(Exact name of registrant as specified in its charter)
(Address of principal executive office)
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
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 o No o
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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. The number of shares of the issuer’s common stock, $0.01 par value, outstanding as of August 4, 2016 was 51,479,409.
TABLE OF CONTENTS
Item 1.
Financial Statements (Unaudited)
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
Item 4.
Controls and Procedures
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
i
See Accompanying Notes.
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
Interim consolidated financial statements of TICC Capital Corp. (“TICC” and, together with its subsidiaries, the “Company”) are prepared in accordance with generally accepted accounting principles (“GAAP”) for interim financial information and pursuant to the requirements for reporting on Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain disclosures accompanying annual financial statements prepared in accordance with GAAP are omitted. In the opinion of management, all adjustments, consisting of normal recurring accruals, necessary for the fair statement of consolidated financial results for the interim periods have been included. The current period’s consolidated results of operations are not necessarily indicative of results that may be achieved for the year. The interim consolidated financial statements and notes thereto should be read in conjunction with the financial statements and notes thereto included in the Company’s Form 10-K for the year ended December 31, 2015, as filed with the Securities and Exchange Commission (“SEC”).
TICC was incorporated under the General Corporation Laws of the State of Maryland on July 21, 2003 and is a non-diversified, closed-end investment company. TICC has elected to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (the “1940 Act”). In addition, TICC has elected to be treated for tax purposes as a regulated investment company (“RIC”), under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”). The Company’s investment objective is to maximize its total return, by investing primarily in corporate debt securities.
TICC’s investment activities are managed by TICC Management, LLC (“TICC Management”), a registered investment adviser under the Investment Advisers Act of 1940, as amended. BDC Partners, LLC (“BDC Partners”) is the managing member of TICC Management and serves as the administrator of TICC.
The Company’s consolidated operations include the activities of its wholly-owned subsidiaries, TICC CLO 2012-1 LLC (“2012 Securitization Issuer” or “TICC CLO 2012-1”) and TICC Funding, LLC (“TICC Funding”) for the periods during which they were held. These subsidiaries were formed for the purpose of enabling the Company to obtain debt financing and are operated solely for the investment activities of the Company, and the Company has substantial equity at risk. TICC Funding was formed on September 17, 2014, for the purpose of entering into a credit and security agreement with Citibank, N.A. (the “Facility”). During the fourth quarter of 2015, the Company liquidated portions of the TICC Funding portfolio and, as of December 31, 2015, the Facility had been fully repaid. See “Note 7. Borrowings” for additional information on the Company’s subsidiaries and their borrowings.
During the first quarter of 2015, the Company identified a non-material error in its accounting for income from Collateralized Loan Obligation (“CLO”) equity investments. The Company had recorded income from its CLO equity investments using the dividend recognition model as described in ASC 946-320; specifically, dividends were recognized on the applicable record date, subject to estimation and collectability, with a reduction to cost basis in those instances where the Company believed that a return of capital had occurred. The Company has determined that the appropriate method for recording investment income on CLO equity investments is the effective yield method as described in ASC 325-40, Beneficial Interests in Securitized Financial Assets. This method requires the calculation of an effective yield to expected redemption based upon an estimation of the amount and timing of future cash flows, including recurring cash flows as well as future principal repayments; the difference between the actual cash received (and record date distributions to be received) and the effective yield income calculation is an adjustment to cost. The effective yield is reviewed quarterly and adjusted as appropriate.
20
The difference between the two methods resulted in an income reclassification error which would generally have resulted in a decrease in total investment income with a corresponding and offsetting increase to net change in unrealized appreciation/depreciation on investments and net realized gains/losses on investments. The Company quantified this error and assessed it in accordance with the guidance provided in SEC Staff Accounting Bulletin (“SAB”) 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements. Based on this assessment, the Company concluded that the error in income classification did not have a material impact on the Company’s previously filed consolidated financial statements.
As a result of this misclassification of income, net investment income incentive fees were overstated by approximately $2.4 million on a cumulative basis through 2014 and, as a result, total net assets as of December 31, 2014 were understated by the same amount, approximately $0.04 per share. The Company also considered this indirect impact of the error in classification and concluded that the error was not material to the Company’s previously filed consolidated financial statements. The error was corrected by an out-of-period adjustment in the first quarter of 2015, reducing net investment income incentive fees by approximately $2.4 million and recognizing a corresponding “due from affiliate” of $2.4 million. TICC Management repaid in full to TICC, on April 30, 2015, the portion of its previously paid net investment income incentive fees attributable to the overstated amounts.
Prospectively as of January 1, 2015, the Company records income from its CLO equity investments using the effective yield method in accordance with the accounting guidance in ASC 325-40 based upon an effective yield to the expected redemption utilizing estimated cash flows.
The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, TICC CLO 2012-1 and TICC Funding. All inter-company accounts and transactions have been eliminated in consolidation.
Certain prior period balances have been reclassified to conform with current period presentation.
The Company follows the accounting and reporting guidance in FASB Accounting Standards Codification 946, Financial Services — Investment Companies.
The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America that require management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results may differ from those estimates.
In the normal course of business, the Company may enter into contracts that contain a variety of representations and provide indemnifications. The Company’s maximum exposure under these arrangements is unknown as this would involve future claims that may be made against the Company that have not yet occurred. However, based upon experience, the Company expects the risk of loss to be remote.
As provided under Regulation S-X and ASC Topic 946-810, Consolidation, the Company will generally not consolidate its investment in a company other than a wholly-owned investment company or a controlled operating company whose business consists of providing services to the Company. TICC CLO 2012-1 and
21
TICC Funding would be considered investment companies but for the exceptions under Sections 3(c)(1) and 3(c)(7) under the 1940 Act, and were established solely for the purpose of allowing the Company to borrow funds for the purpose of making investments. The Company owns all of the equity in these entities and controls the decision-making power that drives their economic performance. Accordingly, the Company consolidates the results of its wholly-owned subsidiaries in its financial statements, and follows the accounting and reporting guidance in ASC 946-810.
In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis. The new guidance applies to entities in all industries and provides a new scope exception to registered money market funds and similar unregistered money market funds. It makes targeted amendments to the current consolidation guidance and ends the deferral granted to investment companies from applying the VIE guidance. ASU 2015-02 is effective for annual and interim periods in fiscal years beginning after December 15, 2015. The adoption of ASU 2015-02 did not have a material effect on the Company’s consolidated results of operation and financial condition.
Cash and cash equivalents consist of demand deposits and highly liquid investments, such as money market funds, with original maturities of three months or less. Cash and cash equivalents are carried at cost or amortized cost which approximates fair value.
As of June 30, 2016 and December 31, 2015, restricted cash represents the cash held by the trustee of the 2012 Securitization Issuer. These amounts are held by the trustee for payment of interest expense and operating expenses of the entity, principal repayments on borrowings, or new investments, based upon the terms of the indenture, and is not available for general corporate purposes.
The Company fair values its investment portfolio in accordance with the provisions of ASC 820, Fair Value Measurement and Disclosure. Estimates made in the preparation of TICC’s consolidated financial statements include the valuation of investments and the related amounts of unrealized appreciation and depreciation of investments recorded. TICC believes that there is no single definitive method for determining fair value in good faith. As a result, determining fair value requires that judgment be applied to the specific facts and circumstances of each portfolio investment while employing a consistently applied valuation process for the types of investments TICC makes.
ASC 820-10 clarified the definition of fair value and requires companies to expand their disclosure about the use of fair value to measure assets and liabilities in interim and annual periods subsequent to initial recognition. ASC 820-10 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820-10 also establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, which includes inputs such as quoted prices for similar securities in active markets and quoted prices for identical securities in markets that are not active; and Level 3, defined as unobservable inputs for which little or no market data exists, therefore requiring an entity to develop its own assumptions. TICC considers the attributes of current market conditions on an ongoing basis and has determined that due to the general illiquidity of the market for its investment portfolio, whereby little or no market data exists, almost all of TICC’s investments are based upon “Level 3” inputs as of June 30, 2016.
TICC’s Board of Directors determines the value of its investment portfolio each quarter. In connection with that determination, members of TICC Management’s portfolio management team prepare a quarterly analysis of each portfolio investment using the most recent portfolio company financial statements, forecasts
22
and other relevant financial and operational information. Since March 2004, TICC has engaged third-party valuation firms to provide assistance in valuing certain of its syndicated loans and bilateral investments, including related equity investments, although TICC’s Board of Directors ultimately determines the appropriate valuation of each such investment. Changes in fair value, as described above, are recorded in the statement of operations as net change in unrealized appreciation or depreciation.
In accordance with ASC 820-10, TICC’s valuation procedures specifically provide for the review of indicative quotes supplied by the large agent banks that make a market for each security. However, the marketplace from which TICC obtains indicative bid quotes for purposes of determining the fair value of its syndicated loan investments has shown attributes of illiquidity as described by ASC-820-10. During such periods of illiquidity, when TICC believes that the non-binding indicative bids received from agent banks for certain syndicated investments that we own may not be determinative of their fair value or when no market indicative quote is available, TICC may engage third-party valuation firms to provide assistance in valuing certain syndicated investments that TICC owns. In addition, TICC Management prepares an analysis of each syndicated loan, financial summary, covenant compliance review, recent trading activity in the security, if known, and other business developments related to the portfolio company. All available information, including non-binding indicative bids which may not be determinative of fair value, is presented to the Valuation Committee to consider in its determination of fair value. In some instances, there may be limited trading activity in a security even though the market for the security is considered not active. In such cases the Valuation Committee will consider the number of trades, the size and timing of each trade, and other circumstances around such trades, to the extent such information is available, in its determination of fair value. The Valuation Committee will evaluate the impact of such additional information, and factor it into its consideration of the fair value that is indicated by the analysis provided by third-party valuation firms, if any.
During the past six years, TICC has acquired a number of debt and equity positions in CLO investment vehicles and more recently CLO warehouse investments. These investments are special purpose financing vehicles. In valuing such investments, TICC considers the indicative prices provided by a recognized industry pricing service as a primary source, and the implied yield of such prices, supplemented by actual trades executed in the market at or around period-end, as well as the indicative prices provided by the broker who arranges transactions in such investment vehicles. TICC also considers those instances in which the record date for an equity distribution payment falls on the last day of the period, and the likelihood that a prospective purchaser would require a downward adjustment to the indicative price representing substantially all of the pending distribution. Additional factors include any available information on other relevant transactions including firm bids and offers in the market and information resulting from bids-wanted-in-competition. In addition, TICC considers the operating metrics of the specific investment vehicle, including compliance with collateralization tests, defaulted and restructured securities, and payment defaults, if any. TICC Management or the Valuation Committee may request an additional analysis by a third-party firm to assist in the valuation process of CLO investment vehicles. All information is presented to TICC’s Board of Directors for its determination of fair value of these investments.
Bilateral investments for which market quotations are readily available are valued by an independent pricing agent or market maker. If such market quotations are not readily available, under the valuation procedures approved by TICC’s Board of Directors, upon the recommendation of the Valuation Committee, a third-party valuation firm will prepare valuations for each of TICC’s bilateral investments that, when combined with all other investments in the same portfolio company, (i) have a value as of the previous quarter
23
of greater than or equal to 2.5% of its total assets as of the previous quarter, and (ii) have a value as of the current quarter of greater than or equal to 2.5% of its total assets as of the previous quarter, after taking into account any repayment of principal during the current quarter. In addition, in those instances where a third-party valuation is prepared for a portfolio investment which meets the parameters noted in (i) and (ii) above, the frequency of those third-party valuations is based upon the grade assigned to each such security under its credit grading system as follows: Grade 1, at least annually; Grade 2, at least semi-annually; Grades 3, 4, and 5, at least quarterly. Bilateral investments which do not meet the parameters in (i) and (ii) above are not required to have a third-party valuation and, in those instances, a valuation analysis will be prepared by TICC Management. TICC Management also retains the authority to seek, on TICC’s behalf, additional third party valuations with respect to both TICC’s bilateral portfolio securities and TICC’s syndicated loan investments. TICC’s Board of Directors retains ultimate authority as to the third-party review cycle as well as the appropriate valuation of each investment.
Interest income is recorded on an accrual basis using the contractual rate applicable to each debt investment and includes the accretion of discounts and amortization of premiums. Discounts from and premiums to par value on securities purchased are accreted/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 of discounts and amortization of premiums, if any.
