Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollar amounts in thousands, except per share data, unless otherwise indicated)
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes in Part II, Item 8 of this Form 10-K “Financial Statements and Supplementary Data.” This discussion contains forward-looking statements and involves numerous risks and uncertainties, including, but not limited to those described in Part I, Item 1A of this Form 10-K “Risk Factors.” Our actual results could differ materially from those anticipated by such forward-looking information due to factors discussed under “Risk Factors” and “Cautionary Statement Regarding Forward-Looking Statements” appearing elsewhere in this Form 10-K.
Overview
Carlyle Secured Lending III, a Delaware statutory trust, is a specialty finance company that is a closed-end, externally managed, non-diversified management investment company. We have elected to be regulated as a business development company (“BDC”) under the Investment Company Act and have operated our business as a BDC since we began our investment activities. For U.S. federal income tax purposes, we have elected to be treated as a registered investment company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (together with the rules and regulations promulgated thereunder, the “Code”) beginning with the year ending December 31, 2022. We were formed on February 8, 2021 and commenced our operations on May 28, 2021. We conducted the Private Offering of our Shares to investors in reliance on exemptions from the registration requirements provided by Section 4(a)(2) of the Securities Act, Regulation D promulgated thereunder and Regulation S under the Securities Act. Our principal executive offices are located at One Vanderbilt Avenue, Suite 3400, New York, New York 10017.
Our investment objective is to generate current income and, to a lesser extent, capital appreciation primarily through assembling a portfolio of secured debt investments with favorable risk-adjusted returns. Our investment strategy seeks to extract enhanced yield from a directly originated, and defensively constructed, portfolio of credit investments. The strategy’s core focus is U.S. middle market cash flow finance, principally in companies supported by financial sponsors. This core strategy is opportunistically supplemented with differentiated and complementary lending and investing strategies, which take advantage of the broad capabilities of Carlyle’s Global Credit platform while offering risk-diversifying portfolio benefits. In describing our business, we use the term “middle market” to refer generally to companies with approximately $25 million to $100 million of earnings before interest, taxes, depreciation and amortization (“EBITDA”). We seek to achieve our investment objective primarily through a portfolio weighted towards first lien loans or unitranche loans (including last out portions of such loans), while a minority of our portfolio may also include, but not be limited to, assets such as second lien loans, unsecured debt, subordinated debt and select investments in preferred and common equities with loans that typically have a contractual maturity of six to seven years and typically do not early repayment.
We are externally managed by our Investment Adviser, an investment adviser registered under the Investment Advisers Act of 1940, as amended (together with the rules and regulations promulgated thereunder, the “Investment Company Act”) and a subsidiary of Carlyle. We benefit from our Investment Adviser’s investment team of over 200 investment professionals with the deep knowledge and expertise across multiple asset classes who are supported by a team of finance, operations and administrative professionals currently employed by Carlyle Employee Co., a wholly owned subsidiary of Carlyle. In conducting our investment activities, we believe that we benefit from the significant scale, relationships and resources of Carlyle, including our Investment Adviser and its affiliates.
2023 Highlights
2023 Annual Results
• Net investment income was $18.5 million or $2.64 per Share. Dividends declared on Shares were $14.6 million, or $2.08 per Share. Net investment income for the year ended December 31, 2023 included a $26.6 million increase in total investment income from the comparable period in 2022.
• The December 31, 2023 NAV per Share of $21.07 increased by $1.38 from the comparable period in 2022, driven by net investment income in excess of dividends and net unrealized gains on the portfolio.
Portfolio and Investment Activity
• As of December 31, 2023, we held 85 investments across 67 portfolio companies and 23 industries for a total fair value of $316.3 million.
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• During the year ended December 31, 2023, we had investment fundings of $119.4 million and investment repayments of $9.4 million.
Liquidity and Capital Activity
• During the year ended December 31, 2023, we called capital resulting in 3,793,771 Shares issued for total proceeds of $77.9 million.
• We closed on $33.4 million in new commitments with our final close on August 24, 2023. Total commitments are $311.3 million.
• We had net borrowings of $53.4 million on our Credit Facilities and maintained borrowing capacity under the Credit Facilities of $195.0 million.
• Total liquidity as of December 31, 2023 was $72.3 million in cash and undrawn debt capacity.
Key Components of Our Results of Operations
As a BDC, we believe that the key components of our results of operations for our business are earnings per Share, dividends declared, net investment income and net asset value per Share. For the three months ended December 31, 2023, we recorded basic and diluted earnings per Share of $0.72, declared a dividend of $0.54 per Share and earned $0.66 of net investment income per Share. For the year ended December 31, 2023, we recorded basic and diluted earnings per Share of $3.51, declared dividends of $2.08 per Share and earned $2.64 of net investment income per Share.
