SIERRA INCOME CORPORATION The following discussion and analysis should be read in conjunction with our financial statements and related notes and other financial information appearing elsewhere in this annual report on Form 10-K. Except as otherwise specified, references to "we," "us," "our," or the "Company," refers toSierra Income Corporation . "SIC Advisors " or "Adviser" refers toSIC Advisors LLC , our investment adviser.SIC Advisors is a wholly owned subsidiary ofMedley LLC , which is controlled by Medley Management Inc., a publicly traded asset management firm ("MDLY"), which in turn is controlled byMedley Group LLC , an entity wholly-owned by the senior professionals ofMedley LLC . "Medley" refers, collectively, to the activities and operations ofMedley Capital LLC ,Medley LLC , MDLY,Medley Group LLC ,SIC Advisors , associated investment funds and their respective affiliates. Some of the statements in this annual report on Form 10-K constitute forward-looking statements, which relate to future events or our performance or financial condition. The forward-looking statements contained in this annual report on Form 10-K involve risks and uncertainties, including, but not limited to, statements as to: ? our future operating results; ? our business prospects and the prospects of our portfolio companies;
? changes in laws and regulations, changes in political, economic or industry
conditions, and changes in the interest rate environment or other conditions
affecting the financial and capital markets, including with respect to changes
resulting from or in response to, or potentially even the absence of changes
as a result of, the impact of the COVID-19 pandemic;
? risks associated with possible disruptions in our operations or the economy
generally including the current economic downturn as a result of the impact of
the COVID-19 pandemic;
? the risk that, if the current period of capital markets disruption andinstability continues for an extended period of time, that our stockholders
may not receive distributions, if any, or at historical levels and that a
portion of our distribution in the future may be a return of capital;
? the effect of investments that we expect to make;
? our contractual arrangements and relationships with third parties;
? actual and potential conflicts of interest with
affiliates;
? the dependence of our future success on the general economy and its effect on
the industries in which we invest;
? the ability of our portfolio companies to achieve their objectives;
? the use of borrowed money to finance a portion of our investments;
? the adequacy of our financing sources and working capital;
? the timing of cash flows, if any, from the operations of our portfolio
companies;
? the ability of
monitor and administer our investments;
? the ability of
talented professionals;
? our ability to maintain our qualification as a RIC and as a BDC;
? uncertainties associated with the impact from the COVID-19 pandemic,
including: its impact on the global and
and
that outbreak; the effect of the COVID-19 pandemic on our business prospects
and the operational and financial performance of our portfolio companies,
including our and their ability to achieve their respective objectives; the
effect of the disruptions caused by the COVID-19 pandemic on our ability to
continue to effectively manage our business and our use of borrowed money to
finance a portion of our investments; and
? the impact of the termination of the Amended MCC Merger Agreement (as defined
below) and the Amended MDLY Merger Agreement (as defined below) on our
business, financial results, and ability to pay dividends and distributions,
if any, to our stockholders.
Such forward-looking statements may include statements preceded by, followed by
or that otherwise include the words "trend," "opportunity," "pipeline,"
"believe," "comfortable," "expect," "anticipate," "current," "intention,"
"estimate," "position," "assume," "potential," "outlook," "continue," "remain,"
"maintain," "sustain," "seek," "achieve," and similar expressions, or future or
conditional verbs such as "will," "would," "should," "could," "may," or similar
expressions. The forward-looking statements contained in this annual report
involve risks and uncertainties. Our actual results could differ materially from
those implied or expressed in the forward-looking statements for any reason,
including due to the factors set forth in "Risk Factors" and elsewhere in this
annual report on Form 10-K.
We have based the forward-looking statements included in this report on
information available to us on the date of this report, and we assume no
obligation to update any such forward-looking statements. Actual results could
differ materially from those anticipated in our forward-looking statements, and
future results could differ materially from historical performance. Although we
undertake no obligation to revise or update any forward-looking statements,
whether as a result of new information, future events or otherwise, you are
advised to consult any additional disclosures that we may make directly to you
or through reports that we have filed or in the future may file with the SEC ,
including quarterly reports on Form 10-Q, annual reports on Form 10-K, and
current reports on Form 8-K.
COVID-19 Developments
On March 11, 2020 , the World Health Organization declared the novel coronavirus
("COVID-19") as a pandemic, and, on March 13, 2020 , the United States declared a
national emergency with respect to COVID-19. The outbreak of COVID-19 has
severely impacted global economic activity and caused significant volatility and
negative pressure in financial markets. The global impact of the COVID-19
outbreak has been rapidly evolving and has led to, and for an unknown period of
time will continue to lead to, disruptions in local, regional, national and
global markets and economies affected thereby, including the United States . The
COVID-19 pandemic and restrictive measures taken to contain or mitigate its spread have caused, and are continuing to cause, business shutdowns, or the re-introduction of business shutdowns, cancellations of events and restrictions on travel, significant reductions in demand for certain goods and services, reductions in business activity and financial transactions, supply chain interruptions and overall economic and financial market instability both globally and inthe United States . In addition, although theU.S. Food and Drug Administration authorized vaccines for emergency use starting inDecember 2020 , it remains unclear how quickly the vaccines will be distributed nationwide and globally or when "herd immunity" will be achieved and the restrictions that were imposed to slow the spread of the virus will be lifted entirely. The delay in distributing the vaccines could lead people to continue to self-isolate and not participate in the economy at pre-pandemic levels for a prolonged period of time. Even after the COVID-19 pandemic subsides, theU.S. economy and most other major global economies may continue to experience a recession, and we anticipate our business and operations could be materially adversely affected by a prolonged recession inthe United States and other major markets. We have been closely monitoring, and will continue to monitor, the COVID-19 pandemic and its impact on all aspects of our business, including