Generally, when interest and/or principal payments on a loan become past due, or if the Company otherwise does not expect the borrower to be able to service its debt and other obligations, the Company will place the loan on non-accrual status and will generally cease recognizing interest income on that loan for financial reporting purposes until all principal and interest have been brought current through payment or due to restructuring such that the interest income is deemed to be collectible. The Company generally restores non-accrual loans to accrual status when past due principal and interest is paid and, in the Company’s judgment, is likely to remain current. As of June 30, 2016 and December 31, 2015, the Company’s investment in RBS Holding Company’s second lien senior secured notes was on non-accrual status.
In addition, the Company earns income from the discount on debt securities it purchases, including original issue discount (“OID”) and market discount. OID and market discounts are capitalized and amortized into income using the interest method, as applicable.
Income from investments in the equity class securities of CLO vehicles (typically income notes or subordinated notes) is recorded using the effective interest method in accordance with the provisions of ASC 325-40, based upon an effective yield to the expected redemption utilizing estimated cash flows, including those CLO equity investments that have not made their inaugural distribution for the relevant period end. The Company monitors the expected residual payments, and effective yield is determined and updated periodically, as needed. Accordingly, investment income recognized on CLO equity securities in the GAAP statement of operations differs from both the tax-basis investment income and from the cash distributions actually received by the Company during the period.
TICC has investments in its portfolio which contain a contractual payment-in-kind (“PIK”) provision. Certain PIK investments offer issuers the option at each payment date of making payments in cash or additional securities. PIK interest computed at the contractual rate is accrued into income and added to the
24
principal balance on the capitalization date. Upon capitalization, PIK is subject to the fair value estimates associated with their related investments. PIK investments on non-accrual status are restored to accrual status once it becomes probable that PIK will be realized. To maintain its status as a RIC, this income must be paid out to stockholders in the form of distributions, even though TICC has not collected any cash. Amounts necessary to pay these distributions may come from available cash or the liquidation of certain investments.
Other income includes distributions from fee letters and success fees associated with portfolio investments. Distributions from fee letters are an enhancement to the return on a CLO equity investment and are based upon a percentage of the collateral manager’s fees, and are recorded as other income when earned. The Company may also earn success fees associated with its investments in certain securitization vehicles or “CLO warehouse facilities,” which are contingent upon a repayment of the warehouse by a permanent CLO securitization structure; such fees are earned and recognized when the repayment is completed.
Deferred debt issuance costs consist of fees and expenses incurred in connection with the closing or amending of credit facilities and debt offerings, and are capitalized at the time of payment. These costs are amortized using the straight line method over the terms of the respective credit facilities and debt securities. This amortization expense is included in interest expense in the Company’s financial statements. Upon early termination of debt, or a credit facility, the remaining balance of unamortized fees related to such debt is accelerated into interest expense. Deferred offering costs are presented on the balance sheet as a direct deduction from the related debt liability.
In April 2015, the FASB issued ASU No. 2015-03, Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs (“ASU 2015-03”). The new guidance requires debt issuance costs (deferred financing costs) related to a recognized debt liability to be presented on the balance sheet as a direct deduction from the related debt liability, similar to the presentation of debt discounts. Additionally, in August 2015, the FASB issued Accounting Standards Update 2015-15, Interest — Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements (“ASU 2015-15”), which codifies an SEC staff announcement that entities are permitted to defer and present debt issuance costs related to line of credit arrangements as assets and subsequent amortization of the deferred costs over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. ASU 2015-03 and 2015-15 are effective for fiscal years beginning after December 15, 2015 and interim periods within those fiscal years. The adoption of ASU 2015-03 and 2015-15 did not have a material effect on the Company’s consolidated results of operation and financial condition, however, at June 30, 2016 and December 31, 2015 the adoption of ASU 2015-03 did result in the reclassification of approximately $3.3 million and approximately $3.8 million, respectively, in deferred debt issuance costs which post-adoption are a direct deduction from the related debt liability. The December 31, 2015 balances have been adjusted to reflect the retrospective application, as required by ASU 2015-03.
Equity offering costs consist of fees and expenses incurred in connection with the registration and public offer and sale of the Company’s common stock, including legal, accounting and printing fees. These costs are deferred at the time of incurrence and are subsequently charged to capital when the offering takes place or as shares are issued. Deferred costs are periodically reviewed and expensed if the related registration is no longer active.
25
From time to time, the Company’s Board of Directors may authorize a share repurchase program under which shares are purchased in open market transactions. Since the Company is incorporated in the State of Maryland, state law requires share repurchases to be accounted for as a share retirement. The cost of repurchased shares is charged against capital on the settlement date.
Other assets consists of funds held in escrow from sales of investments, prepaid expenses associated primarily with insurance and deferred equity offering costs. At June 30, 2016, funds held in escrow totaled approximately $740,000 related to the sale of Ai Squared during the quarter ended June 30, 2016. The funds are expected to be released during the fourth quarter of 2017, net of settlement of any indemnity claims and expenses related to the transaction.
The Company intends to operate so as to qualify to be taxed as a RIC under Subchapter M of the Code and, as such, to not be subject to U.S. federal income tax on the portion of its taxable income and gains distributed to stockholders. To qualify for RIC tax treatment, TICC is required to distribute at least 90% of its investment company taxable income annually, meet asset diversification requirements quarterly and file Form 1120-RIC, as defined by the Code.
Because U.S. federal income tax regulations differ from accounting principles generally accepted in the United States, 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 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.
For tax purposes, the cost basis of the portfolio investments at June 30, 2016 and December 31, 2015, was $795,845,510 and $830,119,903, respectively.
The Company’s assets measured at fair value on a recurring basis at June 30, 2016 were as follows:
26
The Company’s assets measured at fair value on a recurring basis at December 31, 2015 were as follows:
The following tables provide quantitative information about the Company’s Level 3 fair value measurements as of June 30, 2016 and December 31, 2015, respectively. The Company’s valuation policy, as described above, establishes parameters for the sources and types of valuation analysis, as well as the methodologies and inputs that the Company uses in determining fair value. If the Valuation Committee or TICC Management determines that additional techniques, sources or inputs are appropriate or necessary in a given situation, such additional work will be undertaken. The tables, therefore, are not all-inclusive, but provide information on the significant Level 3 inputs that are pertinent to the Company’s fair value measurements. The weighted average calculations in the table below are based on principal balances for all debt related calculations and CLO equity.
27
28
29
The following table presents the carrying value and fair value of the Company’s financial liabilities disclosed, but not carried, at fair value as of June 30, 2016 and the level of each financial liability within the fair value hierarchy:
30
The following table presents the carrying value and fair value of the Company’s financial liabilities disclosed, but not carried, at fair value as of December 31, 2015 and the level of each financial liability within the fair value hierarchy:
31
A reconciliation of the fair value of investments for the three months ended June 30, 2016, utilizing significant unobservable inputs, is as follows:
32
A reconciliation of the fair value of investments for the six months ended June 30, 2016, utilizing significant unobservable inputs, is as follows:
33
A reconciliation of the fair value of investments for the year ended December 31, 2015, utilizing significant unobservable inputs, is as follows:
The following table shows the fair value of TICC’s portfolio of investments by asset class as of June 30, 2016 and December 31, 2015:
34
At June 30, 2016 and December 31, 2015, respectively, cash, cash equivalents and restricted cash were as follows:
In accordance with the 1940 Act, with certain limited exceptions, the Company is only allowed to borrow amounts such that its asset coverage, as defined in the 1940 Act, is at least 200% immediately after such borrowing. As of June 30, 2016, the Company’s asset coverage for borrowed amounts was 193%. As a result of the asset coverage being less than 200%, the Company would be precluded from taking on additional borrowings.
The following are the Company’s outstanding principal amounts, carrying values and fair values of the Company’s borrowings as of June 30, 2016 and December 31, 2015. Fair values of our notes payable are based upon the bid price provided by the placement agent at the measurement date, if available:
The weighted average stated interest rate and weighted average maturity on all our debt outstanding as of June 30, 2016 were 4.59% and 5.3 years, respectively, and as of December 31, 2015 were 4.41% and 5.8 years, respectively.
35
The table below summarizes the components of interest expense for the three months ended June 30, 2016 and 2015:
The table below summarizes the components of interest expense for the six months ended June 30, 2016 and 2015:
The aggregate accrued interest which remained payable at June 30, 2016 and December 31, 2015, was approximately $2.2 million and $2.1 million, respectively.
36
On August 23, 2012, the Company completed a $160 million debt securitization financing transaction, consisting of $120 million in secured notes and $40 million of the 2012 Subordinated Notes. On February 25, 2013 and May 28, 2013, TICC CLO 2012-1 issued additional secured notes totaling an aggregate of $120 million and 2012 Subordinated Notes totaling an aggregate of $40 million, which 2012 Subordinated Notes were purchased by us, under the “accordion” feature of the debt securitization which allowed, under certain circumstances and subject to the satisfaction of certain conditions, for an increase in the amount of secured and subordinated notes. It is not necessary that the Company own all or any of the notes permitted by this feature, which may affect the accounting treatment of the debt securitization financing transaction. As of June 30, 2016, the secured notes of the 2012 Securitization Issuer have an aggregate face amount of $240 million and were issued in four classes. The class A-1 notes have a current face amount of $176 million, are rated AAA (sf)/Aaa (sf) by Standard & Poor’s Ratings Services (S&P) and Moody’s Investors Service, Inc. (Moody’s), respectively, and bear interest at three-month LIBOR plus 1.75%. The class B-1 notes have a current face amount of $20 million, are rated AAA (sf)/Aa1 (sf) by S&P and Moody’s, respectively, and bear interest at three-month LIBOR plus 3.50%. The class C-1 notes have a current face amount of $23 million, are rated AA+ (sf)/A1 (sf) by S&P and Moody’s, respectively, and bear interest at three-month LIBOR plus 4.75%. The class D-1 notes have a current face amount of $21 million, are rated A+ (sf)/Baa1 (sf) by S&P and Moody’s, respectively, and bear interest at three-month LIBOR plus 5.75%. TICC presently owns all of the 2012 Subordinated Notes, which totaled $80 million as of June 30, 2016.
During a period of up to four years from the closing date, all principal collections received on the underlying collateral may be used by the 2012 Securitization Issuer to purchase new collateral under our direction in our capacity as collateral manager of the 2012 Securitization Issuer and in accordance with our investment strategy, allowing us to maintain the initial leverage in the securitization for such four-year period. All note classes are scheduled to mature on August 25, 2023.
The proceeds of the private placement of the Classes A, B, C, D and 2012 Subordinated Notes of the 2012 Securitization Issuer, net of discount and debt issuance costs, were used for investment purposes. As part of the securitization, we entered into a master loan sale agreement with TICC CLO 2012-1 pursuant to which we agreed to sell or contribute certain senior secured and second lien loans (or participation interests therein) to TICC CLO 2012-1, and to purchase or otherwise acquire the 2012 Subordinated Notes. The Classes A, B, C, D and 2012 Subordinated Notes of the 2012 Securitization Issuer are the secured obligations of TICC CLO 2012-1, and an indenture governing the notes of the 2012 Securitization Issuer includes customary covenants and events of default.
As of June 30, 2016, there were 37 investments in portfolio companies with a total fair value of approximately $268.6 million, collateralizing the secured notes of the 2012 Securitization Issuer. The pool of loans in the securitization must meet certain requirements, including asset mix and concentration, collateral coverage, term, agency rating, minimum coupon, minimum spread and sector diversity requirements.
The aggregate accrued interest payable on the notes of the 2012 Securitization Issuer at June 30, 2016 was approximately $0.8 million. Deferred debt issuance costs consist of fees and expenses incurred in connection with debt offerings. As of June 30, 2016, TICC had a deferred debt issuance balance of approximately $2.5 million associated with this securitization. Aggregate net discount on the notes of the 2012 Securitization Issuer at the time of issuance totaled approximately $4.9 million. These amounts are being amortized and included in interest expense in the consolidated statements of operations over the term of the debt securitization. The following table sets forth the components of interest expense, effective annualized
37
average interest rates, and cash paid for interest of the Class A-1, B-1, C-1 and D-1 for the three and six months ended June 30, 2016 and 2015, respectively:
Effective January 1, 2016 and through February 24, 2016, the interest charged under the securitization was based on three-month LIBOR, which was 0.393%. Effective February 25, 2016 and through May 25, 2016, the interest charged under the securitization was based on three-month LIBOR, which was approximately 0.629%. Effective May 26, 2016 and through June 30, 2016, the interest charged under the securitization was based on three-month LIBOR, which was approximately 0.662%.
