 | 114,920,499 | 54 | ||||||||||||||||||
|
Mezzanine
Investment
|
10,744,496 | 250,000 | - | 28,606,852 | 19,235,444 | 9 | ||||||||||||||||||
|
Senior
Subordinated Bond
|
4,240,630 | 3,964,233 | 2 | 3,007,167 | 2,415,000 | 1 | ||||||||||||||||||
|
Senior
Unsecured Bond
|
- | - | - | 2,000,000 | 1,710,000 | 1 | ||||||||||||||||||
|
Preferred
Stock
|
400,000 | 384,000 | - | - | - | - | ||||||||||||||||||
|
CLO
Fund Securities
|
68,258,657 | 52,751,000 | 26 | 68,195,049 | 48,971,000 | 23 | ||||||||||||||||||
|
Equity
Securities
|
14,216,146 | 5,989,599 | 3 | 12,365,603 | 4,713,246 | 2 | ||||||||||||||||||
|
Affiliate
Asset Managers
|
44,219,947 | 49,149,581 | 25 | 40,751,511 | 58,064,720 | 27 | ||||||||||||||||||
|
Total
|
$ | 381,173,054 | $ | 323,540,647 | 161 | % | $ | 463,368,312 | $ | 409,105,621 | 191 | % | ||||||||||||
¹ Calculated as a percentage of net asset value.
33
The
industry concentrations, based on the fair value of the Company’s investment
portfolio as of September 30, 2010 and December 31, 2009, were as
follows:
|
September 30, 2010 (unaudited)
|
December 31, 2009
|
|||||||||||||||||||||||
|
Industry Classification
|
Cost
|
Fair Value
|
%¹
|
Cost
|
Fair Value
|
%¹
|
||||||||||||||||||
|
Aerospace
and Defense
|
$ | 18,029,023 | $ | 17,037,661 | 9 | % | $ | 33,652,058 | $ | 33,416,670 | 16 | % | ||||||||||||
|
Asset Management
Companies2
|
44,219,947 | 49,149,581 | 25 | 40,751,511 | 58,064,720 | 27 | ||||||||||||||||||
|
Automobile
|
- | - | - | 1,940,876 | 1,800,631 | 1 | ||||||||||||||||||
|
Broadcasting
and Entertainment
|
2,988,898 | 3,000,000 | 2 | 2,986,206 | 2,862,000 | 1 | ||||||||||||||||||
|
Buildings and Real
Estate3
|
33,380,978 | 6,411,638 | 3 | 36,498,537 | 9,840,946 | 5 | ||||||||||||||||||
|
Cargo
Transport
|
4,940,182 | 4,940,182 | 2 | 13,389,865 | 13,359,403 | 6 | ||||||||||||||||||
|
Chemicals,
Plastics and Rubber
|
3,975,956 | 4,000,000 | 2 | 3,970,688 | 4,000,000 | 2 | ||||||||||||||||||
|
CLO
Fund Securities
|
68,258,657 | 52,751,000 | 26 | 68,195,049 | 48,971,000 | 23 | ||||||||||||||||||
|
Containers,
Packaging and Glass
|
7,042,719 | 6,989,847 | 3 | 7,056,701 | 6,852,738 | 3 | ||||||||||||||||||
|
Diversified/Conglomerate
Manufacturing
|
3,261,662 | 3,259,010 | 2 | 4,046,728 | 4,042,346 | 2 | ||||||||||||||||||
|
Diversified/Conglomerate
Service
|
15,332,837 | 12,772,049 | 6 | 15,382,035 | 14,350,438 | 7 | ||||||||||||||||||
|
Ecological
|
2,675,508 | 2,678,977 | 1 | 2,695,103 | 2,699,907 | 1 | ||||||||||||||||||
|
Electronics
|
5,438,457 | 4,999,080 | 2 | 14,874,472 | 14,407,265 | 7 | ||||||||||||||||||
|
Farming
and Agriculture
|
- | - | - | 1,441,277 | 217,001 | - | ||||||||||||||||||
|
Finance
|
3,647,725 | 3,597,108 | 2 | 5,460,445 | 5,372,881 | 3 | ||||||||||||||||||
|
Healthcare,
Education and Childcare
|
32,275,520 | 32,990,504 | 16 | 41,647,084 | 42,177,498 | 20 | ||||||||||||||||||
|
Home
and Office Furnishings, Housewares, and Durable Consumer
Goods
|
18,286,200 | 17,391,586 | 9 | 20,694,006 | 18,080,134 | 8 | ||||||||||||||||||
|
Hotels,
Motels, Inns and Gaming
|
3,277,741 | 3,007,350 | 1 | 3,438,128 | 3,171,363 | 1 | ||||||||||||||||||
|
Insurance
|
4,882,962 | 3,840,000 | 2 | 4,861,123 | 4,490,000 | 2 | ||||||||||||||||||
|
Leisure,
Amusement, Motion Pictures, Entertainment
|
2,034,233 | 2,018,233 | 1 | 14,572,761 | 14,227,907 | 7 | ||||||||||||||||||
|
Machinery
(Non-Agriculture, Non-Construction, Non-Electronic)
|
17,897,748 | 17,224,943 | 9 | 33,015,472 | 31,956,312 | 15 | ||||||||||||||||||
|
Mining,
Steel, Iron and Non-Precious Metals
|
14,315,602 | 14,441,061 | 7 | 13,861,498 | 13,021,854 | 6 | ||||||||||||||||||
|
Oil
and Gas
|
- | - | - | 5,998,652 | 6,000,000 | 3 | ||||||||||||||||||
|
Personal
and Non Durable Consumer Products (Mfg. Only)
|
10,908,755 | 9,104,308 | 5 | 14,424,931 | 9,146,146 | 4 | ||||||||||||||||||
|
Personal,
Food and Miscellaneous Services
|
14,729,308 | 4,194,000 | 2 | 14,759,522 | 4,559,444 | 2 | ||||||||||||||||||
|
Printing
and Publishing
|
8,967,784 | 8,588,871 | 4 | 23,867,184 | 23,506,057 | 11 | ||||||||||||||||||
|
Retail
Stores
|
3,363,854 | 3,239,391 | 2 | 3,543,046 | 3,521,787 | 2 | ||||||||||||||||||
|
Time
Deposits and Money Market Account
|
24,742,023 | 24,742,023 | 12 | 126 | 126 | - | ||||||||||||||||||
|
Utilities
|
12,298,775 | 11,172,244 | 6 | 16,343,228 | 14,989,047 | 6 | ||||||||||||||||||
|
Total
|
$ | 381,173,054 | $ | 323,540,647 | 161 | % | $ | 463,368,312 | $ | 409,105,621 | 191 | % | ||||||||||||
|
1
|
Calculated as a percentage of net asset value. |
|
2
|
Represents Katonah Debt Advisors
and related asset manager
affiliates.
|
|
3
|
Buildings and real estate relate
to real estate ownership, builders, managers and developers and excludes
mortgage debt investments and mortgage lenders or originators. As of
September 30, 2010 and December 31, 2009, the Company had no exposure to
mortgage securities (residential mortgage bonds, commercial mortgage
backed securities, or related asset backed securities) or companies
providing mortgage
lending.
|
34
The
Company may invest up to 30% of the investment portfolio in opportunistic
investments in high-yield bonds, debt and equity securities of CLO Funds,
distressed debt or equity securities of public companies. However, the Company’s
investment strategy is to limit the value of its investments in debt or equity
securities issued by CLO Funds to not more than 15% of the value of its total
investment portfolio at the time of investment. The Company expects that these
public companies generally will have debt that is non-investment grade. The
Company also may invest in debt of middle market companies located outside of
the United States, which investments (excluding the Company’s investments in CLO
Funds) are generally not anticipated to be in excess of 10% of the investment
portfolio at the time such investments are made. The Company is generally
prohibited from buying or selling any security from or to any portfolio company
of a private equity fund managed by Kohlberg & Co. without the prior
approval of the SEC. In addition, the Company may co-invest on a concurrent
basis with Kohlberg & Co. or any of its affiliates, subject to
compliance with existing regulatory guidance, applicable regulations and its
allocation procedures. Certain types of negotiated co-investments may be made
only if the Company receives an order from the SEC permitting it to do so. There
can be no assurance that any such order will be applied for or, if applied for,
obtained.
At
September 30, 2010 and December 31, 2009, approximately 25% and 12% of the
Company’s investments were foreign assets (including the Company’s investments
in CLO Funds, which are typically domiciled outside the U.S. and represented
approximately 16% and 12% of its portfolio on such dates), respectively. At
September 30, 2010, approximately $25 million of foreign assets were in U.S.
dollar denominated over-night time Eurodollar deposits which revert to cash each
business morning.
At
September 30, 2010 and December 31, 2009, the Company’s ten largest portfolio
companies represented approximately 47% and 37%, respectively, of the total fair
value of its investments. The Company’s largest investment, Katonah Debt
Advisors which is its wholly-owned portfolio company, represented 15% and 14% of
the total fair value of the Company’s investments at September 30, 2010 and
December 31, 2009, respectively. Excluding Katonah Debt Advisors and CLO Fund
securities, the Company’s ten largest portfolio companies represented
approximately 19% and 19% of the total fair value of the Company’s investments
at September 30, 2010 and December 31, 2009, respectively.
Investment
in CLO Fund Securities
The
Company typically makes a minority investment in the most junior class of
securities of CLO Funds (typically preferred shares or subordinated securities)
managed by Katonah Debt Advisors and may selectively invest in securities issued
by funds managed by other asset management companies. However, as noted above,
the Company’s investment strategy is to limit the value of its investments in
the debt or equity securities issued by CLO Funds to not more than 15% of the
value of its total investment portfolio at the time of investment. Preferred
shares or subordinated securities issued by CLO Funds are entitled to recurring
dividend 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 and CLO Fund expenses. CLO Funds managed by Katonah Debt
Advisors (“CLO fund securities managed by affiliate”) 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 and exclude mortgage pools or mortgage securities
(residential mortgage bonds, commercial mortgage backed securities, or related
asset-backed securities), debt to companies providing mortgage lending and
emerging markets investments. The CLO Funds are leveraged funds and any excess
cash flow or “excess spread” (interest earned by the underlying securities in
the fund less payments made to senior bond holders, fund expenses and management
fees) is paid to the holders of the CLO Fund’s subordinated securities or
preferred shares.
On
January 23, 2008, the Company’s wholly-owned asset management company,
Katonah Debt Advisors, closed the Katonah 2007-1 CLO, a $315 million CLO Fund.
The Company received a structuring fee upon closing and Katonah Debt Advisors
earns an ongoing asset management fee based on the par amount of the underlying
investments in the CLO Fund. Securities issued by CLO Funds managed by Katonah
Debt Advisors are primarily held by third parties. Kohlberg Capital invested
approximately $29 million to acquire all of the shares of the most junior class
of securities of this CLO Fund.
The
subordinated securities and preferred share securities are considered equity
positions in the CLO Funds and, as of September 30, 2010 and December 31, 2009,
the Company had approximately $46 million and $45 million, respectively, of such
CLO equity investments at fair value. The cost basis of the Company’s investment
in CLO Fund equity securities as of September 30, 2010 was approximately $67
million and aggregate unrealized depreciation on the CLO Fund securities totaled
approximately $21 million. The cost basis of the Company’s investment in CLO
Fund equity securities as of December 31, 2009, was approximately $67 million
and aggregate unrealized depreciation on the CLO Fund securities totaled
approximately $23 million.
In May,
2009 the Company purchased the class B-2L notes of the Katonah 2007-1 CLO
investment managed by Katonah Debt Advisors (“Katonah 2007-1 B-2L”). The Company
purchased the Katonah 2007-1 B-2L for 10% of the par value. The fair value, cost
basis, and aggregate unrealized appreciation of the Katonah 2007-1 B-2L
investment as of September 30, 2010 were approximately $7 million, $1 million,
and $6 million, respectively, and at December 31, 2009, the fair value, cost
basis, and aggregate unrealized appreciation of the Katonah 2007-1 B-2L
investment were $4 million, $1 million, and $3 million, respectively. Both the
B-2L notes and preferred shares of Katonah 2007-1 are owned 100% by the Company
and are making their required quarterly distributions.
35
Fair
Value Measurements
The
Company follows the provisions of Fair Value Measurements and
Disclosures, 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. Fair
Value Measurements and Disclosures 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 Fair Value Measurements and
Disclosures, the FASB has issued various staff positions clarifying the
initial standard (see Note 2. “Significant Accounting
Policies—Investments”).
Fair Value Measurements and
Disclosures 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 Fair Value Measurements and
Disclosures, 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 corporate loans and bonds 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.
Substantially all of the Company’s investments are classified as Level III. The
Company evaluates the source of inputs, including any markets in which its
investments are trading, in determining fair value. Inputs that are backed by
actual transactions, those that are highly correlated to the specific investment
being valued and those derived from reliable or knowledgeable sources will tend
to have a higher weighting in determining fair value. Ongoing reviews by the
Company’s investment analysts, Chief Investment Officer, Valuation Committee and
independent valuation firms (if engaged) are based on 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 Fair Value Measurements and
Disclosures fair value hierarchy levels as of September 30, 2010
(unaudited) and December 31, 2009, respectively:
36
|
As of September, 30 2010
|
||||||||||||||||
|
Level I
|
Level II
|
Level III
|
Total
|
|||||||||||||
|
Time
deposit and money market account
|
$ | — | $ | 24,742,022 | $ | — | $ | 24,742,022 | ||||||||
|
Debt
securities
|
— | — | 190,908,445 | 190,908,445 | ||||||||||||
|
CLO
fund securities
|
— | — | 52,751,000 | 52,751,000 | ||||||||||||
|
Equity
securities
|
— | — | 5,989,599 | 5,989,599 | ||||||||||||
|
Asset
manager affiliate
|
— | — | 49,149,581 | 49,149,581 | ||||||||||||
|
As of December 31, 2009
|
||||||||||||||||
|
Level I
|
Level II
|
Level III
|
Total
|
|||||||||||||
|
Time
deposit and money market account
|
$ | — | $ | 126 | $ | — | $ | 126 | ||||||||
|
Debt
securities
|
— | — | 297,356,529 | 297,356,529 | ||||||||||||
|
CLO
fund securities
|
— | — | 48,971,000 | 48,971,000 | ||||||||||||
|
Equity
securities
|
— | — | 4,713,246 | 4,713,246 | ||||||||||||
|
Asset
manager affiliate
|
— | — | 58,064,720 | 58,064,720 | ||||||||||||
37
Investment
values derived by a third party pricing service are deemed Level III values
since such values are not traded on an active public exchange and may represent
a traded or broker quote on an asset that is infrequently traded.
The
Company derives fair value for its illiquid investments that do not have
indicative fair values based upon active trades primarily by using the Market
Yield Approach and also considers 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 investments. Because the Company has
not identified any market index that directly correlates to the loan and debt
investments held by the Company and therefore uses the two 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 Market
Yield 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. The appropriateness of specific valuation methods and techniques may
change as market conditions and available data change.
The
Company engaged VRC, an independent valuation firm, to provide third-party
valuation estimates for approximately 39% of its portfolio at fair value as of
December 31, 2009. VRC’s valuation estimates were considered as one of the
relevant data inputs in the Company’s determination of fair value. Though the
Board of Directors did not engage VRC to provide valuation estimates for any of
the assets in the Company’s portfolio as of September 30, 2010, the Board of
Directors 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 Company’s annual year end valuation
process.
Values
derived for debt securities using public/private company comparables 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 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 asset manager affiliates using public/private company comparables
generally utilize market-observable data from such comparables and specific,
non-public and non-observable financial measures (such as assets under
management, historical and prospective earnings) for the asset manager
affiliate. The Company recognizes that comparable asset managers may not be
fully comparable to its 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
changes in investments measured at fair value for which the Company has used
unobservable inputs to determine fair value are as follows:
|
Nine Months Ended September 30, 2010
|
||||||||||||||||||||
|
CLO Fund
|
Equity
|
Asset Manager
|
||||||||||||||||||
|
Debt Securities
|
Securities
|
Securities
|
Affiliates
|
Total
|
||||||||||||||||
|
Balance,
December 31, 2009
|
$ | 297,356,529 | $ | 48,971,000 | $ | 4,713,246 | $ | 58,064,720 | $ | 409,105,495 | ||||||||||
|
Transfers
in/out of Level III
|
— | — | — | — | — | |||||||||||||||
|
Net
accretion of discount
|
307,500 | 63,608 | — | 371,108 | ||||||||||||||||
|
Purchases
(sales), net
|
(101,874,675 | ) | — | 1,850,543 | 3,468,436 | (96,555,696 | ) | |||||||||||||
|
Total
loss realized and unrealized included in earnings
|
(4,880,909 | ) | 3,716,392 | (574,190 | ) | (12,383,575 | ) | (14,122,282 | ) | |||||||||||
|
Balance,
September 30, 2010
|
$ | 190,908,445 | $ | 52,751,000 | $ | 5,989,599 | $ | 49,149,581 | $ | 298,798,625 | ||||||||||
|
Changes
in unrealized gains (losses) included in earnings related to investments
still held at reporting date
|
$ | 5,871,658 | $ | 3,716,392 | $ | (574,190 | ) | $ | (12,383,575 | ) | $ | (3,369,715 | ) | |||||||
38
|
Nine Months Ended September 30, 2009
|
||||||||||||||||||||
|
Debt Securities
|
CLO Fund
Securities
|
Equity
Securities
|
Asset Manager
Affiliates
|
Total
|
||||||||||||||||
|
Balance,
December 31, 2008
|
$ | 353,859,007 | $ | 34,640,000 | $ | 5,087,512 | $ | 54,734,812 | $ | 448,321,331 | ||||||||||
|
Transfers
in/out of Level III
|
— | — | — | — | — | |||||||||||||||
|
Net
accretion of discount
|
780,964 | 723,739 | — | — | 1,504,703 | |||||||||||||||
|
Purchases
(sales), net
|
(40,448,631 | ) | 1,076,250 | — | 4,018,309 | (35,354,072 | ) | |||||||||||||
|
Total
loss realized and unrealized included in earnings
|
9,156,290 | 10,276,011 | (567,278 | ) | (2,009,094 | ) | 16,855,929 | |||||||||||||
|
Balance,
September 30, 2009
|
$ | 323,347,630 | $ | 46,716,000 | $ | 4,520,234 | $ | 56,744,027 | $ | 431,327,891 | ||||||||||
|
Changes
in unrealized gains (losses) included in earnings related to investments
still held at reporting date
|
$ | 15,800,620 | $ | 10,276,011 | $ | (567,279 | ) | $ | 205,975 | $ | 25,715,327 | |||||||||
5.
