PORTMAN RIDGE FINANCE CORPORATION The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes included in this Quarterly Report on Form 10-Q. 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 our annual report on Form 10-K for the year endedDecember 31, 2021 and Part II, Item 1A of this Form 10-Q of this Quarterly Report. Our actual results could differ materially from those anticipated by such forward-looking statements due to factors discussed under the "Risk Factors" section included in ourSEC filings and "Note About Forward-Looking Statements" appearing elsewhere in this Form 10-Q.
GENERAL
We are an externally managed, non-diversified closed-end investment company that
has elected to be regulated as a business development company ("BDC") under the
Investment Company Act of 1940 (the "1940 Act"). Sierra Crest Investment
Management LLC (the "Adviser") is an affiliate of BC Partners LLP ("BC
Partners "). Subject to the overall supervision of the Board, the Adviser is
responsible for managing our business and activities, including sourcing
investment opportunities, conducting research, performing diligence on potential
investments, structuring our investments, and monitoring our portfolio companies
on an ongoing basis through a team of investment professionals.
We originate, structure, and invest in secured term loans, bonds or notes and
mezzanine debt primarily in privately-held middle market companies but may also
invest in other investments such as loans to publicly-traded companies,
high-yield bonds, and distressed debt securities (collectively the "Debt
Securities Portfolio"). We also invest in debt and subordinated securities
issued by collateralized loan obligation funds ("CLO Fund Securities "). In
addition, from time to time we may invest in the equity securities of privately
held middle market companies and may also receive warrants or options to
purchase common stock in connection with our debt investments.
In our Debt Securities Portfolio, our investment objective is to generate
current income and, to a lesser extent, capital appreciation from the
investments in senior secured term loans, mezzanine debt and selected equity
investments in privately-held middle market companies. We define the middle
market as comprising companies with EBITDA of $10 million to $50 million and/or
total debt of $25 million to $150 million . We primarily invest in first and
second lien term loans which, because of their priority in a company's capital
structure, we expect will have lower default rates and higher rates of recovery
of principal if there is a default and which we expect will create a stable
stream of interest income. While there is no specific collateral associated with
senior unsecured debt, such positions are senior in payment priority over
subordinated debt investments. The investments in our Debt Securities Portfolio
are all or predominantly below investment grade, and have speculative
characteristics with respect to the issuer's capacity to pay interest and repay
principal.
From time-to-time we have also made investments in CLO Fund Securities managed
by other asset managers. Our collateralized loan obligation funds ("CLO Funds")
typically invest in broadly syndicated loans, high-yield bonds and other credit
instruments.
Our portfolio may include "covenant-lite" loans which generally refer to loans
that do not have a complete set of financial maintenance covenants. Generally,
"covenant-lite" loans provide borrower companies more freedom to negatively
impact lenders because their covenants are incurrence-based, which means they
are only tested and can only be breached following an affirmative action of the
borrower, rather than by a deterioration in the borrower's financial condition.
Accordingly, to the extent we invest in "covenant-lite" loans, we may have fewer
rights against a borrower and may have a greater risk of loss on such
investments as compared to investments in or exposure to loans with financial
maintenance covenants.
We have elected to be treated for U.S. federal income tax purposes as a RIC
under the Code and intend to operate in a manner to maintain our RIC status. As
a RIC, we intend to distribute to our stockholders substantially all of our net
ordinary taxable income and the excess of realized net short-term capital gains
over realized net long-term capital losses, if any, for each year. To qualify as
a RIC, we must, among other things, meet certain source-of-income and asset
diversification requirements. Pursuant to this election, we generally will not
have to pay corporate-level U.S. federal income taxes on any income that we
timely distribute to our stockholders.
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. In addition,
we evaluate strategic opportunities available to us, including mergers,
divestures, spin-offs, joint ventures and other similar transactions from time
to time.
The Externalization
On April 1, 2019 (the "Closing"), we became externally managed (the
"Externalization") by the Adviser, pursuant to a stock purchase and transaction
agreement (the "Externalization Agreement") with BC Partners Advisors L.P.
