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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

  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

 

OR

 

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

 

Commission file number 814-00149

 

LOGO

 

AMERICAN CAPITAL, LTD.

 

Delaware   52-1451377

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

 

2 Bethesda Metro Center

14th Floor

Bethesda, Maryland 20814

(Address of principal executive offices)

(301) 951-6122

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class  

Name of each exchange

on which registered

Common Stock, $0.01 par value per share  

The NASDAQ Stock Market LLC

(NASDAQ Global Select Market)

 

Securities registered pursuant to section 12(g) of the Act: NONE

 

Indicate by check mark whether the registrant (1) has filed all reports 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 earlier period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨.

 

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

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Act.

 

Large accelerated filer  x

     Accelerated filer  ¨

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 Exchange Act).    Yes  ¨    No.  x

 

The number of shares of the issuer’s common stock, $0.01 par value, outstanding as of November 1, 2010, was 341,259,564.

 

 


Table of Contents

 

AMERICAN CAPITAL, LTD.

 

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION

  
Item 1.   

Financial Statements

     3   
Item 2.   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     54   
Item 3.   

Quantitative and Qualitative Disclosure About Market Risk

     77   
Item 4.   

Controls and Procedures

     77   

PART II. OTHER INFORMATION

  
Item 1.   

Legal Proceedings

     79   
Item 1A.   

Risk Factors

     79   
Item 2.   

Unregistered Sales of Equity Securities and Use of Proceeds

     91   
Item 3.   

Defaults Upon Senior Securities

     91   
Item 4.   

[Removed and Reserved]

     91   
Item 5.   

Other Information

     91   
Item 6.   

Exhibits

     92   

Signatures

     94   

 

2


Table of Contents

 

Item 1. Financial Statements

 

AMERICAN CAPITAL, LTD.

CONSOLIDATED BALANCE SHEETS

(in millions, except per share amounts)

 

     September 30,
2010
    December 31,
2009
 
     (unaudited)        

Assets

    

Investments at fair value (cost of $8,142 and $9,158, respectively)

    

Non-Control/Non-Affiliate investments (cost of $4,285 and $4,839, respectively)

   $ 2,941      $ 3,036   

Affiliate investments (cost of $293 and $251, respectively)

     197        204   

Control investments (cost of $3,564 and $4,068, respectively)

     2,428        2,335   
                

Total investments at fair value

     5,566        5,575   

Cash and cash equivalents

     109        835   

Restricted cash and cash equivalents

     129        96   

Interest receivable

     36        38   

Derivative agreements at fair value

     4        1   

Other

     128        127   
                

Total assets

   $ 5,972      $ 6,672   
                

Liabilities and Shareholders’ Equity

    

Debt ($172 and $2,666 due within one year, respectively)

   $ 2,517      $ 4,142   

Derivative agreements at fair value

     130        102   

Other

     54        99   
                

Total liabilities

     2,701        4,343   
                

Commitments and contingencies

    

Shareholders’ equity:

    

Undesignated preferred stock, $0.01 par value, 5.0 shares authorized, 0 issued and outstanding

     —          —     

Common stock, $0.01 par value, 1,000.0 shares authorized, 351.8 and 292.9 issued and 341.0 and 280.9 outstanding, respectively

     3        3   

Capital in excess of par value

     7,060        6,735   

Distributions in excess of net realized earnings

     (1,086     (709

Net unrealized depreciation of investments

     (2,706     (3,700
                

Total shareholders’ equity

     3,271        2,329   
                

Total liabilities and shareholders’ equity

   $ 5,972      $ 6,672   
                

Net Asset Value Per Common Share

   $ 9.59      $ 8.29   
                

 

See accompanying notes.

 

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AMERICAN CAPITAL, LTD.

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

(in millions, except per share data)

 

     Three Months
Ended September 30,
    Nine Months
Ended September 30,
 
         2010             2009             2010             2009      

Operating Income

        

Interest and dividend income

        

Non-Control/Non-Affiliate investments

   $ 65      $ 110      $ 232      $ 305   

Affiliate investments

     6        14        21        36   

Control investments

     54        52        160        141   
                                

Total interest and dividend income

     125        176        413        482   
                                

Fee income

        

Non-Control/Non-Affiliate investments

     5        9        13        17   

Control investments

     12        8        31        29   
                                

Total asset management and other fee income

     17        17        44        46   
                                

Total operating income

     142        193        457        528   
                                

Operating Expenses

        

Interest

     36        85        149        197   

Salaries, benefits and stock-based compensation

     31        47        99        147   

General and administrative

     16        23        51        63   

Debt refinancing costs

     —          5        21        15   
                                

Total operating expenses

     83        160        320        422   
                                

Net Operating Income Before Income Taxes

     59        33        137        106   

(Provision) benefit for income taxes

     —          (1     —          10   
                                

Net Operating Income

     59        32        137        116   
                                

Net gain on extinguishment of debt

     —          —          —          12   
                                

Net realized (loss) gain on investments

        

Non-Control/Non-Affiliate investments

     (38     (27     (308     (96

Affiliate investments

     3        —          10        (5

Control investments

     (19     (20     (154     (333

Foreign currency transactions

     —          —          (2     (2

Derivative and option agreements

     (14     (19     (60     (87
                                

Total net realized loss on investments

     (68     (66     (514     (523
                                

Net unrealized appreciation (depreciation) of investments

        

Portfolio company investments

     28        86        1,080        (750

Foreign currency translation

     141        57        (71     54   

Derivative and option agreements and other

     (11     (32     (15     74   
                                

Total net unrealized appreciation (depreciation) of investments

     158        111        994        (622
                                

Total net gain, (loss), unrealized appreciation, (depreciation) on investments

     90        45        480        (1,145
                                

Net Increase (Decrease) in Net Assets Resulting from Operations (“Net Earnings (Loss)”)

   $ 149      $ 77      $ 617      $ (1,017
                                

Net Operating Income Per Common Share

        

Basic

   $ 0.17      $ 0.12      $ 0.43      $ 0.51   

Diluted

   $ 0.17      $ 0.11      $ 0.42      $ 0.51   

Net Earnings (Loss) Per Common Share

        

Basic

   $ 0.43      $ 0.30      $ 1.93      $ (4.48

Diluted

   $ 0.43      $ 0.27      $ 1.91      $ (4.48

Weighted Average Shares of Common Stock Outstanding

        

Basic

     343.5        256.5        319.6        226.9   

Diluted

     348.0        284.3        323.5        226.9   

Dividends Declared Per Common Share

   $ —        $ —        $ —        $ 1.07   

 

See accompanying notes.

 

4


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AMERICAN CAPITAL, LTD.

CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS

(unaudited)

(in millions, except per share data)

 

     Nine Months
Ended September 30,
 
         2010             2009      

Operations

    

Net operating income

   $ 137      $ 116   

Net gain on extinguishment of debt

     —          12   

Net realized loss on investments

     (514     (523

Net unrealized appreciation (depreciation) of investments

     994        (622
                

Net earnings (loss)

     617        (1,017
                

Shareholder Dividends

    

Common stock dividends from net operating income

     —          (116

Common stock dividends in excess of net operating income and net realized gain on investments

     —          (115
                

Net decrease in net assets resulting from shareholder dividends

     —          (231
                

Capital Share Transactions

    

Issuance of common stock

     295        232   

Stock-based compensation

     30        52   

Other

     —          (1
                

Net increase in net assets resulting from capital share transactions

     325        283   
                

Total increase (decrease) in net assets

     942        (965

Net assets at beginning of period

     2,329        3,155   
                

Net assets at end of period

   $ 3,271      $ 2,190   
                

Net asset value per common share

   $ 9.59      $ 7.80   
                

Common shares outstanding at end of period

     341.0        280.6   
                

 

See accompanying notes.

 

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AMERICAN CAPITAL, LTD.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(in millions)

 

     Nine Months
Ended September 30,
 
         2010             2009      

Operating Activities

    

Net earnings (loss)

   $ 617      $ (1,017

Adjustments to reconcile net earnings (loss) to net cash provided by operating activities:

    

Net unrealized (appreciation) depreciation of investments

     (994     622   

Net realized loss on investments

     514        523   

Net gain on extinguishment of debt

     —          (12

Accrued payment-in-kind interest and dividends on investments

     (107     (58

Accrued payment-in-kind interest for make-whole payment on debt

     —          22   

Amortization of deferred finance costs, premiums and discounts

     11        10   

Depreciation of property and equipment

     12        11   

Stock-based compensation

     30        52   

Increase in interest receivable

     (1     (10

(Increase) decrease in other assets

     (5     12   

Decrease in other liabilities

     (28     (34

Other

     (2     (1
                

Net cash provided by operating activities

     47        120   
                

Investing Activities

    

Purchases of investments

     (182     (107

Repayments from (fundings on) portfolio company revolving credit facility investments, net

     40        (72

Principal repayments on debt investments

     566        262   

Proceeds from loan syndications and loan sales

     40        107   

Collection of payment-in-kind notes and dividends and accreted loan discounts

     44        32   

Proceeds from sales of equity investments

     169        266   

Interest rate derivative periodic interest payments, net

     (46     (40

Termination of European Capital Limited put option agreement

     —          (65

Other

     (18     (12
                

Net cash provided by investing activities

     613        371   
                

Financing Activities

    

Payments on unsecured borrowings

     (1,230     —     

Payments on notes payable from asset securitizations

     (393     (151

Increase in deferred financing costs

     (26     —     

Issuance of common stock

     295        —     

Increase in debt service escrows

     (32     (61

Dividends paid

     —          (24

Other

     —          (19
                

Net cash used in financing activities

     (1,386     (255
                

Net (decrease) increase in cash and cash equivalents

     (726     236   

Cash and cash equivalents at beginning of period

     835        209   
                

Cash and cash equivalents at end of period

   $ 109      $ 445   
                

Non-cash Investing and Financing Activities

    

Debt investment received from the sale of equity investments

   $ 33      $ —     

Issuance of common stock in conjunction with acquisition of European Capital Limited

   $ —        $ 25   

Issuance of common stock in conjunction with shareholder distribution

   $ —        $ 207   

 

See accompanying notes.

 

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AMERICAN CAPITAL, LTD.

CONSOLIDATED FINANCIAL HIGHLIGHTS

(unaudited)

(in millions, except per share data)

 

     Nine Months
Ended September 30,
 
         2010             2009      

Per Share Data

    

Net asset value at beginning of the period

   $ 8.29      $ 15.41   
                

Net operating income(1)

     0.43        0.51   

Net gain on extinguishment of debt(1)

     —          0.05   

Net realized loss on investments(1)

     (1.61     (2.30

Net unrealized appreciation (depreciation) on investments(1)

     3.11        (2.74
                

Net earnings (loss)(1)

     1.93        (4.48

Issuance of common stock(2)

     (0.57     (0.70

Shareholder dividends

     —          (1.07

Other, net(3)

     (0.06     (1.36
                

Net asset value at end of period

   $ 9.59      $ 7.80   
                

Ratio/Supplemental Data

    

Per share market value at end of period

   $ 5.81      $ 3.23   

Total investment return(4)

     138.11     32.82

Shares outstanding at end of period

     341.0        280.6   

Net assets at end of period

   $ 3,271      $ 2,190   

Average net assets(5)

   $ 2,810      $ 2,472   

Average debt outstanding(6)

   $ 3,575      $ 4,343   

Average debt outstanding per common share(1)

   $ 11.19      $ 19.14   

Ratio of operating expenses to average net assets(7)

     15.23     22.82

Ratio of operating expenses, net of interest expense, to average net assets(7)

     8.14     12.17

Ratio of interest expense to average net assets(7)

     7.09     10.65

Ratio of net operating income to average net assets(7)

     6.52     6.27

 

(1) Weighted average basic per share data.
(2) For the nine months ended September 30, 2009, represents the issuance of common stock in conjunction with the acquisition of European Capital Limited (“European Capital”).
(3) Represents the impact of (i) the other components in the changes in net assets, including other capital transactions such as the issuance of common stock through a shareholder distribution, the purchase of common stock held in deferred compensation trusts, stock-based compensation, income tax deductions related to the exercise of stock options and distribution of stock awards in excess of GAAP expense credited to additional paid-in capital, repayments of notes receivable from the sale of common stock and the purchase of treasury stock and (ii) the different share amounts used in calculating per share data as a result of calculating certain per share data based upon the weighted average basic shares outstanding during the period and certain per share data based on the shares outstanding as of a period end or transaction date.
(4) Total investment return is based on the change in the market value of our common stock taking into account dividends reinvested in accordance with the terms of our dividend reinvestment plan.
(5) Based on the quarterly average of net assets as of the beginning and end of each period presented.
(6) Based on a daily weighted average balance of debt outstanding during the period.
(7) Ratios are annualized.

 

See accompanying notes.

 

7


Table of Contents

 

AMERICAN CAPITAL, LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS

September 30, 2010

(unaudited)

(in millions, except share data)

 

Company (4)

 

Industry

 

Investments

 

Interest
Rate (5)

   

Maturity
    Date    

   

# of

shares/

units

owned

   

Principal

   

Cost

   

Fair
Value

 

NON-CONTROL / NON-AFFILIATE INVESTMENTS

           

AFA Investment Inc.

  Food Products   Senior Debt     12.5     2/15              $ 5.1      $ 4.3      $ 3.7   

Affordable Care Holding Corp.

 

Health Care Providers & Services

  Subordinated Debt(7)     15.0     11/13-11/14          68.1        67.5        68.2   
   

Convertible Preferred Stock(7)

        70,752          96.6        109.4   
   

Common Stock(1)(7)

        17,687,156          17.7        20.9   
                                              181.8        198.5   

Algoma Holding Company

 

Building Products

  Subordinated Debt(7)     14.1     9/13                15.5        15.5        15.2   

American Acquisition, LLC

 

Capital Markets

  Senior Debt(7)     13.9     12/12                17.5        17.3        16.0   

AmWins Group, Inc.

 

Insurance

  Senior Debt(7)     5.8     6/14                18.5        18.6        14.6   

Avalon Laboratories Holding Corp.

 

Health Care Equipment & Supplies

  Senior Debt(7)     11.0     1/14          17.2        17.1        17.2   
   

Subordinated Debt(7)

    18.6     1/15          25.4        25.2        25.4   
   

Convertible Preferred Stock(1)(7)

        148,742          24.3        17.4   
   

Common Stock(1)(7)

        7,829          1.3        —     
                                              67.9        60.0   

Avanti Park Place LLC

 

Real Estate

  Senior Debt(7)     6.8     6/13                4.8        4.8        4.4   

BBB Industries, LLC

 

Auto Components

  Senior Debt(7)     9.3     6/14                21.2        21.2        20.7   

Berry-Hill Galleries, Inc.

 

Distributors

  Senior Debt(7)     13.8     12/10                8.4        8.4        8.0   

Blue Wolf Capital Fund II, L.P.

 

Capital Markets

 

Limited Partnership Interest

                                    2.5        2.5   

CAMP Systems International, Inc.

 

Air Freight & Logistics

  Senior Debt(7)     6.2     9/14                30.0        29.8        22.4   

Carestream Health, Inc.

 

Health Care Equipment & Supplies

  Senior Debt(7)     5.5     10/13                15.0        15.0        13.5   

CIBT Travel Solutions, LLC

 

Commercial Services & Supplies

  Senior Debt(7)     9.5     1/13          50.2        50.0        50.2   
   

Subordinated Debt(7)

    15.0     1/15-1/16          55.8        55.4        55.8   
   

Redeemable Preferred Stock(7)

        15,000          20.1        20.2   
   

Convertible Preferred Stock(1)(7)

        926,800          92.7        81.1   
   

Common Stock(1)(7)

        194,200          19.4        —     
                                              237.6        207.3   

Cinelease Holdings, LLC

 

Electronic Equipment, Instruments & Components

  Senior Debt(7)     11.5     3/12-4/13          53.1        52.8        51.6   
   

Common Stock(1)

        583          0.6        0.8   
                                              53.4        52.4   

Contec, LLC

 

Household Durables

  Subordinated Debt(7)     14.0     9/15-9/16                135.0        133.9        123.4   

Delsey Holding(3)

 

Textiles, Apparel & Luxury Goods

  Senior Debt(7)     7.1     2/14                20.5        20.5        14.8   

DelStar, Inc.

 

Building Products

  Subordinated Debt(7)     14.0     12/12          19.4        19.3        19.4   
   

Redeemable Preferred Stock(7)

        26,613          21.5        38.4   
   

Convertible Preferred Stock(7)

        29,569          3.6        3.6   
   

Common Stock Warrants(1)(7)

        89,020          16.9        5.8   
                                              61.3        67.2   

Dyno Holding Corp.

 

Auto Components

  Senior Debt(7)     11.7     11/13-11/15          41.4        41.1        41.4   
   

Subordinated Debt(6)(7)

    3.8     11/16          28.2        25.6        9.5   
   

Convertible Preferred Stock(1)(7)

        389,759          40.5        —     
   

Common Stock(1)(7)

        97,440          10.1        —     
                                              117.3        50.9   

 

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AMERICAN CAPITAL, LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

September 30, 2010

(unaudited)

(in millions, except share data)

 

Company (4)

 

Industry

 

Investments

 

Interest
Rate (5)

   

Maturity
    Date    

   

# of

shares/

units

owned

   

Principal

   

Cost

   

Fair
Value

 

Easton Bell Sports, LLC

 

Leisure Equipment & Products

  Redeemable Preferred Stock         1,171          1.4        1.4   
    Common Units(1)         3,830,068          0.7        3.0   
                                              2.1        4.4   

FAMS Acquisition, Inc.

 

Diversified Financial Services

  Subordinated Debt(7)     14.0     11/13          14.9        14.8        14.9   
   

Subordinated Debt(6)(7)

    15.5     11/14          15.7        11.8        2.3   
   

Redeemable Preferred Stock(1)(7)

        919          0.9        —     
   

Convertible Preferred Stock(1)(7)

        861,364          20.9        —     
                                              48.4        17.2   

FCC Holdings, LLC

 

Commercial Banks

  Subordinated Debt(7)     15.1     12/12                50.0        49.8        49.8   

Ford Motor Company(2)

 

Automobiles

  Senior Debt(7)     3.0     12/13                7.9        7.7        7.7   

FPI Holding Corporation

 

Food Products

  Senior Debt(7)     8.5     11/10-5/13          19.9        19.8        18.7   
   

Senior Debt(6)(7)

    15.8     6/14-6/15          18.5        13.4        0.9   
   

Subordinated Debt(6)(7)

    21.6     6/15-5/16          28.1        17.3        —     
   

Redeemable Preferred Stock(1)(7)

        4,469          39.1        —     
   

Convertible Preferred Stock(1)(7)

        21,715          23.3        —     
   

Common Stock(1)(7)

        5,429          5.8        —     
                                              118.7        19.6   

HMSC Corporation

 

Insurance

 

Senior Debt(6)(7)

    5.8     10/14                3.5        3.2        1.8   

Hoppy Holdings, Corp.

 

Auto Components

 

Subordinated Debt(7)

    15.1     7/12          40.1        40.0        40.6   
   

Redeemable Preferred Stock(7)

        2,915          7.8        7.8   
                                              47.8        48.4   

Infiltrator Systems, Inc.

 

Building Products

 

Senior Debt(7)

    16.5     10/13                41.5        41.2        41.6   

Intergraph Corporation

 

Software

 

Senior Debt(7)

    10.3     12/14                3.0        3.0        2.8   

JHCI Acquisition, Inc.

 

Air Freight & Logistics

 

Senior Debt(7)

    5.8     12/14                19.0        19.1        13.7   

Jones Stephens Corp.(8)

 

Building Products

 

Subordinated Debt(6)(7)

    13.0     9/13                11.7        11.1        —     

KIK Custom Products, Inc.(3)

 

Household Products

 

Senior Debt(6)(7)

    5.3     12/14                22.5        18.9        15.2   

LabelCorp Holdings, Inc

 

Paper & Forest Products

 

Senior Debt(7)

    8.0     8/13-8/14          3.2        3.0        3.0   
   

Subordinated Debt(7)

    14.0     8/15-8/16          45.2        44.9        39.9   
                                              47.9        42.9   

LCW Holdings, LLC

 

Real Estate

 

Senior Debt(7)

    11.0     10/12          15.4        15.1        14.0   
   

Warrant(1)

        12.5       0.9        3.5   
                                              16.0        17.5   

LJVH Holdings Inc.(3)

 

Beverages

 

Senior Debt(7)

    5.8     1/15                28.5        28.5        28.1   

LN Acquisition Corp.

 

Machinery

 

Senior Debt(7)

    6.0     1/15                21.5        21.6        17.2   

Mirion Technologies, Inc.

 

Electrical Equipment

 

Senior Debt(7)

    5.4     7/11-11/11          127.4        127.2        128.2   
   

Subordinated Debt(7)

    13.9     7/11-5/12          54.5        54.2        54.5   
   

Convertible Preferred Stock(7)

        435,724          59.5        98.5   
   

Common Stock(1)(7)

        208,276          2.8        3.2   
   

Common Stock Warrants(1)(7)

        222,156          18.6        27.9   
                                              262.3        312.3   

 

9


Table of Contents

AMERICAN CAPITAL, LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

September 30, 2010

(unaudited)

(in millions, except share data)

 

Company (4)

 

Industry

 

Investments

 

Interest
Rate (5)

   

Maturity
    Date    

   

# of

shares/

units

owned

   

Principal

   

Cost

   

Fair
Value

 

Mitchell International, Inc.

 

IT Services

 

Senior Debt(7)

    5.6     3/15                5.0        5.0        3.3   

National Processing Company Group, Inc.

 

IT Services

 

Senior Debt(7)

    10.8     9/14                53.0        52.8        52.6   

NBD Holdings Corp.

 

Diversified Financial Services

 

Subordinated Debt(7)

    14.0     8/13          47.7        47.4        48.3   
   

Convertible Preferred Stock(1)

        84,174          8.7        7.8   
   

Common Stock(1)

        633,408          0.1        —     
                                              56.2        56.1   

Net1 Las Colinas Manager, LLC

 

Real Estate

 

Senior Debt(7)

    7.7     10/15                4.1        4.1        3.5   

Nivel Holdings, LLC

 

Distributors

 

Senior Debt(7)

    11.2     10/12-10/13                58.9        58.5        58.9   

Orchard Brands Corporation

 

Internet & Catalog Retail

 

Senior Debt(7)

    4.3     4/13          109.4        102.2        89.6   
   

Senior Debt(6)(7)

    9.8     4/14          282.6        197.8        —     
   

Subordinated Debt(6)(7)

    9.8     4/14          71.6        49.9        —     
                                              349.9        89.6   

Orion Foundry, Inc.(3)

 

Internet Software & Services

 

Senior Debt(7)

    9.0     6/14                27.7        26.1        26.1   

Pan Am International Flight Academy, Inc.

 

Professional Services

 

Subordinated Debt(6)(7)

    18.0     7/13          38.4        32.1        35.0   
   

Convertible Preferred Stock(1)(7)

        14,938          14.9        —     
                                              47.0        35.0   

PaR Systems, Inc.

 

Machinery

 

Senior Debt(7)

    3.3     7/13                3.6        3.4        3.2   

Parts Holding Coörperatief U.A(3)

 

Distributors

 

Membership Entitlements(1)(7)

                    173,060                6.4        —     

Phillips & Temro Industries, Inc.

 

Auto Components

 

Senior Debt(7)

    13.0     12/13          24.4        24.4        24.7   
   

Subordinated Debt(7)

    18.0     12/13          22.5        22.5        22.6   
   

Common Stock Warrants(1)(7)

        5,000,000          —          6.8   
                                              46.9        54.1   

Qioptiq S.A.R.L.(3)

 

Electronic Equipment, Instruments & Components

 

Subordinated Debt(7)

    10.0     3/18                32.2        32.0        31.7   

Ranpak Acquisition Company

 

Containers & Packaging

 

Senior Debt(7)

    6.6     12/13-12/14                22.7        22.4        18.7   

RDR Holdings, Inc.

 

Household Durables

 

Subordinated Debt(7)

    16.2     10/14-11/15          104.3        103.6        104.3   
   

Convertible Preferred Stock(1)(7)

        1,541          154.2        24.7   
   

Common Stock(1)(7)

        15,414          1.5        —     
                                              259.3        129.0   

Roark—Money Mailer, LLC

 

Media

 

Common Membership Units(1)

                    3.5             0.9        0.6   

Scanner Holdings Corporation

 

Computers & Peripherals

 

Subordinated Debt(7)

    14.0     6/14          17.3        17.2        17.3   
   

Convertible Preferred Stock(1)(7)

        77,640,000          7.8        17.1   
   

Common Stock(1)(7)

        78,242          0.1        —     
                                              25.1        34.4   

Seroyal Holdings, L.P.(3)

 

Pharmaceuticals

 

Redeemable Preferred Units

        32,462          0.8        1.1   
   

Partnership Units(1)

        95,280          0.8        1.5   
   

Common Stock Warrants(1)

        41,661          0.1        0.5   
                                              1.7        3.1   

Soil Safe Holdings, LLC

 

Professional Services

 

Senior Debt(7)

    9.7     8/13-8/14          40.6        40.3        39.3   
   

Subordinated Debt(7)

    15.5     8/15-8/16          39.9        39.6        35.6   
   

Subordinated Debt(6)(7)

    17.5     8/17          27.1        18.7        21.4   
                                              98.6        96.3   

 

10


Table of Contents

AMERICAN CAPITAL, LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

September 30, 2010

(unaudited)

(in millions, except share data)

 

Company (4)

 

Industry

 

Investments

 

Interest
Rate (5)

   

Maturity
    Date    

   

# of

shares/

units

owned

   

Principal

   

Cost

   

Fair
Value

 

SPL Acquisition Corp.

 

Pharmaceuticals

 

Senior Debt(7)

    11.0     6/14          57.9        57.5        57.9   
   

Subordinated Debt(7)

    15.3     6/15-6/16          52.9        52.4        52.9   
   

Convertible Preferred Stock(1)(7)

        84,043          40.8        27.2   
                                              150.7        138.0   

Swank Audio Visuals, LLC

 

Commercial Services & Supplies

 

Senior Debt(7)

    7.1     8/14          36.4        36.2        29.2   
   

Senior Debt(6)(7)

    7.8     8/14          12.1        11.5        5.6   
                                              47.7        34.8   

T&H Group Inc.

 

Insurance

 

Redeemable Preferred Stock

                    376                0.5        0.5   

The Tensar Corporation

 

Construction & Engineering

 

Senior Debt(7)

    8.3     5/13          82.0        81.4        61.1   
   

Subordinated Debt(6)(7)

    17.5     10/13          57.9        41.5        43.9   
                                              122.9        105.0   

ThreeSixty Sourcing, Inc.(3)

 

Commercial Services & Supplies

 

Common Stock Warrants(1)(7)

                    35                4.1        —     

TransFirst Holdings, Inc.

 

Commercial Services & Supplies

 

Senior Debt(7)

    6.3     6/15                54.0        53.6        42.1   

triVIN Holdings, Inc.

 

IT Services

 

Subordinated Debt(7)

    15.0     6/14-6/15          20.8        20.7        20.8   
   

Convertible Preferred Stock(7)

        247,000,000          32.3        32.3   
   

Common Stock(1)(7)

        6,319,923          6.3        3.7   
                                              59.3        56.8   

Tyden Cayman Holdings Corp.(3)

 

Electronic Equipment, Instruments & Components

 

Common Stock(1)

                    3,218,667                3.8        4.3   

WRH, Inc.

 

Life Sciences Tools & Services

 

Senior Debt(7)

    4.3     9/13-9/14          3.9        3.9        3.9   
   

Subordinated Debt(7)

    14.6     7/14-9/15          94.0        93.5        92.2   
   

Convertible Preferred Stock(1)(7)

        2,008,575          210.0        50.3   
   

Common Stock(1)(7)

        502,144          49.9        —     
                                              357.3        146.4   

WWC Acquisitions, Inc.

 

Professional Services

 

Senior Debt(7)

    7.0     12/11-12/13                34.0        33.7        30.4   

CMBS INVESTMENTS

           

Banc of America Commercial Mortgage Trust 2007-1

 

Real Estate

 

Commercial Mortgage Pass-Through Certificates(7)

    5.7     2/17-2/18              $ 12.4      $ 4.7      $ 0.8   

CD 2007-CD4 Commercial Mortgage Trust

 

Real Estate

 

Commercial Mortgage Pass-Through Certificates(1)(7)

    5.7     4/17                14.0        8.7        —     

CD 2007-CD5 Mortgage Trust

 

Real Estate

 

Commercial Mortgage Pass-Through Certificates(7)

    6.2     12/17                14.8        10.4        0.8   

Citigroup Commercial Mortgage Securities Trust 2007-C6

 

Real Estate

 

Commercial Mortgage Pass-Through Certificates(7)

    5.6     7/17                112.5        67.8        8.8   

COBALT CMBS Commercial Mortgage Trust 2007-C3

 

Real Estate

 

Commercial Mortgage Pass-Through Certificates(1)(7)

    5.2     10/17                11.1        8.2        0.3   

Countrywide Commercial Mortgage Trust 2007-MF1

 

Real Estate

 

Commercial Mortgage Pass-Through Certificates(1)(7)

    6.1     11/37-12/37                12.8        6.4        —     

Credit Suisse Commercial Mortgage Trust Series 2007-C4

 

Real Estate

 

Commercial Mortgage Pass-Through Certificates(7)

    5.8     8/17                20.8        12.7        2.2   

GE Commercial Mortgage Corporation, Series 2007-C1

 

Real Estate

 

Commercial Mortgage Pass-Through Certificates(1)(7)

    5.7     12/19                24.8        21.9        —     

GS Mortgage Securities Trust 2006-GG10

 

Real Estate

 

Commercial Mortgage Pass-Through Certificates(1)(7)

    5.8     7/17                7.0        4.1        —     

 

11


Table of Contents

AMERICAN CAPITAL, LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

September 30, 2010

(unaudited)

(in millions, except share data)

 

Company (4)

 

Industry

 

Investments

 

Interest
Rate (5)

   

Maturity
    Date    

   

# of

shares/

units

owned

   

Principal

   

Cost

   

Fair
Value

 

J.P. Morgan Chase Commercial Mortgage Securities Trust 2007-LDP11

 

Real Estate

 

Commercial Mortgage Pass-Through Certificates(7)

    5.6     7/17                87.2        55.6        0.2   

LB-UBS Commercial Mortgage Trust 2007-C6

 

Real Estate

 

Commercial Mortgage Pass-Through Certificates(7)

    6.2     8/17                36.6        22.8        2.8   

LB-UBS Commercial Mortgage Trust 2008-C1

 

Real Estate

 

Commercial Mortgage Pass-Through Certificates(1)(7)

    6.2     7/23-7/24                19.4        7.6        0.3   

ML-CFC Commercial Mortgage Trust 2007-6

 

Real Estate

 

Commercial Mortgage Pass-Through Certificates(7)

    5.8     4/17                9.8        3.2        0.5   

ML-CFC Commercial Mortgage Trust 2007-8

 

Real Estate

 

Commercial Mortgage Pass-Through Certificates(7)

    6.0     8/17                32.8        19.5        0.8   

Wachovia Bank Commercial Mortgage Trust 2007-C31

 

Real Estate

 

Commercial Mortgage Pass-Through Certificates(7)

    5.8     5/17                20.0        11.9        1.0   

Wachovia Bank Commercial Mortgage Trust, Series 2007-C32

 

Real Estate

 

Commercial Mortgage Pass-Through Certificates(7)

    5.7     10/17                85.1        56.5        4.6   

Wachovia Bank Commercial Mortgage Trust, Series 2007-C34

 

Real Estate

 

Commercial Mortgage Pass-Through Certificates(7)

    5.3     10/17-9/24                96.2        42.2        4.5   

Wachovia Bank Commercial Trust 2006-C28

 

Real Estate

 

Commercial Mortgage Pass-Through Certificates(1)(7)

    6.0     11/16                5.0        3.2        —     

CLO INVESTMENTS

           

ACAS CLO 2007-1, Ltd.

 

Diversified Financial Services

 

Secured Notes(7)

        $ 8.5      $ 8.4      $ 4.3   
   

Subordinated Notes(7)

          25.9        19.4        15.0   
                                              27.8        19.3   

Ares IIIR/IVR CLO Ltd.

 

Diversified Financial Services

 

Subordinated Notes(7)

                            20.0        18.1        7.7   

Ares VIII CLO, Ltd.

 

Diversified Financial Services

 

Preference Shares(7)

                    6,241                4.7        1.6   

Avalon Capital Ltd. 3

 

Diversified Financial Services

 

Preferred Securities(7)

                    13,796                6.0        5.8   

Babson CLO Ltd. 2006-II

 

Diversified Financial Services

 

Income Notes(7)

                            15.0        12.9        10.7   

BALLYROCK CLO 2006-2 LTD.

 

Diversified Financial Services

 

Deferrable Notes(7)

                            2.0        1.6        1.0   

Cent CDO 12 Limited

 

Diversified Financial Services

 

Income Notes(7)

                            26.4        19.0        15.2   

Centurion CDO 8 Limited

 

Diversified Financial Services

 

Subordinated Notes(7)

                            5.0        2.8        2.7   

Champlain CLO

 

Diversified Financial Services

 

Preferred Securities(7)

                    1,000,000                0.8        0.5   

CoLTs 2005-1 Ltd.(3)

 

Diversified Financial Services

 

Preference Shares(1)(7)

                    360                6.7        0.7   

CoLTs 2005-2 Ltd.(3)

 

Diversified Financial Services

 

Preference Shares(7)

                    34,170,000                23.5        7.8   

CREST Exeter Street Solar 2004-2

 

Diversified Financial Services

 

Preferred Securities(7)

                    3,089,177                3.1        0.6   

Eaton Vance CDO X PLC(3)

 

Diversified Financial Services

 

Secured Subordinated Income Notes(7)

                            15.0        13.5        4.8   

Essex Park CDO Ltd.

 

Diversified Financial Services

 

Preferred Securities(7)

                    5,750,000                2.4        2.1   

 

12


Table of Contents

AMERICAN CAPITAL, LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

September 30, 2010

(unaudited)

(in millions, except share data)

 

Company (4)

 

Industry

 

Investments

 

Interest
Rate (5)

   

Maturity
    Date    

   

# of

shares/

units

owned

   

Principal

   

Cost

   

Fair
Value

 

Flagship CLO V

 

Diversified Financial Services

 

Deferrable Notes(7)

          1.7        1.3        0.9   
   

Subordinated Securities(7)

        15,000          11.1        6.9   
                                              12.4        7.8   

Galaxy III CLO, Ltd

 

Diversified Financial Services

 

Subordinated Notes(1)(7)

                            4.0        2.1        0.6   

LightPoint CLO IV, LTD

 

Diversified Financial Services

 

Income Notes(7)

                            6.7        7.6        1.6   

LightPoint CLO VII, Ltd.