how it has, an impact our portfolio companies, employees, due diligence and underwriting processes, and financial markets. In addition, as a result of the adverse effects of the COVID-19 pandemic and the related disruption and financial distress, certain portfolio companies may seek to modify their loans from us, which could reduce the amount or extend the time for payment of principal, reduce the rate or extend the time of payment of interest, and/or increase the amount of PIK interest we receive with respect to such investment, among other things. The effects of the COVID-19 pandemic have also impeded, and may continue to impede, the ability of certain of our portfolio companies to raise additional capital and/or pursue asset sales or otherwise execute strategic transactions, which could have a material adverse effect on the valuation of our investments in such companies. Portfolio companies operating in certain industries may be more susceptible to these risks than other portfolio companies in other industries in light of the effects of the COVID-19 pandemic. Given the rapid development and fluidity of this situation, we cannot estimate the long-term impact of COVID-19 on our business, future results of operations, financial position or cash flows at this time. Further, the operational and financial performance of the portfolio companies in which we make investments may be significantly impacted by COVID-19, which may in turn impact the valuation of our investments. We believe our portfolio companies have taken, and continue to take, immediate actions to effectively and efficiently respond to the challenges posed by COVID-19 and related orders imposed by state and local governments, including developing liquidity plans supported by internal cash reserves, shareholder support, and, as appropriate, accessing their ability to participate in the government Paycheck Protection Program, including the second draw Paycheck Protection Program loans. The extent to which our operations may be impacted by the COVID-19 pandemic will depend largely on future developments, which are highly uncertain and cannot be accurately predicted, including guidance fromU.S. and international authorities, including federal, state and local public health authorities. Furthermore, the impacts of a potential worsening of global economic conditions and the continued disruptions to and volatility in the financial markets remain unknown. COVID-19 presents material uncertainty and risks with respect to the underlying value of the Company's portfolio companies, the Company's business, financial condition, results of operations and cash flows, such as the potential negative impact to financing arrangements, increased costs of operations, changes in law and/or regulation, and uncertainty regarding government and regulatory policy. We have evaluated subsequent events fromDecember 31, 2020 through the filing date of this annual report on Form 10-K. However, as the discussion in this Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations relates to the Company's financial statements for the year endDecember 31, 2020 , the analysis contained herein may not fully account for impacts relating to the COVID-19 pandemic. In that regard, for example, as ofDecember 31, 2020 , the Company valued its portfolio investments in conformity withU.S. GAAP based on the facts and circumstances known by the Company at that time, or reasonably expected to be known at that time. Due to the overall volatility that the COVID-19 pandemic has caused during the months that followed ourDecember 31, 2020 valuation, any valuations conducted now or in the future in conformity withU.S. GAAP could result in a lower fair value of our portfolio. The impact to our results going forward will depend to a large extent on future developments and new information that may emerge regarding the duration of COVID-19 and the actions taken by authorities and other entities to contain the coronavirus or treat its impact, all of which are beyond our control. Accordingly, the Company cannot predict the extent to which its financial condition and results of operations will be affected at this time. Overview We are an externally managed non-diversified closed-end management investment company that has elected to be treated as a BDC under the 1940 Act. We are externally managed bySIC Advisors , which is an investment adviser registered with theSEC under the Advisers Act.SIC Advisors is responsible for sourcing potential investments, conducting due diligence on prospective investments, analyzing investment opportunities, structuring investments and monitoring our portfolio on an ongoing basis. In addition, we have elected, and intend to qualify annually to be treated, forU.S. federal income tax purposes, as a RIC under Subchapter M of the Code. Under our Investment Advisory Agreement, we paySIC Advisors a base management fee as well as an incentive fee based on our investment performance. Also, under the Administration Agreement, we reimburse Medley for the allocable portion of overhead and other expenses incurred byMedley Capital LLC in performing its obligations under the Administration Agreement, including our allocable portion of the costs of compensation and related expenses of our Chief Compliance Officer, Chief Financial Officer and their respective staffs. We intend to meet our investment objective by primarily lending to, and investing in, the debt of privately ownedU.S. middle market companies, which we define as companies with annual revenue between$50 million and$1 billion . We intend to focus primarily on making investments in first lien senior secured debt, second lien secured debt, and to a lesser extent, subordinated debt, of middle market companies in a broad range of industries. We expect that the majority of our debt investments will bear interest at floating interest rates, but our portfolio may also include fixed-rate investments. We will originate transactions sourced throughSIC Advisors' existing network, and, to a lesser extent, expect to acquire debt securities through the secondary market. We may make equity investments in companies that we believe will generate appropriate risk adjusted returns, although we do not expect such investments to be a substantial portion of our portfolio. The level of our investment activity depends on many factors, including the amount of debt and equity capital available to prospective portfolio companies, the level of merger, acquisition and refinancing activity for such portfolio companies, the availability of credit to finance transactions, the general economic environment and the competitive environment for the types of investments we make. Based on prevailing market conditions, we anticipate that we will invest the proceeds from each subscription closing generally within 30-90 days. The precise timing will depend on the availability of investment opportunities that are consistent with our investment objectives and strategies. As a BDC, we are required to comply with certain regulatory requirements. For instance, we generally have to invest at least 70% of our total assets in "qualifying assets," including securities of private or thinly traded publicU.S. companies, cash, cash equivalents,U.S. government securities and high-quality debt investments that mature in one year or less. In addition, we are only allowed to borrow money such that our asset coverage, as defined in the 1940 Act, equals at least 200% (or 150% if certain requirements under the 1940 Act are met) after such borrowing, with certain limited exceptions. To maintain our RIC tax treatment, we must meet specified source-of-income and asset diversification requirements. To be eligible for RIC tax treatment under Subchapter M forU.S. federal income tax purposes, we must distribute at least 90% of our net ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any, for the taxable year. 34
