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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

 

FORM 10-K

 

 

(Mark One)

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

For the fiscal year ended December 31, 2012

OR

 

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

For the transition period from             to             

Commission file number 814-00789

 

 

THL CREDIT, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Delaware   27-0344947

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

100 Federal St., 31st Floor, Boston, MA   02110
(Address of Principal Executive Offices)   (Zip Code)

Registrant’s Telephone Number, Including Area Code: 800-454-4424

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

 

Title of Each Class

 

Name of Each Exchange on Which Registered

Common Stock, par value $0.001 per share

  NASDAQ Global Select Market

Securities registered pursuant to 12(g) of the Act:

None.

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

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

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ¨

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

  ¨     Accelerated filer   x

Non-Accelerated filer

  ¨  

(Do not check if a smaller reporting company)

  Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).    Yes  ¨    No  x

The aggregate market value of common stock held by non-affiliates of the Registrant as of the last business day of the Registrant’s most recently completed second fiscal quarter was approximately $269 million based on the closing price on that date of $13.47 on the NASDAQ Global Select Market. For the purposes of calculating this amount only, all directors and executive officers of the Registrant have been treated as affiliates.

As of March 4, 2013, there were 26,315,202 shares of the Registrant’s common stock outstanding.

Documents Incorporated by Reference

Portions of the Registrant’s definitive Proxy Statement relating to its 2012 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A with the Securities and Exchange Commission, are incorporated by reference into Part III of this Annual Report on Form 10-K as indicated herein.

 

 

 

 


Table of Contents

THL CREDIT, INC.

FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2012

Table of Contents

 

PART I   
Item 1.   

Business

     3   
Item 1A.   

Risk Factors

     30   
Item 1B.   

Unresolved Staff Comments

     52   
Item 2.   

Properties

     52   
Item 3.   

Legal proceedings

     52   
Item 4.   

Mine Safety Disclosures

     52   
PART II   
Item 5.   

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     53   
Item 6.   

Selected Financial Data

     57   
Item 7.   

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

     59   
Item 7A.   

Quantitative and Qualitative Disclosures About Market Risk

     86   
Item 8.   

Financial Statements and Supplementary Data

     87   
Item 9.   

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     126   
Item 9A.   

Controls and Procedures

     126   
Item 9B.   

Other Information

     127   
PART III   
Item 10.   

Directors, Executive Officers and Corporate Governance

     128   
Item 11.   

Executive Compensation

     128   
Item 12.   

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     128   
Item 13.   

Certain Relationships and Related Transactions and Director Independence

     128   
Item 14.   

Principal Accountant Fees and Services

     128   
PART IV   
Item 15.   

Exhibits and Financial Statement Schedules

     129   
Signatures         131   

 

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PART I

In this annual report on Form 10-K, except where the context suggests otherwise, the terms “we,” “us,” “our” and “THL Credit” refer to THL Credit, Inc.; “THL Credit Advisors,” the “Advisor” or the “Administrator” refers to THL Credit Advisors LLC; “Greenway” refers to THL Credit Greenway Fund LLC; “THL Credit Opportunities” refers to THL Credit Opportunities, L.P.; “BDC Holdings” refers to THL Credit Partners BDC Holdings, L.P.; and “THL Credit Group” refers to THL Credit Group, L.P. Some of the statements in this annual report constitute forward-looking statements, which relate to future events, future performance or financial condition. These forward-looking statements involve risk and uncertainties and actual results could differ materially from those projected in the forward-looking statements for any reason, including those factors discussed in “Risk Factors” and elsewhere in this report.

 

Item 1. Business

THL Credit, Inc.

We are an externally managed, non-diversified closed-end management investment company incorporated in Delaware on May 26, 2009, that has elected to be regulated as a business development company, or BDC, under the Investment Company Act of 1940, as amended, or the 1940 Act. In addition, we have elected to be treated for tax purposes as a regulated investment company, or RIC, under Subchapter M of the Internal Revenue Code of 1986, as amended, or the Code. Our investment activities are managed by THL Credit Advisors and supervised by our board of directors, a majority of whom are independent of THL Credit Advisors and its affiliates. As a BDC, we are required to comply with certain regulatory requirements. See “Regulation” for discussion of BDC regulation and other regulatory considerations. We are also registered as an investment adviser under the Advisers Act.

Our investment objective is to generate both current income and capital appreciation, primarily through investments in privately negotiated debt and equity securities of middle market companies. We are a direct lender to middle market companies and invest in subordinated, or mezzanine, debt and second lien secured debt, which may include an associated equity component such as warrants, preferred stock or other similar securities. We may also selectively invest in first lien secured loans that generally have structures with higher interest rates, which include unitranche investments, or loan structures that combine characteristics of traditional first lien senior secured as well as second lien and subordinated loans. In certain instances we will also make direct equity investments, including equity investments into or through funds, and we may also selectively invest in more broadly syndicated first lien secured loans from time to time. We also may provide advisory services to managed funds.

We define middle market companies to mean both public and privately-held companies with annual revenues of between $25 million and $500 million. We expect to generate returns through a combination of contractual interest payments on debt investments, equity appreciation (through options, warrants, conversion rights or direct equity investments) and origination and similar fees. We can offer no assurances that we will achieve our investment objective.

Since April 2010, after we completed our initial public offering and commenced principal operations, we have been responsible for making, on behalf of ourselves and our managed funds, over an aggregate $664 million in commitments into 40 separate portfolio companies through a combination of both initial and follow-on investments.

As a BDC, we are required to comply with certain regulatory requirements. See “Regulation” for discussion of BDC regulation and other regulatory considerations. We are generally required to invest at least 70% of our total assets primarily in securities of private and certain U.S. public companies (other than certain financial institutions), cash, cash equivalents and U.S. government securities and other high quality debt investments that mature in one year or less.

 

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We are permitted to borrow money from time to time within the levels permitted by the 1940 Act (which generally allows us to incur leverage for up to one half of our assets). We have used, and expect to continue to use, our credit facilities, along with proceeds from the rotation of our portfolio and proceeds from public and private offerings of securities to finance our investment objectives. See “Regulation” for discussion of BDC regulation and other regulatory considerations.

Organizational Overview

 

LOGO

THL Credit Advisors LLC

Our investment activities are managed by our investment adviser, THL Credit Advisors. THL Credit Advisors is responsible for sourcing potential investments, conducting research on prospective investments, analyzing investment opportunities, structuring our investments, and monitoring our investments and portfolio companies on an ongoing basis. THL Credit Advisors was formed as a Delaware limited liability company on June 26, 2009 and is registered as an investment adviser under the Advisers Act. THL Credit Advisors is led by James K. Hunt, W. Hunter Stropp and Sam W. Tillinghast, who, along with Terrence W. Olson, Stephanie Paré Sullivan, Christopher J. Flynn and Scott V. Turco constitute its principals, collectively the THL Credit Principals. Messrs. Hunt, Stropp, Tillinghast and Flynn constitute the investment principals of THL Credit Advisors, or the THL Credit Investment Principals.

The THL Credit Principals and other investment professionals make up our investment team. THL Credit Advisors is owned and controlled by certain of the THL Credit Investment Principals and a partnership consisting of certain of the partners of THL Partners. The THL Credit Investment Principals have worked together over the past five years and in the past investing through multiple business and credit cycles, across the

 

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entire capital structure. We believe the THL Credit Investment Principals bring a unique investment perspective and skill set by virtue of their complementary, collective experience as both debt and equity investors. In addition, we believe they bring an active equity ownership mentality and focus on adding value to portfolio companies through board representation, when possible, active monitoring and direct dialogue with management.

THL Credit Advisors also serves as our Administrator and leases office space to us and provides us with equipment and office services. The tasks of the Administrator include overseeing our financial records, preparing reports to our stockholders and reports filed with the SEC and generally monitoring the payment of our expenses and the performance of administrative and professional services rendered to us by others. THL Credit Senior Loan Strategies LLC (“THL Credit SLS”), a subsidiary of THL Credit Advisors, acquired McDonnell Investment Management’s Alternative Credit Strategies group on June 29, 2012. THL Credit SLS focuses principally on broadly syndicated senior loans. The acquisition is intended to result in benefits to the Company by providing access to greater credit resources, including, but not limited to, origination sources, credit analysis and industry specialization that the THL Credit SLS team has developed over the years. The Company does not expect to co-invest with THL Credit SLS on transactions, except in limited circumstances on identical terms.

Thomas H. Lee Partners, L.P. (“THL Partners”)

Founded in 1974, THL Partners is a leading private equity firm based in Boston, MA. THL Partners focuses on identifying and obtaining substantial ownership positions in large growth-oriented companies where it can add managerial and strategic expertise to create value for its partners. As one of the oldest and most experienced private equity firms, THL Partners has raised approximately $20 billion of equity capital and invested in more than 100 businesses with an aggregate purchase price of more than $150 billion. THL Partners seeks to build companies of lasting value while generating superior returns for its investors and operating partners. We benefit from THL Credit Advisors’ relationship with THL Partners. THL Credit Advisors has access to the contacts and industry knowledge of THL Partners’ investment team to enhance its transaction sourcing capabilities and consults with the THL Partners team on specific industry issues, trends and other matters to complement our investment process.

Investment Approach

Our investment approach consists of the following four separate and distinct phases: (1) sourcing; (2) selecting; (3) structuring; and (4) supervising investments. Sourcing involves our efforts to generate as vast a universe of relevant and actionable investment opportunities as possible. Selecting represents our decision-making process regarding which of those investments to pursue. Structuring summarizes our creative approach to deploying capital on a case by case basis in a way that maximizes value. Supervising is a reference to our ongoing rigorous credit monitoring.

Sourcing

The elements of our sourcing efforts include: (i) determining the market in which we intend to participate; (ii) identifying the opportunities within that market; (iii) having a clear strategy; (iv) knowing the competition; and (v) distinguishing our competitive advantages.

Determining the Market

We invest primarily in debt securities of sponsored and unsponsored issuers, including subordinated or mezzanine debt and second lien secured debt, which may include an associated equity component such as warrants, preferred stock and other similar securities. We may also selectively invest in first lien secured loans that generally have structures with higher interest rates, which include unitranche investments, or loan structures that combine characteristics of traditional first lien senior secured as well as second lien and subordinated loans. In certain instances we will also make direct equity investments, including equity investments into or through funds, and we may also selectively invest in more broadly syndicated first lien secured loans from time to time. We also may provide advisory services to managed funds.

 

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It is also our belief that a combination of sponsored and unsponsored investments in debt securities is important to having the most attractive opportunities across investment cycles. To that end, our nationwide origination efforts target both private equity sponsors and referral sources of unsponsored companies.

Unsponsored companies are either privately-held companies typically owned and controlled by entrepreneurs rather than private equity firms or microcap public companies, or those public companies with market capitalization of less than $300 million. We believe that unsponsored middle market companies represent a large, attractive and less competitive investment opportunity for two primary reasons: (1) the number of unsponsored companies far exceeds the number of sponsored companies; and (2) many debt investors focus primarily on sponsored companies. We also believe because unsponsored companies often have less access to capital providers, they generally provide us more attractive economics, greater alignment of interests with management, and greater control over the business and capital structure.

With respect to sponsored transactions, which we define as those companies controlled by private equity firms, or sponsors, we expect the demand for leveraged buyouts to grow as mergers and acquisition activity increases, although with reduced senior lending from banks and what may be reduced participation from collateralized loan obligation vehicles in the middle market. We believe debt providers will see increasing opportunities to fill this financing gap. We expect significant demand from sponsors who need to recapitalize the balance sheets of certain of their portfolio companies or, in certain situations, acquire portfolio companies.

Market opportunity

We believe the environment for investing in middle market companies is attractive for several reasons, including:

Improved company fundamentals creating favorable lending trends. Middle market companies are experiencing improved fundamentals driven by a stabilizing economy and an increase in confidence. During 2012, middle market companies displayed improvements in operating performance, resulting in stronger credit quality. Default levels remain relatively low, and volatility in the broader capital markets has eased, resulting in more middle market companies seeking growth capital at attractive lender credit metrics.

Consolidation among commercial banks has reduced the focus on middle market business. We believe that many senior lenders have de-emphasized their service and product offerings to middle market companies in favor of lending to large corporate clients, managing capital markets transactions and providing other non-credit services to their customers. Further, many financial institutions and traditional lenders are faced with constrained balance sheets and are requiring existing issuers to reduce leverage.

Middle market companies are increasingly seeking lenders with long-term capital for debt and equity capital. We believe that many middle market companies prefer to execute transactions with private capital providers such as us, rather than execute high-yield bond or equity transactions in the public markets, which may necessitate increased financial and regulatory compliance and reporting obligations. Further, we believe many middle market companies are inclined to seek capital from a small number of skilled, reliable and predictable providers with access to permanent capital that can satisfy their specific needs and serve as value-added financial partners with an understanding of, and longer-term view oriented towards the growth of their businesses.

The current market environment may mean more favorable opportunities for investing in lower middle market companies. We believe that as part of the path of economic recovery following the credit crisis, select market participants such as hedge funds and collateralized loan obligation vehicles are not as active as lenders in the middle market, a space in which we focus, resulting in fewer lender participants and a greater opportunity for us to originate proprietary investment opportunities in the lower middle market. Fewer participants also results in a more disciplined approach to investment opportunities, a situation on which we are well positioned to capitalize given the extensive level of experience of the THL Credit Investment Principals, who have worked closely together and have invested through multiple business and credit cycles. In addition, investing in debt securities in

 

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the middle market may offer more favorable returns relative to their investment risk, when compared to investments in public high yield or syndicated bank loan securities. For example, such securities generally involve better pricing terms, access to information, and the ability to diligence and evaluate management teams.

Investment strategy

We believe a strategy focused primarily on debt securities in middle market companies has a number of compelling attributes. First, the market for these instruments is relatively inefficient, allowing an experienced investor an opportunity to produce high risk-adjusted returns. Second, downside risk can be managed through an extensive credit-oriented underwriting process, creative structuring techniques and intensive portfolio monitoring. We believe private debt investments generally require the highest level of credit and legal due diligence among debt or credit asset classes. Lastly, compared with equity investments, returns on debt loans tend to be less volatile given the substantial current return component and seniority in the capital structure relative to equity.

Competition

Our primary competitors to providing financing to middle market companies will include other BDCs, public and private funds, commercial and investment banks, CLO funds, commercial finance companies and, to the extent they provide an alternative form of financing, private equity and hedge funds. Many of our competitors are substantially larger and have considerably greater financial and marketing resources than we do. For example, some competitors may have access to funding sources that are not available to us. In addition, some 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 than us.

Competitive advantages

We believe that, through THL Credit Advisors, we possess the following competitive advantages over many other debt lenders to middle market companies:

Experienced management team. As stated above, the THL Credit Investment Principals are experienced and have worked together extensively through multiple business and credit cycles, investing across the entire capital structure with the objective of generating attractive, long-term, risk-adjusted returns. Each of the THL Credit Investment Principals brings a unique investment perspective and skill-set by virtue of their complementary collective experiences as both debt and equity investors.

Proactive Sourcing Platform. We take a proactive, hands-on, and creative approach to investment sourcing. Our disciplined origination process includes proprietary tools and resources and employs a national platform with a regional focus. With offices in Boston, Houston and Los Angeles, the THL Credit Investment Principals have a deep and diverse relationship network in the debt capital and private equity markets. National origination activities and relationships are centrally managed by a dedicated director of origination. These activities and relationships provide an important channel through which we generate investment opportunities consistent with our investment strategy. The THL Credit Investment Principals have activities and relationships with investment bankers, commercial bankers (national, regional and local), lawyers, accountants and business brokers as well as access to the extensive network of THL Partners, which has 38 years of experience. The THL Credit Investment Principals actively utilize these activities, relationships and networks to source and execute attractive investments, and maintain a database and set of reports where the details of all potential investment opportunities are tracked. Further, we believe the investment history and long-standing reputation of the THL Credit Investment Principals provides us with an early look at new investment opportunities.

Ability to execute unsponsored transactions. We believe we are one of the few credit market participants that actively seeks unsponsored investments and possesses the experience and resources, as a result of the long-standing relationships of the THL Credit Investment Principals and ongoing development of new relationships

 

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with referral sources and equity sponsors, to source unsponsored transactions. Furthermore, we have the capability to perform the rigorous in-house due diligence, structuring and monitoring activities necessary to execute such transactions.

Affiliation with THL Partners and THL Credit SLS. We are managed by THL Credit Advisors, the credit affiliate of THL Partners and parent of THL Credit SLS. As such, we have access to the relationship network and industry knowledge of both THL Partners and THL Credit SLS to enhance transaction sourcing capabilities. This provides us with the opportunity to consult with the THL Partners investment teams on specific industry issues, trends and other complementary matters.

Selecting

Selecting investments to pursue requires us to have an employable investment philosophy, know our key metrics, have a process to consistently measure those metrics and adhere to a repeatable underwriting process that enables our investment committee to make well reasoned decisions.

Investment Philosophy

Our investment philosophy will focus on capital preservation, relative value, and establishing close relationships with portfolio companies. It is our expectation that this multifaceted focus should generate consistent, attractive, risk-adjusted returns coupled with low volatility.

Capital Preservation. We believe that the key to capital preservation is comprehensive and fundamental credit analysis. We take a long term view of our investments and portfolios with the perspective that most of our investments may need to endure through economic cycles. We refrain from market timing and generally do not enter into investments with the sole intention of realizing short term gains based on changes in market prices. However, we will not hesitate to sell an investment if we believe that it is deteriorating in value and that more recovery will be obtained by selling rather than holding the investment.

Relative Value. Relative value is an essential part of every investment decision. Relative value is determined in a variety of ways including comparisons to other opportunities available in the same asset class and with portfolio companies in the same or similar industries. Relative value is also analyzed across asset classes (senior vs. subordinate, secured vs. unsecured, debt vs. equity) to ensure that the return of a potential investment is appropriate relative to its position in the capital structure.

Key Investment Metrics

Our value-oriented investment philosophy is primarily focused on maximizing yield relative to risk. Upon identifying a potential opportunity, THL Credit Advisors performs an initial screen to determine whether pursuing intensive due diligence is merited. As part of this process, we have identified several criteria we believe are important in evaluating and investing in prospective portfolio companies. These criteria provide general guidelines for our investment decisions. However, each prospective portfolio company in which we choose to invest may not meet all of these criteria.

Value orientation/positive cash flow. Our investment philosophy places a premium on fundamental credit analysis and has a distinct value orientation. We generally focus on companies in which we can invest at relatively low multiples of operating cash flow and that are profitable at the time of investment on an operating cash flow basis. Although we obtain liens on collateral when appropriate and available, we are primarily focused on the predictability of future cash flow. We generally do not intend to invest in start-up companies or companies with speculative business plans.

Seasoned management with significant equity ownership. Strong, committed management teams are important to the success of an investment and we focus on companies where strong management teams are either

 

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already in place or where new management teams have been identified. Additionally, we will generally require the portfolio companies to have in place compensation provisions that appropriately incentivize management to succeed and to act in our interests as investors.

Strong competitive position. We will seek to invest in companies that have developed competitive advantages and defensible market positions within their respective markets and are well positioned to capitalize on growth opportunities.

Exit strategy. We will seek companies that we believe will generate consistent cash flow to repay our loans and reinvest in their respective businesses. We expect such internally generated cash flow in portfolio companies to be a key means by which we exit from our investments over time. In addition, we will invest in companies whose business models and expected future cash flows offer attractive exit possibilities for the equity component of our returns. These companies include candidates for strategic acquisition by other industry participants and companies that may repay our investments through an initial public offering of common stock or another capital market transaction.

Due Diligence and Investment Process

We employ a rigorous and disciplined underwriting and due diligence process. Our process includes a comprehensive understanding of a portfolio company’s industry, market, operational, financial, organizational and legal position and prospects. In addition to our own analysis, we will frequently use the service of third parties (either those of the sponsor, if applicable, or those which we retain) for quality of earnings reports, environmental diligence, legal reviews, industry and customer surveys, and background checks. We conduct thorough reference and background checks on senior management for all investments, including, but not limited to reference calls to several constituencies including senior management of past employers, business associates, customers, industry experts, such as equity research analysts and, when appropriate, competitors.

We seek borrowers that have proven management teams that have a vested interest in the company in the form of a meaningful level of equity ownership, that generate stable and predictable cash flow, and whose market position is defensible. We invest in companies with the expectation that we will own the investment through a complete business cycle, and possibly a recession, and we determine the appropriate amount of debt for the company accordingly. In addition, we view a sale of the company which might result in a refinancing of our investment as a possibility but not an expectation. Our intention is to craft strong and lender-friendly credit agreements with covenants, events of default, remedies and inter-creditor agreements being an integral part of our legal documents.

Our due diligence will typically include the following elements (although not all elements will necessarily form part of every due diligence project):

Portfolio Company Characteristics: key levers of the business including a focus on drivers of cash flow and growth; revenue visibility; customer and supplier concentrations; historical revenue and margin trends; fixed versus variable costs; free cash flow analysis; portfolio company performance in view of industry performance; and sensitivity analysis around various future performance scenarios (with a focus on downside scenario analysis);

Industry Analysis: including the portfolio company’s position within the context of the general economic environment and relevant industry cycles; industry size and growth rates; competitive landscape; barriers to entry and potential new entrants; product position and defensibility of market share; technological, regulatory and similar threats; and pricing power and cost considerations;

Management: including the quality, breadth and depth of the portfolio company’s management; track record and prior experience; background checks; reputation; compensation and equity incentives; corporate overhead; motivation; interviews with management, employees, customers and vendors;

 

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Financial Analysis: an understanding of relevant financial ratios and statistics, including various leverage, liquidity, free cash flow and fixed charge coverage ratios; impact on ratios in various future performance scenarios and comparison of ratios to industry competitors; satisfaction with the auditor of the financial statements; quality of earnings analysis;

Capital Structure: diverse considerations regarding leverage (including understanding seniority and leverage multiples); ability to service debt; collateral and security protections; covenants and guarantees; equity investment amounts and participants (where applicable); review of other significant structural terms and pertinent legal documentation; and

Collateral and Enterprise Value: analysis of relevant collateral coverage, including assets on a liquidation basis and enterprise value on a going concern basis; matrix analysis of cash flow and valuation multiples under different scenarios along with recovery estimates; comparison to recent transaction multiples and valuations.

Investment Committee

The purpose of the investment committee is to evaluate and approve, as deemed appropriate, all investments by THL Credit Advisors. The committee process is intended to bring the diverse experience and perspectives of the committee’s members to the analysis and consideration of every investment. The committee also serves to provide investment consistency and adherence to THL Credit Advisors’ investment philosophies and policies. The investment committee also determines appropriate investment sizing and suggests ongoing monitoring requirements.

In addition to reviewing investments, the investment committee meetings serve as a forum to discuss credit views and outlooks. Potential transactions and investment sourcing are also reviewed on a regular basis. Members of our investment team are encouraged to share information and views on credits with the investment committee early in their analysis. This process improves the quality of the analysis and assists the deal team members to work more efficiently.

Each transaction is presented to the investment committee in a formal written report. Our investment committee currently consists of James K. Hunt, W. Hunter Stropp, Sam W. Tillinghast and Christopher J. Flynn. To approve a new investment, or to exit or sell an existing investment, the consent of a majority of the four members of the committee is required, with Mr. Hunt, the Chief Executive Officer and Chief Investment Officer, having veto power.

Structuring

Our approach to structuring involves us choosing the most appropriate variety of security for each particular investment and negotiating the best and most favorable terms.

Investment Structure

We invest primarily in debt securities, including subordinated, or mezzanine debt, and second lien senior secured debt, which may include an associated equity component such as warrants, preferred stock or other similar securities. We may also selectively invest in first lien secured loans that generally have structures with higher interest rates, which include unitranche investments, or loan structures that combine characteristics of traditional first lien senior secured as well as second lien and subordinated loans. In certain instances we will also make direct equity investments, including equity investments into or through funds, and we may also selectively invest in more broadly syndicated first lien secured loans from time to time.

We generally do not intend to invest in start-up companies, operationally distressed situations or companies with speculative business plans. In addition, we may invest up to 30% of our portfolio in opportunistic

 

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investments which will be intended to diversify or complement the remainder of our portfolio and to enhance our returns to stockholders. These investments may include high-yield bonds, private equity investments, securities of public companies that are broadly traded and securities of non-U.S. companies. We expect that these public companies generally will have debt securities that are non-investment grade.

Once we have determined that a prospective portfolio company is suitable for investment, we work with the management of that company and its other capital providers, including, as applicable, senior, junior, and equity capital providers, to structure an investment, typically investing an average of approximately $10 million to $25 million of capital per transaction. We negotiate among these parties to agree on how our investment is expected to perform relative to the other capital in the portfolio company’s capital structure.

Security types we invest in include:

Mezzanine Loans. We structure our subordinated, or mezzanine investments, primarily as unsecured, subordinated loans that provide for relatively high, fixed interest rates that will provide us with current interest income. Generally, mezzanine loans rank subordinate in priority of payment to senior debt, such as senior bank debt, and are often unsecured. However, mezzanine loans rank senior to common and preferred equity in a borrowers’ capital structure. Mezzanine loans typically have interest-only payments in the early years, with amortization of principal deferred to the later years and may include an associated equity component such as warrants, preferred stock or other similar securities. The warrants associated with mezzanine loans are typically detachable, which allows lenders to receive repayment of their principal on an agreed amortization schedule while retaining their equity interest in the borrower. Also, in some cases our mezzanine loans will be collateralized by a subordinated lien on some or all of the assets of the borrower. Typically, our mezzanine loans will have maturities of five to ten years. In determining whether a prospective mezzanine loan investment satisfies our investment criteria, we generally seek a high total return potential, although there can be no assurance we will find investments satisfying that criterion or that any such investments will perform in accordance with expectations.

Second Lien Loans. We structure our second lien investments as junior, secured loans. We obtain security interests in the assets of the portfolio company that serve as collateral in support of the repayment of such loans. This collateral may take the form of second priority liens on the assets of a portfolio company. Second lien loans may provide for moderate loan amortization in the initial years of the facility, with the majority of the amortization deferred until loan maturity, although there can be no assurance we will find investments providing for such amortization.

First Lien Senior Secured Loans. To the extent we invest in first lien or senior secured loans, we expect such loans to have terms of three to ten years and may provide for deferred interest payments in the first few years of the term of the loan. To the extent we invest in senior secured loans, we obtain first lien security interests in the assets of these portfolio companies that serve as collateral in support of the repayment of these loans. First lien secured loans may also include unitranche loan structures, which typically combine characteristics of traditional first lien senior secured and second lien and subordinated loans. We may obtain security interests in the asset of the portfolio company that serve as collateral in support of the repayment of these loans. This collateral may take the form of first-priority liens on the assets of the portfolio company and may provide for moderate loan amortization in the initial years of the facility, with the majority of the amortization deferred until loan maturity, although there can be no assurance we will find investments providing for such amortization. Unitranche loans generally allow the borrower to make a large lump sum payment of principal at the end of the loan term, and there is a risk of loss if the borrower is unable to pay the lump sum or refinance the amount owed at maturity.

Investment Terms

We tailor the terms of each investment to the facts and circumstances of the transaction and the prospective portfolio company, negotiating a structure that protects our rights and manages our risk while creating incentives

 

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for the portfolio company to achieve its business plan and improve its profitability. We seek to limit the downside potential of our investments by:

 

   

requiring a total return on our investments (including both interest and potential equity appreciation) that compensates us for credit risk; and

 

   

negotiating covenants in connection with our investments that afford our portfolio companies as much flexibility in managing their businesses as possible, consistent with preservation of our capital. Such restrictions may include affirmative and negative covenants, default penalties, lien protection, change of control provisions and board rights, including either observation or rights to a seat on the board under some circumstances or participation rights.

Our investments may include equity features, such as warrants or options to buy a minority interest in the portfolio company. Any warrants we receive with our debt securities generally require only a nominal cost to exercise, and thus, as a portfolio company appreciates in value, we may achieve additional investment return from this equity interest. We may structure the warrants to provide provisions protecting our rights as a minority-interest holder, as well as puts, or rights to sell such securities back to the company, upon the occurrence of specified events. In many cases, we also obtain registration rights in connection with these equity interests, which may include demand and “piggyback” registration rights.

Supervising

Successful supervision of our investments involves employing active monitoring methods and developing strong underlying management teams at each portfolio company.

Monitoring

We view active portfolio monitoring as a vital part of our investment process. We consider board observation rights, regular dialogue with company management and sponsors, and detailed internally generated monitoring reports to be critical to our performance. We have developed a monitoring template that promotes compliance with these standards and that is used as a tool by the Advisor’s investment committee to assess investment performance relative to plan. In addition, our portfolio companies may rely on us to provide financial and capital market expertise and may view us as a value-added resource.

As part of the monitoring process, the Advisor assesses the risk profile of each of our investments and assigns each investment a score of a 1, 2, 3, 4 or 5. Effective March 31, 2012, the Advisor revised its scoring system in order to categorize, on a more granular level, each investment based upon its performance and may revise the scoring system in the future depending upon the nature of the portfolio. The changes from December 31, 2011, included moving investments with a previous score of a 2 to a new investment performance score of 3 and bifurcating a previous score of 1 between new investment performance scores of 1 and 2 based upon its performance. Overall, there was no significant change in the risk profile of the portfolio companies between December 31, 2011 and December 31, 2012 or between March 31, 2012 and December 31, 2012.

The revised investment performance scores, or IPS, are as follows:

1 – The portfolio company is performing above our underwriting expectations.

2 – The portfolio company is performing as expected at the time of underwriting. All new investments are initially scored a 2.

3 – The portfolio company is operating below our underwriting expectations, and requires closer monitoring. The company may be out of compliance with financial covenants, however, principal or interest payments are generally not past due.

 

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4 – The portfolio company is performing materially below our underwriting expectations and returns on our investment are likely to be impaired. Principal or interest payments may be past due, however, full recovery of principal is expected.

5 – The portfolio company is performing substantially below expectations and the risk of the investment has increased substantially. The company is in payment default and the principal amount is not expected to be repaid in full.

For any investment receiving a score of a 3 or lower, our manager increases its level of focus and prepares regular updates for the investment committee summarizing current operating results, material impending events and recommended actions.

The Advisor monitors and, when appropriate, changes the investment scores assigned to each investment in our portfolio. In connection with our investment valuation process, the Advisor and board of directors review these investment scores on a quarterly basis. Our average investment score was 2.12 at December 31, 2012. The following is a distribution of the investment scores of our portfolio companies at December 31, 2012:

 

     December 31, 2012  

Investment Score

   Investments at
Fair Value
     % of Total
Portfolio
 

1(a)

   $ 20,040,000         5.1

2(b)

     312,461,130         79.2

3(c)

     55,490,878         14.1

4(d)

     6,357,126         1.6

5

     —           —     
  

 

 

    

 

 

 

Total

   $ 394,349,134         100.0
  

 

 

    

 

 

 

 

(a) 

As of December 31, 2012, Investment Score “1” included $8.2 million of loans to companies in which we also hold equity securities.

(b) 

As of December 31, 2012, Investment Score “2” included $49.4 million of loans to companies in which we also hold equity securities.

(c) 

As of December 31, 2012, Investment Score “3” included $27.0 million of loans to companies in which we also hold equity securities.

(d) 

As of December 31, 2012, Investment Score “4” included no loans to companies in which we also hold equity securities.

Loans are placed on non-accrual status when principal or interest payments are past due 30 days or more and/or when there is reasonable doubt that principal or interest will be collected. However, we may make exceptions to this policy if the loan has sufficient collateral value and is in the process of collection. As of December 31, 2012 and December 31, 2011, we had no loans on non-accrual.

Investment management agreement

THL Credit Advisors serves as our investment adviser. THL Credit Advisors is registered as an investment adviser under the Advisers Act. Subject to the overall supervision of our board of directors, THL Credit Advisors manages the day-to-day operations of, and provide investment advisory and management services to, THL Credit, Inc. We provide similar services to SBIC LP under its investment management agreement with us. The address of THL Credit Advisors is 100 Federal Street, 31st Floor, Boston, Massachusetts 02110.

 

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Under the terms of our investment management agreement, THL Credit Advisors:

 

   

determines the composition of our portfolio, the nature and timing of the changes to our portfolio and the manner of implementing such changes;

 

   

identifies, evaluates and negotiates the structure of the investments we make (including performing due diligence on our prospective portfolio companies); and

 

   

closes, monitors and administers the investments we make, including the exercise of any voting or consent rights.

THL Credit Advisors’ services under the investment management agreement are not exclusive, and it is free to furnish similar services to other entities so long as its services to us are not impaired.

Pursuant to our investment management agreement, we pay THL Credit Advisors a fee for investment advisory and management services consisting of a base management fee and a two-part incentive fee.

Management Fee. The base management fee is calculated at an annual rate of 1.5% of our gross assets payable quarterly in arrears on a calendar quarter basis. For purposes of calculating the base management fee, “gross assets” is determined without deduction for any liabilities. For the first quarter of our operations, the base management fee was calculated based on the initial value of our gross assets. Beginning with our second quarter of operations, the base management fee was calculated based on the value of our gross assets at the end of the most recently completed calendar quarter, and appropriately adjusted for any share issuances or repurchases during the current calendar quarter. Base management fees for any partial quarter are appropriately prorated. For the years ended December 31, 2012, 2011 and 2010, THL Credit Advisors earned base management fees of $4.9 million, $4.0 million and $2.7 million, respectively, from us.

Incentive Fee. The incentive fee has two components, ordinary income and capital gains, calculated as follows:

The ordinary income component is calculated and payable quarterly in arrears based on our preincentive fee net investment income for the immediately preceding calendar quarter, subject to a total return requirement and deferral of non-cash amounts, and will be 20.0% of the amount, if any, by which our preincentive fee net investment income, expressed as a rate of return on the value of our net assets attributable to our common stock, for the immediately preceding calendar quarter exceeds a 2.0% (which is 8.0% annualized) hurdle rate and a “catch-up” provision measured as of the end of each calendar quarter. Under this provision, in any calendar quarter, our investment adviser receives no incentive fee until our preincentive fee net investment income equals the hurdle rate of 2.0%, but then receives, as a “catch-up,” 100% of our preincentive fee net investment income with respect to that portion of such preincentive fee net investment income, if any, that exceeds the hurdle rate but is less than 2.5%. The effect of the “catch-up” provision is that, subject to the total return and deferral provisions discussed below, if preincentive fee net investment income exceeds 2.5% in any calendar quarter, our investment adviser receives 20.0% of our preincentive fee net investment income as if a hurdle rate did not apply. For this purpose, preincentive fee net investment income means interest income, dividend income and any other income (including any other fees, such as commitment, origination, structuring, diligence, managerial assistance and consulting fees or other fees that we receive from portfolio companies) accrued during the calendar quarter, minus our operating expenses for the quarter (including the base management fee, expenses payable under the administration agreement (as defined below), and any interest expense and any dividends paid on any issued and outstanding preferred stock, but excluding the incentive fee and any offering expenses and other expenses not charged to operations but excluding certain reversals to the extent such reversals have the effect of reducing previously accrued incentive fees based on the deferral of non-cash interest). Preincentive fee net investment income includes, in the case of investments with a deferred interest feature (such as original issue discount, debt instruments with PIK interest and zero coupon securities), accrued income that we have not yet received in cash. The foregoing incentive fee is subject to a total return requirement, which provides that no incentive fee in respect of the Company’s preincentive fee net investment income will be payable except to the extent 20.0% of

 

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the cumulative net increase in net assets resulting from operations over the then current and 11 preceding quarters exceeds the cumulative incentive fees accrued and/or paid for the 11 preceding quarters. In other words, any ordinary income incentive fee that is payable in a calendar quarter will be limited to the lesser of (i) 20% of the amount by which our preincentive fee net investment income for such calendar quarter exceeds the 2.0% hurdle, subject to the “catch-up” provision, and (ii) (x) 20% of the cumulative net increase in net assets resulting from operations for the then current and 11 preceding calendar quarters minus (y) the cumulative incentive fees accrued and/or paid for the 11 preceding calendar quarters. For the foregoing purpose, the “cumulative net increase in net assets resulting from operations” is the amount, if positive, of the sum of preincentive fee net investment income, base management fees, realized gains and losses and unrealized appreciation and depreciation of the Company for the then current and 11 preceding calendar quarters. In addition, the portion of such incentive fee that is attributable to deferred interest (such as PIK interest or OID) will be paid to THL Credit Advisors, together with interest thereon from the date of deferral to the date of payment, only if and to the extent we actually receive such interest in cash, and any accrual thereof will be reversed if and to the extent such interest is reversed in connection with any write-off or similar treatment of the investment giving rise to any deferred interest accrual. Any reversal of such accounts would reduce net income for the quarter by the net amount of the reversal (after taking into account the reversal of incentive fees payable) and would result in a reduction and possibly elimination of the incentive fees for such quarter. There is no accumulation of amounts on the hurdle rate from quarter to quarter and accordingly there is no clawback of amounts previously paid if subsequent quarters are below the quarterly hurdle and there is no delay of payment if prior quarters are below the quarterly hurdle.

Preincentive fee net investment income does not include any realized capital gains, realized capital losses or unrealized capital appreciation or depreciation. Because of the structure of the incentive fee, it is possible that we may pay an incentive fee in a quarter where we incur a loss, subject to the total return requirement and deferral of non-cash amounts. For example, if we receive preincentive fee net investment income in excess of the quarterly minimum hurdle rate, we will pay the applicable incentive fee even if we have incurred a loss in that quarter due to realized and unrealized capital losses. Our net investment income used to calculate this component of the incentive fee is also included in the amount of our gross assets used to calculate the 1.5% base management fee. These calculations will be appropriately prorated for any period of less than three months and adjusted for any share issuances or repurchases during the current quarter.

The following is a graphical representation of the calculation of the income-related portion of the incentive fee:

Quarterly Incentive Fee Based on Net Investment Income

Pre-incentive fee net investment income (expressed as a percentage of the value of net assets)

 

LOGO

Percentage of pre-incentive fee net investment income allocated to first component of incentive fee

The capital gains component of the incentive fee is determined and payable in arrears as of the end of each calendar year (or upon termination of the investment management agreement, as of the termination date) and is equal to 20.0% of our cumulative aggregate realized capital gains from inception through the end of that calendar year, computed net of our aggregate cumulative realized capital losses and our aggregate cumulative unrealized capital depreciation through the end of such year, less the aggregate amount of any previously paid capital gains

 

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incentive fees. If such amount is negative, then no capital gains incentive fee will be payable for such year. Additionally, if the investment management agreement is terminated as of a date that is not a calendar year end, the termination date will be treated as though it were a calendar year end for purposes of calculating and paying the capital gains incentive fee. For the years ended December 31, 2012, 2011 and 2010, THL Credit Advisors earned incentive fees of $7.0 million, $4.8 million and $0.0 million, respectively, from us.

Examples of Quarterly Incentive Fee Calculation

Example 1: Income Portion of Incentive Fee before Total Return Requirement Calculation:

Assumptions

 

   

Hurdle rate(1) = 2.00%

 

   

Base management fee(2) = 0.375%

 

   

Other expenses (legal, accounting, custodian, transfer agent, etc.)(3) = 0.40%

Alternative 1

Additional Assumptions

 

   

Investment income (including interest, dividends, fees, etc.) = 1.25%

 

   

Pre-incentive fee net investment income (investment income—(base management fee + other expenses)) = 0.475%

Pre-incentive net investment income does not exceed hurdle rate, therefore there is no incentive fee.

Alternative 2

Additional Assumptions

 

   

Investment income (including interest, dividends, fees, etc.) = 2.90%

 

   

Preincentive fee net investment income (investment income—(base management fee + other expenses)) = 2.125%

Preincentive fee net investment income exceeds hurdle rate, therefore there is an incentive fee.

Incentive fee = (100% × “Catch-Up”) + (the greater of 0% AND (20.0% × (preincentive fee net investment income—2.5%)))

= (100.0% x (preincentive fee net investment income—2.00%)) +0%

= (100.0% x (2.125%—2.00%))

= 100% x 0.125%

= 0.125%

Alternative 3

Additional Assumptions

 

   

Investment income (including interest, dividends, fees, etc.) = 3.50%

 

   

Preincentive fee net investment income (investment income—(base management fee + other expenses)) = 2.725%

 

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Preincentive fee net investment income exceeds hurdle rate, therefore there is an incentive fee.

Incentive Fee = (100% × “Catch-Up”) + (the greater of 0% AND (20.0% × (preincentive fee net investment income—2.5%)))

= (100% × (2.5%—2.0%)) + (20.0% × (2.725%—2.5%))

= 0.5% + (20.0% × 0.225%)

= 0.5% + 0.045%

= 0.545%

 

(1) 

Represents 8.0% annualized hurdle rate.

(2) 

Represents 1.5% annualized base management fee.

(3) 

Excludes organizational and offering expenses.

Example 2: Income Portion of Incentive Fee with Total Return Requirement Calculation:

Assumptions

 

   

Hurdle rate (1) = 2.00%

 

   

Base management fee (2) = 0.375%

 

   

Other expenses (legal, accounting, transfer agent, etc.) (3) = 0.40%

 

   

Cumulative incentive compensation accrued and/or paid for preceding 11 calendar quarters = $9,000,000

Alternative 1

Additional Assumptions

 

   

Investment income (including interest, dividends, fees, etc.) = 3.50%

 

   

Preincentive fee net investment income (investment income – (base management fee + other expenses)) = 2.725%

 

   

20.0% of cumulative net increase in net assets resulting from operations over current and preceding 11 calendar quarters = $8,000,000

Although our preincentive fee net investment income exceeds the hurdle rate of 2.0% (as shown in Alternative 3 of Example 1 above), no incentive fee is payable because 20.0% of the cumulative net increase in net assets resulting from operations over the then current and 11 preceding calendar quarters did not exceed the cumulative income and capital gains incentive fees accrued and/or paid for the preceding 11 calendar quarters.

Alternative 2

Additional Assumptions

 

   

Investment Income (including interest, dividends, fees, etc.) = 3.50%

 

   

Preincentive fee net investment income (investment income – (base management fee + other expenses)) = 2.725%.

 

   

20% of cumulative net increase in net assets resulting from operations over current and preceding 11 calendar quarters = $10,000,000

Because our preincentive fee net investment income exceeds the hurdle rate of 2.0% and because 20.0% of the cumulative net increase in net assets resulting from operations over the then current and 11 preceding

 

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calendar quarters exceeds the cumulative income and capital gains incentive fees accrued and/or paid for the preceding 11 calendar quarters, an incentive fee would be payable, as shown in Alternative 3 of Example 1 above.

 

(1) 

Represents 8.0% annualized hurdle rate.

(2) 

Represents 1.5% annualized base management fee.

(3) 

Excludes organizational and offering expenses.