The following table sets forth the calculation of basic and diluted earnings per Share (dollar amounts in thousands, except per share data):
For the years ended December 31,
Net increase (decrease) in net assets resulting from operations
Weighted-average Shares outstanding
Earnings per Share - Basic and Diluted
For the years ended December 31, 2023, and 2022, we declared dividends per Share of $2.08 and $1.37, respectively. We did not declare dividends during the period from commencement to December 31, 2021. For the years ended December 31, 2023 and 2022, our NAV per share was $21.07 and $19.69, respectively.
Investment Income
We generate investment income primarily in the form of interest income on debt investments we hold. In addition, we generate income from dividends on direct equity investments, capital gains on the sales of loans and debt and equity securities and various loan origination and other fees. Our debt investments generally have a stated term of five to eight years and generally bear interest at a floating rate usually determined on the basis of a benchmark such as SOFR. Interest on these debt investments is generally paid quarterly. In some instances, we receive payments on our debt investments based on scheduled amortization of the outstanding balances. At times, we receive repayments of some of our debt investments prior to their scheduled maturity date. The frequency or volume of these repayments fluctuates significantly from period to period. Our portfolio activity reflects the proceeds of sales of securities. We may also generate investment income in the form of commitment, origination, amendment, structuring or due diligence fees, fees for providing managerial assistance and consulting fees.
Expenses
Our primary operating expenses include: (i) investment advisory fees, including base management fees and incentive fees, to our Investment Adviser pursuant to the Investment Advisory Agreement; (ii) debt service and other costs of borrowings or other financing arrangements; (iii) costs and other expenses and our allocable portion of overhead incurred by our Administrator in performing its administrative obligations under the Administration Agreement; and (iv) other operating expenses summarized below:
• administration fees payable under our Administration Agreement and Sub-Administration Agreements, including related expenses;
• the costs of any offerings of our Shares and other securities, if any;
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• calculating individual asset values and our net asset value (including the cost and expenses of any independent valuation firms);
• expenses, including travel expenses, incurred by our Investment Adviser, or members of our Investment Adviser team managing our investments, or payable to third parties, performing due diligence on prospective portfolio companies;
• the allocated costs incurred by our Investment Adviser in providing managerial assistance to those portfolio companies that request it;
• amounts payable to third parties relating to, or associated with, making or holding investments;
• the costs associated with subscriptions to data service, research-related subscriptions and expenses and quotation equipment and services used in making or holding investments;
• transfer agent and custodial fees;
• commissions and other compensation payable to brokers or dealers;
• U.S. federal, state and local taxes;
• independent trustee fees and expenses;
• costs of preparing financial statements and maintaining books and records, costs of preparing tax returns, costs of Sarbanes-Oxley Act compliance and attestation and costs of filing reports or other documents with the SEC (or other regulatory bodies), and other reporting and compliance costs, including federal and state registration and any applicable listing fees;
• the costs of any reports, proxy statements or other notices to our shareholders and the costs of any shareholders’ meetings;
• the costs of specialty and custom software for monitoring risk, compliance and overall portfolio;
• fidelity bond, liability insurance, and any other insurance premiums;
• indemnification payments;
• direct fees and expenses associated with independent audits, agency, consulting and legal costs; and
• all other expenses incurred by us or our Administrator in connection with administering our business, including our allocable share of certain officers and their staff compensation.
Net Investment Income
The following table summarizes our net investment income and net investment income per common share:
For the years ended December 31,
Total investment income
Total expenses (including excise tax expense)
Net investment income
Weighted-average Shares outstanding
Net investment income per Share
Portfolio and Investment Activity
Portfolio Overview
The following tables summarize certain characteristics of our investment portfolio as of December 31, 2023:
First Lien Debt
Second Lien Debt
Equity Investments
Total Investments
Count of investments
Investments, at amortized cost
Investments, at fair value
Percentage of total investments at fair value
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Weighted Average Yields at
Amortized Cost
Fair Value
First Lien Debt (1)
Second Lien Debt (1)
Total Debt and Income Producing Investments (1)(2)
(1) Weighted average yields include the effect of accretion of discounts and amortization of premiums and are based on interest rates as of December 31, 2023. Weighted average yield at fair value is computed as (a) the annual stated interest rate or yield earned plus the net annual amortization of original issue discount (“OID”) and market discount earned, divided by (b) total fair value included in such securities. Weighted average yield at amortized cost is computed as (a) the annual stated interest rate or yield earned plus the net annual amortization of OID and market discount earned, divided by (b) total amortized cost included in such securities. Actual yields earned over the life of each investment could differ materially from the yields presented above.
(2) Weighted average yields for total investments includes income producing equity investments.