The classes, interest rates, spread over LIBOR, cash paid for interest, stated interest expense and note discount expense of each of the Class A-1, B-1, C-1 and D-1 for the three and six months ended June 30, 2016, respectively, is as follows:
The classes, interest rates, spread over LIBOR, cash paid for interest, stated interest expense and note discount expense of each of the Class A-1, B-1, C-1 and D-1 for the three and six months ended June 30, 2015 is as follows:
38
The amounts, ratings and interest rates (expressed as a spread to LIBOR) of the Class A-1, B-1, C-1, D-1 and 2012 Subordinated Notes as of June 30, 2016 are as follows:
The amounts, ratings and interest rates (expressed as a spread to LIBOR) of the Class A-1, B-1, C-1, D-1 and 2012 Subordinated Notes as of June 30, 2015 are as follows:
TICC serves as collateral manager to the 2012 Securitization Issuer under a collateral management agreement. TICC is entitled to a deferred fee for its services as collateral manager. The deferred fee is eliminated in consolidation.
On September 26, 2012, the Company issued $105.0 million aggregate principal amount of the 7.50% Senior Convertible Notes due 2017 (“Convertible Notes”) and an additional $10.0 million aggregate principal amount of the Convertible Notes was issued on October 22, 2012 pursuant to the exercise of the initial purchasers’ option to purchase additional Convertible Notes. The Convertible Notes bear interest at a rate of 7.50% per year, payable semi-annually in arrears on May 1 and November 1 of each year, commencing on May 1, 2013. The Convertible Notes are convertible into shares of TICC’s common stock based on an initial conversion rate of 87.2448 shares of its common stock per $1,000 principal amount of Convertible Notes, which is equivalent to an initial conversion price of approximately $11.46 per share of common stock. The conversion price for the Convertible Notes will be reduced for quarterly cash distributions paid to common shares to the extent that the quarterly distribution exceeds $0.29 cents per share, subject to adjustment. The Convertible Notes mature on November 1, 2017, unless previously converted in accordance with their terms. TICC does not have the right to redeem the Convertible Notes prior to maturity. The aggregate accrued interest payable on the Convertible Notes at June 30, 2016 was approximately $1.4 million. Deferred debt issuance costs represent fees and other direct incremental costs incurred in connection with the Convertible Notes. As of June 30, 2016, the Company had a deferred debt issuance balance of approximately $0.8 million. This amount is being amortized and is included in interest expense in the consolidated statements of operations over the term of the Convertible Notes.
39
The following table sets forth the components of interest expense, effective annualized average interest rates and cash paid for interest of the Convertible Notes for the three and six months ended June 30, 2016 and 2015, respectively:
In certain circumstances, the Convertible Notes will be convertible into shares of TICC’s common stock at its initial conversion rate (listed below) subject to customary anti-dilution adjustments and the requirements of its indenture, at any time on or prior to the close of business on the business day immediately preceding the maturity date. The Company will in certain circumstances increase the conversion rate by a number of additional shares.
As of June 30, 2016, the principal amount of the Convertible Notes exceeded the value of the underlying shares multiplied by the per share closing price of the Company’s common stock.
The Convertible Notes are TICC’s general, unsecured obligations and rank equal in right of payment with all of TICC’s existing and future senior, unsecured indebtedness and senior in right of payment to any of its subordinated indebtedness. As a result, the Convertible Notes will be effectively subordinated to TICC’s existing and future secured indebtedness to the extent of the value of the assets securing such indebtedness and structurally subordinated to any existing and future liabilities and other indebtedness of its subsidiaries.
On October 27, 2014, TICC Funding, a special purpose vehicle and wholly-owned subsidiary of the Company, entered into a revolving credit facility (the “Facility”) with Citibank, N.A. Subject to certain exceptions, pricing under the Facility is based on the London interbank offered rate (“LIBOR”) for an interest period equal to three months plus a spread of 1.50% per annum. Pursuant to the terms of the credit agreement governing the Facility, TICC Funding borrowed, on a revolving basis, the maximum aggregate principal amount of $150,000,000.
During the fourth quarter of 2015, the Company liquidated portions of the TICC Funding portfolio and fully repaid the Facility.
40
The following table sets forth the components of interest expense, effective annualized average interest rates and cash paid for interest of the Facility for the three and six months ended June 30, 2015:
Each of TICC CLO 2012-1 and TICC Funding are consolidated subsidiaries of TICC. The Company consolidated the results of its wholly-owned subsidiaries in its consolidated financial statements as the subsidiaries are operated solely for investment activities of the Company, and the Company has substantial equity at risk. The creditors of TICC CLO 2012-1 have received security interests in the assets owned by TICC CLO 2012-1 and such assets are not intended to be available to the creditors of TICC (or any other affiliate of TICC).
The following table sets forth the computation of basic and diluted net increase in net assets resulting from investment income per share for the three and six months ended June 30, 2016 and 2015, respectively:
41
The following table sets forth the computation of basic and diluted net increase in net assets resulting from operations per share for the three and six months ended June 30, 2016 and 2015, respectively:
42
In March 2016, TICC Management, LLC, in consultation with the independent members of the Board of Directors, agreed to a series of ongoing fee waivers with respect to its management fee and income incentive fee. Under the terms of the fee waiver letter, which took effect on April 1, 2016:
43
After these changes took effect on April 1, 2016, under no circumstances will the aggregate fees earned from April 1, 2016 by TICC Management in any quarterly period be higher than those aggregate fees would have been prior to the adoption of these changes.
The Company has entered into an investment advisory agreement with TICC Management (the “Investment Advisory Agreement”) under which TICC Management, subject to the overall supervision of TICC’s Board of Directors, manages the day-to-day operations of, and provides investment advisory services to, TICC. For providing these services TICC Management receives a fee from TICC, consisting of two components: a base management fee (the “Base Fee”) and an incentive fee. Through March 31, 2016, the Base Fee was calculated at an annual rate of 2.00%. Effective April 1, 2016, the Base Fee is calculated at an annual rate of 1.5%. The Base Fee is payable quarterly in arrears, and is calculated based on the average value of TICC’s gross assets at the end of the two most recently completed calendar quarters, and appropriately adjusted for any equity or debt capital raises, repurchases or redemptions during the current calendar quarter. Accordingly, the Base Fee will be payable regardless of whether the value of the Company’s gross assets have decreased during the quarter.
The following table represents the Base Fee for the three and six months ended June 30, 2016 and 2015, respectively:
The investment advisory fee payable to TICC Management as of June 30, 2016 and December 31, 2015, was $2,411,762 and $4,195,901, respectively.
The incentive fee has two parts, net investment income incentive fee and capital gains incentive fee. The first part is calculated and payable quarterly in arrears based on the Company’s “Pre-Incentive Fee Net Investment Income” for the immediately preceding calendar quarter. For this purpose, “Pre-Incentive Fee Net Investment Income” means interest income, income from securitization vehicles and equity investments and any other income (including any other fees that TICC receives from portfolio companies) accrued during the calendar quarter, minus the Company’s operating expenses for the quarter (including the Base Fee, expenses payable under the Company’s administration agreement with BDC Partners (the “Administration Agreement”), and any interest expense and dividends paid on any issued and outstanding preferred stock, but excluding the incentive fee). “Pre-Incentive 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 the Company has not yet received in cash. “Pre-Incentive Fee Net Investment Income” does not include any realized gains, realized losses or unrealized appreciation or depreciation. “Pre-Incentive Fee Net Investment Income,” expressed as a rate of return on the value of the Company’s net assets at the end of the immediately preceding calendar quarter, is compared to one-fourth of
44
an annual “hurdle rate.” Given that this portion of the incentive fee is payable without regard to any gain, loss or unrealized depreciation that may occur during the quarter, this portion of TICC Management’s incentive fee may also be payable notwithstanding a decline in net asset value that quarter.
From January 1, 2005 through March 31, 2016, the annual hurdle rate was determined as of the immediately preceding December 31st by adding 5.0% to the interest rate then payable on the most recently issued five-year U.S. Treasury Notes, up to a maximum annual hurdle rate of 10.0%. The annual hurdle rates for the 2015, 2014 and 2013 calendar years were 6.65%, 6.75% and 5.72%, respectively. The hurdle rate through March 31, 2016, calculated as of December 31, 2015, was 6.76%.
Effective April 1, 2016, the calculation of the Company’s net investment income incentive fee was revised to include a total return requirement that will limit TICC’s obligation to pay TICC Management a net investment income incentive fee if TICC has generated cumulative net decreases in net assets resulting from operations during the calendar quarter for which such fees are being calculated and the eleven preceding quarters (or if shorter, the number of quarters since April 1, 2016) due to unrealized or realized net losses on investments and even in the event TICC’s net investment income exceeds the minimum return to TICC’s stockholders required to be achieved before TICC Management is entitled to receive an income incentive fee (which minimum return is commonly referred to as the preferred return or the hurdle rate). The hurdle rate was changed from a variable rate to a fixed rate of 7.00%. Additionally, effective April 1, 2016, the net investment income incentive fee incorporates a “catch-up” provision which provides that TICC Management will receive 100% of TICC’s net investment income with respect to that portion of such net investment income, if any, that exceeds the hurdle rate but is less than 2.1875% quarterly (8.75% annualized) and 20% of any net investment income thereafter. Under the revised net investment income incentive fee terms, under no circumstances will the aggregate fees earned from April 1, 2016 by TICC Management in any quarterly period will not be higher than those aggregate fees would have been earned prior to the adoption of these changes.
The following table represents the net investment income incentive fees for the three and six months ended June 30, 2016 and 2015, respectively:
During the first quarter of 2015, the Company identified a non-material error in its accounting policy for revenue recognition — refer to “Note 3. Change of Accounting for Collateralized Loan Obligation Equity Income.” As a result of this error, because the net investment income incentive fee in prior years was based upon net investment income as previously reported, the net investment income incentive fees were overstated by approximately $2.4 million on a cumulative basis through the year ended 2014. Therefore, a reduction in expenses as well as a “due from affiliate” amount of approximately $2.4 million was recorded for the quarter ended March 31, 2015, which represents the cumulative indirect effect of the error on the Company’s net investment income incentive fees. This reversal of expenses was partially offset by net investment income incentive fees incurred for the three months ended March 31, 2015 of approximately $318,000. TICC Management repaid in full to TICC, on April 30, 2015, the portion of its previously paid net investment income incentive fees attributable to the overstated amounts.
The net investment income incentive fee payable to TICC Management as of June 30, 2016 and December 31, 2015, was approximately $1,243,766 and $0, respectively.
In addition, in the event the Company recognizes payment-in-kind, or “PIK,” interest income in excess of its available capital, the Company may be required to liquidate assets in order to pay a portion of the
45
incentive fee. TICC Management, however, is not required to reimburse the Company for the portion of any incentive fees attributable to PIK loan interest income in the event of a subsequent default.
The second part of the incentive fee is determined and payable in arrears as of the end of each calendar year (or upon termination of the Investment Advisory Agreement, as of the termination date), and equals 20% of the Company’s “Incentive Fee Capital Gains,” which consists of the Company’s realized gains for each calendar year, computed net of all realized losses and unrealized depreciation for that calendar year. For accounting purposes only, in order to reflect the theoretical capital gains incentive fee that would be payable for a given period as if all unrealized gains were realized, the Company will accrue a capital gains incentive fee based upon net realized gains and unrealized depreciation for that calendar year (in accordance with the terms of the Investment Advisory Agreement), plus unrealized appreciation on investments held at the end of the period. It should be noted that a fee so calculated and accrued would not necessarily be payable under the Investment Advisory Agreement, and may never be paid based upon the computation of capital gains incentive fees in subsequent periods. Amounts paid under the Investment Advisory Agreement will be consistent with the formula reflected in the Investment Advisory Agreement.