Example 3: Capital Gains Portion of Incentive Fee:

Alternative 1:

Assumptions

 

   

Year 1: $20 million investment made in Company A (“Investment A”), and $30 million investment made in Company B (“Investment B”)

 

   

Year 2: Investment A sold for $50 million and fair market value, or FMV, of Investment B determined to be $32 million

 

   

Year 3: FMV of Investment B determined to be $25 million

 

   

Year 4: Investment B sold for $31 million

The capital gains portion of the incentive fee would be:

 

   

Year 1: None

 

   

Year 2: Capital gains incentive fee of $6.0 million ($30 million realized capital gains on sale of Investment A multiplied by 20.0%)

 

   

Year 3: None; $5.0 million (20.0% multiplied by ($30 million cumulative capital gains less $5 million cumulative capital depreciation)) less $6.0 million (previous capital gains fee paid in Year 2)

 

   

Year 4: Capital gains incentive fee of $200,000; $6.20 million ($31 million cumulative realized capital gains multiplied by 20.0%) less $6.0 million (capital gains fee paid in Year 2)

Alternative 2

Assumptions

 

   

Year 1: $20 million investment made in Company A (“Investment A”), $30 million investment made in Company B (“Investment B”) and $25 million investment made in Company C (“Investment C”)

 

   

Year 2: Investment A sold for $50 million, FMV of Investment B determined to be $25 million and FMV of Investment C determined to be $25 million

 

   

Year 3: FMV of Investment B determined to be $27 million and Investment C sold for $30 million

 

   

Year 4: FMV of Investment B determined to be $35 million

 

   

Year 5: Investment B sold for $20 million

The capital gains portion of the incentive fee would be:

 

   

Year 1: None

 

   

Year 2: Capital gains incentive fee of $5.0 million; 20.0% multiplied by $25 million ($30 million realized capital gains on Investment A less $5 million unrealized capital depreciation on Investment B)

 

   

Year 3: Capital gains incentive fee of $1.4 million; $6.4 million (20.0% multiplied by $32 million ($35 million cumulative realized capital gains less $3 million unrealized capital depreciation on Investment B)) less $5.0 million capital gains fee received in Year 2

 

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Year 4: None

 

   

Year 5: None; $5.0 million of capital gains incentive fee (20.0% multiplied by $25 million (cumulative realized capital gains of $35 million less realized capital losses of $10 million)) less $6.4 million cumulative capital gains fee paid in Year 2 and Year 3

Payment of our expenses

All investment professionals and staff of THL Credit Advisors, when and to the extent engaged in providing investment advisory and management services, and the compensation and routine overhead expenses of such personnel allocable to such services (including health insurance, 401(k) plan benefits, payroll taxes and other compensation related matters), are provided and paid for by THL Credit Advisors. We bear all other costs and expenses of our operations and transactions, including those relating to:

 

   

our organization;

 

   

calculating our net asset value and net asset value per share (including the cost and expenses of any independent valuation firm);

 

   

expenses, including travel-related expenses, incurred by THL Credit Advisors or payable to third parties in originating investments for the portfolio, performing due diligence on prospective portfolio companies, monitoring our investments and, if necessary, enforcing our rights;

 

   

interest payable on debt, if any, incurred to finance our investments;

 

   

the costs of future offerings of common shares and other securities, if any;

 

   

the base management fee and any incentive management fee;

 

   

distributions on our shares;

 

   

administrator expenses payable under our administration agreement;

 

   

transfer agent and custody fees and expenses;

 

   

the allocated costs incurred by THL Credit Advisors as our Administrator in providing managerial assistance to those portfolio companies that request it;

 

   

amounts payable to third parties relating to, or associated with, evaluating, making and disposing of investments;

 

   

brokerage fees and commissions;

 

   

registration fees;

 

   

listing fees;

 

   

taxes;

 

   

independent director fees and expenses;

 

   

costs of preparing and filing reports or other documents with the SEC;

 

   

the costs of any reports, proxy statements or other notices to our stockholders, including printing costs;

 

   

costs of holding stockholder meetings;

 

   

our fidelity bond;

 

   

directors and officers/errors and omissions liability insurance, and any other insurance premiums;

 

   

litigation, indemnification and other non-recurring or extraordinary expenses;

 

   

direct costs and expenses of administration and operation, including audit and legal costs;

 

   

dues, fees and charges of any trade association of which we are a member; and

 

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all other expenses reasonably incurred by us or the Administrator in connection with administering our business, such as the allocable portion of overhead under our administration agreement, including rent and other allocable portions of the cost of certain of our officers and their respective staffs.

We reimburse THL Credit Advisors for costs and expenses incurred by THL Credit Advisors for office space rental, office equipment and utilities allocable to the performance by THL Credit Advisors of its duties under the investment management agreement, as well as any costs and expenses incurred by THL Credit Advisors relating to any non-investment advisory, administrative or operating services provided by THL Credit Advisors to us or in the form of managerial assistance to portfolio companies that request it.

THL Credit Advisors may pay amounts owed by us to third party providers of goods or services. We will subsequently reimburse THL Credit Advisors for such amounts paid on our behalf.

Limitation of liability and indemnification

The investment management agreement provides that THL Credit Advisors and its officers, directors, employees and affiliates are not liable to us or any of our stockholders for any act or omission by it or its employees in the supervision or management of our investment activities or for any loss sustained by us or our stockholders, except that the foregoing exculpation does not extend to any act or omission constituting willful misfeasance, bad faith, gross negligence or reckless disregard of its obligations under the investment management agreement. The investment management agreement also provides for indemnification by us of THL Credit Advisors’ members, directors, officers, employees, agents and control persons for liabilities incurred by it in connection with their services to us, subject to the same limitations and to certain conditions.

Duration and termination

The investment management agreement was approved by our board of directors on February 27, 2013, as described further below under “Business—Board Approval of the Investment Advisory Agreement.” Unless terminated earlier as described below, it will remain in effect from year to year if approved annually by our board of directors or by the affirmative vote of the holders of a majority of our outstanding voting securities, including, in either case, approval by a majority of our directors who are not interested persons. The investment management agreement will automatically terminate in the event of its assignment. The investment management agreement may be terminated by either party without penalty upon not less than 60 days written notice to the other. Any termination by us must be authorized either by our board of directors or by vote of our stockholders. See “Risk Factors—Risks relating to our business.” We are dependent upon senior management personnel of our investment adviser for our future success, and if our investment adviser is unable to retain qualified personnel or if our investment adviser loses any member of its senior management team, our ability to achieve our investment objective could be significantly harmed.

Board Approval of the Investment Advisory Agreement

At a meeting of our Board of Directors held on February 27, 2013, our board of directors unanimously voted to approve the investment advisory agreement. In reaching a decision to approve the investment advisory agreement, the board of directors reviewed a significant amount of information and considered, among other things:

 

   

the nature, quality and extent of the advisory and other services to be provided to us by THL Credit Advisors LLC;

 

   

the fee structures of comparable externally managed business development companies that engage in similar investing activities;

 

   

our projected operating expenses and expense ratio compared to business development companies with similar investment objectives;

 

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any existing and potential sources of indirect income to THL Credit Advisors LLC from its relationship with us and the profitability of that relationship, including through the investment advisory agreement;

 

   

information about the services to be performed and the personnel performing such services under the investment advisory agreement;

 

   

the organizational capability and financial condition of THL Credit Advisors LLC and its affiliates; and

 

   

various other matters.

Based on the information reviewed and the discussions detailed above, the board of directors, including all of the directors who are not “interested persons” as defined in the 1940 Act, concluded that the investment advisory fee rates and terms are reasonable in relation to the services provided and approved the investment advisory agreement as being in the best interests of our stockholders.

Administration agreement

We have entered into an administration agreement with THL Credit Advisors, which we refer to as the “administration agreement,” under which the Administrator provides administrative services to us. For providing these services, facilities and personnel, we reimburse the Administrator for our allocable portion of overhead and other expenses incurred by the Administrator in performing its obligations under the administration agreement, including rent and our allocable portion of the cost of certain of our officers and their respective staffs.

The Administrator may pay amounts owed by us to third-party providers of goods or services. We will subsequently reimburse the Administrator for such amounts paid on our behalf.

Additionally, at our request, the Administrator provides on our behalf significant managerial assistance to our portfolio companies to which we are required to provide such assistance.

License agreement

We and THL Credit Advisors have entered into a license agreement with THL Partners under which THL Partners has granted to us and THL Credit Advisors a non-exclusive, personal, revocable worldwide non-transferable license to use the trade name and service mark THL, which is a proprietary mark of THL Partners, for specified purposes in connection with our respective businesses. This license agreement is royalty-free, which means we are not charged a fee for our use of the trade name and service mark THL. The license agreement is terminable either in its entirety or with respect to us or THL Credit Advisors by THL Partners at any time in its sole discretion upon 60 days prior written notice, and is also terminable with respect to either us or THL Credit Advisors by THL Partners in the case of certain events of non-compliance. After the expiration of its first one year term, the entire license agreement is terminable by either us or THL Credit Advisors at our or its sole discretion upon 60 days prior written notice. Upon termination of the license agreement, we and THL Credit Advisors must cease to use the name and mark THL, including any use in our respective legal names, filings, listings and other uses that may require us to withdraw or replace our names and marks. Other than with respect to the limited rights contained in the license agreement, we and THL Credit Advisors have no right to use, or other rights in respect of, the THL name and mark. We are an entity operated independently from THL Partners, and third parties who deal with us have no recourse against THL Partners.

Regulation

Regulated Investment Company and Business Development Company Regulations

We have elected to be regulated as a BDC under the 1940 Act. We have also elected to be treated for tax purposes as a RIC under Subchapter M of the Code. The 1940 Act contains prohibitions and restrictions relating to transactions between BDCs and their affiliates (including any investment advisers or sub-advisers), principal underwriters and affiliates of those affiliates or underwriters and requires that a majority of the directors be persons other than “interested persons,” as that term is defined in the 1940 Act.

 

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In addition, the 1940 Act provides that we may not change the nature of our business so as to cease to be, or to withdraw our election as, a BDC unless approved by “a majority of our outstanding voting securities” as defined in the 1940 Act. A majority of the outstanding voting securities of a company is defined under the 1940 Act as the lesser of: (a) 67% or more of such company’s voting securities present at a meeting if more than 50% of the outstanding voting securities of such company are present or represented by proxy, or (b) more than 50% of the outstanding voting securities of such company. We do not anticipate any substantial change in the nature of our business.

We are not generally able to issue and sell our common stock at a price below net asset value per share. We may, however, issue and sell our common stock, or warrants, options or rights to acquire our common stock, at a price below the then-current net asset value of our common stock if (1) our board of directors determines that such sale is in our best interests and the best interests of our stockholders, and (2) our stockholders have approved our policy and practice of making such sales within the preceding 12 months. In any such case, the price at which our securities are to be issued and sold may not be less than a price which, in the determination of our board of directors, closely approximates the market value of such securities. At our Annual Meeting of Stockholders on June 7, 2012, our stockholders approved a proposal authorizing us to sell up to 25% of our common stock at a price below our then-current net asset value per share, subject to approval by our board of directors for the offering. The authorization expires on the earlier of June 7, 2013 and the date of our 2013 Annual Meeting of Stock holders, which is expected to be held in June 2013. Our stockholders also approved a proposal to authorize us to offer and issue debt with warrants or debt convertible into shares of our common stock at an exercise or conversion price that, at the time such warrants or convertible debt are issued, will not be less than the market value per share but may be below our then-current net asset value per share.

As a BDC, we are required to meet a coverage ratio of the value of total assets to senior securities, which include all of our borrowings and any preferred stock we may issue in the future, of at least 200%. We may also be prohibited under the 1940 Act from knowingly participating in certain transactions with our affiliates without the prior approval of our board of directors who are not interested persons and, in some cases, prior approval by the SEC.

In January 2013, legislation was introduced in the U.S. House of Representatives intended to revise certain regulations applicable to BDCs. The legislation provides for (i) increasing the amount of funds BDCs may borrow by reducing asset to debt limitations from 2:1 to 3:2, (ii) permitting BDCs to file registration statements with the U.S. Securities and Exchange Commission that incorporate information from already-filed reports by reference, (iii) utilizing other streamlined registration processes afforded to operating companies, and (iv) allowing BDCs to own investment adviser subsidiaries. There are no assurances as to when the legislation will be enacted by Congress, if at all, or, if enacted, what final form the legislation would take.

We may invest up to 100% of our assets in securities acquired directly from issuers in privately negotiated transactions. With respect to such securities, we may, for the purpose of public resale, be deemed an “underwriter” as that term is defined in the Securities Act of 1933, or the Securities Act. We do not intend to acquire securities issued by any investment company that exceed the limits imposed by the 1940 Act. Under these limits, except for registered money market funds, we generally cannot acquire more than 3% of the voting stock of any investment company, invest more than 5% of the value of our total assets in the securities of one investment company or invest more than 10% of the value of our total assets in the securities of more than one investment company. With regard to that portion of our portfolio invested in securities issued by investment companies, it should be noted that such investments might indirectly subject our stockholders to additional expenses as they will indirectly be responsible for the costs and expenses of such companies. None of our investment policies are fundamental and any may be changed without stockholder approval.

 

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Qualifying assets

Under the 1940 Act, a BDC may not acquire any asset other than assets of the type listed in section 55(a) of the 1940 Act, which are referred to as qualifying assets, unless, at the time the acquisition is made, qualifying assets represent at least 70% of the company’s total assets. The principal categories of qualifying assets relevant to our proposed business are the following:

 

   

Securities purchased in transactions not involving any public offering from the issuer of such securities, which issuer (subject to certain limited exceptions) is an eligible portfolio company, or from any person who is, or has been during the preceding 13 months, an affiliated person of an eligible portfolio company, or from any other person, subject to such rules as may be prescribed by the SEC. An eligible portfolio company is defined in the 1940 Act as any issuer which:

 

   

is organized under the laws of, and has its principal place of business in, the United States;

 

   

is not an investment company (other than a small business investment company wholly owned by the BDC) or a company that would be an investment company but for certain exclusions under the 1940 Act; and

 

   

satisfies either of the following:

 

   

has a market capitalization of less than $250 million or does not have any class of securities listed on a national securities exchange; or

 

   

is controlled by a BDC or a group of companies including a BDC, the BDC actually exercises a controlling influence over the management or policies of the eligible portfolio company, and, as a result thereof, the BDC has an affiliated person who is a director of the eligible portfolio company.

 

   

Securities of any eligible portfolio company which we control.

 

   

Securities purchased in a private transaction from a U.S. issuer that is not an investment company or from an affiliated person of the issuer, or in transactions incident thereto, if the issuer is in bankruptcy and subject to reorganization or if the issuer, immediately prior to the purchase of its securities was unable to meet its obligations as they came due without material assistance other than conventional lending or financing arrangements.

 

   

Securities of an eligible portfolio company purchased from any person in a private transaction if there is no ready market for such securities and we already own 60% of the outstanding equity of the eligible portfolio company.

 

   

Securities received in exchange for or distributed on or with respect to securities described above, or pursuant to the exercise of warrants or rights relating to such securities.

 

   

Cash, cash equivalents, U.S. Government securities or high-quality debt securities maturing in one year or less from the time of investment.

Control, as defined by the 1940 Act, is presumed to exist where a BDC beneficially owns more than 25% of the outstanding voting securities of the portfolio company.

Significant managerial assistance to portfolio companies

A BDC must have been organized and have its principal place of business in the United States and must be operated for the purpose of making investments in the types of securities described in “Business—Regulation—Qualifying assets” above. However, in order to count portfolio securities as qualifying assets for the purpose of the 70% test, the BDC must either control the issuer of the securities or must offer to make available to the issuer of the securities (other than small and solvent companies described above) significant managerial assistance. Where the BDC purchases such securities in conjunction with one or more other persons acting together, the BDC will satisfy this test if one of the other persons in the group makes available such managerial assistance,

 

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although this may not be the sole method by which the BDC satisfies the requirement to make available managerial assistance. Making available managerial assistance means, among other things, any arrangement whereby the BDC, through its directors, officers or employees, offers to provide, and, if accepted, does so provide, significant guidance and counsel concerning the management, operations or business objectives and policies of a portfolio company.

Temporary investments

Pending investment in other types of “qualifying assets,” as described above, our investments may consist of cash, cash equivalents, U.S. government securities or high-quality debt securities maturing in one year or less from the time of investment, which we refer to, collectively, as temporary investments, so that 70% of our assets are qualifying assets. Typically, we invest in highly rated commercial paper, U.S. Government agency notes, U.S. Treasury bills or in repurchase agreements relating to such securities that are fully collateralized by cash or securities issued by the U.S. government or its agencies. A repurchase agreement involves the purchase by an investor, such as us, of a specified security and the simultaneous agreement by the seller to repurchase it at an agreed-upon future date and at a price which is greater than the purchase price by an amount that reflects an agreed-upon interest rate. Consequently, repurchase agreements are functionally similar to loans. There is no percentage restriction on the proportion of our assets that may be invested in such repurchase agreements. However, the 1940 Act and certain diversification tests in order to qualify as a RIC for federal income tax purposes typically require us to limit the amount we invest with any one counterparty. Our investment adviser monitors the creditworthiness of the counterparties with which we enter into repurchase agreement transactions.

Warrants and Options

Under the 1940 Act, a BDC is subject to restrictions on the amount of warrants, options, restricted stock or rights to purchase shares of capital stock that it may have outstanding at any time. Under the 1940 Act, we may generally only offer warrants provided that (i) the warrants expire by their terms within ten years, (ii) the exercise or conversion price is not less than the current market value at the date of issuance, (iii) our stockholders authorize the proposal to issue such warrants, and our board of directors approves such issuance on the basis that the issuance is in the best interests of THL Credit and its stockholders and (iv) if the warrants are accompanied by other securities, the warrants are not separately transferable unless no class of such warrants and the securities accompanying them has been publicly distributed. The 1940 Act also provides that the amount of our voting securities that would result from the exercise of all outstanding warrants, as well as options and rights, at the time of issuance may not exceed 25% of our outstanding voting securities In particular, the amount of capital stock that would result from the conversion or exercise of all outstanding warrants, options or rights to purchase capital stock cannot exceed 25% of the BDC’s total outstanding shares of capital stock.

Senior securities

We are permitted, under specified conditions, to issue multiple classes of indebtedness and one class of stock senior to our common stock if our asset coverage, as defined in the 1940 Act, is at least equal to 200% immediately after each such issuance. In addition, while any preferred stock or publicly traded debt securities are outstanding, we must make provisions to prohibit any distribution to our stockholders or the repurchase of such securities or shares unless we meet the applicable asset coverage ratios at the time of the distribution or repurchase. We may also borrow amounts up to 5% of the value of our total assets for temporary or emergency purposes without regard to asset coverage. For a discussion of the risks associated with leverage, see “Risks—Risks related to our operations as a BDC.”

No-action relief from registration as a commodity pool operator

We are relying on a no-action letter (the “No-Action Letter”) issued by the staff of the Commodity Futures Trading Commission (the “CFTC”) as a basis to avoid registration with the CFTC as a commodity pool operator (“CPO”). The No-Action Letter allows an entity to engage in CFTC-regulated transactions (“commodity interest

 

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transactions”) that are “bona fide hedging” transactions (as that term is defined and interpreted by the CFTC and its staff), but prohibit an entity from entering into commodity interest transactions if they are non-bona fide hedging transactions, unless immediately after entering such non-bona fide hedging transaction (a) the sum of the amount of initial margin deposits on the entity’s existing futures or swaps positions and option or swaption premiums does not exceed 5% of the market value of the entity’s liquidating value, after taking into account unrealized profits and unrealized losses on any such transactions, or (b) the aggregate net notional value of the entity’s commodity interest transactions would not exceed 100% of the market value of the entity’s liquidating value, after taking into account unrealized profits and unrealized losses on any such transactions. We are required to operate pursuant to these trading restrictions if we intend to continue to rely on the No-Action Letter as a basis to avoid CPO registration.

Proxy voting policies and procedures

We have delegated our proxy voting responsibility to THL Credit Advisors. The Proxy Voting Policies and Procedures of THL Credit Advisors are set forth below. The guidelines are reviewed periodically by THL Credit Advisors and our independent directors, and, accordingly, are subject to change.

Introduction

THL Credit Advisors is registered as an investment adviser under the Advisers Act. As an investment adviser registered under the Advisers Act, THL Credit Advisors has fiduciary duties to us. As part of this duty, THL Credit Advisors recognizes that it must vote client securities in a timely manner free of conflicts of interest and in our best interests and the best interests of our stockholders. THL Credit Advisors’ Proxy Voting Policies and Procedures have been formulated to ensure decision-making consistent with these fiduciary duties.

These policies and procedures for voting proxies for our investment advisory clients are intended to comply with Section 206 of, and Rule 206(4)-6 under, the Advisers Act.

Proxy policies

THL Credit Advisors evaluates routine proxy matters, such as proxy proposals, amendments or resolutions on a case-by-case basis. Routine matters are typically proposed by management and THL Credit Advisors will normally support such matters so long as they do not measurably change the structure, management control, or operation of the corporation and are consistent with industry standards as well as the corporate laws of the state of incorporation.

THL Credit Advisors also evaluates non-routine matters on a case-by-case basis. Non-routine proposals concerning social issues are typically proposed by stockholders who believe that the corporation’s internally adopted policies are ill-advised or misguided. If THL Credit Advisors has determined that management is generally socially responsible, THL Credit Advisors will generally vote against these types of non-routine proposals. Non-routine proposals concerning financial or corporate issues are usually offered by management and seek to change a corporation’s legal, business or financial structure. THL Credit Advisors will generally vote in favor of such proposals provided the position of current stockholders is preserved or enhanced. Non-routine proposals concerning stockholder rights are made regularly by both management and stockholders. They can be generalized as involving issues that transfer or realign board or stockholder voting power. THL Credit Advisors typically would oppose any proposal aimed solely at thwarting potential takeovers by requiring, for example, super-majority approval. At the same time, THL Credit Advisors believes stability and continuity promote profitability. THL Credit Advisors’ guidelines in this area seek a middle road and individual proposals will be carefully assessed in the context of their particular circumstances.

If a vote may involve a material conflict of interest, prior to approving such vote, THL Credit Advisors must consult with its chief compliance officer to determine whether the potential conflict is material and if so, the appropriate method to resolve such conflict. If the conflict is determined not to be material, THL Credit Advisors’ employees shall vote the proxy in accordance with THL Credit Advisors’ proxy voting policy.

 

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Proxy voting records

You may obtain information about how we voted proxies by making a written request for proxy voting information to:

General Counsel

THL Credit, Inc.

100 Federal Street, 31st Floor

Boston, MA 02110

Code of ethics

We have adopted a code of ethics pursuant to Rule 17j-1 under the 1940 Act that establishes procedures for personal investments and restricts certain personal securities transactions. Personnel subject to the code of ethics may invest in securities for their personal investment accounts, including securities that may be purchased or held by us, so long as such investments are made in accordance with the code of ethics requirements. Our code of ethics is available, free of charge, on our website at www.thlcredit.com. We intend to disclose any amendments to, or waivers from, our code of ethics that are required to be publicly disclosed pursuant to rules of the Securities and Exchange Commission (the “SEC”) and the NASDAQ Global Select Market by filing such amendment or waiver with the Securities and Exchange Commission and by posting it on our website. You may read and copy the code of ethics at the SEC’s Public Reference Room in Washington, D.C. You may obtain information on the operation of the Public Reference Room by calling the SEC at (202) 551-8090. In addition, the code of ethics is attached as an exhibit to this Registration Statement on Form N-2 and will be available on the SEC’s Internet site at http://www.sec.gov. You may also obtain copies of the code of ethics, after paying a duplicating fee, by electronic request at the following e-mail address: publicinfo@sec.gov, or by writing the SEC’s Public Reference Section, 100 F Street, N.E., Washington, D.C. 20549.

Privacy Principles

We are committed to maintaining the privacy of stockholders and to safeguarding our non-public personal information. The following information is provided to help you understand what personal information we collect, how we protect that information and why, in certain cases, we may share information with select other parties.

Generally, we do not receive any nonpublic personal information relating to our stockholders, although certain nonpublic personal information of our stockholders may become available to us. We do not disclose any nonpublic personal information about our stockholders or former stockholders to anyone, except as permitted by law or as is necessary in order to service stockholder accounts (for example, to a transfer agent or third party administrator).

We restrict access to nonpublic personal information about our stockholders to our investment adviser’s employees with a legitimate business need for the information. We maintain physical, electronic and procedural safeguards designed to protect the nonpublic personal information of our stockholders.

Compliance with the Sarbanes-Oxley Act of 2002 and The NASDAQ Global Select Market Corporate Governance Regulations

The Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) imposes a wide variety of regulatory requirements on publicly-held companies and their insiders. Many of these requirements affect us. The Sarbanes-Oxley Act has required us to review our policies and procedures to determine whether we comply with the Sarbanes-Oxley Act and the regulations promulgated thereunder. We will continue to monitor our compliance with all future regulations that are adopted under the Sarbanes-Oxley Act and will take actions necessary to ensure that we are in compliance therewith.

 

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In addition, The NASDAQ Global Select Market has adopted various corporate governance requirements as part of its listing standards. We believe we are in compliance with such corporate governance listing standards. We will continue to monitor our compliance with all future listing standards and will take actions necessary to ensure that we are in compliance therewith.

Other

We have adopted an investment policy that mirrors the requirements applicable to us as a BDC under the 1940 Act.

We are subject to periodic examination by the SEC for compliance with the Exchange Act and the 1940 Act.

We are required to provide and maintain a bond issued by a reputable fidelity insurance company to protect us against larceny and embezzlement. Furthermore, as a BDC, we are prohibited from protecting any director or officer against any liability to us or our stockholders arising from willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of such person’s office.

We and THL Credit Advisors have adopted and implemented written policies and procedures reasonably designed to prevent violation of the federal securities laws, and will review these policies and procedures annually for their adequacy and the effectiveness of their implementation. We and THL Credit Advisors have designated a chief compliance officer to be responsible for administering the policies and procedures.

You may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549, on official business days during the hours of 10:00 am to 3:00 pm. You may obtain information on the operation of the Public Reference Room by calling the SEC at (202)551-8090. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The address of that site is http://www.sec.gov.

Our internet address is www.thlcredit.com. We make available free of charge on our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.

Certain U.S Federal Income Tax Considerations

We have elected to be treated as a RIC under Subchapter M of the Code. As a RIC, we generally do not have to pay corporate-level federal income taxes on any income that we distribute to our stockholders from our tax earnings and profits. To maintain our qualification as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements (as described below). In addition, in order maintain RIC tax treatment, we must distribute to our stockholders, for each taxable year, at least 90% of our “investment company taxable income,” which is generally our net ordinary income plus the excess, if any, of realized net short-term capital gains over realized net long-term capital losses (the “Annual Distribution Requirement”).

Taxation as a Regulated Investment Company

If we:

 

   

maintain our qualification as a RIC; and

 

   

satisfy the Annual Distribution Requirement,

then we will not be subject to U.S. federal income tax on the portion of our income we distribute (or are deemed to distribute) to stockholders. We will be subject to U.S. federal income tax at the regular corporate rates on any income or capital gains not distributed (or deemed distributed) to our stockholders.

 

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In order to maintain our qualification as a RIC for federal income tax purposes, we must, among other things:

 

   

continue to qualify as a BDC under the 1940 Act at all times during each taxable year;

 

   

derive in each taxable year at least 90% of our gross income from dividends, interest, payments with respect to certain securities loans, gains from the sale of stock or other securities, net income from certain “qualified publicly traded partnerships,” or other income derived with respect to our business of investing in such stock or securities (the “90% Income Test”); and

 

   

diversify our holdings so that at the end of each quarter of the taxable year:

 

   

at least 50% of the value of our assets consists of cash, cash equivalents, U.S. Government securities, securities of other RICs, and other securities if such other securities of any one issuer do not represent more than 5% of the value of our assets or more than 10% of the outstanding voting securities of the issuer; and

 

   

no more than 25% of the value of our assets is invested in the securities, other than U.S. Government securities or securities of other RICs, of one issuer, of two or more issuers that are controlled, as determined under applicable Code rules, by us and that are engaged in the same or similar or related trades or businesses or of certain “qualified publicly traded partnerships” (the “Diversification Tests”).

We will be subject to a 4% nondeductible federal excise tax on certain undistributed income unless we distribute in a timely manner an amount at least equal to the sum of (1) 98% of our net ordinary income for each calendar year, (2) 98.2% of our capital gain net income for each calendar year and (3) any income recognized, but not distributed, in preceding years and on which we paid no federal income tax (the “Excise Tax Avoidance Requirement”). We may choose to retain a portion of our ordinary income and/or capital gain net income in any year and pay the 4% U.S. federal excise tax on the retained amounts. For federal income tax purposes, we may be required to recognize taxable income in circumstances in which we do not receive a corresponding payment in cash. For example, if we hold debt obligations that are treated under applicable tax rules as having original issue discount (such as debt instruments with PIK interest or, in certain cases, increasing interest rates or debt instruments that were issued with warrants), we must include in income each year a portion of the original issue discount that accrues over the life of the obligation, regardless of whether cash representing such income is received by us in the same taxable year. We may also have to include in income other amounts that we have not yet received in cash, such as deferred loan origination fees that are paid after origination of the loan or are paid in non-cash compensation such as warrants or stock. Certain consolidated subsidiaries of the Company are subject to U.S. federal and state income taxes. These taxable entities are not consolidated with the Company for income tax purposes and may generate income tax liabilities or assets from temporary differences in the recognition of items for financial reporting and income tax purposes at the subsidiaries.

Because any original issue discount or other amounts accrued will be included in our investment company taxable income for the year of the accrual, we may be required to make a distribution to our stockholders in order to satisfy the Annual Distribution Requirement, even though we will not have received any corresponding cash amount. As a result, we may have difficulty meeting the annual distribution requirement necessary to obtain and maintain RIC tax treatment under the Code. We may have to sell some of our investments at times and/or at prices we would not consider advantageous, raise additional debt or equity capital or forgo new investment opportunities for this purpose. If we are not able to obtain cash from other sources, we may fail to qualify for RIC tax treatment and thus become subject to corporate-level income tax.

We are authorized to borrow funds and to sell assets in order to satisfy distribution requirements. However, under the 1940 Act, we are not permitted to make distributions to our stockholders while our debt obligations and other senior securities are outstanding unless certain “asset coverage” tests are met. Moreover, our ability to dispose of assets to meet our distribution requirements may be limited by (1) the illiquid nature of our portfolio and/or (2) other requirements relating to our status as a RIC, including the Diversification Tests. If we dispose of assets in order to meet the Annual Distribution Requirement or the Excise Tax Avoidance Requirement, we may make such dispositions at times that, from an investment standpoint, are not advantageous.

 

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Certain of our investment practices may be subject to special and complex federal income tax provisions that may, among other things, (1) treat dividends that would otherwise qualify for the dividends received deduction or constitute qualified dividend income as ineligible for such treatment, (2) disallow, suspend or otherwise limit the allowance of certain losses or deductions, (3) convert lower-taxed long-term capital gain into higher-taxed short-term capital gain or ordinary income, (4) convert an ordinary loss or a deduction into a capital loss (the deductibility of which is more limited), (5) cause us to recognize income or gain without receipt of a corresponding distribution of cash, (6) adversely affect the time as to when a purchase or sale of stock or securities is deemed to occur, (7) adversely alter the characterization of certain complex financial transactions and (8) produce income that will not be qualifying income for purposes of the 90% Income Test. We will monitor our transactions and may make certain tax elections to mitigate the potential adverse effect of these provisions, but there can be no assurance that any adverse effects of these provisions will be mitigated.

If we purchase shares in a “passive foreign investment company” (a “PFIC”), we may be subject to federal income tax on its allocable share of a portion of any “excess distribution” received on, or any gain from the disposition of, such shares even if our allocable share of such income is distributed as a taxable dividend to its stockholders. Additional charges in the nature of interest generally will be imposed on us in respect of deferred taxes arising from any such excess distribution or gain. If we invest in a PFIC and elect to treat the PFIC as a “qualified electing fund” under the Code (a “QEF”), in lieu of the foregoing requirements, we will be required to include in income each year our proportionate share of the ordinary earnings and net capital gain of the QEF, even if such income is not distributed by the QEF. Alternatively, we may be able to elect to mark-to-market at the end of each taxable year our shares in a PFIC; in this case, we will recognize as ordinary income our allocable share of any increase in the value of such shares, and as ordinary loss our allocable share of any decrease in such value to the extent that any such decrease does not exceed prior increases included in its income. Under either election, we may be required to recognize in a year income in excess of distributions from PFICs and proceeds from dispositions of PFIC stock during that year, and such income will nevertheless be subject to the Annual Distribution Requirement and will be taken into account for purposes of the 4% excise tax.

The remainder of this discussion assumes that we obtain and maintain our qualification as a RIC and have satisfied the Annual Distribution Requirement.

 

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Item 1A. Risk Factors

Before you invest in our securities, you should be aware of various risks, including those described below. You should carefully consider these risk factors, together with all of the other information included in this prospectus, before you decide whether to make an investment in our securities. The risks set out below are not the only risks we face, but they are the principal risks associated with an investment in the Company. If any of the following events occur, our business, financial condition and results of operations could be materially adversely affected. In such case, our net asset value and the trading price of our common stock could decline, and you may lose all or part of your investment.

RISKS RELATED TO OUR BUSINESS

We are a new company with a limited operating history.

We were incorporated in May 2009, completed an initial public offering of our common stock in April 2010 and have a limited operating history. We are subject to all of the business risks and uncertainties associated with any new business, including the risk that we will not achieve our investment objective and that the value of our common stock could decline substantially.

Our investment adviser and the members of its investment committee have limited experience managing a BDC.

The 1940 Act imposes numerous constraints on the operations of BDCs and RICs. For example, under the 1940 Act, BDCs companies are required to invest at least 70% of their total assets primarily in securities of private or thinly traded U.S. public companies, cash, cash equivalents, U.S. government securities and other high quality debt investments that mature in one year or less. Moreover, qualification for taxation as a RIC under subchapter M of the Code requires satisfaction of source-of-income and diversification requirements and our ability to avoid corporate-level income taxes on our income and gains depends on our satisfaction of distribution requirements. The failure to comply with these provisions in a timely manner could prevent us from qualifying as BDC or RIC or could force us to pay unexpected taxes and penalties, which could be material. Our investment adviser and the majority of the members of our senior management only have limited experience managing or providing management consulting services to a BDC. Our investment adviser’s and the members of its investment committee’s lack of experience in managing a portfolio of assets under such constraints may hinder their ability to take advantage of attractive investment opportunities and, as a result, achieve our investment objective.

We may suffer credit losses.

Investment in middle market companies is highly speculative and involves a high degree of risk of credit loss, and therefore our securities may not be suitable for someone with a low tolerance for risk. These risks are likely to increase during an economic recession.

The lack of liquidity in our investments may adversely affect our business.

Our investments generally are made in private companies. Substantially all of these securities are subject to legal and other restrictions on resale or will be otherwise less liquid than publicly traded securities. The illiquidity of our investments may make it difficult for us to sell such investments if the need arises. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we had previously recorded our investments. Further, we may face other restrictions on our ability to liquidate an investment in a portfolio company to the extent that we or an affiliated manager have material non-public information regarding such portfolio company.

 

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There will be uncertainty as to the value of our portfolio investments.

A large percentage of our portfolio investments are in the form of securities that are not publicly traded. The fair value of securities and other investments that are not publicly traded may not be readily determinable. We value these securities on a quarterly basis in accordance with our valuation policy, which is at all times consistent with U.S. generally accepted accounting policies (“GAAP”). Our board of directors utilizes the services of third-party valuation firms to aid it in determining the fair value of these securities. The board of directors discusses valuations and determines the fair value in good faith based on the input of our investment adviser and the respective third-party valuation firms. The factors that may be considered in fair value pricing our investments include the nature and realizable value of any collateral, the portfolio company’s ability to make payments and its earnings, the markets in which the portfolio company does business, comparisons to publicly traded companies, discounted cash flow and other relevant factors. Because such valuations, and particularly valuations of private securities and private companies, are inherently uncertain, may fluctuate over short periods of time and may be based on estimates, our determinations of fair value may differ materially from the values that would have been used if a ready market for these securities existed. Our net asset value could be adversely affected if our determinations regarding the fair value of our investments were materially higher than the values that we ultimately realize upon the disposal of such securities.

If we are unable to manage our investments effectively, we may be unable to achieve our investment objective.

Our ability to achieve our investment objective will depend on our ability to manage our business, which will depend, in turn, on the ability of THL Credit Advisors to identify, invest in and monitor companies that meet our investment criteria. Accomplishing this result largely will be a function of THL Credit Advisors’ investment process and, in conjunction with its role as Administrator, its ability to provide competent, attentive and efficient services to us.

We may experience fluctuations in our periodic operating results.

We could experience fluctuations in our periodic operating results due to a number of factors, including the interest rates payable on the debt securities we acquire, the default rates on such securities, the level of our expenses (including the interest rates payable on our borrowings), the dividend rates payable on preferred stock we issue, 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 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.

Any failure on our part to maintain our status as a BDC would reduce our operating flexibility.

If we fail to continue to qualify as a BDC, we might be regulated as a closed-end investment company under the 1940 Act, which would subject us to substantially more regulatory restrictions under the 1940 Act and correspondingly decrease our operating flexibility and could significantly increase our costs of doing business. Furthermore, any failure to comply with the requirements imposed on BDCs by the 1940 Act could cause the SEC to bring an enforcement action against us.

To the extent we use debt or preferred stock to finance our investments, changes in interest rates will affect our cost of capital and net investment income.

To the extent we borrow money, or issue preferred stock, to make investments, our net investment income will depend, in part, upon the difference between the rate at which we borrow funds or pay dividends on preferred stock and the rate at which we invest those funds. As a result, we can offer no assurance that a significant change in market interest rates will not have a material adverse effect on our net investment income in the event we use debt to finance our investments. In periods of rising interest rates, our cost of funds would increase, except to the extent we issue fixed rate debt or preferred stock, which could reduce our net investment

 

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income. We expect that our long-term fixed-rate investments will be financed primarily with equity and long-term debt. We may use interest rate risk management techniques in an effort to limit our exposure to interest rate fluctuations. Such techniques may include various interest rate hedging activities to the extent permitted by the 1940 Act.

A rise in the general level of interest rates can be expected to lead to higher interest rates applicable to our debt investments. Accordingly, an increase in interest rates would make it easier for us to meet or exceed the incentive fee hurdle rate and may result in a substantial increase of the amount of incentive fees payable to our investment adviser with respect to our pre-incentive fee net investment income.

Because we borrow money, there could be increased risk in investing in our company.

Lenders have fixed dollar claims on our assets that are superior to the claims of stockholders, and we have granted, and may in the future grant, lenders a security interest in our assets in connection with borrowings. In the case of a liquidation event, those lenders would receive proceeds before our stockholders. In addition, borrowings, also known as leverage, magnify the potential for gain or loss on amounts invested and, therefore, increase the risks associated with investing in our securities. Leverage is generally considered a speculative investment technique. If the value of our assets increases, then leveraging would cause the net asset value attributable to our common stock to increase more than it otherwise would have had we not leveraged. Conversely, if the value of our assets decreases, leveraging would cause the net asset value attributable to our common stock to decline more than it otherwise would have had we not leveraged. Similarly, any increase in our revenue in excess of interest expense on our borrowed funds would cause our net income to increase more than it would without the leverage. Any decrease in our revenue would cause our net income to decline more than it would have had we not borrowed funds and could negatively affect our ability to make distributions on common stock. Our ability to service any debt that we incur will depend largely on our financial performance and will be subject to prevailing economic conditions and competitive pressures. We and, indirectly, our stockholders will bear the cost associated with our leverage activity.

On May 10, 2012, we entered into the Amendment to our $50.0 million Term Loan Facility expiring in May 2017 with ING Capital LLC. The Amendment revised the Revolving Facility, dated March 11, 2011, to, among other things, increase the amount available for borrowing from $125.0 million to $140.0 million and extended the maturity date from May 2014 to May 2016 (with a one year term out period beginning in May 2015). The Revolving Facility and Term Loan facility, together the Facilities contain financial and operating covenants that could restrict our business activities, including our ability to declare dividends if we default under certain provisions. As of December 31, 2012, there was $50.0 million of borrowings outstanding against the Facilities and our asset coverage ratio was over 200%. Our borrowings had a weighted average interest rate at the time of 4.21% exclusive of non-use and other fees associated with the Facilities. Accordingly, to cover the annual interest on our borrowings outstanding at December 31, 2012, at the then current rate, we would have to receive an annual yield of at least 0.15% (net of expenses). This example is for illustrative purposes only, and actual interest rates on our Facility borrowing are likely to fluctuate. On May 10, 2012, we amended the Facility and entered into a new senior secured term loan credit facility. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial condition, liquidity and capital resources—Credit Facility” for additional information about the Amendment and the Term Loan Facility.

As a BDC, generally we are not permitted to incur indebtedness unless immediately after such borrowing we have an asset coverage for total borrowings of at least 200% (i.e., the amount of debt may not exceed 50% of the value of our assets). In addition, we may not be permitted to declare any cash dividend or other distribution on our outstanding common shares, or purchase any such shares, unless, at the time of such declaration or purchase, we have asset coverage of at least 200% after deducting the amount of such dividend, distribution, or purchase price. If this ratio declines below 200%, we may not be able to incur additional debt and may need to sell a portion of our investments to repay some debt when it is disadvantageous to do so, and we may not be able to make distributions.

 

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The following table is designed to illustrate the effect on return to a holder of our common stock on the leverage created by our use of borrowing at December 31, 2012 of $50.0 million at an average interest rate at the time of 4.21%, and assuming hypothetical annual returns on our portfolio of minus 10 to plus 10 percent. The table also assumes that we maintain a constant level of leverage and a constant weighted average interest rate. The amount of leverage we use will vary from time to time. As can be seen, leverage generally increases the return to stockholders when the portfolio return is positive and decreases return to stockholders when the portfolio return is negative. Actual returns may be greater or less than those appearing in the table below.

 

Assumed return on portfolio (net of expenses)(1)

     (10.00%     (5.00%     0.00%        5.00     10.00

Corresponding return to common stockholders(2)

     (10.55%     (5.37%     (0.20%     4.98     10.16

 

(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 stockholders,” the “assumed return on the portfolio” is multiplied by the total value of our assets at the beginning of the period ($277.1 million as of December 31, 2011) to obtain an assumed return to us. From this amount, all interest expense expected to be accrued during the period ($0.7 million) is subtracted to determine the return available to stockholders. The return available to stockholders is then divided by the total value of our net assets as of the beginning of the period ($267.6 million) to determine the “corresponding return to common stockholders.”

We may in the future determine to fund a portion of our investments with preferred stock, which would magnify the potential for gain or loss and the risks of investing in us in the same way as our borrowings.

Preferred stock, which is another form of leverage, has the same risks to our common stockholders as borrowings because the dividends on any preferred stock we issue must be cumulative. Payment of such dividends and repayment of the liquidation preference of such preferred stock must take preference over any dividends or other payments to our common stockholders, and preferred stockholders are not subject to any of our expenses or losses and are not entitled to participate in any income or appreciation in excess of their stated preference.

Our use of borrowed funds to make investments exposes us to risks typically associated with leverage.

We borrow money and may issue additional debt securities or preferred stock to leverage our capital structure. As a result:

 

   

our common shares would be exposed to incremental risk of loss; therefore, a decrease in the value of our investments would have a greater negative impact on the value of our common shares than if we did not use leverage;

 

   

any depreciation in the value of our assets may magnify losses associated with an investment and could totally eliminate the value of an asset to us;

 

   

if we do not appropriately match the assets and liabilities of our business and interest or dividend rates on such assets and liabilities, adverse changes in interest rates could reduce or eliminate the incremental income we make with the proceeds of any leverage;

 

   

our ability to pay dividends on our common stock may be restricted if our asset coverage ratio, as provided in the 1940 Act, is not at least 200%, and any amounts used to service indebtedness or preferred stock would not be available for such dividends;

 

   

any credit facility would be subject to periodic renewal by our lenders, whose continued participation cannot be guaranteed;

 

   

such securities would be governed by an indenture or other instrument containing covenants restricting our operating flexibility or affecting our investment or operating policies, and may require us to pledge assets or provide other security for such indebtedness;

 

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we, and indirectly our common stockholders, bear the entire cost of issuing and paying interest or dividends on such securities;

 

   

if we issue preferred stock, the special voting rights and preferences of preferred stockholders may result in such stockholders’ having interests that are not aligned with the interests of our common stockholders, and the rights of our preferred stockholders to dividends and liquidation preferences will be senior to the rights of our common stockholders;

 

   

any convertible or exchangeable securities that we issue may have rights, preferences and privileges more favorable than those of our common shares; and

 

   

any custodial relationships associated with our use of leverage would conform to the requirements of the 1940 Act, and no creditor would have veto power over our investment policies, strategies, objectives or decisions except in an event of default or if our asset coverage was less than 200%.