The geographical composition of investments at fair value as of December 31, 2023 were as follows:
Geography—% of Fair Value
December 31, 2023
Australia
Canada
United Kingdom
United States
Total
The industry composition of investments at fair value as of December 31, 2023 were as follows:
Industry—% of Fair Value
December 31, 2023
Aerospace & Defense
Automotive
Beverage & Food
Business Services
Capital Equipment
Chemicals, Plastics & Rubber
Construction & Building
Consumer Goods: Durable
Consumer Goods: Non-Durable
Consumer Services
Containers, Packaging & Glass
Diversified Financial Services
Environmental Industries
Healthcare & Pharmaceuticals
High Tech Industries
Leisure Products & Services
Media: Advertising, Printing & Publishing
Retail
Software
Sovereign & Public Finance
Telecommunications
Transportation: Cargo
Wholesale
Total
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Our investment activity for the years ended December 31, 2023 and 2022 is presented below (information presented herein is at amortized cost unless otherwise indicated):
For the years ended December 31,
Investments:
Total investments, beginning of year
New investments purchased
Net accretion of discount on investments
Net realized gain (loss) on investments
Investments sold or repaid
Total Investments, end of year
Principal amount of investments funded:
First Lien Debt
Second Lien Debt
Equity Investments (1)
Total
Principal amount of investments sold or repaid:
First Lien Debt
Second Lien Debt
Equity Investments (1)
Total
Number of new funded debt investments (2)
Average amount of new funded debt investments
(1) Based on cost/proceeds of equity activity.
(2) For the years ended December 31, 2023 and 2022, 100.0% of new funded debt investments were at floating interest rates.
See the Consolidated Schedules of Investments as of December 31, 2023 and 2022 to the consolidated financial statements included in Part II, Item 8 of this Form 10-K for more information on these investments, including a list of companies and type and amount of investments.
Portfolio Credit
As part of the monitoring process, our Investment Adviser has developed risk assessment policies pursuant to which it regularly assesses the risk profile of each of our debt investments and rates each of them based on the following categories, which we refer to as “Internal Risk Ratings”. Key drivers of internal risk ratings include financial metrics, financial covenants, liquidity and enterprise value coverage. Pursuant to these risk policies, an Internal Risk Rating of 1 – 5, which are defined below, is assigned to each debt investment in our portfolio.
Rating
Definition
Borrower is operating above expectations, and the trends and risk factors are generally favorable.
Borrower is operating generally as expected or at an acceptable level of performance. The level of risk to our initial cost basis is similar to the risk to our initial cost basis at the time of origination. This is the initial risk rating assigned to all new borrowers.
Borrower is operating below expectations and level of risk to our cost basis has increased since the time of
origination. The borrower may be out of compliance with debt covenants. Payments are generally current although there may be higher risk of payment default.
Borrower is operating materially below expectations and the loan’s risk has increased materially since origination. In addition to the borrower being generally out of compliance with debt covenants, loan payments may be past due, but generally not by more than 120 days. It is anticipated that we may not recoup our initial cost basis and may realize a loss of our initial cost basis upon exit.
Borrower is operating substantially below expectations and the loan’s risk has increased substantially since origination. Most or all of the debt covenants are out of compliance and payments are substantially delinquent. It is anticipated that we will not recoup our initial cost basis and may realize a substantial loss of our initial cost basis upon exit.
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Our Investment Adviser monitors and, when appropriate, changes the risk ratings assigned to each debt investment in our portfolio. Our Investment Adviser reviews our investment ratings in connection with our quarterly valuation process. The below table summarizes the Internal Risk Ratings as of December 31, 2023 and 2022.
December 31, 2023
December 31, 2022
Fair Value
% of Fair Value
Fair Value
% of Fair Value
Internal Risk Rating 1
Internal Risk Rating 2
Internal Risk Rating 3
Internal Risk Rating 4
Internal Risk Rating 5
Total
As of December 31, 2023 and 2022, the weighted average Internal Risk Rating of our debt investment portfolio was 2.0 and none of our debt investments were assigned an Internal Risk Rating of 4-5, respectively.
As of December 31, 2023 and 2022, there were no first or second lien debt investments on non-accrual status. For information regarding our non-accrual policy, see Note 2, Significant Accounting Policies, to the consolidated financial statements included in Part II, Item 8 of this Form 10-K.
Portfolio Financing
Our primary source of financing consist of secured debt, which are presented on the Consolidated Statements of Assets and Liabilities as Secured borrowings. Refer to Note 5, Borrowings, to the consolidated financial statements included in Part II, Item 8 of this Form 10-K for additional information regarding our financing. The following table details those sources of financing:
Outstanding Principal Balance, as of
December 31, 2023
December 31, 2022
Subscription Facility
SPV Credit Facility
Total
Weighted average interest rate
Subscription Facility
On April 22, 2022, we entered into a senior secured revolving credit facility (the “Subscription Facility”), as amended from time to time. The Subscription Facility provides for secured borrowings of $45,000,000 as of December 31, 2023. In connection with the March 1, 2024 amendment, the secured borrowing capacity will decrease to $30,000 effective April 22, 2024. The maximum principal amount is subject to availability under the Subscription Facility, which is based on certain of our investor equity capital commitments and a percentage determined in the lender’s reasonable discretion to account for foreign exchange volatility. The Subscription Facility has a maturity date of April 22, 2025. We may borrow amounts in U.S. Dollars or certain other permitted currencies. Borrowings under the Subscription Facility bear interest at a spread to the applicable benchmark rate of 2.50% to 2.60%. The Company also pays a fee of 0.30% per year on undrawn amounts under the Subscription Facility. Subject to certain exceptions, the Subscription Facility is secured by a first lien security interest in the Company’s unfunded investor equity capital commitments. The Subscription Facility includes customary covenants, certain limitations on the incurrence of additional indebtedness and liens, and other maintenance covenants, as well as usual and customary events of default for senior secured revolving credit facilities of this nature.