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Termination of the Agreements and Plan of Mergers
OnJuly 29, 2019 , the Company entered into the Amended and Restated Agreement and Plan of Merger, dated as ofJuly 29, 2019 (the "Amended MCC Merger Agreement"), by and betweenMedley Capital Corporation ("MCC") and the Company, pursuant to which MCC would, on the terms and subject to the conditions set forth in the Amended MCC Merger Agreement, merge with and into the Company, with the Company as the surviving company in the merger (the "MCC Merger"). In addition, onJuly 29, 2019 , the Company entered into the Amended and Restated Agreement and Plan of Merger, dated as ofJuly 29, 2019 (the "Amended MDLY Merger Agreement"), by and among MDLY, the Company, andSierra Management, Inc. , a wholly owned subsidiary of the Company ("Merger Sub"), MDLY would, on the terms and subject to the conditions set forth in the Amended MDLY Merger Agreement, merge with and into Merger Sub, with Merger Sub as the surviving company in the merger (the "MDLY Merger" together with the MCC Merger, the "Proposed Mergers"). Section 9.1(c) of the Amended MCC Merger Agreement and Section 9.1(c) of the Amended MDLY Merger Agreement each permits the Company and either MCC or MDLY, as applicable, to terminate the Amended MCC Merger Agreement and the Amended MDLY Merger Agreement, respectively, if the MCC Merger or the MDLY Merger, as applicable, has not been consummated on or beforeMarch 31, 2020 (the "Outside Date"). OnMay 1, 2020 , the Company terminated both the Amended MCC Merger Agreement and the Amended MDLY Merger Agreement effective as ofMay 1, 2020 as the Outside Date had passed and neither the MCC Merger or the MDLY Merger had been consummated. In determining to terminate the Amended MCC Merger Agreement and the Amended MDLY Merger Agreement, the Company considered a number of factors, including, among other factors, changes in the relative valuations of the Company, MCC, and MDLY, the changed circumstances and the unpredictable economic conditions resulting from the global health crisis caused by the coronavirus (COVID-19) pandemic, and the uncertainty regarding the parties' ability to satisfy the conditions to closing in a timely manner. Revenues We generate revenue in the form of interest on the debt securities that we hold and distributions and capital gains on other interests that we acquire in our portfolio companies. We expect that the senior debt we invest in will generally have stated terms of three to ten years and that the subordinated debt we invest in will generally have stated terms of five to ten years. Our senior and subordinated debt investments bear interest at a fixed or floating rate. Interest on debt securities is generally payable monthly, quarterly or semiannually. In addition, some of our investments provide for deferred interest payments or PIK interest. The principal amount of the debt securities and any accrued but unpaid interest generally will become due at the maturity date. In addition, we may generate revenue in the form of commitment and other fees in connection with transactions. OIDs and market discounts or premiums will be capitalized, and we will accrete or amortize such amounts as interest income. We will record prepayment premiums on loans and debt securities as fee income. Dividend income, if any, will be recognized on an accrual basis to the extent that we expect to collect such amounts. Expenses Our primary annual operating expenses consist of the payment of advisory fees and the reimbursement of expenses under our Investment Advisory Agreement withSIC Advisors and our Administration Agreement withMedley Capital LLC . We bear other expenses, which include, among other things:
• corporate, organizational and offering expenses relating to offerings of our
common stock, subject to limitations included in our Investment Advisory
Agreement;
• the cost of calculating our NAV, including the related fees and cost of any
third-party valuation services;
• the cost of effecting sales and repurchases of shares of our common stock and
other securities;
• fees payable to third parties relating to, or associated with, monitoring our
financial and legal affairs, making investments, and valuing investments,
including fees and expenses associated with performing due diligence reviews
of prospective investments;
• interest payable on debt, if any, incurred to finance our investments;
35
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Table of Contents • transfer agent and custodial fees;
• fees and expenses associated with marketing efforts subject to limitations
included in the Investment Advisory Agreement;
• federal and state registration fees and any stock exchange listing fees;
• federal, state and local taxes; • independent directors' fees and expenses, including travel expenses;
• costs of director and stockholder meetings, proxy statements, stockholders'
reports and notices;
• costs of fidelity bonds, directors and officers/errors and omissions liability
insurance and other types of insurance;
• direct costs, including those relating to printing of stockholder reports and
advertising or sales materials, mailing, long distance telephone and staff
subject to limitations included in the Investment Advisory Agreement;
• fees and expenses associated with independent audits and outside legal costs,
including compliance with the Sarbanes-Oxley Act of 2002, the 1940 Act and
applicable federal and state securities laws;
• brokerage commissions for our investments;
• all other expenses incurred by us or SIC Advisors in connection withadministering our investment portfolio, including expenses incurred by SIC
Advisors in performing certain of its obligations under the Investment
Advisory Agreement; and
• the reimbursement of the compensation of our Chief Financial Officer and Chief
Compliance Officer and their respective staffs, whose compensation is paid by
annually approved by our independent director committee and subject to the
limitations included in our Administration Agreement.
Administrative Services
We reimburse Medley Capital LLC for the administrative expenses necessary for
its performance of services to us. However, such reimbursement is made at an
amount equal to the lower of Medley Capital LLC's actual costs or the amount
that we would be required to pay for comparable administrative services in the
same geographic location. Also, such costs will be reasonably allocated to us on
the basis of assets, revenues, time records or other reasonable methods. We will
not reimburse Medley Capital LLC for any services for which it receives a
separate fee or for rent, depreciation, utilities, capital equipment or other
administrative items allocated to a controlling person of Medley Capital LLC .