The amount of the capital gains incentive fee expense related to the hypothetical liquidation of the portfolio (and assuming no other changes in realized or unrealized gains and losses) would only become payable to TICC Management in the event of a complete liquidation of our portfolio as of period end and the termination of the Investment Advisory Agreement on such date. Also, it should be noted that the capital gains incentive fee expense fluctuates with the Company’s overall investment results.
There were no capital gains incentive fees incurred during the three and six months ended June 30, 2016 and 2015. There were no accrued capital gains incentive fee payable to TICC Management as of June 30, 2016 and December 31, 2015.
The Company has also entered into the Administration Agreement with BDC Partners under which BDC Partners provides administrative services for TICC. The Company pays BDC Partners an allocable portion of overhead and other expenses incurred by BDC Partners in performing its obligations under the Administration Agreement, including a portion of the rent and the compensation of the Company’s Chief Financial Officer, accounting staff and other administrative support personnel, which creates potential conflicts of interest that the Board of Directors must monitor.
TICC Management is controlled by BDC Partners, its managing member. Charles M. Royce holds a minority, non-controlling interest in TICC Management. BDC Partners manages the business and internal affairs of TICC Management. Jonathan H. Cohen, the Company’s Chief Executive Officer, as well as a Director, is the managing member of BDC Partners. Saul B. Rosenthal, the Company’s President and Chief Operating Officer, is also the President and Chief Operating Officer of TICC Management and a member of BDC Partners. Messrs. Cohen and Rosenthal have an equal equity interest in BDC Partners. Mr. Royce does not take part in the management or participate in the operations of TICC Management; however, Mr. Royce is expected to be available from time to time to TICC Management to provide certain consulting services without compensation.
The Company reimburses BDC Partners for the costs associated with the functions performed by TICC’s Chief Compliance Officer that BDC Partners paid on the Company’s behalf pursuant to the terms of an agreement between the Company and Alaric Compliance Services, LLC.
For the three months ended June 30, 2016 and 2015, TICC incurred $179,000 and $396,000, respectively, in compensation expenses for the services of employees allocated to the administrative activities of TICC,
46
pursuant to the Administration Agreement with BDC Partners; for the six months ended June 30, 2016 and 2015, TICC incurred $420,000 and $876,000, respectively. Further, TICC incurred $28,000 and $37,000 for facility costs allocated under the agreement for the three months ended June 30, 2016 and 2015, respectively; for the six months ended June 30, 2016 and 2015, TICC incurred $55,000 and $55,000, respectively.
The Company intends to continue to operate so as to qualify to be taxed as a RIC under the Code and, as such, the Company would not be subject to federal income tax on the portion of its taxable income and gains distributed to stockholders. To qualify to be taxed as a RIC, the Company is required, among other requirements, to distribute at least 90% of its annual investment company taxable income, as defined by the Code. The amount to be paid out as a distribution is determined by the Board of Directors each quarter and is based upon the annual taxable income estimated by the management of the Company. Income calculated in accordance with U.S. federal income tax regulations differs substantially from GAAP income. To the extent that the Company’s taxable earnings fall below the amount of distributions declared, however, a portion of the total amount of the Company’s distributions for the fiscal year may be deemed a return of capital for tax purposes to the Company’s stockholders.
The Company intends to comply with the applicable provisions of the Code pertaining to RICs to make distributions of taxable income sufficient to relieve it of substantially all federal income taxes. The Company, at its discretion, may carry forward taxable income in excess of calendar year distributions and pay a 4% excise tax on this income. The Company will accrue excise tax on estimated excess taxable income, if any, as required.
On June 30, 2016 the Company paid a distribution of $0.29 per share. The Company has a distribution reinvestment plan under which all distributions are paid to stockholders in the form of additional shares issued or purchased in the open market, unless a stockholder elects to receive cash.
The Company’s net asset value per share at June 30, 2016 was $6.54, and at December 31, 2015 was $6.40. In determining the Company’s net asset value per share, the Board of Directors determined in good faith the fair value of the Company’s portfolio investments for which reliable market quotations are not readily available.
47
The following tables set forth the components of investment income for the three months ended June 30, 2016 and 2015, respectively:
The following tables set forth the components of investment income for the six months ended June 30, 2016 and 2015, respectively:
The 1940 Act requires that a business development company offer managerial assistance to its portfolio companies. The Company may receive fee income for managerial assistance it renders to portfolio companies in connection with its investments. For the three and six months ended June 30, 2016 and 2015, respectively, the Company received no fee income for managerial assistance.
48
On December 18, 2014, the Board of Directors authorized a repurchase program to be in place until the earlier of June 30, 2015 or until $50 million of the Company’s outstanding shares of common stock have been repurchased. During the year ending December 31, 2015, under that repurchase program, the Company repurchased 315,783 shares of outstanding common stock for approximately $2.4 million at the average weighted price of $7.56 per share, inclusive of commission, while complying with the prohibitions under our Insider Trading Policies and Procedures and the guidelines specified in Rule 10b-18 of the Securities Exchange Act of 1934, as amended, including certain price, market volume and timing constraints. In addition, repurchases were conducted in accordance with the 1940 Act.
On November 5, 2015, the Board of Directors authorized a new program for the purpose of repurchasing up to $75 million worth of the Company’s common stock. Under this repurchase program, we were authorized, but we were not obligated, to repurchase outstanding common stock in the open market from time to time through June 30, 2016, provided that repurchases comply with the prohibitions under the Company’s Insider Trading Policies and Procedures and the guidelines specified in Rule 10b-18 of the Securities Exchange Act of 1934, as amended, including certain price, market volume and timing constraints. Further, any repurchases must be conducted in accordance with the 1940 Act. Additionally, the Company entered into a Rule 10b5-1 trading plan to undertake accretive share repurchasing on a non-discretionary basis of up to $50 million until March 4, 2016. In aggregate, under the repurchase program authorized on November 5, 2015, the Company repurchased 3,591,551 shares of our common stock for approximately $23.7 million at the weighted average price of approximately $6.63 per share, inclusive of commissions, through December 31, 2015. This represents a premium of approximately 3.6% of the net asset value per share at December 31, 2015.
During the three months ended June 30, 2016, the Company did not repurchase shares. During the six months ended June 30, 2016, the Company repurchased shares under the November 5, 2015 repurchase program totaling 4,917,026 shares of our common stock for approximately $25.6 million at the weighted average price of approximately $5.20 per share, inclusive of commissions. This represents a discount of approximately 20.4% of the net asset value per share at June 30, 2016.
49
In the normal course of business, the Company enters into a variety of undertakings containing a variety of warranties and indemnifications that may expose the Company to some risk of loss. The risk of future loss arising from such undertakings, while not quantifiable, is expected to be remote.
As of June 30, 2016, the Company had no commitments to purchase additional debt investments.
Financial highlights for the three and six months ended June 30, 2016 and 2015, respectively, are as follows:
50
In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements — Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. The update is intended to define management’s responsibility to evaluate whether there is a substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosure. ASU 2014-15 is effective for annual periods ending after December 15, 2016, and interim periods within those annual periods. The Company adopted ASU 2014-15 beginning with the quarter ended March 31, 2016. The adoption of ASU 2014-15 did not have a material effect on the Company’s consolidated results of operation and financial condition.
51
In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis. The new guidance applies to entities in all industries and provides a new scope exception to registered money market funds and similar unregistered money market funds. It makes targeted amendments to the current consolidation guidance and ends the deferral granted to investment companies from applying the VIE guidance. ASU 2015-02 is effective for annual periods ending after December 15, 2015, and interim periods within those annual periods. The Company adopted ASU 2015-02 beginning with the quarter ended March 31, 2016. The adoption of ASU 2015-02 did not have a material effect on the Company’s consolidated results of operation and financial condition.
In April 2015, the FASB issued ASU No. 2015-03, Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. The new guidance requires debt issuance costs (deferred financing costs) related to a recognized debt liability to be presented on the balance sheet as a direct deduction from the related debt liability, similar to the presentation of debt discounts. Additionally, in August 2015, the FASB issued Accounting Standards Update 2015-15, “Interest — Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements” (“ASU 2015-15”), which codifies an SEC staff announcement that entities are permitted to defer and present debt issuance costs related to line of credit arrangements as assets and subsequent amortization of the deferred costs over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. ASU 2015-03 and 2015-15 are effective for annual periods ending after December 15, 2015, and interim periods within those annual periods. The Company adopted ASU 2015-03 and 2015-15 beginning with the quarter ended March 31, 2016. The adoption of ASUs 2015-03 and 2015-15 did not have a material effect on the Company’s consolidated results of operation and financial condition, however, at June 30, 2016 and December 31, 2015 the adoption of ASU 2015-03 did result in the reclassification of approximately $3.3 million and approximately $3.8 million, respectively, in deferred debt issuance costs which post-adoption are a direct deduction from the related debt liability. The December 31, 2015 balances have been adjusted to reflect the retrospective application, as required by ASU 2015-03.
In May 2015, the FASB issued Accounting Standards Update (“ASU”) 2015-07, “Fair Value Measurement (Topic 820): Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent).” Under the amendments in this Update, investments for which fair value is measured at net asset value per share (or its equivalent) using the practical expedient should not be categorized in the fair value hierarchy. Removing those investments from the fair value hierarchy not only eliminates the diversity in practice resulting from the way in which investments measured at net asset value per share (or its equivalent) with future redemption dates are classified, but also ensures that all investments categorized in the fair value hierarchy are classified using a consistent approach. Investments that calculate net asset value per share (or its equivalent), but for which the practical expedient is not applied will continue to be included in the fair value hierarchy. ASU 2015-07 is effective for annual periods ending after December 15, 2015, and interim periods within those annual periods. The Company adopted ASU 2014-07 beginning with the quarter ended March 31, 2016. The adoption of ASU 2015-07 did not have a material effect on the Company’s consolidated results of operations and financial condition.
The Company places its cash and cash equivalents with financial institutions and, at times, cash held in checking accounts may exceed the Federal Deposit Insurance Corporation insured limit. In addition, the Company’s portfolio may be concentrated in a limited number of portfolio companies, which will subject the Company to a risk of significant loss if any of these companies defaults on its obligations under any of its debt securities that the Company holds or if those sectors experience a market downturn.
52
The U.S. capital markets have recently experienced periods of extreme volatility and disruption. Disruptions in the capital markets tend to increase the spread between the yields realized on risk-free and higher risk securities, resulting in illiquidity in parts of the capital markets. The Company believes these conditions may reoccur in the future. A prolonged period of market illiquidity may have an adverse effect on the Company’s business, financial condition and results of operations. Adverse economic conditions could also increase the Company’s funding costs, limit the Company’s access to the capital markets or result in a decision by lenders not to extend credit to the Company. These events could limit the Company’s investment originations, limit the Company’s ability to grow and negatively impact the Company’s operating results.
Many of the companies in which the Company has made or will make investments may be susceptible to adverse economic conditions, which may affect the ability of a company to repay TICC’s loans or engage in a liquidity event such as a sale, recapitalization, or initial public offering. Therefore, the Company’s nonperforming assets may increase, and the value of the Company’s portfolio may decrease during this period. Adverse economic conditions also may decrease the value of any collateral securing some of the Company’s loans and the value of its equity investments. Adverse economic conditions could lead to financial losses in the Company’s portfolio and a decrease in its revenues, net income, and the value of the Company’s assets.
A portfolio company’s failure to satisfy financial or operating covenants imposed by the Company 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 the Company holds. The Company 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 the Company may have structured its investment as senior debt or secured debt, depending on the facts and circumstances, including the extent to which the Company actually provided significant “managerial assistance,” if any, to that portfolio company, a bankruptcy court might re-characterize the Company’s debt holding and subordinate all or a portion of the Company’s claim to that of other creditors. These events could harm the Company’s financial condition and operating results.
As a BDC, the Company is required to carry its 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 its Board of Directors. Decreases in the market values or fair values of the Company’s investments are recorded as unrealized depreciation. Depending on market conditions, the Company could incur substantial losses in future periods, which could have a material adverse impact on its business, financial condition and results of operations.
In August 2015 a Special Committee was established to evaluate any or all strategic alternatives for the Company, including but not limited to continuing with the Company’s current strategic plan, making changes to the current strategic plan, liquidating the Company’s assets and/or a potential transaction involving some or all of the stock, assets or business of the Company or TICC Management, or any other alternative transaction.