AFFILIATE ASSET MANAGERS
Wholly-Owned
Asset Manager
Prior to
its IPO, the Company issued an aggregate of 2,226,333 common shares, having a
value of approximately $33 million, to affiliates of Kohlberg & Co. to
acquire Katonah Debt Advisors. As a result, Katonah Debt Advisors is a
wholly-owned portfolio company. Katonah Debt Advisors manages CLO Funds
primarily for third party investors that invest in broadly syndicated loans,
high yield bonds and other credit instruments issued by corporations. These CLO
Funds do not invest in asset-backed securities secured by commercial mortgages,
residential mortgages or other consumer borrowings. At September 30, 2010,
Katonah Debt Advisors had approximately $2.1 billion of par value of assets
under management, and the Company’s 100% equity interest in Katonah Debt
Advisors was valued at approximately $49 million.
As a
manager of the CLO Funds, Katonah Debt Advisors receives contractual and
recurring management fees and may receive a one-time structuring fee from the
CLO Funds for its management and advisory services. The annual fees which
Katonah Debt Advisors receives are generally based on a fixed percentage of
assets under management (at par value and not subject to changes in market
value), and Katonah Debt Advisors generates annual operating income equal to the
amount by which its fee income exceeds it operating expenses. The annual
management fees Katonah Debt Advisors receives have two components - a senior
management fee and a subordinated management fee. At September 30, 2010, Katonah
Debt Advisors continued to receive all senior management fees payable by the CLO
Funds managed by it.
During
2009, certain CLO funds managed by Katonah Debt Advisors were restricted from
currently paying their subordinated management fees as a result of the failure
by those CLO Funds to satisfy certain restrictive covenants contained in their
indenture agreements. At such time, those subordinated management fees continued
to be accrued by the applicable CLO Fund to become payable to Katonah Debt
Advisors when such CLO Fund becomes compliant with the applicable covenants.
During the nine months ended September 30, 2010, all those CLO Funds which
deferred payment of their subordinated management fees regained compliance with
all applicable covenants in order to pay current subordinated management fees as
well as a portion of previously accrued subordinated management fees. During the
nine months ended September 30, 2010, approximately $4 million of deferred
subordinated management fees have been paid and approximately $1 million of
deferred subordinated management fees on one CLO remain deferred for payment in
the fourth quarter of 2010. Currently, all CLO Funds managed by Katonah Debt
Advisors are paying both their senior and subordinated management fees on a
current basis.
39
In future
years, Katonah Debt Advisors may receive accrued incentive fees upon the
liquidation of CLO Funds it manages, provided such CLO Funds have achieved a
minimum investment return to holders of their subordinated securities or
preferred shares.
On
January 2, 2008, the Katonah Debt Advisors platform acquired substantially
all of the assets of Scott’s Cove Capital Management LLC (“Scott’s Cove”), an
asset manager focused on an event-driven credit long short investment strategy.
As a result of the acquisition, approximately $60 million of fee paying assets
under management were integrated into the Katonah Debt Advisors asset management
platform. In connection with the acquisition, Katonah Debt Advisors entered into
employment agreements with three Scott’s Cove investment professionals, and
expects these individuals will assist in structuring, raising and investing new
funds to be managed by Katonah Debt Advisors. As of September 30, 2010, Scott’s
Cove had approximately $150 million of assets under management.
The
revenue that Katonah Debt Advisors generates through the fees it receives for
managing CLO Funds and after paying the expenses associated with its operations,
including compensation of its employees, may be distributed to the Company. Any
distributions of Katonah Debt Advisors’ net income are recorded as dividends
from affiliate asset manager. For the nine months ended September 30, 2010,
Katonah Debt Advisors had approximately $2 million of pre-tax net income and
made distributions of $3 million to the Company, a portion of which represented
undistributed earnings from prior years. For the nine months ended September 30,
2009, Katonah Debt Advisors earned approximately $2 million of pre-tax net
income and made no distributions to the Company; dividends are recorded as
declared (where declaration date represents ex-dividend date) by Katonah Debt
Advisors as income on our statement of operations.
As with
all other investments, Katonah Debt Advisors’ fair value is periodically
determined. The valuation is primarily based on an analysis of both a percentage
of its assets under management and Katonah Debt Advisors’ estimated operating
income. Any change in value from period to period is recognized as unrealized
gain or loss. See Note 2, “Significant Accounting Policies” and Note 4,
“Investments” for further information relating to the Company’s valuation
methodology.
As a
separately regarded entity for tax purposes, Katonah Debt Advisors is taxed at
normal corporate rates. For tax purposes, any distributions of taxable net
income earned by Katonah Debt Advisors to the Company would generally need to be
distributed to the Company’s shareholders. Generally, such distributions of
Katonah Debt Advisors’ income to the Company’s shareholders will be considered
as qualified dividends for tax purposes. Katonah Debt Advisors’ taxable net
income will differ from GAAP net income because of deferred tax timing
adjustments and permanent tax adjustments. Deferred tax timing adjustments may
include differences for the recognition and timing of depreciation, bonuses to
employees and stock option expense. 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 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 will be amortized for tax
purposes on a straight-line basis over 15 years, which accounts for an annual
difference between GAAP income and taxable income by approximately $2 million
per year over such period.
At
September 30, 2010 a net amount due from affiliates totaled approximately
$1,643 , and at December 31, 2009 a net amount due from affiliates totaled
approximately $44,000.
6.
BORROWINGS
The
Company’s debt obligations consist of the following:
|
|
As of
|
As of
|
||||||
|
September 30, 2010
|
December 31, 2009
|
|||||||
|
Secured credit facility, due
February 28, 20111
|
137,159,147 | 218,050,363 | ||||||
1 February
28, 2011 is the maturity date as established by a Forbearance and Settlement
Agreement dated September 20, 2010.
40
On
February 14, 2007, the Company entered into an arrangement under which the
Company may obtain up to $200 million in financing (the “Facility”). On
October 1, 2007, the Company amended the Facility to increase the Company’s
borrowing capacity from $200 million to $275 million, extend the maturity date
from February 12, 2012 to October 1, 2012 and increase the interest
spread charged on outstanding borrowings by 15 basis points to 0.85%. The
interest rate is based on prevailing commercial paper rates plus 0.85% or, if
the commercial paper market is at any time unavailable, prevailing LIBOR rates
plus an applicable spread. Interest is payable monthly. As a result of the
assertion of BMO Capital Markets Corp., as the agent (the “Agent”), that a
Termination Event occurred under the LFSA, for the period June 2009 through
September 2010, interest under the LFSA has been calculated at a higher default
rate (equal to 0.85% above the prime rate plus 0.75%).
Fair Value of Debt. The
Company records debt at cost. The fair value of the Company’s outstanding debt
was approximately $133 Million and $218 million at September 30, 2010 and
December 31, 2009, respectively. The fair value of the Company’s debt was
determined based on market interest rates for similar instruments as of the
balance sheet dates.The Facility is secured by loans acquired by the Company
with the advances under the Facility. The Company borrows under the Facility
through its wholly-owned, special-purpose bankruptcy remote subsidiary, KCAP
Funding.
In
connection with the Facility, the Company is party to a Loan Funding and
Servicing Agreement, dated as of February 14, 2007 (as amended, the “LFSA”), by
and among the Borrower, the Company, as the servicer, BMO Capital Markets Corp,
as the agent (the “Agent”), U.S. Bank National Association, a national banking
association, as the trustee (the “Trustee”) and the other Lender Parties and
other parties thereto (the “Lender Parties”).
In August
2008, The Company was notified by the Lender Parties that the banks providing
the underlying funding for the Facility did not intend to renew their liquidity
facility to the lenders unless the Company agreed to certain revised terms for
the Facility. The Lender Parties proposed new terms to us as a condition to
extending the underlying liquidity purchase agreements. The Company viewed
such proposed terms as unfavorable and did not agree to such new terms, causing
the Agent and Lender Parties to declare a Termination Date based upon their
contention that the underlying liquidity purchase agreements had expired,
thereby terminating The Company’s ability to obtain revolving advances and
commencing the amortization of existing borrowings under the Facility. Since
September 2008, all principal and excess interest collected from the assets
securing the Facility have been and continue to be used to amortize the
Facility. On June 9, 2009, The Company received a letter from a
representative of the Lender Parties alleging that The Company’s failure to
determine ratings on certain pledged loans and The Company’s alleged breach of
certain covenants had resulted in the occurrence of a Termination Event under
the LFSA and that, as a result, the interest payable under the LFSA would be
calculated at the higher default rate (equal to 0.85% above the prime rate plus
0.75%) applicable to periods during which a Termination Event had occurred and
was continuing. Beginning June 2009, based on the Agent’s assertion (despite our
disagreement with such assertion) that a Termination Event had occurred, the
interest payable under the LFSA began to be calculated at such elevated rate and
the Company has paid such higher interest under protest.
As a
result of the actions of the Lender Parties, on August 28, 2009, the Company
filed a complaint with the Supreme Court of the State of New York against the
Agent and the other Lender Parties to the LFSA (the “Litigation”). The
Litigation reflected the Company’s beliefs that the termination date of the
revolving period and the commencement of the amortization period under the LFSA
were wrongful and that the assertions of alleged breaches of our obligations
under the LFSA and the alleged occurrence of Termination Event(s) were without
merit.
On
September 20, 2010, the Company entered into a Forbearance and Settlement
Agreement (the “Settlement Agreement”) with the Agent and Lender Parties (the
Company, Agent and lenders collectively known as the “Parties”) in order to
settle all outstanding claims of the Parties under the LFSA and all related
claims asserted by the Parties in connection with the Litigation noted above as
filed by the Company.
Pursuant
to the Settlement Agreement, the Lender Parties have agreed to refrain, during
the Forbearance Term, from the exercise of any right or remedy relating to any
termination events alleged by any of the Lender Parties to have occurred (or
that resulted from or otherwise relates to an event that occurred or a condition
that existed prior to the date of the Settlement Agreement and that was known or
reasonably should have been known to the Lender Parties) under the LFSA and the
related documents on or before September 20, 2010, the date of the Settlement
Agreement. The Forbearance Term is defined in the Settlement
Agreement to include the period from the date of the Settlement Agreement
through the earliest to occur of (i) any new termination event under the LFSA
(as modified by the Settlement Agreement to provide that the Company’s failure
to comply with certain provisions of the LFSA, including those relating to the
maximum amount of outstanding advances, minimum overcollateralization,
permissible equity shortfalls and a rolling three-month default ratio,
collateral quality and required ratings for specified loans, will not give rise
to a termination event during the Forbearance Term), (ii) the first
determination date on which the Company fails to maintain an overcollaterization
ratio of at least 115%, (iii) the first date on which the Company fails to
maintain a minimum net worth of at least $150 million, (iv) the date on which it
is determined that any representation or warranty made by the Company pursuant
to the Settlement Agreement is untrue or misleading in any material respect, (v)
the date on which any action is commenced challenging the terms of the
Settlement Agreement, the LFSA, the amount of outstanding advances under the
LFSA or the existence, priority or enforceability of the liens or other security
interests in any of the collateral securing the obligations under the LFSA, (vi)
February 28, 2011 and (vii) the failure, subject to certain exceptions, to pay
to the Lender Parties amounts sufficient to reduce the advances outstanding
under the LFSA as set forth in the following amortization
schedule:
41
|
Date
|
Advances Outstanding
|
|
|
September
30, 2010
|
$125
million or less
|
|
|
November
3, 2010
|
$115
million or less
|
|
|
December
1, 2010
|
$105
million or less
|
|
|
January
3, 2011
|
$95
million or less
|
|
|
February
1, 2011
|
$85
million or less
|
|
|
February
28, 2011
|
|
$0
|
Under the
terms of the Settlement Agreement, (i) the Lender Parties have agreed to pay to
the Company $2 million so long as all outstanding advances under the LFSA and
accrued interest thereon (exclusive of any fees or expenses, including
attorneys’ fees and indemnification payments, of the Lender Parties incurred in
connection with the Litigation or any other fees or expenses payable to the
Lender Parties under the LFSA or the related documents other than fees or
expenses incurred in connection with or related to the exercise of remedies
following the occurrence of a Forbearance Term termination event) are repaid in
full on or before February 28, 2011, (ii) from September 10, 2010 through the
end of the Forbearance Term, interest on advances outstanding under the LFSA
will accrue at the rate provided for under the LFSA prior to the occurrence of a
termination event (equal to 0.85% above the prevailing commercial paper rate, or
prevailing LIBOR if the commercial paper market is at any time unavailable),
(iii) upon execution of the Settlement Agreement, the Company has agreed to
release the Lender Parties from any and all claims that any of them may have
under the LFSA and the related documents or the Litigation, (iv) upon payment in
full in accordance with the Agreement of all outstanding advances and accrued
interest thereon and all other amounts due to the Lender Parties under the LFSA,
the Lender Parties have agreed to release the Company from any and all claims
that any of them may have under the LFSA and the related documents or the
Litigation and (v) the parties have stipulated to dismiss the Litigation, with
prejudice, by stipulation of discontinuance filed with the Court on September
21, 2010.
The
Company will generally be permitted, without further consent from the Lender
Parties, to make discretionary sales of loans included in the collateral
securing the LFSA so long as the proceeds from any such sale are at least equal
to 90% of par value of such loans (or, in certain circumstances, 90% of the
Company’s most recent mark-to-market valuation or 90% of such loan’s purchase
price). Other discretionary sales will require the prior written
consent of the Lender Parties.
As noted
above, prior to entering into the Settlement Agreement, the interest rate being
charged on outstanding amounts under the Facility was at a rate equal to 0.85%
above the prime rate plus 0.75%, or approximately 4.9%, and the Company had been
paying interest at such rate under protest. Under the terms of the Settlement
Agreement, commencing on September 10, 2010, the advances under the Facility
will accrue interest at the rate provided for under the LFSA prior to the
occurrence of a termination event, equal to 0.85% above the prevailing
commercial paper rate, or 1.2% as of such date.
The
Company is in compliance with all covenants and terms as provided in the
Settlement Agreement. Under the Settlement Agreement, the Company must have
advances outstanding under the Facility of no greater than $125 million as of
September 30, 2010. Under the terms of the Settlement Agreement, the Company
calculates the advances outstanding under the Facility after consideration of
amortization and pre-payments in the next scheduled distribution to the lenders,
and as of September 30, 2010 the Company’s advances outstanding, calculated in
accordance with the Settlement Agreement, was approximately $116 million as of
September 30, 2010 (the reported outstanding balance of $137 million less
approximately $20 million of pre-payments scheduled for settlement on October
10, 2010).
Under the
Settlement Agreement, the Company must maintain an overcollateralization ratio
of at least 115%. As of September 30, 2010, the Company’s overcollateralization
ratio was 152%. As a BDC, the Company is limited in the amount of leverage it
can incur and is required to meet a coverage ratio of total asset to total
senior securities of at least 200% before incurring new debt. As of September
30, 2010, the Company’s asset coverage ratio was 246%.
Under the
terms of the Settlement Agreement, the Lender Parties will pay to the Company $2
million provided all outstanding advances and accrued interest under the LFSA
are repaid in full on or before February 28, 2011. As this payment is contingent
on the repayment of the Facility and other terms and conditions per the
Settlement Agreement, the Company has not currently recognized such settlement
payment.
42
The
Company believes it has sufficient cash and liquid assets (both those securing
the Facility and those not included in the collateral securing the Facility)
which could be sold, potentially at a loss, to generate cash to fund normal
operations and dividend distributions as well as any Facility outstanding
balance that may exist at February 28, 2011 or any interim date by which a
maximum advances outstanding balance is calculated. The Company may enter into a
new agreement with other lenders or into alternative financing arrangements with
another lender.
The
Company estimates that the portfolio of loans securing the Facility will be
required to generate an annual rate of return of approximately 1% to cover
annual interest payments on obligations incurred under the
Facility.
The
weighted average daily debt balance for the nine months ended September 30, 2010
and 2009 was approximately $141 million and $231 million, respectively. For the
three months ended September 30, 2010 and 2009, the weighted average interest
rate on weighted average outstanding borrowings was approximately 4% and 5%
respectively, which excludes the amortization of deferred financing costs and
facility and program fees on unfunded balances. As of September 30, 2010, the
Company had restricted cash and time deposit balances of approximately $20
million which it maintained in accordance with the terms of the
Facility.
7.
DISTRIBUTABLE TAX INCOME
Effective
December 11, 2006, the Company elected to be treated as a RIC under the
Code and adopted a December 31 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
dividends, if any, are determined by the Board of Directors. The Company
anticipates distributing at least 90% of its taxable income and gains, within
the Subchapter M rules, and thus the Company anticipates that it will not incur
any federal or state income tax at the RIC level. As a RIC, the Company is also
subject to a federal excise tax based on distributive requirements of its
taxable income on a calendar year basis (e.g., calendar year 2010). Depending on
the level of taxable income earned in a tax year, the Company may choose to
carry forward taxable income in excess of current year distributions into the
next tax year and pay a 4% excise tax on such income, to the extent required.
The Company anticipates timely distribution of its taxable income within the tax
rules, and the Company anticipates that it will not incurr a US federal excise
tax for the calendar year 2010.
The
following reconciles net decrease in net assets resulting from operations to
taxable income for the nine months ended September 30, 2010:
|
Nine Months Ended
September 30, 2010
|
||||
|
(unaudited)
|
||||
|
Net
decrease in net assets resulting from operations
|
$ | (7,415,319 | ) | |
|
Net
change in unrealized (appreciation) depreciation from
investments
|
3,369,715 | |||
|
Excess
capital losses over capital gains
|
10,752,567 | |||
|
Income
not on GAAP books currently taxable
|
1,729,018 | |||
|
Income
not currently taxable
|
(57,348 | ) | ||
|
Expenses
not currently deductible
|
166,089 | |||
|
Expenses
not on GAAP books currently deductible
|
(3,978 | ) | ||
|
Taxable
income before deductions for distributions
|
$ | 8,540,744 | ||
|
Taxable
income before deductions for distributions per weighted average shares for
the period
|
$ | 0.38 | ||
For the
quarter ended September 30, 2010, the Company declared a dividend on September
20, 2010 of $0.17 per share for a total of approximately $4 million. The
record date was October 8, 2010 and the dividend was distributed on October 29,
2010.