Portfolio and Investment Activity
The following table shows the amortized cost and the fair value of our
investment portfolio as of
Amortized Cost Percentage Fair Value Percentage
Senior secured first lien term loans $ 369,385,810 52.7 % $ 315,490,601 52.3 %
Senior secured second lien term loans 103,081,287 14.7 % 93,794,917 15.5 %
Senior secured first lien notes 8,473,750 1.2 % 8,548,755 1.4 %
Subordinated notes 65,561,840 9.4 % 50,039,500 8.3 %
Sierra Senior Loan Strategy JV I LLC 110,050,000 15.7 % 81,788,964 13.5 %
Equity/warrants 44,451,252 6.3 % 54,323,743 9.0 %
Total $ 701,003,939 100.0 % $ 603,986,480 100.0 %
As of
As ofDecember 31, 2020 , our income-bearing investment portfolio, which represented 87.2% of our total portfolio, had a weighted average yield based upon the cost of our portfolio investments of approximately 8.0%, and 3.50% of our income-bearing portfolio bore interest based on fixed rates, and 96.50% of our income-bearing portfolio bore interest at floating rates, such as LIBOR. For the year endedDecember 31, 2020 , we invested$79.0 million of principal in directly originated transactions across 15 portfolio companies and$54.2 million of principal in syndicated transactions across 15 portfolio companies. As ofDecember 31, 2020 , the investment portfolio was comprised of$541.1 million of principal in directly originated transactions across 67 portfolio companies and$62.9 million of principal in syndicated transactions across 16 portfolio companies. 36
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The following table shows the amortized cost and the fair value of our
investment portfolio as of
Amortized Cost Percentage Fair Value Percentage
Senior secured first lien term loans $ 382,580,269 48.0 % $ 328,816,197 48.7 %
Senior secured second lien term loans 157,794,323 19.8 122,817,885 18.2
Senior secured first lien notes 15,217,625 1.9 14,354,825 2.1
Subordinated notes 70,422,851 8.8 63,021,420 9.3
Sierra Senior Loan Strategy JV I LLC 92,050,000 11.5 68,434,389 10.1
Equity/warrants 79,968,093 10.0 78,179,214 11.6
Total $ 798,033,161 100.0 % $ 675,623,930 100.0 %
As of
As ofDecember 31, 2019 , our income-bearing investment portfolio, which represented 87.2% of our total portfolio, had a weighted average yield based upon the cost of our investment portfolio of approximately 9.6%, and 4.5% of our income-bearing portfolio bore interest based on fixed rates, while 95.5% of our income-bearing portfolio bore interest at floating rates, such as LIBOR. For the year endedDecember 31, 2019 , we invested$107.5 million of principal in directly originated transactions across 24 portfolio companies and$60.3 million of principal in syndicated transactions across 14 portfolio companies. As ofDecember 31, 2019 , the investment portfolio was comprised of$634.5 million of principal in directly originated transactions across 62 portfolio companies and$131.1 million of principal in syndicated transactions across 22 portfolio companies.
The following table shows weighted average current yield to maturity based on
fair value as of
December 31, 2020 December 31, 2019
Weighted Weighted
Average Average
Current Yield Current Yield
Percentage of for Total Percentage of for Total
Total Investments Investments Total Investments Investments Senior secured first lien term loans
52.7 % 9.3 % 48.7 % 10.4 %
Senior secured first lien notes 1.2 % 11.0 % 2.1 11.0
Senior secured second lien term loans 14.7 % 10.9 % 18.2 29.6
Subordinated notes 9.4 % 8.8 % 9.3 10.8
Sierra Senior Loan Strategy JV I LLC 15.7 % 9.0 % 10.1 9.6
Equity/warrants 6.3 % 6.0 % 11.6 9.7
Total 100.0 % 9.5 % 100.0 % 10.9 %
(1) The weighted average current yield for total investments does not represent
the total return to our stockholders.
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The following table shows the portfolio composition by industry classification,
based on fair value at
Amortized Cost Percentage Fair Value Percentage
Multi-Sector Holdings $ 174,660,001 24.9 % $ 131,792,864 21.8 %
Services: Business 79,260,551 11.3 % 73,716,395 12.2 %
High Tech Industries 75,519,344 10.8 % 71,792,022 11.9 %
Healthcare & Pharmaceuticals 68,599,968 9.8 % 58,275,198 9.6 %
Consumer Goods: Durable 32,045,028 4.6 % 41,016,292 6.8 %
Construction & Building 42,928,750 6.1 % 38,356,358 6.4 %
Banking, Finance, Insurance & Real Estate 27,848,664 4.0 % 37,620,161 6.2 %
Aerospace & Defense 33,558,896 4.8 % 29,723,725 4.9 %
Hotel, Gaming & Leisure 36,326,705 5.2 % 24,013,769 4.0 %
Automotive 18,886,756 2.7 % 17,404,476 2.9 %
Containers, Packaging & Glass 15,206,840 2.2 % 15,120,424 2.5 %
Environmental Industries 5,041,430 0.7 % 10,052,691 1.7 %
Services: Consumer 9,700,000 1.4 % 9,725,000 1.6 %
Chemicals, Plastics & Rubber 10,060,861 1.4 % 9,063,498 1.5 %
Forest Products & Paper 6,477,887 0.9 % 7,770,704 1.3 %
Media: Diversified & Production 15,474,145 2.2 % 6,780,000 1.1 %
Transportation: Cargo 6,877,294 1.0 % 6,770,781 1.1 %
Transportation: Consumer 7,975,416 1.1 % 6,068,082 1.0 %
Metals & Mining 3,492,436 0.5 % 3,492,479 0.6 %
Energy: Oil & Gas 20,868,832 3.0 % 2,625,018 0.4 %
Wholesale 2,212,919 0.3 % 1,746,044 0.3 %
Retail 7,934,347 1.1 % 1,012,358 0.2 %
Beverage & Food 46,869 0.0 % 48,141 0.0 %
Total $ 701,003,939 100.0 % $ 603,986,480 100.0 %
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The following table shows the portfolio composition by industry classification,
including the total return swap ("TRS") underlying loans, based on fair value as