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The Subscription Facility consisted of the following as of December 31, 2023 and 2022:
Total Facility
Borrowings
Outstanding
Unused
Portion (1)
Amount
Available (2)
Weighted Average Interest Rate
December 31, 2023
December 31, 2022
(1) The unused portion is the amount upon which commitment fees are based
(2) Available for borrowing based on the computation of collateral to support the borrowings and subject to compliance with applicable covenants and financial ratios.
SPV Credit Facility
The SPV entered into a senior secured revolving credit facility (the “SPV Credit Facility” and together with the Subscription Facility, the “Credit Facilities”) with a lender on September 30, 2022, which was subsequently amended May 11, 2023. The SPV Credit Facility provides for secured borrowings of $150.0 million, subject to availability under the SPV Credit Facility and restrictions imposed on borrowings under the Investment Company Act. The SPV Credit Facility has a revolving period through September 30, 2025 and a maturity date of September 30, 2030, with one one-year extension option, at the SPV’s election. The SPV may borrow amounts in U.S. Dollars or certain other permitted currencies. Borrowings under the SPV Credit Facility bear interest initially at the annual rate of three month SOFR (or, if applicable, a rate based on the prime rate or federal funds rate plus 0.50%) plus 2.85%. The SPV also pays a fee of 0.30% per year on undrawn amounts under the SPV Credit Facility. Payments under the SPV Credit Facility are made quarterly. The SPV Credit Facility is secured by a first lien security interest on substantially all of the assets of the SPV. The SPV Credit Facility includes customary covenants, certain limitations on the incurrence of additional indebtedness and liens, and other maintenance covenants, as well as usual and customary events of default for senior secured revolving credit facilities of this nature.
The SPV Credit Facility consisted of the following as of December 31, 2023 and 2022:
Total Facility
Borrowings
Outstanding
Unused
Portion (1)
Amount
Available (2)
Weighted Average Interest Rate
December 31, 2023
December 31, 2022
(1) The unused portion is the amount upon which commitment fees are based
(2) Available for borrowing based on the computation of collateral to support the borrowings and subject to compliance with applicable covenants and financial ratios.
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Consolidated Results of Operations
For the years ended December 31, 2023 and 2022
The following table sets forth information regarding our consolidated results of operations for the years ended December 31, 2023 and 2022. For information regarding results of operations for the year ended December 31, 2021, see the Company’s Form 10-K for the fiscal year ended December 31, 2021.
Year Ended December 31,
Investment income:
Interest income
PIK income
Other income
Total investment income
Expenses:
Organizational expenses
Offering cost expense
Net investment income incentive fees
Professional fees
Administrative service fees
Interest expense and credit facility fees
Trustees’ fees and expense
Other general and administrative
Excise tax expense
Total expenses
Less waivers and reimbursements of expenses
Expenses after waivers and reimbursements of expenses
Net investment income (loss)
Net realized gain (loss) and net change in unrealized appreciation (depreciation):
Net realized gain (loss) on investments
Net realized currency gain (loss) on non-investment assets and liabilities
Net change in unrealized appreciation (depreciation) on investments
Net change in unrealized currency gains (losses) on non-investment assets and liabilities
Net realized gain (loss) and net change in unrealized appreciation (depreciation) on investments and non-investment assets and liabilities
Net increase (decrease) in net assets resulting from operations
Investment Income
The increase in investment income for the year ended December 31, 2023 from the comparable period in 2022 was primarily driven by an increase in interest income due to an increase in our investment portfolio and higher weighted average interest rates. As of December 31, 2023, the size of our portfolio increased to $311,762 from $202,115 as of December 31, 2022 at amortized cost. As of December 31, 2023, the weighted average yield of our total debt and income producing investments increased to 12.5% from 11.5% as of December 31, 2022, on amortized cost, primarily due to higher benchmark interest rates.
Interest income and PIK income on our first and second lien debt investments are dependent on the composition and credit quality of the portfolio. Generally, we expect the portfolio to generate predictable quarterly interest income based on the terms stated in each loan’s credit agreement. As of December 31, 2023 and 2022, there were no first or second lien debt investments on non-accrual status.