 

Diversified Financial Services

 

Subordinated Notes(7)

                            9.0        6.5        4.9   

LightPoint CLO VIII, Ltd.

 

Diversified Financial Services

 

Deferrable Notes(7)

                            7.0        6.5        4.1   

Mayport CLO Ltd.

 

Diversified Financial Services

 

Income Notes(7)

                            14.0        12.0        6.2   

NYLIM Flatiron CLO 2006-1 LTD.(3)

 

Diversified Financial Services

 

Subordinated Securities(7)

                    10,000                6.9        5.1   

Octagon Investment Partners VII, Ltd.

 

Diversified Financial Services

 

Preferred Securities(7)

                    5,000,000                1.8        1.4   

Sapphire Valley CDO I, Ltd.

 

Diversified Financial Services

 

Subordinated Notes(7)

                            14.0        15.0        2.2   

Vitesse CLO, Ltd.

 

Diversified Financial Services

 

Preferred Securities(7)

                    20,000,000                15.1        8.7   

Subtotal Non-Control / Non-Affiliate Investments (53% of total investments at fair value)

  

          $ 4,284.5      $ 2,940.9   

AFFILIATE INVESTMENTS

           

American Capital Agency Corp(2)

 

Real Estate

 

Common Stock(7)

                    2,500,100              $ 50.0      $ 66.4   

Anchor Drilling Fluids USA, Inc.

 

Energy Equipment & Services

 

Senior Debt(7)

    11.3     12/13        $ 6.6        6.6        6.1   
   

Redeemable Preferred Stock(1)(7)

        859          1.6        0.8   
   

Common Stock(1)(7)

        3,061          5.0        —     
                                              13.2        6.9   

Comfort Co., Inc.

 

Household Durables

 

Senior Debt(7)

    11.4     3/12-3/15          13.2        13.2        11.8   
   

Common Stock(1)(7)

        110,365          11.8        9.4   
                                              25.0        21.2   

Egenera, Inc.

 

Computers & Peripherals

 

Subordinated Debt(6)

    15.0     12/10          4.3        3.2        1.4   
   

Common Stock(1)(7)

        8,569,905          25.4        —     
                                              28.6        1.4   

HALT Medical, Inc.

 

Health Care Equipment & Supplies

 

Convertible Preferred Stock(1)(7)

                    5,592,367                8.9        10.3   

IEE Holding 1 S.A.(3)

 

Auto Components

 

Common Stock(1)

                    250,000                4.5        —     

IS Holdings I, Inc.

 

Software

 

Redeemable Preferred Stock(7)

        1,297          1.9        1.9   
   

Common Stock(1)(7)

        1,165,930          —          9.0   
                                              1.9        10.9   

LTM Enterprises, Inc.

 

Personal Products

 

Senior Debt(6)(7)

    17.3     11/11                23.4        18.4        13.7   

Primrose Holding Corporation

 

Diversified Consumer Services

 

Common Stock(1)(7)

                    4,213                2.7        3.8   

Qualitor Component Holdings, LLC

 

Auto Components

 

Subordinated Debt(7)

    17.1     7/13          38.8        38.6        38.7   
   

Redeemable Preferred Units(1)

        3,150,000          3.2        —     
   

Common Units(1)

        350,000          0.3        —     
                                              42.1        38.7   

 

13


Table of Contents

AMERICAN CAPITAL, LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

September 30, 2010

(unaudited)

(in millions, except share data)

 

Company (4)

 

Industry

 

Investments

 

Interest
Rate (5)

   

Maturity
    Date    

   

# of

shares/

units

owned

   

Principal

   

Cost

   

Fair
Value

 

Radar Detection Holdings Corp.

 

Household Durables

 

Senior Debt(7)

    13.0     11/12          16.3        15.8        14.9   
   

Convertible Preferred Stock(1)

        7,075          0.7        1.6   
   

Common Stock(1)

        40,688          0.6        —     
                                              17.1        16.5   

Small Smiles Holding Company, LLC

 

Health Care Providers & Services

 

Senior Debt(7)

    3.8     2/15          10.3        7.2        5.4   
   

Subordinated Debt(6)(7)

    11.0     2/17          27.9        19.0        —     
   

Redeemable Preferred Stock(1)(7)

        12.8       37.8        —     
   

Common Membership Interest(1)(7)

            13.8        —     
                                              77.8        5.4   

WFS Holding, LLC

  Software   Preferred Interest(1)                     20,403,772                3.0        2.2   

Subtotal Affiliate Investments (3% of total investments at fair value)

  

  $ 293.2      $ 197.4   

CONTROL INVESTMENTS

           

ACAS Equity Holdings Corp.

 

Diversified Financial Services

 

Common Stock(1)(7)

                    589              $ 15.1      $ 1.8   

ACAS Real Estate Holdings Corporation

 

Real Estate

 

Subordinated Debt(6)(7)

    15.0     5/16        $ 4.6        3.7        4.6   
   

Common Stock(1)(7)

        100       11.5        0.5   
                                              15.2        5.1   

American Capital, LLC

 

Capital Markets

 

Common Membership Interest(7)

                    100             65.8        87.2   

American Driveline Systems, Inc.

 

Diversified Consumer Services

 

Subordinated Debt(7)

    14.0     12/14-12/15          42.8        42.4        42.8   
   

Redeemable Preferred Stock(7)

        403,357          35.0        50.8   
   

Common Stock(1)(7)

        128,681          10.8        1.2   
   

Common Stock Warrants(1)(7)

        204,663          17.3        1.9   
                                              105.5        96.7   

Aptara, Inc.

 

IT Services

 

Senior Debt(7)

    11.5     8/12          2.5        2.5        2.5   
   

Subordinated Debt(7)

    17.0     8/12          60.2        60.0        62.2   
   

Redeemable Preferred Stock(1)(7)

        15,107          14.1        21.0   
   

Convertible Preferred Stock(1)(7)

        2,549,410          8.7        —     
   

Preferred Stock Warrants(1)(7)

        230,681          1.0        —     
                                              86.3        85.7   

Capital.com, Inc.

 

Diversified Financial Services

 

Common Stock(1)(7)

                    8,500,100                0.9        —     

CH Holding Corp.

 

Leisure Equipment & Products

 

Senior Debt(7)

    7.3     5/13          18.1        18.0        18.1   
   

Redeemable Preferred Stock(1)(7)

        21,215          42.8        3.7   
                                              60.8        21.8   

CMX Inc.

 

Construction & Engineering

 

Senior Debt(6)(7)

    3.5     5/11                6.6        6.5        0.5   

Contour Semiconductor, Inc.

 

Semiconductors & Semiconductor Equipment

 

Convertible Preferred Stock(1)(7)

                    11,532,842                12.4        21.6   

Core Financial Holdings, LLC

 

Diversified Financial Services

 

Subordinated Debt(7)

    13.6     4/14-5/15          37.8        37.5        37.5   
   

Common Units(1)(7)

        57,940,360          54.4        12.5   
                                              91.9        50.0   

 

14


Table of Contents

AMERICAN CAPITAL, LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

September 30, 2010

(unaudited)

(in millions, except share data)

 

Company (4)

 

Industry

 

Investments

 

Interest
Rate (5)

   

Maturity
    Date    

   

# of

shares/

units

owned

   

Principal

   

Cost

   

Fair
Value

 

ECA Acquisition Holdings, Inc.

 

Health Care Equipment & Supplies

 

Subordinated Debt(7)

    16.5     12/14          13.8        13.7        13.8   
   

Common Stock(1)(7)

        583          11.1        13.4   
                                              24.8        27.2   

eLynx Holdings, Inc.

 

IT Services

 

Senior Debt(7)

    8.8     7/13          9.6        9.6        9.6   
   

Subordinated Debt(6)(7)

    9.0     7/13          17.1        13.4        3.2   
   

Redeemable Preferred Stock(1)(7)

        21,113          8.9        —     
   

Convertible Preferred Stock(1)(7)

        7,929          6.0        —     
   

Common Stock(1)(7)

        11,261          1.1        —     
   

Common Stock Warrants(1)(7)

        1,078,792          13.1        —     
                                              52.1        12.8   

European Capital Limited(3)

 

Diversified Financial Services

 

Subordinated Debt(7)

    7.3     7/12          12.2        12.0        12.2   
   

Ordinary Shares(1)(7)

        431,895,528          1,267.3        499.3   
                                              1,279.3        511.5   

European Touch, LTD. II

 

Leisure Equipment & Products

 

Senior Debt(7)

    9.0     8/11-1/12          0.9        0.9        0.9   
   

Subordinated Debt(6)(7)

    16.0     1/11          20.7        13.5        1.8   
   

Redeemable Preferred Stock(1)(7)

        263          0.3        —     
   

Common Stock(1)(7)

        1,688          0.9        —     
   

Common Stock Warrants(1)(7)

        7,105          3.7        —     
                                              19.3        2.7   

EXPL Pipeline Holdings LLC

 

Oil, Gas & Consumable Fuels

 

Senior Debt(7)

    8.0     1/17          45.8        45.5        45.8   
   

Common Membership Units(1)(7)

        58,297          44.5        9.3   
                                              90.0        55.1   

FL Acquisitions Holdings, Inc.

 

Computers & Peripherals

 

Senior Debt(7)

    8.3     10/12-10/13          40.0        39.8        40.0   
   

Subordinated Debt(7)

    18.6     4/14-10/14          33.2        33.1        33.2   
   

Subordinated Debt(6)(7)

    22.5     10/14          16.2        8.6        8.6   
   

Redeemable Preferred Stock(1)

        583,000          0.6        —     
   

Common Stock(1)

        129,514          15.6        —     
                                              97.7        81.8   

Formed Fiber Technologies, Inc.

 

Auto Components

 

Common Stock(1)(7)

                    31,250                8.1        5.6   

Fosbel Global Services (LUXCO) S.C.A.(3)

 

Commercial Services & Supplies

 

Subordinated Debt(7)

    18.6     12/13-12/14          51.2        51.0        51.1   
   

Redeemable Preferred Stock(1)

        18,449,456          18.5        6.5   
   

Convertible Preferred Stock(1)

        1,519,368          3.0        —     
   

Common Stock(1)

        108,526          0.2        —     
                                              72.7        57.6   

FreeConference.com, Inc.

 

Diversified Telecommunication Services

 

Senior Debt(7)

    8.5     5/11          9.9        9.9        9.9   
   

Subordinated Debt(6)(7)

    15.0     5/12          10.6        9.2        4.2   
   

Redeemable Preferred Stock(1)(7)

        14,042,095          12.8        —     
   

Common Stock(1)(7)

        6,088,229          2.3        —     
                                              34.2        14.1   

Future Food, Inc.

 

Food Products

 

Senior Debt(7)

    5.3     12/10          1.6        1.6        1.6   
   

Senior Debt(6)(7)

    5.3     12/10          15.4        15.4        10.1   
   

Common Stock(1)(7)

        64,917          12.9        —     
   

Common Stock Warrants(1)(7)

        6,500          1.3        —     
                                              31.2        11.7   

 

15


Table of Contents

AMERICAN CAPITAL, LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

September 30, 2010

(unaudited)

(in millions, except share data)

 

Company (4)

 

Industry

 

Investments

 

Interest
Rate (5)

   

Maturity
    Date    

   

# of

shares/

units

owned

   

Principal

   

Cost

   

Fair
Value

 

Group Montana, Inc.

 

Textiles, Apparel & Luxury Goods

 

Senior Debt(7)

    10.6     1/11-10/11          17.6        17.6        17.6   
   

Senior Debt(6)(7)

    12.8     10/11          5.9        4.6        2.2   
   

Subordinated Debt(6)(7)

    24.5     10/12          15.1        6.7        —     
   

Convertible Preferred Stock(1)(7)

        4,000          1.0        —     
   

Common Stock(1)(7)

        2.5       0.7        —     
                                              30.6        19.8   

Halex Holdings, Inc.

 

Construction Materials

 

Senior Debt(6)(7)

    7.0     9/11          11.6        9.8        6.0   
   

Redeemable Preferred Stock(1)(7)

        23,737,746          30.8        —     
                                              40.6        6.0   

Hartstrings Holdings Corp.

 

Textiles, Apparel & Luxury Goods

 

Senior Debt(6)(7)

    4.5     12/10          9.4        9.4        6.7   
   

Convertible Preferred Stock(1)(7)

        10,196          3.0        —     
   

Common Stock(1)(7)

        14,250          4.8        —     
                                              17.2        6.7   

J-Pac, LLC

 

Health Care Equipment & Supplies

 

Senior Debt(7)

    11.0     1/12-1/14          3.1        3.0        3.1   
   

Senior Debt(6)(7)

    12.3     1/14          11.8        11.6        0.3   
   

Subordinated Debt(6)(7)

    18.9     1/14          13.3        8.7        —     
   

Preferred Unit Warrants(1)(7)

        263,158          0.2        —     
                                              23.5        3.4   

Kingway Inca Clymer Holdings, Inc.

 

Building Products

 

Subordinated Debt(6)(7)

    12.2     4/12          2.8        —          1.1   
   

Redeemable Preferred Stock(1)

        13,709          9.2        —     
                                              9.2        1.1   

Lifoam Holdings, Inc.

 

Leisure Equipment & Products

 

Senior Debt(7)

    10.5     12/14          18.9        18.9        18.9   
   

Subordinated Debt(7)

    8.0     12/14          42.3        42.2        42.3   
   

Redeemable Preferred Stock(1)(7)

        6,160          4.2        7.4   
   

Convertible Preferred Stock(1)(7)

        15,797          12.3        —     
   

Common Stock(1)(7)

        14,000          1.4        —     
   

Common Stock Warrants(1)(7)

        479,882          2.9        —     
                                              81.9        68.6   

LLSC Holdings Corporation

 

Personal Products

 

Senior Debt(7)

    6.3     8/12          4.0        4.0        4.0   
   

Subordinated Debt(7)

    12.0     9/13          5.5        5.5        5.5   
   

Convertible Preferred Stock(1)(7)

        7,496          8.1        4.8   
                                              17.6        14.3   

LVI Holdings, LLC

 

Professional Services

 

Senior Debt(7)

    7.3     12/10          2.7        2.7        3.0   
   

Subordinated Debt(6)(7)

    18.0     2/13          12.7        8.9        5.0   
                                              11.6        8.0   

Medical Billing Holdings, Inc.

 

IT Services

 

Subordinated Debt(7)

    15.0     9/13          11.2        11.1        11.2   
   

Convertible Preferred Stock(1)(7)

        13,199,000          13.2        11.3   
   

Common Stock(1)(7)

        3,299,582          3.3        —     
                                              27.6        22.5   

Montgomery Lane, LLC

 

Diversified Financial Services

 

Common Membership Units(1)(7)

                    100                7.6        4.6   

Montgomery Lane, LTD(3)

 

Diversified Financial Services

 

Common Membership Units(1)

                    50,000                6.2        —     

 

16


Table of Contents

AMERICAN CAPITAL, LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

September 30, 2010

(unaudited)

(in millions, except share data)

 

Company (4)

 

Industry

 

Investments

 

Interest
Rate (5)

   

Maturity
    Date    

   

# of

shares/

units

owned

   

Principal

   

Cost

   

Fair
Value

 

MW Acquisition Corporation

 

Health Care Providers & Services

 

Subordinated Debt(7)

    16.3     2/13-2/14          26.8        26.6        26.8   
   

Redeemable Preferred Stock(7)

        2,485          1.1        1.1   
   

Convertible Preferred Stock(1)(7)

        38,192          13.6        14.7   
                                              41.3        42.6   

NECCO Holdings, Inc.

 

Food Products

 

Senior Debt(6)(7)

    18.0     11/13          18.2        16.6        1.6   
   

Common Stock(1)(7)

        782,609          0.1        —     
                                              16.7        1.6   

NECCO Realty Investments, LLC

 

Real Estate

 

Senior Debt(6)(7)

    14.0     12/17          42.0        37.2        38.0   
   

Common Membership Units(1)(7)

        7,450          4.9        —     
                                              42.1        38.0   

Paradigm Precision Holdings, LLC

 

Aerospace & Defense

 

Subordinated Debt(7)

    17.0     8/14          63.3        62.9        63.3   
   

Subordinated Debt(6)(7)

    20.0     8/14-10/14          77.4        53.6        0.2   
   

Common Membership Units(1)(7)

        478,488          17.5        —     
                                              134.0        63.5   

PHC Sharp Holdings, Inc.

 

Commercial Services & Supplies

 

Senior Debt(7)

    5.9     12/11-12/12          16.2        16.0        14.7   
   

Subordinated Debt(6)(7)

    17.0     12/14          11.1        7.3        —     
   

Common Stock(1)(7)

        367,881          4.2        —     
                                              27.5        14.7   

PHI Acquisitions, Inc.

 

Internet & Catalog Retail

 

Subordinated Debt(7)

    15.3     3/16          27.6        27.4        27.6   
   

Redeemable Preferred Stock(7)

        36,267          31.2        42.8   
   

Common Stock(1)(7)

        40,295          3.9        6.8   
   

Common Stock Warrants(1)(7)

        116,065          11.6        19.5   
                                              74.1        96.7   

Sixnet Holdings, LLC

 

Electronic Equipment, Instruments & Components

 

Senior Debt(7)

    11.1     6/12-6/13          37.0        36.8        37.0   
   

Convertible Preferred Stock(1)(7)

        94          0.5        0.5   
   

Membership Units(1)(7)

        446          5.6        2.2   
                                              42.9        39.7   

SMG Holdings, Inc.

 

Hotels, Restaurants & Leisure

 

Senior Debt(7)

    3.5     7/14          5.8        5.8        5.8   
   

Subordinated Debt(7)

    12.6     6/15          128.9        128.1        129.1   
   

Convertible Preferred Stock(7)

        1,101,673          136.0        132.5   
   

Common Stock(1)

        275,419          27.6        —     
                                              297.5        267.4   

Specialty Brands of America, Inc.

 

Food Products

 

Subordinated Debt(7)

    14.0     5/14          35.4        35.1        35.4   
   

Redeemable Preferred Stock(7)

        122,017          10.2        15.9   
   

Common Stock(1)(7)

        128,175          2.3        18.0   
   

Common Stock Warrants(1)(7)

        56,819          1.4        7.9   
                                              49.0        77.2   

Spring Air International, LLC

 

Household Durables

 

Common Membership Units(1)(7)

                    49             2.7        0.4   

TestAmerica Environmental Services, LLC

 

Commercial Services & Supplies

 

Senior Debt(7)

    6.5     12/11-12/12          24.6        20.5        17.3   
   

Preferred Membership Units(1)(7)

        20,000          19.3        13.3   
   

Common Stock(1)(7)

        490,000          2.0        —     
                                              41.8        30.6   

UFG Real Estate Holdings, LLC

 

Real Estate

 

Common Membership(1)(7)

                                    —          0.9   

 

17


Table of Contents

AMERICAN CAPITAL, LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

September 30, 2010

(unaudited)

(in millions, except share data)

 

Company (4)

 

Industry

 

Investments

 

Interest
Rate (5)

   

Maturity
    Date    

   

# of

shares/

units

owned

   

Principal

   

Cost

   

Fair
Value

 

Unique Fabricating Incorporated

 

Auto Components

 

Senior Debt(7)

    9.9     10/10-2/12          6.2        6.2        6.2   
   

Redeemable Preferred Stock(1)(7)

        301,556          7.9        7.0   
   

Common Stock Warrants(1)(7)

        6,862          0.2        —     
                                              14.3        13.2   

Unwired Holdings, Inc.

 

Household Durables

 

Senior Debt(7)

    8.6     6/11-6/12          16.0        16.0        16.0   
   

Subordinated Debt(6)(7)

    14.5     6/12          19.6        7.9        19.8   
   

Redeemable Preferred Stock(1)

        14,630          14.6        —     
   

Common Stock(1)

        126,001          1.3        —     
                                              39.8        35.8   

VP Acquisition Holdings, Inc.

 

Health Care Equipment & Supplies

 

Subordinated Debt(7)

    14.5     10/13-10/14          20.4        20.3        20.4   
   

Common Stock(1)(7)

        19,780          24.7        61.6   
                                              45.0        82.0   

Warner Power, LLC

 

Electrical Equipment

 

Subordinated Debt(7)

    14.6     1/12          5.9        5.9        5.9   
   

Redeemable Preferred Membership Units(1)(7)

        3,796,269          3.0        3.0   
   

Common Membership Units(1)(7)

        27,400          1.9        —     
                                              10.8        8.9   

WIS Holding Company, Inc.

 

Commercial Services & Supplies

 

Subordinated Debt(7)

    14.9     1/14-1/15          113.5        112.9        113.5   
   

Convertible Preferred Stock(7)

        703,406          94.8        159.2   
   

Common Stock(1)(7)

        175,852          17.6        33.7   
                                              225.3        306.4   

WSACS RR Holdings, LLC

 

Real Estate

 

Common Membership Units(1)(7)

                    3,384,615                3.4        —     

CDO / CLO INVESTMENTS

                                               

ACAS Wachovia Investments, L.P.

 

Diversified Financial Services

 

Partnership Interest

                    90           $ 12.7      $ 2.4   

Subtotal Control Investments (44% of total investments at fair value)

                                  $ 3,564.3      $ 2,427.5   

Total Investment Assets

                                          $ 8,142.0      $ 5,565.8   

 

Counterparty

 

Instrument

 

Interest
Rate (5)

   

Expiration
Date (5)

   

# of
contracts

   

Notional

   

Cost

   

Fair
Value

 

DERIVATIVE AGREEMENTS

           

Wells Fargo Bank, N.A

 

Balance Differential Swap - Pay Fixed/ Receive Floating(7)

    5.1%/LIBOR        8/19        1        17.1        —          3.8   

Subtotal Derivative Assets

                                      $ —        $ 3.8   

DERIVATIVE AGREEMENTS

           

Citibank, N.A.

 

Interest Rate Swap - Pay Fixed/ Receive Floating(7)

    4.9%/LIBOR        4/12-11/19        4        388.9        —          (29.1

BMO Financial Group

 

Interest Rate Swap - Pay Fixed/ Receive Floating(7)

    5.4%/LIBOR        2/13-8/17        5        323.8        —          (45.2

Wells Fargo Bank, N.A

 

Interest Rate Swap - Pay Fixed/ Receive Floating(7)

    4.9%/LIBOR        1/14-8/19        3        295.8        —          (33.1

UniCredit Group

 

Interest Rate Swap - Pay Fixed/ Receive Floating(7)

    5.7%/LIBOR        7/17        1        66.0        —          (13.5

Citibank, N.A.

 

Balance Differential Swap - Pay Fixed/ Receive Floating(7)

    5.2%/LIBOR        11/19        1        45.5        —          (3.6

Fortis Financial Services LLC

 

Interest Rate Swap - Pay Fixed/ Receive Floating(7)

    5.7%/LIBOR        7/17        1        22.3        —          (4.6

Citibank, N.A.

 

Foreign Exchange Swap - Pay Euros/ Receive GBP(7)

            2/11        1                —          (1.0

Subtotal Derivative Liabilities

                                  $ —        $ (130.1

Total Derivative Agreements, Net

                                  $ —        $ (126.3

 

18


Table of Contents

AMERICAN CAPITAL, LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

September 30, 2010

(unaudited)

(in millions, except share data)

 

 

Funds   Cost     Fair
Value
 

MONEY MARKET FUNDS(7)(9)

   

Dreyfus Cash Management—INST

  $ 4.0      $ 4.0   

Federated INV PRM CSH OBL-I

    4.0        4.0   

Dreyfus Cash Advantage Fund

    3.0        3.0   

Fidelity Institutional Money Market Funds—Money Market Portfolio

    2.3        2.3   

DWS Money Market Series—INST

    2.0        2.0   

Fidelity Institutional Money Market Funds—Prime Money Market Portfolio

    0.7        0.7   

Total Money Market Funds

  $ 16.0      $ 16.0   

 

(1) Non-income producing.
(2) Publicly traded company or a consolidated subsidiary of a public company.
(3) International investment.
(4) Certain of the securities are issued by affiliate(s) of the listed portfolio company.
(5) Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by the nature of indebtedness by a single issuer. The maturity dates represent the earliest and the latest maturity dates.
(6) Loan is on non-accrual status and therefore considered non-income producing.
(7) All or a portion of the investments or instruments are pledged as collateral under various secured financing arrangements.
(8) Portfolio company has filed for reorganization under Chapter 11 of the United States code.
(9) Included in cash and cash equivalents on our Consolidated Balance Sheets.

 

19


Table of Contents

 

AMERICAN CAPITAL, LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS

December 31, 2009

(in millions, except share data)

 

Company (4)

 

Industry

 

Investments

 

Interest
Rate (5)

 

Maturity
    Date    

   

# of
shares/
units
owned

   

Principal

   

Cost

   

Fair
Value

 

NON-CONTROL / NON-AFFILIATE INVESTMENTS

  

       

Affordable Care Holding Corp.

 

Health Care Providers & Services

 

Subordinated Debt(7)

  15.0%     11/13-11/14        $ 66.6      $ 65.9      $ 66.6   
   

Convertible Preferred Stock

        70,752          91.0        99.4   
   

Common Stock(1)

        17,687,156          17.7        19.8   
                                          174.6        185.8   

Algoma Holding Company

 

Building Products

 

Subordinated Debt(7)

  12.6%     4/13                15.2        15.1        14.9   

American Acquisition, LLC

 

Capital Markets

 

Senior Debt

  14.2%     12/12                15.7        15.4        13.5   

AmWins Group, Inc.

 

Insurance

 

Senior Debt(7)

    5.8%     6/14                18.5        18.6        12.1   

Anchor Drilling Fluids USA, Inc.

 

Energy Equipment & Services

 

Senior Debt(7)

  11.3%     4/13          7.9        7.8        6.3   
   

Subordinated Debt(6)(7)

  14.7%     4/15          5.2        5.0        —     
                                          12.8        6.3   

Aspect Software

  IT Services  

Senior Debt(7)

    7.3%     7/12                20.0        19.9        16.6   

Avalon Laboratories Holding Corp.

 

Health Care Equipment & Supplies

 

Senior Debt(7)

  11.0%     1/14          17.7        17.6        17.7   
   

Subordinated Debt(7)

  18.0%     1/15          22.9        21.7        20.6   
   

Convertible Preferred Stock(1)

        148,742          24.3        —     
   

Common Stock(1)

        7,829          1.3        —     
                                          64.9        38.3   

Avanti Park Place LLC

  Real Estate  

Senior Debt

    8.3%     6/10                5.7        5.8        5.8   

BBB Industries, LLC

  Auto Components  

Senior Debt(7)

    5.7%     6/14                21.2        21.2        15.9   

Berry-Hill Galleries, Inc.

  Distributors  

Senior Debt

  13.7%     3/10                7.9        7.9        7.9   

Blue Wolf Capital Fund II, L.P.

  Capital Markets  

Limited Partnership Interest

                                2.5        2.5   

CAMP Systems International, Inc.

  Air Freight & Logistics  

Senior Debt(7)

    6.4%     9/14                30.0        29.8        20.6   

Carestream Health, Inc.

 

Health Care Equipment & Supplies

 

Senior Debt(7)

    5.5%     10/13                15.0        15.0        11.6   

CH Holding Corp.

 

Leisure Equipment & Products

 

Senior Debt(6)

    7.2%     5/11          16.2        13.0        13.7   
   

Redeemable Preferred Stock(1)

        21,215          42.7        —     
                                          55.7        13.7   

Cinelease Holdings, LLC

 

Electronic Equipment, Instruments & Components

 

Senior Debt(7)

    7.7%     3/12-4/13          47.9        47.6        41.3   
   

Senior Debt(6)(7)

    8.3%     4/13          10.4        10.4        7.1   
   

Common Stock(1)

        583          0.5        —     
                                          58.5        48.4   

Compusearch Holdings Company, Inc.

 

Software

 

Subordinated Debt(7)

  12.0%     7/12          12.6        12.5        12.6   
   

Convertible Preferred Stock(1)

        23,342          0.9        2.7   
                                          13.4        15.3   

Contec, LLC

 

Household Durables

 

Subordinated Debt(7)

  14.0%     9/15-9/16                135.0        133.8        114.6   

Delsey Holding(3)

 

Textiles, Apparel & Luxury Goods

 

Senior Debt

    7.2%     2/12                20.5        20.5        15.0   

DelStar, Inc.

 

Building Products

 

Subordinated Debt(7)

  14.0%     12/12          19.1        19.0        19.1   
   

Redeemable Preferred Stock

        26,613          19.4        36.7   
   

Convertible Preferred Stock(1)

        29,569          3.0        —     
   

Common Stock Warrants(1)

        89,020          16.9        —     
                                          58.3        55.8   

Direct Marketing International LLC

 

Media

 

Subordinated Debt(7)

  15.2%     7/12                30.3        30.1        26.8   

 

20


Table of Contents

AMERICAN CAPITAL, LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

December 31, 2009

(in millions, except share data)

 

Company (4)

 

Industry

 

Investments

 

Interest
Rate (5)

   

Maturity
    Date    

   

# of
shares/
units
owned

   

Principal

   

Cost

   

Fair
Value

 

Dyno Holding Corp.

 

Auto Components

 

Senior Debt(7)

    11.7%        11/13-11/15          41.6        41.3        41.6   
   

Subordinated Debt(6)(7)

      3.7%        11/16          27.0        25.6        9.9   
   

Convertible Preferred Stock(1)

        389,759          40.5        —     
   

Common Stock(1)

        97,440          10.1        —     
                                              117.5        51.5   

Easton Bell Sports, LLC

 

Leisure Equipment & Products

 

Redeemable Preferred Stock

Common Units(1)

       

 

1,171

3,830,068

  

  

     

 

1.3

0.7

  

  

   

 

1.3

2.0

  

  

                                              2.0        3.3   

FAMS Acquisition, Inc.

 

Diversified Financial Services

 

Subordinated Debt(7)

Subordinated Debt(6)(7)

   

 

14.0%

15.5%

  

  

   

 

11/13

11/14

  

  

     

 

13.1

13.6

  

  

   

 

13.0

11.8

  

  

   

 

13.1

3.1

  

  

   

Redeemable Preferred Stock(1)

        919          0.9        —     
   

Convertible Preferred Stock(1)

        861,364          20.9        —     
                                              46.6        16.2   

FCC Holdings, LLC

 

Commercial Banks

 

Subordinated Debt

    15.1%        12/12                75.0        74.6        67.7   

Ford Motor Company(2)

  Automobiles  

Senior Debt

      3.4%        12/13                21.2        20.6        18.3   

FPI Holding Corporation

  Food Products  

Senior Debt

      7.6%        11/10-5/11          7.4        7.3        7.4   
   

Senior Debt(6)

    13.9%        5/13-6/15          24.0        23.2        5.7   
   

Subordinated Debt(6)

    21.6%        6/15-5/16          23.2        17.3        —     
   

Redeemable Preferred Stock(1)

        4,469          39.1        —     
   

Convertible Preferred Stock(1)

        21,715          23.3        —     
   

Common Stock(1)

        5,429          5.8        —     
                                              116.0        13.1   

Genband Inc.

 

Communications Equipment

 

Common Stock(1)

                    3,407,419                14.7        0.2   

Golden Key US LLC

 

Diversified Financial Services

 

Commercial Paper(1)

      5.3%        1/14                7.3        7.3        3.9   

HMSC Corporation

  Insurance  

Senior Debt(6)(7)

      5.8%        10/14                3.4        3.4        1.2   

Hoppy Holdings, Corp.

  Auto Components  

Subordinated Debt(7)

    15.3%        7/12          39.0        38.8        38.4   
   

Redeemable Preferred Stock

        2,915          7.0        6.8   
                                              45.8        45.2   

Infiltrator Systems, Inc.

  Building Products  

Senior Debt(7)

    16.5%        10/13                39.5        39.1        38.5   

Innova-Extel Acquisition Holdings, Inc.

 

Software

 

Senior Debt(7)

      7.7%        4/13          11.5        11.4        11.5   
   

Subordinated Debt(7)

    15.0%        3/14          18.2        18.0        18.2   
   

Convertible Preferred Stock

        14,283          23.3        28.9   
                                              52.7        58.6   

Inovis International, Inc.

  Software  

Senior Debt(7)

    16.0%        6/10                89.2        89.0        89.0   

Intergraph Corporation

  Software  

Senior Debt(7)

      6.3%        12/14                3.0        3.0        2.8   

iTradeNetwork, Inc.

  IT Services  

Senior Debt(7)

    11.5%        12/13                25.0        24.8        25.0   

JHCI Acquisition, Inc.

 

Air Freight & Logistics

 

Senior Debt(7)

      5.7%        12/14                19.0        19.1        12.1   

Jones Stephens Corp.(8)

  Building Products  

Subordinated Debt(6)(7)

    13.5%        9/13-9/14                23.5        22.1        13.2   

J-Pac, LLC

 

Health Care Equipment & Supplies

 

Senior Debt(7)

    11.0%        1/14          3.1        3.0        3.1   
   

Senior Debt(6)(7)

    12.3%        1/14          11.9        11.8        1.2   
   

Subordinated Debt(6)

    18.9%        1/14          11.6        8.7        —     
   

Common Unit Warrants(1)

        500,000          0.2        —     
                                              23.7        4.3   

KIK Custom Products, Inc.(3)

  Household Products  

Senior Debt(6)

      5.3%        12/14                20.0        20.0        12.3   

LabelCorp Holdings, Inc

  Paper & Forest Products  

Senior Debt

      8.2%        8/13-8/14          2.5        2.2        2.3   
   

Subordinated Debt(7)

    14.0%        8/15-8/16          44.5        44.2        39.2   
                                              46.4        41.5   

 

21


Table of Contents

AMERICAN CAPITAL, LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

December 31, 2009

(in millions, except share data)

 

Company (4)

 

Industry

 

Investments

 

Interest
Rate (5)

   

Maturity
    Date    

   

# of
shares/
units
owned

   

Principal

   

Cost

   

Fair
Value

 

LCW Holdings, LLC

  Real Estate  

Senior Debt

      6.7%        10/12          32.2        31.4        30.3   
   

Warrant(1)

        12.5       0.9        3.5   
                                              32.3        33.8   

LJVH Holdings Inc.(3)

  Beverages  

Senior Debt(7)

      5.8%        1/15                28.5        28.5        21.0   

LN Acquisition Corp.

  Machinery  

Senior Debt(7)

      6.0%        1/15                21.5        21.6        14.4   

Logex Corporation

  Road & Rail  

Subordinated Debt(6)

      0.0%        3/10                1.1        0.9        1.0   

MagnaCare Holdings, Inc.

 

Health Care Providers & Services

 

Subordinated Debt(7)

    14.8%        1/13                14.3        14.2        14.2   

Medical Billing Holdings, Inc.

  IT Services  

Subordinated Debt(7)

    15.0%        9/13          11.0        10.9        11.0   
   

Convertible Preferred Stock(1)

        13,199,000          13.2        10.0   
   

Common Stock(1)

        3,299,582          3.3        —     
                                              27.4        21.0   

Mirion Technologies, Inc.