of December 31, 2019 :
Amortized Cost Percentage Fair Value Percentage
Multi-Sector Holdings $ 161,308,341 20.2 % $ 130,278,650 19.2 %
High Tech Industries 86,735,849 10.8 81,531,661 12.1
Services: Business 131,560,449 16.5 81,285,736 12.0
Healthcare & Pharmaceuticals 59,511,718 7.5 57,374,851 8.5
Banking, Finance, Insurance & Real Estate 45,286,982 5.7 52,049,297 7.7
Construction & Building 42,797,402 5.4 39,865,739 5.9
Wholesale 34,519,910 4.3 35,186,289 5.2
Aerospace & Defense 34,876,226 4.4 34,475,020 5.1
Consumer Goods: Durable 21,962,500 2.8 24,214,089 3.6
Hotel, Gaming & Leisure 21,373,829 2.7 21,365,163 3.2
Automotive 22,312,149 2.8 19,861,655 2.9
Containers, Packaging & Glass 16,263,768 2.0 15,655,179 2.3
Transportation: Cargo 12,734,167 1.6 12,771,231 1.9
Energy: Oil & Gas 21,692,260 2.7 10,007,469 1.5
Chemicals, Plastics & Rubber 10,090,722 1.3 9,505,614 1.4
Media: Diversified & Production 14,279,258 1.8 9,493,583 1.4
Forest Products & Paper 6,455,137 0.8 7,182,914 1.1
Transportation: Consumer 6,966,133 0.9 6,877,180 1.0
Capital Equipment 6,778,258 0.8 6,537,927 1.0
Environmental Industries 5,021,241 0.6 6,414,400 0.9
Consumer Goods: Non-durable 4,912,500 0.6 4,721,895 0.7
Metals & Mining 3,257,979 0.4 3,258,022 0.5
Media: Broadcasting & Subscription 10,408,142 1.3 2,163,218 0.3
Retail 8,304,830 1.0 1,846,648 0.3
Media: Advertising, Printing & Publishing 8,623,411 1.1 1,700,500 0.3
Total $ 798,033,161 100.0 % $ 675,623,930 100.0 %
(1) Does not include TRS underlying loans
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SIC Advisors regularly assesses the risk profile of our portfolio investments and rates each of them based on the categories set forth below, which we refer to asSIC Advisors' investment credit rating. Investment credit ratings are assigned to each of the investments in our portfolio that are directly held by the Company, but exclude any off-balance sheet interests of the Company.
Investment
Credit Rating Definition
1 Investments that are performing above expectations.
2 Investments that are performing within expectations, with risks that
are neutral or favorable compared to risks at the time of origination
or purchase. All new loans are rated '2'.
3 Investments that are performing below expectations and that require
closer monitoring, but where no loss of interest, dividend or
principal is expected. Companies rated '3' may be out of compliance
with financial covenants, however, loan payments aregenerally not
past due.
4 Investments that are performing below expectations and for which risk
has increased materially since origination or purchase. Some loss of
interest or dividend is expected, but no loss of principal. In
addition to the borrower being generally out of compliance with debt
covenants, loan payments may be past due (but generally not more than
180 days past due).
5 Investments that are performing substantially below expectations and
whose risks have increased substantially since origination or
purchase. Most or all of the debt covenants are out of compliance and
payments are substantially delinquent. Some loss of principal is
expected.
The following table shows the distribution of our investment portfolio, not
including cash and cash equivalents, on the 1 to 5 investment credit rating
scale at fair value as of
December 31, 2020 December 31, 2019
Investments at Investments at
Investment Credit Rating Fair Value Percentage
Fair Value Percentage
1 $ 51,481,987 8.5 % $ 58,241,430 8.6 %
2 410,310,087 67.9 % 455,613,817 67.5
3 110,668,216 18.3 % 144,141,977 21.3
4 13,500,546 2.3 % 7,187,740 1.1
5 18,025,644 3.0 % 10,438,966 1.5
Total $ 603,986,480 100.0 % $ 675,623,930 100.0 %
Results of Operations
The following table shows operating results for the years ended December 31,
2020 , 2019 and 2018:
2020 2019 2018
Total investment income $ 47,893,107 $ 80,097,606 $ 97,172,641
Total expenses 50,366,188 48,015,704 50,443,855
Net investment income/(loss) (2,473,081 ) 32,081,902 46,728,786
Net realized gain/(loss) from investments
and total return swap (73,666,673 ) (27,723,609 ) (57,661,458 )
Net change in unrealized
appreciation/(depreciation) on investments
and total return swap 25,390,519 (33,698,261 ) (17,836,419 )
Change in provision for deferred taxes on
unrealized (appreciation)/depreciation on
investments (2,149,661 ) (240,935 ) 291,455
Loss on extinguishment of debt (217,950 ) - -
Net increase/(decrease) in net assets
resulting from operations $ (53,116,846 ) $
(29,580,903 )
Investment Income Total investment income decreased$32,204,499 , or 40.2%, to$47,893,107 for the year endedDecember 31, 2020 , compared to$80,097,606 for the year endedDecember 31, 2019 . Total investment income consisted primarily of portfolio interest, which decreased$29,332,140 , or 39.3%, to$45,251,944 for the year endedDecember 31, 2020 , compared to$74,584,084 for the year endedDecember 31, 2019 . This decrease was primarily due to a$189 million , or 24.4%, decrease in our average investment portfolio. Fee income decreased$2,802,932 or 69.4%, to$1,236,934 for the year endedDecember 31, 2020 , compared to$4,039,866 for the year endedDecember 31, 2019 , primarily due to a decrease in fees associated with loan originations and loan prepayments. 40