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The increase in other income for the year ended December 31, 2023 from the comparable period in 2022 was primarily driven by higher commitment fees and prepayment fees.
Expenses
The increase in interest expense and credit facility fees for the year ended December 31, 2023 compared to the comparable period in 2022 was primarily driven by higher benchmark interest rates and higher weighted average principal balance.
The increase in incentive fees for the year ended December 31, 2023 from the comparable period in 2022 was driven by higher pre-incentive fee net investment income.
For the years ended December 31, 2023 and 2022, there were no accrued capital gains incentive fees based upon the cumulative net realized and unrealized appreciation (depreciation) as of December 31, 2023 and 2022, respectively. The accrual for any capital gains incentive fee under accounting principles generally accepted in the United States (“U.S. GAAP”) in a given period may result in an additional expense if such cumulative amount is greater than in the prior period or a reduction of previously recorded expense if such cumulative amount is less than in the prior period. If such cumulative amount is negative, then there is no accrual. See Note 4, Related Party Transactions, to the consolidated financial statements included in Part II, Item 8 of this Form 10-K for more information on our incentive and base management fees.
Organizational expenses and offering cost expenses include expenses incurred in the initial formation of the Company and in the offering of the Shares incurred on or prior to the Final Closing Date. Professional fees include legal, rating agencies, audit, tax, valuation, technology and other professional fees incurred related to the management of the Company. Administrative service fees represent fees paid to the Administrator for our allocable portion of overhead and other expenses incurred by the Administrator in performing its obligations under the Administration Agreement, including our allocable portion of the cost of certain of our executive officers and their respective staff. Other general and administrative expenses include fees paid under the Sub-Administration Agreements, insurance, filing, research, subscriptions, and other costs. Waivers and reimbursements of expenses represents the amounts reimbursed by the Investment Adviser pursuant to the Reimbursement Agreement.
Net Realized Gain (Loss) and Net Change in Unrealized Appreciation (Depreciation) on Investments
The amount of and number of investments with realized gain (loss) and change in appreciation (depreciation) for the years ended December 31, 2023 and 2022 were as follows:
For the years ended December 31,
Realized gain on investments
Number of investments with realized gains
Realized losses on investments
Number of investments with realized losses
Change in unrealized appreciation on investments
Number of investments with unrealized appreciation
Change in unrealized depreciation on investments
Number of investments with unrealized depreciation
Net change in unrealized appreciation (depreciation) in our investments for the year ended December 31, 2023 compared to the comparable period in 2022 was primarily driven by tighter credit spreads.
Net change in unrealized appreciation (depreciation) is driven by changes in other inputs utilized under our valuation methodology, including, but not limited to, enterprise value multiples, borrower leverage multiples and borrower ratings, and the impact of exits.
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For the three months ended December 31, 2023 and September 30, 2023
The following table sets forth information regarding our consolidated results of operations for the three month periods ending December 31, 2023 and September 30, 2023, respectively:
Three Months Ended
Change
December 31, 2023
September 30, 2023
Investment income:
Interest income
PIK income
Other income
Total investment income
Expenses:
Organizational expenses
Offering cost expense
Net investment income incentive fees
Professional fees
Administrative service fees
Interest expense and credit facility fees
Trustees’ fees and expense
Other general and administrative
Excise tax expense
Total expenses
Less waivers and reimbursements of expenses
Expenses after waivers and reimbursements of expenses
Net investment income (loss)
Net realized gain (loss) and net change in unrealized appreciation (depreciation):
Net realized currency gain (loss) on non-investment assets and liabilities
Net change in unrealized appreciation (depreciation) on investments
Net change in unrealized currency gains (losses) on non-investment assets and liabilities
Net realized gain (loss) and net change in unrealized appreciation (depreciation) on investments and non-investment assets and liabilities
Net increase (decrease) in net assets resulting from operations
Investment Income
The increase in investment income for the three months ended December 31, 2023 as compared to the three months ended September 30, 2023 was primarily driven by an increase in interest income due to an increase in our investment portfolio and higher weighted average interest rates. As of December 31, 2023, the size of our portfolio increased to $311,762 from $273,832 as of September 30, 2023, at amortized cost. As of December 31, 2023, the weighted average yield of our total debt and income producing investments decreased to 12.5% from 12.6% as of September 30, 2023 on amortized cost.
Interest income and PIK income on our first and second lien debt investments are dependent on the composition and credit quality of the portfolio. Generally, we expect the portfolio to generate predictable quarterly interest income based on the terms stated in each loan’s credit agreement. As of December 31, 2023 and September 30, 2023, there were no first or second lien debt investments on non-accrual status.
The increase in other income for the three months ended December 31, 2023 from the three months ended September 30, 2023 was primarily driven by higher prepayment fees.
Expenses
The increase in incentive fees was driven by higher pre-incentive fee net investment income for the three months ended December 31, 2023 compared to the three months ended September 30, 2023.