  Electrical Equipment  

Senior Debt(7)

      5.3%        6/11-11/11          127.7        127.4        129.1   
   

Subordinated Debt(7)

    13.8%        7/11-5/12          52.9        52.6        52.9   
   

Convertible Preferred Stock

        435,724          54.6        104.1   
   

Common Stock(1)

        24,503          2.8        3.6   
   

Common Stock Warrants(1)

        222,156          18.5        31.8   
                                              255.9        321.5   

Mitchell International, Inc.

  IT Services  

Senior Debt(7)

      5.6%        3/15                5.0        5.0        3.3   

National Processing Company Group, Inc.

  IT Services  

Senior Debt(7)

    10.8%        9/14                53.0        52.8        43.6   

NBD Holdings Corp.

 

Diversified Financial Services

 

Subordinated Debt(7)

    14.0%        8/13          46.8        46.4        46.8   
   

Convertible Preferred Stock

        84,174          11.3        11.3   
   

Common Stock(1)

        633,408          0.1        1.5   
                                              57.8        59.6   

Net1 Las Colinas Manager, LLC

  Real Estate  

Senior Debt

      7.7%        10/15                4.5        4.6        3.9   

Nivel Holdings, LLC

  Distributors  

Senior Debt(7)

    10.8%        10/12-10/13                61.6        61.1        58.6   

Orchard Brands Corporation

 

Internet & Catalog Retail

 

Senior Debt(7)

      7.3%        4/13-4/14          174.4        173.2        138.8   
   

Senior Debt(6)

    10.0%        4/14          158.5        118.6        33.1   
   

Subordinated Debt(6)

      9.7%        4/14          66.4        49.9        —     
                                              341.7        171.9   

Pan Am International Flight Academy, Inc.

 

Professional Services

 

Subordinated Debt(6)(7)

    18.0%        7/13          33.4        25.0        14.2   
   

Convertible Preferred Stock(1)

        8,234          8.2        —     
                                              33.2        14.2   

PaR Systems, Inc.

  Machinery  

Senior Debt

      3.6%        7/13                4.1        3.9        3.4   

Parts Holding
Coörperatief U.A(3)

  Distributors  

Membership Entitlements(1)

                    173,060                6.4        —     

Phillips & Temro Industries, Inc.

 

Auto Components

 

Senior Debt(7)

    13.0%        12/13          24.1        24.1        24.1   
   

Subordinated Debt(7)

    18.0%        12/13          18.4        18.3        17.0   
                                              42.4        41.1   

Qioptiq S.A.R.L.(3)

 

Electronic Equipment, Instruments & Components

 

Subordinated Debt

    10.0%        3/18                30.9        30.7        29.3   

Ranpak Acquisition Company

  Containers & Packaging  

Senior Debt(7)

      6.7%        12/13-12/14                20.8        20.4        16.9   

 

22


Table of Contents

AMERICAN CAPITAL, LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

December 31, 2009

(in millions, except share data)

 

Company (4)

 

Industry

 

Investments

 

Interest
Rate (5)

   

Maturity
    Date    

   

# of
shares/
units
owned

   

Principal

   

Cost

   

Fair
Value

 

RDR Holdings, Inc.

 

Household Durables

 

Subordinated Debt(7)

    16.1%        10/14-11/15          98.1        97.4        98.1   
   

Convertible Preferred Stock(1)

        1,541          165.6        56.7   
   

Common Stock(1)

        15,414          1.6        —     
                                              264.6        154.8   

Roark - Money Mailer, LLC

  Media  

Common Membership Units(1)

                    3.5             0.9        —     

Scanner Holdings Corporation

 

Computers & Peripherals

 

Subordinated Debt(7)

    14.0%        6/14          19.1        18.9        19.1   
   

Convertible Preferred Stock(1)

        77,640,000          7.8        13.7   
   

Common Stock(1)

        78,242          0.1        —     
                                              26.8        32.8   

Seroyal Holdings, L.P.(3)

 

Pharmaceuticals

 

Redeemable Preferred Units

        32,462          0.7        0.9   
   

Common Units(1)

        95,280          0.8        1.6   
   

Common Unit Warrants(1)

        41,661          0.1        0.1   
                                              1.6        2.6   

Small Smiles Holding Company, LLC

 

Health Care Providers & Services

 

Senior Debt

      5.3%        9/12          12.1        8.1        6.1   
   

Subordinated Debt(6)

    14.5%        9/13          77.2        70.6        —     
                                              78.7        6.1   

Soil Safe Holdings, LLC

  Professional Services  

Senior Debt

      9.6%        8/13-8/14          40.8        40.5        38.4   
   

Subordinated Debt(7)

    16.3%        8/15-8/17          62.7        62.2        52.6   
                                              102.7        91.0   

SPL Acquisition Corp.

  Pharmaceuticals  

Senior Debt

      6.7%        10/12-10/13          58.5        57.9        58.5   
   

Subordinated Debt(7)

    15.3%        8/14-8/15          51.6        51.1        51.6   
   

Convertible Preferred Stock(1)

        84,043          40.8        31.1   
                                              149.8        141.2   

Swank Audio Visuals, LLC

 

Commercial Services & Supplies

 

Senior Debt(7)

      6.7%        8/14          12.1        12.0        12.1   
   

Senior Debt(6)(7)

      7.4%        8/14          35.9        35.6        3.7   
                                              47.6        15.8   

Tanenbaum-Harber Co. Holdings, Inc.

 

Insurance

 

Redeemable Preferred Stock

                    376                0.5        0.5   

TestAmerica Environmental Services, LLC

 

Commercial Services & Supplies

 

Senior Debt(7)

      5.3%        12/11          7.5        7.4        6.9   
   

Senior Debt(6)(7)

      7.2%        12/12-12/13          43.3        37.3        12.6   
   

Preferred Units(1)

        11,659,298          6.9        —     
   

Preferred Unit Warrants(1)

        1,998,961          4.8        —     
                                              56.4        19.5   

The Tensar Corporation

 

Construction & Engineering

 

Senior Debt(7)

      8.2%        5/13          82.0        81.3        57.0   
   

Subordinated Debt(6)

    17.5%        10/13          51.2        39.9        36.3   
                                              121.2        93.3   

ThreeSixty Sourcing, Inc.(3)

 

Commercial Services & Supplies

 

Common Stock Warrants(1)

                    35                4.1        —     

TransFirst Holdings, Inc.

 

Commercial Services & Supplies

 

Senior Debt(7)

      7.0     6/15                51.8        51.4        36.6   

triVIN, Holdings, Inc.

  IT Services  

Subordinated Debt(7)

    15.0%        6/14-6/15          20.4        20.3        20.4   
   

Convertible Preferred Stock

        247,000,000          28.9        24.4   
   

Common Stock(1)

        6,319,923          6.3        —     
                                              55.5        44.8   

Tyden Cayman Holdings Corp.

 

Electronic Equipment, Instruments & Components

 

Common Stock(1)

                    3,072,494                3.5        3.7   

 

23


Table of Contents

AMERICAN CAPITAL, LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

December 31, 2009

(in millions, except share data)

 

Company (4)

 

Industry

 

Investments

 

Interest
Rate (5)

 

Maturity
    Date    

   

# of
shares/
units
owned

   

Principal

   

Cost

   

Fair
Value

 

WRH, Inc.

 

Life Sciences Tools & Services

 

Senior Debt(7)

    4.0%     9/13-9/14          4.0        3.9        4.0   
   

Subordinated Debt(7)

  14.6%     7/14-9/15          87.8        87.2        88.3   
   

Convertible Preferred Stock(1)

        2,008,575          214.7        77.6   
   

Common Stock(1)

        502,144          49.9        —     
                                          355.7        169.9   

WWC Acquisitions, Inc.

 

Professional Services

 

Senior Debt(7)

    7.0%     12/11-12/13                34.0        33.6        26.3   

CMBS AND REAL ESTATE CDO INVESTMENTS

  

       

ACAS CRE CDO 2007-1, Ltd

  Real Estate  

Class C through Class K Notes(1)

    2.7%     11/31              $ 345.5      $ 170.5      $ 0.5   

Banc of America Commercial Mortgage Trust 2007-1

  Real Estate  

Commercial Mortgage Pass-Through Certificates

    5.7%     2/17-2/18                12.4        4.8        1.3   

CD 2007-CD4 Commercial Mortgage Trust

  Real Estate  

Commercial Mortgage Pass-Through Certificates(1)

    5.7%     4/17                14.0        8.9        —     

CD 2007-CD5 Mortgage Trust

  Real Estate  

Commercial Mortgage Pass-Through Certificates

    6.4%     12/17                14.8        10.5        1.8   

Citigroup Commercial Mortgage Securities Trust 2007-C6

  Real Estate  

Commercial Mortgage Pass-Through Certificates

    5.5%     7/17                112.5        82.9        10.9   

COBALT CMBS Commercial Mortgage Trust 2007-C3

  Real Estate  

Commercial Mortgage Pass-Through Certificates

    5.2%     10/17                11.1        8.6        0.7   

Countrywide Commercial Mortgage Trust 2007-MF1

  Real Estate  

Commercial Mortgage Pass-Through Certificates

    6.1%     11/37-11/40                12.8        8.7        1.0   

Credit Suisse Commercial Mortgage Trust 2007-C3

  Real Estate  

Commercial Mortgage Pass-Through Certificates(1)

    5.6%     7/17                13.2        10.7        —     

Credit Suisse Commercial Mortgage Trust Series 2007-C4

  Real Estate  

Commercial Mortgage Pass-Through Certificates

    5.8%     8/17                20.8        12.6        5.4   

GE Commercial Mortgage Corporation, Series 2007-C1

  Real Estate  

Commercial Mortgage Pass-Through Certificates

    5.5%     12/19                37.0        31.2        2.6   

GS Mortgage Securities Trust 2007-GG10

  Real Estate  

Commercial Mortgage Pass-Through Certificates(1)

    5.7%     7/17                63.7        52.7        —     

J.P. Morgan Chase Commercial Mortgage Securities Trust 2007-LDP11

  Real Estate  

Commercial Mortgage Pass-Through Certificates

    5.6%     7/17                87.2        55.8        1.3   

LB-UBS Commercial Mortgage Trust 2007-C6

  Real Estate  

Commercial Mortgage Pass-Through Certificates

    6.2%     8/17                36.6        22.9        4.7   

LB-UBS Commercial Mortgage Trust 2008-C1

  Real Estate  

Commercial Mortgage Pass-Through Certificates

    6.1%     7/23-7/24                19.4        7.4        2.0   

ML-CFC Commercial Mortgage Trust 2007-6

  Real Estate  

Commercial Mortgage Pass-Through Certificates(1)

    5.8%     4/17                9.8        3.3        0.2   

ML-CFC Commercial Mortgage Trust 2007-8

  Real Estate  

Commercial Mortgage Pass-Through Certificates

    6.0%     8/17                32.8        20.0        3.6   

 

24


Table of Contents

AMERICAN CAPITAL, LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

December 31, 2009

(in millions, except share data)

 

Company (4)

 

Industry

 

Investments

 

Interest
Rate (5)

   

Maturity
    Date    

   

# of
shares/
units
owned

   

Principal

   

Cost

   

Fair
Value

 

Wachovia Bank Commercial Mortgage Trust 2007-C31

  Real Estate  

Commercial Mortgage Pass-Through Certificates

      5.8     5/17                20.0        11.9        2.9   

Wachovia Bank Commercial Mortgage Trust, Series 2007-C32

  Real Estate  

Commercial Mortgage Pass-Through Certificates

      5.7     10/17                85.1        75.2        6.7   

Wachovia Bank Commercial Mortgage Trust, Series 2007-C34

  Real Estate  

Commercial Mortgage Pass-Through Certificates

      5.3     10/17-9/24                70.3        43.4        6.0   

Wachovia Bank Commercial Trust 2006-C28

  Real Estate  

Commercial Mortgage Pass-Through Certificates

      6.0     11/16                5.0        3.1        0.4   

CLO INVESTMENTS

  

       

ACAS CLO 2007-1, Ltd.

 

Diversified Financial Services

 

Secured Notes

        $ 8.5      $ 8.4      $ 4.0   
   

Subordinated Notes

          25.9        21.5        13.4   
                                              29.9        17.4   

Ares IIIR/IVR CLO Ltd.

 

Diversified Financial Services

 

Subordinated Notes

                            20.0        18.3        7.2   

Ares VIII CLO, Ltd.

 

Diversified Financial Services

 

Preference Shares

                    6,241                4.7        1.4   

Avalon Capital Ltd.(3)

 

Diversified Financial Services

 

Preferred Securities

                    13,796                5.2        4.1   

Babson CLO Ltd. 2006-II

 

Diversified Financial Services

 

Income Notes

                            15.0        14.4        8.8   

BALLYROCK CLO 2006-2 LTD.

 

Diversified Financial Services

 

Deferrable Notes

                            2.0        1.6        1.0   

Cent CDO 12 Limited

 

Diversified Financial Services

 

Income Notes

                            26.4        19.9        14.0   

Centurion CDO 8 Limited

 

Diversified Financial Services

 

Subordinated Notes

                            5.0        3.1        2.2   

Champlain CLO

 

Diversified Financial Services

 

Preferred Securities

                    1,000,000                0.7        0.3   

CoLTs 2005-1 Ltd.(3)

 

Diversified Financial Services

 

Preference Shares(1)

                    360                6.7        2.2   

CoLTs 2005-2 Ltd.(3)

 

Diversified Financial Services

 

Preference Shares

                    34,170,000                24.5        9.7   

CREST Exeter Street Solar 2004-2

 

Diversified Financial Services

 

Preferred Securities

                    3,089,177                2.9        0.9   

Eaton Vance CDO X PLC(3)

 

Diversified Financial Services

 

Secured Subordinated Income Notes

                            15.0        13.9        4.7   

Essex Park CDO Ltd.

 

Diversified Financial Services

 

Preferred Securities

                    5,750,000                2.1        1.8   

Flagship CLO V

 

Diversified Financial Services

 

Deferrable Notes

          1.7        1.3        0.6   
   

Subordinated Securities

        15,000          12.1        7.7   
                                              13.4        8.3   

Galaxy III CLO, Ltd

 

Diversified Financial Services

 

Subordinated Notes

                            4.0        2.5        0.3   

LightPoint CLO IV, LTD

 

Diversified Financial Services

 

Income Notes

                            6.7        6.8        1.5   

 

25


Table of Contents

AMERICAN CAPITAL, LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

December 31, 2009

(in millions, except share data)

 

Company (4)

 

Industry

 

Investments

 

Interest
Rate (5)

   

Maturity
    Date    

   

# of
shares/
units
owned

   

Principal

   

Cost

   

Fair
Value

 

LightPoint CLO VII, Ltd.

 

Diversified Financial Services

 

Subordinated Notes

                            9.0        7.5        3.8   

LightPoint CLO VIII, Ltd.

 

Diversified Financial Services

 

Deferrable Notes

                            7.0        6.4        3.7   

Mayport CLO Ltd.

 

Diversified Financial Services

 

Income Notes

                            14.0        12.7        4.9   

NYLIM Flatiron CLO 2006-1 LTD.(3)

 

Diversified Financial Services

 

Subordinated Securities

                    10,000                7.6        5.2   

Octagon Investment Partners VII, Ltd.

 

Diversified Financial Services

 

Preferred Securities

                    5,000,000                2.0        1.3   

Sapphire Valley CDO I, Ltd.

 

Diversified Financial Services

 

Subordinated Notes

                            14.0        13.8        0.8   

Vitesse CLO, Ltd.

 

Diversified Financial Services

 

Preferred Securities

                    20,000,000                15.5        7.8   

Subtotal Non-Control / Non-Affiliate Investments (54% of total investments at fair value)

  

          $ 4,838.8      $ 3,036.2   

AFFILIATE INVESTMENTS

  

       

American Capital Agency Corp(2)

 

Real Estate Investment Trusts

 

Common Stock

                    2,500,100              $ 50.0      $ 66.4   

Comfort Co., Inc.

 

Household Durables

 

Senior Debt(6)(7)

    11.5%        3/12-3/15        $ 12.1        11.1        8.7   
   

Common Stock(1)

        110,365          11.8        —     
                                              22.9        8.7   

Egenera, Inc.

  Computers & Peripherals  

Subordinated Debt

    15.0%        12/10          3.9        3.7        2.5   
   

Redeemable Preferred Stock(1)

        523,040          0.4        —     
   

Common Stock(1)

        8,046,865          25.0        —     
                                              29.1        2.5   

HALT Medical, Inc.

 

Health Care Equipment & Supplies

 

Convertible Preferred Stock(1)

                    5,592,367                8.9        9.6   

IEE Holding 1 S.A.(3)

 

Auto Components

 

Common Stock(1)

                    250,000                4.5        —     

IS Holdings I, Inc.

  Software  

Senior Debt(7)

      6.2%        6/14          20.0        19.9        18.2   
   

Redeemable Preferred Stock(1)

        1,297          1.7        1.9   
   

Common Stock(1)

        1,165,930          —          6.4   
                                              21.6        26.5   

LTM Enterprises, Inc.

 

Personal Products

 

Senior Debt(6)(7)

    17.3     11/11                20.1        18.5        5.5   

Narus, Inc.

 

Internet Software & Services

 

Convertible Preferred Stock(1)

        31,835,900          9.2        6.8   
   

Preferred Stock Warrants(1)

        9,567,232          0.1        2.2   
                                              9.3        9.0   

Primrose Holding Corporation

 

Diversified Consumer Services

 

Common Stock(1)

                    4,213                2.7        3.3   

Qualitor Component Holdings, LLC

  Auto Components  

Subordinated Debt(7)

Redeemable Preferred Units(1)

    17.1%        7/13     

 

3,150,000

  

    36.2       

 

36.0

3.1

  

  

   

 

36.0

—  

  

  

   

Common Units(1)

        350,000          0.4        —     
                                              39.5        36.0   

Radar Detection Holdings Corp.

  Household Durables  

Senior Debt(7)

Common Stock(1)

      9.5%        11/12     

 

40,688

  

    13.0       

 

13.0

0.6

  

  

   

 

10.5

1.0

  

  

                                              13.6        11.5   

Roadrunner Dawes, Inc.

  Road & Rail  

Subordinated Debt(7)

    18.5%        8/12          20.5        20.4        20.5   
   

Common Stock(1)

        7,000          7.0        0.9   
                                              27.4        21.4   

 

26


Table of Contents

AMERICAN CAPITAL, LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

December 31, 2009

(in millions, except share data)

 

Company (4)

 

Industry

 

Investments

 

Interest
Rate (5)

   

Maturity
    Date    

   

# of
shares/
units
owned

   

Principal

   

Cost

   

Fair
Value

 

WFS Holding, LLC

  Software  

Preferred Interest

                    20,403,772                3.0        3.7   

Subtotal Affiliate Investments (4% of total investments at fair value)

  

          $ 251.0      $ 204.1   

CONTROL INVESTMENTS

  

       

ACAS Equity Holdings Corp.

 

Diversified Financial Services

 

Common Stock(1)

                    589              $ 14.8      $ 1.4   

ACAS Real Estate Holdings Corporation

  Real Estate  

Subordinated Debt(6)

Common Stock(1)

    15.0%        5/16        100   $ 3.9       

 

3.5

11.5

  

  

   

 

3.9

0.6

  

  

                                              15.0        4.5   

American Capital, LLC

  Capital Markets  

Senior Debt

      5.7%        9/12          7.4        7.3        7.5   
   

Common Membership Interest

        100       82.0        41.6   
                                              89.3        49.1   

American Driveline Systems, Inc.

 

Diversified Consumer Services

 

Subordinated Debt(7)

    14.0%        12/14-12/15          42.3        41.9        42.3   
   

Redeemable Preferred Stock

        403,357          32.1        47.8   
   

Common Stock(1)

        128,681          10.7        1.4   
   

Common Stock Warrants(1)

        204,663          17.3        2.2   
                                              102.0        93.7   

Aptara, Inc.

  IT Services  

Senior Debt

    11.5%        2/11          3.0        3.0        3.0   
   

Subordinated Debt(7)

    16.9%        2/11          58.0        57.8        60.0   
   

Redeemable Preferred Stock(1)

        15,107          14.1        21.0   
   

Convertible Preferred Stock(1)

        2,549,410          8.7        —     
   

Preferred Stock Warrants(1)

        230,681          1.0        —     
                                              84.6        84.0   

Capital.com, Inc.

 

Diversified Financial Services

 

Common Stock(1)

                    8,500,100                0.9        —     

CIBT Travel Solutions, LLC

 

Commercial Services & Supplies

 

Senior Debt(7)

      9.5%        1/13          49.8        49.4        49.9   
   

Subordinated Debt(7)

    15.0%        1/15-1/16          54.6        54.2        54.6   
   

Redeemable Preferred Stock

        15,000          17.6        17.7   
   

Convertible Preferred Stock(1)

        776,800          77.7        14.2   
   

Common Stock(1)

        194,200          19.4        —     
                                              218.3        136.4   

CMX Inc.

 

Construction & Engineering

 

Senior Debt(6)(7)

      5.2     5/12                19.3        19.2        16.1   

Contour Semiconductor, Inc.

 

Semiconductors & Semiconductor Equipment

 

Convertible Preferred Stock(1)

                    11,532,842                12.4        19.6   

Core Financial Holdings, LLC

 

Diversified Financial Services

 

Subordinated Debt

Common Stock(1)

    13.6%        4/14-5/15     

 

57,940,360

  

    37.8       

 

37.5

54.4

  

  

   

 

37.5

23.7

  

  

                                              91.9        61.2   

Creditcards.com, Inc.

 

Internet Software & Services

 

Senior Debt(7)

    13.9%        6/13-10/13          79.9        79.5        79.9   
   

Subordinated Debt(7)

    19.0%        6/14-10/14          15.5        15.4        15.5   
   

Redeemable Preferred Stock(1)

        257,510          53.6        11.8   
   

Common Stock(1)

        176,430,690          2.5        —     
                                              151.0        107.2   

ECA Acquisition
Holdings, Inc

 

Health Care Equipment & Supplies

 

Subordinated Debt(7)

    16.5%        12/14          13.5        13.3        13.5   
   

Common Stock(1)

        583          11.1        12.8   
                                              24.4        26.3   

 

27


Table of Contents

AMERICAN CAPITAL, LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

December 31, 2009

(in millions, except share data)

 

Company (4)

 

Industry

 

Investments

 

Interest
Rate (5)

   

Maturity
    Date    

   

# of
shares/
units
owned

   

Principal

   

Cost

   

Fair
Value

 

eLynx Holdings, Inc.

  IT Services  

Senior Debt

      8.7%        7/13          9.6        9.6        9.7   
   

Subordinated Debt

      8.5%        7/13          4.0        4.0        4.0   
   

Subordinated Debt(6)

      9.2%        7/13          12.1        10.0        4.3   
   

Redeemable Preferred Stock(1)

        21,113          8.9        —     
   

Convertible Preferred Stock(1)

        7,929          6.0        —     
   

Common Stock(1)

        11,261          1.1        —     
   

Common Stock Warrants(1)

        1,078,792          13.1        —     
                                              52.7        18.0   

Endeavor Fund I, LP

 

Thrifts & Mortgage Finance

 

Partnership Interest

                    100             18.2        17.0   

ETG Holdings, Inc.

  Containers & Packaging  

Senior Debt(6)

      8.7%        5/11          15.6        11.6        —     
   

Convertible Preferred Stock(1)

        233,201          11.4        —     
                                              23.0        —     

European Capital Limited(3)

 

Diversified Financial Services

 

Subordinated Debt

      7.3%        2/11          25.3        25.0        25.8   
   

Ordinary Shares(1)

        431,895,528          1,267.3        243.1   
                                              1,292.3        268.9   

European Touch, LTD. II

 

Leisure Equipment & Products

 

Senior Debt

      6.8%        8/11-1/12          0.4        0.3        0.4   
   

Subordinated Debt(6)

    16.0%        1/11          18.9        13.5        1.8   
   

Redeemable Preferred Stock(1)

        263          0.3        —     
   

Common Stock(1)

        1,688          0.9        —     
   

Common Stock Warrants(1)

        7,105          3.7        —     
                                              18.7        2.2   

EXPL Pipeline Holdings LLC

 

Oil, Gas & Consumable Fuels

 

Senior Debt

      8.0%        1/17          43.9        43.6        43.9   
   

Common Membership Units(1)

        58,297          44.5        12.1   
                                          88.1        56.0   

FL Acquisitions Holdings, Inc.

  Computers & Peripherals  

Senior Debt(7)

      8.3%        10/12-10/13          40.0        39.8        40.0   
   

Subordinated Debt(7)

    18.5%        4/14-10/14          30.8        30.6        30.8   
   

Subordinated Debt(6)(7)

    22.5%        10/14          13.4        8.8        8.6   
   

Redeemable Preferred Stock(1)

        583,000          0.6        —     
   

Common Stock(1)

        129,514          15.6        —     
                                              95.4        79.4   

Formed Fiber Technologies, Inc.

  Auto Components  

Common Stock(1)

                    31,250                8.1        0.5   

Fosbel Global Services (LUXCO) S.C.A.(3)

 

Commercial Services & Supplies

 

Subordinated Debt

    17.3%        12/13          23.6        23.4        23.6   
   

Subordinated Debt(6)

    20.0%        12/14          21.6        15.1        5.6   
   

Redeemable Preferred Stock(1)

        18,449,456          18.5        —     
   

Convertible Preferred Stock(1)

        1,519,368          3.0        —     
   

Common Stock(1)

        108,526          0.2        —     
                                              60.2        29.2   

Fountainhead Estate Holding Corp.(3)

 

Internet Software & Services

 

Senior Debt

      4.0%        10/13          21.0        21.0        21.0   
   

Redeemable Preferred Stock

        115,538          15.5        15.5   
   

Convertible Preferred Stock(1)

        59,250          59.2        16.9   
                                              95.7        53.4   

FreeConference.com, Inc.

 

Diversified Telecommunication Services

 

Senior Debt(7)

      6.7%        4/11-5/11          11.9        11.8        11.9   
   

Subordinated Debt

    15.0%        5/12          10.4        10.3        10.4   
   

Redeemable Preferred Stock(1)

        14,042,095          12.8        4.0   
   

Common Stock(1)

        6,088,229          2.3        —     
                                              37.2        26.3   

Future Food, Inc.

  Food Products  

Senior Debt

      5.2%        8/10          17.1        17.1        13.5   
   

Common Stock(1)

        64,917          13.0        —     
   

Common Stock Warrants(1)

        6,500          1.3        —     
                                              31.4        13.5   

 

28


Table of Contents

AMERICAN CAPITAL, LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

December 31, 2009

(in millions, except share data)

 

Company (4)

 

Industry

 

Investments

 

Interest
Rate (5)

   

Maturity
    Date    

   

# of
shares/
units
owned

   

Principal

   

Cost

   

Fair
Value

 

FV Holdings Corporation

  Food Products  

Subordinated Debt(7)

    14.5%        6/15          23.7        23.7        23.7   
   

Convertible Preferred Stock(1)

        292,000          14.3        20.9   
   

Common Stock(1)

        125,000          6.1        8.9   
                                              44.1        53.5   

Group Montana, Inc.

 

Textiles, Apparel & Luxury Goods

 

Senior Debt(7)

    10.0%        10/10-10/11          15.9        15.8        15.9   
   

Senior Debt(6)(7)

    12.5%        10/11          5.4        4.8        3.7   
   

Subordinated Debt(6)

    24.5%        10/12          12.3        6.8        —     
   

Convertible Preferred Stock(1)

        4,000          1.0        —     
   

Common Membership Interest(1)

        2.5       0.7        —     
                                              29.1        19.6   

Halex Holdings, Inc.

  Construction Materials  

Senior Debt(6)

      7.0%        9/11          11.0        9.8        6.8   
   

Redeemable Preferred Stock(1)

        23,504,546          30.6        —     
                                              40.4        6.8   

Hartstrings Holdings Corp.

 

Textiles, Apparel & Luxury Goods

 

Senior Debt(6)

      4.5%        12/10          9.3        9.3        6.6   
   

Convertible Preferred Stock(1)

        10,196          2.9        —     
   

Common Stock(1)

        14,250          4.8        —     
                                              17.0        6.6   

Kingway Inca Clymer Holdings, Inc.

  Building Products  

Subordinated Debt(6)

    12.2%        4/12          2.1        —          1.1   
   

Redeemable Preferred Stock(1)

        13,709          9.2        —     
                                              9.2        1.1   

Lifoam Holdings, Inc.

 

Leisure Equipment & Products

 

Senior Debt

    10.5%        12/14          19.1        19.1        19.1   
   

Subordinated Debt

      8.0%        12/14          39.8        39.7        39.8   
   

Redeemable Preferred Stock(1)

        6,160          4.2        7.4   
   

Convertible Preferred Stock(1)

        15,797          12.2        —     
   

Common Stock(1)

        14,000          1.4        —     
   

Common Stock Warrants(1)

        464,242          2.9        —     
                                              79.5        66.3   

LLSC Holdings Corporation

  Personal Products  

Senior Debt(7)

      6.2%        8/12          4.5        4.5        4.5   
   

Subordinated Debt(7)

    12.0%        9/13          5.5        5.5        5.5   
   

Convertible Preferred Stock(1)

        7,496          8.1        4.8   
                                              18.1        14.8   

LVI Holdings, LLC

  Professional Services  

Senior Debt(7)

      7.2%        2/10          2.7        2.7        2.7   
   

Subordinated Debt(6)(7)

    18.0%        2/13          12.1        10.2        11.0   
                                              12.9        13.7   

Montgomery Lane, LLC

 

Diversified Financial Services

 

Common Membership Units(1)

                    100                8.6        4.9   

Montgomery Lane, LTD(3)

 

Diversified Financial Services

 

Common Membership Units(1)

                    50,000                6.9        0.5   

MW Acquisition Corporation

 

Health Care Providers & Services

 

Subordinated Debt(7)

    16.2%        2/13-2/14          25.5        25.3        25.5   
   

Redeemable Preferred Stock

        2,485          1.0        1.0   
   

Convertible Preferred Stock(1)

        38,016          13.4        8.5   
                                              39.7        35.0   

 

29


Table of Contents

AMERICAN CAPITAL, LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

December 31, 2009

(in millions, except share data)

 

Company (4)

 

Industry

 

Investments

 

Interest
Rate (5)

   

Maturity
    Date    

   

# of
shares/
units
owned

   

Principal

   

Cost

   

Fair
Value

 

NECCO Holdings, Inc.

  Food Products  

Senior Debt

    13.5%        12/12          4.4        4.4        4.4   
   

Common Stock(1)

        760,869          0.1        —     
                                              4.5        4.4   

NECCO Realty Investments, LLC

  Real Estate  

Senior Debt(7)

    14.0%        12/17          40.0        39.3        40.0   
   

Common Membership Units(1)

        7,000          4.9        8.0   
                                              44.2        48.0   

Paradigm Precision Holdings, LLC

  Aerospace & Defense  

Subordinated Debt

    17.0%        8/14          57.0        56.6        57.0   
   

Subordinated Debt(6)

    20.0%        8/14-10/14          68.4        54.1        0.8   
   

Common Membership Units(1)

        478,488          17.5        —     
                                              128.2        57.8   

PHC Sharp Holdings, Inc.

 

Commercial Services & Supplies

 

Senior Debt(7)

      5.9%        12/11-12/12          16.9        16.8        12.5   
   

Subordinated Debt(6)

    17.0%        12/14          9.8        7.3        —     
   

Common Stock(1)

        367,881          4.2        —     
                                              28.3        12.5   

PHI Acquisitions, Inc.

  Internet & Catalog Retail  

Senior Debt(7)

    12.0%        6/12          10.2        10.2        10.3   
   

Subordinated Debt(7)

    17.7%        6/13          24.5        24.3        24.6   
   

Redeemable Preferred Stock

        36,267          40.6        52.2   
   

Common Stock(1)

        40,295          3.9        3.0   
   

Common Stock Warrants(1)

        116,065          11.6        8.6   
                                              90.6        98.7   

Resort Funding Holdings, Inc.

 

Diversified Financial Services

 

Senior Debt

      8.2%        4/10          8.8        8.8        7.7   
   

Common Stock(1)

        583          20.5        —     
                                              29.3        7.7   

Sixnet Holdings, LLC

 

Electronic Equipment, Instruments & Components

 

Senior Debt(7)

    11.1%        6/12-6/13          37.3        37.1        36.2   
   

Membership Units(1)

        446          5.6        2.6   
                                            42.7        38.8   

SMG Holdings, Inc.

 

Hotels, Restaurants & Leisure

 

Senior Debt(7)

      3.4%        7/14          5.9        5.9        5.9   
   

Subordinated Debt(7)

    12.5%        6/15          124.6        123.8        124.8   
   

Convertible Preferred Stock(1)

        1,101,673          124.2        105.6   
   

Common Stock(1)

        275,419          27.5        —     
                                              281.4        236.3   

Specialty Brands of America, Inc.

  Food Products  

Subordinated Debt(7)

    14.0%        5/14          34.8        34.6        34.8   
   

Redeemable Preferred Stock

        122,017          9.3        15.0   
   

Common Stock(1)

        128,175          2.3        12.1   
   

Common Stock Warrants(1)

        56,819          1.4        5.3   
                                              47.6        67.2   

Spring Air International, LLC

  Household Durables  

Common Membership Units(1)

                    49             2.8        0.5   

UFG Member, LLC

  Food Products  

Subordinated Debt(6)

    16.5%        5/15          36.4        30.4        26.9   
   

Common Stock(1)

        937          64.7        —     
                                              95.1        26.9   

UFG Real Estate Holdings, LLC

  Real Estate  

Common Membership(1)

                                    —          0.9   

Unique Fabricating Incorporated

  Auto Components  

Senior Debt

      5.1%        10/10-2/11          1.0        1.0        1.0   
   

Senior Debt(6)

    10.7%        2/12          5.0        4.2        0.9   
   

Redeemable Preferred Stock(1)

        301,556          7.9        —     
   

Common Stock Warrants(1)

        6,862          0.2        —     
                                              13.3        1.9   

 

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AMERICAN CAPITAL, LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

December 31, 2009

(in millions, except share data)

 

Company (4)

 

Industry

 

Investments

 

Interest
Rate (5)

   

Maturity
    Date    

   

# of
shares/
units
owned

   

Principal

   

Cost

   

Fair
Value

 

Unwired Holdings, Inc.

  Household Durables  

Senior Debt

      5.0%        6/10          1.6        1.6        1.6   
   

Senior Debt(6)

      8.5%        6/11          11.4        7.6        8.1   
   

Redeemable Preferred Stock(1)

        14,630          14.6        —     
   

Common Stock(1)

        126,001          1.3        —     
                                              25.1        9.7   

VP Acquisition Holdings, Inc.