("BCP"), an affiliate of BC Partners . In connection with the Externalization,
our stockholders approved an investment advisory agreement (the "Advisory
Agreement") with the Adviser. See "-Advisory Agreement" below.
Pursuant to the Externalization Agreement with BCP, the Adviser became our
investment adviser in exchange for a cash payment from BCP, or its affiliate, of
$25 million , or $0.669672 per share of our common stock, directly to our
stockholders. In addition, the Adviser (or its affiliate) will use up to $10
million of the incentive fee actually paid to the Adviser prior to the second
anniversary of the Closing to buy newly issued shares of our common stock at the
most recently determined net asset value per share of our common stock at the
time of such purchase. In November 2020 , the Adviser purchased approximately
$570 thousand newly issued shares of our common stock in connection therewith,
and in May 2021 , the Adviser purchased approximately $4.0 million of newly
issued shares of our common stock in connection therewith. In both cases, the
shares were issued at the most recently determined net asset value per share of
our common stock. The obligations of the Advisor to use incentive fees to
purchase shares expired on April 1, 2021 . For the period of one year from the
first day of the first quarter following the quarter in which the Closing
occurred, the Adviser will permanently forego up to the full amount of the
incentive fees earned by the Adviser without recourse against or reimbursement
by us, to the extent necessary in order to achieve aggregate net investment
income per share of common stock for such one-year period to be at least equal
to $0.40 per share, subject to certain adjustments. BCP and the Adviser's total
financial commitment to the transactions contemplated by the Externalization
Agreement was $35.0 million .
GARS Transaction
On October 28, 2020 , we completed our acquisition of Garrison Capital Inc. , a
publicly traded BDC ("GARS", and such transaction, the "GARS Acquisition"). To
effect the acquisition, our wholly owned merger subsidiary merged with and into
GARS, with GARS surviving the merger as our wholly owned subsidiary. Immediately
thereafter and as a single integrated transaction, GARS consummated a second
merger, whereby GARS merged with and into us, with the Company surviving the
merger.
In accordance with the terms of the merger agreement for the GARS Acquisition,
dated June 24, 2020 (the "GARS Merger Agreement"), each share of common stock,
par value $0.001 per share, of GARS (the "GARS Common Stock") issued and
outstanding was converted into the right to receive (i) an amount in cash,
without interest, equal to approximately $1.19 and (ii) approximately 1.917
shares of common stock, par value $0.01 per share, of the Company (plus any
applicable cash in lieu of fractional shares). Each share of GARS Common Stock
issued and outstanding received, as additional consideration funded by the
Adviser, an amount in cash, without interest, equal to approximately $0.31 . In
connection with the closing of the GARS Acquisition, the Board approved an
increase in the size of the Board from seven members to nine members, and
appointed each of Matthew Westwood and Joseph Morea to serve on the Board.
46
--------------------------------------------------------------------------------HCAP Acquisition and Assumption and Redemption of HCAP Notes
OnJune 9, 2021 we completed our acquisition ofHarvest Capital Credit Corporation , a publicly traded BDC ("HCAP", and such transaction, the "HCAP Acquisition"). To effect the acquisition, our wholly owned merger subsidiary ("Acquisition Sub") merged with and into HCAP, with HCAP surviving the merger as the Company's wholly owned subsidiary. Immediately thereafter and as a single integrated transaction, HCAP consummated a second merger, whereby HCAP merged with and into the Company, with the Company surviving the merger. As a result of, and as of the effective time of, the second merger, HCAP's separate corporate existence ceased. Under the terms of the merger agreement for the HCAP Acquisition, datedDecember 23, 2020 (the "HCAP Merger Agreement"), HCAP stockholders as of immediately prior to the effective time of the first merger (other than shares held by a subsidiary of HCAP or held, directly or indirectly, by the Company or Acquisition Sub, and all treasury shares (collectively, "Cancelled Shares")) received a combination of (i)$18.54 million in cash paid by the Company, (ii) 15,252,453 validly issued, fully paid and non-assessable shares of the Company's common stock, par value$0.01 per share, and (iii) an additional cash payment from the Adviser of$2.15 million in the aggregate. With respect to the merger consideration from the Company, HCAP