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Total investment income decreased$17,075,035 , or 17.6%, to$80,097,606 for the year endedDecember 31, 2019 , compared to$97,172,641 for the year endedDecember 31, 2018 . Total investment income consisted primarily of portfolio interest, which decreased$18,710,179 , or 20.1%, to$74,584,084 for the year endedDecember 31, 2019 , compared to$93,294,263 for the year endedDecember 31, 2018 . This decrease was primarily due to a$191 million , or 19.2%, decrease in our average investment portfolio. Fee income increased$491,486 , or 13.9%, to$4,039,866 for the year endedDecember 31, 2019 , compared to$3,548,380 for the year endedDecember 31, 2018 , primarily due to an increase in fees associated with loan originations and loan prepayments. Operating Expenses The following table shows operating expenses for the years endedDecember 31, 2020 , 2019 and 2018: 2020 2019 2018 Base management fees$ 12,185,544 $ 17,018,479 $ 19,011,460
Interest and financing expenses 11,835,466 20,489,217 21,356,282 Incentive fees
- 176,061 -
General and administrative expenses 12,363,215 5,885,448 5,034,100 Administrator expenses 2,231,015 2,538,480 2,699,176 Offering costs 38,846 43,987 633,317 Professional fees 11,712,102 1,864,032 1,709,520 Total expenses$ 50,366,188 $ 48,015,704 $ 50,443,855 Total expenses increased$2,350,484 , or 4.9%, to$50,366,188 for the year endedDecember 31, 2020 , as compared to$48,015,704 for the year endedDecember 31, 2019 , primarily due to an increase in professional fees and general and administrative expenses related to deferred transaction costs (see Note 2), partially offset by a decrease in base management fees and a decrease in interest and financing expenses. Total expenses decreased$2,428,151 , or 4.8%, to$48,015,704 for the year endedDecember 31, 2019 , as compared to$50,443,855 for the year endedDecember 31, 2018 , primarily due to a decrease in management fees. Base management fees decreased$4,832,935 , or 28.4%, to$12,185,544 for the year endedDecember 31, 2020 , as compared to$17,018,479 for the year endedDecember 31, 2019 , primarily due to a decrease in our average gross assets of$274 million , or 28.3%. Base management fees decreased$1,992,981 , or 10.5%, to$17,018,479 for the year endedDecember 31, 2019 , as compared to$19,011,460 for the year endedDecember 31, 2018 , primarily due to a decrease in our average gross assets of$123 million , or 11.1%. Interest and financing expenses decreased$8,653,751 , or 42.2%, to$11,835,466 for the year endedDecember 31, 2020 , as compared to$20,489,217 for the year endedDecember 31, 2019 , primarily due to the wind-down and termination of the Company's senior secured syndicated revolving credit facility (the "ING Credit Facility" as amended from time to time as described below) fromMay 2020 throughJuly 2020 . Interest and financing expenses decreased$867,065 , or 4.1%, to$20,489,217 for the year endedDecember 31, 2019 , as compared to$21,356,282 for the year endedDecember 31, 2018 , primarily due to a decrease in the weighted average interest on our credit facilities of 0.5%.
Net Realized Gains/Losses on Investments
We measure realized gains or losses by the difference between the net proceeds from the disposition and the amortized cost basis of an investment, without regard to unrealized gains or losses previously recognized.
During the years ended
Net Unrealized Appreciation/Depreciation on Investments
Net change in unrealized appreciation/depreciation on investments reflects the net change in the fair value of our total investments including the TRS and provision for deferred taxes. For the year endedDecember 31, 2020 we recorded a net change in unrealized appreciation of$23,240,858 . The unrealized appreciation resulted from the reversal of previously recorded unrealized depreciation on investments that were realized, partially sold, or written-off during the year, partially offset by net unrealized depreciation on the current portfolio. For the years endedDecember 31, 2019 and 2018, we recorded a net change in unrealized depreciation of$33,939,196 and$17,544,964 on total investments, respectively. The unrealized depreciation resulted from negative credit-related adjustments that caused a reduction in fair value of certain portfolio investments.
Changes in Net Assets from Operations
For the year endedDecember 31, 2020 , we recorded a net decrease in net assets resulting from operations of$53,116,846 compared to a net decrease in net assets resulting from operations of$29,580,903 for the year endedDecember 31, 2019 . Based on 102,744,642 and 100,582,788 weighted average common shares outstanding for the years endedDecember 31, 2020 and 2019, respectively, our per share net decrease in net assets resulting from operations was$0.52 for the year endedDecember 31, 2020 compared to a per share net decrease in net assets from operations of$0.29 for the year endedDecember 31, 2019 . 41
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For the year endedDecember 31, 2019 , we recorded a net decrease in net assets resulting from operations of$29,580,903 compared to a net decrease in net assets resulting from operations of$28,477,636 for the year endedDecember 31, 2018 . Based on 100,582,788 and 97,404,685 weighted average common shares outstanding for the years endedDecember 31, 2019 and 2018, respectively, our per share net decrease in net assets resulting from operations was$0.29 for the year endedDecember 31, 2019 compared to a per share net decrease in net assets from operations of$0.29 , for the year endedDecember 31, 2018 .