 

Health Care Equipment & Supplies

 

Subordinated Debt(7)

    14.5%        10/13-10/14          20.0        19.8        20.0   
   

Common Stock(1)

        19,780          24.7        37.4   
                                              44.5        57.4   

Warner Power, LLC

  Electrical Equipment  

Subordinated Debt(6)(7)

    12.6%        11/10          5.0        5.0        1.7   
   

Redeemable Preferred Membership Units(1)

        3,796,269          3.0        —     
   

Common Membership Units(1)

        27,400          1.9        —     
                                              9.9        1.7   

WIS Holding Company, Inc.

 

Commercial Services & Supplies

 

Subordinated Debt(7)

    14.8%        1/14-1/15          109.1        108.4        109.1   
   

Convertible Preferred Stock

        703,406          89.2        137.2   
   

Common Stock(1)

        175,852          17.6        29.6   
                                              215.2        275.9   

WSACS RR Holdings, LLC

  Real Estate  

Common Membership Units(1)

                    3,384,615                3.4        —     

CDO/ CLO INVESTMENTS

  

       

ACAS Wachovia Investments, L.P.

 

Diversified Financial Services

 

Partnership Interest

                    90           $ 12.0      $ 2.0   

Subtotal Control Investments (42% of total investments at fair value)

  

                  $ 4,068.4      $ 2,335.0   

Total Investment Assets

  

                  $ 9,158.2      $ 5,575.3   

Counterparty

 

Instrument

 

Interest
Rate (5)

   

Expiration
  Date (5)  

   

# of
contracts

 

Notional

    

Cost

   

Fair
Value

 
DERIVATIVE AGREEMENTS        

Wachovia Bank, N.A.

 

Balance Differential Swap - Pay Fixed/ Receive Floating

    LIBOR/5.1%        8/19      1   $ 22.5       $ —        $ 0.9   

Subtotal Derivative Agreements

             —          0.9   

Total Derivative Assets

  

   $ —        $ 0.9   
DERIVATIVE AGREEMENTS        

BMO Financial Group

 

Interest Rate Swap - Pay Fixed/ Receive Floating

    5.4%/LIBOR        2/13-8/17      5   $ 391.4       $ —        $ (30.2)   

Citibank, N.A.

 

Interest Rate Swap - Pay Fixed/ Receive Floating

    4.8%/LIBOR        4/12-11/19      4     524.0         —          (30.7)   

Wachovia Bank, N.A.

 

Interest Rate Swap - Pay Fixed/ Receive Floating

    4.9%/LIBOR        1/14-8/19      3     323.3         —          (25.7)   

Citibank, N.A.

 

Balance Differential Swap - Pay Fixed/ Receive Floating

    5.2%/LIBOR        11/19      1     30.5         —          (2.5)   

UniCredit Group

 

Interest Rate Swap - Pay Fixed/ Receive Floating

    5.7%/LIBOR        7/17      1     66.0         —          (8.8)   

Fortis Financial Services LLC

 

Interest Rate Swap - Pay Fixed/ Receive Floating

    5.7%/LIBOR        7/17      1     22.3         —          (3.0)   

Citibank, N.A.

 

Foreign Exchange Swap - Pay Euros/ Receive GBP

      2/11      1        —          (1.2)   

Total Derivative Liabilities

  

   $ —        $ (102.1)   

Total Derivative Agreements, Net

  

   $ —        $ (101.2)   

 

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AMERICAN CAPITAL, LTD.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

December 31, 2009

(in millions, except share data)

 

Fund

                            

Cost

   

Fair
Value

 

MONEY MARKET FUNDS(9)

  

 

Federated Government Obligations Fund

             $ 57.6      $ 57.6   

Fidelity Institutional Money Market Funds - Money Market Portfolio

               48.5        48.5   

Fidelity Institutional Money Market Funds - Prime Money Market Portfolio

               47.1        47.1   

Dreyfus Cash Advantage Fund

               47.0        47.0   

Federated Tax-Free Obligations Fund

               46.9        46.9   

First American Prime Obligations Fund

               45.7        45.7   

BlackRock Liquidity Funds TempFund Portfolio

               44.9        44.9   

Goldman Sachs Financial Square Funds - Prime Obligations Fund

               44.7        44.7   

Federated Prime Cash Obligations Fund

               39.0        39.0   

Goldman Sachs Financial Square Fund - Money Market Fund

               38.7        38.7   

AIM STIT - Liquid Assets Portfolio

               37.5        37.5   

Dreyfus Institutional Reserves Money Fund

               37.4        37.4   

BlackRock Cash Funds - Prime

               34.1        34.1   

Dreyfus Government Cash Management

               31.5        31.5   

Goldman Sachs Financial Square Funds - Government Fund

               28.3        28.3   

AIM STIT-STIC Prime Portfolio

               25.0        25.0   

Federated Prime Obligations Fund

               25.0        25.0   

Fidelity Institutional Money Market Funds - Government Portfolio

               10.2        10.2   

First American Government Obligations Fund

               5.7        5.7   

Total Money Market Funds

  

   $ 694.8      $ 694.8   

 

(1) Non-income producing.
(2) Publicly traded company or a consolidated subsidiary of a public company.
(3) International investment.
(4) Certain of the securities are issued by affiliate(s) of the listed portfolio company.
(5) Interest rates represent the weighted average annual stated interest rate on loans and debt securities, which are presented by the nature of indebtedness by a single issuer. The maturity dates represent the earliest and the latest maturity dates.
(6) Loan is on non-accrual status and therefore considered non-income producing.
(7) All or a portion of the loans are pledged as collateral under various secured financing arrangements.
(8) Portfolio Company has filed for reorganization under Chapter 11 of the United States Code.
(9) Included in Cash and cash equivalents on our Consolidated Balance Sheets.

 

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AMERICAN CAPITAL, LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

(in millions, except per share data)

 

Note 1. Unaudited Interim Consolidated Financial Statements

 

Interim consolidated financial statements of American Capital, Ltd. (which is referred throughout this report as “American Capital”, the “Company”, “we”, “us” and “our”) are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and pursuant to the requirements for reporting on Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain disclosures accompanying annual financial statements prepared in accordance with GAAP are omitted. In the opinion of management, all adjustments, consisting solely of normal recurring accruals, necessary for the fair presentation of financial statements for the interim periods have been included. The current period’s results of operations are not necessarily indicative of results that ultimately may be achieved for the year. The unaudited interim consolidated financial statements and notes thereto should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2009, as filed with the Securities and Exchange Commission (“SEC”) on Form 8-K on July 1, 2010 and our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2010 and June 30, 2010, as filed with the SEC on May 10, 2010 and August 6, 2010, respectively.

 

Reclassifications

 

We have reclassified certain prior period amounts in our interim consolidated financial statements to conform to our current period presentation.

 

Note 2. Organization

 

We are a 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 (“1940 Act”). We operate so as to qualify to be taxed as a regulated investment company (“RIC”) as defined in Subtitle A, Chapter 1, under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”). As a BDC, we primarily invest in senior debt, subordinated debt and equity in the buyouts of private companies sponsored by us, the buyouts of private companies sponsored by other private equity firms and directly to early stage and mature private and small public companies. We refer to these investments as our private finance portfolio. We also invest in structured financial product investments (“Structured Products”) including commercial mortgage backed securities (“CMBS”), commercial collateralized loan obligation (“CLO”) securities and collateralized debt obligation (“CDO”) securities and invest in alternative asset funds managed by us. Our primary business objectives are to increase our taxable income, net realized earnings and net asset value (“NAV”) by making investments with attractive current yields and/or potential for equity appreciation and realized gains.

 

On June 30, 2010, we merged our consolidated taxable operating subsidiary, American Capital Financial Services, Inc. (“ACFS”), into American Capital, Ltd. See Note 9 for additional disclosure regarding this merger.

 

Note 3. Investments

 

Our investments consist of loans and securities issued by public and privately-held companies, including senior debt, subordinated debt, equity warrants and preferred and common equity securities. Certain of our investments do not produce current income. These investments typically consist of equity warrants, common equity and preferred equity and are identified in the accompanying consolidated schedule of investments. We also have investments in both investment grade and non-investment grade Structured Products.

 

We fair value our investments in accordance with the 1940 Act and Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements and Disclosures (“ASC 820”) as determined in good faith by our Board of Directors. When available, we base the fair value of our investments on directly observable market prices or on market data derived for comparable assets. For all

 

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Table of Contents

AMERICAN CAPITAL, LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

(in millions, except per share data)

 

other investments, inputs used to measure fair value reflect management’s best estimate of assumptions that would be used by market participants in pricing the investment in a hypothetical transaction. For these investments, we estimate the fair value of our senior debt, subordinated debt, redeemable and convertible preferred equity, common equity and equity warrants using either an enterprise value waterfall methodology or a market yield valuation methodology that generally combines market, income and cost approaches and our Structured Products using a market yield valuation methodology that combines market and income approaches.

 

Under the enterprise value waterfall methodology, we estimate the enterprise value of a portfolio company and then waterfall the enterprise value over the portfolio company’s securities in order of their preference relative to one another. To estimate the enterprise value of the portfolio company, we prepare an analysis of traditional valuation methodologies including valuations of comparable public companies, recent sales of private and public comparable companies, discounting the forecasted cash flows of the portfolio company, estimating the liquidation or collateral value the portfolio company’s assets, third-party valuations of the portfolio company, offers from third-parties to buy the company, estimating the value to potential strategic buyers and considering the value of recent investments in the equity securities of the portfolio company. Significant inputs in these valuation methodologies to estimate enterprise value include the historical or projected operating results of the portfolio company, discounts or premiums to the prices of comparable companies and discount rates applied to the forecasted cash flows. The operating results of a portfolio company may be unaudited, projected or pro forma financial information and may require significant judgment in its determination. In determining a discount or premium, if any, to prices of comparable companies, we use significant judgment for factors such as size, marketability and relative performance. In determining a discount rate to apply to forecasted cash flows, we use significant judgment in the development of an appropriate discount rate including the evaluation of an appropriate risk premium.

 

For an investment in an investment fund that does not have a readily determinable fair value, we measure the fair value of our investment predominately based on the NAV per share of the investment fund if the NAV of the investment fund is calculated in a manner consistent with the measurement principles of ASC Topic 946, Financial Services—Investments Companies, as of our measurement date, including measurement of all or substantially all of the underlying investments of the investee in accordance with ASC 820. However, in determining the fair value of our investment, we may make adjustments to the NAV per share in certain circumstances, based on our analysis of any restrictions on redemption of our shares of our investment as of the measurement date, comparisons of price to NAV per share of comparable publicly traded funds and trades or sales of comparable private and publicly traded funds, recent actual sales or redemptions of shares of the investment fund, expected future cash flows available to equity holders or other uncertainties surrounding our ability to realize the full NAV per share of the investment fund.

 

As of September 30, 2010 and December 31, 2009, we had an investment in European Capital, a wholly-owned investment fund that invests in and sponsors management and employee buyouts, invests in private equity buyouts and provides capital directly to private and mid-sized public companies primarily in Europe. It primarily invests in senior debt, subordinated debt and equity. We concluded that the fair value of our investment in European Capital as of September 30, 2010 and December 31, 2009 was less than the NAV of European Capital such dates, respectively, due to the risks associated with European Capital’s ability to realize the full fair value of its underlying assets for several reasons, including the yield and tenor of its credit facilities, comparable publicly traded funds currently trading at a discount to NAV, recent sales of comparable funds at a discount to NAV and an implied required market return on equity by market participants. See Note 11 for unfunded commitments related to European Capital.

 

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Table of Contents

AMERICAN CAPITAL, LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

(in millions, except per share data)

 

 

Significant inputs to the market yield valuation methodology for senior debt, subordinated debt and redeemable preferred equity include third-party broker quotes, estimated remaining life, estimated market debt leverage levels, current market yield and interest rate spreads of similar loans and securities as of the measurement date. We weight the use of third-party broker quotes, if any, in determining fair value based on our understanding of the level of actual transactions used by the broker to develop the quote and whether the quote was an indicative price or binding offer, depth and consistency of broker quotes and the correlation of changes in broker quotes with underlying performance and other market indices. We estimate the remaining life based on pre-payment market data of the average life of similar loans. However, if we have information available to us that the loan is expected to be repaid in the near term, we would use an estimated remaining life based on the expected repayment date. If there is a significant deterioration of the credit quality of a loan, we may consider other factors that a hypothetical market participant would use to estimate fair value, including the proceeds that would be received in a liquidation analysis.

 

Significant inputs to the market yield valuation methodology for Structured Products include third-party broker quotes, sales of the same or similar securities, and our cash flow forecasts subject to assumptions a market participant would use regarding the investments’ underlying collateral including, but not limited to, assumptions of default and recovery rates, reinvestment spreads and prepayment rates, industry research reports and transactions of securities and indices with similar structure and risk characteristics. We weight the use of third-party broker quotes, if any, in determining fair value based on our understanding of the level of actual transactions used by the broker to develop the quote and whether the quote was an indicative price or binding offer, depth and consistency of broker quotes and the correlation of changes in broker quotes with underlying performance and other market indices.

 

Due to the uncertainty inherent in the valuation process, estimates of fair value may differ significantly from the values that would have been used had a ready market for our investments existed, and the differences could be material. Additionally, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different than the valuations currently assigned.

 

The levels of fair value inputs used to measure our investments are characterized in accordance with the fair value hierarchy established by ASC 820. Where inputs for an asset or liability fall in more than one level in the fair value hierarchy, the investment is classified in its entirety based on the lowest level input that is significant to that investment’s fair value measurement. We use judgment and consider factors specific to the investment in determining the significance of an input to a fair value measurement. Our policy is to recognize transfers in and out of levels as of the beginning of each reporting period. The three levels of the fair value hierarchy and investments that fall into each of the levels are described below:

 

   

Level 1: Level 1 inputs are unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. We use Level 1 inputs for investments in publicly traded unrestricted securities. Such investments are valued at the closing price on the measurement date.

 

   

Level 2: Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. We did not value any of our investments using Level 2 inputs as of September 30, 2010.

 

   

Level 3: Level 3 inputs are unobservable and cannot be corroborated by observable market data. We use Level 3 inputs for measuring the fair value of substantially all of our investments.

 

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Table of Contents

AMERICAN CAPITAL, LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

(in millions, except per share data)

 

 

The following fair value hierarchy tables set forth our assets and liabilities that are measured at fair value on a recurring basis by level as of September 30, 2010 and December 31, 2009:

 

     September 30, 2010  
     Level 1      Level 2      Level 3     Total  

Senior debt

   $ —         $ —         $ 1,511      $ 1,511   

Subordinated debt

     —           —           1,868      $ 1,868   

Preferred equity

     —           —           1,072      $ 1,072   

Common equity

     66         —           822      $ 888   

Structured Products

     —           —           153      $ 153   

Equity warrants

     —           —           74      $ 74   

Derivative agreements, net

     —           —           (126   $ (126
                                  

Total

   $ 66       $ —         $ 5,374      $ 5,440   
                                  
     December 31, 2009  
     Level 1      Level 2      Level 3     Total  

Senior debt

   $ —         $ —         $ 1,791      $ 1,791   

Subordinated debt

     —           —           1,938        1,938   

Preferred equity

     —           —           1,049        1,049   

Common equity

     66         —           510        576   

Structured Products

     —           —           167        167   

Equity warrants

     —           —           54        54   

Derivative agreements, net

     —           —           (113     (113
                                  

Total

   $ 66       $ —         $ 5,396      $ 5,462   
                                  

 

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Table of Contents

AMERICAN CAPITAL, LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

(in millions, except per share data)

 

 

The following tables set forth the summary of changes in the fair value of investment assets and liabilities measured using Level 3 inputs for the three months ended September 30, 2010 and 2009:

 

    Balances,
July 1,
2010
    Realized
Gains
(Losses) (1)
    Reversal of
Prior Period
(Appreciation)
Depreciation
on Realization (2)
    Unrealized
Appreciation
(Depreciation) (2)(3)
    Purchases, Sales,
Issuances &
Settlements, Net (4)
    Transfers
In &

Out of
Level 3
    Balances,
September 30,
2010
 

Senior debt

  $ 1,692      $ (2   $ 3      $ (68   $ (114   $ —        $ 1,511   

Subordinated debt

    1,933        (5     2        (4     (58     —          1,868   

Preferred equity

    1,084        (8     (3     52        (53     —          1,072   

Common equity

    699        1        3        128        (9     —          822   

Structured Products

    149        (42     41        11        (6     —          153   

Equity warrants

    71        2        (2     4        (1     —          74   

Derivative agreements, net

    (117     (14     14        (23     14        —          (126
                                                       

Total

  $ 5,511      $ (68   $ 58      $ 100      $ (227   $ —        $ 5,374   
                                                       
    Balances,
July 1,
2009
    Realized
Gains
(Losses) (1)
    Reversal of
Prior Period
(Appreciation)
Depreciation
on Realization (2)
    Unrealized
Appreciation
(Depreciation) (2)(3)
    Purchases, Sales,
Issuances &
Settlements, Net (4)
    Transfers
In &

Out of
Level 3
    Balances,
September 30,
2009
 

Senior debt

  $ 2,147      $ (20   $ 25      $ 8      $ (98   $ —        $ 2,062   

Subordinated debt

    2,141        (99     95        (16     (66     —          2,055   

Preferred equity

    1,119        49        (44     48        (123     —          1,049   

Common equity

    421        10        (17     27        (33     —          408   

Structured Products

    174        —          —          22        —          —          196   

Equity warrants

    68        13        (10     —          (19     —          52   

Derivative and option agreements and other, net

    (87     (19     19        (51     18        —          (120
                                                       

Total

  $ 5,983      $ (66   $ 68      $ 38      $ (321   $ —        $ 5,702   
                                                       

 

(1) Included in net realized loss on investments in the consolidated statements of operations.
(2) Included in net unrealized appreciation (depreciation) of investments in the consolidated statements of operations.
(3) Excludes $0 million and $1 million of unrealized depreciation related to foreign currency translation for American Capital assets and liabilities not measured at fair value that are denominated in a foreign currency for the three months ended September 30, 2010 and 2009, respectively. Also excludes unrealized appreciation (depreciation) from Level 1 and 2 assets and liabilities.
(4) Includes increases in the cost basis of investments resulting from new portfolio investments, PIK interest or dividends, the amortization of discounts, premiums and closing fees and the exchange of one or more existing securities for one or more new securities as well as decreases in the cost basis of investments resulting from principal repayments or sales and the exchange of one or more existing securities for one or more new securities.

 

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AMERICAN CAPITAL, LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

(in millions, except per share data)

 

 

The following tables set forth the summary of changes in the fair value of investment assets and liabilities measured using Level 3 inputs for the nine months ended September 30, 2010 and 2009:

 

    Balances,
January 1,
2010
    Realized
Gains
(Losses) (1)
    Reversal of
Prior Period
(Appreciation)
Depreciation
on Realization (2)
    Unrealized
Appreciation
(Depreciation) (2)(3)
    Purchases, Sales,
Issuances &
Settlements, Net (4)
    Transfers
In &
Out of
Level 3
    Balances,
September 30,
2010
 

Senior debt

  $ 1,791      $ (17   $ 28      $ (20   $ (271   $ —        $ 1,511   

Subordinated debt

    1,938        (29     14        91        (146     —          1,868   

Preferred equity

    1,049        (38     36        110        (85     —          1,072   

Common equity

    510        (91     101        351        (49     —          822   

Structured Products

    167        (274     274        (4     (10     —          153   

Equity warrants

    54        (3     3        21        (1     —          74   

Derivative agreements and other, net

    (113     (60     60        (73     60        —          (126
                                                       

Total

  $ 5,396      $ (512   $ 516      $ 476      $ (502   $ —        $ 5,374   
                                                       
    Balances,
January 1,
2009
    Realized
Gains
(Losses) (1)
    Reversal of
Prior Period
(Appreciation)
Depreciation
on Realization (2)
    Unrealized
Appreciation
(Depreciation) (2)(3)
    Purchases, Sales,
Issuances &
Settlements, Net (4)
    Transfers
In &

Out of
Level 3
    Balances,
September 30,
2009
 

Senior debt

  $ 2,396      $ (173   $ 175      $ (179   $ (157   $ —        $ 2,062   

Subordinated debt

    2,715        (321     319        (232     (426     —          2,055   

Preferred equity

    1,344        17        (11     (172     (129     —          1,049   

Common equity

    601        39        (38     (587     393        —          408   

Structured Products

    186        —          —          12        (2     —          196   

Equity warrants

    74        4        (3     3        (26     —          52   

Derivative and option agreements and other, net

    (213     (87     89        (15     106        —          (120
                                                       

Total

  $ 7,103      $ (521   $ 531      $ (1,170   $ (241   $ —        $ 5,702   
                                                       

 

(1) Included in net realized loss on investments in the consolidated statements of operations. Excludes $2 million in losses on realized foreign currency transactions on American Capital assets and liabilities that are denominated in a foreign currency for the nine months ended September 30, 2010 and 2009. Also excludes realized gains (losses) from Level 1 and 2 assets and liabilities.
(2) Included in net unrealized appreciation (depreciation) of investments in the consolidated statements of operations.
(3) Excludes $2 million of unrealized appreciation and $3 million of unrealized depreciation related to foreign currency translation for American Capital assets and liabilities not measured at fair value that are denominated in a foreign currency for the nine months ended September 30, 2010 and 2009, respectively. Also excludes unrealized appreciation (depreciation) from Level 1 and 2 assets and liabilities.
(4) Includes increases in the cost basis of investments resulting from new portfolio investments, PIK interest or dividends, the amortization of discounts, premiums and closing fees and the exchange of one or more existing securities for one or more new securities as well as decreases in the cost basis of investments resulting from principal repayments or sales and the exchange of one or more existing securities for one or more new securities.

 

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AMERICAN CAPITAL, LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

(in millions, except per share data)

 

 

As of September 30, 2010 and December 31, 2009, loans on non-accrual status had a cost basis of $746 million and $811 million, respectively, and a fair value of $265 million and $290 million, respectively. As of September 30, 2010 and December 31, 2009, loans with a cost basis of $50 million, respectively, were greater than 90 days due, excluding loans on non-accrual status.

 

The composition summaries of our investment portfolio at cost and fair value as a percentage of total investments are shown in the following tables:

 

     September 30, 2010     December 31, 2009  

COST

    

Subordinated debt

     25.6     24.8

Common equity

     23.4     22.2

Senior debt

     23.2     24.0

Preferred equity

     19.2     18.1

Structured Products

     7.5     9.8

Equity warrants

     1.1     1.1
                
     100.0     100.0
                

FAIR VALUE

    

Subordinated debt

     33.5     34.8

Senior debt

     27.1     32.1

Preferred equity

     19.3     18.8

Common equity

     16.0     10.3

Structured Products

     2.8     3.0

Equity warrants

     1.3     1.0
                
     100.0     100.0
                

 

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AMERICAN CAPITAL, LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

(in millions, except per share data)

 

 

We use the Global Industry Classification Standards for classifying the industry groupings of our portfolio companies. The following tables show the portfolio composition by industry grouping at cost and at fair value as a percentage of total investments. Our investments in European Capital and CLO and CDO securities are excluded from the table below. Our investments in ACAS CRE CDO 2007-1, Ltd. and CMBS are classified in the Real Estate and Real Estate Investment Trusts category.

 

     September 30, 2010     December 31, 2009  

COST

    

Commercial Services and Supplies

     10.7     8.9

Real Estate and Real Estate Investment Trusts

     7.6     10.5

Household Durables

     7.2     6.1

Internet and Catalog Retail

     6.4     5.7

Life Sciences Tools and Services

     5.4     4.7

Health Care Providers and Services

     4.7     4.1

Auto Components

     4.6     3.8

Hotels, Restaurants and Leisure

     4.5     3.7

IT Services

     4.3     4.2

Electrical Equipment

     4.1     3.5

Food Products

     3.3     4.4

Diversified Financial Services

     3.2     3.3

Professional Services

     3.0     2.5

Health Care Equipment and Supplies

     2.8     2.4

Leisure Equipment and Products

     2.5     2.0

Pharmaceuticals

     2.3     2.0

Computers and Peripherals

     2.3     2.0

Building Products

     2.1     1.9

Electronic Equipment, Instruments and Components

     2.0     1.8

Aerospace and Defense

     2.0     1.7

Construction and Engineering

     2.0     1.8

Diversified Consumer Services

     1.6     1.4

Other

     11.4     17.6
                
     100.0     100.0
                

 

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AMERICAN CAPITAL, LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

(in millions, except per share data)

 

 

     September 30, 2010     December 31, 2009  

FAIR VALUE

    

Commercial Services and Supplies

     14.1     10.1

Household Durables

     6.6     5.8

Electrical Equipment

     6.5     6.2

Hotels, Restaurants and Leisure

     5.4     4.6

Health Care Providers and Services

     5.0     4.6

IT Services

     4.7     4.9

Auto Components

     4.7     3.7

Health Care Equipment and Supplies

     4.0     2.8

Internet and Catalog Retail

     3.8     5.2

Professional Services

     3.4     2.8

Real Estate and Real Estate Investment Trusts

     3.3     4.1

Life Sciences Tools and Services

     3.0     3.3

Pharmaceuticals

     2.9     2.8

Electronic Equipment, Instruments and Components

     2.6     2.3

Diversified Financial Services

     2.6     3.0

Building Products

     2.5     2.4

Computers and Peripherals

     2.4     2.2

Food Products

     2.3     3.4

Capital Markets

     2.2     1.3

Construction and Engineering

     2.1     2.1

Diversified Consumer Services

     2.0     1.9

Leisure Equipment and Products

     2.0     1.7

Other

     11.9     18.8
                
     100.0     100.0
                

 

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AMERICAN CAPITAL, LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

(in millions, except per share data)

 

 

The following tables show the portfolio composition by geographic location at cost and at fair value as a percentage of total investments, excluding Structured Products. The geographic composition is determined by the location of the corporate headquarters of the portfolio company.

 

     September 30, 2010     December 31, 2009  

COST

    

Southwest

     20.6     21.1

International

     20.0     19.0

Mid-Atlantic

     19.5     18.4

Northeast

     14.6     13.5

South-Central

     9.5     11.6

Southeast

     9.3     9.7

North-Central

     6.0     6.3

Northwest

     0.5     0.4
                
     100.0     100.0
                
     September 30, 2010     December 31, 2009  

FAIR VALUE

    

Southwest

     24.2     25.3

Mid-Atlantic

     21.2     19.8

Northeast

     14.5     14.9

International

     12.8     8.0

Southeast

     11.0     11.2

South-Central

     8.5     12.5

North-Central

     7.3     7.8

Northwest

     0.5     0.5
                
     100.0     100.0
                

 

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AMERICAN CAPITAL, LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

(in millions, except per share data)

 

 

Note 4. Borrowings

 

Our debt obligations consisted of the following as of September 30, 2010 and December 31, 2009:

 

     September 30, 2010      December 31, 2009  

Fixed rate private secured notes due December 2013

   $ 373       $ —     

Floating rate private secured loans due December 2013

     206         —     

Fixed rate public secured notes due December 2013

     524         —     

Floating rate public secured notes due December 2013

     4         —     

Unsecured public debt due August 2012

     11         548   

ACAS Business Loan Trust 2004-1 asset securitization

     130         170   

ACAS Business Loan Trust 2005-1 asset securitization

     541         696   

ACAS Business Loan Trust 2006-1 asset securitization

     310         377   

ACAS Business Loan Trust 2007-1 asset securitization

     225         294   

ACAS Business Loan Trust 2007-2 asset securitization

     193         255   

Unsecured revolving credit facility

     —           1,388   

Unsecured private debt due September 2009

     —           84   

Unsecured private debt due August 2010

     —           134   

Unsecured private debt due February 2011

     —           26   

Unsecured private debt due September 2011

     —           95   

Unsecured private debt due October 2020

     —           75   
                 

Total

   $ 2,517       $ 4,142   
                 

 

The daily weighted average debt balance for the three months ended September 30, 2010 and 2009 was $2,715 million and $4,289 million, respectively. The daily weighted average debt balance for the nine months ended September 30, 2010 and 2009 was $3,575 million and $4,343 million, respectively. The weighted average interest rate on all of our borrowings, including amortization of deferred financing costs, for the three months ended September 30, 2010 and 2009 was 5.3% and 7.9%, respectively. The weighted average interest rate on all of our borrowings, including amortization of deferred financing costs, for the nine months ended September 30, 2010 and 2009 was 5.6 % and 6.0%, respectively. Comparisons to the prior periods of the weighted average interest rate is also impacted by additional interest expense during the three and nine months ended September 30, 2009 for the accrual of a $22 million make-whole interest payment on our unsecured debt that was refinanced in the second quarter of 2010.

 

As of September 30, 2010 and December 31, 2009, the aggregate fair value of the above borrowings was $2,490 million and $3,929 million, respectively. The fair values of our debt obligations are determined in accordance with ASC 820, which defines fair value in terms of the price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. It assumes that the liability is transferred to a market participant at the measurement date and that the nonperformance risk relating to that liability is the same before and after the transfer. Nonperformance risk refers to the risk that the obligation will not be fulfilled and affects the value at which the liability is transferred. The fair value of our debt obligations is valued at the closing market quotes as of the measurement date for our public notes or estimated based upon market interest rates for our own borrowings or entities with similar credit risk, adjusted for nonperformance risk, if any, based on a quantitative and/or qualitative evaluation of our credit risk.

 

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AMERICAN CAPITAL, LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

(in millions, except per share data)

 

 

Refinancing Transaction

 

Unsecured Revolving Credit Facility—On June 28, 2010, we amended and restated the credit agreement (“Amended and Restated Credit Agreement”) for our $1.4 billion unsecured revolving credit facility, with Wells Fargo Bank, N.A. as administrative agent, pursuant to which $680 million of our outstanding loans were repaid in cash, and our remaining loans were converted into (i) $277 million of new floating rate secured loans under the Amended and Restated Credit Agreement (“Floating Rate Private Secured Loans”) and (ii) $430 million of new fixed rate secured notes (“Fixed Rate Private Secured Notes”) issued under a new indenture (the “Indenture,” and together with the Amended and Restated Credit Agreement, the “New Debt Agreements”). We also paid a fee of $14 million, or 2% of the principal balance of the Floating Rate Private Secured Loans and Fixed Rate Private Secured Notes, to the holders of such debt.

 

Unsecured Private Debt—On June 28, 2010, we completed an exchange transaction with the noteholders of $336 million of our unsecured private notes for (i) an aggregate cash payment of $264 million, (ii) $72 million of Fixed Rate Private Secured Notes, and (iii) a fee of $1 million representing 2% of the principal balance of the Fixed Rate Private Secured Notes. We also repaid in full our remaining unsecured private notes for $75 million.

 

Unsecured Public Debt—On June 28, 2010, we completed an exchange transaction with the noteholders of $539 million of our unsecured public notes for (i) an aggregate cash payment of $11 million, (ii) $4 million of new call-protected floating rate secured notes (“Floating Rate Public Secured Notes”) and $524 million of new call-protected fixed rate secured notes (“Fixed Rate Public Secured Notes,” and collectively with the Floating Rate Public Secured Notes, the “New Secured Public Notes”) issued under the Indenture, and (iii) a fee of $11 million representing 2% of the principal balance of the New Secured Public Notes. The remaining $11 million of the original $550 million of unsecured public notes were amended on June 28, 2010 pursuant to a Second Supplemental Indenture to the indenture for the notes to remove substantially all material affirmative and negative covenants, other than the covenant to pay principal and interest on such notes, and to remove certain events of default. All other terms of such notes remain unchanged.

 

The exchange transactions discussed above are accounted for as a modification of debt in accordance with ASC 470-50, Modifications and Extinguishments. Accordingly, the aggregate fees of $26 million paid at closing to the lenders and noteholders were capitalized and are amortized into interest expense over the life of the notes and loans using the effective interest method, while fees paid to other third-party advisors were expensed as incurred. As a result, we recognized $21 million of debt refinancing costs during the nine months ended September 30, 2010 consisting of fees paid to third-party advisors and the writeoff of a portion of the existing unamortized deferred financing costs attributable to the unsecured debt that was repaid in cash.

 

Maturity Date and Optional Redemption—The Floating Rate Private Secured Loans, Fixed Rate Private Secured Notes and New Secured Public Notes (collectively, the “New Secured Debt”) have a final maturity date of December 31, 2013, unless earlier repaid. The Floating Rate Private Secured Loans and Fixed Rate Private Secured Notes may be repaid prior to maturity at our option in whole or in part from time to time at a price equal to 100% of the principal amount repaid, plus accrued and unpaid interest to the payment date. Prior to August 1, 2012, the New Secured Public Notes may be redeemed at our option in whole or in part from time to time (so long as the Floating Rate Private Secured Loans and Fixed Rate Private Secured Notes are no longer outstanding) at a price equal to accrued and unpaid interest on the principal amount being redeemed plus the greater of (i) 100% of the principal amount being redeemed, and (ii) the sum of the present values of the remaining scheduled payments of principal and interest on the principal amount being redeemed discounted to the redemption date on a semi-annual basis at the Adjusted Treasury Rate (as defined in the Indenture for the New Secured Public Notes), plus 30 basis points.

 

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Table of Contents

AMERICAN CAPITAL, LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

(in millions, except per share data)

 

Notwithstanding the foregoing, prior to August 1, 2012, the New Secured Public Notes may also be redeemed at our option in whole or in part from time to time at a price equal to 100% of the principal amount being redeemed, plus accrued and unpaid interest to the date of redemption, but without payment of any premium, with Realized Proceeds (as defined in the New Debt Agreements) so long as there are no Floating Rate Private Secured Loans and Fixed Rate Private Secured Notes outstanding.

 

Scheduled Amortization—The following table sets forth the aggregate scheduled amortization (“Aggregate Scheduled Amortization Amounts”) on the Floating Rate Private Secured Loans and the Fixed Rate Private Secured Notes as of September 30, 2010. The New Secured Public Notes are not subject to amortization or other mandatory redemptions. Under the terms of the New Debt Agreements, we may defer payment of up to $200 million of the Aggregate Scheduled Amortization Amounts prior to June 30, 2013, which payment deferral is reflected in the table below.

 

Date

   Aggregate Scheduled
Amortization
 

December 31, 2011

     $—     

June 30, 2012

     $—     

December 31, 2012

     $—     

June 30, 2013

     $420   

Final Maturity

     Outstanding Balance   

 

The Floating Rate Private Secured Loans and Fixed Rate Private Secured Notes are subject to mandatory redemptions including (i) 100% of the net cash flow proceeds of certain debt incurred, (ii) 50% of the net cash flow proceeds of any capital stock issued after June 28, 2012, (iii) an applicable prepayment percentage of any Realized Proceeds, and (iv) an applicable prepayment percentage of Excess Cash Flow (as defined in the New Debt Agreements). However, we are entitled to retain the first $580 million that would otherwise be payable from any cash flow proceeds from debt incurred, capital stock issued, Realized Proceeds or Excess Cash Flow for new investments or other general corporate purposes. The applicable prepayment percentage is 50% if the aggregate outstanding principal amount of the New Secured Debt is greater than or equal to $950 million and 25% if it is less than $950 million. Any above mandatory redemptions will be applied to the payment of the Aggregate Scheduled Amortization Amounts in direct order of maturity.