stockholders as of immediately prior to the effective time of the first merger (other than Cancelled Shares) were entitled, with respect to all or any portion of the shares of HCAP common stock they held as of the effective time of the first merger, to elect to receive the merger consideration in the form of cash (an "Election") or in the form of our common stock, subject to certain conditions and limitations in the merger agreement. Any HCAP stockholder who did not validly make an Election was deemed to have elected to receive shares of the Company's common stock with respect to the merger consideration as payment for their shares of HCAP common stock. Each share of HCAP common stock (other than Cancelled Shares) with respect to which an Election was made was treated as an "Electing Share" and each share of HCAP Common Stock (other than Cancelled Shares) with respect to which an Election was not made or that was transferred after the election deadline onJune 2, 2021 was treated as a "Non-Electing Share." Pursuant to the conditions of and adjustment mechanisms in the HCAP Merger Agreement, 475,806 Electing Shares were converted to Non-Electing Shares for purposes of calculating the total mix of consideration to be paid to each Electing Share in order to ensure that the value of the aggregate cash consideration paid to holders of the Electing Shares equaled the aggregate cash consideration that HCAP received from the Company under the terms of the HCAP Merger Agreement. Accordingly, as a result of the Elections received from HCAP stockholders and any resulting adjustment under the terms of the HCAP Merger Agreement, each Electing Share received, in aggregate, approximately$7.43 in cash and 0.74 shares of the Company's common stock, while each Non-Electing Share received, in aggregate, approximately 3.86 shares of the Company's common stock. OnJune 9, 2021 , the Company entered into a third supplemental indenture (the "HCAP Third Supplemental Indenture") by and between the Company andU.S. Bank National Association , as trustee (the "Trustee"), effective as of the closing of the HCAP Acquisition. The HCAP Third Supplemental Indenture relates to the Company's assumption of$28.75 million in aggregate principal amount of HCAP's 6.125% Notes dueSeptember 15, 2022 (the "HCAP Notes"). Pursuant to the HCAP Third Supplemental Indenture, the Company expressly assumed the due and punctual payment of the principal of (and premium, if any) and interest, if any, on the HCAP Notes and the performance of HCAP's covenants under the base indenture, dated as ofJanuary 27, 2015 , by and between HCAP and the Trustee, as supplemented by the second supplemental indenture, dated as ofAugust 24, 2017 , by and between HCAP and the Trustee. No change of control offer was required to be made in respect of the HCAP Notes in connection with the consummation of the HCAP Acquisition. The HCAP Notes could be redeemed by the Company at any time at par value plus accrued and unpaid interest. OnJuly 23, 2021 , the Company redeemed the entire notional amount of$28.75 million of the HCAP Notes.
Reverse Stock Split
OnAugust 23, 2021 , the Company filed a Certificate of Amendment (the "Reverse Stock Split Certificate of Amendment") to the Company's Certificate of Incorporation with the Secretary of State of theState of Delaware to effect a 1-for-10 reverse stock split of the issued and outstanding (or held in treasury) shares of the Company's common stock, par value$0.01 per share (the "Reverse Stock Split"). The Reverse Stock Split became effective as of12:01 a.m. (Eastern Time) onAugust 26, 2021 . As a result of the Reverse Stock Split, every ten shares of issued and outstanding common stock were automatically combined into one issued and outstanding share of common stock, without any change in the par value per share. No fractional shares were issued as a result of the Reverse Stock Split. Instead, any stockholder who would have been entitled to receive a fractional share as a result of the Reverse Stock Split received cash payments in lieu of such fractional shares (without interest and subject to backup withholding and applicable withholding taxes). OnAugust 23, 2021 , the Company filed a Certificate of Amendment to decrease the number of authorized shares of common stock by one half of the reverse stock split ratio (the "Decrease Shares Certificate of Amendment") with the Secretary of State of theState of Delaware . The Decrease Shares Certificate of Amendment became effective as of12:05 a.m. (Eastern Time) onAugust 26, 2021 . Following the effectiveness of the Decrease Shares Certificate of Amendment, the number of authorized shares of common stock under the Company's Certificate of Incorporation was reduced from 100 million shares to 20 million shares.