Financial Condition, Liquidity and Capital Resources
This "Liquidity and Capital Resources" section should be read in conjunction with "COVID-19 Developments" above and "Risk Factors" in Part I, Item 1A of this Annual Report on Form 10-K. As a BDC, we distribute substantially all of our net income to our stockholders and have an ongoing need to raise additional capital for investment purposes. To fund growth, we have a number of alternatives available to increase capital, including increasing debt and funding from operational cash flow. Our liquidity and capital resources historically have been generated primarily from the net proceeds of our public offering of common stock, use of our credit facilities and our TRS. Currently, our primary source of liquidity derived from the use of our credit facility. As ofDecember 31, 2020 and 2019, we had$65.3 million and$225.3 million , respectively, in cash and cash equivalents. In the future, we may generate cash from future offerings of securities, future borrowings and cash flows from operations, including interest earned from the temporary investment of cash inU.S. government securities and other high-quality debt investments that mature in one year or less. Our primary use of funds is to make investments in our targeted asset classes, cash distributions to our stockholders, and other general corporate purposes. In order to satisfy the Code requirements applicable to us as a RIC, we intend to distribute to our stockholders substantially all of our taxable income, but we may also elect to periodically spillover certain excess undistributed taxable income from one tax year into the next tax year. In addition, as a BDC, we generally are required to meet a coverage ratio of total assets to total senior securities, which include borrowings and any preferred stock we may issue in the future, of at least 200% (or 150% if certain requirements under the 1940 Act are met) at the time of the borrowing or issuance of preferred stock. This requirement limits the amount that we may borrow. The following table shows our net borrowings as ofDecember 31, 2020 and 2019: December 31, 2020 December 31, 2019 Balance Unused Balance Total Commitment Outstanding
Commitment Total Commitment Outstanding Unused Commitment ING Credit Facility $
- $ - $
-
180,000,000 145,000,000 35,000,000 300,000,000 240,000,000 60,000,000
Total before deferred financing costs 180,000,000 145,000,000 35,000,000 515,000,000 328,100,000 186,900,000 Unamortized deferred financing costs - (659,266 ) - - (2,235,279 ) - Total borrowings outstanding, net deferred financing costs$ 180,000,000 $ 144,340,734 $
35,000,000$ 515,000,000 $ 325,864,721 $ 186,900,000 ING Credit Facility OnAugust 12, 2016 , the Company amended its ING Credit Facility pursuant to a Senior Secured Revolving Credit Agreement (the "Revolving Credit Agreement" as amended from time to time as described below) with certain lenders party thereto from time to time andING Capital LLC , as administrative agent. The ING Credit Facility was secured by substantially all of the Company's assets, subject to certain exclusions as further set forth in an Amended and Restated Guarantee, Pledge and Security Agreement (the "Security Agreement") entered into in connection with the Revolving Credit Agreement, among the Company, the subsidiary guarantors party thereto,ING Capital LLC , as Administrative Agent, each Financial Agent and Designated Indebtedness Holder party thereto andING Capital LLC , as Collateral Agent. The ING Credit Facility also included usual and customary representations, covenants and events of default for senior secured revolving credit facilities of this nature. OnJuly 25, 2019 , the Company entered into Amendment No. 2 to the Revolving Credit Agreement that among other things, (i) reduced the size of the commitments thereunder from$220.0 million to$215.0 million , (ii) extended the Revolver Termination Date (as defined in the Revolving Credit Agreement) fromAugust 12, 2019 toMarch 31, 2020 and (iii) extended the Maturity Date (as defined in the Revolving Credit Agreement) fromAugust 12, 2020 toMarch 31, 2021 . OnMarch 30, 2020 , the Company entered into Amendment No. 3 to the Revolving Credit Agreement that among other things, extended the Revolver Termination Date fromMarch 31, 2020 toApril 30, 2020 after which the Revolving Credit Facility would enter amortization. OnMay 15, 2020 , the Company entered into Amendment No. 4 to the Revolving Credit Agreement to among other things, (i) shorten the maturity date fromMarch 31, 2021 toSeptember 30, 2020 , (ii) accelerate the amortization of the Revolving Credit Agreement, and (iii) provide for the prepayment of the outstanding loans under the Revolving Credit Agreement in an aggregate principal amount of not less than$20 million . OnJuly 22, 2020 , the Company paid all remaining outstanding obligations under the Revolving Credit Agreement. OnJuly 31, 2020 (the "Termination Date"), the Company terminated the commitments on the Credit Agreement. The repayment of the outstanding obligations under the Revolving Credit Agreement was accounted for as a debt extinguishment in accordance with ASC 470-50, Modifications and Extinguishments, which attributed to a realized loss of$217,950 and was recorded on the Consolidated Statements of Operations as a loss on extinguishment of debt. The ING Credit Facility allowed for the Company, at its option, to borrow money at a rate of either (i) an alternate base rate plus 1.50% per annum or (ii) LIBOR plus 2.50% per annum. The interest rate margins were subject to certain step-downs upon the satisfaction of certain conditions described in the Revolving Credit Agreement. The alternate base rate was the greatest of (i) theU.S. Prime Rate set forth in theWall Street Journal , (ii) the federal funds effective rate plus 1/2 of 1%, and (iii) three month LIBOR plus 1.00%. As ofDecember 31, 2020 , there were no commitments under the ING Credit Facility. As ofDecember 31, 2019 , the commitment under the ING Credit Facility was$215,000,000 . Availability of loans under the ING Credit Facility was linked to the valuation of the collateral pursuant to a borrowing base mechanism. The Company was also required to pay a commitment fee to the lenders based on the daily unused portion of the aggregate commitments under the ING Credit Facility. The commitment fee was (i) 1.50% if the used portion of the aggregate commitments is less than or equal to 40%, (ii) 0.75% if the used portion of the aggregate commitments is greater than 40% and less than or equal to 65% or (iii) 0.50% if the used portion of the aggregate commitments is greater than 65%. The ING Credit Facility provided that the Company may use the proceeds of theING Credit Facility for general corporate purposes, including making investments in accordance with the Company's investment objective and strategy. Borrowings under the Revolving Credit Agreement were subject to, among other things, a minimum borrowing base. Substantially all of the Company's assets were pledged as collateral under the Revolving Credit Agreement. The ING Credit Facility required the Company to, among other things (i) make representations and warranties regarding the collateral as well the Company's business and operations, (ii) agree to certain indemnification obligations, and (iii) agree to comply with various affirmative and negative covenants. The documents for the Revolving Credit Agreement also included default provisions, such as the failure to make timely payments under the Revolving Credit Agreement, the occurrence of a change in control, and the failure by the Company to materially perform under the operative agreements governing the Revolving Credit Agreement, which, if not complied with, could have accelerated repayment under the Revolving Credit Agreement, thereby materially and adversely affecting