 

Interest—The Floating Rate Private Secured Loans and Floating Rate Public Secured Notes bear interest at a rate per annum equal to one, two, three or six-month LIBOR, subject to a LIBOR floor of 2% per annum, plus the Applicable Percentage, as defined below, in effect at such time. The Fixed Rate Private Secured Notes and Fixed Rate Public Secured Notes bear interest at 2.46% per annum, plus the Applicable Percentage in effect at the time. The applicable percentage (“Applicable Percentage”) is 6.50% when the aggregate outstanding amount of the New Secured Debt is greater than or equal to $1 billion and 5.50% when the aggregate outstanding amount is less than $1 billion. As of September 30, 2010, the aggregate outstanding amount of the New Secured Debt was $1,107 million.

 

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AMERICAN CAPITAL, LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

(in millions, except per share data)

 

 

In addition, the Applicable Percentage for the New Secured Debt will increase by an additional 0.50% per annum if we fail to pay any of the minimum amortization amounts (“Aggregate Penalty Amortization Amounts”) on the Floating Rate Private Secured Loans and Fixed Rate Private Secured Notes set forth in the table below when due (on a cumulative basis for each failure, if applicable), for each succeeding day until any unpaid Aggregate Penalty Amortization Amounts have been paid.

 

Date

   Aggregate Penalty
Amortization

December 31, 2011

   $—  

June 30, 2012

   $—  

December 31, 2012

   $270

June 30, 2013

   $309

 

The following table sets forth the interest rates on our outstanding secured borrowing arrangements as of September 30, 2010:

 

Facility

   Interest
Rate
 

Fixed rate private secured notes due December 2013

     8.96

Floating rate private secured loans due December 2013

     8.50

Fixed rate public secured notes due December 2013

     8.96

Floating rate public secured notes due December 2013

     8.50

 

Fees—We are required to pay an extension fee in an amount equal to 1% of the aggregate principal amount of the New Secured Debt outstanding on each of December 30, 2011 and December 31, 2012, payable on such date.

 

Security and Ranking—The New Secured Debt is a senior obligation of the company and is secured by a first priority lien (subject to certain permitted liens) on substantially all of our non-securitized assets.

 

Covenants—The financial covenants under the New Debt Agreements include (i) maintenance of a minimum ratio of adjusted operating cash flow to interest expense and (ii) a minimum ratio of pledged assets to secured debt, tested on a quarterly basis. Additional covenants include (i) restrictions on the incurrence of certain additional debt, (ii) restrictions on acquisitions and investments, and (iii) restrictions on the payments of dividends and other distributions. However, we are permitted under the New Debt Agreements to pay dividends to the extent necessary in order to maintain our RIC status provided that such dividends are paid in additional shares of our common stock to the extent allowed by IRS Revenue Procedure 2010-12. There are no limitations in the New Debt Agreements on our payment of cash dividends provided that (i) we maintain an asset coverage ratio of at least 200% as required by the 1940 Act, (ii) we are in pro forma compliance with all financial covenants under the New Debt Agreements, (iii) there are no defaults outstanding under the New Debt Agreements, and (iv) the aggregate principal amount of the New Secured Debt outstanding is less than or equal to $1.4 billion. As of September 30, 2010, we were in compliance with all of the covenants under the New Debt Agreements.

 

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AMERICAN CAPITAL, LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

(in millions, except per share data)

 

 

Securitizations

 

As of September 30, 2010, we were in compliance with all of the covenants for our asset securitizations. Under the terms of each of our asset securitizations, if any loan collateral in each trust becomes a defaulted loan (as defined in each indenture for the respective asset securitization), all interest and principal collections that would be applied to the subordinated notes retained by us are used to sequentially pay down the principal of the notes that are generally held by third-party institutional investors in an amount equal to the principal amount of the defaulted loan collateral. As of September 30, 2010, there was defaulted loan collateral in each of the asset securitization trusts and therefore all interest and principal collections that would have been applied to the subordinated notes retained by us will continue to be applied sequentially to pay down the principal of the notes generally held by third-party institutional investors in an amount equal to the principal amount of the defaulted loan collateral. As of September 30, 2010, our asset securitizations, which have an outstanding balance of $1.4 billion, are secured by portfolio investments and assets with a fair value of approximately $2.1 billion.

 

Note 5. Derivative Agreements

 

We enter into interest rate swap agreements to manage interest rate risk and also to fulfill our obligations under the terms of our asset securitizations. We also enter into foreign exchange swap agreements to manage foreign currency risk. We do not hold or issue interest rate or foreign exchange swap agreements for speculative purposes. We fair value our derivatives in accordance with the 1940 Act and ASC 820 as determined in good faith by our Board of Directors. All derivative financial instruments are recorded at fair value with changes in value reflected in net unrealized appreciation or depreciation of investments during the reporting period. The fair value of our interest rate swap agreements is based on an income approach using a discounted cash flow methodology. Significant inputs to the discounted future cash flow methodology include forward interest rate yield curves in effect as of the end of the measurement period and an evaluation of both our and our counterparty’s credit risk that consider collateral requirements, credit enhancements and the impact of netting arrangements.

 

We have interest rate swap agreements where we generally pay a fixed rate and receive a floating rate based on LIBOR. We may also enter into interest rate swaption agreements where, if exercised, we pay a floating rate based on LIBOR and receive a fixed rate. The fair value of our interest rate derivative agreements are identified as separate items on our consolidated balance sheets and are described in the accompanying consolidated schedules of investments.

 

We record the accrual of periodic interest settlements of interest rate swap agreements in net unrealized appreciation or depreciation of investments and subsequently record the amount as a net realized gain or loss on investments on the interest settlement date. Cash payments received or paid for the termination of an interest rate derivative agreement are recorded as a realized gain or loss upon termination in our consolidated statements of operations and are classified under investing activities in our consolidated statements of cash flows.

 

During the three and nine months ended September 30, 2010, we recorded $9 million and $13 million of net unrealized depreciation, respectively, from interest rate and foreign exchange swap agreements in the financial statement line item derivative and option agreements and other. During the three and nine months ended September 30, 2009, we recorded $32 million of net unrealized depreciation and $25 million of net unrealized appreciation, respectively, from interest rate swap agreements and other in the financial statement line item derivative, option agreements and other in our consolidated statements of operations. During the nine months ended September 30, 2009, we also recorded a $49 million reversal of prior period net unrealized depreciation from the termination of the European Capital put option agreement.

 

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AMERICAN CAPITAL, LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

(in millions, except per share data)

 

 

During the three and nine months ended September 30, 2010, we recorded $14 million and $46 million, respectively, of net realized loss from interest rate swap agreements in the financial statement line item derivative and option agreements in our consolidated statements of operations for periodic interest settlements of interest rate swap agreements. During the nine months ended September 30, 2010, cash termination payments totaling $14 million were made to settle two interest rate swap agreements that were terminated prior to maturity, which are recorded as a net realized loss in the financial statement line item derivative and options agreements in our consolidated statements of operations.

 

During the three and nine months ended September 30, 2009, we recorded $16 million and $40 million, respectively, of net realized loss from interest rate swap agreements in the financial statement line item derivative and option agreements in our consolidated statements of operations for periodic interest settlements of interest rate swap agreements. During the three and nine months ended September 30, 2009, cash termination payments totaling $3 million were made to settle one interest rate swap agreement that was terminated prior to maturity, which was recorded as a net realized loss in the financial statement line item derivative and options agreements in our consolidated statements of operations. During the nine months ended September 30, 2009, we also recorded a realized loss of $44 million from the termination of the European Capital put option agreement.

 

Periodically, an interest rate swap agreement will also be amended whereby any underlying unrealized appreciation or depreciation associated with the original interest rate swap agreement at the time of amendment will be factored into the contractual interest terms of the amended interest rate swap agreement. The contractual terms of the amended interest rate swap agreement are set such that its estimated fair value is equivalent to the estimated fair value of the original interest rate swap agreement. No realized gain or loss is recorded upon amendment when the estimated fair values of the original and amended interest rate swap agreement are substantially the same.

 

As of December 31, 2009, the counterparties under certain of our interest rate swap and foreign exchange agreements had the right to declare an early termination event primarily due to the then outstanding defaults under our primary unsecured debt arrangements which triggered certain cross-default and cross-acceleration events of default under certain of our interest rate swap and foreign exchange agreements, which had a fair value of $36 million and a termination liability of $45 million as of December 31, 2009. As discussed in Note 4, on June 28, 2010, we completed a refinancing of all of our primary unsecured arrangements and obtained a waiver from our respective creditors of such defaults. In addition, in connection with our refinancing transaction, we granted to the counterparties under these interest rate swap and foreign exchange agreements a first priority lien (subject to certain permitted liens) on substantially all of our existing and hereafter acquired unencumbered assets pari passu with the New Secured Debt, so long as the New Secured Debt is outstanding. As of September 30, 2010, we were not in default under any of our interest rate swap or foreign exchange agreements.

 

Credit Risk-Related Contingent Features

 

Certain of our interest rate swap agreements contain an event of default that allows the counterparty to terminate transactions outstanding under the agreement following the occurrence of a cross default on certain of our other indebtedness in amounts equal to or greater than $5 million to $15 million, as applicable. Derivatives under these agreements in a liability position had a GAAP fair value liability of $53 million as of September 30, 2010. While none of our counterparties had the right to elect to terminate their transactions with us as a result of this provision as of September 30, 2010, the termination liability would have been $63 million as of such date. The difference between the GAAP fair value liability and the termination liability represents an adjustment for nonperformance risk of us and our counterparties.

 

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AMERICAN CAPITAL, LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

(in millions, except per share data)

 

 

Certain of our interest rate swap agreements also contain an event of default that allows the counterparty to terminate transactions outstanding under the agreement if certain of our other indebtedness in amounts equal to or greater than $5 million or $15 million, as applicable, is accelerated. Derivatives under these agreements in a liability position had a GAAP fair value liability of $11 million as of September 30, 2010. While none of our counterparties had the right to elect to terminate their transactions with us as a result of this provision as of September 30, 2010, the termination liability would have been $13 million as of such date. The difference between the GAAP fair value liability and the termination liability represents an adjustment for nonperformance risk of us and our counterparties.

 

We have agreed to guarantee the payment of (i) any swap breakage costs related to the interest rate swap agreements held by our asset securitization trusts prior to the occurrence of an event of default under the respective asset securitizations, and (ii) any such swap breakage costs in excess of $500,000 after the occurrence of an event of default under such asset securitizations. Derivatives under these agreements in a liability position had a GAAP fair value liability of $62 million as of September 30, 2010 and are included in our consolidated balance sheets. If such interest rate swap agreements could have been terminated early in accordance with their terms as of September 30, 2010, the aggregate termination liability would have been $69 million as of September 30, 2010. The difference between the GAAP fair value liability and the termination liability represents an adjustment for nonperformance risk of us and our counterparties.

 

Note 6. Earnings Per Share

 

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

 

In computing diluted EPS, only potential common shares that are dilutive, those that reduce earnings per share or increase loss per share, are included. The effect of stock options, unvested employee stock awards and contingently issuable shares are not included if the result would be anti-dilutive, such as when a net loss is reported. The “control number” for determining whether including potential common shares in the diluted EPS computation would be anti-dilutive is net earnings (loss). As a result, if there is a net loss, diluted EPS is computed using the same number of weighted average shares as used in computing basic EPS, even if we have positive net operating income. Therefore, basic EPS and diluted EPS are computed using the same number of weighted average shares for the nine months ended September 30, 2009 as we incurred a net loss. For the three and nine months ended September 30, 2010, 4.5 million shares and 3.9 million shares, respectively, of employee stock options and unvested employee stock awards were included in our diluted weighted average shares outstanding. For the three months ended September 30, 2009, 27.8 million shares of employee stock options, unvested employee stock awards and contingently issuable shares were included in our diluted weighted average shares outstanding.

 

Stock options and unvested employee stock awards of 24.3 million and 21.6 million for the three and nine months ended September 30, 2010, respectively, were not included in the computation of diluted EPS either because the respective exercise prices are greater than the average market price of the underlying stock for the respective periods or their inclusion would have been anti-dilutive. Stock options, unvested employee stock awards and contingently issuable shares of 38.5 million and 56.4 million for the three and nine months ended September 30, 2009, respectively, were not included in the computation of diluted EPS either because the respective exercise prices are greater than the average market price of the underlying stock for the respective periods or their inclusion would have been anti-dilutive.

 

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AMERICAN CAPITAL, LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

(in millions, except per share data)

 

 

Note 7. Commitments

 

As of September 30, 2010, we had commitments under loan and financing agreements to fund up to $205 million to 36 portfolio companies, with $41 million of the commitments related to an undrawn revolving credit facility for European Capital (see Note 11). These commitments are primarily composed of working capital credit facilities, acquisition credit facilities and subscription agreements. The commitments are generally subject to the borrowers meeting certain criteria such as compliance with covenants and availability under borrowing base thresholds. The terms of the borrowings and financings subject to commitment are comparable to the terms of other loan and equity securities in our portfolio.

 

Note 8. Corporate Restructuring Costs

 

To better align our organization and cost structure with current economic conditions, we conducted strategic reviews of our business in 2008 and 2009 which resulted in the closing of several offices and the elimination of certain functions at other offices. As a result, we have recorded corporate restructuring charges for both severance and related employee costs and excess office facilities costs. We recorded corporate restructuring charges for excess office facilities costs of $1 million and $5 million for the three months ended September 30, 2010 and 2009, respectively. We recorded corporate restructuring charges for excess office facilities costs of $5 million and $9 million for the nine months ended September 30, 2010 and 2009, respectively. The excess office facilities costs are included in general and administrative in our consolidated statements of operations for the three and nine months ended September 30, 2010 and 2009. The liability for employee severance costs and excess office facilities is included in other liabilities in our consolidated balance sheets as of September 30, 2010 and December 31, 2009.

 

In determining our liability related to excess office facilities, we are required to estimate such factors as future vacancy rates, the time required to sublet properties and sublease rates. These estimates are reviewed quarterly based on known real estate market conditions and the credit-worthiness of subtenants, and may result in revisions to the liability. Our remaining liability of $14 million as of September 30, 2010 related to excess office facilities represents gross lease commitments with agreements expiring at various dates through 2016 of approximately $45 million, net of committed and estimated sublease income of approximately $27 million and a present value factor of $4 million. We have entered into signed sublease arrangements for approximately $10 million, with the remaining $17 million based on estimated future sublease income.

 

The following table summarizes the restructuring accrual activity during the three and nine months ended September 30, 2010 and 2009:

 

     Severance     Excess Office
Facilities
    Total  

Balance, December 31, 2009

   $ 7      $ 13      $ 20   

Restructuring charges

     —          4        4   

Cash payments

     (5     (1     (6
                        

Balance, March 31, 2010

   $ 2      $ 16      $ 18   
                        

Cash payments

     (1     (2     (3
                        

Balance, June 30, 2010

   $ 1      $ 14      $ 15   
                        

Restructuring charges

     —          1        1   

Cash payments

     —          (1     (1
                        

Balance, September 30, 2010

   $ 1      $ 14      $ 15   
                        

 

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AMERICAN CAPITAL, LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

(in millions, except per share data)

 

     Severance     Excess Office
Facilities
    Total  

Balance, December 31, 2008

   $ 7      $ 5      $ 12   

Restructuring charges

     —          4        4   

Cash payments

     (5     (1     (6

Accretion of net present value

     —          1        1   
                        

Balance, March 31, 2009

   $ 2      $ 9      $ 11   
                        

Cash payments

     (2     (1     (3
                        

Balance, June 30, 2009

   $ —        $ 8      $ 8   
                        

Restructuring charges

     1        5        6   

Cash payments

     —          (2     (2
                        

Balance, September 30, 2009

   $ 1      $ 11      $ 12   
                        

 

Note 9. Income Taxes

 

We operate to qualify as a RIC under Subchapter M of the Code. In order to qualify as a RIC, we must annually distribute in a timely manner to our shareholders at least 90% of our taxable ordinary income based on our tax fiscal year. Ordinary taxable income includes net short-term capital gains but excludes net long-term capital gains. A RIC is not subject to federal income tax on the portion of its taxable ordinary income and long-term capital gains that are distributed to its shareholders, including “deemed distributions.” As permitted by the Code, a RIC can designate dividends paid in the subsequent tax fiscal year as dividends of current year ordinary income and net long-term capital gains if those dividends are both declared by the extended due date of the RIC’s federal income tax return and paid to shareholders by the last day of the subsequent tax fiscal year. We have distributed, or intend to distribute, sufficient dividends to eliminate taxable income for all of our tax fiscal years. However, we may elect to not distribute sufficient dividends to eliminate all of our taxable income so long as we distribute at least 90% of our taxable ordinary income in order to maintain our qualification as a RIC. To the extent we maintain our qualification as a RIC but do not distribute all of our taxable income, we would be subject to income tax on such undistributed amounts. If we fail to satisfy the 90% distribution requirement or otherwise fail to qualify as a RIC in any tax fiscal year, we would be subject to income tax in such year on all of our taxable income, regardless of whether we made any distributions to our shareholders. We have a tax fiscal year that ends on September 30. We have distributed all of our taxable ordinary income for all of our tax fiscal years including our tax fiscal year ended September 30, 2009. For our tax fiscal year ended September 30, 2010, we expect to have a taxable ordinary loss. Also for the tax fiscal year ended September 30, 2009, we had $198 million of net long-term capital losses that may be used in the current tax fiscal year or carried forward to offset long-term capital gains for up to eight years following the year recognized. For our tax fiscal year ended September 30, 2010, we expect to have a net long-term capital loss.

 

Our ordinary taxable income and net long-term capital gains comprise our investment company taxable income which differs from net income as defined by GAAP due primarily to temporary and permanent differences in interest and dividend income recognition, stock-based compensation and other expense recognition and unrealized appreciation or depreciation of investments. In addition, there are classification differences between GAAP and tax as it relates to what is characterized as net operating income for GAAP compared to ordinary taxable income for tax and what is characterized as net realized gains or losses for GAAP compared to net long-term capital gains or losses for tax. These characterization differences between GAAP and tax include the characterization of realized losses for loans, interest receivable write-offs for uncollectible accounts, periodic interest settlements for interest rate swap agreements and the holding period of capital investments.

 

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AMERICAN CAPITAL, LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

(in millions, except per share data)

 

 

As a RIC, we are also subject to a nondeductible federal excise tax of 4% if we do not distribute at least 98% of our ordinary income, excluding net short-term capital gains, in any calendar year and 98% of our capital gains for each one-year period ending October 31, including any undistributed income from the prior excise tax year. For the nine months ended September 30, 2010 and 2009, we did not accrue a federal excise tax because we distributed or intend to distribute sufficient dividends to eliminate any federal excise tax or we expect to have taxable ordinary losses and capital losses for the respective excise tax years.

 

In March 2010, The Patient Protection and Affordable Care Act and The Health Care and Education Reconciliation Act were enacted. This legislation has not resulted in an income tax provision for American Capital or ACFS, our consolidated taxable operating subsidiary.

 

On June 30, 2010, we merged our consolidated taxable operating subsidiary, ACFS, into American Capital, Ltd. For tax purposes, the merger will be treated as a tax-free liquidation of ACFS. Under Subchapter M, when a non-RIC corporation merges into a RIC, the RIC must distribute any accumulated earnings and profits acquired through the merger of the non-RIC prior to the end of the RIC’s taxable year in which the merger occurs in order to maintain RIC status. As of the merger date, ACFS did not have any accumulated earnings and profits. The merger should not adversely affect our qualification as a RIC. As a result of the merger, ACFS’ gross deferred tax asset and associated valuation allowance, which netted to zero as of the merger date, have been eliminated as of June 30, 2010, the date of the merger.

 

Note 10. Shareholders’ Equity

 

In April 2010, we completed a registered direct offering of 58,300,000 shares of our common stock to a group of institutional investors at a price of $5.06 per share. Upon completion of the offering, we received gross proceeds of approximately $295 million.

 

Note 11. Investment in European Capital

 

In February 2008, we entered into a loan agreement to provide a $400 million subordinated, unsecured revolving credit facility (the “Term A Facility”) to European Capital with an original maturity in February 2011. In June 2009, American Capital and European Capital entered into an agreement whereby the outstanding borrowings under the Term A Facility of $319 million were exchanged for 325.1 million ordinary shares of European Capital and the Term A Facility commitment amount was reduced from $400 million to $87 million. In March 2010, we further amended the Term A Facility to further reduce the commitment amount from $87 million to $53 million, extend the maturity date to June 2012, and change the interest rate to LIBOR plus 7.00% payable in kind. As of September 30, 2010, there was a $12 million outstanding balance under the Term A Facility.

 

In October 2008, we amended the loan agreement to extend an additional $250 million subordinated, unsecured revolving credit facility (the “Term B Facility”) to European Capital. In November 2009, the loan agreement was amended to reduce the Term B Facility commitment of $250 million to an amount equal to the existing standby letter of credit issued by us for the benefit of The Royal Bank of Scotland, plc, the agent under European Capital’s unsecured multicurrency revolving facility. In March 2010, European Capital repaid in full and terminated its unsecured multicurrency revolving facility, which resulted in the termination of the standby letter of credit. We also amended our loan agreement with European Capital at the same time to terminate the Term B Facility commitment.

 

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AMERICAN CAPITAL, LTD.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

(in millions, except per share data)

 

 

In March 2010, we entered into another loan agreement with European Capital under which we made a loan (the “Bridge Loan”) for $75 million to European Capital. The Bridge Loan would bear interest at LIBOR plus 7.00% payable in kind and would mature at the earlier of (i) the date on which all obligations under the loan agreement are repaid in full and (ii) September 1, 2010. Under the loan agreement, European Capital could not pledge certain of its investments (the “Deferred Assets”). We also entered into a purchase agreement with European Capital in March 2010 pursuant to which we agreed to purchase the Deferred Assets from European Capital by September 1, 2010 subject to certain conditions. We could pay the purchase price of any deferred asset by setting off any outstanding obligations then due and payable by European Capital to us, including under the Bridge Loan. European Capital used the $75 million of proceeds from the Bridge Loan to repay in full and terminate its unsecured multicurrency revolving facility, which also resulted in the termination of the standby letter of credit that we issued in connection with the facility for the benefit of The Royal Bank of Scotland, plc. In July 2010, European Capital paid down the outstanding balance under the Bridge Loan and the Bridge Loan and the purchase agreement were terminated.

 

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (in millions, except per share data)

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is designed to provide a reader of American Capital’s financial statements with a narrative from the perspective of management. Our MD&A is presented in four sections:

 

   

Executive Overview

 

   

Results of Operations

 

   

Financial Condition, Liquidity and Capital Resources

 

   

Forward-Looking Statements

 

EXECUTIVE OVERVIEW

 

We are a publicly traded private equity firm and a global asset manager. Our $5.6 billion on-balance sheet investment portfolio consists of investments in senior debt, subordinated debt and equity in controlled and non-controlled private and public companies and structured product investments (“Structured Products”), including commercial mortgage backed securities (“CMBS”), commercial collateralized loan obligation (“CLO”) securities and collateralized debt obligation (“CDO”) securities. We are also an alternative asset manager with approximately $12 billion of third-party capital resources under management across four third-party private and public funds that we manage.

 

In June 2010, we successfully completed a refinancing of our $2.3 billion of outstanding unsecured borrowings. Under the terms of the refinancing, lenders and noteholders had the option of receiving either cash or new secured debt, in each case in the full principal amount of their pre-transaction debt. Lenders and noteholders holding $1,030 million of debt selected or otherwise received 100% cash for their debt, while lenders and noteholders holding $1,307 million of debt, or 56% of pre-transaction debt, elected to receive new secured loans or notes of various series. As a result, we repaid $1,030 million of our unsecured obligations and issued $1,307 million of fixed and floating rate secured loans or notes which will mature in December 2013 in exchange for the remaining obligations. We also granted a lien on substantially all of our existing and hereafter acquired unencumbered assets as collateral for the newly issued loans and notes. See Note 4 to our consolidated interim financial statements included in this Form 10-Q for additional disclosures regarding the exchange transaction.

 

As a result of the economic recession and global financial crisis during the past two years and the refinancing transaction discussed above, the current focus of our investment and capitalization strategy is to de-risk our investment portfolio and to continue to de-leverage our balance sheet.

 

Our investment strategy will focus on providing financing to our existing American Capital sponsored buyout portfolio companies to fund organic growth and strategic acquisitions with the goal of enhancing their values. With respect to investing in new portfolio companies, our strategy for the next few years will be to focus on providing second lien and mezzanine debt financing directly to middle market companies and in the buyouts of private companies sponsored by other private equity firms. In addition, we intend to invest only a portion of proceeds from exits of equity investments into the equity of new American Capital One-Stop Buyouts.

 

Our capitalization strategy for the next few years will be to continue to de-leverage our balance sheet by substantially reducing the outstanding balance of our borrowings. In the short-term, by the end of the current fiscal year, we expect to use our disposable cash flow to pay down our new secured debt obligations to under $1 billion so that we can reduce our interest rate to the lowest level under the agreements. Our long term goal over the next few years will be to continue to reduce our leverage so that we operate with an average debt to equity ratio of about 0.6 to 1.0.

 

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American Capital Investing Activity

 

We provide investment capital to middle market companies, which we generally consider to be companies with sales between $10 million and $750 million. We primarily invest in senior debt, subordinated debt and equity in the buyouts of private companies sponsored by us, the buyouts of private companies sponsored by other private equity firms and provide capital directly to early stage and mature private and small public companies. Currently, we will invest up to $100 million in a single middle market transaction in North America. We also have investments in Structured Products and alternative asset funds managed by us. For summary financial information by geographic area, see Note 3 to our consolidated interim financial statements in this Form 10-Q.

 

We seek to be a long-term partner with our portfolio companies. As a long-term partner, we will invest capital in a portfolio company subsequent to our initial investment if we believe that it can achieve appropriate returns for our investment. Add-on financings fund (i) strategic acquisitions by a portfolio company of either a complete business or specific lines of a business that are related to the portfolio company’s business, (ii) recapitalization of a portfolio company to raise financing on better terms, buyout one or several owners or to pay a dividend, (iii) growth of the portfolio company such as product development or plant expansions, or (iv) working capital for a portfolio company, sometimes in distressed situations, that need capital to fund operating costs, debt service, or growth in receivables or inventory.

 

The total fair value of our investment portfolio was $5.6 billion as of September 30, 2010 and December 31, 2009. During the three and nine months ended September 30, 2010 and 2009, we generally limited our investment originations to providing funding to our existing portfolio companies for working capital or to recapitalize or refinance their balance sheets or purchase existing debt in the secondary market, primarily to preserve our investments as well as provide financing to fund strategic acquisitions by our existing portfolio companies. Since our asset coverage ratio was below 200% or our NAV per share was greater than the trading price of our common stock during the three and nine months ended September 30, 2010, regulatory restrictions generally limited our ability to raise debt or equity capital during the quarter to be able to make significant new investments. As a result of appreciation in our investment portfolio during the first nine months of 2010 and our June 28, 2010 refinancing transaction discussed in Note 4 to our consolidated interim financial statements in this Form 10-Q, our asset coverage ratio has improved to 230% as of September 30, 2010.

 

The type and aggregate dollar amount of our new investments were as follows (in millions):

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
         2010              2009              2010              2009      

Add-on financing for purchase in secondary market of debt of a portfolio company

   $ 32       $ —         $ 32       $ —     

Add-on financing for recapitalizations

     —           3         80         19   

Financing for private equity buyouts

     —           —           35         —     

Add-on financing for working capital in distressed situations

     8         3         28         64   

Add-on financing for acquisitions

     22         1         22         1   

Add-on financing for growth and working capital

     1         —           2         2   
                                   

Total

   $ 63       $ 7       $ 199       $ 86   
                                   

 

The amounts of our new investments include both funded commitments and unfunded commitments as of the investment date. Included in the add-on financing for recapitalizations of $80 million for the nine months ended September 30, 2010 was a $75 million bridge loan issued to European Capital Limited (“European Capital”), the proceeds of which were utilized to repay in full and terminate European Capital’s unsecured multicurrency revolving facility. European Capital made payments of $60 million in April 2010 and $15 million in July 2010 to repay the bridge loan and the facility was terminated.

 

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We received cash proceeds from realizations and repayments of portfolio investments as follows (in millions):

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
         2010              2009              2010              2009      

Principal prepayments

   $ 181       $ 151       $ 543       $ 228   

Sale of equity investments

     75         198         169         266   

Loan syndications and sales

     25         78         40         107   

Payment of accrued PIK interest and dividend and original issue discounts

     17         27         44         32   

Scheduled principal amortization

     7         9         23         34   
                                   

Total

   $ 305       $ 463       $ 819       $ 667   
                                   

 

Public Manager of Funds of Alternative Assets

 

We are a global alternative asset manager of third-party funds. Our third-party alternative asset management business is conducted through our wholly-owned portfolio company, American Capital, LLC. We refer to the asset management business throughout this report to include the asset management activities conducted by American Capital, LLC. In addition to managing American Capital’s assets and providing management services to portfolio companies of American Capital, we also manage European Capital, American Capital Agency Corp. (“AGNC”), American Capital Equity I, LLC (“ACE I”), American Capital Equity II, LP (“ACE II”) and ACAS CLO 2007-1, Ltd. (“ACAS CLO-1”). As of September 30, 2010, our assets under management totaled $18 billion, including $12 billion under management in the third-party funds named above, excluding European Capital since it is wholly-owned by us.

 

Through our asset management business, American Capital, LLC generally earns base management fees based on the size of the funds and incentive income, if any, based on the performance of the funds it manages. In addition, we may invest directly into our alternative asset funds and earn investment income from our direct investments in those funds.

 

The following table sets forth certain information with respect to our funds under management as of September 30, 2010:

 

    American Capital   European Capital   AGNC    ACE I    ACE II    ACAS
CLO-1

Fund type

  Public Alternative Asset
Manager & Fund
  Private

Fund

  Public REIT Fund -

The NASDAQ Global Market

   Private
Fund
   Private
Fund
   Private
Fund

Established

  1986   2005   2008    2006    2007    2006

Assets under management

  $6.0 Billion(1)   $1.4 Billion(2)   $10.4 Billion    $0.7 Billion    $0.4 Billion    $0.4 Billion

Investment types

  Senior & Subordinated
Debt, Equity,
Structured Products
  Senior & Subordinated
Debt, Equity,
Structured Products
  Agency Securities    Equity    Equity    Senior
Debt

Capital type

  Permanent   Permanent   Permanent    Finite Life    Finite Life    Finite Life

 

(1) Includes our investment in funds that we manage.
(2) Excluded from our third-party funds under management as we own 100% of European Capital.

 

Summary of Critical Accounting Policies

 

The preparation of our financial condition and results of operations requires us to make judgments and estimates that may have a significant impact upon our financial results. We believe that of our significant accounting policies, the following require estimates and assumptions that require complex, subjective judgments by management, which can materially impact reported results: valuation of investments; interest and dividend income recognition; stock-based compensation; and derivative financial instruments. All of our critical accounting policies are fully described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2009.

 

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See Note 3 to our interim consolidated financial statements for further information regarding the classification of our investment portfolio by levels of fair value inputs used to measure our investments as of September 30, 2010.

 

RESULTS OF OPERATIONS

 

The following analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the notes thereto.

 

Our consolidated financial performance, as reflected in our consolidated statements of operations, is composed of the following three primary elements:

 

   

The first element is “Net operating income,” which is primarily the interest, dividends, prepayment fees, finance and transaction fees and portfolio company management fees earned from investing in debt and equity securities and the fees we earn from fund asset management, less our operating expenses and provision for income taxes.

 

   

The second element is “Net realized gain (loss) on investments,” which reflects the difference between the proceeds from an exit of an investment and the cost at which the investment was carried on our consolidated balance sheets and periodic interest settlements and termination receipts or payments on derivatives, foreign currency transaction gains or losses and income taxes on realized gains.

 

   

The third element is “Net unrealized appreciation (depreciation) of investments,” which is the net change in the estimated fair value of our portfolio investments and of our interest rate derivatives at the end of the period compared with their estimated fair values at the beginning of the period or their stated costs, as appropriate. In addition, our net unrealized depreciation of investments includes the foreign currency translation from converting the cost basis of our assets and liabilities denominated in a foreign currency to the U.S. dollar.

 

The consolidated operating results for the three and nine months ended September 30, 2010 and 2009 were as follows (in millions):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
         2010             2009             2010             2009      

Operating income

   $ 142      $ 193      $ 457      $ 528   

Operating expenses

     83        160        320        422   
                                

Operating income before income taxes

     59        33        137        106   

(Provision) benefit for income taxes

     —          (1     —          10   
                                

Net operating income

     59        32        137        116   

Net gain on extinguishment of debt

     —          —          —          12   

Net realized loss on investments

     (68     (66     (514     (523
                                

Net realized loss

     (9     (34     (377     (395
                                

Net unrealized appreciation (depreciation) of investments

     158        111        994        (622
                                

Net earnings (loss)

   $ 149      $ 77      $ 617      $ (1,017
                                

 

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Operating Income

 

We derive the majority of our operating income by investing in senior and subordinated debt and equity of middle market companies with attractive current yields and/or potential for equity appreciation and realized gains. We also derive operating income from investing in Structured Products. Operating income consisted of the following for the three and nine months ended September 30, 2010 and 2009 (in millions):

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
         2010              2009              2010              2009      

Interest income on debt and Structured Products investments

   $ 109       $ 159       $ 371       $ 437   

Dividend income

     15         16         40         43   

Interest income on bank deposits

     1         1         2         2   
                                   

Interest and dividend income

     125         176         413         482   
                                   

Portfolio company advisory and administrative fees

     3         4         14         15   

Fund asset management fees and reimbursements

     5         5         13         18   

Other fees

     9         8         17         13   
                                   

Fee income

     17         17         44         46   
                                   

Total operating income

   $ 142       $ 193       $ 457       $ 528   
                                   

 

Interest and Dividend Income

 

The following table summarizes selected data for our debt and equity investments, at cost, for the three and nine months ended September 30, 2010 and 2009 (dollars in millions):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
         2010             2009             2010             2009      

Debt and Structured Products investments(1)

   $ 4,700      $ 6,258      $ 5,035      $ 6,793   

Effective interest rate on debt and Structured Products investments(1)

     9.3     10.2     9.8     8.6

Average monthly one-month LIBOR

     0.3     0.3     0.3     0.4

Average non-accrual debt investments at cost(2)

   $ 716      $ 940      $ 728      $ 941   

Equity investments(1)

   $ 3,591      $ 3,848      $ 3,689      $ 3,653   

Effective dividend yield on equity investments(1)

     1.7     1.6     1.5     1.6

Debt, Structured Products and equity investments(1)

   $ 8,291      $ 10,106      $ 8,724      $ 10,446   

Effective yield on debt, Structured Products and equity investments(1)

     6.0     6.9     6.3     6.1

 

(1) Monthly weighted average.
(2) Quarterly average.