43
Taxable
income differs from net decrease in net assets resulting from operations
primarily due to: (1) unrealized appreciation (depreciation) on
investments, as investment gains and losses are not included in taxable income
until they are realized; (2) amortization of discount on CLO Fund
Securities; (3) amortization of organizational costs;
(4) non-deductible expenses; (5) stock compensation expense that is
not currently deductible for tax purposes; (6) excess of capital losses
over capital gains; and (7) recognition of interest income on certain
loans.
At
September 30, 2010, the Company had a net capital loss carryforward of
$25 million to offset net capital gains, to the extent provided by federal
tax law. The capital loss carryforward will begin to expire in the tax year
ending December 31, 2015.
The
Company adopted Financial Accounting Standards Board ASC Topic 740 Accounting
for Uncertainty in Income Taxes (“ASC 740”) as of January 1, 2007. ASC 740
provides guidance for how uncertain tax positions should be recognized,
measured, presented, and disclosed in the 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. Tax
positions not deemed to meet the more-likely-than-not threshold are recorded as
a tax benefit or expense in the current year. Adoption of ASC 740 was applied to
all open taxable years (the last three fiscal years) as of the effective date.
The adoption of ASC 740 did not have an effect on the financial position or
results of operations of the Company as there was no liability for unrecognized
tax benefits and no change to the beginning capital of the Company. Management’s
determinations regarding ASC 740 may be subject to review and adjustment at a
later date based upon factors including, but not limited to, an ongoing analysis
of tax laws, regulations and interpretations thereof.
8.
COMMITMENTS AND CONTINGENCIES
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 both September 30, 2010 and December 31, 2009, the
Company had committed to make a total of approximately $2 million of investments
in various revolving senior secured loans, of which approximately $320,000 had
been funded as of September 30, 2010 and $640,000 had been funded as of December
31, 2009.
The
Company and certain directors and officers are named as defendants in three
putative class actions pending in the Southern District of New York brought by
shareholders of the Company and filed in December 2009 and January 2010. The
complaints in these three actions allege violations of Sections 10 and 20 of the
Exchange Act based on the Company’s disclosures of its year-end 2008 and first-
and second-quarter 2009 financial statements. The Company believes that the
above-mentioned suits are without merit and will defend itself
vigorously.
In
addition, the Company and certain directors and officers were also named as
defendants in a derivative action filed on March 2, 2010 in the Supreme
Court of New York, County of New York. The complaint in this action purported to
state causes of action for breaches of fiduciary duties, unjust enrichment,
abuse of control, gross mismanagement, and corporate waste. On October 19, 2010,
the court dismissed the complaint, and found that plaintiff had not alleged that
any of the Company’s directors “‘knowingly’ misrepresented or permitted others
to misrepresent KCAP’s financial condition,” or that the directors were
confronted with “red flags” sufficient to put them on notice of potential
problems with KCAP’s investment valuations. The court afforded the plaintiff 45
days in which to move for leave to amend his complaint, after which, without
such a motion, the dismissal will become final.
9.
LIQUIDITY
As
discussed in Note 6 above, the Company is currently using any income generated
by the assets collateralizing its secured credit Facility to pay principal,
interest and other expenses of the Facility – despite the fact that, if it wants
to remain a RIC and continue to be afforded favorable tax treatment for U.S.
federal income tax purposes, it is required to distribute to the shareholders
substantially all of its investment company taxable income, including the net
amounts generated by the collateralized assets. These collateralized assets with
a market value of approximately $196 million represent approximately 58%
of the Company’s total assets (at fair value) at September 30, 2010 and
contributed approximately 38% of the Company’s investment income for the
quarter ended September 30, 2010. Because the Company is using net
interest income earned on the assets securing the Facility to amortize the
Facility during the amortization period, the Company may need to sell other
assets not pledged to the Facility, potentially at a loss, in order to generate
sufficient cash to make the required dividend distributions necessary to
maintain its RIC status. In addition, at maturity, the Company may be
required to sell or transfer the remaining assets securing the Facility,
potentially at a loss, to repay any remaining outstanding borrowings. Any such
asset sale could adversely affect the Company’s business, liquidity,
financial condition and results of operations. The Company expects that its
cash on hand, liquid investments, and cash generated from operations, including
income earned from investments and any income distributions made by Katonah Debt
Advisors, the Company’s wholly-owned portfolio company, will be adequate to meet
the Company’s liquidity needs and distribution requirements over the next twelve
months.
44
If the
Company is unable repay the Facility according to the Settlement Agreement terms
or is unable to renew or replace the Facility, the Company’s
liquidity may be significantly reduced. Even if the Company is able to
renew or replace the Facility, such new debt capital may be at a
higher cost and/or on less favorable terms and conditions than the
Facility. In addition, equity capital is, and may continue to be,
difficult to raise because, subject to limited exceptions, the Company
may not issue and sell shares of its common stock at a price
below NAV without stockholder approval and issuing equity at depressed
stock prices can be dilutive to the Company’s stockholders.
These factors and the Company’s inability to
raise additional capital to date have resulted in a
reduction in new originations, curtailed the Company’s ability to grow and
have had a negative impact on the Company’s liquidity and operating
results. The continued inability to raise additional capital could further
constrain the Company’s liquidity, negatively impact the Company’s
business prospects, cause the departure of key employees and negatively
impact the Company’s operating results.
10.
STOCKHOLDERS’ EQUITY
On April
28, 2008, the Company completed a rights offering which resulted in the issuance
of 3.1 million common shares and net proceeds of approximately $27 million. For
the year ended December 31, 2008, the Company issued 359,250 shares of
restricted stock for which 16,667 shares were forfeited and 3,000 shares were
converted to common stock during the year due to vesting. During the year ended
December 31, 2009, the Company issued 501,873 shares under its DRIP and 122,333
shares of restricted stock were exercised and converted to common stock. During
the nine months ended September 30, 2010, the Company issued 242,932 shares of
common stock under its DRIP. The total number of shares issued and outstanding
as of September 30, 2010 and December 31, 2009 was 22,708,399 and 22,363,281,
respectively.
11.
EQUITY INCENTIVE PLAN
During
2006 and as amended in 2008, the Company established an equity incentive plan
(the “Plan”) and reserved 2,000,000 shares of common stock for issuance under
the Plan. The purpose of the Plan is to provide officers and prospective
employees of the Company with additional incentives and align the interests of
its employees with those of its shareholders. Options granted under the 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
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.
Stock
Options
During
the year ended December 31, 2008, and as approved by shareholders during the
annual shareholders’ meeting on June 13, 2008, 20,000 options were granted to
non-employee directors as partial annual compensation for their services as
director. These grants were made with a ten-year exercise period with an
exercise price of $11.97, with a risk free rate of 4.6% with a volatility rate
of 28% and for which 50% of such options vest upon grant date and 50% vest on
the first grant date anniversary. During the year ended December 31, 2009, an
additional 20,000 options were granted to non-employee directors as partial
annual compensation for their services as director. These grants were made with
a ten-year exercise period with an exercise price of $4.93, with a risk free
rate of 4.3% with a volatility rate of 41% and for which 50% of such options
vest upon grant date and 50% vest on the first grant date anniversary. During
the nine months ended September 30, 2010, 20,000 additional options were granted
to non-employee directors as partial annual compensation for their services as
director. These grants were made with a ten-year exercise period with an
exercise price of $4.83, with a risk free rate of 3.1% with a volatility rate of
59% and for which 50% of such options vest upon grant date and 50% vest on the
first grant date anniversary.
On
June 13, 2008, the Company’s Board of Directors authorized the Company to
allow employees who agree to cancel options that they hold to receive one share
of restricted stock for every five options so cancelled. The shares of
restricted stock received by employees through any such transaction will vest
annually generally over the remaining vesting schedule as was applicable to the
cancelled options. During the year ended December 31, 2008, employees
holding options to purchase 1,295,000 shares individually entered into
agreements to cancel such options and to receive 259,000 shares of restricted
stock. As a result, as of December 31, 2008, all options granted to
employees had been converted to restricted stock.
45
As of
December 31, 2009, 40,000 options to non-employee directors remained
outstanding. During the nine months ended September 30, 2010, no such options
were forfeited. As of September 30, 2010, 60,000 total options were outstanding,
50,000 of which were exercisable. The options have an estimated remaining
contractual life of 8.5 years.
Information
with respect to options granted, exercised and forfeited under the Plan for the
period January 1, 2009 through September 30, 2010 is as follows:
|
Shares
|
Weighted Average
Exercise Price per
Share
|
Weighted Average
Contractual
Remaining Term
(years)
|
Aggregate
Intrinsic Value1
|
|||||||||||||
|
Options
outstanding at January 1, 2009
|
20,000 | $ | 11.97 | |||||||||||||
|
Granted
|
20,000 | $ | 4.93 | |||||||||||||
|
Exercised
|
— | $ | — | |||||||||||||
|
Forfeited
|
— | $ | — | |||||||||||||
|
Options
outstanding at December 31, 2009
|
40,000 | $ | 8.45 | |||||||||||||
|
Granted
|
20,000 | $ | 4.83 | |||||||||||||
|
Exercised
|
— | $ | — | |||||||||||||
|
Forfeited
|
— | $ | — | |||||||||||||
|
Outstanding
at September 30, 2010
|
60,000 | $ | 7.24 | 8.7 | $ | - | ||||||||||
|
Total
vested at September 30, 2010
|
50,000 | $ | 7.73 | 8.5 | ||||||||||||
1 Represents the difference between the
market value of shares of the Company upon exercise of the options at September
30, 2010 and the cost for the option holders to exercise the
options.
The
Company uses a Binary Option Pricing Model (American, call option) as its
valuation model to establish the expected value of all stock option grants. For
the nine months ended September 30, 2010 and September 30, 2009, the Company
recognized non-cash compensation expense related to stock options of
approximately $22,000 and $19,000, respectively. At September 30,
2010, there was $12,000 remaining of compensation cost related to unvested
stock-based awards.
Restricted
Stock
On June
13, 2008, the Company’s shareholders approved the Company’s 2006 Equity
Incentive Plan, as amended and the board of directors approved the grant of
awards of 100,250 shares of restricted stock to certain executive officers of
the Company. On July 22, 2010 and August 5, 2009, the board of directors
approved the grant of an additional 103,519 and 84,889 shares of restricted
stock, respectively, to a certain executive officer of the Company. Such awards
of restricted stock will vest as to 50% of the shares on the third anniversary
of the grant date and the remaining 50% of the shares on the fourth anniversary
of the grant date.
On June
13, 2008, the Company’s Board of Directors authorized the Company to allow
employees who agree to cancel options that they hold to receive shares of the
Company's common stock to receive 1 share of restricted stock for every 5
options so cancelled. The shares of restricted stock received by employees
through any such transaction will vest annually generally over the remaining
vesting schedule as was applicable to the cancelled options. Subsequently,
employees holding options to purchase 1,295,000 shares individually entered into
agreements to cancel such options and to receive 259,000 shares of restricted
stock. As of September 30, 2010, 190,000 of such shares were vested and
converted to common shares, and 51,000 of such shares had yet to vest. The
remaining 18,000 shares have been forfeited.
During
the nine months ended September 30, 2010, 64,667 shares of restricted stock were
vested and converted to common shares. As of September 30, 2010, after giving
effect to these option cancellations and restricted stock awards, there were
options to purchase 60,000 shares of common stock outstanding and there were
339,658 shares of restricted stock outstanding. Information with respect to
restricted stock granted, exercised and forfeited under the Plan for the nine
months ended September 30, 2010 is as follows:
46
|
Non-Vested
Restricted
Shares
|
Weighted Average
Exercise Price per
Share
|
|||||||
|
Non-vested
shares outstanding at December 31, 2008
|
339,583 | $ | 10.83 | |||||
|
Granted
|
84,889 | $ | 5.89 | |||||
|
Vested
|
(122,333 | ) | $ | 10.37 | ||||
|
Forfeited
|
— | $ | — | |||||
|
Non-vested
shares outstanding at December 31, 2009
|
302,139 | $ | 9.63 | |||||
|
Granted
|
103,519 | $ | 4.83 | |||||
|
Vested
|
(64,667 | ) | $ | 10.32 | ||||
|
Forfeited
|
(1,333 | ) | $ | 8.41 | ||||
|
Outstanding
at September 30, 2010
|
339,658 | $ | 8.03 | |||||
|
Total
non-vested shares at September 30, 2010
|
339,658 | $ | 8.03 | |||||
For the
nine months ended September 30, 2010, non-cash compensation expense related to
restricted stock was approximately $665,000; of this amount approximately
$475,000 was expensed at the Company and approximately $190,000 was a
reimbursable expense allocated to Katonah Debt Advisors. For the nine months
ended September 30, 2009, non-cash compensation expense related to restricted
stock was approximately $692,000; of this amount approximately $481,000 was
expensed at the Company and approximately $211,000 was a reimbursable expense
allocated to Katonah Debt Advisors. Dividends 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, 2010, there was approximately $2 million of total
unrecognized compensation cost related to nonvested share-based awards. That
cost is expected to be recognized over a weighted average period of 2.5
years.
12.
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 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 2.67% of the employee’s first 74.9% of
maximum eligible compensation, which fully vest at the time of contribution. For
the nine months ended September 30, 2010 and 2009 the Company made contributions
to the 401K Plan of approximately $24,000 and $22,000,
respectively.
The
Company has also adopted a deferred compensation plan (“Pension Plan”) effective
January 1, 2007. Employees are eligible for the Pension Plan provided that
they are employed and working with the Company for 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 Pension Plan. On behalf of the employee, the Company may
contribute to the Pension 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
Pension Plan after five years of service. For the nine months ended September
30, 2010 and 2009, the Company made no contributions to the Pension
Plan.
47
Item 2. Management’s Discussion and Analysis of
Financial Condition and Results of Operations
In this
Quarterly Report on Form 10-Q, “Kohlberg Capital,” “Company,” “we,” “us,” and
“our” refer to Kohlberg Capital Corporation, its subsidiaries and its
wholly-owned portfolio company, Katonah Debt Advisors, L.L.C. (collectively with
its affiliates, “Katonah Debt Advisors”), and related companies, unless the
context otherwise requires.
The
information contained in this section should be read in conjunction with our
financial statements and notes thereto appearing elsewhere in this Quarterly
Report. In addition, some of the statements in this report constitute
forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. The matters discussed in this Quarterly
Report, as well as in future oral and written statements by management of
Kohlberg Capital, 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 funds under our credit facility,
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 impact of investments that we
expect to make;
|
|
•
|
our informal 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 ability of our 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;
|
|
•
|
the adequacy of our cash
resources and working
capital;
|
|
•
|
the
status of our credit facility, including any requirement that we pay our
credit facility in full; and
|
|
•
|
the timing of cash flows, if any,
from the operations of our portfolio companies, including Katonah Debt
Advisors.
|
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 II, “Item 1A. Risk Factors” below and in Part
I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal
year ended December 31, 2009. 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 of this Quarterly
Report.
GENERAL
We are an
internally managed, non-diversified closed-end investment company that has
elected to be regulated as a business development company (“BDC”) under the
Investment Company Act of 1940, as amended (the “1940 Act”). We originate,
structure and invest in senior secured term loans, mezzanine debt and selected
equity securities primarily in privately-held middle market companies. We define
the middle market as comprising companies with earnings before interest, taxes,
depreciation and amortization, which we refer to as “EBITDA,” of $10 million to
$50 million and/or total debt of $25 million to $150 million. In addition to our
middle market investment business, our wholly-owned portfolio company, Katonah
Debt Advisors, manages collateralized loan obligation funds (“CLO Funds”) that
invest in broadly syndicated loans, high-yield bonds and other corporate credit
instruments. We acquired Katonah Debt Advisors and certain related assets prior
to our initial public offering from affiliates of Kohlberg & Co.,
LLC (“Kohlberg & Co.”), a leading private equity firm focused on middle
market investing. As of
September 30, 2010, Katonah Debt Advisors had approximately $2.1 billion of
assets under management.
48
Our
investment objective is to generate current income and capital appreciation from
our investments. We also expect to continue to receive distributions of
recurring fee income and to generate capital appreciation from our investment in
the asset management business of Katonah Debt Advisors. Our investment portfolio
as well as the investment portfolios of the CLO Funds in which we have invested
and the investment portfolios of the CLO Funds managed by Katonah Debt Advisors
consist exclusively of credit instruments and other securities issued by
corporations and do not include any asset-backed securities secured by
commercial mortgages, residential mortgages or other consumer
borrowings.
As a
Regulated Investment Company (“RIC”), we intend to distribute to our
stockholders substantially all of our net taxable income and the excess of
realized net short-term capital gains over realized net long-term capital
losses. To qualify as a RIC, we must, among other things, meet certain
source-of-income and asset diversification requirements. Pursuant to these
elections, we generally will not have to pay corporate-level taxes on any income
that we distribute to our stockholders.
Our
common stock is traded on The NASDAQ Global Select Market under the symbol
“KCAP.” The net asset value (“NAV”) per share of our common stock at September
30, 2010 was $8.84. On September 30, 2010, the last reported sale price of a
share of our common stock on The NASDAQ Global Select Market was
$6.69.