Under the provisions of the 1940 Act, we are permitted, as a BDC, to issue senior securities only in amounts such that our asset coverage ratio equals at least 200% after each issuance of senior securities. If the value of our assets declines, we may be unable to satisfy this test and we may be required to sell a portion of our investments and, depending on the nature of our leverage, repay a portion of our senior securities at a time when such sales may be disadvantageous.

There is a risk that we may not make distributions and consequently will become subject to corporate-level income tax.

We cannot assure you that we will achieve investment results that will allow us to make a specified level of cash distributions or periodically increase our dividend rate.

As a BDC, we are required to carry our investments at market value or, if no market value is ascertainable, at fair value as determined in good faith by or under the direction of our board of directors. Decreases in the market values or fair values of our investments will be recorded as unrealized depreciation. Any unrealized depreciation in our investment portfolio could be an indication of a portfolio company’s potential inability to meet its repayment obligations to us. This could result in realized losses in the future and ultimately in reductions of our income available for distribution in future periods.

To maintain our qualification as a RIC under the Code, we must meet certain source-of-income, asset diversification and annual distribution requirements. The annual distribution requirement for a RIC is satisfied if we distribute at least 90% of our ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any, to our stockholders on an annual basis. To the extent we use debt financing or preferred stock, we may become subject to certain asset coverage ratio requirements and other financial covenants under the terms of our debt or preferred stock, and could in some circumstances also become subject to similar requirements under the 1940 Act, that could, under certain circumstances, restrict us from making distributions necessary to qualify as a RIC. Failure to meet these tests may result in our having to dispose of certain investments quickly in order to prevent the loss of RIC status. Because we anticipate that most of our investments will be in private companies, any such dispositions could be made at disadvantageous prices and may result in substantial losses. If we are unable to obtain cash from other sources, or otherwise prohibited from making distributions, we may fail to qualify as a RIC and, thus, may be subject to corporate-level income tax. If we fail to qualify as a RIC for any reason and become subject to corporate-level income tax, the resulting corporate-level income taxes could substantially reduce our net assets, the amount of income available for distribution and the amount of our distributions.

We may have difficulty paying our required distributions if we recognize income before or without receiving cash representing such income.

For federal income tax purposes, we may include in income certain amounts that we have not yet received in cash, such as original issue discount, which may arise if we receive warrants in connection with the making of a

 

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loan or possibly in other circumstances, or PIK interest, which represents contractual interest added to the loan balance and due at the end of the loan term. Such original issue discount, which could be significant relative to our overall investment activities, or increases in loan balances as a result of PIK arrangements are included in income before we receive any corresponding cash payments. We also may be required to include in income certain other amounts that we do not receive in cash.

Since we may recognize income before or without receiving cash representing such income, we may have difficulty meeting the tax requirement to distribute at least 90% of our ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any, to maintain our status as a RIC. Accordingly, we may have to sell some of our investments at times we would not consider advantageous, raise additional debt or equity capital or reduce new investment originations to meet these distribution requirements.

We may pay incentive fee on income we do not receive in cash.

That part of the incentive fee payable by us that relates to our net investment income is computed and paid on income that may include interest that has been accrued but not yet received in cash. If a portfolio company defaults on a loan, it is possible that accrued interest previously used in the calculation of the incentive fee will become uncollectible. Consequently, while we may make incentive fee payments on income accruals that we may not collect in the future and with respect to which we do not have a formal clawback right against our investment adviser per se, the amount of accrued income written off in any period will reduce the income in the period in which such write-off was taken and thereby reduce such period’s incentive fee payment.

The highly competitive market in which we operate may limit our investment opportunities.

A number of entities compete with us to make the types of investments that we make. We compete with other BDCs, public and private funds, commercial and investment banks, CLO funds, commercial finance companies, and, to the extent they provide an alternative form of financing, private equity and hedge funds. Additionally, because competition for investment opportunities generally has increased among alternative investment vehicles such as hedge funds, entities have begun to invest in areas in which they had not traditionally invested. As a result of these new entrants, competition for investment opportunities intensified in recent years and may intensify further in the future. Some of our existing and potential competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. For example, some competitors may have a lower cost of funds and access to funding sources that are not available to us. In addition, some 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 than us. Furthermore, many of our competitors are not subject to the regulatory restrictions that the 1940 Act imposes on us as a BDC and that the Code imposes on us as a RIC. We cannot assure you that the competitive pressures we face will not have a material adverse effect on our business, financial condition and results of operations. Also, as a result of this existing and potentially increasing competition, we may not be able to take advantage of attractive investment opportunities from time to time, and we can offer no assurance that we will be able to identify and make investments that are consistent with our investment objective.

We are dependent upon senior management personnel of our investment adviser for our future success, and if our investment adviser is unable to retain qualified personnel or if our investment adviser loses any member of its senior management team, our ability to achieve our investment objective could be significantly harmed.

We depend on the members of senior management of THL Credit Advisors, particularly its Chief Executive Officer and Chief Investment Officer, James K. Hunt, its Co-Presidents, W. Hunter Stropp and Sam W. Tillinghast, its Chief Operating Officer and Chief Financial Officer, Terrence W. Olson, its Chief Compliance Officer and General Counsel, Stephanie Paré Sullivan, its Managing Directors, Christopher J. Flynn, its Director Scott V. Turco, collectively, the THL Credit Principals. Messrs. Hunt, Stropp, Tillinghast and Flynn constitute

 

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the investment principals of THL Credit Advisors, or the THL Credit Investment Principals. The THL Credit Investment Principals and other investment professionals make up our investment team and are responsible for the identification, final selection, structuring, closing and monitoring of our investments. These investment team members have critical industry experience and relationships that we will rely on to implement our business plan. Our future success depends on the continued service of the THL Credit Principals and the rest of our investment adviser’s senior management team. The departure of any of the members of THL Credit Advisors’ senior management or a significant number of the members of its investment team could have a material adverse effect on our ability to achieve our investment objective. As a result, we may not be able to operate our business as we expect, and our ability to compete could be harmed, which could cause our operating results to suffer. In addition, we can offer no assurance that THL Credit Advisors will remain our investment adviser or our administrator.

Our investment adviser has the right to resign on 60 days’ notice, and we may not be able to find a suitable replacement within that time, resulting in a disruption in our operations that could adversely affect our business, financial condition and results of operations.

THL Credit Advisors has the right, under our investment management agreement, to resign at any time upon not more than 60 days’ written notice, whether we have found a new replacement or not. If our investment adviser resigns, we may not be able to find a new investment adviser or hire internal management with similar expertise and ability to provide the same or equivalent services on acceptable terms within 60 days, or at all. If we are unable to do so quickly, our operations are likely to experience a disruption, our financial condition, business and results of operations as well as our ability to pay distributions are likely to be adversely affected and the market price of our shares may decline. In addition, the coordination of our internal management and investment activities is likely to suffer if we are unable to identify and reach an agreement with a single institution or group of executives having the expertise possessed by our investment adviser and its affiliates. Even if we are able to retain comparable management, whether internal or external, the integration of such management and their lack of familiarity with our investment objective may result in additional costs and time delays that may adversely affect our business, financial condition and results of operations.

Because we expect to distribute substantially all of our net investment income and net realized capital gains to our stockholders, we will need additional capital to finance our growth and such capital may not be available on favorable terms or at all.

We have elected to be taxed for federal income tax purposes as a RIC under Subchapter M of the Code. If we meet certain requirements, including source of income, asset diversification and distribution requirements, and if we continue to qualify as a BDC, we will continue to qualify to be a RIC under the Code and will not have to pay corporate-level income taxes on income we distribute to our stockholders as dividends, allowing us to substantially reduce or eliminate our corporate-level income tax liability. As a BDC, we are generally required to meet a coverage ratio of total assets to total senior securities, which includes all of our borrowings and any preferred stock we may issue in the future, of at least 200% at the time we issue any debt or preferred stock. This requirement limits the amount that we may borrow. Because we will continue to need capital to grow our investment portfolio, this limitation may prevent us from incurring debt or preferred stock and require us to raise additional equity at a time when it may be disadvantageous to do so. We cannot assure you that debt and equity financing will be available to us on favorable terms, or at all, and debt financings may be restricted by the terms of any of our outstanding borrowings. In addition, as a BDC, we are generally not permitted to issue common stock priced below net asset value without stockholder approval. If additional funds are not available to us, we could be forced to curtail or cease new lending and investment activities, and our net asset value could decline.

Our board of directors may change our investment objective, operating policies and strategies without prior notice or stockholder approval.

Our board of directors has the authority to modify or waive certain of our operating policies and strategies without prior notice and without stockholder approval (except as required by the 1940 Act). However, absent

 

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stockholder approval, we may not change the nature of our business so as to cease to be, or withdraw our election as, a BDC. We cannot predict the effect any changes to our current operating policies and strategies would have on our business, operating results or value of our stock. Nevertheless, the effects could adversely affect our business and impact our ability to make distributions and cause you to lose all or part of your investment.

Our investment adviser and its affiliates, senior management and employees have certain conflicts of interest.

Our investment adviser, its senior management and employees serve or may serve as investment advisers, officers, directors or principals of entities that operate in the same or a related line of business. Accordingly, these individuals may have obligations to investors in those entities or funds, the fulfillment of which might not be in our best interests or the best interests of our stockholders. In addition, certain of the personnel employed by our investment adviser or focused on our business may change in ways that are detrimental to our business. Any affiliated investment vehicle formed in the future and managed by THL Credit Advisors or its affiliates may invest in asset classes similar to those targeted by us. As a result, THL Credit Advisors may face conflicts in allocating investment opportunities between us and such other entities. Although THL Credit Advisors will endeavor to allocate investment opportunities in a fair and equitable manner, it is possible that we may not be given the opportunity to participate in such investments. In any such case, if THL Credit Advisors forms other affiliates in the future, it is possible we may co-invest on a concurrent basis with such other affiliates, subject to compliance with applicable regulations and regulatory guidance, as well as applicable allocation procedures. In certain circumstances, negotiated co-investments may be made only if we receive an order from the SEC permitting us to do so. There can be no assurance when any such order would be obtained or that one will be obtained at all.

There are potential conflicts of interest between us and the fund managed by us which could impact our investment returns.

Greenway is an investment fund with $150 million of capital committed by affiliates of a single institutional investor, which has been called and invested by Greenway, and is managed by us.

Certain of our officers serve or may serve in an investment management capacity to Greenway. As a result, investment professionals may allocate such time and attention as is deemed appropriate and necessary to carry out operations of Greenway. In this respect, they may experience diversions of their attention from us and potential conflicts of interest between their work for us and their work for Greenway in the event that the interests of Greenway run counter to our interests.

Greenway invests in the same or similar asset classes that we target. These investments may be made at the direction of the same individuals acting in their capacity on behalf of us and Greenway. As a result, there may be conflicts in the allocation of investment opportunities between us and Greenway. We may or may not participate in investments made by funds managed by us or one of our affiliates.

RISKS RELATED TO OUR INVESTMENTS

We invest primarily in debt and equity securities of middle market companies and we may not realize gains from our equity investments.

We are a direct lender to middle market companies, and invest in subordinated, or mezzanine, debt and second lien senior secured debt, which may include an associated equity component such as warrants, preferred stock or other similar securities. We may also selectively invest in first lien secured loans that generally have structures with higher interest rates, which include unitranche investments, or loan structures that combine characteristics of traditional first lien senior secured as well as second lien and subordinated loans. In certain instances we will also make direct equity investments, including equity investments into or through funds, and we may also selectively invest in more broadly syndicated first lien secured loans from time to time. Our goal is

 

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ultimately to dispose of such equity interests and realize gains upon our disposition of such interests. However, the equity interests we receive may not appreciate in value and, in fact, may decline in value. Accordingly, we may not be able to realize gains from our equity interests, and any gains that we do realize on the disposition of any equity interests may not be sufficient to offset any other losses we experience.

Our investments in prospective private and middle market portfolio companies are risky, and we could lose all or part of our investment.

Investment in private and middle market companies involves a number of significant risks. Generally, little public information exists about these companies, and we are required to rely on the ability of THL Credit Advisors’ investment professionals to obtain adequate information to evaluate the potential returns from investing in these companies. If we are unable to uncover all material information about these companies, we may not make a fully informed investment decision, and we may lose money on our investments. Middle market companies may have limited financial resources and may be unable to meet their obligations under their debt securities that we hold, which may be accompanied by a deterioration in the value of any collateral and a reduction in the likelihood of our realizing any guarantees we may have obtained in connection with our investment. In addition, they typically have shorter operating histories, narrower product lines and smaller market shares than larger businesses, which tend to render them more vulnerable to competitors’ actions and market conditions, as well as general economic downturns. Additionally, middle market companies are more likely to depend on the management talents and efforts of a small group of persons; therefore, the death, disability, resignation or termination of one or more of these persons could have a material adverse impact on our portfolio company and, in turn, on us. Middle market companies also generally have less predictable 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 and may require substantial additional capital to support their operations, finance expansion or maintain their competitive position. In addition, our executive officers, directors and our investment adviser may, in the ordinary course of business, be named as defendants in litigation arising from our investments in the portfolio companies.

Our investments in lower credit quality obligations are risky and highly speculative, and we could lose all or part of our investment.

Most of our debt investments are likely to be in lower grade obligations. The lower grade investments in which we invest may be rated below investment grade by one or more nationally-recognized statistical rating agencies at the time of investment or may be unrated but determined by the Advisor to be of comparable quality. Debt securities rated below investment grade are commonly referred to as “junk bonds” and are considered speculative with respect to the issuer’s capacity to pay interest and repay principal. The debt in which we invest typically is not rated by any rating agency, but we believe that if such investments were rated, they would be below investment grade (rated lower than “Baa3” by Moody’s Investors Service, lower than “BBB-” by Fitch Ratings or lower than “BBB-” by Standard & Poor’s). We may invest without limit in debt of any rating, as well as debt that has not been rated by any nationally recognized statistical rating organization.

Investment in lower grade investments involves a substantial risk of loss. Lower grade securities or comparable unrated securities are considered predominantly speculative with respect to the issuer’s ability to pay interest and principal and are susceptible to default or decline in market value due to adverse economic and business developments. The market values for lower grade debt tend to be very volatile and are less liquid than investment grade securities. For these reasons, your investment in our company is subject to the following specific risks: increased price sensitivity to a deteriorating economic environment; greater risk of loss due to default or declining credit quality; adverse company specific events are more likely to render the issuer unable to make interest and/or principal payments; and if a negative perception of the lower grade debt market develops, the price and liquidity of lower grade securities may be depressed. This negative perception could last for a significant period of time.

 

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We may not be in a position to exercise control over our portfolio companies or to prevent decisions by management of our portfolio companies that could decrease the value of our investments.

We do not generally intend to take controlling equity positions in our portfolio companies. To the extent that we do not hold a controlling equity interest in a portfolio company, we are subject to the risk that such portfolio company may make business decisions with which we disagree, and the stockholders and management of such portfolio company may take risks or otherwise act in ways that are adverse to our interests. Due to the lack of liquidity for the debt and equity investments that we typically hold in our portfolio companies, we may not be able to dispose of our investments in the event we disagree with the actions of a portfolio company, and may therefore suffer a decrease in the value of our investments.

In addition, we may not be in a position to control any portfolio company by investing in its debt securities. As a result, we are subject to the risk that a portfolio company in which we invest may make business decisions with which we disagree and the management of such company, as representatives of the holders of their common equity, may take risks or otherwise act in ways that do not serve our interests as debt investors.

Our portfolio companies may incur debt that ranks equally with, or senior to, our investments in such companies.

The portfolio companies in which we have invested debt capital usually have, or may be permitted to incur with certain limitations, other debt that ranks equally with, or senior to, the debt securities in which we invest. By their terms, such debt instruments may provide that the holders are entitled to receive payment of interest or principal on or before the dates on which we are entitled to receive payments in respect of the debt securities in which we invest. Also, in the event of insolvency, liquidation, dissolution, reorganization or bankruptcy of a portfolio company, holders of debt instruments ranking senior to our investment in that portfolio company would typically be entitled to receive payment in full before we receive any distribution in respect of our investment. After repaying such senior creditors, such portfolio company may not have any remaining assets to use for repaying its obligation to us. In the case of debt ranking equally with debt securities in which we invest, we would have to share any distributions on an equal and ratable basis with other creditors holding such debt in the event of an insolvency, liquidation, dissolution, reorganization or bankruptcy of the relevant portfolio company.

Additionally, certain loans that we make to portfolio companies may be secured on a second priority basis by the same collateral securing senior secured debt of such companies. The first priority liens on the collateral will secure the portfolio company’s obligations under any outstanding senior debt and may secure certain other future debt that may be permitted to be incurred by the portfolio company under the agreements governing the loans. The holders of obligations secured by the first priority liens on the collateral will generally control the liquidation of and be entitled to receive proceeds from any realization of the collateral to repay their obligations in full before us. In addition, the value of the collateral in the event of liquidation will depend on market and economic conditions, the availability of buyers and other factors. There can be no assurance that the proceeds, if any, from the sale or sales of all of the collateral would be sufficient to satisfy the loan obligations secured by the second priority liens after payment in full of all obligations secured by the first priority liens on the collateral. If such proceeds are not sufficient to repay amounts outstanding under the loan obligations secured by the second priority liens, then we, to the extent not repaid from the proceeds of the sale of the collateral, will only have an unsecured claim against the portfolio company’s remaining assets, if any.

The rights we may have with respect to the collateral securing the mezzanine, or subordinated, loans and second lien loans we make to our portfolio companies with senior debt outstanding may also be limited pursuant to the terms of one or more intercreditor agreements that we enter into with the holders of senior debt. Under such an intercreditor agreement, at any time that obligations that have the benefit of the first priority liens are outstanding, any of the following actions that may be taken in respect of the collateral will be at the direction of the holders of the obligations secured by the first priority liens: the ability to cause the commencement of enforcement proceedings against the collateral; the ability to control the conduct of such proceedings; the

 

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approval of amendments to collateral documents; releases of liens on the collateral; and waivers of past defaults under collateral documents. We may not have the ability to control or direct such actions, even if our rights are adversely affected.

If the assets securing the loans that we make decrease in value, then we may lack sufficient collateral to cover losses.

We will at times take a security interest in the available assets of these portfolio companies, including the equity interests of their subsidiaries and, in some cases, the equity interests of our portfolio companies held by their stockholders. There is a risk that the collateral securing these types of loans may decrease in value over time, may be difficult to sell in a timely manner, may be difficult to appraise and may fluctuate in value based upon the success of the business and market conditions, including as a result of the inability of a portfolio company to raise additional capital. In some circumstances, our lien could be subordinated to claims of other creditors. Additionally, deterioration in a portfolio company’s financial condition and prospects, including its inability to raise additional capital, may be accompanied by deterioration in the value of the collateral for these types of loans. Moreover, in the case of most of our investments, we do not have a first lien position on the collateral. Consequently, the fact that a loan may be secured does not guarantee that we will receive principal and interest payments according to the loan’s terms, or that we will be able to collect on the loan should we be forced to enforce our remedies.

Economic downturns or recessions could impair the value of the collateral for our loans to our portfolio companies and consequently increase the possibility of an adverse effect on our financial condition and results of operations.

Many of our portfolio companies are susceptible to economic recessions and may be unable to repay our loans during such periods. Therefore, our non-performing assets are likely to increase and the value of our portfolio is likely to decrease during such periods. Adverse economic conditions may also decrease the value of collateral securing some of our loans and the value of our equity investments.

Economic slowdowns or recessions could lead to financial losses in our portfolio and a decrease in revenues, net income and assets. Unfavorable economic conditions also could increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us.

A portfolio company’s failure to satisfy financial or operating covenants imposed by us or other lenders could lead to defaults and, potentially, termination of the portfolio company’s loans and foreclosure on its secured assets, which could trigger cross-defaults under other agreements and jeopardize the portfolio company’s ability to meet its obligations under the debt securities that we hold. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms with a defaulting portfolio company. In addition, if a portfolio company goes bankrupt, even though we may have structured our investment as mezzanine debt, or senior secured debt, depending on the facts and circumstances, including the extent to which we actually provided significant “managerial assistance,” if any, to that portfolio company, a bankruptcy court might re-characterize our debt holding and subordinate all or a portion of our claim to that of other creditors. These events could harm our financial condition and operating results.

We may suffer a loss if a portfolio company defaults on a loan and the underlying collateral is not sufficient.

In the event of a default by a portfolio company on a secured loan, we will only have recourse to the assets collateralizing the loan. If the underlying collateral value is less than the loan amount, we will suffer a loss. In addition, we often make loans that are unsecured, which are subject to the risk that other lenders may be directly secured by the assets of the portfolio company. In the event of a default, those collateralized lenders would have priority over us with respect to the proceeds of a sale of the underlying assets. In cases described above, we may

 

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lack control over the underlying asset collateralizing our loan or the underlying assets of the portfolio company prior to a default, and as a result the value of the collateral may be reduced by acts or omissions by owners or managers of the assets.

In the event of bankruptcy of a portfolio company, we may not have full recourse to its assets in order to satisfy our loan, or our loan may be subject to equitable subordination. In addition, certain of our loans are subordinate to other debt of the portfolio company. If a portfolio company defaults on our loan or on debt senior to our loan, or in the event of a portfolio company bankruptcy, our loan will be satisfied only after the senior debt receives payment. Where debt senior to our loan exists, the presence of intercreditor arrangements may limit our ability to amend our loan documents, assign our loans, accept prepayments, exercise our remedies (through “standstill” periods) and control decisions made in bankruptcy proceedings relating to the portfolio company. Bankruptcy and portfolio company litigation can significantly increase collection losses and the time needed for us to acquire the underlying collateral in the event of a default, during which time the collateral may decline in value, causing us to suffer losses.

If the value of collateral underlying our loan declines or interest rates increase during the term of our loan, a portfolio company may not be able to obtain the necessary funds to repay our loan at maturity through refinancing. Decreasing collateral value and/or increasing interest rates may hinder a portfolio company’s ability to refinance our loan because the underlying collateral cannot satisfy the debt service coverage requirements necessary to obtain new financing. If a borrower is unable to repay our loan at maturity, we could suffer a loss which may adversely impact our financial performance.

Our loans could be subject to equitable subordination by a court which would increase our risk of loss with respect to such loans.

Courts may apply the doctrine of equitable subordination to subordinate the claim or lien of a lender against a borrower to claims or liens of other creditors of the borrower, when the lender or its affiliates is found to have engaged in unfair, inequitable or fraudulent conduct. The courts have also applied the doctrine of equitable subordination when a lender or its affiliates is found to have exerted inappropriate control over a client, including control resulting from the ownership of equity interests in a client. We have made direct equity investments or received warrants in connection with loans representing approximately 1.00% of the aggregate outstanding balance of our portfolio as of December 31, 2012. Payments on one or more of our loans, particularly a loan to a client in which we also hold an equity interest, may be subject to claims of equitable subordination. If we were deemed to have the ability to control or otherwise exercise influence over the business and affairs of one or more of our portfolio companies resulting in economic hardship to other creditors of that company, this control or influence may constitute grounds for equitable subordination and a court may treat one or more of our loans as if it were unsecured or common equity in the portfolio company. In that case, if the portfolio company were to liquidate, we would be entitled to repayment of our loan on a pro-rata basis with other unsecured debt or, if the effect of subordination was to place us at the level of common equity, then on an equal basis with other holders of the portfolio company’s common equity only after all of its obligations relating to its debt and preferred securities had been satisfied.

Our failure to make follow-on investments in our portfolio companies could impair the value of our portfolio.

Following an initial investment in a portfolio company, we may make additional investments in that portfolio company as “follow-on” investments in order to: (1) increase or maintain in whole or in part our equity ownership percentage; (2) exercise warrants, options or convertible securities that were acquired in the original or subsequent financing; or (3) attempt to preserve or enhance the value of our initial investment. We have the discretion to make any follow-on investments, subject to the availability of capital resources. We may elect not to make follow-on investments or otherwise lack sufficient funds to make those investments. Our failure to make follow-on investments may, in some circumstances, jeopardize the continued viability of a portfolio company

 

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and our initial investment, or may result in a missed opportunity for us to increase our participation in a successful operation. Even if we have sufficient capital to make a desired follow-on investment, we may elect not to make such follow-on investment because we may not want to increase our concentration of risk, because we prefer other opportunities, because we are inhibited by compliance with BDC requirements or because we desire to maintain our tax status.

Our ability to invest in public companies may be limited in certain circumstances.

To maintain our status as a BDC, we are not permitted to acquire any assets other than “qualifying assets” specified in the 1940 Act unless, at the time the acquisition is made, at least 70% of our total assets are qualifying assets (with certain limited exceptions). Subject to certain exceptions for follow-on investments and distressed companies, an investment in an issuer that has outstanding securities listed on a national securities exchange may be treated as a qualifying asset only if such issuer has a market capitalization that is less than $250 million at the time of such investment and meets the other specified requirements.

Our base management fee may induce our investment adviser to incur leverage.

Our base management fee is calculated on the basis of our total assets, including assets acquired with the proceeds of leverage. This may encourage the Advisor to use leverage to increase the aggregate amount of and the return on our investments, even when it may not be appropriate to do so, and to refrain from delevering when it would otherwise be appropriate to do so. Under certain circumstances, the use of increased leverage may increase the likelihood of default, which would impair the value of our common stock. Given the subjective nature of the investment decisions made by our investment adviser on our behalf, we will not be able to monitor this conflict of interest.

Our incentive fee may induce our investment adviser to make certain investments, including speculative investments.

The incentive fee payable by us to THL Credit Advisors may create an incentive for THL Credit Advisors to make investments on our behalf that are risky or more speculative than would be the case in the absence of such compensation arrangement. The way in which the incentive fee payable to THL Credit Advisors is determined, which is calculated separately in two components as a percentage of the interest and other ordinary income in excess of a quarterly minimum hurdle rate and as a percentage of the realized gain on invested capital, may encourage our THL Credit Advisors to use leverage or take additional risk to increase the return on our investments. Under certain circumstances, the use of leverage may increase the likelihood of default, which would disfavor the holders of our common stock, or of securities convertible into our common stock or warrants representing rights to purchase our common stock or securities convertible into our common stock. In addition, THL Credit Advisors receives the incentive fee based, in part, upon net capital gains realized on our investments. Unlike the portion of the incentive fee based on ordinary income, there is no minimum level of gain applicable to the portion of the incentive fee based on net capital gains. As a result, THL Credit Advisors may have an incentive to invest more in investments that are likely to result in capital gains as compared to income producing securities or to advance or delay realizing a gain in order to enhance its incentive fee. This practice could result in our investing in more speculative securities than would otherwise be the case, which could result in higher investment losses, particularly during economic downturns. A rise in the general level of interest rates can be expected to lead to higher interest rates applicable to certain of our debt investments and may accordingly result in a substantial increase of the amount of incentive fees payable to our investment adviser with respect to our pre-incentive fee net investment income.

We may invest, to the extent permitted by law, in the securities and instruments of other investment companies, including private funds, and, to the extent we so invest, we will bear our ratable share of any such investment company’s expenses, including management and performance fees. We will also remain obligated to pay management and incentive fees to THL Credit Advisors with respect to the assets invested in the securities

 

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and instruments of other investment companies. With respect to each of these investments, each of our common stockholders will bear his or her share of the management and incentive fee of THL Credit Advisors as well as indirectly bear the management and performance fees and other expenses of any investment companies in which we invest.

We may be obligated to pay our investment adviser incentive compensation payments even if we have incurred unrecovered cumulative losses from more than three years prior to such payments and may pay more than 20% of our net capital gains as incentive compensation payments because we cannot recover payments made in previous years.

Our investment adviser will be entitled to incentive compensation for each fiscal quarter in an amount equal to a percentage of the excess of our investment income for that quarter (before deducting incentive compensation) above a threshold return for that quarter and subject to a total return requirement. The general effect of this total return requirement is to prevent payment of the foregoing incentive compensation except to the extent 20.0% of the cumulative net increase in net assets resulting from operations over the then current and 11 preceding calendar quarters exceeds the cumulative incentive fees accrued and/or paid for the 11 preceding calendar quarters. Consequently, we may pay an incentive fee if we incurred losses more than three years prior to the current calendar quarter even if such losses have not yet been recovered in full. Thus, we may be required to pay our investment adviser incentive compensation for a fiscal quarter even if there is a decline in the value of our portfolio or we incur a net loss for that quarter. If we pay an incentive fee of 20.0% of our realized capital gains (net of all realized capital losses and unrealized capital depreciation on a cumulative basis) and thereafter experience additional realized capital losses or unrealized capital depreciation, we will not be able to recover any portion of the incentive fee previously paid.

Our investments in foreign securities may involve significant risks in addition to the risks inherent in U.S. investments.

Our investment strategy contemplates that a portion of our investments may be in securities of foreign companies in order to provide diversification or to complement our U.S. investments although we are required generally to invest at least 70% of our assets in companies organized and having their principal place of business within the U.S. and its possessions. Investing in foreign companies may expose us to additional risks not typically associated with investing in U.S. companies. These risks include changes in exchange control regulations, political and social instability, expropriation, imposition of foreign taxes, less liquid markets and less available information than is generally the case in the United States, higher transaction costs, less government supervision of exchanges, brokers and issuers, less developed bankruptcy laws, difficulty in enforcing contractual obligations, lack of uniform accounting and auditing standards and greater price volatility. These risks many be more pronounced for portfolio companies located or operating primarily in emerging markets, whose economies, markets and legal systems may be less developed.

Although it is anticipated that most of our investments will be denominated in U.S. dollars, our investments that are denominated in a foreign currency will be subject to the risk that the value of a particular currency may change in relation to the U.S. dollar. Among the factors that may affect currency values are trade balances, the level of short-term interest rates, differences in relative values of similar assets in different currencies, long-term opportunities for investment and capital appreciation and political developments. We may employ hedging techniques to minimize these risks, but we can offer no assurance that we will, in fact, hedge currency risk or, that if we do, such strategies will be effective. As a result, a change in currency exchange rates may adversely affect our profitability.

Hedging transactions may expose us to additional risks.

While we may enter into transactions to seek to reduce currency exchange rate and interest rate risks, unanticipated changes in currency exchange rates or interest rates may result in poorer overall investment performance than if we had not engaged in any such hedging transactions. In addition, the degree of correlation

 

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between price movements of the instruments used in a hedging strategy and price movements in the portfolio positions being hedged may vary. Moreover, for a variety of reasons, we may not seek or be able to establish a perfect correlation between such hedging instruments and the portfolio holdings being hedged. Any such imperfect correlation may prevent us from achieving the intended hedge and expose us to risk of loss. In addition, it may not be possible to hedge fully or perfectly against currency fluctuations affecting the value of securities denominated in non-U.S. currencies because the value of those securities is likely to fluctuate as a result of factors not related to currency fluctuations. On May 10, 2012, we entered into a five-year interest rate swap agreement, or swap agreement, with ING Capital Markets, LLC on the Term Loan Facility. Under the swap agreement, with a notional value of $50.0 million, we pay a fixed rate of 1.1425% and receive a floating rate based upon the current three-month LIBOR rate. We entered into the swap agreement to manage interest rate risk and not for speculative purposes.

RISKS IN THE CURRENT ENVIRONMENT

Capital markets may experience periods of disruption and instability. Such market conditions could materially and adversely affect debt and equity capital markets in the United States and abroad, which could have a negative impact on our business, financial condition and results of operations.

Capital markets may experience periods of disruption and instability. For example, we believe that beginning in 2007, and continuing into 2010, the global capital markets entered into a period of disruption as evidenced by a lack of liquidity in the debt capital markets, significant write-offs in the financial services sector, the re-pricing of credit risk in the broadly syndicated credit market and the failure of certain major financial institutions. Despite actions of the United States federal government and foreign governments, these events contributed to worsening general economic conditions that materially and adversely impacted the broader financial and credit markets and reduced the availability of debt and equity capital for the market as a whole and financial services firms in particular. Such a period of economic disruption and instability could occur again, having a similar or worse impact on the broader financial and credit markets. Such conditions could also continue for a prolonged period of time. If these conditions occur and then persist, we and other companies in the financial services sector may be required to, or may choose to, seek access to alternative markets for debt and equity capital. Equity capital may then be difficult to raise if our board of directors does not approve an offering in which we would issue and sell our common stock at a price below net asset value per share. In addition, the debt capital that would be available, if at all, may be at a higher cost, and on less favorable terms and conditions at such time. Conversely, the portfolio companies in which we may invest may not be able to service or refinance their debt, which could materially and adversely affect our financial condition as we would experience reduced income or even losses. In a period of such adverse conditions, the inability to raise capital and the risk of portfolio company defaults may have a negative effect on our business, financial condition and results of operations.

The downgrade in the U.S. credit rating could materially adversely affect our business, financial conditions and results of operations.

On August 5, 2011, Standard & Poor’s downgraded the U.S. credit rating to AA+ from its top rank of AAA. The current U.S. debt ceiling and budget deficit concerns have increased the possibility of other credit-rating agency downgrades and an economic slowdown. The downgrade of the U.S. credit rating could have a material adverse effect on the financial markets and economic conditions in the United States and throughout the world. Additionally, austerity measures necessary to reduce the deficit could accelerate an already slowing economy in the near term.

Downgrading of the U.S. credit rating could negatively impact the trading market for U.S. government securities and would likely impact the credit risk associated with our investments in U.S. Treasury securities. This could reduce the value of the U.S. Treasury securities in our portfolio. In addition, adverse market and economic conditions that could occur due to a downgrade of the U.S. credit rating on the United States’ debt could result in rapidly rising interest rates, a falling dollar, shakier financial markets and slowing or

 

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negative economic growth in the near term. These events could adversely affect our business in many ways, including, but not limited to, adversely impacting our portfolio companies’ ability to obtain financing, or obtaining financing but at significantly lower valuations than the preceding financing rounds. If any of these events were to occur, it could materially adversely affect our business, financial condition and results of operations.

RISKS RELATED TO OUR OPERATIONS AS A BDC

Our ability to enter into transactions with our affiliates will be restricted.

Because we have elected to be treated as a BDC under the 1940 Act, we are prohibited under the 1940 Act from participating in certain transactions with certain of our affiliates without the prior approval of our independent directors and, in some cases, of the SEC. Any person that owns, directly or indirectly, 5% or more of our outstanding voting securities will be our affiliate for purposes of the 1940 Act and we are generally prohibited from buying or selling any security from or to such affiliate, absent the prior approval of our independent directors. The 1940 Act also prohibits certain “joint” transactions with certain of our affiliates, which could include investments in the same portfolio company (whether at the same or different times), without prior approval of our independent directors and, in some cases, of the SEC. We are prohibited from buying or selling any security from or to any person who owns more than 25% of our voting securities or certain of that person’s affiliates, or entering into prohibited joint transactions with such persons, absent the prior approval of the SEC. Similar restrictions limit our ability to transact business with our officers or directors or their affiliates.

Regulations governing our operation as a BDC may limit our ability to, and the way in which we raise additional capital, which could have a material adverse impact on our liquidity, financial condition and results of operations.

Our business may in the future require a substantial amount of capital. We may acquire additional capital from the issuance of senior securities (including debt and preferred stock) or the issuance of additional shares of our common stock. However, we may not be able to raise additional capital in the future on favorable terms or at all. Additionally, we may only issue senior securities up to the maximum amount permitted by the 1940 Act. The 1940 Act permits us to issue senior securities only in amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% after such issuance or incurrence. If our assets decline in value and we fail to satisfy this test, we may be required to liquidate a portion of our investments and repay a portion of our indebtedness at a time when such sales or repayment may be disadvantageous, which could have a material adverse impact on our liquidity, financial condition and results of operations.

 

   

Senior Securities (including debt and preferred stock). As a result of issuing senior securities, we would also be exposed to typical risks associated with leverage, including an increased risk of loss. If we issue preferred securities, such securities would rank “senior” to common stock in our capital structure, resulting in preferred stockholders having separate voting rights, dividend and liquidation rights, and possibly other rights, preferences or privileges more favorable than those granted to holders of our common stock. Furthermore, the issuance of preferred securities could have the effect of delaying, deferring or preventing a transaction or a change of control that might involve a premium price for our common stockholders or otherwise be in your best interest.

 

   

Additional Common Stock. Our board of directors may decide to issue common stock to finance our operations rather than issuing debt or other senior securities. As a BDC, we are generally not able to issue our common stock at a price below net asset value without first obtaining required approvals from our stockholders and our independent directors. At our Annual Meeting of Stockholders on June 7, 2012, our stockholders approved a proposal authorizing us to sell up to 25% of our common stock at a price below the Company’s net asset value per share, subject to approval by our board of directors of the offering. Except in connection with the exercise of warrants or the conversion of convertible securities, in any such case the price at which our securities are to be issued and sold may not be less than a price, that in the determination of our board of directors, closely approximates the market value

 

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of such securities at the relevant time. We may also make rights offerings to our stockholders at prices per share less than the net asset value per share, subject to the requirements of the 1940 Act. If we raise additional funds by issuing more common stock or senior securities convertible into, or exchangeable for, our common stock, the percentage ownership of our stockholders at that time would decrease, and such stockholders may experience dilution.

Additionally, if we do raise additional capital in one or more subsequent financings, until we are able to invest the net proceeds of such any financing in suitable investments, we will invest in temporary investments, such as cash, cash equivalents, U.S. government securities and other high-quality debt investments that mature in one year or less, which we expect will earn yields lower than the interest, dividend or other income that we anticipate receiving in respect of investments in debt and equity securities of our target portfolio companies. As a result, our ability to pay dividends in the years of operation during which we have such net proceeds available to invest will be based on our ability to invest our capital in suitable portfolio companies in a timely manner. Further, the management fee payable to our investment adviser, THL Credit Advisors, will not be reduced while our assets are invested in such temporary investments.

Changes in the laws or regulations governing our business, or changes in the interpretations thereof, and any failure by us to comply with these laws or regulations, could have a material adverse effect on our business, results of operations or financial condition.

Changes in the laws or regulations or the interpretations of the laws and regulations that govern BDCs, RICs or non-depository commercial lenders could significantly affect our operations and our cost of doing business. We are subject to federal, state and local laws and regulations and are subject to judicial and administrative decisions that affect our operations, including our loan originations, maximum interest rates, fees and other charges, disclosures to portfolio companies, the terms of secured transactions, collection and foreclosure procedures and other trade practices. If these laws, regulations or decisions change, or if we expand our business into jurisdictions that have adopted more stringent requirements than those in which we currently conduct business, we may have to incur significant expenses in order to comply, or we might have to restrict our operations. In addition, if we do not comply with applicable laws, regulations and decisions, we may lose licenses needed for the conduct of our business and may be subject to civil fines and criminal penalties.

Pending legislation may allow us to incur additional leverage.

As a BDC, under the 1940 Act generally we are not permitted to incur indebtedness unless immediately after such borrowing we have an asset coverage for total borrowings of at least 200% (i.e., the amount of debt may not exceed 50% of the value of our assets). Recent legislation introduced in the U.S. House of Representatives, if passed, would modify this section of the 1940 Act and increase the amount of debt that business development companies may incur by modifying the percentage from 200% to 150%. As a result, we may be able to incur additional indebtedness in the future and therefore your risk of an investment in us may increase.

If we do not invest a sufficient portion of our assets in qualifying assets, we could fail to qualify as a BDC or be precluded from investing according to our current business strategy, which would have a material adverse effect on our business, financial condition and results of operations.

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. See “Regulation.” We believe that most of the investments that we may acquire in the future will constitute qualifying assets. However, we may be precluded from investing in what we believe are attractive investments if such investments are not qualifying assets for purposes of the 1940 Act. If we do not invest a sufficient portion of our assets in qualifying assets, we could be found to be in violation of the 1940 Act provisions applicable to BDCs and possibly lose our status as a BDC, which would have a material adverse effect on our business, financial condition and results of

 

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operations. Similarly, these rules could prevent us from making follow-on investments in existing portfolio companies (which could result in the dilution of our position) or could require us to dispose of investments at inopportune times in order to come into compliance with the 1940 Act. If we need to dispose of such investments quickly, it may be difficult to dispose of such investments on favorable terms. For example, we may have difficulty in finding a buyer and, even if we do find a buyer, we may have to sell the investments at a substantial loss.

If we are unable to qualify for tax treatment as a RIC, we will be subject to corporate-level income tax, which would have a material adverse effect on our results of operations and financial condition.

We intend to continue to qualify as a RIC under the Code. As a RIC we do not have to pay federal income taxes on our income (including realized gains) that is distributed to our stockholders, provided that we satisfy certain distribution and other requirements. Accordingly, we are not permitted under accounting rules to establish reserves for taxes on our unrealized capital gains. If we fail to qualify for RIC status in any year, to the extent that we had unrealized gains, we would have to establish reserves for taxes, which would reduce our net asset value and the amount potentially available for distribution. In addition, if we, as a RIC, were to decide to make a deemed distribution of net realized capital gains and retain the net realized capital gains, we would have to establish appropriate reserves for taxes that we would have to pay on behalf of stockholders. It is possible that establishing reserves for taxes could have a material adverse effect on the value of our common stock. See “Tax Matters.”

To maintain our qualification as a RIC under the Code, which is required in order for us to distribute our income without being taxed at the corporate level, we must maintain our status as a BDC and meet certain source-of-income, asset diversification and annual distribution requirements and including:

 

   

The annual distribution requirement for a RIC is satisfied if we distribute to our stockholders at least 90% of our ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any, on an annual basis. Because we may use debt financing, we are subject to an asset coverage ratio requirement under the 1940 Act and we may be subject to certain financial covenants under our debt arrangements that could, under certain circumstances, restrict us from making distributions necessary to satisfy the distribution requirement. If we are unable to obtain cash from other sources, we could fail to qualify for RIC tax treatment and, thus, become subject to corporate-level income tax.

 

   

The income source requirement will be satisfied if we obtain at least 90% of our income for each year from dividends, interest, gains from the sale of stock or securities or similar sources.

 

   

The asset diversification requirement will be satisfied if we meet certain asset diversification requirements at the end of each quarter of our taxable year. To satisfy these requirements, at least 50% of the value of our assets must consist of cash, cash equivalents, U.S. government securities, securities of other RICs, and other acceptable securities; and no more than 25% of the value of our assets can be invested in the securities, other than U.S. government securities or securities of other RICs, of one issuer, of two or more issuers that are controlled, as determined under applicable Internal Revenue Code rules, by us and that are engaged in the same or similar or related trades or businesses or of certain “qualified publicly traded partnerships.” Failure to meet these requirements may result in our having to dispose of certain investments quickly in order to prevent the loss of RIC status. Because most of our investments will be in private companies, and, therefore, will be relatively illiquid, any such dispositions could be made at disadvantageous prices and could result in substantial losses.

Satisfying these requirements may require us to take actions we would not otherwise take, such as selling investments at unattractive prices to satisfy diversification, distribution or source of income requirements. In addition, while we are authorized to borrow funds in order to make distributions, under the 1940 Act we are not permitted to make distributions to stockholders while we have debt obligations or other senior securities

 

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outstanding unless certain “asset coverage” tests are met. If we fail to qualify as a RIC for any reason and become or remain subject to corporate-level income tax, the resulting corporate taxes could substantially reduce our net assets, the amount of income available for distribution and the amount of our distributions. Such a failure would have a material adverse effect on our results of operations and financial conditions, and thus, our stockholders.

RISKS RELATED TO AN INVESTMENT IN OUR SECURITIES

Our common stock price may be volatile and may fluctuate substantially.

As with any stock, the price of our common stock will fluctuate with market conditions and other factors. Our common stock is intended for long-term investors and should not be treated as a trading vehicle. Shares of closed-end management investment companies, which are structured similarly to us, frequently trade at a discount from their net asset value. Our shares may trade at a price that is less than the offering price. This risk may be greater for investors who sell their shares in a relatively short period of time after completion of the offering.