 

Interest income on debt and Structured Products investments decreased by $50 million, or 31%, and $66 million, or 15%, for the three and nine months ended September 30, 2010, respectively, over the comparable prior periods in 2009, due to a decrease in our monthly weighted average debt and Structured Products investments and a decrease in interest income recognized on our CMBS investments.

 

Our weighted average debt and Structured Products investments decreased for the three and nine months ended September 30, 2010 over the comparable periods in 2009 primarily as a result of the repayment, sale or write-off of debt and Structured Products investments. During the year ended December 31, 2009 and the nine months ended September 30, 2010, instead of reinvesting the proceeds into new investments we chose to repay our debt obligations with the realized proceeds from the exit of portfolio investments in order to delever our balance sheet.

 

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The monthly weighted average effective interest rate on our debt and Structured Products investments decreased 90 basis points during the three months ended September 30, 2010 over the comparable period in 2009 primarily due to (i) the reversal of prior period interest income on debt investments placed on non-accrual during the three months ended September 30, 2010 and (ii) a decline in interest income recognized from CMBS investments as compared to the prior period as a result of a decrease in projected cash flows partially offset by an approximate $224 million decrease in the average cost basis of non-accrual loans during the three months ended September 30, 2010 over the comparable period in 2009. See our Interest and Dividend Income Recognition policy in our Annual Report on Form 10-K for the year ended December 31, 2009 for a description of how projected cash flows affect revenue recognition on our Structured Products investments. The monthly weighted average effective interest rate on our debt and Structured Products investments increased 120 basis points during the nine months ended September 30, 2010 over the comparable period in 2009 primarily due to (i) a greater negative impact of non-accrual debt investments in the nine months ended September 30, 2009 as compared to the current period and (ii) an approximate $213 million decrease in the average cost basis of non-accrual loans during the nine months ended September 30, 2010 over the comparable period in 2009 partially offset by (iii) a 10 basis point decrease in the average one-month LIBOR and (iv) a decline in interest income recognized from CMBS investments as compared to the prior period as a result of a decrease in projected cash flows.

 

When a debt investment is placed on non-accrual, we record reserves on uncollected payment-in-kind (“PIK”) interest income recorded in prior periods as a reduction of interest income in the current period. Conversely, when a debt investment is removed from non-accrual, we record interest income in the current period on prior period uncollected PIK interest income which was reserved in prior periods. For the three months ended September 30, 2010, we recorded a net reserve on uncollected PIK interest income recorded in prior periods of $11 million as a result of debt investments being placed on non-accrual compared to interest income of $8 million during the three months ended September 30, 2009 as a result of debt investments being removed from non-accrual, which had an approximate 100 basis point negative impact on the weighted average effective interest rate for the three months ended September 30, 2010 compared to an approximate 50 basis point positive impact for the three months ended September 30, 2009. For the nine months ended September 30, 2010 and 2009, we recorded a net reserve on uncollected PIK interest income recorded in prior periods of $6 million and $46 million, respectively, which had an approximate 10 basis point and 90 basis point negative impact on the weighted average effective interest rate for the nine months ended September 30, 2010 and 2009, respectively.

 

The interest income we earn on our debt investments was generally positively impacted by loans that were originated or modified during the last two years. These recent new loans originations and modifications have been priced at generally higher spreads as compared to loans that have been repaid during this period as market spreads have increased during this period.

 

A portion of our debt investments, particularly our senior debt investments, accrue interest at LIBOR plus a spread. These debt investments either have no LIBOR floor or may have a LIBOR floor that is generally around 2.0%. As a result, as LIBOR declines, our interest income generally will decline for our debt investments with interest rates that are based on LIBOR without a LIBOR floor.

 

Dividend income decreased by $1 million, or 6%, and by $3 million, or 7%, for the three and nine months ended September 30, 2010, respectively, over the comparable periods in 2009. As a result, the monthly weighted average effective dividend yield on equity investments was 1.7% and 1.5% for the three and nine months ended September 30, 2010, respectively, a 10 basis point increase and 10 basis point decrease, respectively, from the comparable periods in 2009.

 

When a preferred equity investment is placed on non-accrual, we record net reserves on uncollected accrued dividend income recorded in prior periods as a reduction of dividend income in the current period. Conversely, when a preferred equity investment is removed from non-accrual, we record dividend income in the current period for prior period uncollected accrued dividend income which was reserved in prior periods. For the three and nine months ended September 30, 2010, we recorded net reserves on uncollected accrued dividend income

 

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recorded in prior periods from private finance preferred stock investments of $2 million and $13 million, respectively. For the three and nine months ended September 30, 2009, we recorded net reserves on uncollected accrued dividend income recorded in prior periods from private finance preferred stock investments of $8 million and $33 million, respectively.

 

Fee Income

 

As of September 30, 2010, all of our third-party alternative asset fund management services are conducted through our wholly-owned portfolio company, American Capital, LLC. Fund asset management fees and reimbursements income for the three months ended September 30, 2010 and 2009 represent fees of $5 million and $4 million, respectively, for providing advisory and administrative services to American Capital, LLC. Fund asset management fees and reimbursements income for the nine months ended September 30, 2010 and 2009 represent fees of $13 million and $17 million, respectively, for providing advisory and administrative services to American Capital, LLC.

 

Our fee income includes financial advisory services provided to our portfolio company investments and includes both management fees for providing managerial advice and analysis to our middle market portfolio companies, which can be recurring in nature, and transaction structuring and financing fees for structuring, financing and executing middle market portfolio transactions, which may not be recurring in nature.

 

Operating Expenses

 

Operating expenses decreased $77 million, or 48%, and $102 million, or 24% for the three and nine months ended September 30, 2010, respectively, over the comparable periods in 2009. Operating expenses consisted of the following for the three and nine months ended September 30, 2010 and 2009 (in millions):

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
         2010              2009              2010              2009      

Interest

   $ 36       $ 85       $ 149       $ 197   

Salaries, benefits and stock-based compensation

     31         47         99         147   

General and administrative

     16         23         51         63   

Debt refinancing costs

     —           5         21         15   
                                   

Total operating expenses

   $ 83       $ 160       $ 320       $ 422   
                                   

 

Interest

 

Interest expense for the three and nine months ended September 30, 2010 decreased $49 million, or 58%, and $48 million, or 24%, respectively, from the comparable periods in 2009. The decrease in interest expense was primarily attributable to a decline in the weighted average interest rate on our borrowings and lower weighted average borrowings as a result of our debt refinancing and the associated pay down of $1,030 million of outstanding borrowings on June 28, 2010. The weighted average interest rate on all of our borrowings, including amortization of deferred financing costs, for the three and nine months ended September 30, 2010 was 5.3% and 5.6%, respectively, compared to 7.9% and 6.0%, respectively, for the comparable periods in 2009. Comparisons to the prior periods of the weighted average interest is also impacted by additional interest expense incurred during the three and nine months ended September 30, 2009 for the accrual of a $22 million make-whole interest payment on our unsecured debt that was refinanced in the second quarter of 2010. Our weighted average borrowings decreased to $2,715 million for the three months ended September 30, 2010 from $4,289 million for the comparable period in 2009. Our weighted average borrowings decreased to $3,575 million for the nine months ended September 30, 2010 from $4,343 million for the comparable period in 2009.

 

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Salaries, Benefits and Stock-based Compensation

 

Salaries, benefits and stock-based compensation consisted of the following for the three and nine months ended September 30, 2010 and 2009 (in millions):

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
         2010              2009              2010              2009      

Base salaries

   $ 13       $ 18       $ 41       $ 59   

Incentive compensation

     7         8         20         26   

Benefits

     2         3         8         10   

Stock-based compensation

     9         18         30         52   
                                   

Total salaries, benefits and stock-based compensation

   $ 31       $ 47       $ 99       $ 147   
                                   

 

Salaries, benefits and stock-based compensation for the three and nine months ended September 30, 2010 decreased $16 million, or 34%, and $48 million, or 33%, respectively, from the comparable periods in 2009 primarily due to (i) a decrease in the number of employees and (ii) lower stock-based compensation during the three and nine months ended September 30, 2010 as a result of the acceleration of stock-based compensation in the fourth quarter of 2009 from the completion of a tender offer for certain eligible employee stock options.

 

To better align our organization and cost structure with the current economic conditions, we undertook strategic reviews of our business in 2009 and 2008. As a result of these reviews, we closed several offices and eliminated 160 and 72 positions during the 2008 and 2009 fiscal years, respectively. As of September 30, 2010, we had total employees of 243 compared to total employees of 335 as of September 30, 2009.

 

During the fourth quarter of 2009, we completed a tender offer for certain eligible employee stock options. Pursuant to the tender offer, we offered employees a cash payment for the voluntary cancellation of certain eligible outstanding employee stock options. As a result of the tender offer, unrecognized compensation cost of $21 million for the tendered unvested options expected to vest was accelerated and recorded as compensation expense in the fourth quarter of 2009. Accordingly, the stock-based compensation cost for the three and nine months ended September 30, 2010 is lower as compared to the comparable prior periods in part due to the positive impact of the accelerated employee stock options in future periods.

 

General and Administrative

 

General and administrative expenses decreased by $7 million, or 30%, and by $12 million, or 19%, for the three and nine months ended September 30, 2010, respectively, over the comparable periods in 2009 primarily due to fewer employees and offices.

 

Debt Refinancing Costs

 

During the nine months ended September 30, 2010 and 2009, we incurred non-recurring debt refinancing costs from both our unsecured creditors’ legal and financial advisors that were engaged in connection with our debt refinancing negotiations and the closing of our debt refinancing transaction in June 2010. We do not anticipate any additional costs in future periods associated with our debt refinancing transaction.

 

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Net Realized (Loss) Gain on Investments

 

Our net realized (loss) gain on investments for the three and nine months ended September 30, 2010 and 2009 consisted of the following individual portfolio company realized gain (loss) greater than $15 million (in millions):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
         2010             2009             2010             2009      

Axygen Holdings Corporation

     —        $ 35        —        $ 35   

Edline, LLC

     —          16        —          16   

Piper Aircraft, Inc.

     —          —          —          31   

Other, net

     11        25        29        37   
                                

Total gross realized portfolio gains

   $ 11      $ 76      $ 29      $ 119   
                                

ACAS CRE CDO 2007-1, Ltd.

     —          —          (170     —     

UFG Member, LLC

     (3     —          (81     —     

GS Mortgage Securities Trust 2007-GG10

     (33     —          (49     —     

Fountainhead Estate Holding Corp.

     —          —          (25     —     

ETG Holdings, Inc.

     —          —          (22     —     

Wachovia Bank Commercial Mortgage Trust, Series 2007-C32

     —          —          (19     —     

Resort Funding Holdings, Inc.

     —          —          (18     —     

CCRD Operating Company, Inc.

     (17     —          (17     —     

Genband Inc.

     —          —          (15     —     

Anchor Drilling Fluids USA, Inc.

     —          (40     —          (40

TestAmerica Environment Services, LLC

     —          (39     —          (39

Ford Motor Company

     —          (18     —          (18

Consolidated Bedding, Inc.

     —          —          —          (196

Barton-Cotton Holding Corporation

     —          —          —          (74

Halex Holdings Corp.

     —          —          —          (29

Venus Swimwear, Inc.

     —          —          —          (19

Foamex, L.P.

     —          —          —          (18

Small Smiles Holding Company, LLC

     —          —          —          (17

Other, net

     (12     (26     (65     (103
                                

Total gross realized portfolio loss

   $ (65   $ (123   $ (481   $ (553
                                

Total net realized portfolio loss

   $ (54   $ (47   $ (452   $ (434

Interest rate derivative periodic interest payments, net

     (14     (16     (46     (40

Interest rate derivative termination payments

     —          (3     (14     (3

European Capital put option agreement

     —          —          —          (44

Foreign currency transactions

     —          —          (2     (2
                                

Total net realized loss

   $ (68   $ (66   $ (514   $ (523
                                

 

The following are summary descriptions of portfolio company realized gains or losses greater than $30 million.

 

In the second and third quarters of 2010, we wrote off $49 million of non-investment grade CMBS bonds in GS Mortgage Securities Trust 2007-GG10. We did not receive any proceeds, realizing a loss of $49 million fully offset by a reversal of unrealized depreciation.

 

In the second quarter of 2010, we wrote off our remaining notes in ACAS CRE CDO 2007-1, Ltd., a commercial real estate CDO secured by CMBS bonds, realizing a total loss of $170 million offset by a reversal of unrealized depreciation of $170 million.

 

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In the first quarter of 2010, our portfolio company UFG Member, LLC was sold. As part of the sale proceeds, we received a partial payment on our remaining subordinated debt investment. The sale proceeds we received included a subordinated note from the purchaser, AFA Investments, Inc., that had a fair value of $4 million. We wrote off our remaining subordinated debt investment and our equity investment in UFG Member, LLC realizing a total loss of $81 million offset by a reversal of unrealized depreciation of $68 million.

 

In the third quarter of 2009, we received full payment of our remaining subordinated debt investment in Axygen Holdings Corporation and sold all of our equity interests for $182 million in total proceeds realizing a total gain of $35 million offset by a reversal of unrealized appreciation of $37 million. The gain that we recognized included escrowed proceeds that we expect to receive of $7 million.

 

In the third quarter of 2009, we wrote off $40 million of our subordinated debt investment in Anchor Drilling Fluids USA, Inc. We did not receive any proceeds, realizing a loss of $40 million fully offset by a reversal of unrealized depreciation.

 

In the third quarter of 2009, we wrote off our subordinated debt investment in TestAmerica Environmental Services, LLC. We did not receive any proceeds, realizing a loss of $39 million fully offset by a reversal of unrealized depreciation.

 

In the second quarter of 2009, we received full repayment of our remaining subordinated debt investment in Piper Aircraft, Inc. and sold all of our equity interests for $31 million in total proceeds realizing a total gain of $31 million offset by a reversal of unrealized appreciation of $23 million.

 

In the second quarter of 2009, Consolidated Bedding, Inc. (“Consolidated Bedding”) sold all of its remaining assets to several purchasers for total proceeds consisting of cash, a 49% equity interest in one of the purchasers, Spring Air International, LLC, and the future collection by one of the purchasers of certain accounts receivable of Consolidated Bedding. The total fair value of the cash and non-cash proceeds received, including the present value of future payments expected to be collected, was $14 million, the proceeds of which were used to partially pay down our debt investments. Subsequently, Consolidated Bedding filed for bankruptcy protection under Chapter 7 of the U.S. Bankruptcy Code. We do not expect to receive any further proceeds for our debt and equity investments in Consolidated Bedding, except the collection of the remaining $14 million of total proceeds. We deemed our remaining investments to be worthless and recognized a realized loss of $196 million offset by a reversal of unrealized depreciation of $189 million.

 

In the first quarter of 2009, Barton-Cotton, Incorporated, the wholly-owned operating subsidiary of Barton-Cotton Holding Corporation (“Barton-Cotton”), filed for bankruptcy protection under Chapter 7 of the U.S. Bankruptcy Code. Although we are pursuing our claims, we do not expect to receive any proceeds for our subordinated debt or equity investments in Barton-Cotton. We deemed our investments to be worthless and recognized a realized loss of $74 million fully offset by a reversal of unrealized depreciation.

 

On November 19, 2008, we entered into a put option agreement with European Capital under which European Capital could put some or all of certain investments to us at a predetermined put price. Under the terms of the agreement, the put option could be exercised at any time commencing on January 1, 2010 and expiring on December 31, 2010. In consideration for entering into the put option agreement, European Capital paid us €16 million ($20 million). On March 30, 2009, we entered into a termination agreement with European Capital to terminate the put option agreement. Under the terms of the termination agreement, we settled the put option obligation by paying European Capital the fair value of the put option obligation of $65 million (€49 million). As a result, we recognized a realized loss of $44 million offset by the reversal of unrealized depreciation of $49 million in our consolidated statements of operations.

 

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Net Unrealized Appreciation (Depreciation) of Investments

 

The following table itemizes the change in net unrealized appreciation (depreciation) of investments for the three and nine months ended September 30, 2010 and 2009 (in millions):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
         2010             2009             2010             2009      

Gross unrealized appreciation of private finance portfolio investments

   $ 135      $ 154      $ 483      $ 274   

Gross unrealized depreciation of private finance portfolio investments

     (145     (140     (243     (969
                                

Net unrealized (depreciation) appreciation of private finance portfolio investments

     (10     14        240        (695

Net unrealized appreciation (depreciation) of European Capital investment

     44        42        251        (326

Net unrealized (depreciation) appreciation of European Capital foreign currency translation

     (88     (48     75        (46

Net unrealized appreciation of AGNC

     —          14        —          27   

Net unrealized appreciation (depreciation) of American Capital, LLC

     26        —          62        (158

Net unrealized appreciation (depreciation) of Structured Products investments

     12        23        (4     14   

Reversal of prior period net unrealized depreciation upon realization

     44        41        456        434   
                                

Net unrealized appreciation (depreciation) of portfolio investments

     28        86        1,080        (750

Foreign currency translation—European Capital

     135        53        (70     50   

Foreign currency translation—other

     6        4        (1     4   

Derivative agreements and other

     (11     (32     (15     25   

Reversal of prior period net unrealized depreciation on option agreements upon realization

     —          —          —          49   
                                

Net unrealized appreciation (depreciation) of investments

   $ 158      $ 111      $ 994      $ (622
                                

 

See our “Investment Valuation Policy” in Note 3 in our Annual Report on Form 10-K for the year ended December 31, 2009 for a description of our valuation methodologies.

 

Private Finance Portfolio

 

Our private finance portfolio investments consist of loans and equity securities primarily to privately-held middle market companies with a cost basis of $6,138 million and fair value of $4,747 million as of September 30, 2010. There is generally no publicly available information about these companies and an active primary or secondary market for the trading of these privately issued loans and securities generally does not exist. Our investments have been historically exited through normal repayment or a change in control transaction such as a sale or recapitalization of the portfolio company.

 

For the three months ended September 30, 2010, the $10 million of net unrealized depreciation on our private finance portfolio investments was driven by lower performance and credit of one portfolio company, partially offset by a modest improvement in the performance of a majority of our portfolio companies. For the nine months ended September 30, 2010, the $240 million of net unrealized appreciation on our private finance portfolio investments was driven primarily by improved portfolio company performance, multiple expansion of comparable companies and narrowing investment spreads. The operating results for our private finance portfolio companies began improving in the latter half of 2009 which coincided with the end of the recent global economic recession in June 2009.

 

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For the three months ended September 30, 2009, the $14 million of net unrealized appreciation on our private finance portfolio investments was driven by modestly improved narrowing of market yields on debt investments, partially offset by lower performance and credit on a small population of our portfolio. For the nine months ended September 30, 2009, the $695 million of net unrealized depreciation on our private finance portfolio investments was driven primarily by portfolio company performance and credit. The declines related to portfolio company performance and credit for the nine months ended September 30, 2009 was driven mostly by declines in the operating results of certain of our portfolio companies due to the recent global economic recession.

 

European Capital

 

For the three months ended September 30, 2010, we recognized unrealized depreciation of $44 million on our investment in European Capital comprised of $44 million unrealized appreciation on our investment and $88 million of depreciation from foreign currency translation of the cumulative unrealized depreciation of European Capital. For the nine months ended September 30, 2010, we recognized unrealized appreciation of $326 million on our investment in European Capital comprised of $251 million unrealized appreciation on our investment and $75 million of appreciation from foreign currency translation of the cumulative unrealized depreciation of European Capital. As of September 30, 2010, our investment in European Capital consisted of an equity investment with a cost basis and fair value of $1,267 million and $499 million, respectively, and a debt investment with a fair value and cost basis of $12 million.

 

European Capital is an investment fund that invests in and sponsors management and employee buyouts, invests in private equity buyouts and provides capital directly to private and mid-sized public companies primarily in Europe. It primarily invests in senior debt, subordinated debt and equity. European Capital’s underlying portfolio investments are recorded at fair value determined in accordance with U.S. GAAP and by Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements and Disclosures (“ASC 820”). In determining the fair value of our investment in European Capital, we concluded that our wholly-owned equity investment should be less than the NAV of European Capital due to the risks associated with our ability to realize the full fair value of European Capital’s underlying assets for several reasons, including the yield and tenor of European Capital’s credit facilities, recent comparable transactions and public comparables and an implied required market return on equity by market participants, which indicate fair values at a discount to NAV. The unrealized appreciation on our investment of $44 million and $251 million during the three and nine months ended September 30, 2010, respectively, excluding unrealized appreciation/(depreciation) on foreign currency, was due primarily to an increase in the NAV of European Capital and a reduction to the discount applied to NAV.

 

The following is a summary composition of European Capital’s NAV and our equity investment’s implied discount to its NAV as of September 30, 2010 and December 31, 2009 (€ and $ in millions):

 

     September 30, 2010     December 31, 2009  

Debt investments at fair value

   833      1,038   

Equity investments at fair value

     187        174   

Other assets and liabilities, net

     36        94   

Secured debt at cost

     (355     (569

Unsecured debt at cost

     (109     (191

Unsecured debt from American Capital at cost

     (9     (18
                

NAV (Euros)

   583      528   

Exchange rate

     1.36        1.43   
                

NAV (U.S. dollars)

   $ 793      $ 755   
                

Fair value of American Capital equity investment

   $ 499      $ 243   
                

Implied discount to NAV

     37.1     67.8
                

 

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American Capital, LLC

 

American Capital, LLC, a wholly-owned portfolio company of American Capital, is a holding company of wholly-owned third-party fund managers with a cost basis of $66 million and fair value of $87 million as of September 30, 2010. During the three and nine months ended September 30, 2010, we recognized $26 million and $62 million, respectively, of unrealized appreciation on our investment in American Capital, LLC. The funds managed by American Capital, LLC are European Capital, AGNC, ACE I, ACE II and ACAS CLO-1. The appreciation in the fair value of American Capital, LLC for the three and nine months ended September 30, 2010 was primarily due to improved performance of the funds that it manages and an increase in the size of the AGNC investment portfolio.

 

Structured Products

 

American Capital has investments in Structured Products such as investment and non-investment grade tranches of CMBS, CLO and CDO securities with a cost basis of $609 million and fair value of $153 million as of September 30, 2010. During the three and nine months ended September 30, 2010, we recorded $12 million of net unrealized appreciation and $4 million of net unrealized depreciation on our Structured Products investments, respectively. Our CMBS portfolio experienced $1 million of net unrealized appreciation and $21 million of net unrealized depreciation during the three and nine months ended September 30, 2010, respectively. Our CLO and CDO portfolios of commercial loans experienced $11 million and $17 million of net unrealized appreciation during the three and nine months ended September 30, 2010, respectively.

 

Foreign Currency Translation

 

We have a limited amount of investments in portfolio companies, including European Capital, for which the investment is denominated in a foreign currency, primarily the Euro. We also have other assets and liabilities denominated in foreign currencies. Fluctuations in exchange rates therefore impact our financial condition and results of operations, as reported in U.S. dollars. For the three and nine months ended September 30, 2010, we recorded net unrealized appreciation of $141 million and net unrealized depreciation $71 million, respectively, primarily as a result of changes in the Euro and U.S. dollar exchange rates.

 

For foreign currency denominated investments recorded at fair value, such as European Capital, the net unrealized appreciation or deprecation from foreign currency translation on the accompanying consolidated statements of operations represents the economic impact of translating the cost basis of the investment from a foreign currency, such as the Euro, to the U.S. dollar. However, the economic impact of translating the cumulative unrealized appreciation or depreciation from a foreign currency to the U.S. dollar is not recorded as net unrealized depreciation or appreciation from foreign currency translation but rather is included as net unrealized appreciation or depreciation of portfolio company investments on the accompanying consolidated statements of operations. Accordingly, for the three and nine months ended September 30, 2010, we recorded unrealized appreciation of $135 million and unrealized depreciation of $70 million for foreign currency translation, respectively, for the cost basis in our investment in European Capital (included in our total unrealized appreciation of $141 million and total unrealized depreciation of $71 million for foreign currency translation for the three and nine months ended September 30, 2010, respectively), which was partially offset by unrealized depreciation of $88 million and unrealized appreciation of $75 million, respectively, for the foreign currency translation of our cumulative unrealized depreciation of our investment in European Capital which is included in our total net unrealized appreciation of portfolio investments.

 

Derivative and Option Agreements and other

 

During the three and nine months ended September 30, 2010, we recorded $11 million and $15 million of net unrealized depreciation, respectively, from derivative agreements and other, primarily interest rate swaps. The fair value of the net liability for our derivative agreements as of September 30, 2010 was $126 million, which included a $19 million net reduction related to the incorporation of an adjustment for nonperformance risk of us and our counterparties.

 

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During the three and nine months ended September 30, 2009, we recorded $32 million of net unrealized depreciation and $25 million of net unrealized appreciation, respectively, from derivative agreements and other. In addition, during the nine months ended September 30, 2009, we recorded a $49 million reversal of prior period net unrealized depreciation from the termination of the European Capital put option agreement.

 

Return on Shareholders’ Equity

 

The following table summarizes our returns on shareholders’ equity for the last twelve months (“LTM”) and quarter ended September 30, 2010 and 2009:

 

     Period Ended September 30,  
         2010             2009      

LTM net operating income return on average equity at cost

     2.6     2.5

LTM realized loss return on average equity at cost

     (10.9 )%      (6.1 )% 

LTM earnings (loss) return on average equity

     26.9     (90.3 )% 

Current quarter net operating income return on average equity at cost annualized

     4.0     2.1

Current quarter realized loss return on average equity at cost annualized

     (0.6 )%      (2.2 )% 

Current quarter earnings return on average equity annualized

     18.7     15.0

 

Financial Condition, Liquidity and Capital Resources

 

The economic recession and crisis in the global credit markets during the past two years has adversely affected all industry sectors. During this two-year period, we suffered significant net depreciation, higher defaults and losses in many of our investments, and as a result became over levered and defaulted on our primary unsecured borrowing arrangements. In June 2010, we successfully completed a refinancing of our $2.3 billion of outstanding unsecured borrowings. As a part of the refinancing, we repaid $1,030 million of our unsecured obligations and issued $1,307 million of fixed and floating rate secured loans or notes due December 2013 in exchange for the remaining obligations. During the three months ended September 30, 2010, we repaid $200 million of these newly issued loans and notes, thereby reducing the aggregate outstanding balance to $1,107 million as of September 30, 2010. We also granted a lien on substantially all of our existing and hereafter acquired unencumbered assets as collateral for the newly issued loans and notes. The newly issued loans and notes do not have any scheduled amortization requirements until June 30, 2013. See Note 4 to our consolidated interim financial statements included in this Form 10-Q for additional disclosures regarding the exchange transaction.

 

Additionally we believe that the economic recession and global financial crisis has resulted in fewer firms interested in financing assets or businesses, tighter lending standards and reduced access to capital. The economic recession and global financial crisis has contributed to a decline in earnings and/or decline in valuation multiples for our portfolio companies and widened the investment spreads on Structured Products and certain of our private finance debt investments causing decreases in the fair value of these investments during this two-year period. Although we began to experience some signs of stabilization and improvement during the latter part of 2009 and the first nine months of 2010 in the earnings and valuation multiples of our portfolio companies and in the investments spreads on our Structured Products and private finance debt investments, we may experience volatile market swings that could lead to a further decline in earnings and/or decline in valuation multiples for our portfolio companies or could lead to further widening of investment spreads on Structured Products or private finance debt investments causing a further decrease in the fair value of these investments.

 

Currently, our primary sources of liquidity are our cash and cash equivalents and our portfolio investments. As of September 30, 2010, we had $109 million of cash and cash equivalents and $129 million of restricted cash and cash equivalents. Our restricted cash and cash equivalents consists primarily of collections of interest and principal payments on assets that are securitized. In accordance with the terms of the related securitized debt agreements, based on current characteristics of the securitized loan portfolios, the restricted funds are generally

 

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used each quarter to pay interest and principal on the securitized debt and are not distributed to us or available for our general operations. During the three and nine months ended September 30, 2010, we received cash proceeds from the realizations of portfolio investments of $305 million and $819 million, respectively. During the nine months ended September 30, 2010, we principally funded our operations, including our investing activities, from (i) cash receipts from interest, dividend and fee income from our investment portfolio and (ii) cash proceeds from the realization of portfolio investments through the repayments of loan investments and the sale of loan and equity investments.

 

Operating and Investing Cash Flow

 

For the nine months ended September 30, 2010, cash provided by operations was $47 million compared to $120 million of cash provided by operations during the comparable period in 2009. Our cash flow from operations for the nine months ended September 30, 2010 was primarily negatively impacted by a reduction in the recurring cash flow generated from our declining investment portfolio over the comparable period in 2009. Our cash flows provided by operations improved to $48 million during the three months ended September 30, 2010, as compared to the first and second quarters of 2010, primarily due to the completion of our debt refinancing in June 2010 which eliminated debt refinancing costs and reduced interest expense during the three months ended September 30, 2010. One of our other sources of liquidity is our investment portfolio. For the nine months ended September 30, 2010, we received net cash from investing activities totaling $613 million. Included in our cash from investing activities were cash proceeds from the realization of portfolio investments totaling $819 million for the nine months ended September 30, 2010. As of September 30, 2010, we had portfolio investments totaling $5.6 billion at fair value, including $3.4 billion in debt investments, $2.0 billion in equity investments and $0.2 billion in Structured Product investments. Our investments are generally illiquid and no active primary or secondary market for the trading of these investments exists. We are generally repaid our investments upon a change of control event of the portfolio company such as sale or recapitalization of the portfolio company. We currently have several portfolio companies in various stages of the sale process; however, there are no assurances that we will be able to realize proceeds from our investments in the future.

 

Due to the substantial decline in investing in new portfolio investments and the successful efforts in realizing proceeds from many of our investments, our investment portfolio at cost decreased from $10.7 billion as of December 31, 2008 to $8.1 billion as of September 30, 2010. More specifically, our private finance debt portfolio, which is the significant contributor to our operating income and our operating cash flows, decreased from $6.2 billion at cost as of December 31, 2008 to $4.0 billion at cost as of September 30, 2010. As a result of the decrease in our private finance debt portfolio, costs associated with our debt refinancing and the increase in our cost of capital during 2009 and the first nine months of 2010, our operating cash flows decreased from $120 million for the nine months ended September 30, 2009 to $47 million for the nine months ended September 30, 2010. Furthermore, for the three and nine months ended September 30, 2010, approximately $53 million and $167 million, respectively, of interest income collected during the quarter was generated from securitized assets and is included in our cash flow from operations, all of which is currently required to be used to pay interest and principal on the outstanding notes in our securitizations with such principal payments included in our cash flow from financing activities. We believe that we will continue to generate sufficient cash flow through the receipt of interest, dividend and fee payments from our investment portfolio, as well as the disposition of select portfolio investments, to allow us to continue to service our debt, pay our operating costs and expenses, distribute dividends to maintain our status as a regulated investment company (“RIC”) and fund capital to our current portfolio companies. However, there is no certainty that we will generate sufficient liquidity to meet our liquidity needs. In addition to liquidity generated from our investment portfolio, we may elect to raise new capital to generate liquidity to execute our current business strategy or for other corporate purposes.

 

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Debt Capital

 

Our debt obligations consisted of the following as of September 30, 2010 and December 31, 2009:

 

     September 30, 2010      December 31, 2009  

Fixed rate private secured notes due December 2013

   $ 373       $ —     

Floating rate private secured loans due December 2013

     206         —     

Fixed rate public secured notes due December 2013

     524         —     

Floating rate public secured notes due December 2013

     4         —     

Unsecured public debt due August 2012

     11         548   

ACAS Business Loan Trust 2004-1 asset securitization

     130         170   

ACAS Business Loan Trust 2005-1 asset securitization

     541         696   

ACAS Business Loan Trust 2006-1 asset securitization

     310         377   

ACAS Business Loan Trust 2007-1 asset securitization

     225         294   

ACAS Business Loan Trust 2007-2 asset securitization

     193         255   

Unsecured revolving credit facility

     —           1,388   

Unsecured private debt due September 2009

     —           84   

Unsecured private debt due August 2010

     —           134   

Unsecured private debt due February 2011

     —           26   

Unsecured private debt due September 2011

     —           95   

Unsecured private debt due October 2020

     —           75   
                 

Total

   $ 2,517       $ 4,142   
                 

 

The daily weighted average debt balance for the three months ended September 30, 2010 and 2009 was $2,715 million and $4,289 million, respectively. The daily weighted average debt balance for the nine months ended September 30, 2010 and 2009 was $3,575 million and $4,343 million, respectively. The weighted average interest rate on all of our borrowings, including amortization of deferred financing costs, for the three months ended September 30, 2010 and 2009 was 5.3% and 7.9%, respectively. The weighted average interest rate on all of our borrowings, including amortization of deferred financing costs, for the nine months ended September 30, 2010 and 2009 was 5.6 % and 6.0%, respectively. Comparisons to the prior periods of the weighted average interest rate is also impacted by additional interest expense during the three and nine months ended September 30, 2009 for the accrual of a $22 million make-whole interest payment on our unsecured debt that was refinanced in the second quarter of 2010.

 

As a business development company (“BDC”), we are permitted to issue senior debt securities and preferred stock (collectively, “Senior Securities”) in any amounts as long as immediately after such issuance our asset coverage is at least 200%, or equal to or greater than our asset coverage prior to such issuance, after taking into account the payment of debt with proceeds from such issuance. Asset coverage is defined as the ratio which the value of the total assets, less all liabilities and indebtedness not represented by Senior Securities, bears to the aggregate amount of Senior Securities representing indebtedness. However, if our asset coverage is below 200%, we may also borrow amounts up to 5% of our total assets for temporary purposes even if that would cause our asset coverage ratio to further decline. As of September 30, 2010, our asset coverage was 230%. Prior to June 30, 2010, our asset coverage had been below 200% since December 31, 2008.

 

Refinancing Transaction

 

Unsecured Revolving Credit Facility—On June 28, 2010, we amended and restated the credit agreement (“Amended and Restated Credit Agreement”) for our $1.4 billion unsecured revolving credit facility, with Wells Fargo Bank, N.A. as administrative agent, pursuant to which $680 million of our outstanding loans were repaid in cash, and our remaining loans were converted into (i) $277 million of new floating rate secured loans under the Amended and Restated Credit Agreement (“Floating Rate Private Secured Loans”) and (ii) $430 million of new fixed rate secured notes (“Fixed Rate Private Secured Notes”) issued under a new indenture (the

 

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“Indenture,” and together with the Amended and Restated Credit Agreement, the “New Debt Agreements”). We also paid a fee of $14 million, or 2% of the principal balance of the Floating Rate Private Secured Loans and Fixed Rate Private Secured Notes, to the holders of such debt.