The Reverse Stock Split Certificate of Amendment and the Decrease Shares
Certificate of Amendment were approved by the Company's stockholders at its
annual meeting held on
PORTFOLIO AND INVESTMENT ACTIVITY
Our primary investments are lending to and investing in middle-market businesses through investments in senior secured loans, junior secured loans, subordinated/mezzanine debt investments, and other equity investments, which may include warrants, investments in joint ventures, and investments inCLO Fund Securities . 47 --------------------------------------------------------------------------------
Total portfolio investment activity (excluding activity in short-term
investments) for the three months ended
Asset
Debt CLO Fund Equity Manager Joint Total
($ in thousands) Securities Securities Securities Affiliates Ventures Derivatives Portfolio
Fair Value at December
31, 2020
2021 Activity: 404,861 19,583 13,945 - 49,349 (1,109 ) 486,629
Purchases /
originations / draws 309,363 18,077 9,002 - 34,358 - 370,800
Pay-downs / pay-offs /
sales (287,238 ) (11,675 ) (4,740 ) - (24,925 ) (880 ) (329,458 )
Net accretion of
interest 27,549 4,754 - - - - 32,303
Net realized gains
(losses) 2,361 (5,323 ) (2,176 ) - - 880 (4,258 )
Increase (decrease) in
fair value (21,603 ) 6,216 6,555 - 1,692 (1,303 ) (8,443 )
Fair Value at December
31, 2021
2022 Activity: 435,293 31,632 22,586 - 60,474 (2,412 ) 547,573
Purchases /
originations / draws 58,762 - 4,262 - 940 - 63,964
Pay-downs / pay-offs /
sales (38,797 ) (2,032 ) (6,517 ) - - 2,088 (45,258 )
Net accretion of
interest 3,508 1,634 - - - - 5,142
Net realized gains
(losses) (3,670 ) - 212 - - (2,095 ) (5,553 )
Increase (decrease) in
fair value 985 (2,177 ) 2,090 - (1,197 ) 2,442 2,143
Fair Value at March
31, 2022 $ 456,081 $ 29,057 $ 22,633 $ - $ 60,217 $ 23 $ 568,011
The level of investment activity for investments funded and principal repayments
for our investments can vary substantially from period to period depending on
the number and size of investments that we invest in or divest of, and many
other factors, including the amount and competition for the debt and equity
securities available to middle market companies, the level of merger and
acquisition activity for such companies and the general economic environment.
The following table shows the Company's portfolio by security type at March 31,
2022 and December 31, 2021 :
($ in March 31, 2022
thousands) (Unaudited) December 31, 2021
Cost/Amortized Cost/Amortized
Security Type Cost Fair Value %(¹) Cost Fair Value %(¹)
Senior Secured
Loan $ 394,552 $ 395,062 69 $ 361,556 $ 364,701 66
Junior Secured
Loan 69,795 60,976 11 82,996 70,549 13
Senior
Unsecured Bond 416 43 0 416 43 0
Equity
Securities 24,637 22,633 4 26,680 22,586 4
CLO Fund
Securities 51,163 29,057 5 51,561 31,632 6
Asset Manager
Affiliates(2) 17,791 - - 17,791 - -
Joint Ventures 65,305 60,217 11 64,365 60,474 11
Derivatives 31 23 - 31 (2,412 ) -
Total $ 623,690 $ 568,011 100 % $ 605,396 $ 547,573 100 %
(1)Represents percentage of total portfolio at fair value.
(2)
Represents the equity investment in the Asset Manager Affiliates.