KEY
QUANTITATIVE AND QUALITATIVE FINANCIAL MEASURES AND INDICATORS
Net
Asset Value
Our NAV
per share was $8.84 and $9.56 as of September 30, 2010 and December 31, 2009,
respectively. As we must report our assets at fair value for each reporting
period, NAV also represents the amount of stockholder’s equity per share for the
reporting period. Our NAV is comprised mostly of investment assets less debt and
other liabilities:
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September 30, 2010
|
December 31, 2009
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|||||||||||||||
|
Fair Value ¹
|
Per Share ¹
|
Fair Value ¹
|
Per Share ¹
|
|||||||||||||
|
Investments
at fair value:
|
||||||||||||||||
|
Investments
in time deposits
|
$ | 24,529,777 | $ | 1.08 | $ | 126 | $ | - | ||||||||
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Investments
in money market accounts
|
212,245 | 0.01 | — | - | ||||||||||||
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Investments
in debt securities
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190,908,445 | 8.41 | 297,356,529 | 13.30 | ||||||||||||
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Investments
in CLO Fund securities
|
52,751,000 | 2.32 | 48,971,000 | 2.19 | ||||||||||||
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Investments
in equity securities
|
5,989,599 | 0.26 | 4,713,246 | 0.21 | ||||||||||||
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Investments
in asset manager affiliates
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49,149,581 | 2.16 | 58,064,720 | 2.60 | ||||||||||||
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Cash
|
2,225,116 | 0.10 | 4,140,408 | 0.19 | ||||||||||||
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Restricted
Cash
|
2,239,603 | 0.10 | 18,696,023 | 0.84 | ||||||||||||
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Other
assets
|
11,774,826 | 0.52 | 7,474,005 | 0.33 | ||||||||||||
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Total
Assets
|
$ | 339,780,192 | $ | 14.96 | $ | 439,416,057 | $ | 19.65 | ||||||||
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Borrowings
|
$ | 137,159,147 | $ | 6.04 | $ | 218,050,363 | $ | 9.75 | ||||||||
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Other
liabilities
|
1,819,730 | 0.08 | 7,469,970 | 0.34 | ||||||||||||
|
Total
Liabilities
|
$ | 138,978,877 | $ | 6.12 | $ | 225,520,333 | $ | 10.09 | ||||||||
|
NET
ASSET VALUE
|
$ | 200,801,315 | $ | 8.84 | $ | 213,895,724 | $ | 9.56 | ||||||||
|
¹
|
Our balance sheet at fair value
and resultant NAV are calculated on a basis consistent with accounting
principles generally accepted in the United States of America ("GAAP").
Our per share presentation of such amounts (other than NAV per share) is
an internally derived non-GAAP performance measure calculated by dividing
the applicable balance sheet amount by outstanding shares. We believe that
the per share amounts for such balance sheet items are helpful in
analyzing our balance sheet both quantitatively and qualitatively in that
our shares may trade based on a percentage of NAV and individual investors
may weight certain balance sheet items differently in performing an
analysis of the
Company.
|
49
Leverage
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,
2010, we had approximately $137 million of outstanding borrowings and our asset
coverage ratio of total assets to total borrowings was 246%, 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.
Our
borrowings are through a secured financing facility (the “Facility”). In
connection with the Facility, we are party to a Loan Funding and Servicing
Agreement, dated as of February 14, 2007 (as amended, the “LFSA”), by and
among us, as the servicer, our wholly-owned, special-purpose bankruptcy remote
subsidiary, Kohlberg Capital Funding LLC I, as the borrower (“KCAP Funding” or
the “Borrower”), BMO Capital Markets Corp, as the agent (the “Agent”), U.S. Bank
National Association, a national banking association, as the trustee (the
“Trustee”) and the other Lender Parties and other parties thereto (the “Lender
Parties”).
In August
2008, we were notified by the Lender Parties that the banks providing the
underlying funding for the Facility did not intend to renew their liquidity
facility to the lenders unless we agreed to certain revised terms for the
Facility. The Lender Parties proposed new terms to us as a condition to
extending the underlying liquidity purchase agreements. We viewed such
proposed terms as unfavorable and did not agree to such new terms, causing the
Agent and Lender Parties to declare a Termination Date based upon their
contention that the underlying liquidity purchase agreements had expired,
thereby terminating our ability to obtain revolving advances and commencing the
amortization of existing borrowings under the Facility. Since September 2008,
all principal and excess interest collected from the assets securing the
Facility have been and continue to be used to amortize the Facility. On
June 9, 2009, we received a letter from a representative of the Lender
Parties alleging that our failure to determine ratings on certain pledged loans
and our alleged breach of certain covenants had resulted in the occurrence of a
Termination Event under the LFSA and that, as a result, the interest payable
under the LFSA would be calculated at the higher default rate (equal to 0.85%
above the prime rate plus 0.75%) applicable to periods during which a
Termination Event had occurred and was continuing. Beginning June 2009, based on
the Agent’s assertion (despite our disagreement with such assertion) that a
Termination Event had occurred, the interest payable under the LFSA began to be
calculated at such elevated rate and we have paid such higher interest under
protest.
As a
result of the actions of the Lender Parties, on August 28, 2009, we filed a
complaint (the “Litigation”) with the Supreme Court of the State of New York
against the Agent and the other Lender Parties to the LFSA. The Litigation
reflected our beliefs that the termination date of the revolving period and the
commencement of the amortization period under the LFSA were wrongful and that
the assertions of alleged breaches of our obligations under the LFSA and the
alleged occurrence of Termination Event(s) were without merit.
On
September 20, 2010, we entered into a Forbearance and Settlement Agreement (the
“Settlement Agreement”) with the Agent and Lender Parties (the Company, Agent
and lenders collectively known as the “Parties”) in order to settle all
outstanding claims of the Parties under the LFSA and all related claims asserted
by the Parties in connection with the Litigation noted above as filed by
us.
Pursuant
to the Settlement Agreement, the Lender Parties have agreed to refrain, during
the Forbearance Term, from the exercise of any right or remedy relating to any
termination events alleged by any of the Lender Parties to have occurred (or
that resulted from or otherwise relates to an event that occurred or a condition
that existed prior to the date of the Settlement Agreement and that was known or
reasonably should have been known to the Lender Parties) under the LFSA and the
related documents on or before September 20, 2010, the date of the Settlement
Agreement. The Forbearance Term is defined in the Settlement
Agreement to include the period from the date of the Settlement Agreement
through the earliest to occur of (i) any new termination event under the LFSA
(as modified by the Settlement Agreement to provide that our failure to comply
with certain provisions of the LFSA, including those relating to the maximum
amount of outstanding advances, minimum overcollateralization, permissible
equity shortfalls and a rolling three-month default ratio, collateral quality
and required ratings for specified loans, will not give rise to a termination
event during the Forbearance Term), (ii) the first determination date on which
we fail to maintain an overcollaterization ratio of at least 115%, (iii) the
first date on which the we fail to maintain a minimum net worth of at least $150
million, (iv) the date on which it is determined that any representation or
warranty made by us pursuant to the Settlement Agreement is untrue or misleading
in any material respect, (v) the date on which any action is commenced
challenging the terms of the Settlement Agreement, the LFSA, the amount of
outstanding advances under the LFSA or the existence, priority or enforceability
of the liens or other security interests in any of the collateral securing the
obligations under the LFSA, (vi) February 28, 2011 and (vii) the failure,
subject to certain exceptions, to pay to the Lender Parties amounts sufficient
to reduce the advances outstanding under the LFSA as set forth in the following
amortization schedule:
50
|
Date
|
Advances Outstanding
|
|
|
September
30, 2010
|
$125
million or less
|
|
|
November
3, 2010
|
$115
million or less
|
|
|
December
1, 2010
|
$105
million or less
|
|
|
January
3, 2011
|
$95
million or less
|
|
|
February
1, 2011
|
$85
million or less
|
|
|
February
28, 2011
|
$0
|
Under the
terms of the Settlement Agreement, (i) the Lender Parties have agreed to pay to
us $2 million so long as all outstanding advances under the LFSA and accrued
interest thereon (exclusive of any fees or expenses, including attorneys’ fees
and indemnification payments, of the Lender Parties incurred in connection with
the Litigation or any other fees or expenses payable to the Lender Parties under
the LFSA or the related documents other than fees or expenses incurred in
connection with or related to the exercise of remedies following the occurrence
of a Forbearance Term termination event) are repaid in full on or before
February 28, 2011, (ii) from September 10, 2010 through the end of the
Forbearance Term, interest on advances outstanding under the LFSA will accrue at
the rate provided for under the LFSA prior to the occurrence of a termination
event (equal to 0.85% above the prevailing commercial paper rate, or prevailing
LIBOR if the commercial paper market is at any time unavailable), (iii) upon
execution of the Settlement Agreement, we have agreed to release the Lender
Parties from any and all claims that any of them may have under the LFSA and the
related documents or the Litigation, (iv) upon payment in full in accordance
with the Agreement of all outstanding advances and accrued interest thereon and
all other amounts due to the Lender Parties under the LFSA, the Lender Parties
have agreed to release us from any and all claims that any of them may have
under the LFSA and the related documents or the Litigation and (v) the parties
have stipulated to dismiss the Litigation, with prejudice, by stipulation of
discontinuance filed with the Court on September 21, 2010.
We will
generally be permitted, without further consent from the Lender Parties, to make
discretionary sales of loans included in the collateral securing the LFSA so
long as the proceeds from any such sale are at least equal to 90% of par value
of such loans (or, in certain circumstances, 90% of our most recent
mark-to-market valuation or 90% of such loan’s purchase price). Other
discretionary sales will require the prior written consent of the Lender
Parties.
As noted
above, prior to entering into the Settlement Agreement, the interest rate being
charged on outstanding amounts under the Facility was at a rate equal to 0.85%
above the prime rate plus 0.75%, or approximately 4.9%, and we had been paying
interest at such rate under protest. Under the terms of the Settlement
Agreement, commencing on September 10, 2010, the advances under the Facility
will accrue interest at the rate provided for under the LFSA prior to the
occurrence of a termination event, equal to 0.85% above the prevailing
commercial paper rate, or 1.2% as of such date.
We are in
compliance with all covenants and terms as provided in the Settlement Agreement.
Under the Settlement Agreement, we must have advances outstanding under the
Facility of no greater than $125 million as of September 30, 2010. Under the
terms of the Settlement Agreement, we calculate the advances outstanding under
the Facility after consideration of amortization and pre-payments in the next
scheduled distribution to the lenders, and as of September 30, 2010 the
Company’s advances outstanding, calculated in accordance with the Settlement
Agreement, was approximately $116 (the reported outstanding balance of $137
million less approximately $20 million of pre-payments scheduled for settlement
on October 10, 2010).
Under the
Settlement Agreement, we must maintain an overcollateralization ratio of at
least 115%. As of September 30, 2010, our overcollateralization ratio was 152%.
As a BDC, we are limited in the amount of leverage it can incur and is required
to meet a coverage ratio of total asset to total senior securities of at least
200% before incurring new debt. As of September 30, 2010, our asset coverage
ratio was 246%.
Under the
terms of the Settlement Agreement, the Lender Parties will pay to the Company $2
million provided all outstanding advances and accrued interest under the LFSA
are repaid in full on or before February 28, 2011. As this payment is contingent
on the repayment of the Facility, the Company has not currently recorded such
settlement payment as a receivable or income. At the date the Facility is repaid
in accordance with the Settlement Agreement, the Company will recognize the
settlement payment from the Lending Parties as income.
51
The
Company believes it has sufficient cash and liquid assets (both thosesecuring
the Facility and those not included in the collateral securing the Facility)
which could be sold, potentially at a loss, to generate cash to fund normal
operations and dividend distributions as well as any Facility outstanding
balance that may exist at February 28, 2011 or any interim date by which a
maximum advances outstanding balance is calculated. The Company may enter into a
new agreement with other lenders or into alternative financing arrangements with
another lender.
The
Company estimates that the portfolio of loans securing the Facility will be
required to generate an annual rate of return of approximately 1% to cover
annual interest payments on obligations incurred under the
Facility.
The
weighted average daily debt balance for the six months ended September 30, 2010
and 2009 was approximately $141 million and $231 million, respectively. For the
three months ended September 30, 2010 and 2009, the weighted average interest
rate on outstanding borrowings was approximately 4% and 5% respectively, which
excludes the amortization of deferred financing costs and facility and program
fees on unfunded balances. As of September 30, 2010, the Company had restricted
cash and time deposit balances of approximately $20 million which it maintained
in accordance with the terms of the Facility.
Investment Portfolio Summary
Attributes as of and for the Nine Months ended September 30,
2010
Our
investment portfolio generates net investment income which is generally used to
pay principal and interest on our borrowings under the Facility and to fund our
dividend. Our investment portfolio consists of three primary components: debt
securities, CLO fund securities and our investment in our wholly owned asset
manager, Katonah Debt Advisors. We also have investments in equity securities of
approximately $6 million, which comprises approximately 2% of our investment
portfolio. Below are summary attributes for each of our primary investment
portfolio components (see “—Investment Portfolio” and “—Investments and
Operations” for a more detailed description) as of and for the nine months ended
September 30, 2010:
Debt
Securities
|
|
·
|
represent
approximately 59% of total investment
portfolio;
|
|
|
·
|
represent
credit instruments issued by corporate
borrowers;
|
|
|
·
|
no
asset-backed securities such as those secured by commercial mortgages or
residential mortgages and no consumer
borrowings;
|
|
|
·
|
primarily
senior secured and junior secured loans (50% and 47% of debt securities,
respectively);
|
|
|
·
|
spread
across 23 different industries and 56 different
entities;
|
|
|
·
|
average
balance per investment of approximately $3
million;
|
|
|
·
|
all
but five issuers current on their debt service obligations;
and
|
|
|
·
|
weighted
average interest rate of 5.0%.
|
CLO Fund Securities (as of
the last monthly trustee report prior to September 30, 2010 unless otherwise
specified)
|
·
|
represent
approximately 16% of total investment portfolio at September 30,
2010;
|
|
|
·
|
87%
of CLO Fund Securities represent investments in subordinated securities or
equity securities issued by CLO Funds and 13% of CLO Fund Securities are
rated notes;
|
|
|
·
|
all
CLO Funds invest primarily in credit instruments issued by corporate
borrowers;
|
|
|
·
|
no
asset-backed securities such as those secured by commercial mortgages or
residential mortgages and no consumer
borrowings;
|
|
|
·
|
ten
different CLO Fund securities; six of such CLO Fund securities are managed
by Katonah Debt Advisors; and
|
|
|
·
|
three
CLO Fund securities, representing 6% of all such securities at fair value
or 1% of total investments at fair value, are not currently providing a
dividend payment to the Company.
|
Katonah
Debt Advisors
|
|
·
|
represents
approximately 15% of total investment
portfolio;
|
|
|
·
|
represents
our 100% ownership of the equity interest of a profitable CLO Fund manager
focused on corporate credit
investing;
|
52
|
|
·
|
has
approximately $2.1 billion of assets under
management;
|
|
|
·
|
receives
contractual and recurring asset management fees based on par value of
managed investments;
|
|
|
·
|
typically
receives a one-time structuring fee upon completion of a new CLO
Fund;
|
|
|
·
|
may
receive an incentive fee upon liquidation of a CLO Fund provided that the
CLO Fund achieves a minimum designated return on
investment;
|
|
|
·
|
dividends
paid by Katonah Debt Advisors are recognized as dividend income from
affiliate asset manager on our statement of operations and are an
additional source of income to pay our
dividend;
|
|
|
·
|
for
the nine months ended September 30, 2010, Katonah Debt Advisors had
pre-tax net income of approximately $2 million;
and
|
|
|
·
|
for
the nine months ended September 30, 2010, Katonah Debt Advisors made
distributions of $3 million to the Company in the form of a dividend which
is recognized as current earnings to the
Company.
|
Revenue
Revenues
consist primarily of investment income from interest and dividends on our
investment portfolio and various ancillary fees related to our investment
holdings.
Interest from Investments in Debt
Securities. We generate interest income from our investments in debt
securities which 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.
Dividends from Investments in CLO
Fund Securities. We generate dividend income from our investments in the
securities of CLO Funds (typically preferred shares or subordinated securities)
managed by Katonah Debt Advisors and selective investments in securities issued
by funds managed by other asset management companies. CLO Funds managed by
Katonah Debt Advisors 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 Katonah Debt Advisors as “CLO
fund securities managed by affiliate.” The underlying assets in each of the CLO
Funds in which we have an investment are generally diversified secured or
unsecured corporate debt and exclude mortgage pools or mortgage securities
(residential mortgage bonds, commercial mortgage backed securities, or related
asset-backed securities), debt to companies providing mortgage lending and
emerging markets investments. Our CLO Fund securities that are subordinated
securities or preferred shares (“junior securities”) are subordinated to senior
bond holders who typically receive a fixed rate of return 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 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 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 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. In addition, the failure of CLO Funds in which we invest to
comply with certain financial covenants my lead to the temporary suspension or
deferral of cash distributions to us.
For
non-junior class CLO Fund securities, such as our investment in the class B-2L
notes of the Katonah 2007-1 CLO, interest is earned at a fixed spread relative
to the LIBOR index.
Dividends from Affiliate Asset
Manager. We generate dividend income from our investment in Katonah Debt
Advisors, an asset management company, which is a wholly-owned portfolio company
that manages CLO Funds that invest primarily in broadly syndicated
non-investment grade loans, high yield bonds and other credit instruments issued
by corporations. As a manager of CLO Funds, Katonah Debt Advisors receives
contractual and recurring management fees as well as an expected one-time
structuring fee from the CLO Funds for its management and advisory services. In
addition, Katonah Debt Advisors may also earn income related to net interest on
assets accumulated for future CLO issuances on which it has provided a first
loss guaranty in connection with loan warehouse arrangements for its CLO Funds.
Katonah Debt Advisors generates annual operating income equal to the amount by
which its fee income exceeds it operating expenses. The annual management fees
which Katonah Debt Advisors receives 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 Katonah Debt Advisors manages the fund. As a
result, the annual management fees earned by Katonah Debt Advisors generally are
not subject to market value fluctuations in the underlying collateral. In future
years, Katonah Debt Advisors may receive incentive fees upon the liquidation of
CLO Funds it manages, provided such CLO Funds have achieved a minimum investment
return to holders of their subordinated securities or preferred
shares.
53
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.
Expenses
We are
internally managed and directly incur the cost of management and operations; as
a result, we incur no 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 Amortization of Debt
Issuance Costs. Interest expense is dependent on the average outstanding
balance on our Facility and the base index rate for the period. Debt issuance
costs represent fees and other direct costs incurred in connection with the
Company’s borrowings. These amounts are capitalized and amortized ratably over
the contractual term of the borrowing.
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 significant 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 include professional
fees (primarily legal, accounting, valuation and other professional services),
occupancy costs and general administrative and other costs.
Net
Change in Unrealized Depreciation on Investments
During
the three and nine months ended September 30, 2010, the Company’s investments
had a net change in unrealized depreciation of approximately $4 million and $3
million, respectively; during the three and nine months ended September 30,
2009, the Company’s investments had a net change in unrealized depreciation of
approximately $11 million and $26 million, respectively.
The net
change in unrealized depreciation for the three months ended September 30, 2010
is primarily due to (i) an approximate $1 million net decrease in the market
value of certain loans as a result of credit considerations and current market
conditions; (ii) an approximate $579,000 decrease in the net value of CLO Fund
securities; and (iii) an approximate $5 million decrease in the value of Katonah
Debt Advisors.