 

Unsecured Private Debt—On June 28, 2010, we completed an exchange transaction with the noteholders of $336 million of our unsecured private notes for (i) an aggregate cash payment of $264 million, (ii) $72 million of Fixed Rate Private Secured Notes, and (iii) a fee of $1 million representing 2% of the principal balance of the Fixed Rate Private Secured Notes. We also repaid in full our remaining unsecured private notes for $75 million.

 

Unsecured Public Debt—On June 28, 2010, we completed an exchange transaction with the noteholders of $539 million of our unsecured public notes for (i) an aggregate cash payment of $11 million, (ii) $4 million of new call-protected floating rate secured notes (“Floating Rate Public Secured Notes”) and $524 million of new call-protected fixed rate secured notes (“Fixed Rate Public Secured Notes,” and collectively with the Floating Rate Public Secured Notes, the “New Secured Public Notes”) issued under the Indenture, and (iii) a fee of $11 million representing 2% of the principal balance of the New Secured Public Notes. The remaining $11 million of the original $550 million of unsecured public notes were amended on June 28, 2010 pursuant to a Second Supplemental Indenture to the indenture for the notes to remove substantially all material affirmative and negative covenants, other than the covenant to pay principal and interest on such notes, and to remove certain events of default. All other terms of such notes remain unchanged.

 

The exchange transactions discussed above are accounted for as a modification of debt in accordance with ASC 470-50, Modifications and Extinguishments. Accordingly, the aggregate fees of $26 million paid at closing to the lenders and noteholders were capitalized and are amortized into interest expense over the life of the notes and loans using the effective interest method, while fees paid to other third-party advisors were expensed as incurred. As a result, we recognized $21 million of debt refinancing costs during the nine months ended September 30, 2010 consisting of fees paid to third-party advisors and the writeoff of a portion of the existing unamortized deferred financing costs attributable to the unsecured debt that was repaid in cash.

 

Maturity Date and Optional Redemption—The Floating Rate Private Secured Loans, Fixed Rate Private Secured Notes and New Secured Public Notes (collectively, the “New Secured Debt”) have a final maturity date of December 31, 2013, unless earlier repaid. The Floating Rate Private Secured Loans and Fixed Rate Private Secured Notes may be repaid prior to maturity at our option in whole or in part from time to time at a price equal to 100% of the principal amount repaid, plus accrued and unpaid interest to the payment date. Prior to August 1, 2012, the New Secured Public Notes may be redeemed at our option in whole or in part from time to time (so long as the Floating Rate Private Secured Loans and Fixed Rate Private Secured Notes are no longer outstanding) at a price equal to accrued and unpaid interest on the principal amount being redeemed plus the greater of (i) 100% of the principal amount being redeemed, and (ii) the sum of the present values of the remaining scheduled payments of principal and interest on the principal amount being redeemed discounted to the redemption date on a semi-annual basis at the Adjusted Treasury Rate (as defined in the Indenture for the New Secured Public Notes), plus 30 basis points. Notwithstanding the foregoing, prior to August 1, 2012, the New Secured Public Notes may also be redeemed at our option in whole or in part from time to time at a price equal to 100% of the principal amount being redeemed, plus accrued and unpaid interest to the date of redemption, but without payment of any premium, with Realized Proceeds (as defined in the New Debt Agreements) so long as there are no Floating Rate Private Secured Loans and Fixed Rate Private Secured Notes outstanding.

 

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Scheduled Amortization—The following table sets forth the aggregate scheduled amortization (“Aggregate Scheduled Amortization Amounts”) on the Floating Rate Private Secured Loans and the Fixed Rate Private Secured Notes as of September 30, 2010. The New Secured Public Notes are not subject to amortization or other mandatory redemptions. Under the terms of the New Debt Agreements, we may defer payment of up to $200 million of the Aggregate Scheduled Amortization Amounts prior to June 30, 2013, which payment deferral is reflected in the table below.

 

Date

   Aggregate Scheduled
Amortization

December 31, 2011

   $—  

June 30, 2012

   $—  

December 31, 2012

   $—  

June 30, 2013

   $420

Final Maturity

   Outstanding Balance

 

The Floating Rate Private Secured Loans and Fixed Rate Private Secured Notes are subject to mandatory redemptions including (i) 100% of the net cash flow proceeds of certain debt incurred, (ii) 50% of the net cash flow proceeds of any capital stock issued after June 28, 2012, (iii) an applicable prepayment percentage of any Realized Proceeds, and (iv) an applicable prepayment percentage of Excess Cash Flow (as defined in the New Debt Agreements). However, we are entitled to retain the first $580 million that would otherwise be payable from any cash flow proceeds from debt incurred, capital stock issued, Realized Proceeds or Excess Cash Flow for new investments or other general corporate purposes. The applicable prepayment percentage is 50% if the aggregate outstanding principal amount of the New Secured Debt is greater than or equal to $950 million and 25% if it is less than $950 million. Any above mandatory redemptions will be applied to the payment of the Aggregate Scheduled Amortization Amounts in direct order of maturity.

 

Interest—The Floating Rate Private Secured Loans and Floating Rate Public Secured Notes bear interest at a rate per annum equal to one, two, three or six-month LIBOR, subject to a LIBOR floor of 2% per annum, plus the Applicable Percentage, as defined below, in effect at such time. The Fixed Rate Private Secured Notes and Fixed Rate Public Secured Notes bear interest at 2.46% per annum, plus the Applicable Percentage in effect at the time. The applicable percentage (“Applicable Percentage”) is 6.50% when the aggregate outstanding amount of the New Secured Debt is greater than or equal to $1 billion and 5.50% when the aggregate outstanding amount is less than $1 billion. As of September 30, 2010, the aggregate outstanding amount of the New Secured Debt was $1,107 million.

 

In addition, the Applicable Percentage for the New Secured Debt will increase by an additional 0.50% per annum if we fail to pay any of the minimum amortization amounts (“Aggregate Penalty Amortization Amounts”) on the Floating Rate Private Secured Loans and Fixed Rate Private Secured Notes set forth in the table below when due (on a cumulative basis for each failure, if applicable), for each succeeding day until any unpaid Aggregate Penalty Amortization Amounts have been paid.

 

Date

   Aggregate Penalty
Amortization

December 31, 2011

   $—  

June 30, 2012

   $—  

December 31, 2012

   $270

June 30, 2013

   $309

 

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The following table sets forth the interest rates on our outstanding secured borrowing arrangements as of September 30, 2010:

 

Facility

   Interest
Rate
 

Fixed rate private secured notes due December 2013

     8.96

Floating rate private secured loans due December 2013

     8.50

Fixed rate public secured notes due December 2013

     8.96

Floating rate public secured notes due December 2013

     8.50

 

Fees—We are required to pay an extension fee in an amount equal to 1% of the aggregate principal amount of the New Secured Debt outstanding on each of December 30, 2011 and December 31, 2012, payable on such date.

 

Security and Ranking—The New Secured Debt is a senior obligation of the company and is secured by a first priority lien (subject to certain permitted liens) on substantially all of our non-securitized assets. The cost basis and fair value of the investment collateral securing the New Secured Debt consisted of the following as of September 30, 2010 (in millions):

 

     Cost Basis      Fair Value  

Senior debt

   $ 963       $ 682   

Subordinated debt

     984         792   

Preferred equity

     1,522         1,058   

Common equity

     1,843         869   

Equity warrants

     92         70   

Structured Products

     596         151   
                 

Total investment collateral

   $ 6,000       $ 3,622   
                 

Total investment non-collateral

   $ 8,142       $ 5,566   
                 

 

Covenants—The financial covenants under the New Debt Agreements include (i) maintenance of a minimum ratio of adjusted operating cash flow to interest expense and (ii) a minimum ratio of pledged assets to secured debt, tested on a quarterly basis. Additional covenants include (i) restrictions on the incurrence of certain additional debt, (ii) restrictions on acquisitions and investments, and (iii) restrictions on the payments of dividends and other distributions. However, we are permitted under the New Debt Agreements to pay dividends to the extent necessary in order to maintain our RIC status provided that such dividends are paid in additional shares of our common stock to the extent allowed by IRS Revenue Procedure 2010-12. There are no limitations in the New Debt Agreements on our payment of cash dividends provided that (i) we maintain an asset coverage ratio of at least 200% as required by the 1940 Act, (ii) we are in pro forma compliance with all financial covenants under the New Debt Agreements, (iii) there are no defaults outstanding under the New Debt Agreements, and (iv) the aggregate principal amount of the New Secured Debt outstanding is less than or equal to $1.4 billion. As of September 30, 2010, we were in compliance with all of the covenants under the New Debt Agreements.

 

Securitizations

 

As of September 30, 2010, we were in compliance with all of the covenants for our asset securitizations. Under the terms of each of our asset securitizations, if any loan collateral in each trust becomes a defaulted loan (as defined in each indenture for the respective asset securitization), all interest and principal collections that would be applied to the subordinated notes retained by us are used to sequentially pay down the principal of the notes that are generally held by third-party institutional investors in an amount equal to the principal amount of the defaulted loan collateral. As of September 30, 2010, there was defaulted loan collateral in each of the asset securitization trusts and therefore all interest and principal collections that would have been applied to the

 

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subordinated notes retained by us will continue to be applied sequentially to pay down the principal of the notes generally held by third-party institutional investors in an amount equal to the principal amount of the defaulted loan collateral. As of September 30, 2010, our asset securitizations, which have an outstanding balance of $1.4 billion, are secured by portfolio investments and assets with a fair value of approximately $2.1 billion.

 

Derivative Agreements

 

We enter into interest rate swap agreements to manage interest rate risk and also to fulfill our obligations under the terms of our asset securitizations. We also enter into foreign exchange swap agreements to manage foreign currency risk. We do not hold or issue derivative financial instruments for speculative purposes. All interest rate and foreign currency swap agreements are recorded at fair value with changes in value reflected in net unrealized appreciation or depreciation of investments during the reporting period. The fair value of the interest rate swap agreements is based on the estimated net present value of the future cash flows using the forward interest rate yield curve in effect at the end of the period, adjusted for the nonperformance risk of us and our counterparties.

 

We have interest rate swap agreements where we generally pay a fixed rate and receive a floating rate based on LIBOR. We also may enter into interest rate swaption agreements where, if exercised, we pay a floating rate based on LIBOR and receive a fixed rate. The fair value of our interest rate and foreign currency swap agreements are identified as separate items on our consolidated balance sheets and are described in the accompanying consolidated schedules of investments.

 

As of September 30, 2010, we had derivative agreements, primarily interest rate swap agreements, that had a net fair value liability of $126 million. Certain of our interest rate swap agreements allow the counterparty to terminate the transactions under certain conditions. As of September 30, 2010, none of the counterparties had the right to terminate the agreements.

 

Equity Capital

 

As a BDC, we are generally not able to issue and sell our common stock at a price below our NAV per share, exclusive of any distributing commission or discount, without either shareholder approval or providing all shareholders a right to participate in the issuance of stock below NAV. As of September 30, 2010, our NAV per share was $9.59 per share and our closing market price was $5.81 per share. On February 12, 2010, our shareholders approved a proposal to authorize us to sell shares of our common stock at prices below the NAV per share in one or more offerings subject to certain limitations, including the prior approval of our Board of Directors. The authorization is effective for a twelve month period expiring on February 12, 2011 and the number of shares that may be issued below NAV per share is limited to 58,324,930 shares of common stock, which was 20% of the number of shares outstanding as of the record date for the shareholder vote of the proposal, subject to adjustment for shares issued following the occurrence of events such as stock splits, stock dividends, distributions and recapitalizations.

 

In April 2010, we completed a registered direct offering of 58,300,000 shares of our common stock to a group of institutional investors at a price of $5.06 per share. Upon completion of the offering, we received gross proceeds of approximately $295 million. As such, except as noted above, we presently have the authority to only issue 24,930 additional shares of common stock below our NAV per share.

 

Future Distribution Requirements

 

If we qualify as a RIC and annually distribute to our shareholders in a timely manner at least 90% of our taxable ordinary income, we will not be subject to federal income tax on the portion of our taxable ordinary income and long-term capital gains we distribute to our shareholders. As permitted by the Code, a RIC can designate dividends paid in the subsequent tax fiscal year as dividends of current year ordinary income and net

 

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long-term gains if those dividends are both declared by the extended due date of the RIC’s federal income tax return and paid to shareholders by the last day of the subsequent tax fiscal year. We have a tax fiscal year that ends on September 30. We intend to continue to distribute sufficient dividends to eliminate our taxable income. However, we may elect to not distribute sufficient dividends to eliminate all of our taxable income so long as we distribute at least 90% of our taxable ordinary income in order to maintain our qualification as a RIC. To the extent we maintain our qualification as a RIC but do not distribute all of our taxable income, we would be subject to federal income tax on such undistributed amounts. For our tax fiscal year ended September 30, 2009, we do not have any remaining undistributed ordinary taxable income. For our tax fiscal year ended September 30, 2010, we expect to have a taxable ordinary loss and a net long-term capital loss.

 

For any tax fiscal years ending on or before December 31, 2011, we can fulfill our distribution requirements by distributing up to 90% of a declared dividend in the form of our common stock. In order to utilize this option, we must allow each shareholder to elect to receive his or her entire distribution in either cash or our stock subject to a limitation on the aggregate amount of cash to be distributed to all shareholders, which must be at least 10% of the aggregate declared distribution. If too many shareholders elect to receive cash, each shareholder electing to receive cash will receive a pro rata amount of cash (with the balance of the distribution paid in stock). In no event will any shareholder electing to receive cash receive less than 10% of his or her entire distribution in cash.

 

Commitments

 

As of September 30, 2010, we had commitments under loan and financing agreements to fund up to $205 million to 36 portfolio companies, with $41 million of the commitments related to undrawn revolving credit facilities for European Capital (see Note 11 to our consolidated interim financial statements in this Form 10-Q). These commitments are primarily composed of working capital credit facilities, acquisition credit facilities and subscription agreements. The commitments are generally subject to the borrowers meeting certain criteria such as compliance with covenants and availability under borrowing base thresholds. The terms of the borrowings and financings subject to commitment are comparable to the terms of other loan and equity securities in our portfolio.

 

Portfolio Credit Quality

 

We stop accruing interest on our investments when it is determined that interest is no longer collectible. Our valuation analysis serves as a critical piece of data in this determination. A significant change in the portfolio company valuation assigned by us could have an effect on the amount of our loans on non-accrual status. As of September 30, 2010, loans on non-accrual status for 32 portfolio companies had a cost basis of $746 million and had a fair value of $265 million.

 

As of September 30, 2010 and December 31, 2009, current loans, past due accruing loans and loans on non-accrual status were as follows (dollars in millions):

 

     September 30, 2010     December 31, 2009  

Current

   $ 3,074      $ 3,572   
                

0 - 30 days past due

     102        38   

31 - 60 days past due

     —          —     

61 - 90 days past due

     —          —     

Greater than 90 days past due

     50        50   
                

Total past due accruing loans at cost

     152        88   

Non-accruing loans at cost

     746        811   
                

Total loans at cost

   $ 3,972      $ 4,471   
                

Non-accruing loans at fair value

   $ 265      $ 290   
                

Total loans at fair value

   $ 3,378      $ 3,729   
                

Non-accruing loans at cost as a percent of total loans at cost

     18.8     18.1
                

Non-accruing loans at fair value as a percent of total loans at fair value

     7.8     7.8
                

 

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We believe that debt service collection is probable for our loans that are past due. Non-accruing loans at cost decreased $65 million from December 31, 2009 to September 30, 2010 primarily due to approximately $70 million of loan write-offs and exits, approximately $115 million of loans removed from non-accrual status due to improved portfolio company performance and $77 million of debt-to-equity recapitalizations during the period partially offset by approximately $175 million in loans placed on non-accrual status due to weaker portfolio company performance and an approximate $15 million increase in cost basis of existing loans on non-accrual status.

 

During the second and third quarters of 2010, no portfolio companies were recapitalized that involved exchanging our loans for equity securities. During the first quarter of 2010, three portfolio companies were recapitalized that included exchanging our loans for preferred or common equity securities that had a cost basis of $77 million and a fair value of $6 million.

 

Credit Statistics

 

We monitor several key credit statistics that provide information about credit quality and portfolio performance. These key statistics include:

 

   

Debt to EBITDA Ratio—the sum of all debt with equal or senior security rights to our debt investments divided by the total adjusted earnings before interest, taxes, depreciation and amortization, or EBITDA, of the most recent twelve months or, when appropriate, the forecasted twelve months.

 

   

Interest Coverage Ratio—EBITDA divided by the total scheduled cash interest payments required to have been made by the portfolio company during the most recent twelve-month period, or when appropriate, the forecasted twelve months.

 

   

Debt Service Coverage Ratio—EBITDA divided by the total scheduled principal amortization and the total scheduled cash interest payments required to have been made during the most recent twelve-month period, or when appropriate, the forecasted twelve months.

 

We generally require our portfolio companies to provide annual audited and monthly or quarterly unaudited financial statements. Using these financial statements, we calculate the statistics described above. Buyout and subordinated funds typically adjust EBITDA due to the nature of change of control transactions. Such adjustments are intended to normalize and restate EBITDA to reflect the pro forma results of a company in a change of control transaction. For purposes of analyzing the financial performance of our portfolio companies, we make certain adjustments to EBITDA to reflect the pro forma results of a company consistent with a change of control transaction in addition to adjusting EBITDA for significant non-recurring, unusual or infrequent items. Adjustments to EBITDA may include anticipated cost savings resulting from a merger or restructuring, costs related to new product development, compensation to previous owners, non-recurring revenues or expenses, and other acquisition or restructuring related items.

 

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We track our portfolio investments on a static pool basis, including based on the statistics described above. A static pool consists of the investments made during a given year. The static pool classification is based on the year the initial investment was made. Subsequent add-on investments are included in the static pool year of the original investment. The Pre-2001 static pool consists of the investments made from the time of our initial public offering (“IPO”) through the year ended December 31, 2000. The following table contains a summary of portfolio statistics as of and for the period ended September 30, 2010:

 

    Static Pool (1)  

Portfolio Statistics ($ in millions, unaudited)

  Pre-2001     2001     2002     2003     2004     2005     2006     2007     2008     2009     2010     Pre-2001 - 2010
Aggregate
    2005 - 2010
Aggregate
 

IRR at Fair Value of All Investments(2)

    8.1     18.1     8.3     20.4     13.3     6.8     8.4     -9.9     3.6     —          —          5.7     1.4

IRR of Exited Investments(5)

    8.6     20.3     9.1     23.4     17.1     21.9     10.1     -10.1     -74.9     —          —          11.6     8.5

IRR at Fair Value of Equity Investments Only(2)(3)(4)

    6.0     46.9     11.5     27.4     27.1     -2.8     13.4     -16.2     5.2     —          —          4.3     -1.8

IRR of Exited Equity Investments Only(3)(4)(5)

    8.5     48.8     18.3     32.2     43.0     47.3     18.9     8.2     69.0     —          —          26.3     27.7

Original Investments and Commitments

  $ 1,065      $ 376      $ 962      $ 1,436      $ 2,266      $ 4,643      $ 5,188      $ 7,409      $ 1,036      $ —        $ —        $ 24,381      $ 18,276   

Total Exits and Prepayments of Original Investments and Commitments

  $ 998      $ 353      $ 757      $ 1,083      $ 1,830      $ 2,355      $ 3,521      $ 3,622      $ 55      $ —        $ —        $ 14,574      $ 9,553   

Total Interest, Dividends and Fees Collected

  $ 451      $ 148      $ 345      $ 423      $ 629      $ 1,015      $ 977      $ 974      $ 226      $ —        $ —        $ 5,188      $ 3,192   

Total Net Realized (Loss) Gain on Investments

  $ (128   $ (4   $ (90   $ 142      $ 27      $ 279      $ (103   $ (695   $ (50   $ —        $ —        $ (622   $ (569

Current Cost of Investments

  $ 82      $ 23      $ 202      $ 340      $ 468      $ 2,050      $ 1,332      $ 2,830      $ 815      $ —        $ —        $ 8,142      $ 7,027   

Current Fair Value of Investments

  $ 32      $ 3      $ 148      $ 417      $ 356      $ 1,283      $ 1,098      $ 1,544      $ 685      $ —        $ —        $ 5,566      $ 4,610   

Current Fair Value of Investments as a % of Total Investments at Fair Value

    0.6     0.1     2.6     7.5     6.4     23.1     19.7     27.7     12.3     —          —          100.0     82.8

Net Unrealized Appreciation (Depreciation)

  $ (50   $ (20   $ (54   $ 77      $ (112   $ (767   $ (234   $ (1,286   $ (130   $ —        $ —        $ (2,576   $ (2,417

Non-Accruing Loans at Cost

  $ —        $ 13      $ 28      $ —        $ 47      $ 70      $ 128      $ 438      $ 22      $ —        $ —        $ 746      $ 658   

Non-Accruing Loans at Fair Value

  $ 1      $ 2      $ 21      $ —        $ 16      $ 71      $ 54      $ 74      $ 26      $ —        $ —        $ 265      $ 225   

Equity Interest at Fair Value(3)

  $ 7      $ —        $ 7      $ 184      $ 72      $ 822      $ 415      $ 318      $ 210      $ —        $ —        $ 2,035      $ 1,765   

Debt to EBITDA(6)(7)(8)(12)

    4.4        NM        7.4        3.9        6.0        5.1        5.2        6.7        5.5        —          —          5.7        5.8   

Interest Coverage(6)(8)(12)

    2.3        NM        1.5        3.5        2.1        3.5        2.8        2.1        1.7        —          —          2.5        2.5   

Debt Service Coverage(6)(8)(12)

    2.2        NM        1.3        3.3        1.6        2.8        2.0        1.8        1.6        —          —          2.1        2.0   

Average Age of Companies(8)(12)

    42 yrs        25 yrs        53 yrs        40 yrs        45 yrs        29 yrs        35 yrs        31 yrs        25 yrs        —          —          33 yrs        31 yrs   

Diluted Ownership Percentage(3)(12)

    63     86     37     52     44     66     41     44     41     —          —          49     49

Average Sales(8)(9)(12)

  $ 44      $ 6      $ 53      $ 199      $ 104      $ 105      $ 148      $ 206      $ 101      $ —        $ —        $ 151      $ 155   

Average EBITDA(8)(10)(12)

  $ 5      $ (1   $ 10      $ 40      $ 25      $ 21      $ 35      $ 40      $ 29      $ —        $ —        $ 33      $ 34   

Average EBITDA Margin(12)

    11.4     -16.7     18.9     20.1     24.0     20.0     23.6     19.4     28.7     —          —          21.9     21.9

Total Sales(8)(9)

  $ 79      $ 296      $ 177      $ 1,325      $ 842      $ 1,266      $ 5,397      $ 8,192      $ 1,294      $ —        $ —        $ 18,868      $ 16,149   

Total EBITDA(8)(10)

  $ 8      $ 5      $ 21      $ 198      $ 167      $ 237      $ 665      $ 1,574      $ 258      $ —        $ —        $ 3,133      $ 2,734   

% of Senior Loans(8)(11)

    72     33     55     61     40     36     31     59     26     —          —          45     43

% of Loans with Lien(8)(11)

    100     68     100     100     90     90     93     93     61     —          —          90     88

 

(1) Static pool classification is based on the year the initial investment was made. Subsequent add-on investments are included in the static pool year of the original investment.
(2) Assumes investments are exited at current fair value.
(3) Excludes investments in Structured Products.
(4) Excludes equity investments that are the result of conversions of debt and warrants received with the issuance of debt.
(5) Includes exited securities of existing portfolio companies.
(6) These amounts do not include investments in which we own only equity.
(7) For portfolio companies with a nominal EBITDA amount, the portfolio company’s maximum debt leverage is limited to 15 times EBITDA.
(8) Excludes investments in Structured Products, managed funds and American Capital, LLC.
(9) Sales of the most recent twelve months, or when appropriate, the forecasted twelve months.
(10) EBITDA of the most recent twelve months, or when appropriate, the forecasted twelve months.
(11) As a percentage of our total debt investments.
(12) Weighted average based on fair values.

 

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FORWARD-LOOKING STATEMENTS

 

All statements contained herein that are not historical facts including, but not limited to, statements regarding anticipated activity are forward looking in nature and involve a number of risks and uncertainties. Actual results may differ materially. Among the factors that could cause actual results to differ materially are the following: (i) changes in the economic conditions in which we operate negatively impacting our financial resources; (ii) certain of our competitors have greater financial resources than us reducing the number of suitable investment opportunities offered to us or reducing the yield necessary to consummate the investment; (iii) there is uncertainty regarding the value of our privately held securities that require our good faith estimate of fair value, and a change in estimate could affect our net asset value; (iv) our investments in securities of privately-held companies may be illiquid which could affect our ability to realize a gain; (v) our portfolio companies could default on their loans or provide no returns on our investments which could affect our operating results; (vi) we are dependent on external financing to fund our business; (vii) our ability to retain key management personnel; (viii) a continued economic downturn or recession could further impair our portfolio companies and therefore harm our operating results; (ix) our borrowing arrangements impose certain restrictions; (x) changes in interest rates may affect our cost of capital and net operating income; (xi) we cannot incur additional indebtedness unless immediately after a debt issuance we maintain an asset coverage of at least 200%, or equal to or greater than our asset coverage prior to such issuance, which may affect returns to our shareholder; (xii) we may fail to continue to qualify for our pass-through treatment as a RIC, which could have an effect on shareholder return; (xiii) our common stock price may be volatile;; and (xiv) general business and economic conditions and other risk factors described in our reports filed from time to time with the SEC. We caution readers not to place undue reliance on any such forward-looking statements, which statements are made pursuant to the Private Securities Litigation Reform Act of 1995 and, as such, speak only as of the date made.

 

Item 3. Quantitative and Qualitative Disclosure About Market Risk

 

In the context of Item 3, market risk refers to the risk of loss arising from adverse changes in financial and derivative instrument market rates and prices, such as fluctuations in interest rates and currency exchange rates. For a discussion of sensitivity analysis related to these types of market risks, refer to Part II, Item 7A, Quantitative and Qualitative Disclosures About Market Risk, in our Annual Report on Form 10-K for the year ended December 31, 2009. We believe that there have been no material changes in these market risks since December 31, 2009.

 

Interest Rate Risk

 

As of September 30, 2010, after adjusting for the use of interest rate swaps, 24%, or $1.0 billion of principal, of our debt investments provided fixed rate returns and 76%, or $3.3 billion of principal, provided floating rate returns tied primarily to LIBOR. Excluding debt investments on non-accrual status, 16%, or $0.5 billion of principal, of our accruing debt investments provided fixed rate returns and 84%, or $2.7 billion of principal, provided floating rate returns tied primarily to LIBOR. As of September 30, 2010, we had total borrowings outstanding of $1.6 billion that had a variable rate of interest based on LIBOR, the prime rate or the federal funds rate.

 

Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Securities Exchange Act of 1934, as amended (the “Exchange Act”) reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based on the definition of “disclosure controls and procedures” as promulgated under the Exchange Act, as amended. In

 

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designing and evaluating the disclosure controls and procedures, management recognized 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 necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

 

American Capital, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2010. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective.

 

Changes in Internal Control over Financial Reporting

 

There were no significant changes in our internal controls over financial reporting or in other factors that could significantly affect the internal controls over financial reporting during the third quarter of 2010.

 

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PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

 

We and certain of our executive officers are defendants in a purported class action lawsuit in the United States District Court for the District of Maryland styled as Klugmann v. American Capital, Ltd., et al. The lawsuit was filed on behalf of the purchasers of our common stock between October 31, 2007 and November 7, 2008, and alleges violations of Sections 10(b) and 20A of the Exchange Act and Rule 10b-5 promulgated thereunder, violations of Sections 11 and 12(a)(2) of the Securities Act of 1933, as amended, and in the case of the individual defendants, the control person provisions of the Exchange Act. The factual assertions in the complaint consist primarily of the allegation that the defendants made incorrect statements related to our dividend policy and our revision of that policy to suspend dividends for the fourth quarter of 2008. The complaint seeks unspecified damages, costs and expenses. On June 14, 2010, the court denied the defendants’ motion to dismiss the matter, without prejudice. We intend to contest the matter vigorously.

 

Item 1A. Risk Factors

 

You should carefully consider the risks described below and all other information contained in this quarterly report on Form 10-Q, including our interim financial statements and the related notes thereto before making a decision to purchase our securities. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties not presently known to us, or not presently deemed material by us, may also impair our operations and performance.

 

If any of the following risks actually occur, our business, financial condition or results of operations could be materially adversely affected. If that happens, the trading price of our securities could decline, and you may lose all or part of your investment. The description below includes any material changes to, and supersedes the description of, the risk factors affecting our business previously disclosed in “Part I, Item 1A. Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2009.

 

Risks Related to Our Business and Structure

 

We have been impacted by a period of credit and capital markets disruption and recession

 

There have been traumatic developments in the financial markets worldwide over the past two years which have led to a recession in the U.S. and other countries. We have been adversely affected by these conditions. The recession and global financial crisis has limited our access to the debt and equity capital markets and resulted in significant depreciation of our investment portfolio and overleveraging of our balance sheet. The market disruption and liquidity crisis has also dramatically reduced the volume of mergers and acquisitions in the market place affecting our ability to continue to generate additional liquidity through sales of portfolio investments. Thus, we expect to continue to face significant challenges and uncertainties that could materially adversely affect our business, financial condition, and prospects.

 

Our business has significant capital requirements and may be adversely affected by a prolonged inability to access the capital markets or to sell assets

 

Our business requires a substantial amount of capital to operate. We historically have financed our operations, including the funding of new investments, through cash generated by our operating activities, secured and unsecured borrowings, the sale of investments, the sale of debt by special purpose affiliates to which we have contributed loan assets originated by us, and the sale of our equity. Our ability to continue to rely on such sources or other sources of capital is affected by restrictions in the 1940 Act and in certain of our debt agreements relating to the incurrence of additional indebtedness and the changes in the capital markets from the financial crisis. It is also affected by legal, structural and other factors. There can be no assurance that we will be able to access the funds necessary for our liquidity requirements.

 

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The economic recession has adversely affected our business and a continuation of the adverse market and economic conditions could cause further harm to our operating results

 

The economic recession had a significant negative impact on the fair value of our portfolio investments evidenced by the significant net unrealized depreciation on our portfolio investments during 2008 and 2009. In addition, many of our portfolio companies are susceptible to the current economic downturn and may be unable to repay our debt investments, may be unable to be sold at a price that we could recover our investment, or even continue to operate during such periods. As a result, since the beginning of the economic recession, our non-performing assets have increased and may continue to increase and the value of our portfolio has decreased and may continue to decrease during an economic downturn. Our ability to obtain capital to invest in existing and new portfolio investments has also been impaired by the economic downturn. These results could have a material adverse effect on our business, financial condition and results of operations.

 

We have loans to and investments in middle market borrowers who may default on their loans or provide no return on our investments

 

We have invested in and made loans to privately-held, middle market businesses. There is generally no publicly available information about these businesses. Therefore, we rely on our principals, associates, analysts and consultants to investigate and monitor these businesses. The portfolio companies in which we have invested may have significant variations in operating results, may from time to time be parties to litigation, may be engaged in rapidly changing businesses with products subject to a substantial risk of obsolescence, may require substantial additional capital to support their operations, to finance expansion or to maintain their competitive position, may otherwise have a weak financial position or may be adversely affected by changes in the business cycle. Our portfolio companies may not meet net income, cash flow and other coverage tests typically imposed by senior lenders. Numerous factors may affect a portfolio company’s ability to repay its loan, including the failure to meet its business plan, a downturn in its industry or negative economic conditions. Deterioration in a portfolio company’s financial condition and prospects may be accompanied by deterioration in the collateral for the loan. We have also made unsecured and subordinated loans and invested in equity securities, which involve a higher degree of risk than senior loans. In certain cases, our involvement in the management of our portfolio companies may subject us to additional defenses and claims from borrowers and third parties. These conditions may make it difficult for us to obtain repayment of our investments.

 

Middle market businesses typically have narrower product lines and smaller market shares than large businesses. They tend to be more vulnerable to competitors’ actions and market conditions, as well as general economic downturns. In addition, these companies may face intense competition, including competition from companies with greater financial resources, more extensive development, manufacturing, marketing, and other capabilities, and a larger number of qualified managerial and technical personnel.

 

These businesses may also experience substantial variations in operating results. Typically, the success of a middle market business also depends on the management talents and efforts of one or two persons or a small group of persons. The death, disability or resignation of one or more of these persons could have a material adverse impact on us. In addition, middle market businesses often need substantial additional capital to expand or compete and will have borrowed money from other lenders with claims that are senior to us.

 

Our senior loans generally are secured by the assets of our borrowers, however certain of our senior loans may have a second priority lien and thus, our security interest may be subordinated to the payment rights and security interest of the first lien senior lender. Additionally, our subordinated loans may or may not be secured by the assets of the borrower; however, if a subordinated loan is secured, our rights to payment and our security interest are usually subordinated to the payment rights and security interests of the first lien and second lien senior lenders. Therefore, we may be limited in our ability to enforce our rights to collect our second lien senior loans or subordinated loans and to recover any of the loan balance through a foreclosure of collateral.

 

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There is uncertainty regarding the value of our portfolio investments

 

A substantial portion of our portfolio investments are not publicly traded. As required by law, we fair value these investments in accordance with the 1940 Act and ASC 820 based on a determination made in good faith by our Board of Directors. Due to the uncertainty inherent in valuing investments that are not publicly traded, as set forth in our consolidated financial statements, our determinations of fair value may differ materially from the values that would exist if a ready market for these investments existed. Our determinations of the fair value of our investments have a material impact on our net earnings through the recording of unrealized appreciation or depreciation of investments as well as our assessment of income recognition. Thus, our NAV could be materially affected in the event of any changes in applicable law or accounting pronouncements governing how we currently fair value assets, or if our determinations regarding the fair value of our investments are materially different from the values that would exist if a ready market existed for these securities.

 

We may fail to continue to qualify for our pass-through tax treatment

 

We operate so as to qualify to be taxed as a RIC under Subchapter M of the Code and, provided we meet certain requirements under the Code, we can generally avoid corporate level federal income taxes on income distributed to our shareholders as dividends. We would cease to qualify for this favorable pass-through tax treatment if we are unable to comply with the source of income, asset diversification or distribution requirements contained in Subchapter M of the Code, or if we cease to operate so as to qualify as a BDC under the 1940 Act. There is a risk that we will continue to sell select investments in order to delever our balance sheet over the next several years, and if so, a smaller investment portfolio may make it difficult for us to continue to meet the source of income or asset diversification requirements in order to maintain our qualification as a RIC.