The market price and liquidity of the market for our common shares may be significantly affected by numerous factors, some of which are beyond our control and may not be directly related to our operating performance. These factors include:

 

   

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

 

   

changes in regulatory policies or tax guidelines, particularly with respect to RICs or BDCs;

 

   

loss of RIC status;

 

   

changes in earnings or variations in operating results;

 

   

changes in the value of our portfolio of investments;

 

   

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

 

   

departure of key personnel from our investment adviser;

 

   

operating performance of companies comparable to us;

 

   

general economic trends and other external factors; and

 

   

loss of a major funding source.

Sales of substantial amounts of our common stock in the public market may have an adverse effect on the market price of our common stock.

The shares of our common stock beneficially owned by our principal stockholders are generally available for resale, subject to the provisions of Rule 144 promulgated under the Securities Act. Sales of substantial amounts of our common stock, or the availability of such common stock for sale, could adversely affect the prevailing market prices for our common stock. If this occurs and continues, it could impair our ability to raise additional capital through the sale of securities should we desire to do so.

Certain provisions of the Delaware General Corporation Law and our certificate of incorporation and bylaws could deter takeover attempts and have an adverse impact on the price of our common stock.

The Delaware General Corporation Law, our certificate of incorporation and our bylaws contain provisions that may have the effect of discouraging a third party from making an acquisition proposal for us. We have also

 

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adopted measures that may make it difficult for a third party to obtain control of us, including provisions of our articles of incorporation dividing our board of directors into three classes with the term of one class expiring at each annual meeting of stockholders. These anti-takeover provisions may inhibit a change in control in circumstances that could give the holders of our common stock the opportunity to realize a premium over the market price of our common stock.

Our common stock may trade below its net asset value per share, which limits our ability to raise additional equity capital.

If our common stock is trading below its net asset value per share, we will generally not be able to issue additional shares of our common stock at its market price without first obtaining the approval for such issuance from our stockholders and our independent directors. Shares of BDCs, including shares of our common stock, have traded at discounts to their net asset values. As of December 31, 2012, our net asset value per share was $13.20. The last reported sale price of a share of our common stock on the NASDAQ Global Select Market on March 1, 2013 was $15.45. At our Annual Meeting of Stockholders on June 7, 2012, our stockholders approved a proposal authorizing us to sell up to 25% of our common stock at a price below our then-current net asset value per share, subject to approval by our board of directors for the offering. The authorization expires on the earlier of June 7, 2013 and the date of our 2013 Annual Meeting of Stock holders, which is expected to be held in June 2013. Our stockholders also approved a proposal to authorize us to offer and issue debt with warrants or debt convertible into shares of our common stock at an exercise or conversion price that, at the time such warrants or convertible debt are issued, will not be less than the market value per share but may be below our then-current net asset value per share. If our common stock trades below net asset value, the higher the cost of equity capital may result in it being unattractive to raise new equity, which may limit our ability to grow. The risk of trading below net asset value is separate and distinct from the risk that our net asset value per share may decline. We cannot predict whether shares of our common stock will trade above, at or below our net asset value.

The net asset value per share of our common stock may be diluted if we sell shares of our common stock in one or more offerings at prices below the then current net asset value per share of our common stock or securities to subscribe for or convertible into shares of our common stock.

At our Annual Meeting of Stockholders on June 7, 2012, our stockholders approved a proposal authorizing us to sell up to 25% of our common stock at a price below the Company’s net asset value per share, subject to approval by our board of directors of the offering. If we were to issue shares at a price below net asset value, such sales would result in an immediate dilution to existing common stockholders, which would include a reduction in the net asset value per share as a result of the issuance. This dilution would also include a proportionately greater decrease in a stockholder’s interest in our earnings and assets and voting interest in us than the increase in our assets resulting from such issuance.

In addition, at our 2012 Annual Meeting of Stockholders, our stockholders authorized us to offer and issue debt with warrants or debt convertible into shares of our common stock at an exercise or conversion price that, at the time such warrants or convertible debt are issued, will not be less than the market value per share but may be below our then current net asset value. Such authorization expires on the earlier of the one year anniversary of the date of the Annual Meeting and the date of our 2013 Annual Meeting of Stockholders.

Any decision to sell shares of our common stock below its then current net asset value per share or securities to subscribe for or convert into shares of our common stock would be subject to the determination by our board of directors that such issuance is in our and our stockholders’ best interests.

If we were to sell shares of our common stock below its then current net asset value per share, such sales would result in an immediate dilution to the net asset value per share of our common stock. This dilution would occur as a result of the sale of shares at a price below the then current net asset value per share of our common stock and a proportionately greater decrease in the stockholders’ interest in our earnings and assets and their

 

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voting interest in us than the increase in our assets resulting from such issuance. Because the number of shares of common stock that could be so issued and the timing of any issuance is not currently known, the actual dilutive effect cannot be predicted.

In addition, if we issue warrants or securities to subscribe for or convert into shares of our common stock, subject to certain limitations, the exercise or conversion price per share could be less than net asset value per share at the time of exercise or conversion (including through the operation of anti-dilution protections). Because we would incur expenses in connection with any issuance of such securities, such issuance could result in a dilution of the net asset value per share at the time of exercise or conversion. This dilution would include reduction in net asset value per share as a result of the proportionately greater decrease in the stockholders’ interest in our earnings and assets and their voting interest than the increase in our assets resulting from such issuance.

Further, if our current stockholders do not purchase any shares to maintain their percentage interest, regardless of whether such offering is above or below the then current net asset value per share, their voting power will be diluted. For example, if we sell an additional 10% of our common shares at a 5% discount from net asset value, a stockholder who does not participate in that offering for its proportionate interest will suffer net asset value dilution of up to 0.5% or $5 per $1000 of net asset value. For additional information and hypothetical examples of these risks, see “Sale of Common Stock Below Net Asset Value” and the prospectus supplement pursuant to which such sale is made.

We incur significant costs as a result of being a publicly traded company.

As a publicly traded company, we incur legal, accounting and other expenses, including costs associated with the periodic reporting requirements applicable to a company whose securities are registered under the Securities Exchange Act of 1934, as amended, or the Exchange Act, as well as additional corporate governance requirements, including requirements under the Sarbanes-Oxley Act of 2002, and other rules implemented by the SEC.

If we issue preferred stock, debt securities or convertible debt securities, the net asset value and market value of our common stock may become more volatile.

We cannot assure you that the issuance of preferred stock and/or debt securities would result in a higher yield or return to the holders of our common stock. The issuance of preferred stock, debt securities or convertible debt would likely cause the net asset value and market value of our common stock to become more volatile. If the dividend rate on the preferred stock, or the interest rate on the debt securities, were to approach the net rate of return on our investment portfolio, the benefit of leverage to the holders of our common stock would be reduced. If the dividend rate on the preferred stock, or the interest rate on the debt securities, were to exceed the net rate of return on our portfolio, the use of leverage would result in a lower rate of return to the holders of common stock than if we had not issued the preferred stock or debt securities. Any decline in the net asset value of our investment would be borne entirely by the holders of our common stock. Therefore, if the market value of our portfolio were to decline, the leverage would result in a greater decrease in net asset value to the holders of our common stock than if we were not leveraged through the issuance of preferred stock. This decline in net asset value would also tend to cause a greater decline in the market price for our common stock.

There is also a risk that, in the event of a sharp decline in the value of our net assets, we would be in danger of failing to maintain required asset coverage ratios which may be required by the preferred stock, debt securities, convertible debt or units or of a downgrade in the ratings of the preferred stock, debt securities, convertible debt or units or our current investment income might not be sufficient to meet the dividend requirements on the preferred stock or the interest payments on the debt securities. If we do not maintain our required asset coverage ratios, we may not be permitted to declare dividends. In order to counteract such an event, we might need to liquidate investments in order to fund redemption of some or all of the preferred stock,

 

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debt securities or convertible debt. In addition, we would pay (and the holders of our common stock would bear) all costs and expenses relating to the issuance and ongoing maintenance of the preferred stock, debt securities, convertible debt or any combination of these securities. Holders of preferred stock, debt securities or convertible debt may have different interests than holders of common stock and may at times have disproportionate influence over our affairs.

Holders of any preferred stock that we may issue will have the right to elect members of the board of directors and have class voting rights on certain matters.

The 1940 Act requires that holders of shares of preferred stock must be entitled as a class to elect two directors at all times and to elect a majority of the directors if dividends on such preferred stock are in arrears by two years or more, until such arrearage is eliminated. In addition, certain matters under the 1940 Act require the separate vote of the holders of any issued and outstanding preferred stock, including changes in fundamental investment restrictions and conversion to open-end status and, accordingly, preferred stockholders could veto any such changes. Restrictions imposed on the declarations and payment of dividends or other distributions to the holders of our common stock and preferred stock, both by the 1940 Act and by requirements imposed by rating agencies, might impair our ability to maintain our qualification as a RIC for U.S. federal income tax purposes.

Your interest in us may be diluted if you do not fully exercise your subscription rights in any rights offering. In addition, if the subscription price is less than our net asset value per share, then you will experience an immediate dilution of the aggregate net asset value of your shares.

In the event we issue subscription rights, stockholders who do not fully exercise their subscription rights should expect that they will, at the completion of a rights offering pursuant to this prospectus, own a smaller proportional interest in us than would otherwise be the case if they fully exercised their rights. We cannot state precisely the amount of any such dilution in share ownership because we do not know at this time what proportion of the shares will be purchased as a result of such rights offering.

In addition, if the subscription price is less than the net asset value per share of our common stock, then our stockholders would experience an immediate dilution of the aggregate net asset value of their shares as a result of the offering. The amount of any decrease in net asset value is not predictable because it is not known at this time what the subscription price and net asset value per share will be on the expiration date of a rights offering or what proportion of the shares will be purchased as a result of such rights offering. Such dilution could be substantial.

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

Our publicly issued debt securities may or may not have an established trading market. We cannot assure you that a trading market for our publicly issued debt securities will ever develop or be maintained if developed. In addition to our creditworthiness, many factors may materially adversely affect the trading market for, and market value of, our publicly issued debt securities. These factors include, but are not limited to, the following:

 

   

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 ratings assigned by national statistical ratings agencies;

 

   

the general economic environment;

 

   

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 higher or lower than rates borne by the debt securities.

 

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You should also be aware that there may be a limited number of buyers when you decide to sell your debt securities. This too may materially adversely affect the market value of the debt securities or the trading market for the debt securities.

Terms relating to redemption may materially adversely affect your return on any debt securities that we may issue.

If your debt securities are redeemable at our option, we may choose to redeem your debt securities at times when prevailing interest rates are lower than the interest rate paid on your debt securities. In addition, if your debt securities are subject to mandatory redemption, we may be required to redeem your debt securities also at times when prevailing interest rates are lower than the interest rate paid on your debt securities. In this circumstance, you may not be able to reinvest the redemption proceeds in a comparable security at an effective interest rate as high as your debt securities being redeemed.

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

Our credit ratings are an assessment by third parties of our ability to pay our obligations. Consequently, real or anticipated changes in our credit ratings will generally affect the market value of our debt securities. Our credit ratings, however, may not reflect the potential impact of risks related to market conditions generally or other factors discussed above on the market value of or trading market for the publicly issued debt securities.

 

Item 1B. Unresolved Staff Comments

None.

 

Item 2. Properties

We do not own any real estate or other physical properties materially important to our operation. Our headquarters are currently located at 100 Federal Street, 31st Floor, Boston, MA 02110. THL Credit Advisors furnishes us office space and we reimburse it for such costs on an allocated basis.

 

Item 3. Legal proceedings

As of December 31, 2012, we are not a defendant in any material pending legal proceeding, and no such material proceedings are known to be contemplated. However, from time to time, we may be party to certain legal proceedings incidental to the normal course of our business including the enforcement of our rights under the contracts with our portfolio companies.

 

Item 4. Mine Safety Disclosures

Not applicable.

 

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PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Price Range of Common Stock

Our common stock is traded on the NASDAQ Global Select Market under the ticker symbol “TCRD.” We completed our initial public offering of common stock on April 21, 2010 at a price of $13.00 per share. Prior to such date there was no public market for our common stock. The following table sets forth, for the periods indicated, the range of high and low sales prices for our common stock, as reported on The NASDAQ Global Select Market:

 

     High      Low  

Fiscal year ended December 31, 2012

     

First quarter

   $ 13.49       $ 12.12   

Second quarter

   $ 13.50       $ 12.20   

Third quarter

   $ 14.74       $ 12.88   

Fourth quarter

   $ 15.07       $ 13.03   

Fiscal year ended December 31, 2011

     

First quarter

   $ 14.86       $ 12.59   

Second quarter

   $ 14.39       $ 12.68   

Third quarter

   $ 13.26       $ 10.41   

Fourth quarter

   $ 12.25       $ 10.49   

The last reported price for our common stock on March 1, 2013 was $15.45 per share. As of March 1, we had two stockholders of record, which did not include stockholders for whom shares are held in nominee or “street” name.

 

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Stock Performance Graph

This graph compares the return on our common stock with that of the Standard & Poor’s 500 Stock Index and the Russell 2000 Financial Services Index, for the period from April 21, 2010 (initial public offering) through December 31, 2012. The graph assumes that, on April 21, 2010, a person invested $100 in each of our common stock, the S&P 500 Index, and the Russell 2000 Financial Services Index. The graph measures total stockholder return, which takes into account both changes in stock price and dividends. It assumes that dividends paid are invested in like securities.

 

LOGO

The graph and other information furnished under this Part II Item 5 of this Form 10-K shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C, or to the liabilities of Section 18 of the 1934 Act. The stock price performance included in the above graph is not necessarily indicative of future stock price performance.

Sales of unregistered securities

On April 20, 2010, in anticipation of completing our initial public offering and formally commencing principal operations, we entered into a purchase and sale agreement with THL Credit Opportunities, L.P. and THL Credit Partners BDC Holdings, L.P. (“BDC Holdings”), to effectuate the sale by THL Credit Opportunities, L.P. to us of certain securities valued at $62,107,449, as determined by our board of directors, and on the same day issued 4,140,496 shares of common stock to BDC Holdings valued at $15.00 per share pursuant to such agreement in exchange for the aforementioned securities.

On April 21, 2010 concurrent with our initial public offering, we sold 6,307,692 share of its common stock to BDC Holdings at $13.00 per share that was not subject to an underwriting discount and commission.

We issued a total of 2 shares, 304,093 shares and 124,219 shares of common stock under our dividend reinvestment plan during the years ended December 31, 2012, 2011 and 2010, respectively. The issuance was not subject to the registration requirements of the Securities Act of 1933. The aggregate price for the shares of common stock issued under the dividend reinvestment plan was $26, $4,048,609 and $1,572,685 for the years ended December 31, 2012, 2011 and 2010, respectively.

Issuer purchases of equity securities

None.

 

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Dividends

We have elected to be taxed as a regulated investment company under Subchapter M of the Code. In order to maintain our status as a regulated investment company, we are required to distribute at least 90% of our investment company taxable income. To avoid a 4% excise tax on undistributed earnings, we are required to distribute each calendar year the sum of (i) 98% of our ordinary income for such calendar year (ii) 98.2% of our net capital gains for the one-year period ending October 31 of that calendar year (iii) any income recognized, but not distributed, in preceding years and on which we paid no federal income tax. We intend to make distributions to stockholders on a quarterly basis of substantially all of our net investment income. Although we intend to make distributions of net realized capital gains, if any, at least annually, out of assets legally available for such distributions, we may in the future decide to retain such capital gains for investment. In addition, the extent and timing of special dividends, if any, will be determined by our board of directors and will largely be driven by portfolio specific events and tax considerations at the time.

In addition, we may be limited in our ability to make distributions due to the BDC asset coverage test for borrowings applicable to us as a BDC under the 1940 Act.

The following table summarizes our dividends declared and paid or to be paid on all shares:

 

Date Declared   Record Date   Payment Date   Amount Per Share

August 5, 2010

  September 2, 2010   September 30, 2010   $0.05

November 4, 2010

  November 30, 2010   December 28, 2010   $0.10

December 14, 2010

  December 31, 2010   January 28, 2011   $0.15

March 10, 2011

  March 25, 2011   March 31, 2011   $0.23

May 5, 2011

  June 15, 2011   June 30, 2011   $0.25

July 28, 2011

  September 15, 2011   September 30, 2011   $0.26

October 27, 2011

  December 15, 2011   December 30, 2011   $0.28

March 6, 2012

  March 20, 2012   March 30, 2012   $0.29

March 6, 2012

  March 20, 2012   March 30, 2012   $0.05

May 2, 2012

  June 15, 2012   June 29, 2012   $0.30

July 26, 2012

  September 14, 2012   September 28, 2012   $0.32

November 2, 2012

  December 14, 2012   December 28, 2012   $0.33

December 20, 2012

  December 31, 2012   January 28, 2013   $0.05

February 27, 2013

  March 15, 2013   March 29, 2013   $0.33

On December 20, 2012, our board of directors declared a special dividend of $0.05 per share, which was paid on January 28, 2013 to stockholders of record at the close of business on December 31, 2012.

On February 27, 2013, our board of directors declared a dividend of $0.33 per share, payable on March 29, 2013 to stockholders of record at the close of business on March 15, 2013.

We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of these distributions from time to time. If we do not distribute a certain percentage of our income annually, we will suffer adverse tax consequences, including possible loss of our status as a regulated investment company. We cannot assure stockholders that they will receive any distributions at a particular level.

We maintain an “opt in” dividend reinvestment plan for our common stockholders. As a result, unless stockholders specifically elect to have their dividends automatically reinvested in additional shares of common stock, stockholders will receive all such dividends in cash. With respect to our dividends and distributions paid to stockholders during the year ended December 31, 2012 and 2011, dividends reinvested pursuant to our dividend reinvestment plan totaled $26 and $4,048,609, respectively.

Under the terms of our dividend reinvestment plan, dividends will primarily be paid in newly issued shares of common stock. However, we reserve the right to purchase shares in the open market in connection with the

 

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implementation of the plan. This feature of the plan means that, under certain circumstances, we may issue shares of our common stock at a price below net asset value per share, which could cause our stockholders to experience dilution.

Distributions in excess of our current and accumulated profits and earnings would be treated first as a return of capital to the extent of the stockholder’s tax basis, and any remaining distributions would be treated as a capital gain. The determination of the tax attributes of our distributions will be made annually as of the end of our fiscal year based upon our taxable income for the full year and distributions paid for the full year. Therefore, a determination made on a quarterly basis may not be representative of the actual tax attributes of our distributions for a full year. Each year, a statement on Form 1099-DIV identifying the source of the distribution will be sent to our U.S. stockholders. Our board of directors presently intends to declare and pay quarterly dividends. Our ability to pay dividends could be affected by future business performance, liquidity, capital needs, alternative investment opportunities and loan covenants.

The tax character of distributions declared and paid in 2012 represented $28.5 million from ordinary income, $0.9 million from capital gains and $0 from tax return of capital. Generally accepted accounting principles require adjustments to certain components of net assets to reflect permanent differences between financial and tax reporting. These adjustments have no affect on net asset value per share. Permanent differences between financial and tax reporting at December 31, 2012 and 2011 were $0.2 million and $0.1 million, respectively.

 

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Item 6. Selected Financial Data

The following selected financial data should be read together with our consolidated financial statements and the related notes and the discussion under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” which is included elsewhere in this annual report on Form 10-K. Financial information is presented for the years ended December 31, 2012, 2011 and 2010. Financial information for the periods ending 2012, 2011 and 2010 has been derived from our financial statements that were audited by PricewaterhouseCoopers LLP, our independent registered public accounting firm. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” below for more information.

 

     For the years ended December 31,      At and for the period from
May 26, 2009 (inception)
through December 31, 2009
 
     2012     2011      2010     

Statement of Operations data:

          

Total investment income

   $ 53,125,279      $ 37,408,627       $ 12,325,432       $ —     

Incentive fee

     7,017,252        4,790,457         —           —     

Base management fees

     4,943,025        4,011,897         2,696,647         —     

All other expenses

     10,392,230        7,549,756         3,597,944         171,593   

Income tax provision and excise tax

     581,502        22,000         —           —     

Net investment income

     30,191,270        21,056,517         6,030,841         (171,593

Interest rate derivative periodic interest payments, net

     (179,581     —           —           —     

Net realized gain on investments

     353,199        979,643         —           —     

Net change in unrealized appreciation on investments

     (1,241,415     2,121,321         1,760,389         —     

Net change in unrealized depreciation on interest rate derivative

     (1,053,221     —           —           —     

Net increase (decrease) in net assets resulting from operations

     27,616,694        24,135,481         7,791,230         (171,593

Provision for taxes on unrealized appreciation on investments

     (453,558     —           —           —     

Per share data:

          

Net asset value (net deficit) per common share at year end

     13.20        13.24         13.06         (10.61

Market price at year end

     14.79        12.21         13.01      

Net investment income (loss)

     1.38        1.04         0.31         (25.61

Net realized gain on investments

     0.01        0.05         —           —     

Net change in unrealized appreciation on investments

     (0.06     0.11         0.08         —     

Net change in unrealized depreciation on interest rate derivative

     (0.06     —           —           —     

Provision for taxes on unrealized appreciation on investments

     (0.02     —           —           —     

Net increase (decrease) in net assets resulting from operations

     1.26        1.20         0.39         (25.61

Dividends declared

     1.34        1.02         0.30         —     

Statement of Assets and Liabilities data at period end:

          

Total investments at fair value

     394,349,134        266,993,332         153,529,179         —     

Cash and cash equivalents

     4,818,614        5,572,753         110,140,711         100,500   

Other assets

     7,090,746        4,583,346         719,285         369,767   

Total assets

     406,258,494        277,149,431         264,389,175         470,267   

Loans payable

     50,000,000        5,000,000         —           —     

 

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     For the years ended December 31,     At and for the period from
May 26, 2009 (inception)
through December 31, 2009
 
     2012     2011     2010    

Other liabilities

   $ 8,773,551      $ 4,532,725      $ 4,373,406      $ 541,360   

Total liabilities

     58,773,551        9,532,725        4,373,406        541,360   

Total net assets (deficit)

     347,484,943        267,616,706        260,015,769        (71,093

Other data:

        

Weighted average annual yield on debt investments

     13.7     13.8     15.8     —     

Weighted average annual yield on debt and income-producing equity securities

     13.9     14.0     16.6     —     

Number of investments at year end

     34        24        13        —     

 

Quarter Ended

  Investment Income     Net Investment
Income
    Net Unrealized
Gain (Loss) on
Investments
    Net Realized
Gain on
Investments
    Net Realized/
Unrealized Gain
(Loss) on

Interest Rate
Derivative
    Provision for
taxes on unrealized
appreciation on
investments
    Net Increase
In Net
Assets From
Operations
 
(Unaudited)   Total     Per
Share
    Total     Per
Share
    Total     Per
Share
    Total     Per
Share
    Total     Per
Share
    Total     Per
Share
    Total     Per
Share
 

December 31, 2012

  $ 16,379,669      $ 0.62      $ 9,028,043      $ 0.34      $ 884,710      $ 0.03      $ 353,199      $ 0.01      ($ 37,631   $ 0.00      ($ 453,558   ($ 0.01   $ 9,774,763      $ 0.37   

September 30, 2012

    14,237,468        0.69        8,476,620        0.41        (1,687,173     (0.07     —          —          (620,744     (0.03     —          —          6,168,703        0.31   

June 30, 2012

    11,758,551        0.58        6,514,619        0.32        26,690        —          —          —          (574,427     (0.03     —          —          5,966,882        0.29   

March 31, 2012

    10,749,591        0.53        6,171,988        0.31        (465,642     (0.03     —          —          —          —          —          —          5,706,346        0.28   

 

Quarter Ended

  Investment Income     Net Investment
Income
    Net Unrealized Gain (Loss)
on Investments
    Net Realized Gain
on Investments
    Net Increase
In Net Assets From
Operations
 
(Unaudited)   Total     Per
Share
    Total     Per
Share
        Total         Per
    Share    
    Total     Per
Share
    Total     Per Share  

December 31, 2011

  $ 10,914,290      $ 0.54      $ 6,017,294      $ 0.30      $ 79,220      $ 0.00      $ 979,643      $ 0.05      $ 7,076,157      $ 0.35   

September 30, 2011

    10,318,840        0.51        5,910,636        0.29        (285,818     (0.01     —          —          5,624,818        0.28   

June 30, 2011

    9,117,035        0.45        4,970,876        0.25        1,579,544        0.07        —          —          6,550,420        0.32   

March 31, 2011

    7,058,462        0.35        4,135,711        0.21        748,375        0.03       —          —          4,884,086        0.24   

Quarter Ended

  Investment Income     Net Investment
Income (Loss)
    Net Unrealized Gain on
Investments
    Net Realized Gain
on Investments
    Net Increase (Decrease)
In Net Assets From
Operations
 
(Unaudited)   Total     Per
Share
    Total     Per
Share
    Total     Total     Per Share     Total     Per
    Share     
        Total      

December 31, 2010

  $ 5,804,110      $ 0.29      $ 3,458,019      $ 0.17      $ 597,717      $ 0.03      $ —        $ —        $ 4,055,736      $ 0.20   

September 30, 2010

    4,080,836        0.21        1,863,981        0.09        1,052,967        0.05        —          —          2,916,948        0.15   

June 30, 2010

    2,440,486        0.12        728,841        0.04        109,705        0.01        —          —          838,546        0.04   

March 31, 2010

    —          —          (20,000     (2.99     —          —          —          —          (20,000     (2.99

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The information contained in this section should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this report.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This report, and other statements that we may make, may contain forward-looking statements with respect to future financial or business performance, strategies or expectations. Forward-looking statements are typically identified by words or phrases such as “trend,” “opportunity,” “pipeline,” “believe,” “comfortable,” “expect,” “anticipate,” “current,” “intention,” “estimate,” “position,” “assume,” “potential,” “outlook,” “continue,” “remain,” “maintain,” “sustain,” “seek,” “achieve” and similar expressions, or future or conditional verbs such as “will,” “would,” “should,” “could,” “may” or similar expressions.

Forward-looking statements are subject to numerous assumptions, risks and uncertainties, which change over time. Forward-looking statements speak only as of the date they are made, and we assume no duty to and do not undertake to update forward-looking statements. Actual results could differ materially from those anticipated in forward-looking statements and future results could differ materially from historical performance.

In addition to factors previously identified elsewhere in this filing, the following factors, among others, could cause actual results to differ materially from forward-looking statements or historical performance:

 

   

the introduction, withdrawal, success and timing of business initiatives and strategies;

 

   

changes in political, economic or industry conditions, the interest rate environment or financial and capital markets, which could result in changes in the value of our assets;

 

   

the relative and absolute investment performance and operations of our investment adviser;

 

   

the impact of increased competition;

 

   

the impact of future acquisitions and divestitures;

 

   

the unfavorable resolution of legal proceedings;

 

   

our business prospects and the prospects of our portfolio companies;

 

   

the impact, extent and timing of technological changes and the adequacy of intellectual property protection;

 

   

the impact of legislative and regulatory actions and reforms and regulatory, supervisory or enforcement actions of government agencies relating to us or THL Credit Advisors LLC, the Advisor;

 

   

the ability of the Advisor to identify suitable investments for us and to monitor and administer our investments;

 

   

our contractual arrangements and relationships with third parties;

 

   

any future financings by us;

 

   

the ability of the Advisor to attract and retain highly talented professionals;

 

   

fluctuations in foreign currency exchange rates; and

 

   

the impact of changes to tax legislation and, generally, our tax position.

Overview

THL Credit, Inc. was organized as a Delaware corporation on May 26, 2009 and initially funded on July 23, 2009. We commenced principal operations on April 21, 2010. Our investment objective is to generate both

 

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current income and capital appreciation, primarily through the origination of privately negotiated investments in debt and equity securities in middle market companies.

We are a direct lender to middle-market companies and invest in subordinated, or mezzanine, debt and second lien secured debt, which may include an associated equity component such as warrants, preferred stock or other similar securities. We may also selectively invest in first lien secured loans that generally have structures with higher interest rates, which include unitranche investments, or loan structures that combine characteristics of traditional first lien senior secured as well as second lien and subordinated loans. In certain instances we will also make direct equity investments, including equity investments into or through funds, and we may also selectively invest in more broadly syndicated first lien secured loans from time to time.

We are an externally managed, non-diversified, closed-end investment company that has elected to be regulated as a business development company, or BDC, under the 1940 Act. As a BDC, we are required to comply with certain regulatory requirements. For instance, we generally have to invest at least 70% of our total assets in “qualifying assets,” including securities of private or thinly traded public U.S. companies, cash, cash equivalents, U.S. Government securities and high-quality debt investments that mature in one year or less.

As a BDC, we must not acquire any assets other than “qualifying assets” specified in the 1940 Act unless, at the time the acquisition is made, at least 70% of our total assets are qualifying assets (with certain limited exceptions). Qualifying assets include investments in “eligible portfolio companies.” Under the relevant SEC rules, the term “eligible portfolio company” includes all private companies, companies whose securities are not listed on a national securities exchange, and certain public companies that have listed their securities on a national securities exchange and have a market capitalization of less than $250 million, in each case organized in the United States.

On April 21, 2010, we completed our initial public offering, formally commencing principal operations, and sold 9,000,000 shares of our common stock through a group of underwriters at a price of $13.00 per share, less an underwriting discount and commissions totaling $0.8125 per share. Concurrently, we sold 6,307,692 shares of our common stock to THL Credit Partners BDC Holdings, L.P., or BDC Holdings, at $13.00 per share that was not subject to an underwriting discount and commission. We received $190.7 million of total net proceeds for the aforementioned offerings, which includes an underwriting discount and offering expenses. Since May 2011, BDC Holdings distributed an aggregate of 2.8 million shares of our common stock held by BDC Holdings to its partners. As of December 31, 2012, BDC Holdings owns 15.4% of our common stock.

On September 25, 2012, we closed on a public equity offering selling 6,095,000 shares of our common stock through a group of underwriters at a price of $14.09 per share, less an underwriting discount and offering expenses, and received $81.7 million in proceeds.

We have elected to be treated for tax purposes as a regulated investment company, or RIC, under Subchapter M of the Code. To qualify as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements. Pursuant to these elections, we generally will not have to pay corporate-level income taxes on any income we distribute to our stockholders.

Portfolio Composition and Investment Activity

Portfolio Composition

We completed the year ended December 31, 2012 with $394.3 million (at fair value), which represents a $127.3 million, or 47.7%, increase from the $267.0 million (at fair value) as of December 31, 2011. We also increased our portfolio to thirty-four companies, including THL Credit Greenway Fund LLC, or Greenway, as of December 31, 2012, from twenty-four companies, including Greenway, as of December 31, 2011.

 

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At December 31, 2012, our average portfolio company investment, exclusive of Greenway, at amortized cost and fair value was approximately $11.9 million and $11.9 million, respectively and our largest portfolio company investment by amortized cost and fair value was approximately $36.1 million and $36.1 million, respectively. At December 31, 2011, our average portfolio company investment at amortized cost and fair value was approximately $11.4 million and $11.6 million, respectively and our largest portfolio company investment by amortized cost and fair value was approximately $18.4 million and $19.4 million, respectively.

At December 31, 2012, 43.3% of our debt investments bore interest based on floating rates (subject to interest rate floors), such as LIBOR, and 56.7% bore interest at fixed rates. At December 31, 2011, 40.0% of our debt investments bore interest based on floating rates (subject to interest rate floors), such as LIBOR, and 60.0% bore interest at fixed rates.

The weighted average yield of the debt and income-producing investments in our portfolio at their current cost was 13.9% at December 31, 2012 as compared to 14.0% at December 31, 2011. The weighted average yield on our debt securities at their current cost was 13.7% at December 31, 2012 as compared to 13.8% at December 31, 2011. Yields are computed using interest rates and dividend yields as of the balance sheet date and include amortization of upfront loan origination fees, original issue discount and market premium or discount. Yields exclude common equity investments, preferred equity investments, and cash and cash equivalents.

Our portfolio companies, in which we have debt investments, currently have an average EBITDA of approximately $24 million, excluding one portfolio company with EBITDA levels not representative of a typical portfolio company, based on the latest available financial information provided by the portfolio companies. Our weighted average attachment point in the capital structure of our portfolio companies is approximately 3.8 times EBITDA based on the latest available financial information.

The following table summarizes the amortized cost and fair value of investments as of December 31, 2012 (in millions).

 

Description:

   Amortized Cost      Percentage of
Total
    Fair  Value(1)      Percentage of
Total
 

First lien secured debt

   $ 101.8         26.0   $ 102.2         26.0

Second lien debt

     70.6         18.0     70.0         17.8

Subordinated debt

     184.1         47.1     183.3         46.5

Investments in funds

     9.6         2.4     10.3         2.6

Equity investments

     3.9         1.0     6.8         1.7

Investment in payment rights

     12.3         3.1     12.3         3.1

CLO residual interest

     9.4         2.4     9.4         2.4
  

 

 

    

 

 

   

 

 

    

 

 

 

Total investments

   $ 391.7         100.0   $ 394.3         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

The following table summarizes the amortized cost and fair value of investments as of December 31, 2011 (in millions).

 

Description:

   Amortized Cost      Percentage of
Total
    Fair  Value(1)      Percentage of
Total
 

First lien secured debt

   $ 88.5         33.6   $ 89.5         33.5

Second lien debt

     59.6         22.6     60.2         22.6

Subordinated debt

     99.9         38.0     101.8         38.1

Investments in funds

     12.0         4.6     12.0         4.5

Equity investments

     3.1         1.2     3.5         1.3
  

 

 

    

 

 

   

 

 

    

 

 

 

Total investments

   $ 263.1         100.0   $ 267.0         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1)

All investments are categorized as Level 3 in the fair value hierarchy.

 

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The following is a summary of the industry classification in which the Company invests as of December 31, 2012 (in millions).

 

Industry:

   Cost      Fair Value      % of
Net Assets
 

Aerospace & defense

   $ 4.0       $ 4.0         1.16

Business services

     67.2         66.3         19.09

Chemicals

     9.5         9.5         2.74

Consumer products

     50.0         50.0         14.39

Election services

     9.4         9.5         2.73

Energy / utilities

     9.8         9.8         2.81

Financial services

     31.2         31.9         9.19

Food & beverage

     44.1         43.6         12.54

Healthcare, ambulatory surgery centers

     18.8         20.8         5.99

Healthcare, consulting

     12.3         12.4         3.56

Healthcare, dental services

     1.4         1.4         0.40

Healthcare, device manufacturing

     13.0         12.4         3.57

Industrials

     25.0         25.0         7.19

Manufacturing

     39.0         38.1         10.98

Media

     10.5         10.5         3.03

Media, advertising

     3.2         5.1         1.47

Restaurants

     8.2         8.4         2.42

Retail & grocery

     26.5         27.0         7.76

Textiles

     8.6         8.6         2.47
  

 

 

    

 

 

    

 

 

 

Total investments

   $ 391.7       $ 394.3         113.49
  

 

 

    

 

 

    

 

 

 

The following is a summary of the industry classification in which the Company invests as of December 31, 2011 (in millions).

 

Industry:

   Cost      Fair Value      % of
Net Assets
 

Aerospace & defense

   $ 3.9       $ 3.9         1.47

Business services

     42.1         43.0         16.08

Communications

     11.2         11.5         4.28

Election services

     10.3         10.3         3.85

Energy / utilities

     26.6         27.1         10.10

Financial services

     12.0         12.0         4.49

Food & beverage

     36.1         36.5         13.65

Healthcare, ambulatory surgery centers

     18.4         19.4         7.24

Healthcare, consulting

     12.0         12.0         4.49

Healthcare, dental services

     11.9         12.3         4.61

Manufacturing

     25.4         25.6         9.56

Restaurants

     16.1         16.3         6.08

Retail & grocery

     37.1         37.1         13.87
  

 

 

    

 

 

    

 

 

 

Total investments

   $ 263.1       $ 267.0         99.77
  

 

 

    

 

 

    

 

 

 

 

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Investment Activity

The following is a summary of our investment activity, presented on a cost basis, for the years ended December 31, 2012 and 2011 (in millions).

 

     Year ended December 31,  
         2012             2011      

New portfolio investments(a)(b)

   $ 266.8      $ 129.1   

Existing portfolio investments

    

Follow-on investments

     21.2        11.6   

Delayed draw and revolver investments

     7.2        1.1   
  

 

 

   

 

 

 

Total existing portfolio investments

     28.4        12.7   
  

 

 

   

 

 

 

Total portfolio investments

   $ 295.2      $ 141.8   
  

 

 

   

 

 

 

Number of new portfolio investments

     24        14   

Number of existing portfolio investments

     7        3   

First lien secured debt(a)

   $ 102.8      $ 68.1   

Second lien debt

     41.5        42.0   

Subordinated debt

     127.0        31.3   

Investments in funds

     1.2        —     

Equity investments

     0.8        0.4   

Investment in payment rights

     12.5        —     

CLO residual interest

     9.4        —     
  

 

 

   

 

 

 

Total portfolio investments

   $ 295.2      $ 141.8   
  

 

 

   

 

 

 

Weighted average yield of debt investments

     13.7     13.8

Weighted average yield, including all income-producing investments

     13.9     14.0

 

(a) 

Number of new portfolio investments in 2012 include investments in five companies in which we invested in $23.8 million in broadly syndicated first lien secured term loans for short-term investment purposes. These loans were sold in 2012.

(b) 

Net of amounts sold following an initial investment as a co-investment.

 

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The following is a summary of the proceeds received from prepayments and sales of our investments (in millions).

 

     Year ended December 31,  

Investment

       2012              2011      

AIM Media Texas Operating, LLC

   $ 0.5       $ —     

Anytime Worldwide, LLC

     —           14.9   

Charming Charlie, Inc.

     11.6         —     

Chuy’s Opco, Inc.

     9.2         —     

CRS Reprocessing, LLC

     3.1         —     

Cydcor LLC

     0.4         —     

Duff & Phelps Corporation

     0.2         —     

Food Processing Holdings, LLC

     12.6         —     

Hart InterCivic, Inc.

     0.9         —     

HEALTHCAREfirst, Inc.

     14.1         —     

Hickory Farms, Inc.

     9.5         —     

Intelligrated, Inc.

     —           9.0   

JDC Healthcare Management, LLC

     11.2         —     

LCP Capital Fund LLC

     3.6         0.8   

Loadmaster Derrick & Equipment, Inc.

     3.3         —     

MModal MQ Inc.

     6.9         —     

Pomeroy IT Solutions, Inc.

     18.1         —     

Purple Communications, Inc.

     11.5         0.8   

SiVance, LLC

     —           8.4   

Surgery Center Holdings, Inc.

     —           1.2   

T&D Solutions, LLC

     15.3         1.3   

Texas Honing, Inc.

     14.4         —     

YP Intermediate Holdings Corp.

     6.5         —     

Broadly syndicated loans(a)

     24.2         —     
  

 

 

    

 

 

 

Total(b)(c)

   $ 177.1       $ 36.4   
  

 

 

    

 

 

 

 

(a)

Investments in broadly syndicated first lien secured term loans in five companies made for short-term investment purposes.

(b)

For the year ended December 31, 2012, these proceeds included $2.6 million of prepayment premiums.

(c) 

For the year ended December 31, 2011, these proceeds included $1.1 million of prepayment premiums.

The frequency or volume of any prepayments may fluctuate significantly from period to period. The increase between the December 31, 2012 and 2011 amounts are a result of an increase in prepayments resulting from the performance of certain portfolio companies and the interest rate environment.

Our level of investment activity can vary substantially from period to period depending on many factors, including the amount of debt and equity capital available to middle market companies, the level of merger and acquisition activity, the general economic environment and the competitive environment for the types of investments we make.

Investment Risk

The value of our investments will generally fluctuate with, among other things, changes in prevailing interest rates, federal tax rates, counterparty risk, general economic conditions, the condition of certain financial markets, developments or trends in any particular industry and the financial condition of the issuer. During periods of limited liquidity and higher price volatility, our ability to dispose of investments at a price and time that we deem advantageous may be impaired.

 

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Lower-quality debt securities involve greater risk of default or price changes due to changes in the credit quality of the issuer. The value of lower-quality debt securities often fluctuates in response to company, political, or economic developments and can decline significantly over short periods of time or during periods of general or regional economic difficulty. Lower-quality debt securities can be thinly traded or have restrictions on resale, making them difficult to sell at an acceptable price. The default rate for lower-quality debt securities is likely to be higher during economic recessions or periods of high interest rates.

Investment in Funds

We do not have the ability to redeem our investment in funds but distributions are expected to be received until the dissolution of the funds, which is anticipated to be between 2013 and 2021, as the underlying investments are expected to be liquidated.

Greenway

On January 14, 2011, THL Credit Greenway Fund LLC was formed as a Delaware limited liability company. Greenway is a portfolio company of ours. Greenway is a closed-end investment fund which provides for no liquidity or redemption options and is not readily marketable. Greenway operates under a limited liability agreement dated January 19, 2011 (the “Agreement”). Greenway will continue in existence until January 14, 2021, subject to earlier termination pursuant to certain terms of the Agreement. The term may also be extended for up to three additional one-year periods pursuant to certain terms of the Agreement. Greenway has a two year investment period.

Greenway has $150.0 million of capital committed by affiliates of a single institutional investor, and is managed by us through the investment professionals that serve on our investment committee. Our capital commitment to Greenway is $0.02 million. As of December 31, 2012, all of the capital had been called by Greenway. As of December 31, 2011, $0.01 million had been called by Greenway. As of December 31, 2012 and December 31, 2011, the value of our interest in Greenway was $0.01 million and $0.01 million, respectively, and is reflected in the Consolidated Schedule of Investments.

As manager of Greenway, we act as the investment adviser to Greenway and are entitled to receive certain fees. As a result, Greenway is classified as an affiliate of ours. For the years ended December 31, 2012 and 2011 we earned $2.6 million and $1.8 million in fees related to Greenway, respectively, which are included in other income from non-controlled, affiliated investment in the Consolidated Statements of Operations. As of December 31, 2012 and December 31, 2011, $0.4 million and $0.4 million of fees related to Greenway, respectively, were included in Due from affiliate on the Consolidated Statements of Assets and Liabilities.

Greenway invests in securities similar to those of ours pursuant to investment and allocation guidelines which address, among other things, the size of the borrowers, the types of transactions and the concentration and investment ratio amongst Greenway and us. However, we have the discretion to invest in other securities.

LCP Capital Fund LLC

We have invested in a membership interest of LCP Capital Fund LLC, or LCP, a private investment company that was organized to participate in investment opportunities that arise when a special purpose entity, or SPE, or sponsor thereof, needs to raise capital to achieve ratings, regulatory, accounting, tax, or other objectives. LCP is a closed investment vehicle which provides for no liquidity or redemption options and is not readily marketable. LCP is managed by an unaffiliated third party. As of December 31, 2012 and December 31, 2011, we had contributed $12.0 million of capital in the form of membership interests in LCP, which is invested in an underlying SPE referred to as Series 2005-01. On May 1, 2012, we received $3.6 million in connection with a reduction in its commitment pursuant to the governing documents, which is related to the notional amount of the underlying credit default swaps. Our exposure is limited to the amount of its remaining contributed capital. As of December 31, 2012 and December 31, 2011, the value of our interest in LCP was $8.4 million and $12.0 million, respectively, and is reflected in the Consolidated Schedules of Investments.

 

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Our contributed capital in LCP is maintained in a collateral account held by a third-party custodian, who is neither affiliated with us nor with LCP, and acts as collateral on certain credit default swaps for the Series 2005-01 for which LCP receives fixed premium payments throughout the year, adjusted for expenses incurred by LCP. The SPE purchases assets on a non-recourse basis and LCP agrees to reimburse the SPE up to a specified amount for potential losses. LCP holds the contributed cash invested for an SPE transaction in a segregated account that secures the payment obligation of LCP. We expect to receive distributions from LCP on a quarterly basis. Such distributions are reflected in our Consolidated Statements of Operations as interest income in the period earned. LCP has a remaining life of 18 years; however, it is currently expected that Series 2005-01 will terminate on February 15, 2015, if not extended prior to this date pursuant to the terms of Series 2005-1 SPE. Regardless of the date of dissolution, LCP has the right to receive amounts held in the collateral account if there is an event of default under LCP’s operative agreements. LCP may have other series which will have investments in other SPEs to which we will not be exposed.