The net
change in unrealized depreciation for the nine months ended September 30, 2010
is primarily due to (i) an approximate $6 million net increase in the market
value of certain loans as a result of credit considerations and current market
conditions; (ii) an approximate $4 million increase in the net value of CLO fund
securities; and (iii) an approximate $12 million decrease in the value of
Katonah Debt Advisors.
Net
Change in Stockholders’ Equity Resulting From Operations
The net
change in stockholders’ equity resulting from operations for the three months
ended September 30, 2010 and 2009 was a decrease of approximately $3 million and
an increase of $11 million, respectively, or a decrease of $0.15 and an increase
of $0.48 per share, respectively. The net change in stockholders’ equity
resulting from operations for the nine months ended September 30, 2010 and 2009
was a decrease of approximately $7 million, and an increase of approximately $33
million, respectively, or a decrease of $0.33 and an increase of $1.48 per
share, respectively.
Net
Investment Income and Net Realized Gains (Losses)
Net
investment income and net realized gains (losses) represents the net change in
stockholders’ equity before net unrealized appreciation or depreciation on
investments. For the three months ended September 30, 2010, net investment
income and realized gains was approximately $785,000, or $0.03 per share. For
the three months ended September 30, 2009, net investment income and realized
losses was approximately $292,000, or $0.01, per share. For the nine months
ended September 30, 2010, net investment income and realized losses was
approximately $4 million, or $0.18 per share. For the nine months ended
September 30, 2009, net investment income and realized gains was approximately
$7 million, or $0.31 per share.
54
Dividends
For the
three months ended September 30, 2010, we declared a $0.17 dividend per share.
As a result, there was a dividend distribution of approximately $4 million for
the third quarter declaration, which was booked in the fourth quarter. We intend
to continue to distribute quarterly dividends to our stockholders. To avoid
certain excise taxes imposed on RICs, we currently intend to distribute during
each calendar year an amount at least equal to the sum of:
|
•
|
98% of our ordinary net taxable
income for the calendar
year;
|
|
•
|
98% of our capital gains, if any,
in excess of capital losses for the one-year period ending on
October 31 of the calendar year;
and
|
|
•
|
any net ordinary income and net
capital gains for the preceding year that were not distributed during such
year.
|
The
amount of our declared dividends, as evaluated by management and approved by our
Board of Directors, is based on our evaluation of both distributable income for
tax purposes and GAAP net investment income (which excludes unrealized gains and
losses). Generally, we seek to fund our dividends from GAAP current earnings,
primarily from net interest and dividend income generated by our investment
portfolio and without a return of capital or a high reliance on realized capital
gains. The following table sets forth the quarterly dividends declared by us in
the two most recently completed years, which represent an amount equal to our
estimated net investment income for the specified quarter, including income
distributed from Katonah Debt Advisors received by the Company, plus a portion
of any prior year undistributed amounts of net investment income distributed in
subsequent years:
|
Dividend
|
Declaration
Date
|
Record Date
|
Pay Date
|
||||||
|
2010:
|
|
|
|||||||
|
Third
quarter
|
$
|
0.17
|
9/20/2010
|
10/8/2010
|
10/29/2010
|
||||
|
Second
quarter
|
0.17
|
6/23/2010
|
7/7/2010
|
7/29/2010
|
|||||
|
First
quarter
|
0.17
|
3/19/2010
|
4/7/2010
|
4/29/2010
|
|||||
|
2009:
|
|
|
|||||||
|
Fourth
quarter
|
$
|
0.20
|
12/15/2009
|
12/28/2009
|
1/25/2010
|
||||
|
Third
quarter
|
0.24
|
9/24/2009
|
10/9/2009
|
10/29/2009
|
|||||
|
Second
quarter
|
0.24
|
6/12/2009
|
7/9/2009
|
7/29/2009
|
|||||
|
First
quarter
|
0.24
|
3/23/2009
|
4/8/2009
|
4/29/2009
|
|||||
|
Total
declared for 2009
|
$
|
0.92
|
|||||||
Due to
our ownership of Katonah Debt Advisors and certain timing, structural and tax
considerations our dividend distributions may include a return of capital for
tax purposes. For the nine months ended September 30, 2010, Katonah Debt
Advisors had approximately $2 million of pre-tax net income and made
distributions of $3 million to us, a portion of which represented undistributed
earnings from prior years. For the nine months ended September 30, 2009, Katonah
Debt Advisors earned approximately $2 million of pre-tax net income and made no
distributions to us; dividends are recorded as declared (where declaration date
represents ex-dividend date) by Katonah Debt Advisors as income on our statement
of operations.
INVESTMENT
PORTFOLIO
Investment
Objective
Our
investment objective is to generate current income and 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, and from our investment in Katonah Debt Advisors. We intend to grow
our portfolio of assets by raising additional capital, including through the
prudent use of leverage available to us. 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. 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 larger, publicly-traded
companies, high-yield bonds and distressed debt securities. We may also receive
warrants or options to purchase common stock in connection with our debt
investments. In addition, we may also invest in debt and equity securities
issued by CLO Funds managed by Katonah Debt Advisors or by other asset managers.
However, our investment strategy is to limit the value of our investments in the
debt or equity securities issued by CLO Funds to not more than 15% of the value
of our total investment portfolio at the time of investment. We invest almost
exclusively in credit instruments issued by corporations and do not invest in
asset-backed securities such as those secured by commercial mortgages,
residential mortgages or other consumer borrowings.
55
The
following table shows the Company’s portfolio by security type at September 30,
2010 and December 31, 2009:
|
September 30, 2010
|
December 31, 2009
|
|||||||||||||||||||||||
|
Security
Type
|
Cost
|
Fair Value
|
%¹
|
Cost
|
Fair Value
|
%¹
|
||||||||||||||||||
|
Time
Deposits
|
$ | 24,529,777 | $ | 24,529,777 | 8 | % | $ | 126 | $ | 126 |
—
|
% | ||||||||||||
|
Money
Market Account
|
212,245 | 212,245 | — | - | - | — | ||||||||||||||||||
|
Senior
Secured Loan
|
110,660,494 | 95,668,038 | 30 | 179,425,767 | 159,075,586 | 39 | ||||||||||||||||||
|
Junior
Secured Loan
|
103,690,662 | 90,642,174 | 28 | 129,016,237 | 114,920,499 | 28 | ||||||||||||||||||
|
Mezzanine
Investment
|
10,744,496 | 250,000 | — | 28,606,852 | 19,235,444 | 5 | ||||||||||||||||||
|
Senior
Subordinated Bond
|
4,240,630 | 3,964,233 | 1 | 3,007,167 | 2,415,000 | 1 | ||||||||||||||||||
|
Senior
Unsecured Bond
|
— | — | — | 2,000,000 | 1,710,000 | — | ||||||||||||||||||
|
Preferred
Stock
|
400,000 | 384,000 | — | — | — | — | ||||||||||||||||||
|
CLO
Fund Securities
|
68,258,657 | 52,751,000 | 16 | 68,195,049 | 48,971,000 | 12 | ||||||||||||||||||
|
Equity
Securities
|
14,216,146 | 5,989,599 | 2 | 12,365,603 | 4,713,246 | 1 | ||||||||||||||||||
|
Affiliate
Asset Managers
|
44,219,947 | 49,149,581 | 15 | 40,751,511 | 58,064,720 | 14 | ||||||||||||||||||
|
Total
|
$ | 381,173,054 | $ | 323,540,647 | 100 | % | $ | 463,368,312 | $ | 409,105,621 | 100 | % | ||||||||||||
|
¹
Represents percentage of total portfolio at fair
value.
|
||||||||||||||||||||||||
Investment
Securities
We invest
in senior secured loans, mezzanine debt and, to a lesser extent, equity, of
middle market companies in a variety of industries. We generally target
companies that generate positive cash flows because we look to cash flows as the
primary source for servicing debt. However, we may invest in other industries if
we are presented with attractive opportunities.
We employ
a disciplined approach in the selection and monitoring of our investments.
Generally, we target investments that will provide a current return through
interest income to provide for stability in our net income and place less
reliance on realized capital gains from our investments. Our investment
philosophy is focused on preserving capital with an appropriate return profile
relative to risk. Our investment due diligence and selection generally focuses
on an underlying issuer’s net cash flow after capital expenditures to service
its debt rather than on multiples of net income, valuations or other broad
benchmarks which frequently miss the nuances of an issuer’s business and
prospective financial performance. We also avoid concentrations in any one
industry or issuer. We manage risk through a rigorous credit and investment
underwriting process and an active portfolio monitoring program.
Our Board
of Directors is ultimately and solely responsible for making a good faith
determination of the fair value of portfolio investments on a quarterly basis.
Debt and equity securities for which market quotations are readily available are
generally valued at such market quotations. Debt and equity securities that are
not publicly traded or whose market price is not readily available are valued by
the Board of Directors based on detailed analyses prepared by management, the
Valuation Committee of the Board of Directors, and, in certain circumstances,
third parties with valuation expertise. Valuations are conducted by management
on 100% of the investment portfolio at the end of each quarter. 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 our investments may
differ materially from the values that would have existed had a ready market
existed for such investments. Further, such investments may be generally subject
to legal and other restrictions on resale or otherwise 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.
56
We derive
fair value for our 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 underlying assets with
discount rates imputed by broad market indices, bond spreads and yields for
comparable issuers relative to the subject assets (the “Market Yield Approach”)
and also consider 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. We have identified these two
indices as benchmarks for broad market information related to our loan and debt
investments. Because we have not identified any market index that directly
correlates to the loan and debt investments held by us and therefore use the two
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 Market Yield 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. The appropriateness of specific valuation methods and
techniques may change as market conditions and available data
change.
In
January 2010, the Financial Accounting Standards Board (“FASB”) issued guidance
that clarifies and requires new disclosures about fair value measurements. The
clarifications and requirement 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, were adopted by
us in the first quarter of 2010. Note 4 to the financial statements reflects the
amended disclosure requirements. The new guidance also requires that purchases,
sales, issuances and settlements be presented gross in the Level III
reconciliation and that requirement is effective for fiscal years beginning
after December 15, 2010 and for interim periods within those years, with
early adoption permitted. The Company is evaluating the increased disclosure
requirements for implementation by the effective date. Since this new guidance
only amends the disclosures requirements, it did not impact our statements of
financial position, statements of operations, or cash flow
statements.
Accounting
Standards Codification Fair Value Measurements and Disclosures (“Fair Value Measurements and
Disclosure ”) 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.
We
engaged Valuation Research Corporation (“VRC”), an independent valuation firm,
to provide third-party valuation estimates for approximately 39% of investments
at fair value as of December 31, 2009. VRC’s valuation estimates were
considered as one of the relevant data inputs in the Company’s determination of
fair value. Though the Board of Directors did not engage VRC to provide
valuation estimates for any of the assets in the Company’s portfolio as of
September 30, 2010, the Board of Directors 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 our annual year end
valuation process.
The
majority of our 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, including 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.
Loans
and Debt Securities.
To the
extent that our investments are exchange traded and are priced or have
sufficient price indications from normal course trading at or around the
valuation date (financial reporting date), such pricing will determine fair
value. Pricing service marks from third party pricing services may be used as an
indication of fair value, depending on the volume and reliability of the marks,
sufficient and reasonable correlation of bid and ask quotes, and, most
importantly, the level of actual trading activity. However, most of our
investments are illiquid investments with little or no trading activity.
Further, we have been unable to identify directly comparable market indices or
other market guidance that correlate directly to the types of investments we
own. As a result, for most of our assets, we determine fair value using
alternative methodologies and models using available market data, as adjusted,
to reflect the types of assets we own, their structure, qualitative and credit
attributes and other asset specific characteristics.
57
We derive
fair value for our illiquid investments that do not have indicative fair values
based upon active trades primarily by using the Market Yield Approach and also
consider 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. We have identified these two indices as
benchmarks for broad market information related to our loan and debt
investments. Because we have not identified any market index that directly
correlates to the loan and debt investments held by us and therefore use the two
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 Market Yield 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.
Equity
and Equity-Related Securities.
Our
equity and equity-related 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, 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. The values
of our equity and equity-related securities in public companies for which market
quotations are readily available are based upon the closing public market price
on the balance sheet date. Securities that carry certain restrictions on sale
are typically valued at a discount from the public market value of the
security.
The
significant inputs used to determine the fair value of equity and equity-related
securities include prices, earnings, EBITDA and cash flows after capital
expenditures for similar peer comparables and the investment entity itself.
Equity and equity-related 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 as 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.
At
September 30, 2010 and September 30, 2009, our investments in loans and debt
securities, excluding CLO Fund securities, had a weighted average interest rate
of approximately 5.0% and 6.3%, respectively.
The
investment portfolio (excluding the Company’s investment in asset manager
affiliates and CLO Funds) at September 30, 2010 was spread across 23 different
industries and 56 different entities with an average balance per entity of
approximately $3 million. As of September 30, 2010, all but five of our
portfolio companies were current on their debt service obligations. Our
portfolio, including the CLO Funds in which it invests, and the CLO Funds
managed by Katonah Debt Advisors consist almost exclusively of credit
instruments issued by corporations and do not include investments in
asset-backed securities, such as those secured by commercial mortgages,
residential mortgages or other consumer borrowings.
We may
invest up to 30% of our investment portfolio in opportunistic investments in
high-yield bonds, debt and equity securities of CLO Funds, distressed debt or
equity securities of public companies. However, our investment strategy is to
limit the value of our investments in the debt or equity securities issued by
CLO Funds to not more than 15% of the value of our total investment portfolio at
the time of investment. We expect that these public companies generally will
have debt that is non-investment grade. We also may invest in debt of middle
market companies located outside of the U.S., which investments are generally
not anticipated to be in excess of 10% of our investment portfolio at the time
such investments are made. At September 30, 2010, approximately 25% of our
investments were foreign assets (including our investments in CLO Funds, which
are typically domiciled outside the U.S. and represent approximately 16% of our
portfolio). We are generally prohibited from buying or selling any security from
or to any portfolio company of a private equity fund managed by
Kohlberg & Co. without the prior approval of the U.S. Securities and
Exchange Commission (the “Commission” or the “SEC”). However, we may co-invest
on a concurrent basis with Kohlberg & Co. or any of our affiliates,
subject to compliance with existing regulatory guidance, applicable regulations
and our allocation procedures. Certain types of negotiated co-investments may be
made only if we receive an order from the SEC permitting us to do so. There can
be no assurance that any such order will be applied for or, if applied for,
obtained.
58
At
September 30, 2010, our ten largest portfolio companies represented
approximately 47% of the total fair value of our investments. Our largest
investment, Katonah Debt Advisors which is our wholly-owned portfolio company,
represented 15% of the total fair value of our investments. Excluding Katonah
Debt Advisors and CLO Fund securities, our ten largest portfolio companies
represent approximately 19% of the total fair value of our
investments.
CLO
Fund Securities
We
typically make a minority investment in the subordinated securities or preferred
stock of CLO Funds raised and managed by Katonah Debt Advisors and may
selectively invest in securities issued by CLO Funds managed by other asset
management companies. As of September 30, 2010, we had approximately $53 million
invested in CLO Fund securities, including those issued by funds managed by
Katonah Debt Advisors.
The CLO
Funds managed by Katonah Debt Advisors 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 we
have an investment are generally diversified secured or unsecured corporate
debt. The underlying assets in our CLO Funds exclude mortgage pools or mortgage
securities (residential mortgage bonds, commercial mortgage backed securities,
or related asset-backed securities), debt to companies providing mortgage
lending and emerging markets investments.
Our CLO
Fund investments as of September 30, 2010 and December 31, 2009 are as
follows:
|
September 30, 2010
|
December 31,
2009
|
|||||||||||||||||||||
|
CLO Fund Securities
|
Investment
|
%1
|
Cost
|
Fair Value
|
Cost
|
Fair
Value
|
||||||||||||||||
|
Grant Grove CLO, Ltd.
|
Subordinated Securities
|
22.2 | % | $ | 4,719,717 | $ | 3,390,000 | $ | 4,715,858 | $ | 2,780,000 | |||||||||||
|
Katonah
III, Ltd.
|
Preferred
Shares
|
23.1 | 4,500,000 | 810,000 | 4,500,000 | 950,000 | ||||||||||||||||
|
Katonah
IV, Ltd.3
|
Preferred
Shares
|
17.1 | 3,150,000 | 1,070,000 | 3,150,000 | 290,000 | ||||||||||||||||
|
Katonah
V, Ltd.3
|
Preferred
Shares
|
26.7 | 3,320,000 | 1,000 | 3,320,000 | 1,000 | ||||||||||||||||
|
Katonah VII CLO Ltd.2,
3
|
Subordinated Securities
|
16.4 | 4,500,000 | 2,280,000 | 4,500,000 | 1,840,000 | ||||||||||||||||
|
Katonah VIII CLO Ltd.
|
Subordinated Securities
|
10.3 | 3,400,000 | 1,890,000 | 3,400,000 | 1,760,000 | ||||||||||||||||
|
Katonah IX CLO Ltd.
|
Preferred
Shares
|
6.9 | 2,000,000 | 1,300,000 | 2,000,000 | 1,560,000 | ||||||||||||||||
|
Katonah X CLO Ltd.2
|
Subordinated Securities
|
33.3 | 11,606,522 | 9,110,000 | 11,589,830 | 8,280,000 | ||||||||||||||||
|
Katonah 2007-1 CLO Ltd.2
|
Preferred
Shares
|
100.0 | 29,976,188 | 26,260,000 | 29,940,867 | 27,100,000 | ||||||||||||||||
|
Katonah 2007-1 CLO Ltd.2
|
Class
B-2L Notes
|
100.0 | 1,086,230 | 6,640,000 | 1,078,494 | 4,410,000 | ||||||||||||||||
|
Total
|
$ | 68,258,657 | $ | 52,751,000 | $ | 68,195,049 | $ | 48,971,000 | ||||||||||||||
|
¹ Represents percentage of
class held.
|
||||||||||||||||||||||
|
² An
affiliate CLO Fund managed by Katonah Debt Advisors.
|
||||||||||||||||||||||
|
³ As
of September 30, 2010, these CLO Fund Securities were not providing a
dividend distribution.
|
||||||||||||||||||||||
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 cash
outflows for interest expense, debt paydown 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 us, (ii) a discounted
cash flow model for more recent CLO Funds 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 we have invested.