48
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The industry concentrations, based on the fair value of the Company's investment
portfolio as of
March 31, 2022
($ in thousands) (Unaudited) December 31, 2021
Cost/Amortized Cost/Amortized
Industry Classification Cost Fair Value %(¹) Cost Fair Value %(¹)
Aerospace and Defense $ 10,733 $ 10,562 2 $ 11,730 $ 11,692 2
Asset Management
Company(2) 17,791 - - 17,791 - -
Automotive 11,783 11,806 2 11,331 11,487 2
Banking, Finance,
Insurance & Real Estate 44,955 46,640 8 41,487 42,858 8
Beverage, Food and Tobacco 10,629 10,642 2 5,511 5,625 1
Capital Equipment 14,910 14,005 3 14,387 10,620 2
Chemicals, Plastics &
Rubber 12,718 12,960 2 12,692 12,969 2
CLO Fund Securities 51,163 29,057 5 51,561 31,632 6
Construction & Building 10,559 10,926 2 8,966 9,501 2
Consumer goods: Durable 25,306 24,134 4 25,151 24,831 5
Consumer goods:
Non-durable 4,176 4,194 1 4,162 4,197 1
Containers, Packaging and
Glass 2,774 2,637 0 2,780 2,570 1
Electronics 10,697 11,175 2 10,623 11,089 2
Energy: Oil & Gas 7,298 1,610 0 7,921 2,355 0
Environmental Industries 4,315 5,443 1 4,315 4,200 1
Finance 12,022 12,036 2 10,916 10,912 2
Forest Products & Paper 1,584 1,302 0 1,583 1,271 0
Healthcare, Education and
Childcare 9,769 9,720 2 9,783 9,752 2
Healthcare &
Pharmaceuticals 54,331 46,519 8 71,696 62,275 11
High Tech Industries 62,483 61,862 11 58,803 58,715 11
Hotel, Gaming & Leisure 9,906 9,872 2 4,906 4,898 1
Joint Ventures 65,305 60,217 11 64,365 60,474 11
Machinery
(Non-Agrclt/Constr/Electr) 8,355 9,837 2 7,748 8,967 2
Media: Advertising,
Printing & Publishing 150 246 0 150 246 0
Media: Broadcasting &
Subscription 12,344 13,787 2 12,407 13,255 2
Media: Diversified &
Production 11,088 11,190 2 6,272 6,365 1
Metals & Mining 15,597 14,117 3 15,342 13,647 3
Retail 10,799 11,338 2 6,144 6,775 1
Services: Business 72,942 74,772 13 76,071 77,798 14
Services: Consumer 8,394 8,385 2 990 990 0
Telecommunications 8,488 7,759 1 7,521 6,675 1
Textiles and Leather 12,544 11,476 2 12,496 11,095 2
Transportation: Consumer 7,782 7,785 1 7,795 7,837 1
Total $ 623,690 $ 568,011 100 % $ 605,396 $ 547,573 100 %
(1)Calculated as a percentage of total portfolio at fair value.
(2)
Represents the equity investment in the Asset Manager Affiliates.
Debt Securities Portfolio
At
The investment portfolio (excluding our investments in the CLO Funds, Joint Ventures and short-term investments) atMarch 31, 2022 was spread across 30 different industries and 116 different entities with an average par balance per entity of approximately$3.3 million . As ofMarch 31, 2022 , six of our investments were on non-accrual status. As ofDecember 31, 2021 , seven of our investments were on non-accrual status. We may invest up to 30% of our investment portfolio in "non-qualifying" opportunistic investments such as high-yield bonds, debt and equity securities of CLO Funds, foreign investments, joint ventures, managed funds, partnerships and distressed debt or equity securities of large cap public companies. AtMarch 31, 2022 andDecember 31, 2021 , the total amount of non-qualifying assets to total assets was approximately 16.4% and 15.8% of total assets, respectively. The majority of non-qualifying assets were the Company's investments in Joint Ventures, in the aggregate representing approximately 9.1% and 9.3%, of the total assets as ofMarch 31, 2022 andDecember 31, 2021 , respectively, and our total assets including our investments in CLO Funds, which are typically domiciled outside theU.S. and represented approximately 4.4% and 4.9% of total assets on such dates, respectively.
Asset Manager Affiliates
As ofMarch 31, 2022 , our remaining asset management affiliates (the "Asset Manager Affiliates") have limited operations and are expected to be liquidated. As ofMarch 31, 2022 , the Asset Manager Affiliates manage CLO Funds that invest in broadly syndicated loans, high yield bonds and other credit instruments.
We have made minority investments in the subordinated securities or preferred shares of CLO Funds managed by the Disposed Manager Affiliates and may selectively invest in securities issued by CLO Funds managed by other asset management companies. As ofMarch 31, 2022 andDecember 31, 2021 , we had approximately$29.1 million and$31.6 million , respectively, invested inCLO Fund Securities , issued primarily by CLO Funds managed by the Disposed Manager Affiliates.