CLO residual interest

Interest income from our CLO residual interest is recorded based upon an estimation of an effective yield to expected maturity using anticipated cash flows with any remaining amount recorded to the cost basis of the investment. We monitor the anticipated cash flows from its CLO residual interest and will adjust its effective yield periodically.

Investment in Tax Receivable Agreement Payment Rights

In June 2012, we invested in a TRA that entitles us to certain payment rights, or TRA Payment Rights, from Duff & Phelps Corporation, or Duff & Phelps. The TRA transfers the economic value of certain tax deductions, or tax benefits, taken by Duff & Phelps to us and entitles us to a stream of payments to be received. The TRA payment right is, in effect, a subordinated claim on the issuing company which can be valued based on the credit risk of the issuer, which includes projected future earnings, the liquidity of the underlying payment right, risk of tax law changes, the effective tax rate and any other factors which might impact the value of the payment right.

Through the TRA, we are entitled to receive an annual tax benefit payment based upon 85% of the savings from certain deductions along with interest. The payments that we are entitled to receive result from cash savings, if any, in U.S. federal, state or local income tax that Duff & Phelps realizes (i) from the tax savings derived from the goodwill and other intangibles created in connection with the Duff & Phelps initial public offering (ii) from other income tax deductions. These tax benefit payments will continue until the relevant deductions are fully utilized, which is projected to be 17 years. Pursuant to the TRA, we maintain the right to enforce Duff & Phelps payment obligations as a transferee of the TRA contract. If Duff & Phelps chooses to pre-pay and terminate the TRA, we will be entitled to the present value of the expected future TRA payments. If Duff & Phelps breaches any material obligation than all obligations are accelerated and calculated as if an early termination occurred. Failure to make a payment is a breach of a material obligation if the failure occurs for more than three months.

The projected annual tax benefit payment will be accrued on a quarterly basis and paid annually. The payment will be allocated between a reduction in the cost basis of the investment and interest income based upon an amortization schedule. Based upon the characteristics of the investment, we have chosen to categorize the investment in the TRA payment rights as investment in payment rights in the fair value hierarchy. The valuation will be based principally on a discounted cash flow analysis of projected future cash flow streams assuming an appropriate discount rate, which will among other things consider other transactions in the market, the current credit environment, performance of Duff & Phelps and the length of the remaining payment stream. During the year ended December 31, 2012, we recognized $1.2 million of income in connection with the TRA payment rights. As of December 31, 2012, the value of our interest in the TRA was $12.2 million and is reflected in the Consolidated Schedule of Investments.

 

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Asset Quality

We view active portfolio monitoring as a vital part of our investment process. We consider board observation rights, regular dialogue with company management and sponsors, and detailed internally generated monitoring reports to be critical to our performance. We have developed a monitoring template that promotes compliance with these standards and that is used as a tool by the Advisor’s investment committee to assess investment performance relative to plan. In addition, our portfolio companies may rely on us to provide financial and capital market expertise and may view us as a value-added resource.

As part of the monitoring process, the Advisor assesses the risk profile of each of our investments and assigns each investment a score of a 1, 2, 3, 4 or 5. Effective March 31, 2012, the Advisor revised its scoring system in order to categorize, on a more granular level, each investment based upon its performance and may revise the scoring system in the future depending upon the nature of the portfolio. The changes from December 31, 2011, included moving investments with a previous score of a 2 to a new investment performance score of 3 and bifurcating a previous score of 1 between new investment performance scores of 1 and 2 based upon its performance. Overall, there was no significant change in the risk profile of the portfolio companies between December 31, 2011 and December 31, 2012 or between March 31, 2012 and December 31, 2012.

The revised investment performance scores, or IPS, are as follows:

1 – The portfolio company is performing above our underwriting expectations.

2 – The portfolio company is performing as expected at the time of underwriting. All new investments are initially scored a 2.

3 – The portfolio company is operating below our underwriting expectations, and requires closer monitoring. The company may be out of compliance with financial covenants, however, principal or interest payments are generally not past due.

4 – The portfolio company is performing materially below our underwriting expectations and returns on our investment are likely to be impaired. Principal or interest payments may be past due, however, full recovery of principal and interest payments are expected.

5 – The portfolio company is performing substantially below expectations and the risk of the investment has increased substantially. The company is in payment default and the principal and interest payments are not expected to be repaid in full.

For any investment receiving a score of a 3 or lower, our manager increases its level of focus and prepares regular updates for the investment committee summarizing current operating results, material impending events and recommended actions.

 

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The Advisor monitors and, when appropriate, changes the investment scores assigned to each investment in our portfolio. In connection with our investment valuation process, the Advisor and board of directors review these investment scores on a quarterly basis. Our average investment score was 2.12 at December 31, 2012. The following is a distribution of the investment scores of our portfolio companies at December 31, 2012 (in millions):

 

     December 31, 2012  

Investment Score

   Investments at
Fair Value
     % of  Total
Portfolio
 

1(a)

   $ 20.0         5.1

2(b)

     312.5         79.2

3(c)

     55.5         14.1

4(d)

     6.4         1.6

5

     —          —    
  

 

 

    

 

 

 

Total

   $ 394.3         100.0
  

 

 

    

 

 

 

 

(a) 

As of December 31, 2012, Investment Score “1” included $8.2 million of loans to companies in which we also hold equity securities.

(b) 

As of December 31, 2012, Investment Score “2” included $49.4 million of loans to companies in which we also hold equity securities.

(c) 

As of December 31, 2012, Investment Score “3” included $27.0 million of loans to companies in which we also hold equity securities.

(d) 

As of December 31, 2012, Investment Score “4” included no loans to companies in which we also hold equity securities.

Loans are placed on non-accrual status when principal or interest payments are past due 30 days or more and/or when it is no longer probable that principal or interest will be collected. However, we may make exceptions to this policy if the loan has sufficient collateral value and is in the process of collection. As of December 31, 2012 and December 31, 2011, we had no loans on non-accrual.

Results of Operations

The principal measure of our financial performance is net increase (decrease) in net assets resulting from operations, which includes net investment income (loss), net realized gain (loss), net unrealized appreciation (depreciation) and interest rate derivative periodic interest payments, net. Net investment income (loss) is the difference between our income from interest, dividends, fees and other investment income and our operating expenses. Net realized gain (loss) on investments is the difference between the proceeds received from dispositions of portfolio investments and their amortized cost. Net unrealized appreciation (depreciation) on investments is the net change in the fair value of our investment portfolio. Net unrealized appreciation (depreciation) on interest rate derivative is the net change in the fair value of the interest rate derivative agreement. Interest rate derivative periodic interest payments, net are the difference between the proceeds received or the amounts paid on the interest rate derivative.

Comparison of the Years Ended December 31, 2012, 2011 and 2010

Investment Income

We generate revenues primarily in the form of interest on the debt and other income-producing securities we hold. Income-producing securities include investments in funds, investment in payment rights and collateralized loan obligation, or CLO, residual interest. Our investments in fixed income instruments generally have an expected maturity of five to seven years, and typically bear interest at a fixed or floating rate. Interest on our debt securities is generally payable quarterly. Payments of principal of our debt investments may be amortized over the stated term of the investment, deferred for several years or due entirely at maturity. In some cases, our debt

 

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instruments and preferred stock investments may defer payments of dividends or pay interest in-kind, or PIK. Any outstanding principal amount of our debt securities and any accrued but unpaid interest will generally become due at the maturity date. The level of interest income we receive is directly related to the balance of interest-bearing investments multiplied by the weighted average yield of our investments. In addition, we may generate revenue in the form of fees from the management of Greenway, prepayment premiums, commitment, loan origination, structuring or due diligence fees, fees for providing significant managerial assistance and consulting fees.

The following shows the breakdown of investment income for the years ended December 31, 2012, 2011 and 2010 (in millions):

 

     Year ended December 31,  
     2012      2011      2010  

Interest income on debt securities

        

Cash interest on debt securities

   $ 36.7       $ 26.9       $ 8.4   

Interest earned from bank accounts

     0.0         0.1         0.3   

PIK interest

     4.1         2.6         0.9   

Prepayment premiums

     2.6         1.1         —    

Accretion of discounts and other fees

     3.6         2.1         0.4   
  

 

 

    

 

 

    

 

 

 

Total interest on debt securities

     47.0         32.8         10.0   

Interest income on income-producing securities

     2.8         2.1         2.2   

Fees related to Greenway

     2.6         1.8         —    

Dividend income(a)

     0.4         0.3         —     

Other income

     0.3         0.4         0.1   
  

 

 

    

 

 

    

 

 

 

Total

   $ 53.1       $ 37.4       $ 12.3   
  

 

 

    

 

 

    

 

 

 

 

(a) 

For the year ended December 31, 2012, dividend income represents a tax distribution received by a wholly-owned blocker corporation. A corresponding expense has been recorded in excise and income tax provision on the Consolidated Statements of Operations.

The following shows a rollforward of PIK income for the years ended December 31, 2012 and 2011 (in millions):

 

Accumulated PIK balance at December 31, 2010

   $ 0.9   

PIK income capitalized/receivable

     2.6   
  

 

 

 

Accumulated PIK balance at December 31, 2011

   $ 3.5   

PIK income capitalized/receivable

     4.1   

PIK received in cash from prepayments

     (1.8
  

 

 

 

Accumulated PIK balance at December 31, 2012

   $ 5.8   
  

 

 

 

The increases in investment income from the respective periods were due to the growth in the overall investment portfolio, an increase in prepayment premiums and the closing of Greenway in January 2011.

In certain investment transactions, we may provide advisory services. For services that are separately identifiable and external evidence exists to substantiate fair value, income is recognized as earned. We had no income from advisory services for the years ended December 31, 2012, 2011 and 2010.

Expenses

Our primary operating expenses include the payment of base management fees, an incentive fee, and expenses reimbursable under the investment management agreement and the allocable portion of overhead under the administration agreement (“administrator expenses”). The base management fee compensates the Advisor for work in identifying, evaluating, negotiating, closing and monitoring our investments. Our investment

 

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management agreement and administration agreement provides that we will reimburse the Advisor for costs and expenses incurred by the Advisor for facilities, office equipment and utilities allocable to the performance by the Advisor of its duties under the agreements, as well as any costs and expenses incurred by the Advisor relating to any administrative or operating services provided by the Advisor to us. We bear all other costs and expenses of our operations and transactions.

Operating expenses totaled $22.3 million, $16.4 million and $6.3 million for the years ended December 31, 2012, 2011 and 2010, respectively, and consisted of base management fees, incentive fees, administrator expenses, and other expenses including fees related to our credit facility, professional fees, insurance expenses, directors’ fees, and other general and administrative expenses. The increase in operating expenses was due primarily to the increase in base management fees, incentive fee, credit facility and excise and income tax provision expenses for the respective periods.

The base management fees for the years ended December 31, 2012, 2011 and 2010 were $4.9 million, $4.0 million and $2.7 million, respectively, as provided for in the investment management agreement. The incentive fees incurred for the years ended December 31, 2012, 2011 and 2010 were $7.0 million, $4.8 million and $0 and such amounts include the effect of unrealized appreciation or depreciation of ($0.5) million, $0.8 million and $0, respectively. Approximately $0.4 million of the accrued incentive fee for the year ended December 31, 2011 was related to unrealized appreciation on investments in periods prior to 2011. Such amounts were not material to current or prior periods’ financial statements. There can be no assurance that such unrealized appreciation or depreciation will be realized in the future. Accordingly, such fee, as calculated and accrued is currently not, and would not necessarily be, payable under the investment management agreement, and may never be paid based upon the computation of capital gains incentive fees in subsequent periods. The accrued incentive fee related to capital gains may differ from the actual incentive fee that may be paid to the Advisor depending on whether we are ultimately able to generate a net realized capital gain. The increase in base management fees and incentive fee expenses for the respective periods is due to the growth in both the portfolio and net investment income.

For the years ended December 31, 2012, 2011 and 2010, fees and expenses related to our credit facility, including amortization of deferred financing costs, were $4.1 million, $1.7 million and $0, respectively. Borrowings under the credit facility were $189.9 million and $28.5 million, respectively, for the years ended December 31, 2012 and 2011. Repayments under the credit facility were $144.9 million and $23.5 million, respectively, for the years ended December 31, 2012 and 2011. As of December 31, 2012 and December 31, 2011, there were $50.0 million and $5.0 million of borrowings outstanding at a weighted average interest rate of 4.2110% and 3.8125%, respectively. The increase in expenses related to the credit facility is due principally to the timing of the facility closing in March 2011, the level of borrowings in connection with investment activity and amortization of deferred financing costs.

Administrator expenses for the years ended December 31, 2012, 2011 and 2010 totaled $3.2 million, $2.9 million and $1.7 million, respectively. Expenses for professional fees, insurance expenses, directors’ fees, and other general and administrative expense for the years ended December 31, 2012, 2011 and 2010 totaled $3.1 million, $3.0 million and $1.9 million, respectively. The increase in administrator expenses is due principally to additional resources and related costs to support our portfolio growth.

Income tax provision and excise tax for the years ended December 31, 2012, 2011 and 2010 totaled $0.6 million ($0.1 million excise tax and $0.5 million income tax provision), $0.0 million ($0.0 excise tax) and $0, respectively. The increase in excise taxes is due to the retention of taxable income being higher during the current year. The increase in current year income tax provision is due to our consolidated taxable subsidiary receiving tax distributions from an underlying portfolio company for the payment of the current year’s tax obligation.

We expect certain of our operating expenses, including administrator expenses, professional fees and other general and administrative expenses to decline as a percentage of our total assets during periods of growth and increase as a percentage of our total assets during periods of asset declines.

 

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Net Investment Income

Net investment income was $30.2 million, or $1.38 per common share based on a weighted average of 21,852,197 common shares outstanding for the year ended December 31, 2012, as compared to $21.0 million, or $1.04 per common share based on a weighted average of 20,167,092 common shares outstanding for the year ended December 31, 2011 and $6.0 million, or $0.31 per common share based on a weighted average of 19,762,756 common shares outstanding for the year ended December 31, 2010.

The increase in net investment income is primarily attributable to the growth in the portfolio and an increase in prepayment activity.

Net Realized Gains and Losses on Investments

We measure realized gains or losses by the difference between the net proceeds from the repayment or sale and the amortized cost basis of the investment, using the specific identification method, without regard to unrealized appreciation or depreciation previously recognized.

We recognized realized gains on our portfolio company investments during the year ended December 31, 2012, 2011 and 2010 of $0.4 million, $1.0 million and $0, respectively.

Net Change in Unrealized Appreciation of Investments

Net change in unrealized appreciation primarily reflects the change in portfolio investment values during the reporting period, including the reversal or previously recorded appreciation or depreciation when gains or losses are realized.

Net change in unrealized appreciation on investments totaled ($1.2) million, $2.1 million and $1.8 million for the years ended December 31, 2012, 2011 and 2010, respectively. The change in unrealized appreciation on our investments was driven primarily by the reversal of previously unrealized appreciation on investments, changes in the capital market conditions, and in the financial performance of certain portfolio companies.

The following shows the breakdown in the changes in unrealized appreciation of investments for the years ended December 31, 2012, 2011 and 2010 (in millions):

 

     Year ended December 31,  
     2012     2011     2010  

Gross unrealized appreciation on investments

   $ 4.5      $ 5.1      $ 1.8   

Gross unrealized depreciation on investments

     (2.8     (1.2     —    

Reversal of prior period net unrealized appreciation upon a realization

     (2.9     (1.8     —    
  

 

 

   

 

 

   

 

 

 

Total

   $ (1.2   $ 2.1      $ 1.8   
  

 

 

   

 

 

   

 

 

 

Provision for taxes on unrealized appreciation on investments

Certain consolidated subsidiaries of ours are subject to U.S. federal and state income taxes. These taxable entities are not consolidated with the Company for income tax purposes and may generate income tax liabilities or assets from temporary differences in the recognition of items for financial reporting and income tax purposes at the subsidiaries. For the years ended December 31, 2012, 2011 and 2010, the Company recognized a provision for tax on unrealized appreciation of $0.5 million, $0, and $0, respectively, for a consolidated subsidiary. The Company is not subject to income taxes, however, certain consolidated taxable subsidiaries may be subject to income taxes. The provision relates only to an individual subsidiary of the Company.

 

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Realized and Unrealized Gain (Loss) of Interest Rate Derivative

The interest rate derivative was entered into on May 10, 2012. Unrealized depreciation reflects the value of the interest rate derivative agreement during the reporting period. Unrealized depreciation on interest rate derivative totaled $1.1 million for the year ended December 31, 2012 and was due to capital markets changes impacting interest rate swap spreads.

We measure realized gains or losses on the interest rate derivative based upon the difference between the proceeds received or the amount paid on the interest rate derivative. We recognized a realized loss for the year ended December 31, 2012 of $0.2 million as interest rate derivative periodic interest payments, net.

Net Increase in Net Assets Resulting from Operations

Net increase in net assets resulting from operations totaled $27.6 million, or $1.26 per common share based on a weighted average of 21,852,197 common shares for the year ended December 31, 2012, as compared to $24.1 million, or $1.20 per common share based on a weighted average of 20,167,092 common shares outstanding, for the year ended December 31, 2011 and $7.8 million, or $0.39 per common share based on a weighted average of 19,762,756 common shares outstanding, for the year ended December 31, 2010.

The increase in net assets resulting from operations is due to the continued growth in net investment income, which is a result of growing our portfolio, and an increase in prepayment premiums.

Financial condition, liquidity and capital resources

Cash Flows from Operating and Financing Activities

Our liquidity and capital resources are derived from our revolving credit agreement, or Revolving Facility, and senior secured term loan credit facility, or Term Loan Facility, and cash flows from operations, including investment sales and repayments, and income earned. Our primary use of funds from operations includes investments in portfolio companies, payment of dividends to the holders of our common stock and payments of fees and other operating expenses we incur. We have used, and expect to continue to use, our borrowings and the proceeds from the turnover in our portfolio and from public and private offerings of securities to finance our investment objectives, to the extent permitted by the 1940 Act. We may raise additional equity or debt capital through both registered offerings off a shelf registration statement and private offerings of securities, by securitizing a portion of our investments or borrowings.

On September 25, 2012, we received $81.7 million in proceeds, net of offering fees and underwriting discount, from our public equity offering of common stock and used $46.1 million to pay down outstanding loans on our Revolving Facility.

As of December 31, 2012, we had $50.0 million outstanding under our Term Loan Facility. There were no borrowings outstanding under the Revolving Facility as of December 31, 2012. The Term Loan Facility had a weighted average interest rate of 4.21%. We borrowed $139.9 million under our Revolving Facility and $50.0 million under our Term Loan Facility for the year ended December 31, 2012 and repaid $144.9 million funds on our Revolving Facility from proceeds received from the public equity offering, term loan, sales and repayments and investment income. As of December 31, 2011, we had no borrowings outstanding under our Revolving Facility as we had borrowed and repaid $11.0 million during the year ended December 31, 2011.

Our operating activities used cash of $95.4 million, $87.2 million $83.5 million for the years ended December 31, 2012, 2011 and 2010, respectively, primarily in connection with the purchase of portfolio investments. For the years ended December 31, 2012, our financing activities provided cash of $45.0 million from net borrowings and $81.7 million from our common stock offering, net of offering costs, and used cash of $29.4 million for distributions to stockholders and $2.9 million for the payment of financing costs. For the year

 

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ended December 31, 2011, our financing activities provided cash of $5.0 million from net borrowings and used cash of $19.5 million for distributions to stockholders and $2.5 million for the payment of financing costs. For the year ended December 31, 2010, our financing activities provided cash of $194.6 from our initial public offering and used cash of $1.4 million for distributions to stockholders.

As of December 31, 2012 and December 31, 2011, we had cash of $4.8 million and $5.6 million, respectively. We had no cash equivalents as of December 31, 2012 and December 31, 2011.

We believe cash balances, our Revolving Facility capacity and any proceeds generated from the sale or pay down of investments provides us with ample liquidity to acquit our pipeline for the coming quarters.

Credit Facility

On May 10, 2012, we entered into an amendment, or the Amendment, to our Revolving Facility, and entered into a Term Loan Facility, and together with the Revolving Facility, the Facilities, with ING Capital LLC.

The Amendment revised the Revolving Facility, dated March 11, 2011, to (among other things) increase the amount available for borrowing from $125.0 million to $140.0 million; permit the Term Loan Facility; extend the maturity date from May 2014 to May 2016 (with a one year term out period beginning in May 2015); and change the non-use fee from 1.00% annually if we use 50% or less of the Revolving Facility and 0.50% annually if we use more than 50% of the Revolving Facility to 1.00% annually if the we use 35% or less of the Revolving Facility and 0.50% annually if we use more than 35% of the Revolving Facility. The Amendment also changes the interest rate of the Revolving Facility from (a) Eurocurrency loans from LIBOR plus 3.50% to (i) when the facility is more than 35% drawn and the step-down condition is satisfied, LIBOR plus 3.00%, (ii) when the facility is more than 35% drawn and the step-down condition is not satisfied, LIBOR plus 3.25%, (iii) when the facility is less than or equal to 35% drawn and the step-down condition is satisfied, LIBOR plus 3.25%, and (iv) when the facility is less than or equal to 35% drawn and the step-down condition is not satisfied, LIBOR plus 3.50% and (b) alternative base rate loans based, or ABR, on the highest rate of the Prime Rate, Federal Funds Rate plus 0.5% or three month LIBOR plus 1.0% per annum to (i) when the facility is more than 35% drawn and the step-down condition is satisfied, ABR plus 2.00%, (ii) when the facility is more than 35% drawn and the step-down condition is not satisfied, ABR plus 2.25%, (iii) when the facility is less than or equal to 35% drawn and the step-down condition is satisfied, ABR plus 2.25%, and (iv) when the facility is less than or equal to 35% drawn and the step-down condition is not satisfied, ABR plus 2.50%.

The Term Loan Facility provides us with a $50.0 million senior secured term loan, or Term Loan. The Term Loan expires in May 2017, bears interest at LIBOR plus 4.00% (with no LIBOR Floor) and has substantially similar terms to our existing Revolving Facility (as amended by the Amendment).

Each of the Facilities includes an accordion feature permitting us to expand the Facilities, if certain conditions are satisfied; provided, however, that the aggregate amount of the Facilities, collectively, is capped at $225.0 million.

The Facilities generally require payment of interest on a quarterly basis for ABR loans, and at the end of the applicable interest period for Eurocurrency loans bearing interest at LIBOR. All outstanding principal is due upon each maturity date. The Facilities also require a mandatory prepayment of interest and principal upon certain customary triggering events (including, without limitation, the disposition of assets or the issuance of certain securities).

Borrowings under the Facilities are subject to, among other things, a minimum borrowing/collateral base. The Facilities have certain collateral requirements and/or financial covenants, including covenants related to: (a) limitations on the incurrence of additional indebtedness and liens, (b) limitations on certain investments, (c) limitations on certain restricted payments, (d) limitations on the creation or existence of agreements that

 

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prohibit liens on certain properties of ours and our subsidiaries, and (e) compliance with certain financial maintenance standards including (i) minimum stockholders’ equity, (ii) a ratio of total assets (less total liabilities not represented by senior securities) to the aggregate amount of senior securities representing indebtedness, of us and our subsidiaries, of not less than 2.25:1.0, (iii) minimum liquidity, (iv) minimum net worth, and (v) a consolidated interest coverage ratio. In addition to the financial maintenance standards, described in the preceding sentence, borrowings under the Facilities (and the incurrence of certain other permitted debt) are subject to compliance with a borrowing base that applies different advance rates to different types of assets in our portfolio.

The Facilities’ documents also include default provisions such as the failure to make timely payments under the Facilities, the occurrence of a change in control, and the failure by us to materially perform under the operative agreements governing the Facilities, which, if not complied with, could, at the option of the lenders under the Facilities, accelerate repayment under the Facilities, thereby materially and adversely affecting our liquidity, financial condition and results of operations. Each loan originated under the Revolving Facility is subject to the satisfaction of certain conditions. We cannot be assured that we will be able to borrow funds under the Revolving Facility at any particular time or at all. We are currently in compliance with all financial covenants under the Facilities.

For the year ended December 31, 2012, we borrowed $189.9 million and made $144.9 million of repayments under the Facilities. For the year ended December 31, 2011, we borrowed $28.5 million and made $23.5 million of repayments under the Facilities. As of December 31, 2012 and December 31, 2011, there were $50.0 million and $5.0 million of borrowings outstanding at a weighted average interest rate of 4.2110% and 3.8125%, respectively. Interest expense and related fees of $3.1 million and $1.0 million were incurred in connection with the Facilities during the years ended December 31, 2012 and 2011, respectively.

In accordance with the 1940 Act, with certain exceptions, the Company is only allowed to borrow amounts such that its asset coverage, as defined in the 1940 Act, is at least 200% after such borrowing. The asset coverage as of December 31, 2012 is in excess of 200%.

Interest Rate Derivative

On May 10, 2012, we entered into a five-year interest rate swap agreement, or swap agreement, with ING Capital Markets, LLC on its Term Loan Borrowing. Under the swap agreement, with a notional value of $50 million, we pay a fixed rate of 1.1425% and receive a floating rate based upon the current three-month LIBOR rate. We entered into the swap agreement to manage interest rate risk and not for speculative purposes.

We use an income approach using a discounted cash flow methodology to value the interest rate derivative. Significant inputs to the discounted cash flows methodology include the forward interest rate yield curves in effect as of the end of the measurement period and an evaluation of the counterparty’s credit risk.

We record the change in valuation of the swap agreement in unrealized appreciation (depreciation) as of each measurement period. When the quarterly swap amounts are paid or received under the swap agreement, the amounts are recorded as a realized gain (loss).

For the year ended December 31, 2012, we recognized $0.2 million of realized loss from the swap agreement, which is reflected as interest rate derivative periodic interest payments, net in the Consolidated Statements of Operations.

For the year ended December 31, 2012, we recognized $1.1 million of net unrealized depreciation from the swap agreement, which is listed under unrealized depreciation on interest rate derivative in the Consolidated Statements of Operations. As of December 31, 2012, our fair value of the swap agreement is $1.1 million, which is listed as an interest rate derivative liability on the Consolidated Statements of Assets and Liabilities.

 

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Other

On January 16, 2013, we withdrew our application with the Investment Division of the U.S. Small Business Administration, or SBA, to license a small business investment company, or SBIC. We may consider pursuing a new application for a license from the SBA in the future.

As of December 31, 2012, the THL Credit SBIC, LP, a wholly owned subsidiary of the Company, had three investments with an aggregate amortized cost basis of $28.9 million and fair market value of $28.1 million. As of December 31, 2011, the SBIC LP had made one investment with an aggregate amortized cost basis and fair market value of $12.8 million. On February 22, 2013, the investments held in the SBIC, LP were transferred to the Company.

Commitments and Contingencies

From time to time, we, or the Advisor, may become party to legal proceedings in the ordinary course of business, including proceedings related to the enforcement of our rights under contracts with our portfolio companies. Neither we, nor the Advisor, are currently subject to any material legal proceedings.

Unfunded commitments to provide funds to portfolio companies are not reflected on our balance sheet. Our unfunded commitments may be significant from time to time. These commitments will be subject to the same underwriting and ongoing portfolio maintenance as are the on-balance sheet financial instruments that we hold. Since these commitments may expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. We intend to use cash flow from normal and early principal repayments and proceeds from borrowings and offerings to fund these commitments.

As of December 31, 2012 and December 31, 2011, we have the following unfunded commitments to portfolio companies (in millions):

 

     As of  
     December 31, 2012      December 31, 2011  

Unfunded revolving commitments

   $ 10.9       $ 10.4   

Unfunded delayed draw and capital expenditure facilities

     12.0         7.9   

Unfunded commitments to investments in funds

     4.0         —    
  

 

 

    

 

 

 

Total unfunded commitments

   $ 26.9       $ 18.3   
  

 

 

    

 

 

 

Dividends

We have elected to be taxed as a regulated investment company under Subchapter M of the Code. In order to maintain our status as a regulated investment company, we are required to to distribute at least 90% of our investment company taxable income. To avoid a 4% excise tax on undistributed earnings, we are required to distribute each calendar year the sum of (i) 98% of our ordinary income for such calendar year (ii) 98.2% of our net capital gains for the one-year period ending October 31 of that calendar year (iii) any income recognized, but not distributed, in preceding years and on which we paid no federal income tax. We intend to make distributions to stockholders on a quarterly basis of substantially all of our net investment income. Although we intend to make distributions of net realized capital gains, if any, at least annually, out of assets legally available for such distributions, we may in the future decide to retain such capital gains for investment. In addition, the extent and timing of special dividends, if any, will be determined by our board of directors and will largely be driven by portfolio specific events and tax considerations at the time.

In addition, we may be limited in our ability to make distributions due to the BDC asset coverage test for borrowings applicable to us as a BDC under the 1940 Act.

 

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The following table summarizes our dividends declared and paid or to be paid on all shares:

 

Date Declared   Record Date   Payment Date   Amount Per Share

August 5, 2010

  September 2, 2010   September 30, 2010   $0.05

November 4, 2010

  November 30, 2010   December 28, 2010   $0.10

December 14, 2010

  December 31, 2010   January 28, 2011   $0.15

March 10, 2011

  March 25, 2011   March 31, 2011   $0.23

May 5, 2011

  June 15, 2011   June 30, 2011   $0.25

July 28, 2011

  September 15, 2011   September 30, 2011   $0.26

October 27, 2011

  December 15, 2011   December 30, 2011   $0.28

March 6, 2012

  March 20, 2012   March 30, 2012   $0.29

March 6, 2012

  March 20, 2012   March 30, 2012   $0.05

May 2, 2012

  June 15, 2012   June 29, 2012   $0.30

July 26, 2012

  September 14, 2012   September 28, 2012   $0.32

November 2, 2012

  December 14, 2012   December 28, 2012   $0.33

December 20, 2012

  December 31, 2012   January 28, 2013   $0.05

February 27, 2013

  March 15, 2013   March 29, 2013   $0.33

On December 20, 2012, our board of directors declared a special dividend of $0.05 per share, which was paid on January 28, 2013 to stockholders of record at the close of business on December 31, 2012.

On February 27, 2013, our board of directors declared a dividend of $0.33 per share, payable on March 29, 2013 to stockholders of record at the close of business on March 15, 2013.

We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of these distributions from time to time. If we do not distribute a certain percentage of our income annually, we will suffer adverse tax consequences, including possible loss of our status as a regulated investment company. We cannot assure stockholders that they will receive any distributions at a particular level.

We maintain an “opt in” dividend reinvestment plan for our common stockholders. As a result, unless stockholders specifically elect to have their dividends automatically reinvested in additional shares of common stock, stockholders will receive all such dividends in cash. With respect to our dividends and distributions paid to stockholders during the year ended December 31, 2012 and 2011, dividends reinvested pursuant to our dividend reinvestment plan totaled $0 and $4.0 million, respectively.

Under the terms of our dividend reinvestment plan, dividends will primarily be paid in newly issued shares of common stock. However, we reserve the right to purchase shares in the open market in connection with the implementation of the plan. This feature of the plan means that, under certain circumstances, we may issue shares of our common stock at a price below net asset value per share, which could cause our stockholders to experience dilution.

Distributions in excess of our current and accumulated profits and earnings would be treated first as a return of capital to the extent of the stockholder’s tax basis, and any remaining distributions would be treated as a capital gain. The determination of the tax attributes of our distributions will be made annually as of the end of our fiscal year based upon our taxable income for the full year and distributions paid for the full year. Therefore, a determination made on a quarterly basis may not be representative of the actual tax attributes of our distributions for a full year. Each year, a statement on Form 1099-DIV identifying the source of the distribution will be sent to our U.S. stockholders.

The tax character of distributions declared and paid in 2012 represented $28.5 million from ordinary income, $0.9 million from capital gains and $0 from tax return of capital. Generally accepted accounting principles require adjustments to certain components of net assets to reflect permanent differences between

 

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financial and tax reporting. These adjustments have no affect on net asset value per share. Permanent differences between financial and tax reporting at December 31, 2012 and 2011 were $0.2 million and $0.1 million, respectively.

Contractual obligations

We have entered into a contract with the Advisor to provide investment advisory services. Payments for investment advisory services under the investment management agreement in future periods will be equal to (a) an annual base management fee of 1.5% of our gross assets and (b) an incentive fee based on our performance. In addition, under our administration agreement, the Advisor will be reimbursed for administrative services incurred on our behalf. See description below under Related Party Transactions.

The following table shows our contractual obligations as of December 31, 2012 (in millions):

 

     Payments due by period  

Contractual Obligations(1)

   Total      Less than
1 year
     1 – 3 years      3 – 5 years      After 5
years
 

Term Loan Facility

   $ 50.0         —          —        $ 50.0         —    

 

(1) 

Excludes commitments to extend credit to our portfolio companies.

We entered into an interest rate derivative to manage interest rate risk. We record the change in valuation of the swap agreement in unrealized appreciation (depreciation) as of each measurement period. When the quarterly interest rate swap amounts are paid or received under the swap agreement, the amounts are recorded as a realized gain (loss). Further discussion of the interest rate derivative is included in Note 1 “Significant Accounting Policies” and Note 7 “Interest Rate Derivative” in the “Notes to Consolidated Financial Statements”.

Off-Balance sheet arrangements

We currently have no off-balance sheet arrangements, including any risk management of commodity pricing or other hedging practices.

Related Party Transactions

Investment Management and Administration Agreements

On February 27, 2013, our investment management agreement with the Advisor was re-approved by our Board of Directors. Under the investment management agreement, the Advisor, subject to the overall supervision of our board of directors, manages the day-to-day operations of, and provides investment advisory services to us.

The Advisor receives a fee for investment advisory and management services consisting of a base management fee and a two-part incentive fee.

The base management fee is calculated at an annual rate of 1.5% of our gross assets payable quarterly in arrears on a calendar quarter basis. For purposes of calculating the base management fee, “gross assets” is determined as the value of our assets without deduction for any liabilities. The base management fee is calculated based on the value of our gross assets at the end of the most recently completed calendar quarter, and appropriately adjusted for any share issuances or repurchases during the current calendar quarter.

For the years ended December 31, 2012, 2011 and 2010 we incurred base management fees payable to the Advisor of $4.9 million, $4.0 million and $2.7 million, respectively. As of December 31, 2012 and December 31, 2011, $1.5 million and $1.0 million, respectively, was payable to the Advisor.

 

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The incentive fee has two components, ordinary income and capital gains, as follows:

The ordinary income component is calculated, and payable, quarterly in arrears based on our preincentive fee net investment income for the immediately preceding calendar quarter, subject to a cumulative total return requirement and to deferral of non-cash amounts. The preincentive fee net investment income, which is expressed as a rate of return on the value of our net assets attributable to our common stock, for the immediately preceding calendar quarter, will have a 2.0% (which is 8.0% annualized) hurdle rate (also referred to as “minimum income level”). Preincentive fee net investment income means interest income, dividend income and any other income (including any other fees, such as commitment, origination, structuring, diligence, managerial assistance and consulting fees or other fees that we receive from portfolio companies) accrued during the calendar quarter, minus our operating expenses for the quarter (including the base management fee, expenses payable under our administration agreement (discussed below), and any interest expense and any dividends paid on any issued and outstanding preferred stock, but excluding the incentive fee and any offering expenses and other expenses not charged to operations but excluding certain reversals to the extent such reversals have the effect of reducing previously accrued incentive fees based on the deferral of non-cash interest. Preincentive fee net investment income includes, in the case of investments with a deferred interest feature (such as original issue discount, debt instruments with PIK interest and zero coupon securities), accrued income that we have not yet received in cash. The Advisor receives no incentive fee for any calendar quarter in which our preincentive fee net investment income does not exceed the minimum income level. Subject to the cumulative total return requirement described below, the Advisor receives 100% of our preincentive fee net investment income for any calendar quarter with respect to that portion of the preincentive net investment income for such quarter, if any, that exceeds the minimum income level but is less than 2.5% (which is 10.0% annualized) of net assets (also referred to as the “catch-up” provision) and 20.0% of our preincentive fee net investment income for such calendar quarter, if any, greater than 2.5% (10.0% annualized) of net assets. The foregoing incentive fee is subject to a total return requirement, which provides that no incentive fee in respect of our preincentive fee net investment income is payable except to the extent 20.0% of the cumulative net increase in net assets resulting from operations over the then current and 11 preceding calendar quarters exceeds the cumulative incentive fees accrued and/or paid for the 11 preceding quarters. In other words, any ordinary income incentive fee that is payable in a calendar quarter is limited to the lesser of (i) 20% of the amount by which our preincentive fee net investment income for such calendar quarter exceeds the 2.0% hurdle, subject to the “catch-up” provision, and (ii) (x) 20% of the cumulative net increase in net assets resulting from operations for the then current and 11 preceding quarters minus (y) the cumulative incentive fees accrued and/or paid for the 11 preceding calendar quarters. For the foregoing purpose, the “cumulative net increase in net assets resulting from operations” is the amount, if positive, of the sum of our preincentive fee net investment income, base management fees, realized gains and losses and unrealized appreciation and depreciation for the then current and 11 preceding calendar quarters. In addition, the Advisor is not paid the portion of such incentive fee that is attributable to deferred interest until we actually receive such interest in cash.

For the years ended December 31, 2012, 2011 and 2010 we incurred $7.4 million, $3.8 million and $0, respectively, of incentive fees related to ordinary income.

The second component of the incentive fee (capital gains incentive fee) is determined and payable in arrears as of the end of each calendar year (or upon termination of the investment management agreement, as of the termination date). This component is equal to 20.0% of our cumulative aggregate realized capital gains from inception through the end of that calendar year, computed net of the cumulative aggregate realized capital losses and cumulative aggregate unrealized capital depreciation through the end of such year. The aggregate amount of any previously paid capital gains incentive fees is subtracted from such capital gains incentive fee calculated. The capital gains incentive fee payable to our Advisor under the investment management agreement as of December 31, 2012 and December 31, 2011 was $0.0 million and $0.2 million, respectively.

As of December 31, 2012, $2.3 million of such incentive fees are currently payable to the Advisor, as $0.6 million of incentive fees incurred by us were generated from deferred interest (i.e. PIK and certain discount accretion) and are not payable until such amounts are received in cash.

 

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GAAP requires that the incentive fee accrual considers the cumulative aggregate unrealized capital appreciation or depreciation of investments or other financial instruments, such as an interest rate derivative, in the calculation, as an incentive fee would be payable if such unrealized capital appreciation or depreciation were realized, even though such unrealized capital appreciation or depreciation is not permitted to be considered in calculating the fee actually payable under the investment management agreement. For accounting purposes in accordance with GAAP only, in order to reflect the potential incentive fee that would be payable for a given period as if all unrealized gains or losses were realized, we have accrued incentive fees of ($0.4) million and $0.8 million as of December 31, 2012 and December 31, 2011, respectively, based upon unrealized appreciation or depreciation of investments and the interest rate derivative for that period (in accordance with the terms of the investment management agreement). There can be no assurance that such unrealized appreciation or depreciation will be realized in the future. Accordingly, such fee, as calculated and accrued would not necessarily be payable under the investment management agreement, and may never be paid based upon the computation of incentive fees in subsequent periods. Approximately $0.4 million of the accrued incentive fee for the year ended December 31, 2011 was related to unrealized appreciation on investments in periods prior to 2011. Such amounts were not material to current or to prior periods’ consolidated financial statements.

We have also entered into an administration agreement with the Advisor under which the Advisor will provide administrative services to us. Under the administration agreement, the Advisor performs, or oversees the performance of administrative services necessary for our operation, which include, among other things, being responsible for the financial records which we are required to maintain and preparing reports to our stockholders and reports filed with the SEC. In addition, the Advisor assists in determining and publishing our net asset value, oversees the preparation and filing of our tax returns and the printing and dissemination of reports to our stockholders, and generally oversees the payment of our expenses and the performance of administrative and professional services rendered to us by others. We will reimburse the Advisor for our allocable portion of the costs and expenses incurred by the Advisor for overhead in performance by the Advisor of its duties under the administration agreement and the investment management agreement, including facilities, office equipment and our allocable portion of cost of compensation and related expenses of our chief financial officer and chief compliance officer and their respective staffs, as well as any costs and expenses incurred by the Advisor relating to any administrative or operating services provided to us by the Advisor. Such costs are reflected as Administrator expenses in the accompanying Consolidated Statements of Operations. Under the administration agreement, the Advisor provides, on our behalf, managerial assistance to those portfolio companies to which the Company is required to provide such assistance. To the extent that our Advisor outsources any of its functions, the Company pays the fees associated with such functions on a direct basis without profit to the Advisor.

For the years ended December 31, 2012, 2011 and 2010 we incurred administrator expenses of $3.2 million, $2.9 million and $1.7 million, respectively. As of December 31, 2012 and December 31, 2011, $0.3 million and $0.3 million, respectively, was payable to the Advisor.

License Agreement

We and the Advisor have entered into a license agreement with THL Partners under which THL Partners has granted to us and the Advisor a non-exclusive, personal, revocable worldwide non-transferable license to use the trade name and service mark THL, which is a proprietary mark of THL Partners, for specified purposes in connection with our respective businesses. This license agreement is royalty-free, which means we are not charged a fee for our use of the trade name and service mark THL. The license agreement is terminable either in its entirety or with respect to us or the Advisor by THL Partners at any time in its sole discretion upon 60 days prior written notice, and is also terminable with respect to either us or the Advisor by THL Partners in the case of certain events of non-compliance. After the expiration of its first one year term, the entire license agreement is terminable by either us or the Advisor at our or its sole discretion upon 60 days prior written notice. Upon termination of the license agreement, we and the Advisor must cease to use the name and mark THL, including any use in our respective legal names, filings, listings and other uses that may require us to withdraw or replace our names and marks. Other than with respect to the limited rights contained in the license agreement, we and the

 

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Advisor have no right to use, or other rights in respect of, the THL name and mark. We are an entity operated independently from THL Partners, and third parties who deal with us have no recourse against THL Partners.

Due to and from Affiliates

The Advisor paid certain other general and administrative expenses on our behalf. As of December 31, 2011, $0.0 million of expenses were included in Due to affiliate on the Consolidated Statements of Assets and Liabilities. There were no amounts due to affiliate as of December 31, 2012.

As manager of Greenway, we act as the investment adviser to Greenway and are entitled to receive certain fees. As a result, Greenway is classified as an affiliate of us. As of December 31, 2012 and December 31, 2011, $0.4 million and $0.4 million of fees related to Greenway, respectively, were included in Due from affiliate on the Consolidated Statements of Assets and Liabilities.

Managed Funds

Greenway

On January 14, 2011, Greenway was formed as a Delaware limited liability company. Greenway is a portfolio company of THL Credit, Inc. Greenway is a closed-end investment fund which provides for no liquidity or redemption options and is not readily marketable. Greenway operates under a limited liability agreement dated January 19, 2011. Greenway will continue in existence until January 14, 2021, subject to earlier termination pursuant to certain terms of the Agreement. The term may also be extended for up to three additional one-year periods pursuant to certain terms of the Agreement. Greenway has a two year investment period.

Greenway has $150.0 million of capital committed by affiliates of a single institutional investor, and is managed by THL Credit, Inc. through the investment professionals that serve on our investment committee. Our capital commitment to Greenway is $0.02 million. As of December 31, 2012, all of the capital had been called by Greenway. As of December 31, 2011, $0.1 million had been called by Greenway. As of December 31, 2012 and December 31, 2011, the value of our interest in Greenway was $0.01 million and $0.01 million, respectively, and is reflected in the Consolidated Schedules of Investments.