 

If we fail to qualify to be taxed as a RIC or to distribute our income to shareholders on a current basis, we would be subject to corporate level taxes which would significantly reduce the amount of income available for distribution to our shareholders. The loss of our RIC qualification could have a material adverse effect on the total return, if any, obtainable from an investment in our common stock.

 

A change in interest rates may adversely affect our profitability

 

Because we have funded a portion of our investments with borrowings, our net increase in assets from operations is affected by the spread between the rate at which we have invested and the rate at which we borrowed. We have attempted to match-fund our liabilities and assets by financing floating rate assets with floating rate liabilities and fixed rate assets with fixed rate liabilities or equity. We have entered into interest rate basis swap agreements to match the interest rate basis of our assets and liabilities, thereby locking in the spread between our asset yield and the cost of our borrowings, and to fulfill our obligations under the terms of our asset securitizations. However, our derivatives are considered economic hedges that do not qualify for hedge accounting under ASC Topic 815, Derivatives and Hedging (“ASC 815”).

 

Under our interest rate swap agreements, we generally pay a fixed rate and receive a floating interest rate based on LIBOR. We may enter into interest rate swaption agreements where, if exercised, we would receive a fixed rate and pay a floating rate based on LIBOR. We may also enter into interest rate cap agreements that would entitle us to receive an amount, if any, by which our interest payments on our variable rate debt exceed specified interest rates.

 

An increase or decrease in interest rates could reduce the spread between the rate at which we invest and the rate at which we borrow, and thus, adversely affect our profitability, if we have not appropriately match-funded our liabilities and assets or hedged against such event. Alternatively, our interest rate hedging activities may limit our ability to participate in the benefits of lower interest rates with respect to the hedged portfolio.

 

Also, the fair value of certain of our debt investments is based in part on the current market yields or interest rates of similar securities. A change in interest rates could have a significant impact on our determination of the fair value of these debt investments. In addition, a change in interest rates could also have an impact on the fair

 

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value of our interest rate swap agreements that could result in the recording of unrealized appreciation or depreciation in future periods. For example, a decline, or a flattening, of the forward interest rate yield curve will typically result in the recording of unrealized depreciation of our interest rate swap agreements.

 

Therefore, adverse developments resulting from changes in interest rates could have a material adverse effect on our business, financial condition and results of operations. See “Management’s Discussion And Analysis Of Financial Condition And Results Of Operations—Quantitative and Qualitative Disclosures About Market Risk” and “Financial Statements and Supplementary Data” for additional information on interest rate swap agreements.

 

A change in currency exchange rates may adversely affect our profitability

 

We have or may make investments in debt instruments that are denominated in currencies other than the U.S. dollar. In addition, we have or may make investments in the equity of portfolio companies whose functional currency is not the U.S. dollar. Our domestic portfolio companies may also transact a significant amount of business in foreign countries and therefore their profitability may be impacted by changes in foreign currency exchange rates. The functional currency of our largest portfolio company, European Capital, is the Euro. European Capital also has investments in other European currencies, including the British Pound. As a result, an adverse change in currency exchange rates may have a material adverse impact on our business, financial condition and results of operations.

 

We may experience fluctuations in our quarterly results

 

We have and could experience further fluctuations in our quarterly operating results due to a number of factors including, among others, variations in and the timing of the recognition of realized and unrealized gains or losses, the degree to which we encounter competition in our markets, the ability to sell investments at attractive terms, the ability to fund and close suitable investments, the timing of the recognition of fee income from closing investment transactions and general economic conditions. As a result of these factors, results for any period should not be relied upon as being indicative of performance in future periods. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

We are dependent upon our key management personnel for our future success

 

We are dependent on the diligence and skill of our senior management and other members of management for raising capital and the selection, structuring, monitoring, restructuring/amendment and sale of our investments. Our future success depends to a significant extent on the continued service and coordination of our senior management and other members of management. Due to such factors as limitations on our ability to raise capital for new investments, it may be difficult to retain such individuals. The departure of certain executive officers or key employees could materially adversely affect our ability to implement our business strategy. We do not maintain key man life insurance on any of our officers or employees.

 

We operate in a highly competitive market for investment opportunities

 

We compete with hundreds of private equity and subordinated funds and other financing sources, including traditional financial services companies such as finance companies, commercial banks, investment banks and other equity and non-equity based investment funds. Some of our competitors are substantially larger and have considerably greater financial resources than us. Competitors may have lower cost of funds and many have access to funding sources that are not available to us. In addition, certain of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships and build their market shares. There is no assurance that the competitive pressures we face will not have a material adverse effect on our business, financial condition and results of operations. In addition, as a result of this competition, we may not be able to take advantage of attractive investment opportunities from time to time and there can be no assurance that we will be able to identify and make investments that satisfy our investment objectives or that we will be able to meet our investment goals.

 

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Changes in laws or regulations governing our operations or our failure to comply with those laws or regulations may adversely affect our business

 

We and our portfolio companies are subject to regulation by laws at the local, state, federal and foreign level, including with respect to securities laws, tax and accounting standards. These laws and regulations, as well as their interpretation, may be changed from time to time. Accordingly, any change in these laws or regulations or the failure to comply with these laws or regulations could have a material adverse impact on our business. Certain of these laws and regulations pertain specifically to RICs or BDCs.

 

We could face losses and potential liability if intrusions, viruses or similar disruptions to our technology jeopardize our confidential information or that of users of our technology

 

Although we have implemented, and will continue to implement, security measures, our technology platform is and will continue to be vulnerable to intrusion, computer viruses or similar disruptive problems caused by transmission from unauthorized users. In addition, any misappropriation of proprietary information could expose us to a risk of loss or litigation.

 

Risks Related to Liquidity and Capital Resources

 

Our secured borrowing arrangements impose significant limitations on us

 

New Secured Debt. As of September 30, 2010, we had $206 million of floating rate secured loans under our term facility with Citicorp North America, Inc., as administrative agent (the “Credit Facility”), and $901 million of fixed and floating rate secured notes, issued under an indenture with Wilmington Trust FSB, as trustee (collectively, the “New Secured Debt”). Certain tranches of the secured notes are call-protected and except under certain circumstances, may only be redeemed by us prior to August 1, 2012 with a penalty. The remaining secured loans and notes have scheduled amortization and are subject to mandatory redemptions with proceeds from new debt and equity issuances, realized proceeds and excess cash flow. As a result, our ability to utilize our excess cash flow, investment sale proceeds or capital raising proceeds for reinvestment purposes is limited.

 

Our New Secured Debt imposes additional covenants upon us, including a limitation on our ability to enter into new debt financing, pay cash dividends, dispose of assets and fund new investments. In addition, we will have to maintain the following financial covenants: a minimum ratio of operating cash flow to interest expense and a minimum ratio of pledged assets to secured debt. There can be no assurance that we will be able to maintain in compliance with any such covenants and a failure to do so could have a material adverse effect on our business, financial condition and results of operations.

 

Securitized Debt. As of September 30, 2010, we also had $1.4 billion outstanding under secured private term debt (“Term Debt Notes”) issued by our consolidated trusts to institutional investors. These securities contain customary default provisions, as well as the following default provisions: a failure on our part, as the originator of the loans securing the Term Debt Notes or as the servicer of these loans, to make any payment or deposit required under related agreements within two business days after the date the payment or deposit is required to be made, or if we alter or amend our credit and collection policy in a manner that could have a material adverse effect on the holders of the Term Debt Notes or the voluntary or involuntary commencement of a case against us under Title eleven of the United States Code.

 

Under the terms of each of our Term Debt Notes, if any loan collateral in each trust becomes a defaulted loan, as defined in each indenture, all interest and principal collections that would be applied to the subordinated notes retained by us are used to sequentially pay down the principal of the notes that are generally held by third party institutional investors in an amount equal to the principal amount of the defaulted loan collateral. As of September 30, 2010, there was defaulted loan collateral in each of the consolidated trusts and therefore all interest and principal collections that would have been applied to the subordinated notes retained by us will continue to be applied sequentially to pay down the principal of the notes generally held by third party

 

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institutional investors in an amount equal to the principal amount of the defaulted loan collateral. As a result, all current interest and principal collections from the loan collateral in the consolidated trusts is required to be used to repay the Term Debt Notes and is not available to fund our other operating, investing or financing requirements.

 

As a BDC, the 1940 Act generally limits our ability to issue Senior Securities if our asset coverage ratio does not exceed 200% immediately after each issuance of Senior Securities or remain equal to or greater than our asset coverage prior to such issuance.

 

As a BDC, the 1940 Act generally limits our ability to issue Senior Securities if our asset coverage ratio does not exceed 200% immediately after each issuance of Senior Securities or remain equal to or greater than our asset coverage prior to such issuance. Asset coverage ratio is defined in the 1940 Act as the ratio which the value of the total assets, less all liabilities and indebtedness not represented by Senior Securities, bears to the aggregate amount of Senior Securities representing indebtedness. From December 31, 2008 through March 31, 2010, our asset coverage ratio was less than 200%, and we were prohibited from issuing any additional Senior Securities other than for the purpose of immediately repaying existing debt, until our asset coverage ratio exceeded 200%, except for temporary borrowings that are repaid within 60 days and, limited to no more than 5% of our total assets. As of September 30, 2010, our asset coverage ratio was 230%. There are no assurances that we will be able to remain in compliance with this requirement. Thus, our access to funding to operate our business may be prohibited again in the future, and may have a material adverse affect on our business operations.

 

As a BDC, the 1940 Act generally limits our ability to issue equity below our NAV per share

 

Because we are subject to regulatory restrictions on the amount of debt we can issue, we are dependent on the issuance of equity as a financing source. As a BDC, we are generally not able to issue and sell our common stock at a price below our NAV per share, exclusive of any distributing commission or discount, without shareholder approval. Earlier this year, we received shareholder approval to sell a limited number of shares of our common stock at prices below our NAV per share in one or more offerings subject to certain conditions, including the prior approval of our Board of Directors. We subsequently sold almost all of such shares in a public offering, and only have shareholder authorization until February 12, 2011 to sell up to the remaining 24,930 shares at a price below our NAV per share. As of September 30, 2010, the closing price of our common stock was $5.81 per share, which was significantly less than our NAV of $9.59 per share. If our common stock continues to trade at a discount to NAV, this regulatory restriction could adversely affect our financial condition by impairing our ability to raise additional equity capital, which could help reduce our borrowing costs and strengthen our balance sheet. In addition, even if we were to issue equity at a price below our NAV per share, it could result in a dilution in our NAV per share, which could result in a decline in the market price of our common stock.

 

Our interest rate swap agreements contain covenants that place limitations on us

 

We enter into interest rate swap agreements to manage interest rate risk and also to fulfill our obligations under the terms of our asset securitizations. Certain of our interest rate swap agreements contain an event of default that allows the counterparty to terminate transactions outstanding under the agreement following the occurrence of a cross default on certain of our other indebtedness in amounts equal to or greater than $5 million to $15 million, as applicable. Certain of our interest rate swap agreements also contain an event of default that allows a counterparty to terminate transactions outstanding under the agreement if certain of our other indebtedness in amounts equal to or greater than $5 million or $15 million, as applicable, is accelerated. As of September 30, 2010, all of our interest rate swap agreements not held by our consolidated affiliate trusts were secured by a first priority lien, subject to certain permitted liens, on substantially all of our non-securitized assets pari passu with our New Secured Debt. We are prohibited under the terms of our New Secured Debt from collateralizing any new hedging agreements entered into after June 28, 2010.

 

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As of September 30, 2010, we were in compliance with the above covenants for our interest rate swap agreements. However, there are no assurances that we will be able to remain in compliance. In the event of a default under our interest rate swap agreements, if our counterparties elected to terminate their agreements with us, it could have a material adverse effect on our business, financial condition and results of operations.

 

The lack of liquidity of our privately-held securities may adversely affect our business

 

Most of our investments consist of securities acquired directly from their issuers in private transactions. Some of these securities are subject to restrictions on resale or otherwise are less liquid than public securities. The illiquidity of our investments may make it difficult for us to obtain cash equal to the value at which we record our investments if the need arises.

 

We and certain of our executive officers are defendants in a purported class action lawsuit

 

We and certain of our executive officers were named as defendants in a purported class action lawsuit, filed on behalf of the purchasers of our common stock between October 31, 2007 and November 7, 2008. The complaint alleges certain securities law violations relating to the revision of our dividend policy to suspend dividends for the fourth quarter of 2008. The complaint seeks unspecified damages, costs and expenses. While we cannot predict the outcome with any certainty, we do not expect that it will materially affect our financial condition or results of operations. However, there can be no assurance whether this pending legal proceeding will have a material adverse effect on our financial condition or results of operations in any future reporting period.

 

Risks Related to Our Investing and Financing Strategy

 

We have and may incur additional debt that could increase your investment risks

 

We or our consolidated affiliates borrow money or issue debt securities to provide us with additional funds to invest. Our lenders have fixed dollar claims on our assets or the assets of our consolidated affiliates that are senior to the claims of our shareholders and, thus, our lenders have preference over our shareholders with respect to these assets. In particular, the assets that our consolidated affiliates have pledged to lenders under the Term Debt Notes were sold or contributed to separate affiliated statutory trusts prior to such pledge. While we own a beneficial interest in these trusts, these assets are the property of the respective trusts, available to satisfy the debts of the trusts, and would only become available for distribution to our shareholders to the extent specifically permitted under the agreements governing those Term Debt Notes. See “Risk Factors—Our secured borrowing arrangements impose certain limitations on us.” Additionally, we have granted a security interest in substantially all of our other assets to the holders of our New Secured Debt.

 

The following table is designed to illustrate the effect on returns to a holder of our common stock of the leverage created by our use of borrowing, at the weighted average interest rate of 5.6% for the twelve months ended September 30, 2010, and assuming hypothetical annual returns on our portfolio of minus 15% to plus 15%. As can be seen, leverage generally increases the return to shareholders when the portfolio return is positive and decreases return when the portfolio return is negative. Actual returns may be greater or less than those appearing in the table.

 

Assumed Return on Portfolio (Net of Expenses)(1)

     -15     -10     -5     0     5     10     15

Corresponding Return to Common Stockholders(2)

     -21.0     -11.9     -2.8     6.4     15.5     24.6     33.7

 

(1) The assumed portfolio return is required by regulation of the SEC and is not a prediction of, and does not represent, our projected or actual performance.
(2) In order to compute the “Corresponding Return to Common Shareholders,” the “Assumed Return on Portfolio” is multiplied by the total value of our assets at the beginning of the period to obtain an assumed return to us. From this amount, all interest expense accrued during the period is subtracted to determine the return available to shareholders. The return available to shareholders is then divided by the total value of our net assets as of the beginning of the period to determine the “Corresponding Return to Common Shareholders.”

 

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Although borrowing money for investment increases the potential for gain, it also increases the risk of a loss. A decrease in the value of our investments will have a sharper impact on our NAV if we borrow money to make investments. Our ability to pay dividends could also be adversely impacted. In addition, our ability to pay dividends or incur additional indebtedness is restricted if our asset coverage is not equal to at least twice our indebtedness and also by the terms of the New Secured Debt.

 

We currently have a non-investment grade corporate credit rating and we could experience further downgrades

 

As of September 30, 2010, our corporate credit rating was B2, B- and B+ by Moody’s Investor Services, Standard & Poor’s Ratings Services and Fitch Ratings, respectively, which represents a downgrade from Baa3, BBB and BBB, respectively, as of December 31, 2008. Any rating below BBB or Baa2 is considered non-investment grade. If these credit ratings were to not improve or even be further downgraded, our ability to refinance or raise additional debt, particularly at attractive rates, could be negatively impacted. Any of these occurrences could have a material effect on our business, financial condition and results of operations.

 

Our credit ratings may not reflect all risks of an investment in our debt securities

 

Our credit ratings are an assessment by major debt rating agencies of our ability to pay our obligations. Consequently, actual or expected changes in our credit ratings will likely affect the market value of our publicly issued debt securities. Our credit ratings, however, may not fully or accurately reflect all of the credit and market risks associated with our publicly issued debt securities.

 

We have limitations on our ability to obtain liquidity by selling our investments at prices lower than our current fair values

 

We may need to generate liquidity in our portfolio in order to meet principal amortization payments under the terms of certain of our indebtedness, including our New Secured Debt and remaining unsecured public notes. We may also need to generate liquidity to meet our current operating and financing costs or to fund any cash dividend to our shareholders to maintain our qualification as a RIC. In order to generate current liquidity, we may need to sell our debt and/or equity investments at prices lower than our current fair values or at prices lower than we could realize in future periods if we were to continue to hold the investments. We are prohibited though under the terms of our New Secured Debt from selling our portfolio investments below their fair market values. Thus, there can be no assurances that we will be able to sell assets in our portfolio to generate sufficient liquidity when necessary.

 

We may not realize gains from our equity investments

 

We invest in equity interests with the goal to realize gains from the disposition of the interests. Certain of our equity interests may not appreciate in value and, in fact, have depreciated in value. Accordingly, we may not be able to realize gains from our equity interests.

 

Failure to deploy capital effectively or obtain financing to make additional investments may reduce our return on equity

 

If we fail to invest new capital effectively, or obtain additional funds to grow, our return on equity may be negatively impacted, which could reduce the price of the securities that you own.

 

Our portfolio companies may be highly leveraged

 

Leverage may have important adverse consequences to our portfolio companies and to us as an investor. Portfolio companies that are leveraged may be subject to restrictive financial and operating covenants. The

 

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leverage may impair these companies’ ability to finance their future operations and capital needs. As a result, their flexibility to respond to changing business and economic conditions and to business opportunities may be limited. A leveraged company’s income and net assets will tend to increase or decrease at a greater rate than if borrowed money were not used.

 

Investment in non-investment grade Structured Products may be illiquid, may have a higher risk of default, and may not produce current returns

 

Our investments in Structured Product securities are generally non-investment grade, which means that major rating agencies rate them below the top four investment-grade rating categories (i.e., “AAA” through “BBB”), and are sometimes referred to as “junk bonds.” Non-investment grade Structured Product bonds and preferred shares tend to be less liquid, may have a higher risk of default and may be more difficult to value. Economic recessions or downturns may cause defaults or losses on collateral securities to increase. Non-investment grade securities are considered speculative, and their capacity to pay principal and interest in accordance with the terms of their issue is not certain.

 

Our assets include investments in Structured Products which are subordinate in right of payment to more senior securities

 

Our assets include subordinated CMBS, CLO and CDO securities which are the most subordinate class of securities in a structure of securities secured by a pool of loans and accordingly are the first to bear the loss upon a restructuring or liquidation of the underlying collateral and the last to receive payment of interest and principal. The economic recession has caused defaults on the underlying collateral to increase; therefore we do not expect to recover the full amount of our initial investment in such subordinated interests. Additionally, estimated fair values of these subordinated interests tend to be more sensitive to changes in economic conditions than more senior securities. As a result, such subordinated interests generally are not actively traded and may not provide holders thereof with liquid investments.

 

The trading market or market value of our publicly issued debt securities may fluctuate

 

Our publicly issued debt securities do not have an established trading market. There is no assurance that a trading market for our publicly issued debt securities will ever develop or be maintained if developed. Additionally, many factors may materially adversely affect the trading market for, and market value of, our publicly issued debt securities including, but not limited to, the following:

 

   

future defaults under the securities;

 

   

our creditworthiness;

 

   

the time remaining to the maturity of these debt securities;

 

   

the outstanding principal amount of debt securities with terms identical to these debt securities;

 

   

the supply of debt securities trading in the secondary market, if any;

 

   

the redemption or repayment features, if any, of these debt securities;

 

   

the level, direction and volatility of market interest rates generally; and

 

   

market rates of interest that are higher or lower than rates borne by the debt securities.

 

There may also be a limited number of buyers when an investor decides to sell its debt securities. This too may materially adversely affect the market value of the debt securities or the trading market for the debt securities.

 

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If we fail to invest a sufficient portion of our assets in qualifying assets, we could lose our BDC status

 

As a BDC, we may not acquire any assets other than “qualifying assets” unless, at the time of and after giving effect to such acquisition, at least 70% of our total assets are qualifying assets. Thus, we may be precluded from investing in potentially attractive investments if such investments are not qualifying assets for purposes of the 1940 Act. If we fail to invest a sufficient portion of our assets in qualifying assets, we could lose our status as a BDC, which would have a material adverse effect on our business, financial condition and results of operations. In addition, there is a risk that this restriction could prevent us from making additional investments in our existing portfolio companies, which could cause our position to be diluted. We could also be forced to sell certain of our investments at to comply with the 1940 Act, which may result in us receiving significantly less than the current value of such investments.

 

Risks Related to Our Common Stock

 

There is a risk that you may not receive dividends

 

Since our IPO, we have distributed and currently intend to distribute more than 90% of our taxable ordinary income to our shareholders in order to continue to qualify as a RIC and have distributed and currently intend to distribute sufficient dividends to eliminate our taxable ordinary income and capital gains. However, due to the global financial and liquidity crisis, there can be no assurance that we will have sufficient liquidity to pay these amounts by the required dates to maintain our qualification as a RIC and to eliminate all of our taxable ordinary income.

 

Pursuant to applicable tax regulations, we are also required to include in taxable income certain amounts that have not yet been collected in cash such as payment-in-kind interest or original issue discount accretion. Since we may be required to recognize taxable income before or without receiving cash representing such income, we may have difficulty meeting the requirement to distribute at least 90% of our taxable ordinary income to continue to qualify as a RIC.

 

As a RIC, we could elect to retain our net long-term capital gains and pay a federal income tax on such gains on behalf of our shareholders treating them as a deemed distribution for tax purposes.

 

Historically, we have declared a dividend every quarter since our IPO through the third quarter of 2008. However, we have not declared a dividend since the second quarter of 2009. There may be a risk that we will generate taxable income in future periods that is significantly lower than in prior periods or there may be a risk that we do not generate any taxable income in future periods, which could result in significantly reduced dividends, if any, in future periods as compared to historical levels. We expect to incur a taxable ordinary loss for the tax fiscal year ended September 30, 2010 and therefore do not expect to have any dividend distribution requirements for such tax fiscal year. We had a net capital loss carryforward of $198 million for our tax fiscal year ending September 30, 2009, which may be carried forward for up to eight years, and expect to incur a net capital loss for our tax fiscal year ended September 30, 2010. To the extent we generate future long-term taxable capital gains, our requirement to distribute those gains as dividends will be reduced by the amount of our net capital loss carryforward. We may also realize losses on certain of our debt and CMBS investments that could qualify as taxable ordinary losses under Section 165, Section 166 or Section 1221 of the Code. As of September 30, 2010, our total debt and CMBS investment portfolio had accumulated net unrealized depreciation of $934 million. In future periods, we could realize losses on certain of these debt and CMBS investments that could qualify as taxable ordinary losses, which could significantly reduce our taxable ordinary income in future periods or could even result in us incurring a taxable ordinary loss in future periods. To the extent our taxable ordinary income is reduced from ordinary losses on the realization of our debt investments, the amount of our taxable ordinary income that we are required to distribute to our shareholders as dividends to maintain our qualification as a RIC or to eliminate our taxable income would be reduced.

 

We cannot assure you that we will achieve investment results or maintain a tax status that will allow any specified level of cash dividends or year-to-year increases in cash dividends.

 

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There is a risk that you may receive our stock as dividends

 

Under the 1940 Act, if a BDC has any senior debt investments outstanding that were publicly issued, the BDC must make provision to prohibit the declaration of any dividend (except a dividend payable in the stock of the BDC) if its asset coverage ratio is below certain thresholds at the time of the distribution after deducting the amount of such dividend. We have received guidance from the staff of the SEC that notwithstanding this provision of the 1940 Act, we are able to declare and pay dividends pursuant to a revenue procedure issued by the IRS. On January 7, 2009, the IRS issued Revenue Procedure 2009-15, which temporarily allows a RIC to distribute its own stock as a dividend for the purpose of fulfilling its distribution requirements. Pursuant to this revenue procedure, we may treat a distribution of our stock as a dividend if (i) the stock is publicly traded on an established securities market, (ii) the distribution is declared with respect to a taxable year ending on or before December 31, 2009, and (iii) each shareholder may elect to receive his or her entire distribution in either cash or our stock subject to a limitation on the aggregate amount of cash to be distributed to all shareholders, which must be at least 10% of the aggregate declared distribution. If too many shareholders elect to receive cash, each shareholder electing to receive cash will receive a pro rata amount of cash (with the balance of the distribution paid in stock). In no event would any shareholder electing to receive cash receive less than 10% of his or her entire distribution in cash. On December 23, 2009, the IRS issued Revenue Procedure 2010-12, which extends under similar terms the temporary guidance provided by Revenue Procedure 2009-15. This new guidance applies to distributions by a RIC of its own stock declared by December 31, 2012 with respect to RIC distribution requirements for taxable years ending on or before December 31, 2011. Future dividends with respect to a taxable year ending on or before December 31, 2011, if any, may be paid in shares of our common stock, subject to the limitations discussed above.

 

As noted above, our ability to pay cash dividends is also restricted under certain circumstances under the terms of our New Secured Debt. We are permitted to pay cash dividends only: (i) to the extent required to maintain our status as a RIC and eliminate our taxable income so long as we pay a portion of such dividends in shares of our common stock to the maximum level permitted by applicable law, or (ii) if our asset coverage is at least 200% after giving effect to such cash dividends and we are not in default under the agreements and the aggregate principal amount of the New Secured Debt is equal to or less than $1.4 billion.

 

Future equity financings may be on terms adverse to shareholder interests

 

We have issued, and may issue in the future, equity capital to help fund our operations and to make investments. Our shareholders approved a proposal at a special meeting on February 12, 2010 that extended the authority we previously received in February 2009, allowing us to sell shares of common stock below NAV per share subject to certain limitations. We issued shares of common stock below our NAV per share in the second quarter of 2010 to certain institutional investors, and in the first quarter of 2009 in connection with our acquisition of those shares of European Capital that we did not own. If we issue any additional shares of common stock below our NAV per share, the interests of our existing shareholders may be further diluted.

 

The following table is designed to illustrate the dilutive effect on NAV per share if we issue additional shares of common stock below our NAV per share. The table below reflects NAV per share diluted for the hypothetical issuance of 50,000,000 shares of common stock, at hypothetical sales prices of 5%, 10%, 15%, 20%, 25% and 50% below the September 30, 2010 NAV of $9.59 per share.

 

Assumed Sales price per share below NAV(1)

     -50     -25     -20     -15     -10     -5

Diluted NAV per share

   $ 8.98      $ 9.29      $ 9.35      $ 9.41      $ 9.47      $ 9.53   

% Dilution

     -6.4     -3.2     -2.6     -1.9     -1.3     -0.6

 

(1) The assumed sales price per share is assumed to be net of any applicable underwriting commissions or discounts.

 

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If we cannot meet NASDAQ’s continued listing requirements, NASDAQ may delist our common stock, which would have an adverse impact on the liquidity and market price of our common stock

 

Our common stock is currently listed on The NASDAQ Global Select Market. Under NASDAQ rules, a stock can be delisted and not allowed to trade on NASDAQ if the closing bid price of the stock over a 30 consecutive trading-day period is less than $1.00 per share. Since the beginning of the financial markets crisis, we have and continue to experience significant volatility, including substantial decreases, in the price of our common stock. For the year ended December 31, 2009, the low closing price of our common stock as reported on The NASDAQ Global Select Market was $0.58 per share and the closing price on December 31, 2009 was $2.44 per share. As of September 30, 2010, our closing price was $5.81 per share. There is a risk that the share price of our common stock could decline further if the depressed state of the economy and credit and capital markets continue to impact our operations. There could then be a risk that the share price of our common stock could fall below the minimum listing requirement again, and thus be delisted from NASDAQ. A delisting of our common stock could negatively impact us by reducing the liquidity and market price of our common stock and the number of investors willing to hold or acquire our common stock, which could negatively impact our ability to raise equity financing.

 

The market price of our common stock may fluctuate significantly

 

The market price and marketability of shares of our securities may from time to time be significantly affected by numerous factors, including many over which we have no control and that may not be directly related to us. These factors include the following:

 

   

price and volume fluctuations in the stock market from time to time, which are often unrelated to the operating performance of particular companies;

 

   

significant volatility in the market price and trading volume of securities of RICs, BDCs or other companies in our sector, which is not necessarily related to the operating performance of these companies;

 

   

changes in laws, regulatory policies, tax guidelines or financial accounting standards, particularly with respect to RICs or BDCs;

 

   

changes in our dividend policy and earnings or variations in operating results;

 

   

any shortfall in revenue or net income or any increase in losses from levels expected by securities analysts;

 

   

decreases in our NAV per share;

 

   

general economic trends and other external factors; and

 

   

loss of a major funding source.

 

Fluctuations in the trading price of our common stock may adversely affect the liquidity of the trading market for our common stock and, in the event that we seek to raise capital through future equity financings, our ability to raise such equity capital.

 

Our common stock may be difficult to resell

 

Investors may not be able to resell shares of common stock at or above their purchase prices due to a number of factors, including:

 

   

actual or anticipated fluctuation in our operating results;

 

   

volatility in our common stock price;

 

   

changes in expectations as to our future financial performance or changes in financial estimates of securities analysts; and

 

   

departures of key personnel.

 

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Provisions of our Third Amended and Restated Certificate of Incorporation and Second Amended and Restated Bylaws could deter takeover attempts

 

Our Third Amended and Restated Certificate of Incorporation, as amended and Second Amended and Restated Bylaws and the Delaware General Corporation Law contain provisions that may have the effect of discouraging and delaying or making more difficult a change in control. The existence of these provisions may negatively impact the price of our common stock and may discourage third party bids. These provisions may reduce any premiums paid to our shareholders for shares of our common stock that they own. Furthermore, we are subject to Section 203 of the Delaware General Corporation Law. Section 203 governs business combinations with interested shareholders, and also could have the effect of delaying or preventing a change in control.

 

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

 

None.

 

Item 3. Defaults Upon Senior Securities

 

None.

 

Item 4. [Removed and Reserved]

 

Item 5. Other Information

 

None.

 

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Item 6. Exhibits

 

(a) Exhibits

 

  *3.1.       American Capital Strategies, Ltd. Third Amended and Restated Certificate of Incorporation, incorporated herein by reference to Exhibit 2.a. of the Registration Statement on Form N-2 (File No. 333-161421), filed August 19, 2009.
  *3.2.       American Capital Strategies, Ltd. Second Amended and Restated Bylaws, as amended, incorporated herein by reference to Exhibit 3.2 of Form 10-Q for the quarter ended June 30, 2008 (File No.: 814-00149), dated August 11, 2008.
  *4.3.       Indenture between American Capital, Ltd. and Wilmington Trust Company, as successor trustee, dated as of April 26, 2007, incorporated herein by reference to Exhibit 2.d.3. of the Registration Statement on Form N-2 (File No. 333-142398), filed on April 26, 2007.
  *4.4.       First Supplemental Indenture by and between American Capital, Ltd. and Wilmington Trust Company, as successor trustee, dated as of July 17, 2007, incorporated herein by reference to Exhibit 4.4 on Form 10-Q for the quarter ended June 30, 2010 (File No.: 814-00149), filed on August 6, 2010.
  *4.5.       Second Supplemental Indenture between American Capital, Ltd. and Wilmington Trust Company, as Trustee, dated as of June 28, 2010, incorporated herein by reference to Exhibit 4.6 on Form 10-Q for the quarter ended June 30, 2010 (File No.: 814-00149), filed on August 6, 2010.
  *4.6.       Indenture between American Capital, Ltd. and Wilmington Trust FSB, as Trustee, dated as of June 28, 2010, incorporated herein by reference to Exhibit 4.7 on Form 10-Q for the quarter ended June 30, 2010 (File No.: 814-00149), filed on August 6, 2010.
  *4.7.       Senior Secured Non-Amortizing Call-Protected Adjustable Fixed Rate Dollar Unrestricted Global Note, No. B-1, CUSIP No. 02503YAF0, payable to Cede & Co., in the amount of $500,000,000, incorporated herein by reference to Exhibit 4.8 on Form 10-Q for the quarter ended June 30, 2010 (File No.: 814-00149), filed on August 6, 2010.
  *4.8.       Senior Secured Non-Amortizing Call-Protected Adjustable Fixed Rate Dollar Unrestricted Global Note, No. B-2, CUSIP No. 02503YAF0, payable to Cede & Co., in the amount of $24,098,000, incorporated herein by reference to Exhibit 4.9 on Form 10-Q for the quarter ended June 30, 2010 (File No.: 814-00149), filed on August 6, 2010.
  *4.9.       Senior Secured Non-Amortizing Call-Protected Floating Rate Dollar Unrestricted Global Note, No. C-1, CUSIP No. 02503YAE3, payable to Cede & Co., in the amount of $4,300,000, incorporated herein by reference to Exhibit 4.10 on Form 10-Q for the quarter ended June 30, 2010 (File No.: 814-00149), filed on August 6, 2010.
  *4.10.       Senior Secured Amortizing Adjustable Fixed Rate Dollar Rule 144A Global Note, No. D-1, CUSIP No. 02503YAC7, payable to Cede & Co., in the amount of $500,000,000, incorporated herein by reference to Exhibit 4.11 on Form 10-Q for the quarter ended June 30, 2010 (File No.: 814-00149), filed on August 6, 2010.
  *4.11.       Senior Secured Amortizing Adjustable Fixed Rate Dollar Rule 144A Global Note, No. D-2, CUSIP No. 02503YAC7, payable to Cede & Co., in the amount of $2,431,467, incorporated herein by reference to Exhibit 4.12 on Form 10-Q for the quarter ended June 30, 2010 (File No.: 814-00149), filed on August 6, 2010.
  *4.12.       Series 6.85% Senior Notes Due 2012, No. 1, CUSIP No. 024937AA2, payable to Cede & Co., in the amount of $500,000,000, incorporated herein by reference to Exhibit 4.13 on Form 10-Q for the quarter ended June 30, 2010 (File No.: 814-00149), filed on August 6, 2010.

 

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  *4.13.       Series 6.85% Senior Notes Due 2012, No. 2, CUSIP No. 024937AA2, payable to Cede & Co., in the amount of $50,000,000, incorporated herein by reference to Exhibit 4.14 on Form 10-Q for the quarter ended June 30, 2010 (File No.: 814-00149), filed on August 6, 2010.
  *10.1.       Resignation and Successor Agent Agreement, dated as of July 19, 2010 with Citicorp North America, Inc. and Wells Fargo Bank, N.A., filed as Exhibit 10.1 to Form 8-K (File No. 814-00149), filed on July 22, 2010.
  31.1.       Certification of CEO Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31.2.       Certification of CFO Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  32.       Certification of CEO and CFO Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

* Fully or partly previously filed

 

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SIGNATURES

 

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

 

AMERICAN CAPITAL, LTD.

By:   /s/    RICHARD E. KONZMANN        
 

Richard E. Konzmann

Senior Vice President, Accounting

 

Date: November 5, 2010

 

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