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For the three months ended December 31, 2023 and three months ended September 30, 2023, there were no accrued capital gains incentive fees based upon the cumulative net realized and unrealized appreciation (depreciation) as of December 31, 2023 or September 30, 2023. The accrual for any capital gains incentive fee under U.S. GAAP in a given period may result in an additional expense if such cumulative amount is greater than in the prior period or a reduction of previously recorded expense if such cumulative amount is less than in the prior period. If such cumulative amount is negative, then there is no accrual. See Note 4, Related Party Transactions, to the consolidated financial statements included in Part II, Item 8 of this Form 10-K for more information on the incentive and base management fees.
Net Realized Gain (Loss) and Net Change in Unrealized Appreciation (Depreciation)
The amount of and number of investmenrealized gain (loss) and change in appreciation (depreciation) for the three months ended December 31, 2023 and September 30, 2023 were as follows:
Three Months Ended
December 31, 2023
September 30, 2023
Realized gain on investments
Number of investments with realized gains
Realized losses on investments
Number of investments with realized losses
Change in unrealized appreciation on investments
Number of investments with unrealized appreciation
Change in unrealized depreciation on investments
Number of investments with unrealized depreciation
Net change in unrealized appreciation (depreciation) in our investments for the three months ended December 31, 2023 was primarily driven by improving credit fundamentals and positive impact of foreign currency exchange rates.
Net change in unrealized appreciation (depreciation) is driven by changes in other inputs utilized under our valuation methodology, including, but not limited to, enterprise value multiples, borrower leverage multiples and borrower ratings, and the impact of exits.
Financial Condition, Liquidity and Capital Resources
Capitalization
We have capitalized our business to date primarily through the issuance and sale of our Shares and asset-level financing. We may also fund a portion of our investments through borrowings under the Credit Facilities, as well as through securitization of a portion of our existing investments. As of December 31, 2023, we had $152,512 of outstanding consolidated indebtedness under the Credit Facilities, as previously discussed within Portfolio and Investment Activity - Portfolio Financing . As of December 31, 2023, we had $72,282 of liquidity that can be used to satisfy our short-term cash requirements and working capital for our business. Refer to Note 5, Borrowings to the consolidated financial statements included in Part II, Item 8 of this Form 10-K for additional information regarding our financing. As of December 31, 2023 and 2022, net financial leverage was 0.57x and 0.85x, respectively.
Sources of Liquidity
Our primary sources of liquidity include cash and cash equivalents and available borrowings under our Credit Facilities.
December 31, 2023
December 31, 2022
Cash, cash equivalents and restricted cash
Available borrowings under Credit Facilities
Total Liquidity
We generate cash from the net proceeds of offerings of our Shares and through cash flows from operations, including investment sales and repayments as well as income earned on investments and cash equivalents. We may also fund a portion of our investments through borrowings under the Credit Facilities, the issuance of debt, and through securitization of a portion of our existing investments. The primary use of existing funds and any funds raised in the future is expected to be for investments
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in portfolio companies, repayment of indebtedness, cash distributions to our shareholders, repurchases of our Shares and for other general corporate purposes. We believe our current cash position, available capacity on our revolving credit facilities, which is well in excess of our unfunded commitments, and net cash provided by operating activities will provide us with sufficient resources to meet our obligations and continue to support our investment objectives, including reserving for the capital needs which may arise at our portfolio companies.
Liquidity Needs
Our primary liquidity needs include our funding of new and existing portfolio investments, payment of operating expenses and interest and principal payments under the Credit Facilities.
Contractual Obligations and Contingencies
In the ordinary course of our business, we enter into contracts or agreements that contain indemnifications or warranties. Future events could occur which may give rise to liabilities arising from these provisions against us. We believe that the likelihood of such an event is remote; however, the maximum potential exposure is unknown. No accrual has been made in these consolidated financial statements as of December 31, 2023 and 2022 in Part II, Item 8 of this Form 10-K for any such exposure.
We have in the past, currently are and may in the future become obligated to fund commitments such as revolving credit facilities, bridge financing commitments, or delayed draw commitments. We had the following unfunded commitments to fund delayed draw and revolving senior secured loans as of December 31, 2023 and 2022:
Par / Principal Amount as of December 31,
Unfunded delayed draw commitments
Unfunded revolving commitments
Total unfunded commitments
Cash Flows
The following table details the net change in our cash and cash equivalents:
For the years ended December 31,
Cash flows provided by (used in) operating activities
Cash flows provided by (used in) financing activities
Net increase (decrease) in cash, cash equivalents and restricted cash
During the year ended December 31, 2023, we paid $126,442 related to cost of investments purchased and received $18,677 in repayments on our investments. During the year ended December 31, 2023, we received $53,370 of net proceeds on the Credit Facilities. During the year ended December 31, 2023, we issued 3,793,771 Shares for an aggregate offering price of approximately $77,933.