As manager of Greenway, we act as the investment adviser to Greenway and are entitled to receive certain fees. As a result, Greenway is classified as an affiliate of the Company. For the years ended December 31, 2012, and 2011, we earned $2.6 million and $1.8 million in fees related to Greenway, respectively, which are included in other income from non-controlled, affiliated investment in the Consolidated Statements of Operations. As of December 31, 2012 and December 31, 2011, $0.4 and $0.4 million of fees related to Greenway, respectively, were included in Due from affiliate on the Consolidated Statements of Assets and Liabilities.

Greenway invests in securities similar to those of ours pursuant to investment and allocation guidelines which address, among other things, the size of the borrowers, the types of transactions and the concentration and investment ratio amongst Greenway and us. However, we have the discretion to invest in other securities.

THL Credit SBIC, LP

On January 16, 2013, we withdrew our application with the SBA to license a SBIC. We may consider pursuing a new application for a license from the SBA in the future.

As of December 31, 2012, the SBIC LP had three investments with an aggregate amortized cost basis of $28.9 million and fair market value of $28.1 million. As of December 31, 2011, the SBIC LP had made one investment with an aggregate amortized cost basis and fair market value of $12.8 million. On February 22, 2013, the investments held in SBIC, LP were transferred to the Company.

 

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Affiliated Stockholders

THL Credit Opportunities, L.P. and BDC Holdings own 6,974 and 4,047,720 shares, respectively, or 0.03% and 15.38%, respectively, of our common stock as of December 31, 2012, compared with 6,974 and 8,972,720 shares, respectively, or 0.03% and 44.38%, respectively, as of December 31, 2011.

Critical accounting policies

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Changes in the economic environment, financial markets and any other parameters used in determining such estimates could cause actual results to differ. In addition to the discussion below, the Company’s significant accounting policies are further described in the notes to the consolidated financial statements.

Valuation of Portfolio Investments

As a BDC, we generally invest in illiquid securities including debt and equity investments of middle-market companies. Investments for which market quotations are readily available are valued using market quotations, which are generally obtained from an independent pricing service or one or more broker-dealers or market makers. Debt and equity securities for which market quotations are not readily available are valued at fair value as determined in good faith by our board of directors. Because we expect that there will not be a readily available market value for many of the investments in our portfolio, it is expected that many of our portfolio investments’ values will be determined in good faith by our board of directors in accordance with a documented valuation policy that has been reviewed and approved by our board of directors in accordance with GAAP. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of our investments may differ significantly from the values that would have been used had a readily available market value existed for such investments, and the differences could be material.

With respect to investments for which market quotations are not readily available, our board of directors undertakes a multi-step valuation process each quarter, as described below:

 

   

our quarterly valuation process begins with each portfolio company or investment being initially valued by the investment professionals responsible for the portfolio investment;

 

   

preliminary valuation conclusions are then documented and discussed with senior management of the Advisor;

 

   

to the extent determined by the audit committee of our board of directors, independent valuation firms engaged by us conduct independent appraisals and review the Advisor’s preliminary valuations in light of their own independent assessment;

 

   

the audit committee of our board of directors reviews the preliminary valuations of the Advisor and independent valuation firms and, if necessary, responds and supplements the valuation recommendation of the independent valuation firm to reflect any comments; and

 

   

our board of directors discusses valuations and determines the fair value of each investment in our portfolio in good faith based on the input of the Advisor, the respective independent valuation firms and the audit committee.

The types of factors that we may take into account in fair value pricing our investments include, as relevant, the nature and realizable value of any collateral, the portfolio company’s ability to make payments and its earnings and discounted cash flows, the markets in which the portfolio company does business, comparison to publicly traded securities and other relevant factors. We utilize an income approach to value our debt investments

 

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and a combination of income and market approaches to value our equity investments. With respect to unquoted securities, the Advisor and our board of directors, in consultation with our independent third party valuation firm, values each investment considering, among other measures, discounted cash flow models, comparisons of financial ratios of peer companies that are public and other factors, which valuation is then approved by our board of directors. For debt investments, we determine the fair value primarily using an income, or yield, approach that analyzes the discounted cash flows of interest and principal for the debt security, as set forth in the associated loan agreements, as well as the financial position and credit risk of each portfolio investments. Our estimate of the expected repayment date is generally the legal maturity date of the instrument. The yield analysis considers changes in leverage levels, credit quality, portfolio company performance and other factors.

We value our interest rate derivative agreement using an income approach that analyzes the discounted cash flows associated with the interest rate derivative agreement. Significant inputs to the discounted cash flows methodology include the forward interest rate yield curves in effect as of the end of the measurement period and an evaluation of the counterparty’s credit risk.

We value our CLO residual interest investment in a collateralized loan obligation using an income approach that analyzes the projected discounted cash flows of our residual interest. Significant inputs to the discounted cash flows methodology include the risk associated with the underlying investments and the expected term of the collateralized loan obligation.

The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities (including a business). The income approach uses valuation techniques to convert future cash flows or earnings to a single present amount (discounted). The measurement is based on the value indicated by current market expectations about those future amounts. In following these approaches, the types of factors that we may take into account in fair value pricing our investments include, as relevant: available current market data, including relevant and applicable market trading and transaction comparables, applicable market yields and multiples, the current investment performance rating, security covenants, call protection provisions, information rights, the nature and realizable value of any collateral, the portfolio company’s ability to make payments, its earnings and discounted cash flows, the markets in which the portfolio company does business, comparisons of financial ratios of peer companies that are public, transaction comparables, our principal market as the reporting entity and enterprise values, among other factors.

In accordance with the authoritative guidance on fair value measurements and disclosures under GAAP, we disclose the fair value of our investments in a hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The guidance establishes three levels of the fair value hierarchy as follows:

Level 1 – Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

Level 2 – Quoted prices in markets that are not considered to be active or financial instruments for which significant inputs are observable, either directly or indirectly;

Level 3 – Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

The level of an asset or liability within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. However, the determination of what constitutes “observable” requires significant judgment by management.

We consider whether the volume and level of activity for the asset or liability have significantly decreased and identifies transactions that are not orderly in determining fair value. Accordingly, if we determine that either

 

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the volume and/or level of activity for an asset or liability has significantly decreased (from normal conditions for that asset or liability) or price quotations or observable inputs are not associated with orderly transactions, increased analysis and management judgment will be required to estimate fair value. Valuation techniques such as an income approach might be appropriate to supplement or replace a market approach in those circumstances.

We have adopted the authoritative guidance under GAAP for estimating the fair value of investments in investment companies that have calculated net asset value per share in accordance with the specialized accounting guidance for Investment Companies. Accordingly, in circumstances in which net asset value per share of an investment is determinative of fair value, we estimate the fair value of an investment in an investment company using the net asset value per share of the investment (or its equivalent) without further adjustment, if the net asset value per share of the investment is determined in accordance with the specialized accounting guidance for investment companies as of the reporting entity’s measurement date.

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-04”), which amends the existing fair value guidance within ASC 820-10. The amendments include: (1) application of the concepts of the highest and best use valuation premise only to measuring the fair value of nonfinancial assets (that is, it does not apply to financial assets or any liabilities), (2) an exception to fair value measurement principles for financial assets and financial liabilities (and derivatives) with offsetting positions in market risks or counterparty credit risk, which allows an entity to measure the fair value of the net risk position when several criteria are met, (3) extension of the prohibition of a blockage factor application to all fair value measurements, (4) a model for the fair value measurement of instruments classified within an entity’s stockholders’ equity which is consistent with the guidance of measuring the fair value for liabilities, (5) additional disclosures for fair value measurements categorized in Level 3 of the fair value hierarchy: (i) quantitative information about unobservable inputs used, (ii) a description of the valuation processes used by the entity and (iii) a qualitative discussion about the sensitivity of the measurements, (6) disclosure of the level in the fair value hierarchy of assets and liabilities not recorded at fair value but where fair value is disclosed and (7) disclosure of any transfers between Levels 1 and 2 of the fair value hierarchy, not just significant transfers. The provisions of ASU 2011-04 were adopted by us on January 1, 2012. The adoption of this standard has been reflected in our financial statement disclosures.

Revenue Recognition

We record interest income on an accrual basis to the extent that we expect to collect such amounts. For loans and debt investments with contractual PIK interest which represents contractual interest accrued and added to the loan balance that generally becomes due at maturity. We will cease accruing PIK interest if there is sufficient value to support the accrual or if we do not expect amounts to be collectible. We do not accrue as a receivable interest on loans and debt investments if we determine that it is probable that we will not be able to collect such interest. Loans are placed on non-accrual status when principal or interest payments are past due 30 days or more and/or when it is no longer probable that principal or interest will be collected. However, we may make exceptions to this policy if the loan has sufficient collateral value and is in the process of collection. As of December 31, 2012 and December 31, 2011, we did not have any loans on non-accrual status. Upfront loan origination fees, original issue discount and market discount or premium are capitalized, and we then amortize such amounts as interest income using the effective yield method. We record prepayment premiums on loans and debt investments as interest income. Interest income from our investment in TRA and CLO residual interest is recorded based upon an estimation of an effective yield to expected maturity using anticipated cash flows with any remaining amount recorded to the cost basis of the investment. We monitor the anticipated cash flows from our TRA and CLO residual interest and will adjust our effective yield periodically.

Net Realized Gains or Losses and Net Change in Unrealized Appreciation or Depreciation

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unrealized appreciation or depreciation previously recognized. We measure realized gains or losses on the interest rate derivative based upon the difference between the proceeds received or the amounts paid on the interest rate derivative. Net change in unrealized appreciation or depreciation reflects the change in portfolio investment values or value of the interest rate derivative during the reporting period, including any reversal of previously recorded unrealized appreciation or depreciation, when gains or losses are realized.

Federal Income Taxes, including excise tax

We operate so as to maintain our status as a RIC under Subchapter M of the Code and intend to continue to do so. Accordingly, we are not subject to federal income tax on the portion of our taxable income and gains distributed to stockholders. In order to qualify for favorable tax treatment as a RIC, we are required to distribute annually to our stockholders at least 90% of our investment company taxable income, as defined by the Code. To avoid a 4% federal excise tax, we must distribute each calendar year the sum of (i) 98% of our ordinary income for each such calendar year, and (ii) 98.2% of our net capital gains for the one-year period ending October 31 of that calendar year, and (iii) any income recognized, but not distributed, in preceding years and on which we paid no federal income tax. We may choose not to distribute all of our taxable income for the calendar year and pay a non-deductible 4% excise tax on this income. If we choose to do so, all other things being equal, this would increase expenses and reduce the amount available to be distributed to stockholders. To the extent that the Company determines that its estimated current year annual taxable income will be in excess of estimated current year dividend distributions from such taxable income, the Company accrues excise taxes on estimated excess taxable income as taxable income is earned using an annual effective excise tax rate. We will accrue excise tax on undistributed taxable income as required. Please refer to “Dividends” above for a summary of the distributions made in 2012. For the years ended December 31, 2012, 2011 and 2010, we incurred excise tax expense of $0.1 million, $0 and $0, respectively.

Certain consolidated subsidiaries are subject to U.S. federal and state income taxes. These taxable entities are not consolidated for income tax purposes and may generate income tax liabilities or assets from temporary differences in the recognition of items for financial reporting and income tax purposes at the subsidiaries. For the years ended December 31, 2012, 2011 and 2010, we recognized current income tax expense of $0.5 million, $0, and $0, respectively, and a provision for tax on unrealized appreciation of $0.5 million, $0, and $0, respectively, for consolidated subsidiaries in the Consolidated Statements of Operations. During 2012, a taxable subsidiary received distributions of $0.5 million from an underlying portfolio company for the payment of current year tax obligations, which is included as dividend income on the Consolidated Statement of Operations. As of December 31, 2012 and December 31, 2011, $0.5 million and $0 of income tax expense, respectively, were included in deferred tax liability on the Consolidated Statements of Assets and Liabilities relating to deferred tax on unrealized appreciation on investments. The Company is not subject to income taxes, however, certain consolidated taxable subsidiaries may be subject to income taxes. The provision relates only to an individual subsidiary of the Company.

The following table summarizes the activity related to the Company’s tax expense incurred for the year ended December 31, 2012 (in millions):

 

Tax expense on current earnings

   $ 0.5   

Increase in deferred tax liability on unrealized appreciation of investments

     0.4   
  

 

 

 

Total tax expense

   $ 0.9   
  

 

 

 

Because federal income tax regulations differ from GAAP, distributions in accordance with tax regulations may differ from net investment income and realized gains recognized for financial reporting purposes. Differences may be permanent or temporary. Permanent differences are reclassified among capital accounts in the consolidated financial statements to reflect their tax character. Temporary differences arise when certain items of income, expense, gain or loss are recognized at some time in the future. Differences in classification may also result from the treatment of short-term gains as ordinary income for tax purposes.

 

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Recent developments

On January 31, 2013, THL Credit Greenway Fund II LLC was formed as a Delaware limited liability company. We had a nominal commitment in THL Credit Greenway Fund II LLC as part of a closing of the fund on February 11, 2013 and subsequently invested $0.0 million on March 1, 2013.

On February 15, 2013, we closed on a $15.0 million investment in Embarcadero Technologies, Inc., or Embarcadero, and subsequently sold $3.0 million to Greenway II on March 1, 2013. Headquartered in San Francisco, CA, Embarcadero provides data management solutions to organizations.

On February 22, 2013, investments held in the SBIC, LP were transferred to the Company.

On February 27, 2013, our board of directors declared a dividend of $0.33 per share, payable on March 29, 2013 to stockholders of record at the close of business on March 15, 2013. The dividend will be paid out of net investment income earned in the period from January 1, 2013 through March 31, 2013.

On February 27, 2013, our investment management agreement was re-approved by our board of directors.

On March 1, 2013, we sold $15.7 million of our investment in Gold, Inc. to Greenway II and outside co-investors.

On March 4, 2013, we closed on a $20.4 million investment in Tri-Starr Management Services, Inc., or Tri-Starr. Headquartered in Portsmouth, NH, Tri-Starr is a distribution, technology and integrated third-party logistics provider.

 

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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

We are subject to financial market risks, including changes in interest rates. As of December 31, 2012, 51.5%, or seventeen, of the debt investments in our portfolio bore interest at fixed rates. Sixteen of the debt investments in our portfolio have interest rate floors, which have effectively converted the debt investments to fixed rate loans in the current interest rate environment. In the future, we expect other debt investments in our portfolio will have floating rates. Our borrowings as well as the amount we receive under the interest rate derivative agreement are based upon floating rates. Assuming that the Consolidated Statement of Assets and Liabilities as of December 31, 2012 were to remain constant and no actions were taken to alter the existing interest rate sensitivity, a hypothetical one percent increase in LIBOR would increase our net investment income by $0.1 million. A hypothetical decrease in LIBOR would not affect our net income, again, due to the aforementioned floors in place. Although we believe that this measure is indicative of our sensitivity to interest rate changes, it does not adjust for potential changes in credit quality, size and composition of the assets on the balance sheet and other business developments that could affect net increase in net assets resulting from operations, or net income. Accordingly, no assurances can be given that actual results would not differ materially from the potential outcome simulated by this estimate. We currently hedge against interest rate fluctuations by using an interest rate swap whereby we pay a fixed rate of 1.1425% and receive three-month LIBOR. In the future, we may use other standard hedging instruments such as futures, options and forward contacts subject to the requirements of the 1940 Act. While hedging activities may insulate us against adverse changes in interest rates, they may also limit our ability to participate in the benefits of lower interest rates with respect to our portfolio of investments.

 

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Item 8. Financial Statements and Supplementary Data

Index to Financial Statements

 

Report of Independent Registered Public Accounting Firm

     88   

Consolidated Statements of Assets & Liabilities as of December 31, 2012 and 2011

     89   

Consolidated Statements of Operations for the years ended December 31, 2012, 2011 and 2010

     90   

Consolidated Statements of Changes in Net Assets (Deficit) for the years ended December  31, 2012, 2011 and 2010

     91   

Consolidated Statements of Cash Flows for the years ended December 31, 2012, 2011 and 2010

     92   

Consolidated Schedule of Investments as of December 31, 2012 and December 31, 2011

     93   

Notes to Consolidated Financial Statements

     103   

 

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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of

THL Credit, Inc.:

In our opinion, the accompanying consolidated statements of assets and liabilities, including the consolidated schedule of investments, and the related consolidated statements of operations, of changes in net assets (deficit), and of cash flows present fairly, in all material respects, the financial position of THL Credit, Inc. and its subsidiaries (the “Company”) at December 31, 2012 and 2011, and the results of their operations, of their changes in net assets (deficit), and of their cash flows for each of the three years in the period ended December 31, 2012 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A(b) of the annual report to stockholders. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our audits (which were integrated audits in 2012 and 2011). We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. Our procedures included confirmation of securities at December 31, 2012 by correspondence with the issuers or custodian, and where replies were not received, we performed other auditing procedures. We believe that our audits provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PricewaterhouseCoopers LLP

Boston, Massachusetts

March 4, 2013

 

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Table of Contents

THL Credit, Inc. and Subsidiaries

Consolidated Statements of Assets and Liabilities

 

     December 31,
2012
    December 31,
2011
 

Assets:

    

Investments at fair value:

    

Non-controlled, non-affiliated investments (cost of $391,698,777 and $263,100,758, respectively)

   $ 394,339,072      $ 266,981,836   

Non-controlled, affiliated investments (cost of $10,062 and $10,864, respectively)

     10,062        11,496   
  

 

 

   

 

 

 

Total investments at fair value (cost of $391,708,839 and $263,111,622, respectively)

     394,349,134        266,993,332   

Cash

     4,818,614        5,572,753   

Deferred financing costs

     3,817,044        1,860,484   

Interest receivable

     2,594,082        1,440,057   

Due from affiliate

     420,301        511,842   

Deferred offering costs

     —         327,267   

Receivable for paydown of investment

     125,000        258,621   

Prepaid expenses and other assets

     134,319        185,075   
  

 

 

   

 

 

 

Total assets

   $ 406,258,494      $ 277,149,431   
  

 

 

   

 

 

 

Liabilities:

    

Loans payable

   $ 50,000,000      $ 5,000,000   

Accrued incentive fees

     3,277,937        2,689,030   

Base management fees payable

     1,514,422        1,013,048   

Dividends payable

     1,315,760        —    

Interest rate derivative

     1,053,221        —    

Accrued expenses

     739,149        466,030   

Accrued credit facility fees and interest

     115,013        5,451   

Deferred tax liability

     453,558        —    

Accrued administrator expenses

     304,491        338,569   

Due to affiliate

     —         20,597   
  

 

 

   

 

 

 

Total liabilities

     58,773,551        9,532,725   

Net Assets:

    

Preferred stock, par value $.001 per share, 100,000,000 preferred shares authorized, no preferred shares issued and outstanding

     —         —    

Common stock, par value $.001 per share, 100,000,000 common shares authorized, 26,315,202 and 20,220,200 shares issued and outstanding at December 31, 2012 and December 31, 2011, respectively

     26,315        20,220   

Paid-in capital in excess of par

     343,722,878        262,289,351   

Net unrealized appreciation on investments, net of provision for taxes

     2,186,737        3,881,710   

Net unrealized depreciation on interest rate derivative

     (1,053,221     —    

Interest rate derivative periodic interest payments, net

     (179,581     —    

Accumulated net realized gain

     348,548        917,830   

Accumulated undistributed net investment income

     2,433,267        507,595   
  

 

 

   

 

 

 

Total net assets

     347,484,943        267,616,706   
  

 

 

   

 

 

 

Total liabilities and net assets

   $ 406,258,494      $ 277,149,431   
  

 

 

   

 

 

 

Net asset value per share

   $ 13.20      $ 13.24   
  

 

 

   

 

 

 

See accompanying notes to these consolidated financial statements.

 

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Table of Contents

THL Credit, Inc. and Subsidiaries

Consolidated Statements of Operations

 

     For the years ended December 31,  
     2012     2011      2010  

Investment Income:

       

From non-controlled, non-affiliated investments:

       

Interest income

   $ 49,807,892      $ 34,903,428       $ 12,260,072   

Dividend income

     456,432        279,676         —    

Other income

     269,317        415,529         65,360   

From non-controlled, affiliated investments:

       

Other income

     2,591,638        1,809,994         —    
  

 

 

   

 

 

    

 

 

 

Total investment income

     53,125,279        37,408,627         12,325,432   

Expenses:

       

Incentive fees

     7,017,252        4,790,457         —    

Base management fees

     4,943,025        4,011,897         2,696,647   

Administrator expenses

     3,224,597        2,871,778         1,715,694   

Professional fees

     1,200,161        1,092,364         649,249   

Credit facility interest and fees

     3,138,276        1,043,070         —    

Amortization of deferred financing costs

     967,607        687,069         —    

Other general and administrative expenses

     906,089        793,548         291,132   

Directors’ fees

     517,000        535,000         389,625   

Insurance expenses

     438,500        526,927         532,244   

Organizational expenses

     —         —          20,000   
  

 

 

   

 

 

    

 

 

 

Total expenses

     22,352,507        16,352,110         6,294,591   

Excise and income tax provision

     581,502        22,000         —     
  

 

 

   

 

 

    

 

 

 

Net investment income

     30,191,270        21,034,517         6,030,841   

Interest rate derivative periodic interest payments, net

     (179,581     —          —    

Realized and Unrealized Gain on Investments:

       

Net realized gain on non-controlled, non-affiliated investments

     353,199        979,643         —    

Net change in unrealized appreciation on:

       

Non-controlled, non-affiliated investments

     (1,240,783     2,120,689         1,760,389   

Non-controlled, affiliated investments

     (632     632         —    
  

 

 

   

 

 

    

 

 

 

Net change in unrealized appreciation on investments

     (1,241,415     2,121,321         1,760,389   
  

 

 

   

 

 

    

 

 

 

Net realized and unrealized (loss) gain from investments

     (888,216     3,100,964         1,760,389   

Provision for taxes on unrealized appreciation on investments

     (453,558     —          —    

Unrealized depreciation on interest rate derivative

     (1,053,221     —          —    
  

 

 

   

 

 

    

 

 

 

Net increase in net assets resulting from operations

   $ 27,616,694      $ 24,135,481       $ 7,791,230   
  

 

 

   

 

 

    

 

 

 

Net investment income per common share:

       

Basic and diluted

   $ 1.38      $ 1.04       $ 0.31   

Net increase in net assets resulting from operations per common share:

       

Basic and diluted

   $ 1.26      $ 1.20       $ 0.39   

Weighted average shares of common stock outstanding:

       

Basic and diluted

     21,852,197        20,167,092         19,762,756   

See accompanying notes to these consolidated financial statements.

 

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THL Credit, Inc. and Subsidiaries

Consolidated Statements of Changes in Net Assets (Deficit)

 

     For the years ended December 31,  
     2012     2011     2010  

Increase in net assets from operations:

      

Net investment income

   $ 30,191,270      $ 21,034,517      $ 6,030,841   

Interest rate derivative periodic interest payments, net

     (179,581     —          —     

Net change in realized gain on investments

     353,199        979,643        —     

Net change in unrealized appreciation on investments

     (1,241,415     2,121,321        1,760,389   

Provision for taxes on unrealized appreciation on investments

     (453,558     —          —     

Unrealized depreciation on interest rate derivative

     (1,053,221     —          —     
  

 

 

   

 

 

   

 

 

 

Net increase in net assets resulting from operations

     27,616,694        24,135,481        7,791,230   

Distributions to stockholders

     (29,411,169     (20,583,153     (5,960,636

Capital share transactions:

      

Issuance of common stock

     85,878,550        —          265,488,445   

Less offering costs

     (4,215,864     —          (8,804,862

Reinvestment of dividends

     26        4,048,609        1,572,685   
  

 

 

   

 

 

   

 

 

 

Net increase in net assets from capital share transactions

     81,662,712        4,048,609        258,256,268   
  

 

 

   

 

 

   

 

 

 

Total increase in net assets

     79,868,237        7,600,937        260,086,862   

Net assets (deficit) at beginning of year

     267,616,706        260,015,769        (71,093
  

 

 

   

 

 

   

 

 

 

Net assets at end of year

   $ 347,484,943      $ 267,616,706      $ 260,015,769   
  

 

 

   

 

 

   

 

 

 

Common shares outstanding at end of year

     26,315,202        20,220,200        19,916,107   
  

 

 

   

 

 

   

 

 

 

Capital share activity:

      

Shares sold

     6,095,000        —          19,785,188   

Shares issued from reinvestment of dividends

     2        304,093        124,219   
  

 

 

   

 

 

   

 

 

 

Net increase in capital share activity

     6,095,002        304,093        19,909,407   
  

 

 

   

 

 

   

 

 

 

See accompanying notes to these consolidated financial statements.

 

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THL Credit, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

 

     For the years ended December 31,  
     2012     2011     2010  

Cash flows from operating activities:

      

Net increase in net assets resulting from operations

   $ 27,616,694      $ 24,135,481      $ 7,791,230   

Adjustments to reconcile net increase in net assets resulting from operations to net cash used for by operating activities:

      

Net change in unrealized appreciation on investments

     1,241,415        (2,121,321     (1,760,389

Unrealized depreciation on interest rate derivative

     1,053,221        —          —     

Purchases of investments

     (298,492,850     (141,818,805     (96,332,993

Proceeds from sale and paydown of investments

     177,671,038        34,892,177        7,975,341   

Increase in investments due to PIK

     (4,026,847     (2,550,001     (935,464

Amortization of deferred financing costs

     967,607        687,069        —     

Accretion of discounts on investments and other fees

     (3,614,937     (2,124,824     (368,225

Increase in interest receivable

     (1,154,025     (807,689     (632,368

Decrease (increase) in due from affiliate

     91,541        (511,842     —     

Decrease (increase) in prepaid expenses and other assets

     107,915        (98,158     (86,917

Increase (decrease) in accrued expenses

     215,960        239,856        (143,826

Increase in accrued credit facility fees and interest

     109,562        5,451        —     

Increase in deferred tax liability

     453,558        —          —     

Increase in base management fees payable

     501,374        33,732        979,316   

(Decrease) increase in accrued administrator expenses

     (34,078     172,319        166,250   

Increase in incentive fees payable

     588,907        2,689,030        —     

Increase in dividends payable

     1,315,760        —          —     

(Decrease) increase in due to affiliate

     (20,597     6,347        (157,110
  

 

 

   

 

 

   

 

 

 

Net cash used for (provided by) operating activities

     (95,408,782     (87,171,178     (83,505,155

Cash flows from financing activities:

      

Borrowings under credit facility

     189,900,000        28,500,000        —     

Repayments under credit facility

     (144,900,000     (23,500,000     —     

Issuance of shares of common stock

     85,878,550        —          203,380,996   

Offering costs paid

     (4,215,864     —          (8,804,862

(Increase) decrease in deferred financing costs

     327,267        (2,547,553     369,767   

Distributions paid to stockholders

     (29,411,143     (19,521,960     (1,400,535

Increase in deferred offering costs

     (2,924,167     (327,267     —     
  

 

 

   

 

 

   

 

 

 

Net cash provided by (used for) financing activities

     94,654,643        (17,396,780     193,545,366   
  

 

 

   

 

 

   

 

 

 

Net (decrease) increase in cash and cash equivalents

     (754,139     (104,567,958     110,040,211   

Cash and cash equivalents, beginning of year

     5,572,753        110,140,711        100,500   
  

 

 

   

 

 

   

 

 

 

Cash and cash equivalents, end of year

   $ 4,818,614      $ 5,572,753      $ 110,140,711   
  

 

 

   

 

 

   

 

 

 

Supplemental Disclosure of Cash Flow Information:

      

Cash interest paid

   $ 1,499,104      $ 20,716      $ —     

Cash paid for income taxes

   $ 456,502      $ —        $ —     

Non-cash financing activities:

On April 20, 2010, the Company issued 4,140,496 shares of common stock to THL Credit Partners BDC Holdings, L.P. for the purchase of investments valued at $62,107,449 from THL Credit Opportunities, L.P.

For the years ended December 31, 2012, 2011 and 2010, 2 shares, 304,093 shares and 124,219 shares, respectively, of common stock were issued in connection with dividend reinvestments of $26, $4,048,609 and $1,572,685, respectively.

See accompanying notes to these consolidated financial statements.

 

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Table of Contents

THL Credit, Inc. and Subsidiaries

Consolidated Schedule of Investments

December 31, 2012

 

Portfolio company/Type of
Investment(1)

  Industry   Yield(2)   Initial
Acquisition
Date
  Maturity/
Dissolution
Date
  Principal(3)
No. of Shares /
    No. of Units     
    Cost     Fair Value  

Non-controlled/non-affiliated investments—113.49% of net asset value

             

20-20 Technologies Inc.

             

Senior Secured Term Loan(4)

  Business
services
  13.2%(5) (LIBOR
+ 11.00%)
  9/12/12   9/12/17   $ 14,000,000      $ 13,665,832      $ 13,665,832   
           

 

 

   

 

 

 
              13,665,832        13,665,832   

AIM Media Texas Operating, LLC

             

Second Lien Loan

  Media   16.0%(6)   6/21/12   6/21/17   $ 9,975,000        9,742,841        9,775,500   

Member interest(7)(8)

      6/21/12   —       0.763636        763,636        763,636   
           

 

 

   

 

 

 
              10,506,477        10,539,136   

Airborne Tactical Advantage Company, LLC

             

Senior Secured Note

  Aerospace &
defense
  11.0%   9/7/11   3/7/16   $ 4,000,000        3,853,669        3,900,000   

Class A Warrants(9)

      9/7/11   —       511,812        112,599        120,000   

Senior Secured Delayed Draw Term Loans(10)

    11.0%   9/7/11   3/7/13     —          —         —    
           

 

 

   

 

 

 
              3,966,268        4,020,000   

C&K Market, Inc.

             

Senior Subordinated Note

  Retail
& grocery
  16.0% (14.0%
Cash and 2.0%
PIK)
  11/3/10   11/3/15   $ 13,581,793        13,176,297        13,479,930   

Warrant for Class B

      11/3/10   —       156,552        349,000        350,000   
           

 

 

   

 

 

 
              13,525,297        13,829,930   

Country Pure Foods, LLC

             

Subordinated Term Loan

  Food &
beverage
  15.0% (12.5%
Cash and 2.5%
PIK)
  8/13/10   2/13/16   $ 16,079,445        15,871,240        15,757,856   
           

 

 

   

 

 

 
              15,871,240        15,757,856   

CRS Reprocessing, LLC

             

Senior Secured Term Loan

  Manufacturing   10.3% (LIBOR
+ 9.3%)
  6/16/11   6/16/15   $ 8,437,945        8,326,829        8,374,660   
           

 

 

   

 

 

 
              8,326,829        8,374,660   

Cydcor LLC

             

Senior Secured Term Loan

  Business
services
  12.3% (LIBOR
+ 9.8%)
  9/18/12   9/17/16   $ 14,649,351        14,269,640        14,269,640   
           

 

 

   

 

 

 
              14,269,640        14,269,640   

Dr. Fresh, LLC

             

Subordinated Term Loan

  Consumer
products
  14.0%(6) (12.0%
Cash and 2.0%
PIK)
  5/15/12   11/15/17   $ 14,158,043        13,892,964        13,945,673   
           

 

 

   

 

 

 
              13,892,964        13,945,673   

 

(Continued on next page)

See accompanying notes to these consolidated financial statements.

 

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THL Credit, Inc. and Subsidiaries

Consolidated Schedule of Investments—(Continued)

December 31, 2012

 

Portfolio company/Type of
Investment(1)

  Industry   Yield(2)   Initial
Acquisition
Date
  Maturity/
Dissolution
Date
  Principal(2)
No. of  Shares /
No. of Units
    Cost     Fair Value  

Duff & Phelps Corporation

             

Tax Receivable Agreement Payment Rights(11)

  Financial
services
  16.4%(12)   6/1/12   12/31/29     —          12,261,736        12,261,736   
           

 

 

   

 

 

 
              12,261,736        12,261,736   

Express Courier International, Inc.

 

Business
services

           

Secured Subordinated Term Loan

    15.0% (PIK)(13)   1/17/12   7/17/16   $ 7,478,972        7,358,487        6,357,126   
           

 

 

   

 

 

 
              7,358,487        6,357,126   

Firebirds International, LLC

             

Senior Secured Term
Loan

  Restaurants   10.5% (LIBOR

+ 9.0%)

  5/17/11   5/17/16   $ 8,200,000        8,080,047        8,200,000   

Senior Secured Revolving Loan(14)(15)

    10.5% (LIBOR
+ 9.0%)
  5/17/11   5/17/16     —          (67,433     —     

Common stock(9)

      5/17/11   —       1,906        190,600        215,000   
           

 

 

   

 

 

 
              8,203,214        8,415,000   

Food Processing Holdings, LLC

             

Senior Subordinated Note(6)(16)

  Food &
beverage
  15.0% (12.0%
Cash and 3.0%
PIK)
  2/28/12   8/28/17   $ 13,847,436        13,726,839        13,397,394   

Class A Units(9)

      4/20/10   —       162.44        163,268        181,000   

Class B Units(9)

      4/20/10   —       406.09        408,161        150,000   
           

 

 

   

 

 

 
              14,298,268        13,728,394   

Gold, Inc.

             

Subordinated Term Loan

  Consumer
products
  15.0%(6 ) (13.0%
Cash and 2.0%
PIK)
  12/31/12   12/31/17   $ 36,800,000        36,064,283        36,064,283   
           

 

 

   

 

 

 
              36,064,283        36,064,283   

Gryphon Partners 3.5, L.P.

             

Partnership interest

  Financial
services
    11/20/12   12/21/18     —          1,195,014        1,895,014   
           

 

 

   

 

 

 
              1,195,014        1,895,014   

Harrison Gypsum, LLC

             

Senior Secured Term Loan

  Industrials   10.5%(6 ) (LIBOR
+ 8.5% and 0.5%
PIK)
  12/21/12   12/21/17   $ 25,380,000        25,001,091        25,001,091   
           

 

 

   

 

 

 
              25,001,091        25,001,091   

Hart InterCivic, Inc.

  Election
services
           

Senior Secured Term
Loan

    10.5% (LIBOR
+ 9.0%)
  7/1/11   7/1/16   $ 9,594,834        9,450,127        9,498,885   

Senior Secured Revolving Loan(10)(15)

    10.5% (LIBOR
+ 9.0%)
  7/1/11   7/1/16     —          (41,938     —     
           

 

 

   

 

 

 
              9,408,189        9,498,885   

HEALTHCAREfirst, Inc.

   

11.5%(5) (LIBOR
+ 10.0%)

         

Senior Secured Term Loan

  Business
services
    8/31/12   8/30/17   $ 9,875,000        9,593,834        9,593,834   
           

 

 

   

 

 

 
              9,593,834        9,593,834   

 

(Continued on next page)

See accompanying notes to these consolidated financial statements.

 

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Table of Contents

THL Credit, Inc. and Subsidiaries

Consolidated Schedule of Investments—(Continued)

December 31, 2012

 

Portfolio company/Type of
Investment(1)

  Industry   Yield(2)   Initial
Acquisition
Date
  Maturity/
Dissolution
Date
  Principal(2)
No. of  Shares /
    No. of Units    
    Cost     Fair Value  

IMDS Corporation

             

Subordinated Term Loan

  Healthcare,
device
manufacturing
  15.5%(6)) (12.5%
Cash and 3.0%
PIK)
  5/2/12   11/2/17   $ 13,266,098        12,967,476        12,403,802   
           

 

 

   

 

 

 
              12,967,476        12,403,802   

Jefferson Management Holdings, LLC

             

Member interest(7)(8)

  Healthcare,
dental services
  N/A   4/20/10   —       1,393        1,393,309        1,388,500   
           

 

 

   

 

 

 
              1,393,309        1,388,500   

LCP Capital Fund LLC

             

Member interest(8)(17)(18)

  Financial
services
  16.2%(19)   4/20/10   2/15/15   $ 8,354,033        8,354,033        8,354,033   
           

 

 

   

 

 

 
              8,354,033        8,354,033   

Loadmaster Derrick & Equipment, Inc.

             

Senior Secured Term
Loan

  Energy /
Utilities
  9.3% (LIBOR

+ 8.3%)

  9/28/12   9/28/17   $ 9,709,456        9,461,653        9,461,653   

Senior Secured Revolving Loan(10)

    9.3% (LIBOR

+ 8.3%)

  9/28/12   9/28/17   $ 290,485       290,485       290,485  

Senior Secured Delayed Draw Term Loans

    9.3% (LIBOR

+ 8.3%)

  9/28/12   9/28/17     —          —          —     
           

 

 

   

 

 

 
              9,752,138        9,752,138   

Marine Acquisition Corp. (Teleflex Marine)

             

Senior Subordinated Note

  Manufacturing   13.5%(6)   9/18/12   5/18/17   $ 16,500,000        16,145,801        16,170,000   
           

 

 

   

 

 

 
              16,145,801        16,170,000   

Martex Fiber Southern Corp.

             

Subordinated Term Loan

  Textiles   13.5%(6) (12.0%
Cash and 1.5%
PIK)
  4/30/12   10/31/19   $ 8,755,800        8,632,700        8,580,684   
           

 

 

   

 

 

 
              8,632,700        8,580,684   

Octagon Income Note XIV, Ltd.

             

Income Notes, Residual Interest(4)

  Financial
Services
  15.5%(20)   12/19/12   1/15/24   $ 10,000,000        9,400,000        9,400,000   
           

 

 

   

 

 

 
              9,400,000        9,400,000   

OEM Group, Inc.

             

Second Lien Term Loan

  Manufacturing   15.0%(6) (12.5%
Cash and 2.5%
PIK)
  10/7/10   10/7/15   $ 14,783,506        14,509,705        13,600,826   

Warrant for Common

              —          —     
           

 

 

   

 

 

 
              14,509,705        13,600,826   

Pinnacle Operating Corporation

             

Second Lien Term Loan

  Chemicals   11.5% (LIBOR
+ 10.3%)
  11/26/12   5/15/19   $ 10,000,000        9,507,630        9,507,630   
           

 

 

   

 

 

 
              9,507,630        9,507,630   

 

(Continued on next page)

See accompanying notes to these consolidated financial statements.

 

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THL Credit, Inc. and Subsidiaries

Consolidated Schedule of Investments—(Continued)

December 31, 2012

 

Portfolio company/Type of
Investment(1)

  Industry   Yield(2)   Initial
Acquisition
Date
  Maturity/
Dissolution
Date
  Principal(2)
No. of  Shares /
No. of Units
    Cost     Fair Value  

Sheplers, Inc.

             

Second Lien Term Loan(7)

  Retail &

grocery

  13.2% (LIBOR +
11.65%)
  12/20/11   12/20/16   $ 11,426,463        11,181,930        11,369,331   

Mezzanine Loan(7)

    17.0% (10.0%
Cash and 7.0%
PIK)
  12/20/11   12/20/17   $ 1,776,476        1,747,347        1,767,593   
           

 

 

   

 

 

 
              12,929,277        13,136,924   

Surgery Center Holdings, Inc.

             

Senior Subordinated Note

  Healthcare,
ambulatory
surgery centers
  15.0%   4/20/10   8/4/17   $ 18,772,751        18,404,850        18,960,478   

Member interest(8)(9)

            469,673        469,673        1,850,000   
           

 

 

   

 

 

 
              18,874,523        20,810,478   

The Studer Group, L.L.C.

             

Senior Subordinated Note

  Healthcare,
consulting
  14.0% (12.0%
Cash and 2.0%
PIK)
  9/29/11   3/29/17   $ 12,454,488        12,251,181        12,361,080   
           

 

 

   

 

 

 
              12,251,181        12,361,080   

Trinity Services Group, Inc.

             

Senior Subordinated Note

  Food &
beverage
  13.5%(6) (12.0%
Cash and 1.5%
PIK)
  3/29/12   9/29/17   $ 14,143,399        13,954,176        14,072,682   
           

 

 

   

 

 

 
              13,954,176        14,072,682   

Vision Solutions, Inc.

 

Business
services

           

Second Lien Term Loan

    9.5% (LIBOR

+ 8.0%)

  3/31/11   7/23/17   $ 11,625,000        11,547,123        11,625,000   
           

 

 

   

 

 

 
              11,547,123        11,625,000   

Washington Inventory Service

             

Second Lien Term Loan

  Business
services
  10.3% (LIBOR

+ 9.0%)

  12/27/12   6/20/19   $ 11,000,000        10,835,379        10,835,379   
           

 

 

   

 

 

 
              10,835,379        10,835,379   

YP Intermediate Holdings Corp.

             

Second Lien Term Loan

  Media,
advertising
  15.0% (12.0%
Cash and 3.0%
PIK)
  5/8/12   5/8/17   $ 3,321,826        3,235,570        3,321,826   

Warrant for Member interest(7)(8)

              93        1,800,000   
           

 

 

   

 

 

 
              3,235,663        5,121,826   
           

 

 

   

 

 

 

Non-controlled/non-affiliated investments—113.49% of net asset value

            $ 391,698,777      $ 394,339,072   

 

(Continued on next page)

See accompanying notes to these consolidated financial statements.

 

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Table of Contents

THL Credit, Inc. and Subsidiaries

Consolidated Schedule of Investments—(Continued)

December 31, 2012

 

Portfolio company/Type of

Investment(1)

  Industry   Yield(2)   Initial
Acquisition
Date
  Maturity/
Dissolution
Date
  Principal(2)
No. of  Shares /
    No. of Units    
    Cost     Fair Value  

Non-controlled/affiliated investment—0.00% of net asset value

             

THL Credit Greenway Fund LLC

             

Member interest(8)(18)

  Financial
services
    1/27/11   1/14/21            10,062        10,062   
           

 

 

   

 

 

 
              10,062        10,062   
           

 

 

   

 

 

 

Total investments—113.49% of net asset value

            $ 391,708,839      $ 394,349,134   
           

 

 

   

 

 

 

 

Derivative Instruments

                                 

Counterparty

  Instrument   Interest Rate   Expiration
Date
  # of
Contracts
  Notional     Cost     Fair Value  

ING Capital Markets, LLC

  Interest Rate Swap
– Pay

Fixed/Receive
Floating

  1.1425%/LIBOR   5/10/17   1   $ 50,000,000      $      $ (1,053,221
           

 

 

   

 

 

 

Total derivative instruments—(0.30)% of net asset value

            $      $ (1,053,221
           

 

 

   

 

 

 

 

(1) 

All debt investments are income-producing. Equity and member interests are non-income-producing unless otherwise noted.

(2) 

Variable interest rate investments bear interest in reference to LIBOR or ABR, which reset monthly or quarterly, subject to interest rate floors. Unless otherwise noted, for each debt investment we have provided the interest rate in effect as of December 31, 2012.

(3) 

Principal includes accumulated PIK, or paid-in-kind, interest and is net of repayments.

(4) 

Foreign company at the time of investment and, as a result, is not a qualifying asset under Section 55(a) of the Investment Company Act of 1940.

(5) 

Unitranche investment; yield reflected represents the effective yield earned on the investment.

(6) 

At the option of the issuer, interest can be paid in cash or cash and PIK

(7)

Interest held by a wholly owned subsidiary of THL Credit, Inc.

(8)

Member interests of limited liability companies are the equity equivalents of the stock of corporations.

(9)

Equity ownership may be held in shares or units of companies related to the portfolio company.

(10) 

Issuer pays 0.5% unfunded commitment fee on facility.

(11) 

Publicly-traded company with a market capitalization in excess of $250 million at the time of investment and, as a result, is not a qualifying asset under Section 55(a) of the Investment Company Act of 1940.

(12)

Income-producing security with no stated coupon; yield from initial investment through December 31, 2012 was approximately 16.4%.

(13) 

Issuer will pay 15% PIK until April 1, 2013, 13.0% cash interest thereafter.

(14) 

Issuer pays 0.25% unfunded commitment fee on revolving loan quarterly.