During the three and six months ended June 30, 2016, the Company recognized expenses of approximately $1.2 million and $2.8 million, respectively, primarily related to the work of the Special Committee, including the engagement of legal and financial advisors to the Special Committee, including the effects of an approximately $791,000 insurance recovery related to previously incurred legal costs.
On July 28, 2016, the Board of Directors declared a distribution of $0.29 per share for the second quarter, payable on September 30, 2016 to shareholders of record as of September 16, 2016.
53
This Quarterly Report on Form 10-Q contains forward-looking statements that involve substantial risks and uncertainties. These forward-looking statements are not historical facts, but rather are based on current expectations, estimates and projections about TICC Capital Corp., our current and prospective portfolio investments, our industry, our beliefs, and our assumptions. Words such as “anticipates,” “expects,” “intends,” “plans,” “will,” “may,” “continue,” “believes,” “seeks,” “estimates,” “would,” “could,” “should,” “targets,” “projects,” and variations of these words and similar expressions are intended to identify forward-looking statements. The forward-looking statements contained in this Quarterly Report on Form 10-Q involve risks and uncertainties, including statements as to:
These statements are not guarantees of future performance and are subject to risks, uncertainties, and other factors, some of which are beyond our control and difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements, including without limitation:
Although we believe that the assumptions on which these forward-looking statements are based are reasonable, any of those assumptions could prove to be inaccurate, and as a result, the forward-looking statements based on those assumptions also could be inaccurate. Important assumptions include our ability to originate new loans and investments, certain margins and levels of profitability and the availability of additional capital. In light of these and other uncertainties, the inclusion of a projection or forward-looking statement in this Quarterly Report on Form 10-Q should not be regarded as a representation by us that our plans and objectives will be achieved. These risks and uncertainties include those described or identified in Item 1A. — Risk Factors contained in our Annual Report on Form 10-K for the year ended December 31,
54
2015, and elsewhere in this Quarterly Report on Form 10-Q. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Quarterly Report on Form 10-Q.
Except where the context requires otherwise, the terms “TICC,” “Company,” “we,” “us” and “our” refer to TICC Capital Corp. together with its subsidiaries, TICC CLO 2012-1 LLC (“2012 Securitization Issuer” or “TICC CLO 2012-1”), and TICC Funding, LLC (“TICC Funding”); “TICC Management” refers to TICC Management, LLC; and “BDC Partners” refers to BDC Partners, LLC.
The following analysis of our financial condition and results of operations should be read in conjunction with our financial statements and the related notes thereto contained elsewhere in this Quarterly Report on Form 10-Q.
Our investment objective is to maximize our portfolio’s total return. Our primary focus is to seek current income by investing in corporate debt securities. We have also invested and may continue to invest in structured finance investments, including CLO vehicles, which own debt securities. We may also invest in publicly traded debt and/or equity securities. We operate as a closed-end, non-diversified management investment company and have elected to be regulated as a BDC under the Investment Company Act of 1940, as amended (the “1940 Act”). We have elected to be treated for tax purposes as a regulated investment company (“RIC”), under the Internal Revenue Code of 1986, as amended (the “Code”), beginning with our 2003 taxable year.
Our investment activities are managed by TICC Management, LLC (“TICC Management”) a registered investment adviser under the Investment Advisers Act of 1940, as amended. TICC Management is owned by BDC Partners, LLC (“BDC Partners”) its managing member, and Charles M. Royce, a member of our Board of Directors, who holds a minority, non-controlling interest in TICC Management. Jonathan H. Cohen, our Chief Executive Officer, and Saul B. Rosenthal, our President and Chief Operating Officer, are the controlling members of BDC Partners. Under an investment advisory agreement (the “Investment Advisory Agreement”), we have agreed to pay TICC Management an annual base fee calculated on gross assets, and an incentive fee based upon our performance. Under an amended and restated administration agreement (the “Administration Agreement”), we have agreed to pay or reimburse BDC Partners, as administrator, for certain expenses incurred in operating TICC. Our executive officers and directors, and the executive officers of TICC Management and BDC Partners, serve or may serve as officers and directors of entities that operate in a line of business similar to our own. Accordingly, they may have obligations to investors in those entities, the fulfillment of which might not be in the best interests of us or our stockholders.
We generally expect to invest between $5 million and $50 million in each of our portfolio companies, although this investment size may vary proportionately as the size of our capital base changes and market conditions warrant, and accrue interest at fixed or variable rates. We expect that our investment portfolio will be diversified among a large number of investments with few investments, if any, exceeding 5.0% of the total portfolio. As of June 30, 2016, our debt investments had stated interest rates of between 4.25% and 15.00% and maturity dates of between 27 and 98 months. In addition, our total portfolio had a weighted average yield on debt investments of approximately 7.5%.
We have historically borrowed funds to make investments and may continue to borrow funds to make investments. As a result, we are exposed to the risks of leverage, which may be considered a speculative investment technique. Borrowings, also known as leverage, magnify the potential for gain and loss on amounts invested and therefore increase the risks associated with investing in our securities. In addition, the costs associated with our borrowings, including any increase in the management fee payable to TICC Management, will be borne by our common stockholders.
In addition, as a BDC under the 1940 Act, we are required to make available significant managerial assistance, for which we may receive fees, to our portfolio companies. These fees would be generally non-recurring, however in some instances they may have a recurring component. We have received no fee income for managerial assistance to date.
55
Prior to making an investment, we may enter into a non-binding term sheet with the potential portfolio company. These term sheets are generally subject to a number of conditions, including but not limited to the satisfactory completion of our due diligence investigations of the company’s business and legal documentation for the loan.
To the extent possible, we will generally seek to invest in loans that are collateralized by a security interest in the borrower’s assets or guaranteed by a principal to the transaction. Interest payments, if not deferred, are normally payable quarterly with most debt investments having scheduled principal payments on a monthly or quarterly basis. When we receive a warrant to purchase stock in a portfolio company, the warrant will typically have a nominal strike price, and will entitle us to purchase a modest percentage of the borrower’s stock.
The preparation of consolidated financial statements and related disclosures in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and revenues and expenses during the periods reported. Actual results could materially differ from those estimates. We have identified investment valuation and investment income as critical accounting policies.
TICC’s Board of Directors determines the value of its investment portfolio each quarter. In connection with that determination, members of TICC Management’s portfolio management team prepare a quarterly analysis of each portfolio investment using the most recent portfolio company financial statements, forecasts and other relevant financial and operational information. Since March 2004, TICC has engaged third-party valuation firms to provide assistance in valuing certain of its syndicated loans and bilateral investments, including related equity investments, although TICC’s Board of Directors ultimately determines the appropriate valuation of each such investment. Changes in fair value, as described above, are recorded in the statement of operations as net change in unrealized appreciation or depreciation.
In accordance with ASC 820-10, TICC’s valuation procedures specifically provide for the review of indicative quotes supplied by the large agent banks that make a market for each security. However, the marketplace from which TICC obtains indicative bid quotes for purposes of determining the fair value of its
56
syndicated loan investments has shown attributes of illiquidity as described by ASC-820-10. During such periods of illiquidity, when TICC believes that the non-binding indicative bids received from agent banks for certain syndicated investments that we own may not be determinative of their fair value or when no market indicative quote is available, TICC may engage third-party valuation firms to provide assistance in valuing certain syndicated investments that TICC owns. In addition, TICC Management prepares an analysis of each syndicated loan, financial summary, covenant compliance review, recent trading activity in the security, if known, and other business developments related to the portfolio company. All available information, including non-binding indicative bids which may not be determinative of fair value, is presented to the Valuation Committee to consider in its determination of fair value. In some instances, there may be limited trading activity in a security even though the market for the security is considered not active. In such cases the Valuation Committee will consider the number of trades, the size and timing of each trade, and other circumstances around such trades, to the extent such information is available, in its determination of fair value. The Valuation Committee will evaluate the impact of such additional information, and factor it into its consideration of the fair value that is indicated by the analysis provided by third-party valuation firms, if any.
During the past seven years, TICC has acquired a number of debt and equity positions in CLO investment vehicles and more recently CLO warehouse investments. These investments are special purpose financing vehicles. In valuing such investments, TICC considers the indicative prices provided by a recognized industry pricing service as a primary source, and the implied yield of such prices, supplemented by actual trades executed in the market at or around period-end, as well as the indicative prices provided by the broker who arranges transactions in such investment vehicles. TICC also considers those instances in which the record date for an equity distribution payment falls on the last day of the period, and the likelihood that a prospective purchaser would require a downward adjustment to the indicative price representing substantially all of the pending distribution. Additional factors include any available information on other relevant transactions including firm bids and offers in the market and information resulting from bids-wanted-in-competition. In addition, TICC considers the operating metrics of the specific investment vehicle, including compliance with collateralization tests, defaulted and restructured securities, and payment defaults, if any. TICC Management or the Valuation Committee may request an additional analysis by a third-party firm to assist in the valuation process of CLO investment vehicles. All information is presented to TICC’s Board of Directors for its determination of fair value of these investments.
Bilateral investments for which market quotations are readily available are valued by an independent pricing agent or market maker. If such market quotations are not readily available, under the valuation procedures approved by TICC’s Board of Directors, upon the recommendation of the Valuation Committee, a third-party valuation firm will prepare valuations for each of TICC’s bilateral investments that, when combined with all other investments in the same portfolio company, (i) have a value as of the previous quarter of greater than or equal to 2.5% of its total assets as of the previous quarter, and (ii) have a value as of the current quarter of greater than or equal to 2.5% of its total assets as of the previous quarter, after taking into account any repayment of principal during the current quarter. In addition, in those instances where a third-party valuation is prepared for a portfolio investment which meets the parameters noted in (i) and (ii) above, the frequency of those third-party valuations is based upon the grade assigned to each such security under its credit grading system as follows: Grade 1, at least annually; Grade 2, at least semi-annually; Grades 3, 4, and 5, at least quarterly. Bilateral investments which do not meet the parameters in (i) and (ii) above are not required to have a third-party valuation and, in those instances, a valuation analysis will be prepared by TICC Management. TICC Management also retains the authority to seek, on TICC’s behalf, additional third party valuations with respect to both TICC’s bilateral portfolio securities and TICC’s syndicated loan investments. TICC’s Board of Directors retains ultimate authority as to the third-party review cycle as well as the appropriate valuation of each investment.
57
58
59
60
61
62
63
64
65
66
TICC has investments in its portfolio which contain a contractual payment-in-kind (“PIK”) provision. Certain PIK investments offer issuers the option at each payment date of making payments in cash or additional securities. PIK interest computed at the contractual rate is accrued into income and added to the principal balance on the capitalization date. Upon capitalization, PIK is subject to the fair value estimates associated with their related investments. PIK investments on non-accrual status are restored to accrual status once it becomes probable that PIK will be realized. To qualify for tax treatment as a RIC, this income must be paid out to stockholders in the form of distributions, even though TICC has not collected any cash. Amounts necessary to pay these distributions may come from available cash or the liquidation of certain investments.
See Note 16 to our consolidated financial statements for a description of recent accounting pronouncements, including the impact on our consolidated financial statements.
67
The total fair value of our investment portfolio was approximately $629.7 million and $656.7 million as of June 30, 2016 and December 31, 2015, respectively. The decrease in the value of investments during the six month period ended June 30, 2016, was due primarily to debt repayments and sales of securities totaling approximately $113.2 million, reductions to CLO equity cost value of $20.9 million and realized losses of $7.9 million, partially offset by purchases of investments of approximately $86.2 million and net unrealized appreciation on our investment portfolio of approximately $28.2 million.
During the quarter ended June 30, 2016, we closed approximately $73.4 million in portfolio investments, including additional investments of approximately $21.3 million in existing portfolio companies and approximately $52.1 million in new portfolio companies. For the year ended December 31, 2015, we closed approximately $234.8 million in portfolio investments, including additional investments of approximately $130.4 million in existing portfolio companies and approximately $104.4 million in new portfolio companies.
In certain instances, we receive payments based on scheduled amortization of the outstanding balances and sales of portfolio investments. In addition, we receive repayments of some of our debt investments prior to their scheduled maturity date. The frequency or volume of these repayments may fluctuate significantly from period to period. For the quarter ended June 30, 2016, we recognized proceeds of approximately $36.0 million from sales whereas, for the year ended December 31, 2015, we recognized proceeds of approximately $196.2 million from the sales of securities. Also, during the quarter ended June 30, 2016, we had repayments and amortization payments of approximately $60.0 million whereas, for the year ended December 31, 2015, we had repayments and amortization payments of approximately $224.2 million.