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 NAVs 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
investments. We determine the fair value of our investments in CLO Fund
securities on an individual security-by-security basis.
59
Due to
the individual attributes of each CLO Fund security, they are classified as a
Level III (as described in—“Critical Accounting Policies—Valuation of Portfolio
Investments” below) investment unless specific trading activity can be
identified at or near the valuation date. When available, Level II (as described
in “—Critical Accounting Policies—Valuation of Portfolio Investments” below)
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 characterizations 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. We evaluate 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 bond
rated 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 considers other factors such as 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. Such adjustments require judgment and may be material to the
calculation of fair value.
The
unaudited table below summarizes certain attributes of each CLO Fund as per
their most recent trustee reports as of September 30, 2010:
|
CLO Fund Securities1
|
Number of
Securities
|
Number of
Issuers
|
Number of
Industries
|
Average Security
Position Size
|
Average Issuer
Position Size
|
|||||||||||||||
|
Grant
Grove CLO, Ltd.
|
245 | 186 | 32 | $ | 1,156,965 | $ | 1,523,960 | |||||||||||||
|
Katonah
III, Ltd.
|
226 | 145 | 30 | 1,443,585 | 2,250,002 | |||||||||||||||
|
Katonah
IV, Ltd.
|
209 | 138 | 25 | 970,378 | 1,469,630 | |||||||||||||||
|
Katonah
V, Ltd.
|
254 | 161 | 29 | 508,308 | 801,927 | |||||||||||||||
|
Katonah
VII CLO Ltd.
|
255 | 194 | 33 | 1,240,989 | 1,631,197 | |||||||||||||||
|
Katonah
VIII CLO Ltd.
|
273 | 205 | 33 | 1,301,341 | 1,733,005 | |||||||||||||||
|
Katonah
IX CLO Ltd.
|
264 | 207 | 33 | 1,498,008 | 1,910,503 | |||||||||||||||
|
Katonah
X CLO Ltd.
|
267 | 206 | 33 | 1,732,210 | 2,245,146 | |||||||||||||||
|
Katonah
2007-1 CLO Ltd.
|
235 | 184 | 31 | 1,312,520 | 1,676,316 | |||||||||||||||
|
¹ All data from most recent
Trustee reports as of September 30, 2010.
|
||||||||||||||||||||
In May
2009, we purchased the class B-2L notes of the Katonah 2007-1 CLO investment
managed by Katonah Debt Advisors (“Katonah 2007-1 B-2L”). We purchased the
Katonah 2007-1 B-2L for 10% of the par value. The fair value, cost basis, and
aggregate unrealized appreciation of the Katonah 2007-1 B-2L investment as of
September 30, 2010 were approximately $7 million, $1 million, and $6 million,
respectively, and at December 31, 2009, the fair value, cost basis, and
aggregate unrealized appreciation of the Katonah 2007-1 B-2L investment were $4
million, $1 million, and $3 million, respectively. Both the B-2L notes and
preferred shares of Katonah 2007-1 are owned 100% by us and Katonah 2007-1 is
current in the payment of all quarterly distributions in respect of the B-2L
notes and the preferred shares.
60
Katonah
Debt Advisors
Katonah
Debt Advisors is our wholly-owned asset management company that manages CLO
Funds that invest in broadly syndicated loans, high yield bonds and other credit
instruments. The CLO Funds managed by Katonah Debt Advisors consist exclusively
of credit instruments issued by corporations and do not invest in asset-backed
securities secured by commercial mortgages, residential mortgages or other
consumer borrowings. As of September 30, 2010, Katonah Debt Advisors had
approximately $2.1 billion of par value of assets under management on which it
earns management fees, and was valued at approximately $49 million.
As a
manager of the CLO Funds, Katonah Debt Advisors receives contractual and
recurring management fees as well as an expected one-time structuring fee from
the CLO Funds for its management and advisory services. In addition, Katonah
Debt Advisors may also earn income related to net interest on assets accumulated
for future CLO issuances on which it has provided a first loss guaranty in
connection with loan warehouse arrangements for its CLO Funds. Katonah Debt
Advisors generates annual operating income equal to the amount by which its fee
income exceeds its operating expenses.
The
annual management fees which Katonah Debt Advisors receives 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 Katonah Debt
Advisors manages the fund. As a result, the annual management fees earned by
Katonah Debt Advisors are not subject to market value fluctuations in the
underlying collateral. The annual management fees Katonah Debt Advisors receives
have two components - a senior management fee and a subordinated management
fee. During 2009, certain CLO funds managed by Katonah Debt Advisors were
restricted from currently paying their subordinated management fees as a result
of the failure by those CLO Funds to satisfy certain restrictive covenants
contained in their indenture agreements. At such time, those subordinated
management fees continued to be accrued by the applicable CLO Fund to become
payable to Katonah Debt Advisors when such CLO Fund becomes compliant with the
applicable covenants. During the nine months ended September 30, 2010, all
those CLO Funds which deferred payment of their subordinated management fees
regained compliance with all applicable covenants in order to pay current
subordinated management fees as well as a portion of previously accrued
subordinated management fees. During the nine months ended September 30,
2010, approximately $4 million of deferred subordinated management fees have
been paid and approximately $1 million of deferred subordinated management fees
on one CLO remain deferred for payment in the fourth quarter of 2010.
Currently, all CLO Funds managed by Katonah Debt Advisors are paying both their
senior and subordinated management fees on a current basis.
In future
years, Katonah Debt Advisors may receive accrued incentive fees upon the
liquidation of CLO Funds it manages, provided such CLO Funds have achieved a
minimum investment return to holders of their subordinated securities or
preferred shares.
Subject to market conditions, we expect
to continue to make investments in CLO Funds managed by Katonah Debt Advisors,
which we believe will provide us with a current cash investment return. We
believe that these investments will provide Katonah Debt Advisors with greater
opportunities to access new sources of capital which will ultimately increase
Katonah Debt Advisors’ assets under management and resulting management fee
income. We also expect to receive distributions of recurring fee income and, if
debt markets stabilize and recover, to generate capital appreciation from our
investment in the asset management business of Katonah Debt
Advisors.
The
revenue that Katonah Debt Advisors generates through the fees it receives for
managing CLO Funds and after paying the expenses pursuant to an overhead
allocation agreement with the Company associated with its operations, including
compensation of its employees, may be distributed to Kohlberg Capital. Cash
distributions of Katonah Debt Advisors’ net income are recorded as dividends
from an affiliate asset manager when declared. As with all other investments,
Katonah Debt Advisors’ fair value is periodically determined. Our investment in
Katonah Debt Advisors is carried at fair value, which is determined after taking
into consideration a percentage of assets under management and a discounted cash
flow model incorporating 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 includes an analysis of comparable asset management companies. Katonah
Debt Advisors is classified as a Level III investment. Any change in value from
period to period is recognized as net change in unrealized appreciation or
depreciation.
PORTFOLIO
AND INVESTMENT ACTIVITY
Our
primary business is lending to and investing in middle-market businesses through
investments in senior secured loans, junior secured loans,
subordinated/mezzanine debt investments, CLO equity investments and other
equity-based investments, which may include warrants.
Total
portfolio investment activity (excluding activity in time deposit and money
market investments) for the nine months ended September 30, 2010 and for the
year ended December 31, 2009 was as follows:
61
|
Debt Securities
|
CLO Fund
Securities
|
Equity Securities
|
Affiliate Asset
Managers
|
Total Portfolio
|
||||||||||||||||
|
Fair
Value at December 31, 2008 (as restated)
|
$
|
353,859,007
|
$
|
34,640,000
|
$
|
5,089,365
|
$
|
54,734,812
|
$
|
448,323,184
|
||||||||||
|
2009
Activity:
|
||||||||||||||||||||
|
Purchases
/ originations /draws
|
$
|
1,509,987
|
$
|
1,076,250
|
$
|
8,625,627
|
$
|
4,018,309
|
$
|
15,230,173
|
||||||||||
|
Pay-downs
/ pay-offs / sales
|
(72,227,405)
|
—
|
—
|
—
|
(72,227,405)
|
|||||||||||||||
|
Net
accretion of discount
|
964,724
|
742,204
|
—
|
—
|
1,706,928
|
|||||||||||||||
|
Net
realized losses
|
(12,050,370)
|
—
|
(1,516,682)
|
(2,215,069)
|
(15,782,121)
|
|||||||||||||||
|
Decrease
in fair value
|
25,300,586
|
12,512,546
|
(7,485,064)
|
1,526,668
|
31,854,736
|
|||||||||||||||
|
Fair
Value at December 31, 2009
|
297,356,529
|
48,971,000
|
4,713,246
|
58,064,720
|
409,105,495
|
|||||||||||||||
|
Year
to Date 2010 Activity:
|
||||||||||||||||||||
|
Purchases
/ originations /draws
|
8,304,867
|
—
|
1,850,543
|
3,468,436
|
13,623,846
|
|||||||||||||||
|
Pay-downs
/ pay-offs / sales
|
(110,179,542)
|
—
|
—
|
—
|
(110,179,542)
|
|||||||||||||||
|
Net
accretion of discount
|
307,500
|
63,608
|
—
|
—
|
371,108
|
|||||||||||||||
|
Net
realized losses
|
(10,752,567)
|
—
|
—
|
—
|
(10,752,567)
|
|||||||||||||||
|
Increase
(decrease) in fair value
|
5,871,658
|
3,716,392
|
(574,190)
|
(12,383,575)
|
(3,369,715)
|
|||||||||||||||
|
Fair
Value at September 30, 2010
|
$
|
190,908,445
|
$
|
52,751,000
|
$
|
5,989,599
|
$
|
49,149,581
|
$
|
298,798,625
|
||||||||||
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.
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, dividends, 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, 2010 and 2009.
Investment
Income
Investment
income for the three months ended September 30, 2010 and 2009 was approximately
$8 million and $8 million, respectively. Of these amounts, approximately $4
million and $6 million was attributable to interest income on our loan and bond
investments, respectively. For each of the three months ended September 30, 2010
and 2009, approximately $3 million of investment income is attributable to
dividends earned on CLO equity investments.
Investment
income for the nine months ended September 30, 2010 and 2009 was approximately
$22 million and $27 million, respectively. Of this amount, approximately $12
million and $19 million, respectively, was attributable to interest income on
our loan and bond investments. For the nine months ended September 30, 2010 and
2009, approximately $7 million and $7 million, respectively, of investment
income is attributable to dividends earned on CLO equity
investments.
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.
62
Dividends
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 income 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.
Dividends
from Affiliate Asset Manager
As of
September 30, 2010, our investment in Katonah Debt Advisors was approximately
$49 million. For the three months ended September 30, 2010 and 2009, Katonah
Debt Advisors had pre-tax net income of approximately $630,000 and $790,000,
respectively. For the nine months ended September 30, 2010 and 2009, Katonah
Debt Advisors had pre-tax net income of approximately $2 million and $2 million,
respectively. For the three and nine months ended September 30, 2010, Katonah
Debt Advisors made distributions of $1.5 million and $3 million, respectively, a
portion of which represented undistributed earnings from prior years. For
the three and nine months ended September 30, 2009, Katonah Debt Advisors
distributed made no distributions of net income.
Distributions
of Katonah Debt Advisors’ net income are recorded as dividends from affiliate
asset manager. The Company intends to distribute the accumulated undistributed
net income of Katonah Debt Advisors in the future. For purposes of calculating
distributable tax income for required quarterly dividends as a RIC, Katonah Debt
Advisors’ net income is further reduced by approximately $2 million per annum
for tax goodwill amortization resulting from its acquisition by us prior to our
initial public offering. As a result, the amount of our declared dividends, as
evaluated by management and approved by our Board of Directors, is based on our
evaluation of both distributable income for tax purposes and GAAP net investment
income (which excludes unrealized gains and losses).
Expenses
Total
expenses for the three months ended September 30, 2010 and 2009 were
approximately $4 million and $5 million, respectively. Interest expense and
amortization on debt issuance costs for the period, which includes facility and
program fees on the unused loan balance, were approximately $2 million and $3
million, respectively, on average debt outstanding of $141 million and $231
million, respectively. Approximately $815,000 and $761,000, respectively, of
expenses were attributable to employment compensation, including salaries,
bonuses and stock option expense for the three months ended September 30, 2010
and 2009. For the three months ended September 30, 2010, other expenses
included approximately $2 million for professional fees, insurance,
administrative and other. For the three months ended September 30, 2009,
other expenses included approximately $870,000 for professional fees, insurance,
administrative and other. For the three months ended September 30, 2010
and 2009, administrative and other costs (including occupancy expense,
insurance, technology and other office expenses) totaled approximately $343,000
and $303,000, respectively.
Total
expenses for the nine months ended September 30, 2010 and 2009 were
approximately $16 million and $11 million, respectively. Interest expense and
amortization on debt issuance costs for the period, which includes facility and
program fees on the unused loan balance, were approximately $7 million and $6
million, on average debt outstanding of $172 million and $241 million,
respectively. Approximately $2 million and $2 million, respectively, of expenses
were attributable to employment compensation, including salaries, bonuses and
stock option expense for the nine months ended September 30, 2010 and
2009. For the nine months ended September 30, 2010 and 2009, other
expenses included approximately $7 million for professional fees, insurance,
administrative and other. For the nine months ended September 30, 2010 and
2009, administrative and other costs totaled approximately $957,000 and
$833,000, respectively, and include occupancy expense, insurance, technology and
other office expenses.
Interest
and compensation expense are generally expected to be our largest expenses each
period. Interest expense is dependent on the average outstanding principal
balance on our Facility and the base index rate for the period. 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 bonus expenses are estimated and accrued since bonuses are paid
annually.
Professional
fee expenses for the three and nine months ended September 30, 2010 are
significantly higher by approximately $4 million relative to the same prior
years periods due to increased legal expenses (approximately $2 million),
accounting (approximately $2 million) and valuation services (approximately
$470,000). This increase in professional fees is primarily related to
legal proceedings and our complaint against our lenders and additional legal,
accounting and valuation costs related to the restatement (and defense on the
related class-action and SEC investigation net of reimbursable legal fees
covered by directors’ and officers’ insurance) of our year-end 2008 and
first-and second- quarter 2009 financial statements.
63
Net
Unrealized Appreciation on Investments
During
the three months ended September 30, 2010 and 2009, our total investments had a
change in net unrealized depreciation of approximately $4 million, and a change
in net unrealized appreciation of approximately $11 million, respectively. For
the three months ended September 30, 2010, Katonah Debt Advisors had a change in
unrealized depreciation of approximately $5 million and our middle market
portfolio of debt securities, equity securities and CLO Fund securities had a
change in net unrealized appreciation of approximately $1 million. For the
three months ended September 30, 2009, Katonah Debt Advisors had a change in
unrealized depreciation of $2 million offset by a change in unrealized
appreciation of approximately $13 million on debt securities, equity securities
and CLO Fund securities in our investment portfolio.
During
the nine months ended September 30, 2010 and 2009, our total investments had a
change in net unrealized depreciation of approximately $3 million and had a
change in net unrealized appreciation of approximately $26 million,
respectively. For the nine months ended September 30, 2010, Katonah Debt
Advisors had a change in unrealized depreciation of approximately $12 million
and our middle market portfolio of debt securities, equity securities and CLO
Fund securities had a change in unrealized appreciation of approximately $9
million. For the nine months ended September 30, 2009, Katonah Debt
Advisors had a change in unrealized appreciation of approximately $206,000 and
unrealized gains of approximately $26 million, on debt securities, equity
securities and CLO Fund securities in our investment portfolio.
Net
Increase (Decrease) in Stockholders’ Equity Resulting From
Operations
The net decrease in stockholders’
equity resulting from operations for the three and nine months ended September
30, 2010 was approximately $3 million and $7 million, respectively, or a
decrease of $0.15 and $0.33, respectively, per share. The net increase in stockholders’
equity resulting from operations for the three and nine months ended September
30, 2009 was approximately $11 million and $33 million, or $0.48 and $1.48,
respectively, 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
dividends 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 abnormal 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.
In
addition to the traditional sources of available funds (issuance of new equity,
debt or undrawn warehouse facility capacity), we also have the ability to raise
additional cash funds through the securitization of assets on our balance sheet
through our wholly-owned asset manager, Katonah Debt Advisors. Such a
securitization would provide cash for new investments on our balance sheet as
well as additional management fee income and potentially increased value (as a
result of increased assets under management) for Katonah Debt Advisors. No new
securitizations by Katonah Debt Advisors have closed since January
2008.
As a BDC,
we are limited in the amount of leverage we can incur to finance our investment
portfolio. In order to incur new debt, we are required to meet a coverage ratio
of total assets to total senior securities of at least 200%. For this purpose,
senior securities include all borrowings and any preferred stock. As a result,
our ability to utilize leverage as a means of financing our portfolio of
investments is limited by this asset coverage test. As of September 30, 2010, we
had $137 million of outstanding borrowings and our asset coverage was 246%,
which is above the minimum asset coverage level generally required by the 1940
Act for a BDC to incur new debt.
64
As of
September 30, 2010 and December 31, 2009 the fair value of investments and cash
were as follows:
|
Investments at Fair Value
|
||||||||
|
Security Type
|
September 30, 2010
|
December 31, 2009
|
||||||
|
Cash
|
$ | 2,225,116 | $ | 4,140,408 | ||||
|
Time
Deposits
|
24,529,777 | 126 | ||||||
|
Money
Market Accounts
|
212,245 | — | ||||||
|
Senior
Secured Loan
|
95,668,038 | 159,075,586 | ||||||
|
Junior
Secured Loan
|
90,642,174 | 114,920,499 | ||||||
|
Mezzanine
Investment
|
250,000 | 19,235,444 | ||||||
|
Senior
Subordinated Bond
|
3,964,233 | 2,415,000 | ||||||
|
Senior
Unsecured Bond
|
— | 1,710,000 | ||||||
|
Preferred
Stock
|
384,000 | — | ||||||
|
CLO
Fund Securities
|
52,751,000 | 48,971,000 | ||||||
|
Equity
Securities
|
5,989,599 | 4,713,246 | ||||||
|
Affiliate
Asset Managers
|
49,149,581 | 58,064,720 | ||||||
|
Total
|
$ | 325,765,763 | $ | 413,246,029 | ||||
On
February 14, 2007, we entered into the Facility under which we may obtain
up to $200 million in financing. On October 1, 2007, we amended the
Facility to increase our borrowing capacity from $200 million to $275 million,
extend the maturity date from February 12, 2012 to October 1, 2012 and
increase the interest spread charged on outstanding borrowings by 15 basis
points to 0.85%. The interest rate is based on prevailing commercial paper rates
plus 0.85% or, if the commercial paper market is at any time unavailable,
prevailing LIBOR rates plus an applicable spread. Interest is payable monthly.