(15) 

The negative cost is the result of the capitalized discount being greater than the principal amount outstanding on the loan.

(16)

Interest held in companies related to the portfolio company.

 

(Continued on next page)

See accompanying notes to these consolidated financial statements.

 

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THL Credit, Inc. and Subsidiaries

Consolidated Schedule of Investments—(Continued)

December 31, 2012

 

(17) 

The Company’s investment in LCP Capital Fund LLC is in the form of membership interests and its contributed capital is maintained in a collateral account held by a custodian and acts as collateral for certain credit default swaps for the Series 2005-1 equity interest. See Note 2 in the Notes to the Consolidated Financial Statements.

(18) 

Non-registered investment company at the time of investment and, as a result, is not a qualifying asset under Section 55(a) of the Investment Company Act of 1940.

(19) 

Income producing security with no stated coupon; cash yield for the three months ended December 31, 2012 was approximately 16.2%.

(20)

Income producing security with no stated coupon; cash yield for the three months ended December 31, 2012 was approximately 15.5%.

See accompanying notes to these consolidated financial statements.

 

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Table of Contents

THL Credit, Inc. and Subsidiaries

Consolidated Schedule of Investments

December 31, 2011

 

Portfolio company/Type of
Investment(1)

  Industry   Yield(2)   Initial
Acquisition
Date
  Maturity/
Dissolution
Date
  Principal(3)
No. of Shares /
    No. of Units    
    Cost     Fair Value  

Non-controlled/non-affiliated investments – 99.77% of net asset value

             

Airborne Tactical Advantage Company, LLC

             

Senior Secured Note

  Aerospace &

defense

  11.0%   9/7/11   3/7/16   $ 4,000,000      $ 3,813,884      $ 3,813,884   

Class A Warrants(4)

    11.0%   9/7/11   —       511,812        112,599        112,599   

Senior Secured Delayed Draw Term Loans(5)

      9/7/11   3/7/13     —          —         —     
           

 

 

   

 

 

 
              3,926,483        3,926,483   

C&K Market, Inc.

             

Senior Subordinated Note
Warrant for Class B

  Retail &
grocery
  16.0% (14.0%
Cash and 2.0%
PIK)
  11/3/10   11/3/15   $ 13,309,104        12,800,455        12,909,831   
      11/3/10   —       156,552        349,000        87,250   
           

 

 

   

 

 

 
              13,149,455        12,997,081   

Charming Charlie, Inc.

             

Subordinated Term Loan

  Retail &
grocery
  14.0%   1/27/11   7/27/15   $ 11,333,333        11,190,332        11,333,333   
           

 

 

   

 

 

 
              11,190,332        11,333,333   

Chuy’s Opco, Inc.

             

Senior Secured Term Loan

  Restaurants   8.5% (LIBOR +
7.0%)
  5/24/11   5/24/16   $ 7,489,562        7,421,884        7,452,114   

Senior Secured Revolving Loan(5)

    8.5% (LIBOR +
7.0%)
  5/24/11   5/24/16   $ 499,500        491,374        499,500   

Senior Secured Term Loan(5)(6)

    8.5% (LIBOR +
7.0%)
  5/24/11   5/24/16     —         (10,835     —    
           

 

 

   

 

 

 
              7,902,423        7,951,614   

Country Pure Foods, Inc.

             

Subordinated Term Loan

  Food &

beverage

  15.0% (12.5%
Cash and 2.0%
PIK)
  8/13/10   2/13/16   $ 14,189,988        13,964,606        13,906,188   
           

 

 

   

 

 

 
              13,964,606        13,906,188   

CRS Reprocessing, LLC

             

Senior Secured Term Loan

  Manufacturing   10.0% (LIBOR +
9.0%)
  6/16/11   6/16/15   $ 11,533,333        11,328,752        11,328,752   
           

 

 

   

 

 

 
              11,328,752        11,328,752   

Firebirds International LLC

             

Senior Secured Term Loan

  Restaurants   10.5% (LIBOR +
9.0%)
  5/17/11   5/17/16   $ 8,200,000        8,052,049        8,118,000   

Senior Secured Revolving Loan(6)(7)

    10.5% (LIBOR +
9.0%)
  5/17/11   5/17/16     —          (87,466     —    

Common stock(4)

        —       1,906        190,600        190,600  
           

 

 

   

 

 

 
              8,155,183        8,308,600   

 

(Continued on next page)

See accompanying notes to these consolidated financial statements.

 

99


Table of Contents

THL Credit, Inc. and Subsidiaries

Consolidated Schedule of Investments—(Continued)

December 31, 2011

 

Portfolio company/Type of
Investment(1)

  Industry   Yield(2)   Initial
Acquisition
Date
  Maturity/
Dissolution
Date
  Principal(3)
No. of Shares /
     No. of Units    
    Cost     Fair Value  

Food Processing Holdings, LLC

             

Senior Subordinated Note

  Food &
beverage
  16.0%(8 )

(13.5% cash
and 2.5% PIK)

  4/20/10   8/10/15   $ 12,569,273        12,131,303        12,569,273   

Class A Units(4)

      4/20/10   —       162.44        163,268        190,000   

Class B Units(4)

      4/20/10   —       406.09        408,161        408,161   
           

 

 

   

 

 

 
              12,702,732        13,167,434   

Hart InterCivic, LLC

             

Senior Secured Term Loan

Senior Secured Revolving Loan(5)(6)

  Election
services
  10.5% (LIBOR +
9.0%)
  7/1/11   7/1/16   $ 10,500,000        10,306,298        10,306,298   
    10.5% (LIBOR +
9.0%)
  7/1/11   7/1/16     —          (53,957     —     
           

 

 

   

 

 

 
              10,252,341        10,306,298   

HEALTHCAREfirst, Inc.

             

Senior Subordinated Note

  Business
services
  16.5%(8)

(13.5% Cash and
3.0% PIK)

  6/4/10   12/4/15   $ 13,624,174        13,298,742        13,624,174   
           

 

 

   

 

 

 
              13,298,742        13,624,174   

Hickory Farms, Inc.

             

Senior Secured Term Loan

  Food &

beverage

  12.0% (LIBOR +
7.8%)
  6/2/11   9/28/12   $ 9,463,885        9,463,885        9,463,885   
           

 

 

   

 

 

 
              9,463,885        9,463,885   

JDC Healthcare Management, LLC

             

Senior Subordinated Note

  Healthcare,
dental services
  15.5%

(12.0% Cash and
3.5% PIK)

  4/20/10   6/16/14   $ 10,938,684        10,523,464        10,938,684   

Member interest(9)(10)

        —       1,393        1,393,309        1,393,309   
           

 

 

   

 

 

 
              11,916,773        12,331,993   

LCP Capital Fund, LLC

             

Member interest(9)(11)(12)(13)

  Financial
services
  19.1%   4/20/10   2/15/13   $ 12,000,000        12,000,000        12,000,000   
           

 

 

   

 

 

 
              12,000,000        12,000,000   

MedQuist Inc.

             

Senior Subordinated Note(14)

  Business

services

  13.0%(8)   9/30/10   10/14/16   $ 6,000,000        5,845,968        6,120,000   
           

 

 

   

 

 

 
              5,845,968        6,120,000   

 

(Continued on next page)

See accompanying notes to these consolidated financial statements.

 

100


Table of Contents

THL Credit, Inc. and Subsidiaries

Consolidated Schedule of Investments—(Continued)

December 31, 2011

 

Portfolio company/Type of
Investment(1)

  Industry   Yield(2)   Initial
Acquisition
Date
  Maturity/
Dissolution
Date
  Principal(3)
No. of Shares  /
    No. of Units    
    Cost     Fair Value  

OEM Group, Inc.

             

Second Lien Term Loan

  Manufacturing   15.0%(8 )
(12.5% Cash
and 2.5% PIK)
  10/7/10   10/7/15   $ 14,413,653        14,065,806        14,125,380   

Warrant for Common

        —       —         —          120,000   
           

 

 

   

 

 

 
              14,065,806        14,245,380   

Pomeroy IT Solutions, Inc.

             

Senior Subordinated Note

  Business
services
  15.0% (13.0%
Cash and 2.0%
PIK)
  2/11/11   2/11/16   $ 13,235,557        13,008,862        13,367,912   
           

 

 

   

 

 

 
              13,008,862        13,367,912   

Purple Communications, Inc.

             

Senior Secured Term Loan

  Communications   10.8% (LIBOR
+ 7.8%)
  12/3/10   12/3/14   $ 11,465,517        11,155,137        11,465,517   
           

 

 

   

 

 

 
              11,155,137        11,465,517   

Sheplers, Inc.

             

Second Lien Term Loan(10)

  Retail &
grocery
  13.2% (LIBOR
+ 11.7%)
  12/20/11   12/20/16   $ 11,426,463        11,142,051        11,142,051   

Mezzanine Loan(10)(9)

    17.0% (10.0%
Cash and 7.0%
PIK)
  12/20/11   12/20/17   $ 1,677,067        1,643,697        1,643,697   
           

 

 

   

 

 

 
              12,785,748        12,785,748   

Surgery Center Holdings, Inc.

             

Senior Subordinated Note

  Healthcare,

ambulatory
surgery centers

  15.0% (12.0%
Cash and 3.0%
PIK)
  4/20/10   8/4/17   $ 18,358,861        17,939,323        18,358,861   

Member interest(4)(9)

        —       469,673        469,673        1,025,000   
           

 

 

   

 

 

 
              18,408,996        19,383,861   

T&D Solutions, LLC

             

Senior Secured Term Loan(15)

  Energy /

Utilities

  13.0%   10/14/10   1/29/15   $ 14,978,952        14,837,337        14,978,952   
           

 

 

   

 

 

 
              14,837,337        14,978,952   

Texas Honing, Inc.

             

Senior Secured Term Loan

  Energy /

Utilities

  11.5% (LIBOR
+ 8.5% Cash
and 2.0% PIK)
  6/22/11   6/22/16   $ 12,061,333        11,840,577        12,061,333   

Senior Secured Revolving Loan(6)(7)

    11.0% (LIBOR
+ 10.0% Cash)
  6/22/11   6/22/16     —          (35,774     —     
           

 

 

   

 

 

 
              11,804,803        12,061,333   

The Studer Group, LLC

             

Senior Subordinated Notes

  Healthcare,
consulting
  14.0% (12.0%
Cash and 2.0%
PIK)
  9/29/11   3/29/17   $ 12,263,422        12,027,298        12,027,298   
           

 

 

   

 

 

 
              12,027,298        12,027,298   

 

(Continued on next page)

See accompanying notes to these consolidated financial statements.

 

101


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THL Credit, Inc. and Subsidiaries

Consolidated Schedule of Investments—(Continued)

December 31, 2011

 

Portfolio company/Type of
Investment(1)

  Industry     Yield(2)     Initial
Acquisition
Date
  Maturity/
Dissolution
Date
  Principal(3)
No. of Shares /
No. of Units
    Cost     Fair Value  

Vision Solutions, Inc.

             

Second Lien Term Loan

   
 
Business
services
  
  
   
 
 
9.5%11.5%
(LIBOR +
8.0%)
  
  
  
  3/31/11   7/23/17   $ 10,000,000        9,909,096        9,900,000   
           

 

 

   

 

 

 
              9,909,096        9,900,000   

Non-controlled/ non-affiliated investments – 99.77% of net asset value

            $ 263,100,758      $ 266,981,836   

Non-controlled/ affiliated investment – 0.00% of net asset value

             

THL Credit Greenway Fund LLC

             

Member interest (9)(13)

   
 
Financial
services
  
  
    1/27/11   1/14/21     —          10,864        11,496   
           

 

 

   

 

 

 
              10,864        11,496   
           

 

 

   

 

 

 

Total investments – 99.77% of net asset value

            $ 263,111,622      $ 266,993,332   
           

 

 

   

 

 

 

 

(1)

All debt investments are income-producing. Equity and member interests are non-income-producing unless otherwise noted.

(2) 

Variable interest rate investments bear interest in reference to LIBOR or ABR, which reset monthly or quarterly, subject to interest rate floors. Unless otherwise noted, for each debt investment we have provided the interest rate in effect as of December 31, 2012.

(3) 

Principal includes accumulated PIK, or paid-in-kind, interest and is net of repayments.

(4) 

Equity ownership may be held in shares or units of companies related to the portfolio company.

(5)

Issuer pays 0.5% unfunded commitment fee on facility.

(6) 

The negative cost is the result of the capitalized discount being greater than the principal amount outstanding on the loan.

(7) 

Issuer pays 0.25% unfunded commitment fee on revolving loan quarterly.

(8) 

At the option of the issuer, interest can be paid in cash or cash and PIK

(9) 

Member interests of limited liability companies are the equity equivalents of the stock of corporations.

(10) 

Interest held by a wholly owned subsidiary of THL Credit, Inc.

(11)

The Company’s investment in LCP Capital Fund LLC is in the form of membership interests and its contributed capital is maintained in a collateral account held by a custodian and acts as collateral for certain credit default swaps for the Series 2005-1 equity interest. See Note 2 in the Notes to the Consolidated Financial Statements.

(12) 

Income-producing security with no stated coupon; yield from initial investment through December 31, 2011 was approximately 19.1%.

(13) 

Non-registered investment company at the time of investment and, as a result, is not a qualifying asset under Section 55(a) of the Investment Company Act of 1940.

(14) 

Publicly-traded company with a market capitalization in excess of $250 million at the time of investment and, as a result, is not a qualifying asset under Section 55(a) of the Investment Company Act of 1940.

(15) 

Stated coupon adjusted to achieve a combined yield of 13.0% for Revolving Loan and Term Loan.

See accompanying notes to these consolidated financial statements.

 

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THL Credit, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012

1. Organization

THL Credit, Inc., or the Company, was organized as a Delaware corporation on May 26, 2009. The Company has elected to be regulated as a business development company, or BDC, under the Investment Company Act of 1940, or 1940 Act. The Company has elected to be treated for tax purposes as a regulated investment company, or RIC, under the Internal Revenue Code of 1986, or the Code, as amended. In 2009, the Company was treated for tax purposes as a corporation. The Company’s investment objective is to generate both current income and capital appreciation, primarily through privately negotiated investments in debt and equity securities of middle-market companies.

The Company was initially funded on July 23, 2009, issuing 6,700 shares of common stock at an aggregate purchase price of $100,500 to THL Credit Opportunities, L.P., an affiliate of THL Credit Advisors LLC, or the Advisor. While the Company incurred certain costs in connection with an anticipated initial public offering, which ultimately would have been borne by the Advisor had the offering not closed; the Company did not formally commence principal operations until the completion of the offering on April 21, 2010, as described below.

On April 20, 2010, in anticipation of completing an initial public offering and formally commencing principal operations, the Company entered into a purchase and sale agreement with THL Credit Opportunities, L.P. and THL Credit Partners BDC Holdings, L.P., or BDC Holdings, an affiliate of the Company, to effectuate the sale by THL Credit Opportunities, L.P. to the Company of certain securities valued at $62,107,449, as determined by the Company’s board of directors, and on the same day issued 4,140,496 shares of common stock to BDC Holdings valued at $15.00 per share, pursuant to such agreement, in exchange for the aforementioned securities. Subsequently, the Company filed an election to be regulated as a BDC.

On April 21, 2010, the Company completed its initial public offering, formally commencing principal operations, and sold 9,000,000 shares of its common stock through a group of underwriters at a price of $13.00 per share, less an underwriting discount and commissions totaling $0.8125 per share. Concurrently, the Company sold 6,307,692 shares of its common stock to BDC Holdings at $13.00 per share, the sale of which was not subject to an underwriting discount and commission. On April 27, 2010, the Company closed the sale of the aforementioned 15,307,692 shares and received $190,683,947 of net proceeds, which includes an underwriting discount and offering expenses.

On May 26, 2010, the underwriters exercised their over-allotment option under the underwriting agreement and elected to purchase an additional 337,000 shares of common stock at $13.00 per share resulting in additional net proceeds of $3,891,850, which includes an underwriting discount and offering expenses.

On September 25, 2012, the Company closed a public equity offering selling 6,095,000 shares of its common stock through a group of underwriters at a price of $14.09 per share, less an underwriting discount and offering expenses, and received $81,656,591 in proceeds.

The Company has established wholly owned subsidiaries, THL Credit AIM Media Holdings Inc., THL Credit Holdings, Inc. and THL Credit YP Holdings Inc, which are structured as Delaware entities, or tax blockers, to hold equity or equity-like investments in portfolio companies organized as limited liability companies, or LLCs (or other forms of pass-through entities). Tax blockers are not consolidated for income tax purposes and may incur income tax expense as a result of their ownership of portfolio companies.

The Company has a wholly owned subsidiary, THL Corporate Finance, Inc., which serves as the administrative agent on certain investment transactions.

THL Credit SBIC, LP, or SBIC LP, and its general partner, THL Credit SBIC GP, LLC, or SBIC GP, were organized in Delaware on August 25, 2011 as a limited partnership and limited liability company, respectively. On January 16, 2013, the Company withdrew its application with the Investment Division of

 

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the U.S. Small Business Administration, or SBA, to license a small business investment company, or SBIC. The Company may consider pursuing a new application for a license from the SBA in the future. Both the SBIC LP and SBIC GP remain consolidated wholly owned subsidiaries of the Company.

As of December 31, 2012, the SBIC LP had three investments with an aggregate amortized cost basis of $28,920,464 and fair market value of $28,074,734. As of December 31, 2011, the SBIC LP had made one investment with an aggregate amortized cost basis and fair market value of $12,785,748. On February 22, 2013, investments held in the SBIC, LP were transferred to the Company.

2. Significant Accounting Policies

Basis of Presentation

The consolidated financial statements include the accounts of the Company and its subsidiaries. All inter-company accounts and transactions have been eliminated in consolidation. In accordance with Article 6 of Regulation S-X under the Securities Act of 1933, as amended, and the Securities and Exchange Act of 1934, as amended, the Company generally will not consolidate its interest in any company other than in investment company subsidiaries and controlled operating companies substantially all of whose business consists of providing services to the Company.

The accompanying consolidated financial statements of the Company have been presented in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and pursuant to the requirements for reporting on Form 10-K and Regulation S-X. The financial results of our portfolio companies are not consolidated in the financial statements. The accounting records of the Company are maintained in U.S. dollars.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that may affect the reported amounts and disclosures in the financial statements. Changes in the economic environment, financial markets, credit worthiness of our portfolio companies and any other parameters used in determining these estimates could cause actual results to differ and these differences could be material.

Cash and Cash Equivalents

Cash and cash equivalents consist of demand deposits and highly liquid investments with original maturities of three months or less. The Company places its cash and cash equivalents with financial institutions and, at certain times, cash held in demand deposit accounts may exceed the Federal Deposit Insurance Corporation insured limit and is therefore subject to credit risk. There were no cash equivalents as of December 31, 2012 and December 31, 2011.

Deferred Financing Costs

Deferred financing costs consist of fees and expenses paid in connection with the closing of credit facilities and are capitalized at the time of payment. Deferred financing costs are amortized using the straight line method over the term of the credit facility.

Deferred Offering Costs

Deferred offering costs consist of fees and expenses incurred in connection with the offer and sale of the Company’s common stock, including legal, accounting, printing fees and other related expenses, as well as costs incurred in connection with the filing of a shelf registration statement.

 

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Interest Rate Derivative

The Company recognizes derivatives as either interest rate derivative assets or liabilities at fair value on its Consolidated Statements of Assets and Liabilities with valuation changes and interest rate payments recorded as net change in unrealized appreciation (depreciation) on interest rate derivative and interest rate derivative periodic interest payments, net, respectively, on the Consolidated Statements of Operations. See also the disclosure in Note 7, Interest Rate Derivative.

Valuation of Investments

Investments, for which market quotations are readily available, are valued using market quotations, which are generally obtained from an independent pricing service or one or more broker-dealers or market makers. Debt and equity securities, for which market quotations are not readily available, are valued at fair value as determined in good faith by the Company’s board of directors. Because we expect that there will not be a readily available market value for many of the investments in the Company’s portfolio, it is expected that many of the Company’s portfolio investments’ values will be determined in good faith by the Company’s board of directors in accordance with a documented valuation policy that has been reviewed and approved by our board of directors in accordance with GAAP. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of our investments may differ significantly from the values that would have been used had a readily available market value existed for such investments, and the differences could be material.

With respect to investments for which market quotations are not readily available, the Company’s board of directors undertakes a multi-step valuation process each quarter, as described below:

 

   

the Company’s quarterly valuation process begins with each portfolio company or investment being initially valued by the investment professionals responsible for the portfolio investment;

 

   

preliminary valuation conclusions are then documented and discussed with senior management of the Advisor;

 

   

to the extent determined by the audit committee of the Company’s board of directors, independent valuation firms engaged by the Company conduct independent appraisals and review the Advisor’s preliminary valuations in light of their own independent assessment;

 

   

the audit committee of our board of directors reviews the preliminary valuations of the Advisor and independent valuation firms and, if necessary, responds and supplements the valuation recommendation of the independent valuation firm to reflect any comments; and

 

   

our board of directors discusses valuations and determines the fair value of each investment in our portfolio in good faith based on the input of the Advisor, the respective independent valuation firms and the audit committee.

The types of factors that the Company may take into account in fair value pricing our investments include, as relevant, the nature and realizable value of any collateral, the portfolio company’s ability to make payments and its earnings and discounted cash flows, the markets in which the portfolio company does business, comparison to publicly traded securities and other relevant factors. The Company utilizes an income approach to value its debt investments and a combination of income and market approaches to value its equity investments. With respect to unquoted securities, the Advisor and the Company’s board of directors, in consultation with the Company’s independent third party valuation firm, values each investment considering, among other measures, discounted cash flow models, comparisons of financial ratios of peer companies that are public and other factors, which valuation is then approved by the board of directors. For debt investments, the Company determines the fair value primarily using an income, or yield, approach that analyzes the discounted cash flows of interest and principal for the debt security, as set forth in the associated loan agreements, as well as the financial position and credit risk of each portfolio investments. The Company’s estimate of the expected repayment date is generally the legal maturity date of the instrument. The yield analysis considers changes in leverage levels, credit quality, portfolio company performance and other factors.

 

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The Company values its interest rate derivative agreement using an income approach that analyzes the discounted cash flows associated with the interest rate derivative agreement. Significant inputs to the discounted cash flows methodology include the forward interest rate yield curves in effect as of the end of the measurement period and an evaluation of the counterparty’s credit risk.

The Company values its CLO residual interest investment in a collateralized loan obligation using an income approach that analyzes the discounted cash flows of our residual interest. Significant inputs to the discounted cash flows methodology include the risk associated with the underlying investments and the expected term of the collateralized loan obligation.

The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities (including a business). The income approach uses valuation techniques to convert future cash flows or earnings to a single present amount (discounted). The measurement is based on the value indicated by current market expectations about those future amounts. In following these approaches, the types of factors that the Company may take into account in fair value pricing the Company’s investments include, as relevant: available current market data, including relevant and applicable market trading and transaction comparables, applicable market yields and multiples, the current investment performance rating, security covenants, call protection provisions, information rights, the nature and realizable value of any collateral, the portfolio company’s ability to make payments, its earnings and discounted cash flows, the markets in which the portfolio company does business, comparisons of financial ratios of peer companies that are public, transaction comparables, our principal market as the reporting entity and enterprise values, among other factors.

In accordance with the authoritative guidance on fair value measurements and disclosures under GAAP, the Company discloses the fair value of its investments in a hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The guidance establishes three levels of the fair value hierarchy as follows:

Level 1—Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

Level 2—Quoted prices in markets that are not considered to be active or financial instruments for which significant inputs are observable, either directly or indirectly;

Level 3—Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

The level of an asset or liability within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. However, the determination of what constitutes “observable” requires significant judgment by management.

The Company considers whether the volume and level of activity for the asset or liability have significantly decreased and identifies transactions that are not orderly in determining fair value. Accordingly, if the Company determines that either the volume and/or level of activity for an asset or liability has significantly decreased (from normal conditions for that asset or liability) or price quotations or observable inputs are not associated with orderly transactions, increased analysis and management judgment will be required to estimate fair value. Valuation techniques such as an income approach might be appropriate to supplement or replace a market approach in those circumstances.

The Company has adopted the authoritative guidance under GAAP for estimating the fair value of investments in investment companies that have calculated net asset value per share in accordance with the specialized accounting guidance for Investment Companies. Accordingly, in circumstances in which net asset value per share of an investment is determinative of fair value, the Company estimates the fair value of an investment in an investment company using the net asset value per share of the investment (or its equivalent) without further adjustment, if the net asset value per share of the investment is determined in accordance with the specialized accounting guidance for investment companies as of the reporting entity’s measurement date.

 

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In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-04”), which amends the existing fair value guidance within ASC 820-10. The amendments include: (1) application of the concepts of the highest and best use valuation premise only to measuring the fair value of nonfinancial assets (that is, it does not apply to financial assets or any liabilities), (2) an exception to fair value measurement principles for financial assets and financial liabilities (and derivatives) with offsetting positions in market risks or counterparty credit risk, which allows an entity to measure the fair value of the net risk position when several criteria are met, (3) extension of the prohibition of a blockage factor application to all fair value measurements, (4) a model for the fair value measurement of instruments classified within an entity’s stockholders’ equity which is consistent with the guidance of measuring the fair value for liabilities, (5) additional disclosures for fair value measurements categorized in Level 3 of the fair value hierarchy: (i) quantitative information about unobservable inputs used, (ii) a description of the valuation processes used by the entity and (iii) a qualitative discussion about the sensitivity of the measurements, (6) disclosure of the level in the fair value hierarchy of assets and liabilities not recorded at fair value but where fair value is disclosed and (7) disclosure of any transfers between Levels 1 and 2 of the fair value hierarchy, not just significant transfers. The provisions of ASU 2011-04 were adopted by the Company on January 1, 2012. The adoption of this standard has been reflected in the Company’s financial statement disclosures.

Investment Risk

The value of investments will generally fluctuate with, among other things, changes in prevailing interest rates, federal tax rates, counterparty risk, general economic conditions, the condition of certain financial markets, developments or trends in any particular industry and the financial condition of the issuer. During periods of limited liquidity and higher price volatility, the Company’s ability to dispose of investments at a price and time that the Company deems advantageous may be impaired. The extent of this exposure is reflected in the carrying value of these financial assets and recorded in the Consolidated Statements of Assets and Liabilities.

Lower-quality debt securities involve greater risk of default or price changes due to changes in the credit quality of the issuer. The value of lower-quality debt securities often fluctuates in response to company, political, or economic developments and can decline significantly over short periods of time or during periods of general or regional economic difficulty. Lower-quality debt securities can be thinly traded or have restrictions on resale, making them difficult to sell at an acceptable price. The default rate for lower-quality debt securities is likely to be higher during economic recessions or periods of high interest rates.

 

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The following is a summary of the industry classification in which the Company invests as of December 31, 2012:

 

Industry:

   Cost      Fair Value      % of
Net Assets
 

Aerospace & defense

   $ 3,966,268       $ 4,020,000         1.16

Business services

     67,270,295         66,346,811         19.09

Chemicals

     9,507,630         9,507,630         2.74

Consumer products

     49,957,247         50,009,956         14.39

Election services

     9,408,189         9,498,885         2.73

Energy / Utilities

     9,752,138         9,752,138         2.81

Financial services

     31,220,845         31,920,845         9.19

Food & beverage

     44,123,684         43,558,932         12.54

Healthcare, ambulatory surgery centers

     18,874,523         20,810,478         5.99

Healthcare, consulting

     12,251,181         12,361,080         3.56

Healthcare, dental services

     1,393,309         1,388,500         0.40

Healthcare, device manufacturing

     12,967,476         12,403,802         3.57

Industrials

     25,001,091         25,001,091         7.19

Manufacturing

     38,982,335         38,145,486         10.98

Media

     10,506,477         10,539,136         3.03

Media, advertising

     3,235,663         5,121,826         1.47

Restaurants

     8,203,214         8,415,000         2.42

Retail & grocery

     26,454,574         26,966,854         7.76

Textiles

     8,632,700         8,580,684         2.47
  

 

 

    

 

 

    

 

 

 

Total investments

   $ 391,708,839       $ 394,349,134         113.49
  

 

 

    

 

 

    

 

 

 

The following is a summary of the geographical concentration of our investment portfolio as of December 31, 2012:

 

Region:

   Cost      Fair Value      % of
Net Assets
 

International

   $ 13,665,832       $ 13,665,832         3.93

Midwest

     62,866,981         63,033,274         18.14

Northeast

     38,658,531         38,606,515         11.11

Northwest

     13,525,297         13,829,930         3.98

Southeast

     101,401,548         104,146,354         29.98

Southwest

     73,786,247         72,432,240         20.84

West

     87,804,403         88,634,989         25.51
  

 

 

    

 

 

    

 

 

 

Total investments

   $ 391,708,839       $ 394,349,134         113.49
  

 

 

    

 

 

    

 

 

 

 

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The following is a summary of the industry classification in which the Company invests as of December 31, 2011:

 

Industry:

   Cost      Fair Value      % of
Net Assets
 

Aerospace & defense

   $ 3,926,483       $ 3,926,483         1.47

Business services

     42,062,668         43,012,086         16.08

Communications

     11,155,137         11,465,517         4.28

Election services

     10,252,341         10,306,298         3.85

Energy / Utilities

     26,642,140         27,040,285         10.10

Financial services

     12,010,864         12,011,496         4.49

Food & beverage

     36,131,223         36,537,507         13.65

Healthcare, ambulatory surgery centers

     18,408,996         19,383,861         7.24

Healthcare, consulting

     12,027,298         12,027,298         4.49

Healthcare, dental services

     11,916,773         12,331,993         4.61

Manufacturing

     25,394,558         25,574,132         9.56

Restaurants

     16,057,606         16,260,214         6.08

Retail & grocery

     37,125,535         37,116,162         13.87
  

 

 

    

 

 

    

 

 

 

Total investments

   $ 263,111,622       $ 266,993,332         99.77
  

 

 

    

 

 

    

 

 

 

The following is a summary of the geographical concentration of our investment portfolio as of December 31, 2011:

 

Region:

   Cost      Fair Value      % of
Net Assets
 

Midwest

   $ 73,850,595       $ 74,476,659         27.82

Northeast

     17,856,832         18,131,496         6.78

Northwest

     13,149,455         12,997,081         4.86

Southeast

     70,058,029         71,792,628         26.83

Southwest

     67,132,478         68,229,951         25.50

West

     21,064,233         21,365,517         7.98
  

 

 

    

 

 

    

 

 

 

Total investments

   $ 263,111,622       $ 266,993,332         99.77
  

 

 

    

 

 

    

 

 

 

The following is a summary of the levels within the fair value hierarchy in which the Company invests as of December 31, 2012:

 

Description:

   Fair Value     Level 1      Level 2     Level 3  

First lien secured debt

   $ 102,256,080      $ —        $ —       $ 102,256,080   

Second lien debt

     70,035,492        —           —          70,035,492   

Subordinated debt

     183,318,581        —           —          183,318,581   

Investments in funds

     10,259,109        —           —          10,259,109   

Equity investments

     6,818,136        —           —          6,818,136   

Investment in payment rights

     12,261,736        —           —          12,261,736   

CLO residual interest

     9,400,000             9,400,000   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total investments

   $ 394,349,134      $ —        $ —       $ 394,349,134   
  

 

 

   

 

 

    

 

 

   

 

 

 

Interest rate derivative

     (1,053,221     —           (1,053,221     —     
  

 

 

   

 

 

    

 

 

   

 

 

 

Total liability at fair value

   $ (1,053,221   $ —        $ (1,053,221   $ —    
  

 

 

   

 

 

    

 

 

   

 

 

 

 

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The following is a summary of the levels within the fair value hierarchy in which the Company invests as of December 31, 2011:

 

Description:

   Fair Value      Level 1      Level 2      Level 3  

First lien secured debt

   $ 89,488,235       $ —          —         $ 89,488,235   

Second lien debt

     60,124,938         —           —           60,124,938   

Subordinated debt

     101,841,744         —           —           101,841,744   

Investments in funds

     12,011,496         —           —           12,011,496   

Equity investments

     3,526,919         —           —           3,526,919   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investments

   $ 266,993,332       $ —        $ —        $ 266,993,332   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table rolls forward the changes in fair value during the year ended December 31, 2012 for investments classified within Level 3:

 

    First lien
secured debt
    Second lien
debt
    Subordinated
debt
    Investments
in funds
    Equity
investments
    Investment
in payment
rights
    CLO
residual
interest
    Totals  

Beginning balance, January 1, 2012

  $ 89,488,235      $ 60,124,938      $ 101,841,744      $ 12,011,496      $ 3,526,919      $ —       $ —       $ 266,993,332   

Purchases

    102,786,035        41,530,740        130,313,397        1,198,949        763,729        12,500,000        9,400,000        298,492,850   

Sales and repayments

    (90,775,106     (32,044,063     (50,829,280     (3,650,704     —          (238,264     —          (177,537,417

Unrealized appreciation (depreciation)(1)

    (592,844     (1,043,598     (2,831,829     699,368        2,527,488          —          (1,241,415

Net amortization of premiums, discounts and fees

    1,183,133        836,230        1,595,574        —          —          —          —          3,614,937   

PIK

    166,627        631,245        3,228,975        —          —          —          —          4,026,847   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance, December 31, 2012

  $ 102,256,080      $ 70,035,492      $ 183,318,581      $ 10,259,109      $ 6,818,136      $ 12,261,736      $ 9,400,000      $ 394,349,134   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net change in unrealized appreciation from investments still held as of the reporting date(1)

  $ 477,167      $ (294,650   $ (1,196,582   $ 699,368      $ 2,527,488      $ —       $ —       $ 2,212,791   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The following table rolls forward the changes in fair value during the year ended December 31, 2011 for investments classified within Level 3(2):

 

    First lien
debt
    Second lien
debt
    Subordinated
debt
    Investments
in funds
    Equity
investments
    Totals  

Beginning balance, January 1, 2011

  $ 35,184,846      $ 33,968,221      $ 66,576,890      $ 12,790,984      $ 5,008,238      $ 153,529,179   

Purchases

    68,110,035        42,024,135        31,289,982        11,602        383,051        141,818,805   

Sales and repayments

    (15,275,757     (16,798,094     (825,540     (791,722     (2,439,328     (36,130,441

Unrealized appreciation (depreciation)(1)

    623,736        (55,130     1,956,768        632        (404,685     2,121,321   

Realized gains

    —          —          —          —          979,643        979,643   

Net amortization of premiums, discounts and fees

    778,042        583,780        763,002        —          —          2,124,824   

PIK

    67,333        402,026        2,080,642        —          —          2,550,001   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance, December 31, 2011

  $ 89,488,235      $ 60,124,938      $ 101,841,744      $ 12,011,496      $ 3,526,919      $ 266,993,332   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net change in unrealized appreciation from investments still held as of the reporting date(1)

  $ 965,090      $ 518,911      $ 1,956,768      $ 632      $ 247,130      $ 3,688,531   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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(1) 

All unrealized appreciation (depreciation) in the table above is reflected in the accompanying Consolidated Statements of Operations.

(2) 

For the year ended December 31, 2011, the Company has reclassified certain of the above investment categories to expand the classification of investments to reflect the security interest of the Company’s debt holdings. The opening balance as of January 1, 2011 has been adjusted to conform to the revised classifications.

The following provides quantitative information about Level 3 fair value measurements:

 

Description:

  Fair Value    

Valuation Technique

 

Unobservable
Inputs

  Range
(Average) (1)

First lien secured debt

  $ 102,256,080      Discounted cash flows (income approach)   Weighted average
cost of capital
(WACC)
  12% - 13% (12%)

Second lien debt

    70,035,492      Discounted cash flows (income approach)   Weighted average
cost of capital
(WACC)
  14% - 16% (15%)

Subordinated debt

    183,318,581      Discounted cash flows (income approach)   Weighted average
cost of capital
(WACC)
  15% - 17% (16%)

Investments in funds

    10,259,109      Discounted cash flows (income approach)   Weighted average
cost of capital
(WACC)
  14% - 18% (16%)

Equity investments

    6,818,136      Net asset value, as a practical expedient   Net asset value   N/A
    Market comparable companies (market approach)   EBITDA multiple   5.0 - 5.7 (5.3)

Investment in payment rights(2)

    12,261,736      Discounted cash flows (income approach)   Weighted average
cost of capital
(WACC) and
federal tax rates
  14% - 18% (16%)

CLO residual interest

    9,400,000      Discounted cash flows (income approach)   Weighted average
cost of capital
(WACC)
  15% - 16% (16%)
 

 

 

       

Total investments

  $ 394,349,134         
 

 

 

       

 

(1) 

Ranges were determined using a weighted average based upon the fair value of the investments in each investment category.

(2) 

Investment in a tax receivable agreement, or TRA, payment rights

The primary significant unobservable input used in the fair value measurement of the Company’s debt securities (first lien secured debt, second lien debt and subordinated debt), including income-producing investments in funds, payment rights and CLO residual interest is the weighted average cost of capital, or WACC. Significant increases (decreases) in the WACC in isolation would result in a significantly lower (higher) fair value measurement. In determining the WACC, for the income, or yield, approach, the Company considers current market yields and multiples, portfolio company performance, leverage levels, credit quality, among other factors, including federal tax rates, in its analysis. In the case of the TRA and CLO residual interest, the Company considers the risk associated with the underlying investments and the expected term of the investment. Changes in one or more of these factors can have a similar directional change on other factors in determining the appropriate WACC to use in the income approach.

The primary significant unobservable input used in the fair value measurement of the Company’s equity investments is the EBITDA multiple, or the Multiple. Significant increases (decreases) in the Multiple in isolation would result in a significantly higher (lower) fair value measurement. To determine the Multiple for the market approach, the Company considers current market trading and/or transaction multiples, portfolio company performance (financial ratios) relative to public and private peer companies and leverage levels, among other factors. Changes in one or more of these factors can have a similar directional change on other factors in determining the appropriate Multiple to use in the market approach.

 

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Investment in Tax Receivable Agreement Payment Rights

In June 2012, the Company invested in a TRA that entitles it to certain payment rights, or TRA Payment Rights, from Duff & Phelps Corporation, or Duff & Phelps. The TRA transfers the economic value of certain tax deductions, or tax benefits, taken by Duff & Phelps to the Company and entitles the Company to a stream of payments to be received. The TRA payment right is, in effect, a subordinated claim on the issuing company which can be valued based on the credit risk of the issuer, which includes projected future earnings, the liquidity of the underlying payment right, risk of tax law changes, the effective tax rate and any other factors which might impact the value of the payment right.

Through the TRA, the Company is entitled to receive an annual tax benefit payment based upon 85% of the savings from certain deductions along with interest. The payments that the Company is entitled to receive result from cash savings, if any, in U.S. federal, state or local income tax that Duff & Phelps realizes (i) from the tax savings derived from the goodwill and other intangibles created in connection with the Duff & Phelps initial public offering (ii) from other income tax deductions. These tax benefit payments will continue until the relevant deductions are fully utilized, which is projected to be 17 years. Pursuant to the TRA, the Company maintains the right to enforce Duff & Phelps payment obligations as a transferee of the TRA contract. If Duff & Phelps chooses to pre-pay and terminate the TRA, the Company will be entitled to the present value of the expected future TRA payments. If Duff & Phelps breaches any material obligation than all obligations are accelerated and calculated as if an early termination occurred. Failure to make a payment is a breach of a material obligation if the failure occurs for more than three months.

The projected annual tax benefit payment will be accrued on a quarterly basis and paid annually. The payment will be allocated between a reduction in the cost basis of the investment and interest income based upon an amortization schedule. Based upon the characteristics of the investment, the Company has chosen to categorize the investment in the TRA payment rights as investment in payment rights in the fair value hierarchy. The valuation will be based principally on a discounted cash flow analysis of projected future cash flow streams assuming an appropriate discount rate, which will among other things consider other transactions in the market, the current credit environment, performance of Duff & Phelps and the length of the remaining payment stream. During the year ended December 31, 2012, the Company recognized $1,170,538 of income in connection with the TRA payment rights, respectively. As of December 31, 2012, the value of the Company’s interest in the TRA was $12,261,736 and is reflected in the Consolidated Schedule of Investments.

Investment in Funds

The Company does not have the ability to redeem its investment in funds but distributions are expected to be received until the dissolution of the funds, which is anticipated to be between 2013 and 2021, as the underlying investments are expected to be liquidated.

Greenway

On January 14, 2011, THL Credit Greenway Fund LLC, or Greenway, was formed as a Delaware limited liability company. Greenway is a portfolio company of the Company. Greenway is a closed-end investment fund which provides for no liquidity or redemption options and is not readily marketable. Greenway operates under a limited liability agreement dated January 19, 2011, or the Agreement. Greenway will continue in existence until January 14, 2021, subject to earlier termination pursuant to certain terms of the Agreement. The term may also be extended for up to three additional one-year periods pursuant to certain terms of the Agreement. Greenway has a two year investment period.

Greenway has $150,000,000 of capital committed by affiliates of a single institutional investor, and is managed by the Company through the investment professionals that serve on the Company’s investment committee. The Company’s capital commitment to Greenway is $15,000. As of December 31, 2012, all of the capital had been called by Greenway. As of December 31, 2011, $11,603 had been called by Greenway. As of December 31, 2012 and December 31, 2011, the value of the Company’s interest in Greenway was $10,062 and $11,496, respectively, and is reflected in the Consolidated Schedules of Investments.

 

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As manager of Greenway, the Company acts as the investment adviser to Greenway and is entitled to receive certain fees. As a result, Greenway is classified as an affiliate of the Company. For the years ended December 31, 2012 and 2011, the Company earned $2,591,638 and $1,809,994 in fees related to Greenway, respectively, which are included in other income from non-controlled, affiliated investment in the Consolidated Statements of Operations. As of December 31, 2012 and December 31, 2011, $402,116 and $410,479 of fees related to Greenway, respectively, were included in Due from affiliate on the Consolidated Statements of Assets and Liabilities.

Greenway invests in securities similar to those of the Company pursuant to investment and allocation guidelines which address, among other things, the size of the borrowers, the types of transactions and the concentration and investment ratio amongst Greenway and the Company. However, the Company has the discretion to invest in other securities.

LCP Capital Fund LLC

The Company has invested in a membership interest of LCP Capital Fund LLC, or LCP, a private investment company that was organized to participate in investment opportunities that arise when a special purpose entity, or SPE, or sponsor thereof, needs to raise capital to achieve ratings, regulatory, accounting, tax, or other objectives. LCP is a closed investment vehicle which provides for no liquidity or redemption options and is not readily marketable. LCP is managed by an unaffiliated third party. As of December 31, 2012 and December 31, 2011, the Company has contributed $12,000,000 of capital in the form of membership interests in LCP, which is invested in an underlying SPE referred to as Series 2005-01. On May 1, 2012, the Company received $3,645,967 in connection with a reduction in its commitment pursuant to the governing documents, which is related to the notional amount of the underlying credit default swaps. The Company’s exposure is limited to the amount of its remaining contributed capital. As of December 31, 2012 and December 31, 2011, the value of the Company’s interest in LCP was $8,354,033 and $12,000,000, respectively, and is reflected in the Consolidated Schedules of Investments.

The Company’s contributed capital in LCP is maintained in a collateral account held by a third-party custodian, who is neither affiliated with the Company nor with LCP, and acts as collateral on certain credit default swaps for the Series 2005-01 for which LCP receives fixed premium payments throughout the year, adjusted for expenses incurred by LCP. The SPE purchases assets on a non-recourse basis and LCP agrees to reimburse the SPE up to a specified amount for potential losses. LCP holds the contributed cash invested for an SPE transaction in a segregated account that secures the payment obligation of LCP. The Company expects to receive distributions from LCP on a quarterly basis. Such distributions are reflected in the Company’s Consolidated Statements of Operations as interest income in the period earned. LCP has a remaining life of 18 years; however, it is currently expected that Series 2005-01 will terminate on February 15, 2015, if not extended prior to this date pursuant to the terms of Series 2005-1 SPE. Regardless of the date of dissolution, LCP has the right to receive amounts held in the collateral account if there is an event of default under LCP’s operative agreements. LCP may have other series which will have investments in other SPEs to which the Company will not be exposed.