The CLO Funds invest primarily in broadly syndicated non-investment grade loans,
high-yield bonds and other credit instruments of corporate issuers. The
underlying assets in each of the
The structure of CLO Funds, which are highly levered, is extremely complicated.
Since we primarily invest in securities representing the residual interests of
CLO Funds, our investments are much riskier than the risk profile of the loans
by which such CLO Funds are collateralized. Our investments in CLO Funds may be
riskier and less
49
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transparent to us and our stockholders than direct investments in the underlying
loans. For a more detailed discussion of the risks related to our investments in
CLO Funds, please see "Risk Factors - Risks Related to Our Investments - Our
investments may be risky, and you could lose all or part of your investment."
Our
March 31, 2022 December 31, 2021
Amortized Amortized
CLO Fund Securities Investment %(1) Cost Fair Value Cost Fair Value
Catamaran CLO 2013- 1 Ltd. Subordinated
Notes 23.3 3,658 1,092 4,198 1,779
Catamaran CLO 2014-1 Ltd. Subordinated
Notes 22.2 9,624 3,757 9,679 4,278
Catamaran CLO 2014-2 Ltd. Subordinated
Notes 24.9 6,066 - 6,066 -
Catamaran CLO 2015-1 Ltd. Subordinated
Notes 9.9 2,546 - 2,549 -
Catamaran CLO 2018-1 Ltd. Subordinated
Notes 24.8 8,651 6,187 8,694 6,314
Dryden 30 Senior Loan Fund Subordinated
Notes 6.8 1,292 1,228 1,147 1,258
JMP CLO IV Junior Sub Note Subordinated
Notes 57.2 8,528 7,549 8,530 8,105
JMP CLO V Junior Sub Note Subordinated
Notes 57.2 10,798 9,244 10,698 9,898
Total $ 51,163 $ 29,057 $ 51,561 $ 31,632
(1)
Represents percentage of class held at
As a result of the severe economic consequences resulting from the COVID 19 pandemic, during the second quarter of 2020, the Company was notified that four of the Catamaran CLO Funds breached certain covenants contained in their respective indentures, and as a result, available cash within theCLO Fund will be diverted away from the subordinated notes owned by the Company and will be applied to more senior noteholders in the capital structure of the CLO Funds. The estimated timing and amount of future distributions if any, from theseCLO Fund Securities is uncertain. Three of the CLO Funds noted above resumed making cash distributions on the Company's investment during the fourth quarter of 2020. Investment in Joint Ventures KCAP Freedom 3 LLC During the third quarter of 2017, we and Freedom 3Opportunities LLC ("Freedom 3 Opportunities"), an affiliate of Freedom 3Capital LLC , entered into an agreement to create KCAP Freedom 3 LLC (the "F3C Joint Venture"). The fund capitalized by the F3C Joint Venture invests primarily in middle-market loans and the F3C Joint Venture partners may source middle-market loans from time-to-time for the fund. We own a 62.8% economic interest in the F3C Joint Venture. The F3C Joint Venture is structured as an unconsolidatedDelaware limited liability company. All portfolio and other material decisions regarding the F3C Joint Venture must be submitted to its board of managers, which is comprised of four members, two of whom were selected by us and two of whom were selected by Freedom 3 Opportunities, and must be approved by at least one member appointed by us and one appointed by Freedom 3 Opportunities. In addition, certain matters may be approved by the F3C Joint Venture's investment committee, which is comprised of one member appointed by us and one member appointed by Freedom 3 Opportunities. We have determined that the F3C Joint Venture is an investment company under Accounting Standards Codification ("ASC"), Financial Services - Investment Companies ("ASC 946"), however, in accordance with such guidance, we will generally not consolidate our investment in a company other than a wholly owned investment company subsidiary or a controlled operating company whose business consists of providing services to us. We do not consolidate its interest in the F3C Joint Venture because we do not control the F3C Joint Venture due to allocation of the voting rights among the F3C Joint Venture partners.
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