As of June 30, 2016, we had investments in debt securities of, or loans to, 42 portfolio companies, with a fair value of approximately $419.7 million, and equity investments of approximately $210.0 million. These debt investments included approximately $0.1 million in PIK interest, which, as described in “— Overview” above, is added to the carrying value of our investments, reduced by repayments of principal.
As of December 31, 2015, we had investments in debt securities of, or loans to, 45 portfolio companies, with a fair value of approximately $468.9 million, and equity investments of approximately $187.8 million. These debt investments included approximately $0.6 million in accrued PIK interest.
A reconciliation of the investment portfolio for the six months ended June 30, 2016 and the year ended December 31, 2015 follows:
68
The following table indicates the quarterly portfolio investment activity for the past six quarters:
The following table shows the fair value of our portfolio of investments by asset class as of June 30, 2016 and December 31, 2015:
Qualifying assets must represent at least 70% of the Company’s total assets at the time of acquisition of any additional non-qualifying assets. As of June 30, 2016, we held qualifying assets that represented 69.6% of our total assets which will prevent us from making further investments in non-qualifying assets until such time that our qualifying assets represent at least 70.0% of our total assets.
69
The following table shows our portfolio of investments by industry at fair value, as of June 30, 2016 and December 31, 2015:
We have adopted a credit grading system to monitor the quality of our debt investment portfolio. As of June 30, 2016 and December 31, 2015, our portfolio had a weighted average grade of 2.2 and 2.2, respectively, based upon the fair value of the debt investments in the portfolio. Equity securities and investments in CLOs are not graded.
70
At June 30, 2016 and December 31, 2015, our debt investment portfolio was graded as follows:
We expect that a portion of our investments will be in the grades 3, 4 or 5 categories from time to time, and, as such, we will be required to work with troubled portfolio companies to improve their business and protect our investment. The number and amount of investments included in grades 3, 4 or 5 may fluctuate from period to period.
Further discussion regarding the other investments which experienced significant unrealized depreciation is presented in “Results of Operations.”
71
Set forth below is a comparison of our results of operations for the three months ended June 30, 2016 to the three months ended June 30, 2015.
Investment income for the three months ended June 30, 2016 and June 30, 2015 was approximately $17.0 million and $23.8 million, respectively, reflecting a decrease of $6.8 million. The following tables set forth the components of investment income for the three months ended June 30, 2016 and June 30, 2015:
The decrease in total investment income was primarily due to a reduction of income from securitization vehicles of $1.6 million resulting from lower yields due to the recent volatility in the corporate loan market and a lower cost basis in the CLO equity portfolio, a decrease in interest income of $4.2 million due to lower yields and a smaller portfolio resulting from loan sales to fund the strategic repayment of the TICC Funding credit facility, and a $0.8 million decrease in total commitment, amendment and other fee income primarily due to non-recurring fees earned during the three month period ended June 30, 2015. The total principal value of income producing debt investments as of June 30, 2016 and June 30, 2015 was approximately $449.0 million and $683.8 million, respectively.
As of June 30, 2016, our debt investments had stated interest rates of between 4.25% and 15.00% and maturity dates of between 27 and 98 months compared to stated interest rates of 4.00% to 15.00% and maturity dates between 13 and 103 months as of June 30, 2015. In addition, our total portfolio had a weighted average yield on debt investments of approximately 7.5%, compared with 7.6% as of June 30, 2015. The reduction in the weighted average yield on our debt portfolio over the past year is primarily a result of our investment in RBS Holding Company being placed on non-accrual during the fourth quarter of 2015 and yield compression resulting from loan repricing for the majority of the period.
Expenses before incentive fees for the quarter ended June 30, 2016 were approximately $9.0 million, which decreased approximately $3.3 million from the quarter ended June 30, 2015, attributable to lower investment advisory fees, interest expense and compensation expense partially offset by higher professional fees and general and administrative expenses. Expenses before incentive fees for the quarter ended June 30, 2015 were approximately $12.3 million.
The investment advisory fee for the quarter ended June 30, 2016 were approximately $2.4 million, representing the base fee as provided for in the Investment Advisory Agreement. The investment advisory fee for the quarter ended June 30, 2015 was approximately $5.3 million. The investment advisory fee for the quarter ended June 30, 2016 was lower because the weighted average gross assets declined due largely to
72
lower fair values, the previously announced fee reduction from 2.0% to 1.5% of gross assets and the sale of certain assets to pay-off the TICC Funding credit facility during the fourth quarter of 2015. At June 30, 2016 and December 31, 2015, approximately $3.7 million and $4.2 million, respectively, of investment advisory fees remained payable to TICC Management, including the net investment income incentive fee discussed below.
Interest expense and other debt financing expenses for the first quarter of 2016 were approximately $4.4 million, which was directly related to our TICC CLO 2012-1 debt and 7.50% Senior Convertible Notes due 2017 (“Convertible Notes”) compared with interest expense and other debt financing expenses of approximately $5.0 million for the quarter ended June 30, 2015. The primary driver of the decrease was the pay-off of the TICC Funding credit facility in the fourth quarter of 2015, partially off-set by higher interest rates on the variable rate debt of TICC CLO 2012-1.
The aggregate accrued interest which remained payable at June 30, 2016, was approximately $2.2 million, comprised of $0.8 million for the notes of TICC CLO 2012-1 and $1.4 million for the Convertible Notes. The aggregate interest payable at December 31, 2015, was approximately $2.1 million.
Professional fees, consisting of legal, financial advisory, valuation, audit and tax fees, were approximately $1.2 million for the quarter ended June 30, 2016, compared to approximately $0.9 million for the quarter ended June 30, 2015. This represented an increase of approximately $1.1 million primarily due to the engagement of legal and financial advisors to the Special Committee of the Board of Directors, partially offset by an insurance recovery of approximately $0.8 million related to previously incurred legal costs.
Compensation expenses were approximately $0.2 million for the quarter ended June 30, 2016 compared to approximately $0.4 million for the quarter ended June 30, 2015, reflecting the allocation of compensation expenses for the services of our chief financial officer, accounting personnel, and other administrative support staff. This decrease was largely the result of staffing changes.
General and administrative expenses, consisting primarily of directors’ fees, insurance, listing fees, transfer agent and custodian fees, office supplies, facilities costs and other expenses, were approximately $0.8 million for the three months ended June 30, 2016 compared to approximately $0.7 million for the three months ended June 30, 2015. Office supplies, facilities costs and other expenses are allocated to us under the terms of the Administration Agreement.
The net investment income incentive fee recorded for the three months ended June 30, 2016 was $1.2 million compared to $0.5 million in the three months ended June 30, 2015. This increase results from modifications made to the incentive fee calculation as described below.
73
The capital gains incentive fee expense, as reported under GAAP, is calculated on the basis of net realized and unrealized gains and losses at the end of each period. The expense related to the hypothetical liquidation of the portfolio (and assuming no other changes in realized or unrealized gains and losses) would only become payable to our investment adviser in the event of a complete liquidation of our portfolio as of period end and the termination of the Investment Advisory Agreement on such date. For the three months ended June 30, 2016 and June 30, 2015, no accrual was required as a result of the impact of accumulated net unrealized depreciation on our portfolio.
The amount of the capital gains incentive fee which will actually be payable is determined in accordance with the terms of the Investment Advisory Agreement and is calculated as of the end of each calendar year (or upon termination of the Investment Advisory Agreement). The terms of the Investment Advisory Agreement state that the capital gains incentive fee calculation is based on net realized gains, if any, offset by gross unrealized depreciation for the calendar year. No effect is given to gross unrealized appreciation in this calculation. For the year ended December 31, 2015, such an accrual was not required under the terms of the Investment Advisory Agreement.
For the three months ended June 30, 2016, we recognized net realized losses on investments of approximately $7.3 million, which primarily reflects the losses from the sale of several CLO equity investments and the sale of our equity investment in Algorithmic Implementations, Inc. (d/b/a “Ai Squared”).
For the three months ended June 30, 2016, our net change in unrealized appreciation/depreciation was approximately $48.8 million primarily due to improvements in the corporate loan market, composed of $42.1 million in gross unrealized appreciation, $5.3 million in gross unrealized depreciation and approximately $12.0 million relating to the reversal of prior period net unrealized depreciation as investment gains and losses were realized. This includes net unrealized appreciation of approximately $9.5 million as a result of reductions to the cost value of our CLO equity investments under the effective yield accounting methodology, whereby the cost value of the respective investments are reduced by the excess of actual cash received (and record date distributions to be received) over the calculated income using the effective yield.
74
The most significant components of the net change in unrealized appreciation and depreciation during the three months ended June 30, 2016 were as follows:
For the quarter ended June 30, 2015, we recorded net realized gains on investments of approximately $4.1 million, which primarily reflects the gains from the sale of our equity investment held in Merrill Communications LLC (approximately $2.8 million) and from the repayment of our debt investment held in Merrill Communications LLC (approximately $2.6 million).
Based upon the fair value determinations made in good faith by the Board of Directors, during the quarter ended June 30, 2015, we had net unrealized depreciation of approximately $5.0 million, composed of $7.5 million in gross unrealized appreciation, $11.4 million in gross unrealized depreciation and approximately $1.1 million relating to the reversal of prior period net unrealized depreciation as investments were realized. This includes net unrealized appreciation of approximately $9.9 million as a result of reductions to the cost value of our CLO equity investments under the effective yield accounting methodology, whereby the cost value of the respective investments are reduced by the excess of actual cash received (and record date distributions to be received) over the calculated income using the effective yield.
75
The most significant changes in net unrealized appreciation and depreciation during the quarter ended June 30, 2015 were as follows (in millions):
Net investment income for the three months ended June 30, 2016 and June 30, 2015 was approximately $6.8 million and $10.9 million, respectively, or a decrease of $4.1 million. The decrease was largely the result of a decrease in investment income of $6.7 million and a reduction in total expenses of $2.6 million, as discussed above.
For the three months ended June 30, 2016, the net increase in net assets resulting from net investment income per common share was $0.13 (basic and diluted), compared to the net increase in net assets resulting from net investment income per share of $0.18 (basic and diluted) for the three months ended June 30, 2015. Due to the anti-dilutive effect on the computation of diluted earnings per share for the three months ended June 30, 2016 and 2015, the adjustments for interest on Convertible Notes, investment advisory fees, deferred issuance costs and net investment income incentive fees as well as adjustments for dilutive effect of Convertible Notes were excluded from the respective period’s diluted earnings per share computation.
For the three months ended June 30, 2016, the net increase in the net assets resulting from core net investment income per common share was $0.32 (basic and diluted), compared to $0.32 (basic and diluted) for the three months ended June 30, 2015.
Please see “— Supplemental Information Regarding Core Net Investment Income” below for more information.
Net increase in net assets resulting from operations for the three months ended June 30, 2016 and June 30, 2015 was approximately $48.3 million and $10.0 million, respectively, or an increase of approximately $38.3 million. This increase was largely due to an increase in unrealized appreciation on investments of $53.8 million, partially offset by a decrease in net investment income of $4.1 million and a decrease in net realized losses of $11.4 million.
For the three months ended June 30, 2016, the net increase in net assets resulting from operations per common share was $0.93 (basic) and $0.81 (diluted), compared to a net increase in net assets resulting from operations per share of approximately $0.17 (basic and diluted) for the three months ended June 30, 2015. Due to the anti-dilutive effect on the computation of diluted earnings per share for the three months ended June 30, 2015, the adjustments for interest on Convertible Notes, investment advisory fees, deferred issuance costs and net investment income incentive fees as well as adjustments for dilutive effect of Convertible Notes were excluded from the respective period’s diluted earnings per share computation.