CLO residual interest

Interest income from the Company’s CLO residual interest is recorded based upon an estimation of an effective yield to expected maturity using anticipated cash flows with any remaining amount recorded to the cost basis of the investment. The Company monitors the anticipated cash flows from its CLO residual interest and will adjust its effective yield periodically.

Security Transactions, Payment-in-Kind, Income Recognition, Realized/Unrealized Gains or Losses

Security transactions are recorded on a trade-date basis. The Company measures realized gains or losses by the difference between the net proceeds from the repayment or sale and the amortized cost basis of the

 

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investment, using the specific identification method. The Company reports changes in fair value of investments that are measured at fair value as a component of net change in unrealized appreciation on investments in the Consolidated Statements of Operations. The Company reports changes in fair value of the interest rate derivative that is measured at fair value as a component of net change in unrealized appreciation or depreciation on interest rate derivative in the Consolidated Statements of Operations.

Interest income, adjusted for amortization of premium and accretion of discount, is recorded on an accrual basis to the extent that the Company expects to collect such amounts. Dividend income is recognized on the ex-dividend date. Original issue discount, principally representing the estimated fair value of detachable equity or warrants obtained in conjunction with the acquisition of debt securities, and market discount or premium are capitalized and accreted or amortized into interest income over the life of the respective security using the effective yield method. The amortized cost of investments represents the original cost adjusted for the accretion/amortization of discounts and premiums and upfront loan origination fees.

The Company has investments in its portfolio which contain a contractual paid-in-kind, or PIK, interest provision. PIK interest is computed at the contractual rate specified in each investment agreement, is added to the principal balance of the investment, and is recorded as income. The Company will cease accruing PIK interest if there is insufficient value to support the accrual or if it does not expect amounts to be collectible. To maintain the Company’s status as a RIC, PIK interest income, which is considered investment company taxable income, must be paid out to stockholders in the form of dividends even though the Company has not yet collected the cash. Amounts necessary to pay these dividends may come from available cash.

The following shows a rollforward of PIK income for the years ended December 31, 2012 and 2011:

 

Accumulated PIK balance at December 31, 2010

   $ 935,464   

PIK income capitalized/receivable

     2,552,572   
  

 

 

 

Accumulated PIK balance at December 31, 2011

   $ 3,488,036   

PIK income capitalized/receivable

     4,124,150   

PIK received in cash from prepayments

     (1,804,847
  

 

 

 

Accumulated PIK balance at December 31, 2012

   $ 5,807,339   
  

 

 

 

Interest income from the Company’s TRA and CLO residual interest is recorded based upon an estimation of an effective yield to expected maturity using anticipated cash flows with any remaining amount recorded to the cost basis of the investment. The Company monitors the anticipated cash flows from its CLO residual interest and will adjust its effective yield periodically as needed.

The Company capitalizes and amortizes upfront loan origination fees received in connection with the closing of investments. The unearned income from such fees is accreted into interest income over the contractual life of the loan based on the effective interest method. Upon prepayment of a loan or debt security, any prepayment premiums, unamortized upfront loan origination fees, and unamortized discounts are recorded as interest income.

In certain investment transactions, the Company may provide advisory services. For services that are separately identifiable and external evidence exists to substantiate fair value, income is recognized as earned. The Company had no income from advisory services for the years ended December 31, 2012, 2011 and 2010, respectively.

Other income includes commitment fees, fees related to the management of Greenway, amendment fees and unused commitment fees associated with investments in portfolio companies.

Expenses are recorded on an accrual basis.

Revolving and Unfunded Delayed Draw Loans

For the Company’s investments in revolving and delayed draw loans, the cost basis of the investments purchased is adjusted for the cash received for the discount on the total balance committed. The fair value is

 

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also adjusted for price appreciation or depreciation on the unfunded portion. As a result, the purchase of commitments not completely funded may result in a negative value until it is offset by the future amounts called and funded.

Income Taxes, Including Excise Tax

The Company has elected to be taxed as a RIC under Subchapter M of the Code and currently qualifies, and intends to continue to qualify each year, as a RIC under the Code.

In order to qualify for favorable tax treatment as a RIC, the Company is required to distribute annually to its stockholders at least 90% of its investment company taxable income, as defined by the Code. To avoid a 4% excise tax on undistributed earnings, we are required to distribute each calendar year the sum of (i) 98% of our ordinary income for such calendar year (ii) 98.2% of our net capital gains for the one-year period ending October 31 of that calendar year (iii) any income recognized, but not distributed, in preceding years and on which we paid no federal income tax. The Company, at its discretion, may choose not to distribute all of its taxable income for the calendar year and pay a non-deductible 4% excise tax on this income. If the Company chooses to do so, all other things being equal, this would increase expenses and reduce the amount available to be distributed to stockholders. To the extent that the Company determines that its estimated current year annual taxable income will be in excess of estimated current year dividend distributions from such taxable income, the Company accrues excise taxes on estimated excess taxable income as taxable income is earned using an annual effective excise tax rate. The annual effective excise tax rate is determined by dividing the estimated annual excise tax by the estimated annual taxable income. See also the disclosure in Note 11, Dividends, for a summary of the dividends paid out during 2012. For the years ended December 31, 2012, 2011 and 2010, the Company incurred excise tax expense of $125,000, $22,000 and $0, respectively.

Certain consolidated subsidiaries of the Company are subject to U.S. federal and state income taxes. These taxable entities are not consolidated with the Company for income tax purposes and may generate income tax liabilities or assets from temporary differences in the recognition of items for financial reporting and income tax purposes at the subsidiaries. For the years ended December 31, 2012, 2011 and 2010, the Company recognized current income tax expense of $456,502, $0, and $0, respectively, and a provision for tax on unrealized appreciation of $453,558, $0, and $0, respectively, for consolidated subsidiaries in the Consolidated Statements of Operations. During 2012, a taxable subsidiary received distributions of $456,432 from an underlying portfolio company for the payment of current year tax obligations, which is included as dividend income on the Consolidated Statement of Operations. As of December 31, 2012 and December 31, 2011, $453,558 and $0 of income tax expense, respectively, were included in deferred tax liability on the Consolidated Statements of Assets and Liabilities relating to deferred tax on unrealized appreciation on investments. The Company is not subject to income taxes, however, certain consolidated taxable subsidiaries may be subject to income taxes. The provision relates only to an individual subsidiary of the Company.

The following table summarizes the activity related to the Company’s income tax expense incurred for the year ended December 31, 2012:

 

Tax expense on current earnings

   $ 456,502   

Increase in deferred tax liability on unrealized appreciation of investments

     453,588   
  

 

 

 

Total income tax expense

   $ 910,060   
  

 

 

 

The Company follows the provisions under the authoritative guidance on accounting for and disclosure of uncertainty in tax positions. The provisions require management to determine whether a tax position of the Company is more likely than not to be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. For tax positions not meeting the more likely than not threshold, the tax amount recognized in the consolidated financial statements is

 

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reduced by the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement with the relevant taxing authority. There are no unrecognized tax benefits or obligations in the accompanying consolidated financial statements. Although the Company files federal and state tax returns, the Company’s major tax jurisdiction is federal. The Company’s inception-to-date federal tax years remain subject to examination by taxing authorities.

Dividends

Dividends and distributions to stockholders are recorded on the applicable record date. The amount to be paid out as a dividend is determined by the Company’s board of directors on a quarterly basis. Net realized capital gains, if any, are generally distributed at least annually out of assets legally available for such distributions, although the Company may decide to retain such capital gains for investment.

Capital transactions in connection with the Company’s dividend reinvestment plan are recorded when shares are issued.

3. Related Party Transactions

On February 27, 2013, the Company’s investment management agreement was re-approved by its board of directors, including a majority of our directors who are not interested persons of the Company. Under the investment management agreement, the Advisor, subject to the overall supervision of the Company’s board of directors, manages the day-to-day operations of, and provides investment advisory services to the Company.

The Advisor receives a fee for investment advisory and management services consisting of a base management fee and a two-part incentive fee.

The base management fee is calculated at an annual rate of 1.5% of the Company’s gross assets payable quarterly in arrears on a calendar quarter basis. For purposes of calculating the base management fee, “gross assets” is determined as the value of the Company’s assets without deduction for any liabilities. The base management fee is calculated based on the value of the Company’s gross assets at the end of the most recently completed calendar quarter, and appropriately adjusted for any share issuances or repurchases during the current calendar quarter.

For the years ended December 31, 2012, 2011 and 2010, the Company incurred base management fees payable to the Advisor of $4,943,025, $4,011,897 and $2,696,647, respectively. As of December 31, 2012 and December 31, 2011, $1,514,422 and $1,013,048, respectively, was payable to the Advisor.

The incentive fee has two components, ordinary income and capital gains, as follows:

The ordinary income component is calculated, and payable, quarterly in arrears based on the Company’s preincentive fee net investment income for the immediately preceding calendar quarter, subject to a cumulative total return requirement and to deferral of non-cash amounts. The preincentive fee net investment income, which is expressed as a rate of return on the value of the Company’s net assets attributable to the Company’s common stock, for the immediately preceding calendar quarter, will have a 2.0% (which is 8.0% annualized) hurdle rate (also referred to as “minimum income level”). Preincentive fee net investment income means interest income, dividend income and any other income (including any other fees, such as commitment, origination, structuring, diligence, managerial assistance and consulting fees or other fees that the Company receives from portfolio companies) accrued during the calendar quarter, minus the Company’s operating expenses for the quarter (including the base management fee, expenses payable under the Company’s administration agreement (discussed below), and any interest expense and any dividends paid on any issued and outstanding preferred stock, but excluding the incentive fee and any offering expenses and other expenses not charged to operations but excluding certain reversals to the extent such reversals have the effect of reducing previously accrued incentive fees based on the deferral of non-cash interest. Preincentive fee net investment income includes, in the case of investments with a deferred

 

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interest feature (such as original issue discount, debt instruments with PIK interest and zero coupon securities), accrued income that the Company has not yet received in cash. The Advisor receives no incentive fee for any calendar quarter in which the Company’s preincentive fee net investment income does not exceed the minimum income level. Subject to the cumulative total return requirement described below, the Advisor receives 100% of the Company’s preincentive fee net investment income for any calendar quarter with respect to that portion of the preincentive net investment income for such quarter, if any, that exceeds the minimum income level but is less than 2.5% (which is 10.0% annualized) of net assets (also referred to as the “catch-up” provision) and 20.0% of the Company’s preincentive fee net investment income for such calendar quarter, if any, greater than 2.5% (10.0% annualized) of net assets. The foregoing incentive fee is subject to a total return requirement, which provides that no incentive fee in respect of the Company’s preincentive fee net investment income is payable except to the extent 20.0% of the cumulative net increase in net assets resulting from operations over the then current and 11 preceding calendar quarters exceeds the cumulative incentive fees accrued and/or paid for the 11 preceding quarters. In other words, any ordinary income incentive fee that is payable in a calendar quarter is limited to the lesser of (i) 20% of the amount by which the Company’s preincentive fee net investment income for such calendar quarter exceeds the 2.0% hurdle, subject to the “catch-up” provision, and (ii) (x) 20% of the cumulative net increase in net assets resulting from operations for the then current and 11 preceding quarters minus (y) the cumulative incentive fees accrued and/or paid for the 11 preceding calendar quarters. For the foregoing purpose, the “cumulative net increase in net assets resulting from operations” is the amount, if positive, of the sum of preincentive fee net investment income, base management fees, realized gains and losses and unrealized appreciation and depreciation of the Company for the then current and 11 preceding calendar quarters. In addition, the Advisor is not paid the portion of such incentive fee that is attributable to deferred interest until the Company actually receives such interest in cash.

For the years ended December 31, 2012, 2011 and 2010, the Company incurred $7,441,725, $3,818,186 and $0, respectively, of incentive fees related to ordinary income.

The second component of the incentive fee (capital gains incentive fee) is determined and payable in arrears as of the end of each calendar year (or upon termination of the investment management agreement, as of the termination date). This component is equal to 20.0% of the Company’s cumulative aggregate realized capital gains from inception through the end of that calendar year, computed net of the cumulative aggregate realized capital losses and cumulative aggregate unrealized capital depreciation through the end of such year. The aggregate amount of any previously paid capital gains incentive fees is subtracted from such capital gains incentive fee calculated. The capital gains incentive fee payable to the Company’s Advisor under the investment management agreement as of December 31, 2012 and December 31, 2011 was $34,723 and $195,929, respectively.

As of December 31, 2012, $2,330,759 of such incentive fees are currently payable to the Advisor, as $630,020 of incentive fees incurred by the Company were generated from deferred interest (i.e. PIK and certain discount accretion) and are not payable until such amounts are received in cash.

GAAP requires that the incentive fee accrual considers the cumulative aggregate unrealized capital appreciation or depreciation of investments or other financial instruments, such as an interest rate derivative, in the calculation, as an incentive fee would be payable if such unrealized capital appreciation or depreciation were realized, even though such unrealized capital appreciation or depreciation is not permitted to be considered in calculating the fee actually payable under the investment management agreement. For accounting purposes in accordance with GAAP only, in order to reflect the potential incentive fee that would be payable for a given period as if all unrealized gains or losses were realized, the Company has accrued incentive fees of ($459,198) and $776,342 as of December 31, 2012 and December 31, 2011, respectively, based upon unrealized appreciation or depreciation of investments and the interest rate derivative for that period (in accordance with the terms of the investment management agreement). There can be no assurance that such unrealized appreciation or depreciation will be realized in the future. Accordingly, such fee, as calculated and accrued would not necessarily be payable under the investment management agreement, and may never be paid based upon the computation of incentive fees in subsequent

 

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periods. Approximately $350,000 of the accrued incentive fee for the year ended December 31, 2011 was related to unrealized appreciation on investments in periods prior to 2011. Such amounts were not material to current or to prior periods’ consolidated financial statements.

The Company has also entered into an administration agreement with the Advisor under which the Advisor will provide administrative services to the Company. Under the administration agreement, the Advisor performs, or oversees the performance of administrative services necessary for the operation of the Company, which include, among other things, being responsible for the financial records which the Company is required to maintain and preparing reports to the Company’s stockholders and reports filed with the SEC. In addition, the Advisor assists in determining and publishing the Company’s net asset value, oversees the preparation and filing of the Company’s tax returns and the printing and dissemination of reports to the Company’s stockholders, and generally oversees the payment of the Company’s expenses and the performance of administrative and professional services rendered to the Company by others. The Company will reimburse the Advisor for its allocable portion of the costs and expenses incurred by the Advisor for overhead in performance by the Advisor of its duties under the administration agreement and the investment management agreement, including facilities, office equipment and our allocable portion of cost of compensation and related expenses of our chief financial officer and chief compliance officer and their respective staffs, as well as any costs and expenses incurred by the Advisor relating to any administrative or operating services provided by the Advisor to the Company. Such costs are reflected as administrator expenses in the accompanying Consolidated Statements of Operations. Under the administration agreement, the Advisor provides, on behalf of the Company, managerial assistance to those portfolio companies to which the Company is required to provide such assistance. To the extent that our Advisor outsources any of its functions, the Company pays the fees associated with such functions on a direct basis without profit to the Advisor.

For the years ended December 31, 2012, 2011 and 2010, the Company incurred administrator expenses of $3,224,597, $2,871,778 and $1,715,694, respectively. As of December 31, 2012 and December 31, 2011, $304,491 and $338,569, respectively, was payable to the Advisor.

The Company and the Advisor have entered into a license agreement with THL Partners, L.P., or THL Partners, under which THL Partners has granted to the Company and the Advisor a non-exclusive, personal, revocable, worldwide, non-transferable license to use the trade name and service mark THL, which is a proprietary mark of THL Partners, for specified purposes in connection with the Company’s and the Advisor’s respective businesses. This license agreement is royalty-free, which means the Company is not charged a fee for its use of the trade name and service mark THL. The license agreement is terminable either in its entirety or with respect to the Company or the Advisor by THL Partners at any time in its sole discretion upon 60 days prior written notice, and is also terminable with respect to either the Company or the Advisor by THL Partners in the case of certain events of non-compliance. After the expiration of its first one year term, the entire license agreement is terminable by either the Company or the Advisor at the Company or its sole discretion upon 60 days prior written notice. Upon termination of the license agreement, the Company and the Advisor must cease to use the name and mark THL, including any use in the Company’s respective legal names, filings, listings and other uses that may require the Company to withdraw or replace the Company’s names and marks. Other than with respect to the limited rights contained in the license agreement, the Company and the Advisor have no right to use, or other rights in respect of, the THL name and mark. The Company is an entity operated independently from THL Partners, and third parties who deal with the Company have no recourse against THL Partners.

Due to and from Affiliates

The Advisor paid certain other general and administrative expenses on behalf of the Company. As of December 31, 2012 and December 31, 2011, $0 and $20,597, respectively, of expenses were included in Due to affiliate on the Consolidated Statements of Assets and Liabilities.

As manager of Greenway, the Company acts as the investment adviser to Greenway and is entitled to receive certain fees. As a result, Greenway is classified as an affiliate of the Company. As of December 31,

 

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2012 and December 31, 2011, $402,116 and $410,479 of fees related to Greenway, respectively, were included in Due from affiliate on the Consolidated Statements of Assets and Liabilities.

Affiliated Stockholders

THL Credit Opportunities, L.P. and BDC Holdings own 6,974 and 4,047,720 shares, respectively, or 0.03% and 15.38%, respectively, of the Company’s common stock as of December 31, 2012, compared with 6,974 and 8,972,720 shares, respectively, or 0.03% and 44.38%, respectively, as of December 31, 2011.

4. Realized Gains on Investments

The Company recognized realized gains for the year s ended December 31, 2012, 2011 and 2010 of $353,199, $979,643 and $0, respectively.

5. Net Increase in Net Assets Per Share Resulting from Operations

The following information sets forth the computation of basic and diluted net increase in net assets per share resulting from operations:

 

     For the years ended December 31,  
     2012      2011      2010  

Numerator—net increase in net assets resulting from operations:

   $ 27,616,694       $ 24,135,481       $ 7,791,230   

Denominator—basic and diluted weighted average common shares:

     21,852,197         20,167,092         19,762,756   

Basic and diluted net increase in net assets per common share resulting from operations:

   $ 1.26       $ 1.20       $ 0.39   

Diluted net increase in net assets per share resulting from operations equals basic net increase in net assets per share resulting from operations for each period because there were no common stock equivalents outstanding during the above periods.

6. Credit Facility

On May 10, 2012, the Company entered into an amendment, or the Amendment, to its existing revolving credit agreement, or Revolving Facility, and entered into a new senior secured term loan credit facility, or Term Loan Facility, and together with the Revolving Facility, the Facilities, with ING Capital LLC.

The Amendment revised the Revolving Facility, dated March 11, 2011, to, among other things, increase the amount available for borrowing from $125,000,000 to $140,000,000; permit the Term Loan Facility; extend the maturity date from May 2014 to May 2016 (with a one year term out period beginning in May 2015); and change the non-use fee from 1.00% annually if the Company uses 50% or less of the Revolving Facility and 0.50% annually if the Company uses more than 50% of the Revolving Facility to 1.00% annually if the Company uses 35% or less of the Revolving Facility and 0.50% annually if the Company uses more than 35% of the Revolving Facility. The Amendment also changes the interest rate of the Revolving Facility from (a) Eurocurrency loans from LIBOR plus 3.50% to (i) when the facility is more than 35% drawn and the step-down condition is satisfied, LIBOR plus 3.00%, (ii) when the facility is more than 35% drawn and the step-down condition is not satisfied, LIBOR plus 3.25%, (iii) when the facility is less than or equal to 35% drawn and the step-down condition is satisfied, LIBOR plus 3.25%, and (iv) when the facility is less than or equal to 35% drawn and the step-down condition is not satisfied, LIBOR plus 3.50% and (b) alternative base rate loans based, or ABR, on the highest rate of the Prime Rate, Federal Funds Rate plus 0.5% or three month LIBOR plus 1.0% per annum to (i) when the facility is more than 35% drawn and the step-down condition is satisfied, ABR plus 2.00%, (ii) when the facility is more than 35% drawn and the

 

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step-down condition is not satisfied, ABR plus 2.25%, (iii) when the facility is less than or equal to 35% drawn and the step-down condition is satisfied, ABR plus 2.25%, and (iv) when the facility is less than or equal to 35% drawn and the step-down condition is not satisfied, ABR plus 2.50%.

The Term Loan Facility provides the Company with a $50,000,000 senior secured term loan, or Term Loan. The Term Loan expires in May 2017, bears interest at LIBOR plus 4.00% (with no LIBOR Floor) and has substantially similar terms to the Company’s existing Revolving Facility (as amended by the Amendment).

Each of the Facilities includes an accordion feature permitting the Company to expand the Facilities, if certain conditions are satisfied; provided, however, that the aggregate amount of the Facilities, collectively, is capped at $225,000,000.

The Facilities generally require payment of interest on a quarterly basis for ABR loans, and at the end of the applicable interest period for Eurocurrency loans bearing interest at LIBOR. All outstanding principal is due upon each maturity date. The Facilities also require a mandatory prepayment of interest and principal upon certain customary triggering events (including, without limitation, the disposition of assets or the issuance of certain securities).

Borrowings under the Facilities are subject to, among other things, a minimum borrowing/collateral base. The Facilities have certain collateral requirements and/or financial covenants, including covenants related to: (a) limitations on the incurrence of additional indebtedness and liens, (b) limitations on certain investments, (c) limitations on certain restricted payments, (d) limitations on the creation or existence of agreements that prohibit liens on certain properties of the Company and its subsidiaries, and (e) compliance with certain financial maintenance standards including (i) minimum stockholders’ equity, (ii) a ratio of total assets (less total liabilities not represented by senior securities) to the aggregate amount of senior securities representing indebtedness, of the Company and its subsidiaries, of not less than 2.25:1.0, (iii) minimum liquidity, (iv) minimum net worth, and (v) a consolidated interest coverage ratio. In addition to the financial maintenance standards, described in the preceding sentence, borrowings under the Facilities (and the incurrence of certain other permitted debt) are subject to compliance with a borrowing base that applies different advance rates to different types of assets in the Company’s portfolio.

The Facilities’ documents also include default provisions such as the failure to make timely payments under the Facilities, the occurrence of a change in control, and the failure by the Company to materially perform under the operative agreements governing the Facilities, which, if not complied with, could, at the option of the lenders under the Facilities, accelerate repayment under the Facilities, thereby materially and adversely affecting the Company’s liquidity, financial condition and results of operations. Each loan originated under the Revolving Facility is subject to the satisfaction of certain conditions. The Company cannot be assured that it will be able to borrow funds under the Revolving Facility at any particular time or at all. The Company is currently in compliance with all financial covenants under the Facilities.

For the year ended December 31, 2012, the Company borrowed $189,900,000 and made $144,900,000 of repayments under the Facilities. For the year ended December 31, 2011, the Company borrowed $28,500,000 and made $23,500,000 of repayments under the Facilities. As of December 31, 2012 and December 31, 2011, there were $50,000,000 and $5,000,000 of borrowings outstanding at a weighted average interest rate of 4.2110% and 3.8125%, respectively. Interest expense and related fees of $3,138,276 and $1,043,070 were incurred in connection with the Facilities during the years ended December 31, 2012 and 2011, respectively.

In accordance with the 1940 Act, with certain exceptions, the Company is only allowed to borrow amounts such that its asset coverage, as defined in the 1940 Act, is at least 200% after such borrowing. The asset coverage as of December 31, 2012 is in excess of 200%.

7. Interest Rate Derivative

On May 10, 2012, the Company entered into a five-year interest rate swap agreement, or swap agreement, with ING Capital Markets, LLC on its Term Loan Borrowing. Under the swap agreement, with a notional

 

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value of $50,000,000, the Company pays a fixed rate of 1.1425% and receives a floating rate based upon the current three-month LIBOR rate. The Company entered into the swap agreement to manage interest rate risk and not for speculative purposes.

The Company uses an income approach using a discounted cash flow methodology to value the interest rate derivative. Significant inputs to the discounted cash flows methodology include the forward interest rate yield curves in effect as of the end of the measurement period and an evaluation of the counterparty’s credit risk.

The Company records the change in valuation of the swap agreement in unrealized appreciation (depreciation) as of each measurement period. When the quarterly interest rate swap amounts are paid or received under the swap agreement, the amounts are recorded as a realized gain (loss).

The Company recognized a realized loss for the year ended December 31, 2012 of $179,581, which is reflected as interest rate derivative periodic interest payments, net on the Consolidated Statements of Operations.

For the year ended December 31, 2012, the Company recognized $1,053,221 of net unrealized depreciation from the swap agreement, which is listed under unrealized depreciation on interest rate derivative in the Consolidated Statements of Operations. As of December 31 2012, the Company’s fair value of its swap agreement is $1,053,221, which is listed as an interest rate derivative liability on the Consolidated Statements of Assets and Liabilities.

8. Offering Expenses

A portion of the net proceeds of the Company’s public equity offering of 6,095,000 shares of common stock on September 25, 2012 was used to pay offering expenses of $4,215,864. Offering costs, which include $3,435,142 of underwriter’s fees, have been charged against paid in capital in excess of par. For the year ended December 31, 2011, $327,267 of offering costs related to the Company’s shelf registration statement were incurred and are reflected in the Consolidated Statements of Assets and Liabilities. All offering costs were borne by the Company.

9. Commitments and Contingencies

From time to time, the Company, or the Advisor, may become party to legal proceedings in the ordinary course of business, including proceedings related to the enforcement of our rights under contracts with our portfolio companies. Neither the Company, nor the Advisor, is currently subject to any material legal proceedings.

Unfunded commitments to provide funds to portfolio companies are not reflected on the Company’s balance sheet. The Company’s unfunded commitments may be significant from time to time. These commitments will be subject to the same underwriting and ongoing portfolio maintenance as are the on-balance sheet financial instruments that the Company holds. Since these commitments may expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. The Company intends to use cash flow from normal and early principal repayments and proceeds from borrowings and offerings to fund these commitments.

As of December 31, 2012 and December 31, 2011, the Company has the following unfunded commitments to portfolio companies (in millions):

 

     As of  
     December 31, 2012      December 31, 2011  

Unfunded revolving commitments

   $ 10,909,515       $ 10,425,500   

Unfunded delayed draw and capital expenditure facilities

     12,000,000         7,850,000   

Unfunded commitments to investments in funds

     3,979,986         —     
  

 

 

    

 

 

 

Total unfunded commitments

   $ 26,889,501       $ 18,275,500   
  

 

 

    

 

 

 

 

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10. Distributable Taxable Income

The following reconciles net increase in net assets resulting from operations to taxable income:

 

     For the years ended December 31,  
     2012      2011  

Net increase in net assets resulting from operations

   $ 27,616,694       $ 24,135,481   

Net change in unrealized depreciation (appreciation)

     1,241,415         (2,121,321

Provision for taxes on unrealized appreciation on investments

     453,558           

Net change in unrealized depreciation on interest rate derivative

     1,053,221          

Expenses not currently deductible and income not currently includable

     996,123         814,230   

Other non-deductible expenses

     223,090         68,970   
  

 

 

    

 

 

 

Taxable income before deductions for dividends paid or deemed paid

   $ 31,584,101       $ 22,897,360   
  

 

 

    

 

 

 

The above amount of 2012 taxable income before deductions for dividends is an estimate. Taxable income will be finalized before the Company files its Federal tax return in September 2013.

The tax character of distributions declared and paid in 2012 represented $28,493,313 from ordinary income, $917,830 from capital gains and $0 from tax return of capital. Generally accepted accounting principles require adjustments to certain components of net assets to reflect permanent differences between financial and tax reporting. These adjustments have no affect on net asset value per share. Permanent differences between financial and tax reporting at December 31, 2012 and 2011 were $223,090 and $68,970, respectively.

At December 31, 2012 and 2011, the cost of investments for tax purposes was $391,797,012 and $263,487,213, respectively, resulting in net unrealized appreciation of $2,552,122 and $3,506,119, respectively. There was no net unrealized depreciation in the Company’s investments at December 31, 2012 and 2011. At December 31, 2012 and 2011, the Company had no net capital loss carry forwards.

11. Dividends

The Company has elected to be taxed as a regulated investment company under Subchapter M of the Code. In order to maintain its status as a regulated investment company, it is required to distribute at least 90% of its investment company taxable income. To avoid a 4% excise tax on undistributed earnings, the Company is required to distribute each calendar year the sum of (i) 98% of its ordinary income for such calendar year (ii) 98.2% of its net capital gains for the one-year period ending October 31 of that calendar year (iii) any income recognized, but not distributed, in preceding years and on which the Company paid no federal income tax. The Company intends to make distributions to stockholders on a quarterly basis of substantially all of its net investment income. In addition, although the Company intends to make distributions of net realized capital gains, if any, at least annually, out of assets legally available for such distributions, it may in the future decide to retain such capital gains for investment.

In addition, the Company may be limited in its ability to make distributions due to the BDC asset coverage test for borrowings applicable to the Company as a BDC under the 1940 Act.

 

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The following table summarizes the Company’s dividends declared and paid or to be paid on all shares:

 

Date Declared    Record Date    Payment Date    Amount Per Share

August 5, 2010

   September 2, 2010    September 30, 2010    $0.05

November 4, 2010

   November 30, 2010    December 28, 2010    $0.10

December 14, 2010

   December 31, 2010    January 28, 2011    $0.15

March 10, 2011

   March 25, 2011    March 31, 2011    $0.23

May 5, 2011

   June 15, 2011    June 30, 2011    $0.25

July 28, 2011

   September 15, 2011    September 30, 2011    $0.26

October 27, 2011

   December 15, 2011    December 30, 2011    $0.28

March 6, 2012

   March 20, 2012    March 30, 2012    $0.29

March 6, 2012

   March 20, 2012    March 30, 2012    $0.05

May 2, 2012

   June 15, 2012    June 29, 2012    $0.30

July 26, 2012

   September 14, 2012    September 28, 2012    $0.32

November 2, 2012

   December 14, 2012    December 28, 2012    $0.33

December 20, 2012

   December 31, 2012    January 28, 2013    $0.05

February 27, 2013

   March 15, 2013    March 29, 2013    $0.33

On December 20, 2012, the Company’s board of directors declared a special dividend of $0.05 per share, which was paid on January 28, 2013 to stockholders of record at the close of business on December 31, 2012.

On February 27, 2013, the Company’s board of directors declared a dividend of $0.33 per share, payable on March 29, 2013 to stockholders of record at the close of business on March 15, 2013.

The Company may not be able to achieve operating results that will allow it to make distributions at a specific level or to increase the amount of these distributions from time to time. If the Company does not distribute a certain percentage of its income annually, it will suffer adverse tax consequences, including possible loss of its status as a regulated investment company. The Company cannot assure stockholders that they will receive any distributions at a particular level.

We maintain an “opt in” dividend reinvestment plan for our common stockholders. As a result, unless stockholders specifically elect to have their dividends automatically reinvested in additional shares of common stock, stockholders will receive all such dividends in cash. With respect to our dividends and distributions paid to stockholders during the years ended December 31, 2012 and 2011, dividends reinvested pursuant to our dividend reinvestment plan totaled $26 and $4,048,597, respectively.

Under the terms of our dividend reinvestment plan, dividends will primarily be paid in newly issued shares of common stock. However, the Company reserves the right to purchase shares in the open market in connection with the implementation of the plan. This feature of the plan means that, under certain circumstances, we may issue shares of our common stock at a price below net asset value per share, which could cause our stockholders to experience dilution.

Distributions in excess of our current and accumulated profits and earnings would be treated first as a return of capital to the extent of the stockholder’s tax basis, and any remaining distributions would be treated as a capital gain. The determination of the tax attributes of our distributions will be made annually as of the end of our fiscal year based upon our taxable income for the full year and distributions paid for the full year. Therefore, a determination made on a quarterly basis may not be representative of the actual tax attributes of our distributions for a full year. Each year, a statement on Form 1099-DIV identifying the source of the distribution will be sent to our U.S. stockholders.

 

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12. Financial Highlights

 

     For the years ended December 31,  
     2012     2011     2010  

Per Share Data:(7)

      

Net asset value, beginning of period

   $ 13.24      $ 13.06      $ 12.99   

Net investment income, after taxes(1)

     1.38        1.04        0.31   

Net change in realized gain on investments(1)

     0.01        0.05        —     

Net change in unrealized appreciation of investments(1)(2)

     (0.06     0.11        0.06   

Provision for taxes on unrealized appreciation on investments(1)

     (0.02     —          —     

Unrealized depreciation of interest rate derivative(1)

     (0.06     —          —     
  

 

 

   

 

 

   

 

 

 

Net increase in net assets resulting from operations(3)

     1.25        1.20        0.37   

Accretive effect of share issuance

     0.05        —          —     

Distributions to stockholders

     (1.34     (1.02     (0.30
  

 

 

   

 

 

   

 

 

 

Net asset value, end of period

   $ 13.20      $ 13.24      $ 13.06   
  

 

 

   

 

 

   

 

 

 

Per share market value at end of period

   $ 14.79      $ 12.21      $ 13.01   

Total return(4)(5)

     27.10     1.87     2.38

Shares outstanding at end of period

     26,315,202        20,220,200        19,916,107   

Ratio/Supplemental Data:

      

Net assets at end of period

   $ 347,484,943      $ 267,616,706      $ 260,015,769   

Ratio of operating expenses to average net assets(6)

     8.08     6.18     3.44

Ratio of net investment income to average net assets(6)

     10.39     7.94     3.39

Portfolio turnover(5)

     53.95     15.43     8.63

 

(1) 

Calculated based on weighted average common shares outstanding.

(2) 

Net change in unrealized appreciation of investments includes the effect of rounding on a per share basis.

(3) 

Includes the cumulative effect of rounding.

(4) 

Total return is based on the change in market price per share during the period. Total return takes into account dividends and distributions, if any, reinvested in accordance with the Company’s dividend reinvestment plan.

(5) 

Not annualized.

(6)

Annualized.

(7) 

Financial highlights for the period from May 26, 2009 (inception) through December 31, 2009 are not presented as the Company’s operations were limited to organization and offering activities only.

13. Subsequent Events

On January 31, 2013, THL Credit Greenway Fund II LLC was formed as a Delaware limited liability company. The Company has a nominal commitment in THL Credit Greenway Fund II LLC as part of a closing of the fund on February 11, 2013 and subsequently invested $1,751 on March 1, 2013.

On February 15, 2013, the Company closed on a $15,000,000 investment in Embarcadero Technologies, Inc., or Embarcadero, and subsequently sold $3,029,346 to Greenway II on March 1, 2013. Headquartered in San Francisco, CA, Embarcadero provides data management solutions to organizations.

On February 22, 2013, investments held in the SBIC, LP were transferred to the Company.

On February 27, 2013, the Company’s board of directors declared a dividend of $0.33 per share, payable on March 29, 2013 to stockholders of record at the close of business on March 15, 2013. The dividend will be paid out of net investment income earned in the period from January 1, 2013 through March 31, 2013.

 

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On February 27, 2013, the Company’s investment management agreement was re-approved by its board of directors.

On March 1, 2013, the Company sold $15,729,427 of its investment in Gold, Inc. to Greenway II and outside co-investors.

On March 4, 2013, the Company closed on a $20,394,227 investment in Tri-Starr Management Services, Inc., or Tri-Starr. Headquartered in Portsmouth, NH, Tri-Starr is a distribution, technology and integrated third-party logistics provider.

 

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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

 

Item 9A. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures

Our Chief Executive Officer and Chief Financial Officer, under the supervision and with the participation of our management, conducted an evaluation of our disclosure controls and procedures, as defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. As of the end of the period covered by this annual report on Form 10-K, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 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.

(b) Management’s Report on Internal Control Over Financial Reporting

The management of THL Credit, Inc. and its Subsidiaries (except where the context suggests otherwise, the terms “we,” “us,” “our,” and “THL Credit” refer to THL Credit, Inc. and its Subsidiaries) is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f), and for performing an assessment of the effectiveness of internal control over financial reporting as of December 31, 2011. Internal control over financial reporting is a process designed by, or under the supervision of, our principal executive and principal financial officers, or persons performing similar functions, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with authorizations; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

Management performed an assessment of the effectiveness of our internal control over financial reporting as of December 31, 2012 based upon the criteria set forth in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on our assessment, management determined that our internal control over financial reporting was effective as of December 31, 2012.

(c) Report of the Independent Registered Public Accounting Firm

The effectiveness of our internal control over financial reporting as of December 31, 2012 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.

 

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(d) Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934 that occurred during our most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Item 9B. Other Information

None.

 

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PART III

We will file a definitive Proxy Statement for our 2013 Annual Meeting of Stockholders with the Securities and Exchange Commission pursuant to Regulation 14A, not later than 120 days after the end of our fiscal year. Accordingly, certain information required by Part III has been omitted under General Instruction G(3) to Form 10-K. Only those sections of our definitive Proxy Statement that specifically address the items set forth herein are incorporated by reference.

 

Item 10. Directors, Executive Officers and Corporate Governance

The information required by Item 10 is hereby incorporated by reference from our definitive Proxy Statement relating to our 2013 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of our fiscal year.

 

Item 11. Executive Compensation

The information required by Item 11 is hereby incorporated by reference from our definitive Proxy Statement relating to our 2013 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of our fiscal year.

 

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information required by Item 12 is hereby incorporated by reference from our definitive Proxy Statement relating to our 2013 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of our fiscal year.

 

Item 13. Certain Relationships and Related Transactions, and Director Independence.

The information required by Item 13 is hereby incorporated by reference from our definitive Proxy Statement relating to our 2013 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of our fiscal year.

 

Item 14. Principal Accountant Fees and Services

The information required by Item 14 is hereby incorporated by reference from our definitive Proxy Statement relating to our 2013 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of our fiscal year.

 

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PART IV

 

Item 15. Exhibits and Financial Statement Schedules

The following documents are filed or incorporated by reference as part of this Annual Report:

1. Consolidated Financial Statements

 

     Page  

Report of Independent Registered Public Accounting Firm

     88   

Consolidated Statements of Assets and Liabilities as of December 31, 2012 and December 31, 2011

     89   

Consolidated Statements of Operations for the years ended December 31, 2012, 2011 and 2010

     90   

Consolidated Statements of Changes in Net Assets (Deficit) for the years ended December  31, 2012, 2011 and 2010

     91   

Consolidated Statements of Cash Flows for the years ended December 31, 2012, 2011 and 2010

     92   

Consolidated Schedules of Investments as of December 31, 2012 and December 31, 2011

     93   

Notes to Consolidated Financial Statements

     103   

2. Financial Statement Schedule

None.

3. Exhibits required to be filed by Item 601 of Regulation S-K

Please note that the agreements included as exhibits to this Form 10-K are included to provide information regarding their terms and are not intended to provide any other factual or disclosure information about us or the other parties to the agreements. The agreements contain representations and warranties by each of the parties to the applicable agreement that have been made solely for the benefit of the other parties to the applicable agreement and may not describe the actual state of affairs as of the date they were made or at any other time.

The following exhibits are filed as part of this report or hereby incorporated by reference to exhibits previously filed with the SEC:

 

  3.1    Amended and Restated Certificate of Incorporation (Incorporated by reference from the Registrant’s pre-effective Amendment No. 4 to the Registration Statement under the Securities Act of 1933, as amended, on Form N-2, filed on April 20, 2010)
  3.2    Bylaws (Incorporated by reference from the Registrant’s pre-effective Amendment No. 1 to the Registration Statement under the Securities Act of 1933, as amended, on Form N-2, filed on July 15, 2009)
  4    Form of Specimen Certificate (Incorporated by reference from the Registrant’s pre-effective Amendment No. 4 to the Registration Statement under the Securities Act of 1933, as amended, on Form N-2, filed on April 20, 2010)
10.1    Dividend Reinvestment Plan (Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q, filed on August 9, 2010)
10.2    Investment Management Agreement (Incorporated by reference from the Registrant’s pre-effective Amendment No. 4 to the Registration Statement under the Securities Act of 1933, as amended, on Form N-2, filed on April 20, 2010)
10.3    Purchase Agreement (Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q, filed on August 9, 2010)

 

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10.4    Custodian Agreement (Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q, filed on August 9, 2010)
10.5    Administration Agreement (Incorporated by reference from the Registrant’s pre-effective Amendment No. 4 to the Registration Statement under the Securities Act of 1933, as amended, on Form N-2, filed on April 20, 2010)
10.6    Sub-Administration Agreement (Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q, filed on August 9, 2010)
10.7    Purchase and Sale Agreement (Incorporated by reference from the Registrant’s pre-effective Amendment No. 4 to the Registration Statement under the Securities Act of 1933, as amended, on Form N-2, filed on April 20, 2010)
10.8    License Agreement (Incorporated by reference from the Registrant’s pre-effective Amendment No. 4 to the Registration Statement under the Securities Act of 1933, as amended, on Form N-2, filed on April 20, 2010)
10.9    Subscription Agreement—THL Credit Opportunities, L.P. (Incorporated by reference from the Registrant’s pre-effective Amendment No. 4 to the Registration Statement under the Securities Act of 1933, as amended, on Form N-2, filed on April 20, 2010)
10.10    Subscription Agreement—THL Credit Partners BDC Holdings, L.P. (Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q, filed on August 9, 2010)
10.11    Senior Secured Revolving Credit Agreement between THL Credit and ING Capital LLC, dated March 11, 2011 (Incorporated by reference from the Registrant’s Current Report on Form 8-K filed on March 15, 2011)
10.12    Amendment No. 1 to Senior Secured Revolving Credit Agreement between THL Credit and ING Capital LLC, dated May 10, 2012 (Incorporated by reference from the Registrant’s Current Report on Form 8-K, filed on May 15, 2012)
10.13    Senior Secured Term Loan Credit Agreement between THL Credit and ING Capital LLC, dated May 10, 2012 (Incorporated by reference from the Registrant’s Current Report on Form 8-K, filed on May 15, 2012)
11    Computation of Per Share Earnings (included in the notes to the financial statements contained in this report).
14    Code of Ethics (Incorporated by reference from the Registrant’s pre-effective Amendment No. 4 to the Registration Statement under the Securities Act of 1933, as amended, on Form N-2, filed on April 20, 2010)
21   

Subsidiaries of the Registrant

THL Credit Holdings, Inc.—Delaware

THL Corporate Finance, Inc.—Delaware

THL Credit SBIC, L.P.—Delaware

THL Credit SBIC GP, LLC—Delaware

THL Credit AIM Media Holdings, Inc.—Delaware

THL Credit YP Holdings, Inc.—Delaware

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

 

(*) Filed herewith

 

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Table of Contents

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

 

    THL CREDIT, INC.

Date: March 4, 2013

  By:  

/S/    JAMES K. HUNT        

James K. Hunt

Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

Date: March 4, 2013

  By:  

/S/    JAMES K. HUNT        

James K. Hunt

Chairman of the Board of Directors and Chief Executive Officer (Principal Executive Officer)

Date: March 4, 2013

  By:  

/S/    TERRENCE W. OLSON        

Terrence W. Olson

Chief Financial Officer (Principal Financial and Accounting Officer)

Date: March 4, 2013

  By:  

/S/    DAVID K. DOWNES        

David K. Downes

Director

Date: March 4, 2013

  By:  

/S/    NANCY HAWTHORNE        

Nancy Hawthorne

Director

Date: March 4, 2013

  By:  

/S/    KEITH W. HUGHES        

Keith W. Hughes

Director

Date: March 4, 2013

  By:  

/S/    JOHN A. SOMMERS        

John A. Sommers

Director

Date: March 4, 2013

  By:  

/S/    DAVID P. SOUTHWELL        

David P. Southwell

Director

 

131