Asset Coverage
In accordance with the Investment Company Act, a BDC is only allowed to borrow amounts such that its “asset coverage,” as defined in the Investment Company Act, satisfies the minimum asset coverage ratio specified in the Investment Company Act after such borrowing. “Asset coverage” generally refers to a company’s total assets, less all liabilities and indebtedness not represented by “senior securities,” as defined in the Investment Company Act, divided by total senior securities representing indebtedness and, if applicable, preferred stock. “Senior securities” for this purpose includes borrowings from banks or other lenders, debt securities and preferred stock.
Prior to March 23, 2018, BDCs were required to maintain a minimum asset coverage ratio of 200%. On March 23, 2018, an amendment to Section 61(a) of the Investment Company Act was signed into law to permit BDCs to reduce the minimum asset coverage ratio from 200% to 150%, so long as certain approval and disclosure requirements are satisfied. Under the 200% minimum asset coverage ratio, BDCs are permitted to borrow up to one dollar for investment purposes for every one dollar of investor equity, and under the 150% minimum asset coverage ratio, BDCs are permitted to borrow up to two dollars for
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investment purposes for every one dollar of investor equity. In other words, Section 61(a) of the Investment Company Act, as amended, permits BDCs to potentially increase their debt-to-equity ratio from a maximum of 1 to 1 to a maximum of 2 to 1.
As of December 31, 2023 and 2022, the Company had total senior securities of $152,512 and $98,631, respectively, consisting of secured borrowings under the Credit Facilities, and had asset coverage ratios of 233.6% and 211.2%, respectively. For a discussion of the principal risk factors associated with these senior securities, see Part I, Item 1A of this Form 10‑K. For purposes of the asset coverage ratio, the Preferred Stock is classified as a senior security.
Critical Accounting Policies and Estimates
The preparation of our consolidated financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses. These estimates and judgments are based on historical information, information currently available to us and on various other assumptions management believes to be reasonable under the circumstances. Actual results could vary from those estimates and we may change our estimates and assumptions in future evaluations. Changes in these estimates and assumptions may have a material effect on our results of operations and financial condition. We believe the critical accounting policies discussed below affect our more significant judgments and estimates used in the preparation of our consolidated financial statements and should be read in conjunction with our consolidated financial statements and related notes in Part II, Item 8, as well as with our “ Risk Factors ” in Part I, Item 1A of this Form 10-K..
Fair Value Measurements
The Company applies fair value accounting in accordance with the terms of Financial Accounting Standards Board ASC Topic 820, Fair Value Measurement (“ASC 820”). ASC 820 defines fair value as the amount that would be exchanged to sell an asset or transfer a liability in an orderly transfer between market participants at the measurement date. Effective September 8, 2022, the Investment Adviser, as the valuation designee pursuant to Rule 2a-5 under the Investment Company Act, determines in good faith the fair value of the Company’s investment portfolio for which market quotations are not readily available. The Investment Adviser values securities/instruments traded in active markets on the measurement date by multiplying the closing price of such traded securities/instruments by the quantity of shares or amount of the instrument held. The Investment Adviser may also obtain quotes with respect to certain of its investments, such as its securities/instruments traded in active markets and its liquid securities/instruments that are not traded in active markets, from pricing services, brokers, or counterparties (i.e., “consensus pricing”). When doing so, the Investment Adviser determines whether the quote obtained is sufficient according to U.S. GAAP to determine the fair value of the security. The Investment Adviser may use the quote obtained, or alternative pricing sources may be utilized, including valuation techniques typically utilized for illiquid securities/instruments.
Securities/instruments that are illiquid, or for which the pricing source does not provide a valuation or methodology, or provides a valuation or methodology that, in the judgment of the Investment Adviser, does not represent fair value, shall each be valued as of the measurement date using all techniques appropriate under the circumstances and for which sufficient data is available. These valuation techniques may vary by investment and include comparable public market valuations, comparable precedent transaction valuations and/or discounted cash flow analyses. The process generally used to determine the applicable value is as follows: (i) the value of each portfolio company or investment is initially reviewed by the investment professionals responsible for such portfolio company or investment and, for non-traded investments, a standardized template designed to approximate fair market value based on observable market inputs, updated credit statistics and unobservable inputs is used to determine a preliminary value, which is also reviewed alongside consensus pricing, where available; (ii) preliminary valuation conclusions are documented and reviewed by a valuation committee comprised of members of senior management; (iii) the Board of Trustees engages a third-party valuation firm to provide positive assurance on portions of the first lien senior secured loans, “unitranche” loans and second lien senior secured loans and equity investments portfolio each quarter (such that each non-traded investment is reviewed by a third-party valuation firm at least once on a rolling twelve month basis) including a review of management’s preliminary valuation and conclusion on fair value; (iv) if applicable, prior to September 8, 2022, the Audit Committee of the Board of Trustees (the “Audit Committee”) reviewed the assessments of the Investment Adviser and the third-party valuation firm; and (v) if applicable, prior to September 8, 2022, the Board of Trustees discussed the valuation recommendations of the Audit Committee and determined the fair value of each investment in the portfolio in faith based on the input of the Investment Adviser and, where applicable, the third-party valuation firm.