76
Investment income for the six months ended June 30, 2016 and June 30, 2015 was approximately $32.3 million and $45.5 million, respectively, reflecting a decrease of $13.2 million. The following tables set forth the components of investment income for the six months ended June 30, 2016 and June 30, 2015:
The decrease in total investment income was primarily due to a reduction of income from securitization vehicles of $3.9 million resulting from lower yields due to the recent volatility in the corporate loan market and a lower cost basis in the CLO equity portfolio, a decrease in interest income of $8.5 million due to lower yields and a smaller portfolio resulting from loan sales to fund the repayment of the TICC Funding credit facility, and a $0.8 million decrease in total commitment, amendment and other fee income primarily due to non-recurring fees earned during the six month period ended June 30, 2015. The total principal value of income producing debt investments as of June 30, 2016 and June 30, 2015 was approximately $449.0 million and $683.8 million, respectively.
Expenses before incentive fees for the six months ended June 30, 2016 were approximately $20.2 million, which decreased approximately $3.6 million from the six months ended June 30, 2015, attributable to lower investment advisory fees, interest expense and compensation expense partially offset by higher professional fees and general and administrative expenses. Expenses before incentive fees for the six months ended June 30, 2015 were approximately $23.8 million.
The investment advisory fee for the six months ended June 30, 2016 was approximately $6.1 million, representing the base fee as provided for in the Investment Advisory Agreement. The investment advisory fee for the six months ended June 30, 2015 was approximately $10.3 million. The investment advisory fee for the six months ended June 30, 2016 was lower because the weighted average gross assets declined due largely to lower fair values, the previously announced fee reduction from 2.0% to 1.5% of gross assets and the sale of
77
certain assets to pay-off the TICC Funding credit facility during the fourth quarter of 2015. At June 30, 2016 and December 31, 2015, approximately $3.7 million and $4.2 million, respectively, of investment advisory fees remained payable to TICC Management, including the net investment income incentive fee discussed below.
Interest expense and other debt financing expenses for the six months ended June 30, 2016 were approximately $8.8 million, which was directly related to our TICC CLO 2012-1 debt and Convertible Notes compared with interest expense and other debt financing expenses of approximately $9.9 million for the six months ended June 30, 2015. The primary driver of the decrease was the pay-off of the TICC Funding credit facility in the fourth quarter of 2015, partially off-set by higher interest rates on the variable rate debt of TICC CLO 2012-1.
Professional fees, consisting of legal, financial advisory, valuation, audit and tax fees, were approximately $3.2 million for the six months ended June 30, 2016, compared to approximately $1.5 million for the six months ended June 30, 2015. This represented an increase of approximately $2.5 million primarily due to the engagement of legal and financial advisors to the Special Committee of the Board of Directors, partially offset by an insurance recovery of approximately $0.8 million related to previously incurred legal costs.
Compensation expenses were approximately $0.4 million for the six months ended June 30, 2016 compared to approximately $0.9 million for the six months ended June 30, 2015, reflecting the allocation of compensation expenses for the services of our chief financial officer, accounting personnel, and other administrative support staff. This decrease was largely the result of staffing changes.
General and administrative expenses, consisting primarily of directors’ fees, insurance, listing fees, transfer agent and custodian fees, office supplies, facilities costs and other expenses, were approximately $1.7 million for the six months ended June 30, 2016 compared to approximately $1.2 million for the six months ended June 30, 2015. Office supplies, facilities costs and other expenses are allocated to us under the terms of the Administration Agreement. The increase is largely the result of non-recurring costs related to the Ai Squared transaction of approximately $0.3 million.
The net investment income incentive fee recorded for the six months ended June 30, 2016 was $1.2 million compared to $(1.5) million for the six months ended June 30, 2015. The six months ended June 30, 2015 represents a credit for net investment income incentive fees of approximately $1.5 million comprised of the fee reversal of approximately $2.4 million recorded during the first quarter ended March 31, 2015 (representing the cumulative overstatement of incentive fees resulting from the identification and correction of a non-material error in our accounting policy for revenue recognition — refer to “Note 3. Change in Accounting for Collateralized Loan Obligation Equity Investment Income” in the notes to our consolidated financial statements), partially offset by the net investment income incentive fees earned for the six months ended June 30, 2015 of approximately $867,000. This increase results from the $2.4 million reversal not recurring in the current period and modifications to the incentive fee calculation described below.
In March 2016, TICC Management, LLC, in consultation with the Independent Directors, agreed to a series of ongoing fee waivers with respect to its management fee and income incentive fee. Under the terms of the fee waiver letter, which took effect on April 1, 2016:
78
The capital gains incentive fee expense, as reported under GAAP, is calculated on the basis of net realized and unrealized gains and losses at the end of each period. The expense related to the hypothetical liquidation of the portfolio (and assuming no other changes in realized or unrealized gains and losses) would only become payable to our investment adviser in the event of a complete liquidation of our portfolio as of period end and the termination of the Investment Advisory Agreement on such date. For the six months ended June 30, 2016 and June 30, 2015, no accrual was required as a result of the impact of accumulated net unrealized depreciation on our portfolio.
For the six months ended June 30, 2016, we recognized net realized losses on investments of approximately $7.9 million, which primarily reflects the losses from the sale of several CLO equity investments and the sale of our equity investment in Ai Squared.
For the six months ended June 30, 2016, our net change in unrealized appreciation/depreciation was approximately $28.2 million, composed of $35.2 million in gross unrealized appreciation, $21.3 million in gross unrealized depreciation and approximately $14.3 million relating to the reversal of prior period net unrealized depreciation as investment gains and losses were realized. This includes net unrealized appreciation of approximately $20.9 million as a result of reductions to the cost value of our CLO equity investments under the effective yield accounting methodology, whereby the cost value of the respective investments are reduced by the excess of actual cash received (and record date distributions to be received) over the calculated income using the effective yield.
79
The most significant components of the net change in unrealized appreciation and depreciation during the six months ended June 30, 2016 were as follows:
For the six months ended June 30, 2015, we recorded net realized losses on investments of approximately $2.6 million, which represents the losses from the restructuring of our debt investment in Unitek Global Services, Inc. (approximately $4.3 million) and from the repayment of our debt and equity investment in Nextag, Inc. (approximately $2.5 million) partially offset by realized gains from the sale of our equity investment held in Merrill Communications LLC (approximately $2.8 million) and from the repayment of our debt investment held in Merrill Communications LLC (approximately $2.6 million).
Based upon the fair value determinations made in good faith by the Board of Directors, during the six months ended June 30, 2015, we had net unrealized appreciation of approximately $10.2 million, composed of $14.1 million in gross unrealized appreciation, $11.1 million in gross unrealized depreciation and approximately $7.2 million relating to the reversal of prior period net unrealized depreciation as investments were realized.
80
The most significant changes in net unrealized appreciation and depreciation during the six months ended June 30, 2015 were as follows (in millions):
Net investment income for the six months ended June 30, 2016 and June 30, 2015 was approximately $10.8 million and $23.2 million, respectively, or a decrease of $12.4 million. The decrease was largely the result of a decrease in investment income of $13.2 million and a reduction in total expenses of $0.9 million, as discussed above.
For the six months ended June 30, 2016, the net increase in net assets resulting from net investment income per common share was $0.21 (basic and diluted), compared to the net increase in net assets resulting from net investment income per share of $0.39 (basic) and $0.38 (diluted) for the six months ended June 30, 2015. Due to the anti-dilutive effect on the computation of diluted earnings per share for the six months ended June 30, 2016, the adjustments for interest on Convertible Notes, investment advisory fees, deferred issuance costs and net investment income incentive fees as well as adjustments for dilutive effect of Convertible Notes were excluded from the respective period’s diluted earnings per share computation.
For the six months ended June 30, 2016, the net increase in the net assets resulting from core net investment income per common share was $0.61 (basic and diluted), compared to $0.70 (basic) and $0.65 (diluted) for the six months ended June 30, 2015.
Net increase in net assets resulting from operations for the six months ended June 30, 2016 and June 30, 2015 was approximately $30.9 million and $30.9 million, respectively.
For the six months ended June 30, 2016, the net increase in net assets resulting from operations per common share was $0.59 (basic) and $0.57 (diluted), compared to a net increase in net assets resulting from operations per share of approximately $0.51 (basic) and $0.49 (diluted) for the six months ended June 30, 2015.
81
On a supplemental basis, we provide information relating to 1) core net investment income and 2) the ratio of core net investment income to net assets, which are non-GAAP measures. These measures are provided in addition to, but not as a substitute for, net investment income. Our non-GAAP measures may differ from similar measures by other companies, even if similar terms are used to identify such measures. Core net investment income represents net investment income adjusted for additional cash distributions received, or entitled to be received (if any, in either case), on our CLO equity investments.
Income from investments in the “equity” class securities of CLO vehicles, for GAAP purposes, is recorded using the effective interest method based upon an effective yield to the expected redemption utilizing estimated cash flows, compared to the cost resulting in an effective yield for the investment; the difference between the actual cash received or distributions entitled to be received and the effective yield calculation is an adjustment to cost. Accordingly, investment income recognized on CLO equity securities in the GAAP statement of operations differs from the cash distributions actually received by us during the period, (referred to below as “CLO equity additional distributions”).
Further, as the RIC requirements are to distribute taxable earnings, core net investment income may provide a better indication of estimated taxable income for a reporting period than does GAAP net investment income, although we can offer no assurance that will be the case as the ultimate tax character of our earnings cannot be determined until tax returns are prepared after the end of a fiscal year. We note that these non-GAAP measures may not be useful indicators of taxable earnings, particularly during periods of market disruption and volatility.
The following tables provide a reconciliation of net investment income to core net investment income for the three and six months ended June 30, 2016 and 2015, respectively:
In addition, the following ratio is presented to supplement the financial highlights included in “Note 15. Financial Highlights” in the notes to our consolidated financial statements:
82
The following table provides a reconciliation of the ratio of net investment income to average net assets to the ratio of core net investment income to average net assets for the three and six months ended June 30, 2016 and 2015, respectively:
83
As of June 30, 2016, cash and cash equivalents were $13.5 million as compared to $23.2 million at December 31, 2015. For the six months ended June 30, 2016, net cash provided by operating activities for the period, consisting primarily of the items described in “— Results of Operations,” was approximately $67.4 million, largely reflecting proceeds from principal repayments and reductions to cost value and sales of investments of approximately $121.0 million and reductions to CLO equity cost value of $20.9 million partially offset by purchases of new investments of approximately $83.5 million and net change in unrealized depreciation/appreciation of $28.2 million. For the three months ended June 30, 2016, net cash used in investing activities of approximately $21.7 million reflects the change in restricted cash in the 2012 Securitization Issuance. For the three months ended June 30, 2016, net cash used by financing activities was approximately $55.4 million, reflecting the distribution of dividends and repurchase of common stock.
From time to time, we may seek to retire, repurchase, or exchange debt securities in open market purchases or by other means dependent on market conditions, liquidity, contractual obligations, and other matters.
A summary of our significant contractual payment obligations as of June 30, 2016 is as follows:
See also “Note 7. Borrowings” in the notes to our consolidated financial statements.
We currently have no off-balance sheet arrangements, including any risk management of commodity pricing or other hedging practices.
On November 5, 2015, the Board of Directors authorized a program for the purpose of repurchasing up to $75 million worth of the Company’s common stock. Under this repurchase program, we were authorized, but we were not obligated, to repurchase outstanding common stock in the open market from time to time through June 30, 2016, provided that repurchases comply with the prohibitions under the Company’s Insider Trading Policies and Procedures and the guidelines specified in Rule 10b-18 of the Securities Exchange Act of 1934, as amended, including certain price, market volume and timing constraints. Further, any repurchases must be conducted in accordance with the 1940 Act. The Company did not repurchase any shares during the quarter ended June 30, 2016 and the repurchase program expired on June 30, 2016.
84
85
The proceeds of the private placement of the Classes A, B, C, D and 2012 Subordinated Notes of the 2012 Securitization Issuer, net of discount and debt issuance costs, were used for investment purposes. As part of the securitization, we entered into a master loan sale agreement with TICC CLO 2012-1 pursuant to which we agreed to sell or contribute certain senior secured and second lien loans (or participation interests therein)
86
to TICC CLO 2012-1, and to purchase or otherwise acquire the 2012 Subordinated Notes. The Classes A, B, C, D and 2012 Subordinated Notes of the 2012 Securitization Issuer are the secured obligations of TICC CLO 2012-1, and an indenture governing the notes of the 2012 Securitization Issuer includes customary covenants and events of default.