As disclosed above, as a result of the Agent’s assertion that a Termination
Event occurred under the LFSA, for the period June 2009 to September 2010
interest under the LFSA has been calculated at a higher default rate (equal to
0.85% above the prime rate plus 0.75%).
Advances
under the Facility (to the extent available to us) are used by us primarily to
make additional investments. The Facility is secured by loans acquired by us
with the advances under the Facility. We borrow under the Facility through our
wholly-owned, special-purpose bankruptcy remote subsidiary, KCAP Funding. As
described further below, we have not drawn on the Facility since August
2008.
In connection with the Facility, we are
party to the LFSA, by and among us as the servicer, KCAP Funding, as the
borrower, the Agent, the Trustee, and the other lender parties and other parties
thereto. As of
September 30, 2010 there were outstanding borrowings of approximately $137
million under the LFSA. In accordance with the terms of the LFSA, the
financial assets acquired with the proceeds of borrowings under the LFSA are
held in a securities account and are subject to a securities account control
agreement granting the Agent certain rights in respect of such securities
account and the financial assets held therein. As of September 30, 2010
there were financial assets held in the securities account with a market value
of approximately $196 million. Borrowings under the Facility are secured only by
these assets and amounts in respect of such assets on deposit in a concentration
account that is subject to an intercreditor and concentration account
administration agreement, and the Facility lenders do not have recourse to any
other of our assets or the investment income associated with any such other
assets. The assets securing the Facility represent approximately 58% of our
total assets (at fair value) at September 30, 2010 and contributed approximately
38% of our investment income for the nine months ended September 30,
2010.
In August
2008, we were notified by the Lender Parties that the banks providing the
underlying funding for the Facility did not intend to renew their liquidity
facility to the lenders unless the we agreed to certain revised terms for the
Facility. The Lender Parties proposed new terms to us as a condition to
extending the underlying liquidity purchase agreements. We viewed such
proposed terms as unfavorable and did not agree to such new terms, causing the
Agent and Lender Parties to declare a Termination Date based upon their
contention that the underlying liquidity purchase agreements had expired,
thereby terminating our ability to obtain revolving advances and commencing the
amortization of existing borrowings under the Facility. Since September 2008,
all principal and excess interest collected from the assets securing the
Facility have been and continue to be used to amortize the Facility. On
June 9, 2009, we received a letter from a representative of the Lender
Parties alleging that our failure to determine ratings on certain pledged loans
and our alleged breach of certain covenants had resulted in the occurrence of a
Termination Event under the LFSA and that, as a result, the interest payable
under the LFSA would be calculated at the higher default rate (equal to 0.85%
above the prime rate plus 0.75%) applicable to periods during which a
Termination Event had occurred and was continuing. Beginning June 2009,
based on the Agent’s assertion (despite our disagreement with such assertion)
that a Termination Event had occurred, the interest payable under the LFSA began
to be calculated at such elevated rate and we have paid such higher interest
under protest.
As a
result of the actions of the Lender Parties, on August 28, 2009, we filed a
complaint with the Supreme Court of the State of New York against the Agent and
the other Lender Parties to the LFSA (the “Litigation”). The Litigation
reflected our beliefs that the termination date of the revolving period and the
commencement of the amortization period under the LFSA were wrongful and that
the assertions of alleged breaches of our obligations under the LFSA and the
alleged occurrence of Termination Event(s) were without merit.
65
On
September 20, 2010, we entered into a Forbearance and Settlement Agreement (the
“Settlement Agreement”) with the Agent and Lender Parties (the Company, Agent
and lenders collectively known as the “Parties”) in order to settle all
outstanding claims of the Parties under the LFSA and all related claims asserted
by the Parties in connection with the Litigation noted above as filed by
us.
Pursuant
to the Settlement Agreement, the Lender Parties have agreed to refrain, during
the Forbearance Term, from the exercise of any right or remedy relating to any
termination events alleged by any of the Lender Parties to have occurred (or
that resulted from or otherwise relates to an event that occurred or a condition
that existed prior to the date of the Settlement Agreement and that was known or
reasonably should have been known to the Lender Parties) under the LFSA and the
related documents on or before September 20, 2010, the date of the Settlement
Agreement. The Forbearance Term is defined in the Settlement Agreement to
include the period from the date of the Settlement Agreement through the
earliest to occur of (i) any new termination event under the LFSA (as modified
by the Settlement Agreement to provide that our failure to comply with certain
provisions of the LFSA, including those relating to the maximum amount of
outstanding advances, minimum overcollateralization, permissible equity
shortfalls and a rolling three-month default ratio, collateral quality and
required ratings for specified loans, will not give rise to a termination event
during the Forbearance Term), (ii) the first determination date on which we fail
to maintain an overcollaterization ratio of at least 115%, (iii) the first date
on which the we fail to maintain a minimum net worth of at least $150 million,
(iv) the date on which it is determined that any representation or warranty made
by us pursuant to the Settlement Agreement is untrue or misleading in any
material respect, (v) the date on which any action is commenced challenging the
terms of the Settlement Agreement, the LFSA, the amount of outstanding advances
under the LFSA or the existence, priority or enforceability of the liens or
other security interests in any of the collateral securing the obligations under
the LFSA, (vi) February 28, 2011 and (vii) the failure, subject to certain
exceptions, to pay to the Lender Parties amounts sufficient to reduce the
advances outstanding under the LFSA as set forth in the following amortization
schedule:
|
Date
|
Advances Outstanding
|
|
September
30, 2010
|
$125
million or less
|
|
November
3, 2010
|
$115
million or less
|
|
December
1, 2010
|
$105
million or less
|
|
January
3, 2011
|
$95
million or less
|
|
February
1, 2011
|
$85
million or less
|
|
February
28, 2011
|
$0
|
Under the
terms of the Settlement Agreement, (i) the Lender Parties have agreed to pay to
the us $2 million so long as all outstanding advances under the LFSA and accrued
interest thereon (exclusive of any fees or expenses, including attorneys’ fees
and indemnification payments, of the Lender Parties incurred in connection with
the Litigation or any other fees or expenses payable to the Lender Parties under
the LFSA or the related documents other than fees or expenses incurred in
connection with or related to the exercise of remedies following the occurrence
of a Forbearance Term termination event) are repaid in full on or before
February 28, 2011, (ii) from September 10, 2010 through the end of the
Forbearance Term, interest on advances outstanding under the LFSA will accrue at
the rate provided for under the LFSA prior to the occurrence of a termination
event (equal to 0.85% above the prevailing commercial paper rate, or prevailing
LIBOR if the commercial paper market is at any time unavailable), (iii) upon
execution of the Settlement Agreement, we have agreed to release the Lender
Parties from any and all claims that any of them may have under the LFSA and the
related documents or the Litigation, (iv) upon payment in full in accordance
with the Agreement of all outstanding advances and accrued interest thereon and
all other amounts due to the Lender Parties under the LFSA, the Lender Parties
have agreed to release us from any and all claims that any of them may have
under the LFSA and the related documents or the Litigation and (v) the parties
have stipulated to dismiss the Litigation, with prejudice, by stipulation of
discontinuance filed with the Court on September 21, 2010.
We will
generally be permitted, without further consent from the Lender Parties, to make
discretionary sales of loans included in the collateral securing the LFSA so
long as the proceeds from any such sale are at least equal to 90% of par value
of such loans (or, in certain circumstances, 90% of our most recent
mark-to-market valuation or 90% of such loan’s purchase price). Other
discretionary sales will require the prior written consent of the Lender
Parties.
As noted
above, prior to entering into the Settlement Agreement, the interest rate being
charged on outstanding amounts under the Facility was at a rate equal to 0.85%
above the prime rate plus 0.75%, or approximately 4.9%, and we had been paying
interest at such rate under protest. Under the terms of the Settlement
Agreement, commencing on September 10, 2010, the advances under the Facility
will accrue interest at the rate provided for under the LFSA prior to the
occurrence of a termination event, equal to 0.85% above the prevailing
commercial paper rate, or 1.2% as of such date.
66
We are in
compliance with all covenants and terms as provided in the Settlement
Agreement. Under the Settlement Agreement, we must have advances
outstanding under the Facility of no greater than $125 million as of September
30, 2010. Under the terms of the Settlement Agreement, we calculate the
advances outstanding under the Facility after consideration of amortization and
pre-payments in the next scheduled distribution to the lenders, and as of
September 30, 2010 the Company’s advances outstanding, calculated in accordance
with the Settlement Agreement, was approximately $116 million (the GAAP
outstanding balance of $136 million less approximately $20 million of
pre-payments scheduled for settlement on October 10, 2010).
Under the
Settlement Agreement, we must maintain an overcollateralization ratio of at
least 115%. As of September 30, 2010, our overcollateralization ratio was
152%. As a BDC, we are limited in the amount of leverage it can incur and
is required to meet a coverage ratio of total asset to total senior securities
of at least 200% before incurring new debt. As of September 30, 2010, our
asset coverage ratio was 246%.
Under the
terms of the Settlement Agreement, the Lender Parties will pay to the Company $2
million provided all outstanding advances and accrued interest under the LFSA
are repaid in full on or before February 28, 2011. As this payment is
contingent on the repayment of the Facility, the Company has not currently
recorded such settlement payment as a receivable or income. At the date
the Facility is repaid in accordance with the Settlement Agreement, the Company
will recognize the settlement payment from the Lending Parties as
income.
The
Company believes it has sufficient cash and liquid assets (both those securing
the Facility and those not included in the collateral securing by the Facility)
which could be sold, potentially at a loss, to generate cash to fund normal
operations and dividend distributions as well as any Facility outstanding
balance that may exist at February 28, 2011 or any interim date by which a
maximum advances outstanding balance is calculated. The Company may enter
into a new agreement with other lenders or into alternative financing
arrangements with another lender.
We
estimate that the portfolio of loans securing the Facility will be required to
generate an annual rate of return of approximately 1% to cover annual interest
payments on obligations incurred under the Facility.
The
weighted average daily debt balance for the three months ended September 30,
2010 and 2009 was approximately $141 million and $231 million, respectively. For
the three months ended September 30, 2010 and 2009, the weighted average
interest rate on weighted average outstanding borrowings was approximately 4%
and 5% respectively, which excludes the amortization of deferred financing costs
and facility and program fees on unfunded balances. As of September 30, 2010, we
had restricted cash balances of approximately $20 million which we maintained in
accordance with the terms of the Facility.
We are
currently using any income generated by the assets collateralizing the Facility
to pay principal, interest and other expenses of the Facility – despite the fact
that, if we want to remain a RIC and continue to be afforded favorable tax
treatment for U.S. federal income tax purposes, we are required to distribute to
the shareholders substantially all of our investment company taxable income,
including the net amounts generated by the collateralized assets. These
collateralized assets with a market value of approximately $196 million
represent approximately 58% of our total assets (at fair value) at
September 30, 2010 and contributed approximately 38% of the Company’s
investment income for the quarter ended September 30, 2010. Because we
are using net interest income earned on the assets securing the Facility to
amortize the Facility during the amortization period (which the Company has
challenged as being wrongfully commenced), we may need to sell other assets
not pledged to the Facility, potentially at a loss, in order to generate
sufficient cash to make the required dividend distributions necessary to
maintain our RIC status. In addition, at maturity, we may be required
to sell or transfer the remaining assets securing the Facility, potentially at a
loss, to repay any remaining outstanding borrowings. Any such asset sale could
adversely affect our business, liquidity, financial condition and results
of operations. We expect that our cash on hand, liquid investments, and
cash generated from operations, including income earned from investments and any
income distributions made by Katonah Debt Advisors, our wholly-owned portfolio
company, will be adequate to meet our liquidity needs and distribution
requirements over the next twelve months.
However,
if we are unable to renew or replace the Facility, our
liquidity may be significantly reduced. If these conditions continue for a
prolonged period of time, or worsen in the future, we could lose key
employees and our business prospects could be negatively impacted. Even
if we are able to renew or replace the Facility, such new debt
capital may be at a higher cost and/or on less favorable terms and
conditions than the Facility. In addition, equity capital is, and
may continue to be, difficult to raise because, subject to limited
exceptions, we may not issue and sell shares of our common
stock at a price below NAV without stockholder approval and issuing
equity at depressed stock prices can be dilutive to our stockholders.
These factors and our inability to raise additional capital to
date have resulted in a reduction in new originations, curtailed our
ability to grow and have had a negative impact on our liquidity and
operating results. The continued inability to raise additional capital could
further constrain our liquidity, negatively impact our business
prospects, cause the departure of key employees and negatively impact our
operating results.
67
COMMITMENTS
AND 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 our 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 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 both September 30, 2010
and December 31, 2009, we had committed to make a total of approximately $2
million and $2 million, respectively, of investments in various revolving senior
secured loans, of which approximately $320,000 had been funded as of September
30, 2010 and $640,000 had been funded as of December 31, 2009. As of September
30, 2010 and December 31, 2009, we had no investments in delayed draw senior
secured loans.
In
October 2007, Katonah Debt Advisors entered into a letter agreement (the “Letter
Agreement”) with Bear Stearns & Co. Inc. (“Bear Stearns”) in connection with
a warehouse credit line established to fund the initial accumulation of assets
for three CLO funds, pursuant to which agreement Katonah Debt Advisors undertook
certain “first loss” commitments with respect to potential losses on assets
purchased using the warehouse credit line. Such “first loss” commitments relate
to (i) losses (if any) as a result of individual loan investments being
ineligible for purchase by a new CLO Fund (typically due to a payment default on
such loan) when such fund formation is completed or (ii) if a new CLO Fund has
not been completed before the expiration of the related warehouse credit line,
the loss (if any, and net of any accumulated interest income) on the resale of
loans and debt securities funded by such warehouse credit line.
Under the
Letter Agreement, Katonah Debt Advisors also engaged Bear Stearns to structure
and raise three CLO funds to be managed by Katonah Debt Advisors (directly or
indirectly through a services contract with an affiliate of Katonah Debt
Advisors). While one of these funds, the Katonah 2007-1 CLO Fund, in which
Kohlberg Capital invested approximately $29 million to acquire all of the shares
of the most junior class of securities, was completed, neither of the other 2008
CLO Funds were successfully raised.
As a
result, pursuant to the Letter Agreement, both Katonah Debt Advisors and J.P.
Morgan Securities Inc. (“JPMorgan”) (f/k/a Bear Stearns & Co. Inc.) asserted
claims against each other and defenses thereto with respect to potential “first
loss” payments. Without admitting any liability or wrongdoing, Katonah Debt
Advisors and JPMorgan agreed to compromise and settle all of the disputes,
issues and claims between them relating to the agreements in exchange for an
agreement to terminate all obligations and liabilities of Katonah Debt Advisors
and of JPMorgan under the existing agreements relating to the 2008 CLO Funds,
payment by Katonah Debt Advisors of an aggregate of $6 million in installments
over a period of one year and the forfeiture by Katonah Debt Advisors of the net
interest income earned through the settlement date on the warehoused assets. In
December 2008, Katonah Debt Advisors entered into a settlement and termination
agreement with JPMorgan reflecting the settlement terms described
above.
As a
result of this settlement, Katonah Debt Advisors recognized a $6 million
settlement cost and write-off of previously accrued net interest income on
warehoused assets of approximately $4 million for the year ended December 31,
2008. We recognized the impact of this settlement and forfeiture of
warehouse income as a non-cash reduction to the unrealized appreciation of our
value of its investment in Katonah Debt Advisors and contributed additional
equity to Katonah Debt Advisors. Consequently, this settlement is not expected
to have a material impact on Kohlberg Capital's net investment income or
quarterly dividend.
CRITICAL
ACCOUNTING POLICIES
The
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 valuation of
investments and certain revenue recognition matters as discussed
below.
Basis
of Presentation
The
accompanying unaudited 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 financial statements. The unaudited interim
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 fiscal
year ended December 31, 2009, as filed with the
Commission.
68
Accounting Standards
Codification. In June 2009, the FASB issued a pronouncement
establishing the FASB Accounting Standards Codification (“ASC”) as the source of
authoritative accounting principles recognized by the FASB to be applied in the
preparation of financial statements in conformity with GAAP. The ASC reorganized
existing U.S. accounting and reporting standards issued by the FASB and other
related private sector standard setters into a single source of authoritative
accounting principles arranged by topic. The standard explicitly recognizes
rules and interpretive releases of the SEC under federal securities laws as
authoritative GAAP for SEC registrants. The ASC supersedes all existing U.S.
accounting standards; all other accounting literature not included in the ASC
(other than SEC guidance for publicly-traded companies) is considered
non-authoritative. The ASC was effective on a prospective basis for interim
and annual reporting periods ending after September 15, 2009. The
adoption of the ASC changed our references to U.S. GAAP accounting standards but
did not impact our results of operations, financial position or
liquidity.
Valuation
of Portfolio Investments
The most
significant estimate inherent in the preparation of our 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 generally (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 a valuation methodology 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 of the portfolio company. Because of the inherent
uncertainty of valuation, the Board of Directors’ determined values may differ
materially from the values that would have been used had a ready market existed
for the investments.
We are,
for GAAP purposes, an investment company under the American Institute of
Certified Public Accountants’ Audit and Accounting Guide for Investment
Companies. As a result, we reflect our investments on our balance sheet at their
estimated fair value with unrealized gains and losses resulting from changes in
fair value reflected as a component of unrealized gains or losses on our
statements of operations. Fair value is the amount that would be received to
sell the investments in an orderly transaction between market participants at
the measurement date (i.e., the exit price). Additionally, we do not consolidate
majority or wholly-owned and controlled investments.
Effective
January 1, 2008 we adopted Fair Value Measurements and
Disclosures . Among other things, this standard requires enhanced
disclosures about financial instruments carried at fair value. See Note 4 to the
financial statements for the additional information about the level of market
observability associated with investments carried at fair value.
We have
valued our investments, in the absence of observable market prices, using the
valuation methodology 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 cash
outflows for interest expense, debt paydown and other fund costs for the CLO
Funds which are approaching or are 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 us, or (ii) the
NAV of the CLO Funds which are approaching or are 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 are negligible net cash distributions to the class of securities
owned by us, or (iii) a discounted cash flow model for more recent CLO
Funds 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 we have invested. 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 NAVs 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 investments. We determine
the fair value of our investments in CLO Fund securities on an individual
security-by-security basis.