All factors that might materially impact the value of an investment are considered, including, but not limited to the assessment of the following factors, as relevant:
• the nature and realizable value of any collateral;
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• call features, put features and other relevant terms of debt;
• the portfolio company’s leverage and ability to make payments;
• the portfolio company’s public or private credit rating;
• the portfolio company’s actual and expected earnings and discounted cash flow;
• prevailing interest rates and spreads for similar securities and expected volatility in future interest rates;
• the markets in which the portfolio company does business and recent economic and/or market events; and
• comparisons to comparable transactions and publicly traded securities.
Investment performance data utilized are the most recently available financial statements and compliance certificate received from the portfolio companies as of the measurement date which, in many cases, may reflect a lag in information.
Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of the Company’s investments may fluctuate from period to period. Because of the inherent uncertainty of valuation, these estimated values may differ significantly from the values that would have been reported had a ready market for the investments existed, and it is reasonably possible that the difference could be material.
In addition, changes in the market environment and other events that may occur over the life of the investments may cause the realized gains or losses on investments to be different from the net change in unrealized appreciation or depreciation currently reflected in the consolidated financial statements as of December 31, 2023 and 2022.
U.S. GAAP establishes a hierarchical disclosure framework which ranks the level of observability of market price inputs used in measuring investments at fair value. The observability of inputs is impacted by a number of factors, including the type of investment and the characteristics specific to the investment and state of the marketplace, including the existence and transparency of transactions between market participants. Investments with readily available quoted prices or for which fair value can be measured from quoted prices in active markets generally have a higher degree of market price observability and a lesser degree of judgment applied in determining fair value.
For further information on the fair value measurements, including fair value hierarchies, our framework for determining fair value, and the composition of our portfolio, see Note 3, Fair Value Measurements, to the consolidated financial statements in Part II, Item 8 of this Form 10-K.
Investments
Investment transactions are recorded on the trade date. Realized gains or losses are measured by the difference between the net proceeds from the repayment or sale and the amortized cost basis of the investment at the time of exit using the specific identification method without regard to unrealized appreciation or depreciation previously recognized, and includes investments written off during the period, net of recoveries. Net change in unrealized appreciation or depreciation on investments as presented in the Consolidated Statements of Operations in Part II, Item 8 of this Form 10-K reflects the net change in the fair value of investments, including the reversal of previously recorded unrealized appreciation or depreciation when gains or losses are realized.
Revenue Recognition - Non-Accrual Income
Loans are generally placed on non-accrual status when principal or interest payments are past due or when there is reasonable doubt that principal or interest will be collected in full. Accrued and unpaid interest is generally reversed when a loan is placed on non-accrual status. Interest payments received on non-accrual loans may be recognized as income or applied to principal depending upon management’s judgment regarding collectability. Non-accrual loans are restored to accrual status when past due principal and interest are current or there is no longer any reasonable doubt that such principal or interest will be collected in full and, in management’s judgment, are likely to remain current. Management may determine not to place a loan on non-accrual status if the loan has sufficient collateral value and is in the process of collection.
Income Taxes
For federal income tax purposes, the Company has elected to be treated as a RIC under the Code, and intends to make the required distributions to its shareholders as specified therein. In order to qualify as a RIC, the Company must meet certain minimum distribution, source-of-income and asset diversification requirements. If such requirements are met, then the Company is generally required to pay income taxes only on the portion of its taxable income and gains it does not distribute.
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The minimum distribution requirements applicable to RICs require the Company to distribute to its shareholders at least 90% of its investment company taxable income (“ICTI”), as defined by the Code, each year. Depending on the level of ICTI earned in a tax year, the Company may choose to carry forward ICTI in excess of current year distributions into the next tax year. Any such carryover ICTI must be distributed before the end of that next tax year through a dividend declared prior to filing the final tax return related to the year which generated such ICTI.
In addition, based on the excise distribution requirements, the Company is subject to a 4% nondeductible federal excise tax on undistributed income unless the Company distributes in a timely manner an amount at least equal to the sum of (1) 98% of its ordinary income for each calendar year, (2) 98.2% of capital gain net income (both long-term and short-term) for the one-year period ending October 31 in that calendar year and (3) any income realized, but not distributed, in the preceding year. For this purpose, however, any ordinary income or capital gain net income retained by the Company that is subject to corporate income tax is considered to have been distributed.
The Company evaluates tax positions taken or expected to be taken in the course of preparing its consolidated financial statements to determine whether the tax positions are “more likely than not” to be sustained by the applicable tax authority. All penalties and interest associated with income taxes, if any, are included in income tax expense.
The SPV is a disregarded entity for tax purposes and is consolidated with the tax return of the Company.
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