The aggregate accrued interest payable on the notes of the 2012 Securitization Issuer at June 30, 2016 was approximately $0.8 million. Deferred debt issuance costs consist of fees and expenses incurred in connection with debt offerings. As of June 30, 2016, TICC had a deferred debt issuance balance of approximately $2.5 million associated with this securitization. Aggregate net discount on the notes of the 2012 Securitization Issuer at the time of issuance totaled approximately $4.9 million. These amounts are being amortized and included in interest expense in the consolidated statements of operations over the term of the debt securitization. The following table sets forth the components of interest expense, effective annualized average interest rates, and cash paid for interest of the Class A-1, B-1, C-1 and D-1 for the three and six months ended June 30, 2016 and 2015, respectively:
87
On September 26, 2012, the Company issued $105.0 million aggregate principal amount of the 7.50% Senior Convertible Notes due 2017 (“Convertible Notes”) and an additional $10.0 million aggregate principal amount of the Convertible Notes was issued on October 22, 2012 pursuant to the exercise of the initial purchasers’ option to purchase additional Convertible Notes. The Convertible Notes bear interest at a rate of 7.50% per year, payable semi-annually in arrears on May 1 and November 1 of each year, commencing on May 1, 2013. The Convertible Notes are convertible into shares of TICC’s common stock based on an initial conversion rate of 87.2448 shares of its common stock per $1,000 principal amount of Convertible Notes, which is equivalent to an initial conversion price of approximately $11.46 per share of common stock. The conversion price for the Convertible Notes will be reduced for quarterly cash distributions paid to common shares to the extent that the quarterly distribution exceeds $0.29 cents per share, subject to adjustment. The Convertible Notes mature on November 1, 2017, unless previously converted in accordance with their terms. TICC does not have the right to redeem the Convertible Notes prior to maturity. The aggregate accrued interest payable on the Convertible Notes at June 30, 2016 was approximately $1.4 million. Deferred debt
88
issuance costs represent fees and other direct incremental costs incurred in connection with the Convertible Notes. As of June 30, 2016, the Company had a deferred debt issuance balance of approximately $0.8 million. This amount is being amortized and is included in interest expense in the consolidated statements of operations over the term of the Convertible Notes.
In order to qualify for tax treatment as a RIC and to avoid corporate level tax on the income we distribute to our stockholders, we are required, under Subchapter M of the Code, to distribute at least 90% of our ordinary income and short-term capital gains to our stockholders on an annual basis.
Effective January 1, 2015, we recorded interest from our investments in the equity class securities of CLO vehicles using the effective interest method in accordance with the provisions of ASC 325-40, Beneficial Interests in Securitized Financial Assets, based upon an estimation of an effective yield to the expected redemption utilizing estimated cash flows, including those CLO equity investments that have not made their inaugural distribution for the relevant period end. We monitor the expected residual payments, and effective yield is determined and updated periodically, as needed. Accordingly, investment income recognized on CLO equity securities in the GAAP statement of operations differs from both the tax-basis investment income and from the cash distributions we actually received during the period. CLO entities generally constitute “passive foreign investment companies” and are subject to complex tax rules; the calculation of taxable income attributed to a CLO equity investment can be dramatically different from the calculation of income for
89
financial reporting purposes. Taxable income is based upon the distributable share of earnings as determined under tax regulations for each CLO equity investment, while accounting income is recorded using the effective yield method. This method requires the calculation of an effective yield to expected redemption based upon an estimation of the amount and timing of future cash flows, including recurring cash flows as well as future principal repayments; the difference between the actual cash received (and record date distributions to be received) and the effective yield income calculation is an adjustment to cost. The effective yield is reviewed quarterly and adjusted as appropriate. Our final taxable earnings for the year ended December 31, 2015 will not be known until our tax returns are filed, but our experience has been that cash flows have historically represented a reasonable estimate of taxable earnings. While GAAP accounting income from our CLO equity class investments for the three months ended June 30, 2016 was approximately $8.0 million, we received or were entitled to receive approximately $17.5 million in distributions. Our distribution policy is based upon our estimate of our taxable net investment income, which includes actual distributions from our CLO equity class investments, with further consideration given to our realized gains or losses on a taxable basis.
The following table reflects the cash distributions, including dividends and returns of capital, if any, per share that our Board of Directors has declared on our common stock since the beginning of 2014:
We have a number of business relationships with affiliated or related parties, including the following:
We have entered into the Investment Advisory Agreement with TICC Management. TICC Management is controlled by BDC Partners, its managing member. BDC Partners, as the managing member of TICC Management, manages the business and internal affairs of TICC Management. In addition, BDC Partners provides us with office facilities and administrative services pursuant to the Administration Agreement. Mr. Cohen is the managing member of and controls BDC Partners. Mr. Rosenthal is also the President of TICC Management and a member of BDC Partners.
Mr. Royce has a minority, non-controlling interest in TICC Management, but he does not take part in the management or participate in the operations of TICC Management; however, Mr. Royce has agreed to make himself available to TICC Management to provide certain consulting services without compensation.
90
Messrs. Cohen and Rosenthal currently serve as Chief Executive Officer and President, respectively, of Oxford Lane Capital Corp., a non-diversified closed-end management investment company that currently invests primarily in debt and equity tranches of CLO vehicles, and its investment adviser, Oxford Lane Management. Messrs. Cohen and Rosenthal also currently serve as Chief Executive Officer and President, respectively, at Oxford Bridge Management, LLC, the investment adviser to Oxford Bridge, LLC, a private fund that invests principally in the equity of CLOs. BDC Partners is the managing member of Oxford Bridge Management, LLC. As a result, Messrs. Cohen and Rosenthal may be subject to certain conflicts of interests with respect to their management of our portfolio on the one hand, and their respective obligations to manage Oxford Lane Capital Corp. and Oxford Bridge, LLC on the other hand.
BDC Partners has adopted a written policy with respect to the allocation of investment opportunities among TICC, Oxford Lane Capital Corp. and Oxford Bridge, LLC in view of the potential conflicts of interest raised by the relationships described above. The allocation policy generally provides that, depending on size and subject to current and anticipated cash availability, among other factors, investments that are suitable for more than one entity will be allocated on a pro rata basis, based on each entity’s order size.
In the ordinary course of business, we may enter into transactions with portfolio companies that may be considered related party transactions. In order to ensure that we do not engage in any prohibited transactions with any persons affiliated with us, we have implemented certain policies and procedures whereby our executive officers screen each of our transactions for any possible affiliations between the proposed portfolio investment, us, companies controlled by us and our employees and directors. We will not enter into any agreements unless and until we are satisfied that doing so will not raise concerns under the 1940 Act or, if such concerns exist, we have taken appropriate actions to seek board review and approval or exemptive relief for such transaction. Our Board of Directors reviews these procedures on an annual basis.
We have also adopted a Code of Ethics which applies to, among others, our senior officers, including our Chief Executive Officer and Chief Financial Officer, as well as all of our officers, directors and employees. Our Code of Ethics requires that all employees and directors avoid any conflict, or the appearance of a conflict, between an individual’s personal interests and our interests. Pursuant to our Code of Ethics, each employee and director must disclose any conflicts of interest, or actions or relationships that might give rise to a conflict, to our Chief Compliance Officer. Our Audit Committee is charged with approving any waivers under our Code of Ethics. As required by the NASDAQ Global Select Market corporate governance listing standards, the Audit Committee of our Board of Directors is also required to review and approve any transactions with related parties (as such term is defined in Item 404 of Regulation S-K).
Information concerning related party transactions is included in the consolidated financial statements and related notes, appearing elsewhere in this quarterly report on Form 10-Q.
91
On July 28, 2016, the Board of Directors declared a distribution of $0.29 per share for the third quarter, payable on September 30, 2016 to shareholders of record as of September 16, 2016.
We are subject to financial market risks, including changes in interest rates. As of June 30, 2016, one debt investment in our portfolio was at a fixed rate, and the remaining 51 debt investments were at variable rates, representing approximately $0.6 million and $471.2 million in principal debt, respectively. At June 30, 2016, approximately $448.4 million of our variable rate investments were income producing. The variable rates are based upon the five-year Treasury note, the Prime rate or LIBOR, and, in the case of our bilateral investments, are generally reset annually, whereas our non-bilateral investments generally reset quarterly. We expect that future debt investments will generally be made at variable rates. Many of the variable rate investments contain floors.
To illustrate the potential impact of a change in the underlying interest rate on our net investment income as it pertains to our debt portfolio, we have assumed a 1% increase in the underlying five-year Treasury note, the Prime rate or LIBOR, and no other change in our portfolio as of June 30, 2016. We have also assumed outstanding variable rate borrowings of $240 million. Under this analysis, net investment income would increase by $0.4 million on an annualized basis, reflecting the amount of investments in our portfolio which have implied floors that would be unaffected by a 1% change in the underlying interest rate. However, if the increase in rates was more significant, such as 5%, the net effect on net investment income would be an increase of approximately $9.6 million. To the extent that the rate underlying certain investments, as well as our borrowings, is at an historic low, it is not possible for the underlying rate to decrease by 1% or 5%. If the underlying rate decreased to 0%, it would have a minimal effect on net investment income. Although management believes that this analysis is indicative of our existing interest rate sensitivity, it does not adjust for changes in the credit quality, size and composition of our portfolio, and other business developments, including a change in the level of our borrowings, that could affect the net increase (or decrease) in net assets resulting from operations. Accordingly, no assurances can be given that actual results would not differ materially from the results under this hypothetical analysis.
In addition, to illustrate the impact of a change in the underlying interest rate on our core net investment income as it pertains to our CLO equity investments, we have assumed a 1% increase in the underlying three-month LIBOR, and no other change in our CLO portfolio, or to any of the credit, spread, default rate or other factors, as of June 30, 2016. Under this analysis, the effect on core net investment income would be a decrease of approximately $12.2 million on an annualized basis, reflecting the portfolio assets held within these CLO vehicles which have implied floors that would be unaffected by a 1% change in the underlying interest rate, compared to the debt carried by those CLO vehicles which are at variable rates and which would be affected by a change in three-month LIBOR. If the increase in three-month LIBOR was more significant, such as 5%, the net effect on core net investment income would be a decrease of approximately $1.2 million. Although management believes that this analysis is indicative of our existing interest rate sensitivity, it does not adjust for changes in any of the other assumptions that effect the return on CLO equity investments, both positively and negatively (and which could accompany changes to the three-month LIBOR rate), such as default rates, recovery rates, prepayment rates and reinvestment rates, that could affect the net increase (or decrease) in net assets resulting from operations. Accordingly, no assurances can be given that actual results would not differ materially from the results under this hypothetical analysis.
We may in the future hedge against interest rate fluctuations by using standard hedging instruments such as futures, options and forward contracts. 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 the investments in our portfolio with fixed interest rates.
92
As of June 30, 2016 (the end of the period covered by this report), we, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended). Based on that evaluation, our management, including the Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective and provided reasonable assurance that information required to be disclosed in our periodic SEC filings is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. However, in evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of such possible controls and procedures.
There have been no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended) that occurred during the quarter ended June 30, 2016 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
93
We and our consolidated subsidiaries are not currently subject to any material legal proceedings. From time to time, we and our consolidated subsidiaries may be a party to certain legal proceedings in the ordinary course of business, including proceedings relating to the enforcement of our rights under contracts with our portfolio companies. While the outcome of these legal proceedings cannot be predicted with certainty, we do not expect that these proceedings will have a material effect upon our financial condition or results of operations.
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Item 1A. Risk Factors in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015, which could materially affect our business, financial condition and/or operating results. The risks described in our Annual Report on Form 10-K are not the only risks facing our company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially and adversely affect our business, financial condition and/or operating results. There have been no material changes during the six months ended June 30, 2016 to the risk factors discussed in Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2015.
We did not engage in unregistered sales of equity securities during the three months ended June 30, 2016, and we did not issue shares of common stock under our distribution reinvestment plan.
None.
Not applicable.
94
The following exhibits are filed as part of this report or hereby incorporated by reference to exhibits previously filed with the SEC:
95
96
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.
By:
/s/ Jonathan H. Cohen Jonathan H. Cohen Chief Executive Officer (Principal Executive Officer)
/s/ Bruce L. Rubin Bruce L. Rubin Chief Financial Officer (Principal Accounting Officer)
97