Our
investment in Katonah Debt Advisors is carried at fair value, which is
determined after taking into consideration a percentage of assets under
management and a discounted cash flow model incorporating 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 includes an analysis of
comparable asset management companies. Katonah Debt Advisors is classified as a
Level III investment (as described below). Any change in value from period to
period is recognized as net change in unrealized appreciation or
depreciation.
69
Fair
values of other equity 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. 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.
We derive
fair value for our illiquid loan investments that do not have indicative fair
values based upon active trades primarily by using the Market Yield 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. Our Board of Directors may consider other methods of
valuation to determine the fair value of investments as appropriate in
conformity with GAAP.
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.
After our
adoption of Fair Value
Measurements and Disclosures, investments measured and reported at fair
value are classified and disclosed in one of the following
categories:
|
|
•
|
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 Fair Value
Measurements and Disclosures , 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 corporate loans and
bonds 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. Our assessment of the significance of
a particular input to the fair value measurement in its entirety requires
judgment, and it considers factors specific to the investment. Substantially all
of our investments are classified as Level III.
70
Interest
Income
Interest
income, adjusted for 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, 2010, five issuers
representing 2% of our total investments were on non-accrual status. As of
December 31, 2009, eight issuers representing 2% of our total investments were
on non-accrual status.
Dividend
Income from CLO Fund Securities
We
generate dividend income from our investments in the most junior class of
securities of CLO Funds (typically preferred shares or subordinated securities)
managed by Katonah Debt Advisors and selective investments in securities issued
by funds managed by other asset management companies. Our CLO Fund securities
are subordinate to senior bond holders who typically receive a fixed rate of
return 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 bond holders, 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 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. 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. We make estimated interim accruals of
such dividend income based on recent historical distributions and CLO Fund
performance and adjust such accruals on a quarterly basis to reflect actual
distributions.
For
non-junior class CLO Fund securities, such as our investment in the class B-2L
notes of the Katonah 2007-1 CLO, interest is earned at a fixed spread relative
to the LIBOR index.
Dividends
from Affiliate Asset Manager
We record
dividend income from our affiliate asset manager on the declaration date, which
represents the ex-dividend date.
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 paid out to
stockholders in the form of dividends, even though we have not yet collected the
cash.
Fee
Income
Fee
income includes fees, if any, for due diligence, structuring, commitment and
facility fees, and, 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 Kohlberg
Capital Amended and Restated 2006 Equity Incentive Plan to officers and
employees for services rendered to us. We follow Compensation-Stock
Compensation, a method by which the fair value of options or restricted
stock is determined and expensed. We use a Binary Option Pricing Model
(American, call option) to establish the expected value of all stock option
grants.
We are
internally managed and therefore do not incur management fees payable to third
parties.
United
States Federal Income Taxes
We have
elected and intend to continue to qualify for the tax treatment applicable to
RICs under Subchapter M of the Internal Revenue Code (“Code”) and, among other
things, intend to make the required distributions to our stockholders as
specified therein. In order to qualify as a RIC, we are required to timely
distribute to our 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.
71
Dividends
Dividends
and distributions to common stockholders are recorded on the ex-dividend date.
The amount to be paid out as a dividend is determined by the Board of Directors
each quarter and is generally based upon the earnings estimated by management
for the period and year.
We have
adopted a dividend reinvestment plan that provides for reinvestment of our
distributions on behalf of our stockholders, unless a stockholder “opts out” of
the plan to receive cash in lieu of having their dividends automatically
reinvested in additional shares of our common stock.
Recent
Accounting Pronouncements
On
April 9, 2009, Accounting Standards Codification — Interim Disclosures about Fair Value
of Financial Instruments was issued. This standard requires disclosures
about financial instruments, including fair value, carrying amount, and method
and significant assumptions used to estimate the fair value. We adopted this
standard as of June 30, 2009 and the adoption of this standard did not
affect our financial statement disclosures.
Two-Class Method of Presenting
Earnings Per Share. In June 2008, Accounting Standards Codification –
Determining Whether
Instruments Granted in Share-based Payment Transactions are Participating
Securities was issued. This standard requires companies to include
unvested share-based payment awards that contain non-forfeitable rights to
dividends in the computation of earnings per share pursuant to the two-class
method. This standard is effective for financial statements issued for the years
beginning after December 15, 2008, and interim periods within those years.
We adopted this standard beginning with our financial statements ended
March 31, 2009 and, as required, applied this standard retroactively to all
reported periods. The adoption of this standard did not have a material impact
on our calculations of earnings per share.
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Item 3.
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Quantitative and Qualitative
Disclosures about Market
Risk
|
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, 2010, approximately 95% of
our loans at fair value in our portfolio were at floating rates with a spread to
an interest rate index such as LIBOR or the prime rate. We generally expect that
future portfolio investments will predominately be floating rate investments. As
of September 30, 2010, we had $137 million of borrowings outstanding at a
floating rate tied to prevailing commercial paper rates plus a margin of
0.85%.
Because
we borrow money to make investments, our net investment income is dependent upon
the difference between the rate at which we borrow funds and the rate at which
we invest the funds borrowed. Accordingly, there can be no assurance that a
significant change in market interest rates will not have a material adverse
effect on our net investment income. In periods of rising interest rates, our
cost of funds would increase, which could reduce our net investment income if
there is not a corresponding increase in interest income generated by floating
rate assets in our investment portfolio.
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, 2010
were to remain constant and no actions were taken to alter the existing interest
rate sensitivity, a hypothetical increase or decrease of a 1% change in interest
rates would correspondingly affect net interest income proportionately by
approximately $1.2 million over a one-year period. Correspondingly, a
hypothetical increase or decrease of a 1% change in interest rates would
correspondingly affect net interest expense proportionately by approximately
$1.2 million over a one-year period. Because most of our investments at
September 30, 2010 were floating rate with a spread to an index similar to our
Facility, we would not expect a significant impact on our net interest
spread.
Although
management believes that this measure is indicative of our sensitivity to
interest rate changes, 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.
72
We did
not hold any derivative financial instruments for hedging purposes as of
September 30, 2010. In connection with the Facility established on February 14,
2007 and as amended on October 1, 2007, our special purpose subsidiary may be
required under certain circumstances to enter into interest rate swap agreements
or other interest rate hedging transactions.
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.
We
engaged VRC, an independent valuation firm, to provide third-party valuation
estimates for 39% of our investments at fair value as of December 31, 2009.
VRC’s valuation estimates were considered as one of the relevant data inputs in
our determination of fair value. Though the Board of Directors did not engage
VRC to provide valuation estimates for any of the assets in the Company’s
portfolio as of September 30, 2010, the Board of Directors 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
our annual year end valuation process.
|
Item 4
|
Controls and
Procedures
|
Evaluation
of Disclosure Controls and Procedures
As
required by Rule 13a-15 under the Exchange Act, management has evaluated,
with the participation of our Chief Executive Officer and Chief Financial
Officer, the effectiveness of our disclosure controls and procedures as of the
end of the period covered by this report. Disclosure controls and procedures
refer to controls and other procedures designed to ensure that information
required to be disclosed in the reports we file or submit under the Exchange Act
is recorded, processed, summarized and reported within the time periods
specified in the rules and forms of the SEC. Disclosure controls and procedures
include, without limitation, controls and procedures designed to ensure that
information required to be disclosed by us in the reports that we file or submit
under the Exchange Act is accumulated and communicated to management, including
our Chief Executive Officer and Chief Financial Officer, as appropriate, to
allow timely decisions regarding our required disclosure. In designing and
evaluating our disclosure controls and procedures, management recognizes that
any controls and procedures, no matter how well designed and operated, can
provide only reasonable assurance of achieving the desired control objectives,
and management was required to apply its judgment in evaluating and implementing
possible controls and procedures.
The
Company’s management, under the supervision and with the participation of
various members of management, including our Chief Executive Officer (“CEO”) and
our Chief Financial Officer (“CFO”), has evaluated the effectiveness of the
design and operation of our 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, our CEO and CFO
have concluded that our current disclosure controls and procedures are effective
as of the end of the period covered by this report.
73
Changes
in Internal Control Over Financial Reporting
Restatement
of Previously Issued Financial Statements
Following the Company’s engagement of
Grant Thornton LLP as its independent registered public accounting firm in
January 2010, the Company’s management and Audit Committee concluded that the
Company would have to restate its previously issued financial statements for the
year ended December 31, 2008 (and the quarterly periods included in such
year) as well as the quarterly periods ended March 31, 2009 and
June 30, 2009. Management and the Audit Committee determined that such
restatement was necessary to correct errors in the application of accounting for
the fair value of the Company’s illiquid investments and the revenue recognition
for certain non-cash PIK investments, which errors impacted the amount of
unrealized gains (losses) reported for the Company's illiquid investments, which
affects the calculation of the Company's NAV and net income, and also impacted
net investment income as well as the cost basis and the net change in unrealized
appreciation on certain non-cash PIK investments. The error related to fair
value measurements was identified through the use and weighting of additional
valuation techniques and a broader consideration of secondary market
inputs. In addition, management concluded that the Company had material
weaknesses in its internal control over financial reporting related to errors in
the application of accounting for the fair value of the Company’s illiquid
investments and the revenue recognition for certain non-cash payment-in-kind
(“PIK”) investments as of the end of each of the years ended December 31, 2009
and December 31, 2008 and each of the quarterly periods included in such
years.
Changes
in Internal Control Over Financial Reporting
To
address these material weaknesses, during the quarter ended June 30, 2010, the
Company revised its valuation procedures for estimating the fair value of its
illiquid investments and has revised its accounting for non-cash PIK interest
income. Under the revised valuation procedures, management considers the
following factors in determining the appropriate weighting of market inputs:
comparability of the market input relative to the investment being valued, the
source of the information, the correlation of the data to any actual observed
transaction activity, the internal consistency of such inputs to other inputs
noted by the same source, and other qualitative factors that may impact the
reliability, comparability, or weighting of the inputs. In addition, for
investments which earn non-cash PIK interest and for which there has been a
substantial decline in fair value due to underlying credit concerns for an
extended period, the Company no longer accrues such non-cash PIK interest as
income. Management continues to implement the foregoing measures which it
believes will effectively remediate these material weaknesses. As of the
date of filing of this report, the Company believes that it has modified its
accounting for the fair value of its investments and its accounting for its
non-cash PIK investments to the extent necessary to prepare the financial
statements and the other financial information contained herein. As the Company
continues to evaluate and work to improve its internal control over financial
reporting, including remediating the material weakness with respect to
maintaining effective controls over its independent review of the fair value
model valuation process, management may determine to take additional measures to
address the material weakness and other control deficiencies.
74
PART II.
Other Information
|
Item 1.
|
Legal Proceedings
|
Legal
Action against Lenders under the Loan Funding and Servicing Agreement Governing
The Facility
On
August 28, 2009 the Company and KCAP Funding (the Borrower under the LFSA)
filed a complaint in the Supreme Court of the State of New York against the
Agent and the other lender parties to the LFSA. The Company’s discussions
with the Agent to reach a mutually agreeable amendment to the LFSA were
terminated prior to the filing of the complaint. The complaint reflects the
Company’s and the Borrower’s beliefs that the Agent’s declaration of a
Termination Date (which ended the revolving period and commenced the
amortization period) was wrongful and the Agent’s assertion of the occurrence of
a Termination Event based upon certain alleged breaches by the Company and the
Borrower of their obligations under the LFSA is without merit. The complaint
also seeks to clarify the Company’s and the Borrower’s rights and obligation
under the LFSA.
On
September 20, 2010, the Company entered into a Forbearance and Settlement
Agreement (the “Settlement Agreement”) with the Agent and Lender Parties (the
Company, Agent and lenders collectively known as the “Parties”) in order to
settle all outstanding claims of the Parties under the LFSA and all related
claims asserted by the Parties in connection with the Litigation noted above as
filed by us.
Pursuant
to the Settlement Agreement, the Lender Parties have agreed to refrain, during
the Forbearance Term, from the exercise of any right or remedy relating to any
termination events alleged by any of the Lender Parties to have occurred (or
that resulted from or otherwise relates to an event that occurred or a condition
that existed prior to the date of the Settlement Agreement and that was known or
reasonably should have been known to the Lender Parties) under the LFSA and the
related documents on or before September 20, 2010, the date of the Settlement
Agreement.
Under the
terms of the Settlement Agreement, (i) the Lender Parties have agreed to pay to
the Company $2 million so long as all outstanding advances under the LFSA and
accrued interest thereon (exclusive of any fees or expenses, including
attorneys’ fees and indemnification payments, of the Lender Parties incurred in
connection with the Litigation or any other fees or expenses payable to the
Lender Parties under the LFSA or the related documents other than fees or
expenses incurred in connection with or related to the exercise of remedies
following the occurrence of a Forbearance Term termination event) are repaid in
full on or before February 28, 2011, (ii) from September 10, 2010 through the
end of the Forbearance Term, interest on advances outstanding under the LFSA
will accrue at the rate provided for under the LFSA prior to the occurrence of a
termination event (equal to 0.85% above the prevailing commercial paper rate, or
prevailing LIBOR if the commercial paper market is at any time unavailable),
(iii) upon execution of the Settlement Agreement, the Company has agreed to
release the Lender Parties from any and all claims that any of them may have
under the LFSA and the related documents or the Litigation, (iv) upon payment in
full in accordance with the Agreement of all outstanding advances and accrued
interest thereon and all other amounts due to the Lender Parties under the LFSA,
the Lender Parties have agreed to release us from any and all claims that any of
them may have under the LFSA and the related documents or the Litigation and (v)
the parties have stipulated to dismiss the Litigation, with prejudice, by
stipulation of discontinuance filed with the Court on September 21,
2010.
Class
Actions against the Company and Certain Directors and Officers
The
Company and certain directors and officers are named as defendants in three
putative class actions pending in the Southern District of New York brought by
shareholders of the Company and filed in December 2009 and January 2010. The
complaints in these three actions allege violations of Sections 10 and 20 of the
Exchange Act based on the Company's disclosures of its year-end 2008 and first-
and second-quarter 2009 financial statements. The Company believes that
the above-mentioned suit is without merit and will defend each
vigorously.
In
addition, the Company and certain directors and officers were also named as
defendants in a derivative action filed on March 2, 2010 in the Supreme
Court of New York, County of New York. The complaint in this action purported to
state causes of action for breaches of fiduciary duties, unjust enrichment,
abuse of control, gross mismanagement, and corporate waste. On October 19,
2010, the court dismissed the complaint, and found that plaintiff had not
alleged that any of the Company’s directors “‘knowingly’ misrepresented or
permitted others to misrepresent KCAP’s financial condition,” or that the
directors were confronted with “red flags” sufficient to put them on notice of
potential problems with KCAP’s investment valuations. The court afforded
the plaintiff 45 days in which to move for leave to amend his complaint, after
which, without such a motion, the dismissal will become final.
75
SEC
Investigation
On
January 11, 2010, the staff of the SEC’s Division of Enforcement informed
the Company that it was conducting an informal inquiry. The focus of the inquiry
concerns the valuation methodology and procedures used by the Company to value
its investments. On April 30, 2010, the SEC Staff advised the Company that
a formal order of private investigation had been issued and that the informal
inquiry was now a formal investigation. A subpoena has been issued to the
Company in connection with the formal investigation. The subpoena requests that
the Company produce documents and/or testimony that primarily relates to the
valuation methodology and procedures used by the Company to value its
investments. Since January 2010, the Company has been providing documents in
response to the informal inquiry and the subpoena. The Company is cooperating
fully with the SEC Staff’s investigation. The Company cannot predict the outcome
of, or the timeframe for, the conclusion of this investigation.
Except as
set forth above, neither the Company, nor any of its subsidiaries, is currently
a party to any material legal proceedings, other than routine litigation and
administrative proceedings arising in the ordinary course of business. Such
proceedings are not expected to have a material adverse effect on the business,
financial condition, or results of the Company’s operations.
|
Item 1A.
|
Risk
Factors
|
Investing
in our common stock involves a high degree of risk. Our Annual Report on Form
10-K for the year ended December 31, 2009 and our Quarterly Report on Form
10-Q for the quarterly period ended June 30, 2010 contain important risk
factors that could cause our actual results to differ materially from our
historical experience or our present expectations and projections. If any such
risks (or any risks we face) occur, our business, financial condition and
results of our operations could be materially adversely affected. In such case,
the NAV and trading price of our common stock could decline, and you may lose
all or part of your investment. 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, 2009 and our
Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2010,
which should be read together with the other risk factors and information
disclosed elsewhere in this Quarterly Report on Form 10-Q and our other reports
filed with the SEC.
|
Item 2.
|
Unregistered
Sales of Equity Securities and Use of
Proceeds
|
None.
|
Item 3.
|
Defaults Upon
Senior Securities
|
None.
|
Item 4.
|
[Removed and
Reserved]
|
None.
|
Item 5.
|
Other
Information
|
None.
|
Item 6.
|
Exhibits
|
|
Exhibit
|
||
|
Number
|
|
Description of Document
|
|
10.1*
|
Forbearance
and Settlement Agreement dated September 20, 2010, by and among the
Company, BMO Capital Markets Corp., and the other lender parties
thereto.
|
|
|
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.
|
76
Table
of Contents
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.
|
KOHLBERG CAPITAL CORPORATION
|
||||||||
|
Date:
November 9, 2010
|
By
|
/s/ Dayl W. Pearson
|
||||||
|
Dayl
W. Pearson
|
||||||||
|
President
and Chief Executive Officer
|
||||||||
|
(Principal
Executive Officer)
|
||||||||
|
Date:
November 9, 2010
|
By
|
/s/ Michael I. Wirth
|
||||||
|
Michael
I. Wirth
|
||||||||
|
Chief
Financial Officer, Chief Compliance Officer, Secretary and
Treasurer
|
||||||||
|
(Principal
Financial and Accounting Officer)
|
||||||||
* * * *
*
77
Table
of Contents
Exhibit
Index
|
Exhibit
|
||
|
Number
|
|
Description
of Document
|
|
10.1*
|
|
Forbearance
and Settlement Agreement dated September 20, 2010, by and among the
Company, BMO Capital Markets Corp., and the other lender parties
thereto.
|
|
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.
|
78