the Company's liquidity, financial condition and results of operations. In connection with the security interest established under the Security Agreement, the Company,ING Capital LLC , in its capacity as collateral agent, andState Street Bank and Trust Company , in its capacity as the Company's custodian, entered into a control agreement dated as ofDecember 4, 2013 , in order to, among other things, perfect the security interest granted pursuant to the Security Agreement in, and provide for control over, the related collateral. As a result of the termination of the Revolving Credit Agreement, the Security Agreement was terminated effective as of the Termination Date. As ofDecember 31, 2019 , the carrying amount of the Company's borrowings under the ING Credit Facility approximated their fair value. The fair value of the Company's debt obligation was determined in accordance with ASC 820, which defines fair value in terms of the price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. The fair value of the Company's borrowings under the ING Credit Facility was estimated based upon market interest rates of the Company's borrowings or entities with similar credit risk, adjusted for nonperformance risk, if any. As ofDecember 31, 2019 , certain unobservable inputs used to value the ING Credit Facility were deemed to be Level 3, as defined in Note 4. Alpine Credit Facility OnSeptember 29, 2017 , the Company's wholly-owned, special purpose financing subsidiary, Alpine, amended its existing revolving credit facility (the "Alpine Credit Facility") pursuant to an Amended and Restated Loan Agreement (the "Loan Agreement") withJPMorgan Chase Bank, National Association ("JPMorgan"), as administrative agent and lender, the Financing Providers from time to time party thereto,SIC Advisors , as the portfolio manager, and the Collateral Administrator, Collateral Agent and Securities Intermediary party thereto. The Loan Agreement was amended to, among other things, (i) extend the reinvestment period untilDecember 29, 2020 , (ii) extend the scheduled termination date untilMarch 29, 2022 , (iii) decrease the applicable margin for advances to 2.85% per annum and (iv) increase the compliance condition for net advances to 55% of net asset value. Alpine's obligations to JPMorgan under the Alpine Credit Facility are secured by a first priority security interest in a significant portions of the assets of Alpine, including its portfolio of loans. The obligations of Alpine under the Alpine Credit Facility are non-recourse to the Company. OnNovember 18, 2020 , Alpine entered into Amendment No.1 to the Loan Agreement to, among other things, (i) extend the reinvestment period fromDecember 29, 2020 toMay 18, 2021 , (ii) increase the applicable margin for advances from 2.85% to 3.10% per annum, (iii) reduce the amount of maximum borrowings in an aggregate principal amount from$300,000,000 to$180,000,000 on a committed basis, (iv) require the Company to maintain a minimum a cash balance of$20,000,000 in Alpine, and (v) decrease the compliance condition for net advances from 55% to 52.5% of net asset value. The maturity date under the Loan Agreement did not change and therefore any amounts borrowed, as well as all accrued and unpaid interest thereunder, will be due and payable onMarch 29, 2022 . In connection with the Amendment, the Company repaid$35,000,000 of the outstanding balance under the Loan Agreement onNovember 18, 2020 , reducing the outstanding balance from$180,000,000 to$145,000,000 . The Alpine Credit Facility provides for borrowings in an aggregate principal amount up to$180,000,000 on a committed basis. Borrowings under the Alpine Credit Facility are subject to compliance with a NAV coverage ratio with respect to the current value of Alpine's portfolio and various eligibility criteria must be satisfied with respect to the initial acquisition of each loan in Alpine's portfolio.Pricing under the Alpine Credit Facility for each one month calculation period is based on LIBOR for an interest period of one month, plus a spread of 3.10% per annum. If LIBOR is unavailable, pricing will be determined at the prime rate offered by JPMorgan or the federal funds effective rate, plus a spread of 3.10% per annum. Interest is payable monthly in arrears. Alpine is also required to pay a commitment fee of 1.00% on the average daily unused amount of the financing commitments to the extent that$180,000,000 has not been borrowed. Borrowings of Alpine are considered borrowings of the Company for purposes of complying with the asset coverage requirements under the 1940 Act, applicable to BDCs. Pursuant to a Sale and Contribution Agreement entered into between the Company and Alpine (the "Sale Agreement") in connection with the Alpine Credit Facility, the Company may sell loans or contribute cash or loans to Alpine from time to time and will retain a residual interest in any assets contributed through its ownership of Alpine or will receive fair market value for any assets sold to Alpine. In certain circumstances the Company may be required to repurchase certain loans sold to Alpine. In addition to the acquisition of loans pursuant to the Sale Agreement, Alpine may purchase additional assets from various sources. Alpine has appointedSIC Advisors to manage its portfolio of assets pursuant to the terms of a Portfolio Management Agreement betweenSIC Advisors and Alpine. As ofDecember 31, 2020 and 2019, the carrying amount of the Company's borrowings under the Alpine Credit Facility approximated the fair value of the Company's debt obligation. The fair value of the Company's debt obligation is determined in accordance with ASC 820, which defines fair value in terms of the price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. The fair value of the Company's borrowings under the Alpine Credit Facility is estimated based upon market interest rates of the Company's borrowings or entities with similar credit risk, adjusted for nonperformance risk, if any. As ofDecember 31, 2020 and 2019, the Alpine Credit Facility would be deemed to be Level 3, as defined in Note 4.
Contractual Obligations
The following table shows our payment obligations for repayment of debt, which
total our contractual obligations at
Payment Due By Period
Less than More than
Total 1 Year 1 - 3 Years 3 - 5 Years 5 Years
Alpine
Credit
Facility 145,000,000 - 145,000,000 - -
Total
Contractual
Obligations $ 145,000,000 $ - $ 145,000,000 $ - $ -
We have entered into certain contracts under which we have material future
commitments. On April 5, 2012 , we entered into the Investment Advisory Agreement
with SIC Advisors in accordance with the 1940 Act. The Investment Advisory
Agreement became effective as of April 17, 2012 , the date that we met the
minimum offering requirement. Pursuant to the 1940 Act, the initial term of the
Investment Advisory Agreement was for two years from its effective date, with
one-year renewals subject to approval by our board of directors, a majority of
whom must be independent directors. Most recently, on April 3, 2020 , the board
of directors approved the renewal of the Investment Advisory Agreement for an
additional one-year term at a board meeting. SIC Advisors serves as our
investment adviser in accordance with the terms of the Investment Advisory
Agreement. Payments under our Investment Advisory Agreement in each reporting
period consist of (i) a management fee equal to a percentage of the value of our
gross assets and (ii) an incentive fee based on our performance.
On April 5, 2012 , we entered into the Administration Agreement with Medley
Capital LLC with an initial term of two years, pursuant to which Medley Capital
LLC furnishes us with administrative services necessary to conduct our
day-to-day operations. The Administration Agreement became effective as of
April 17, 2012 , the date that we met the minimum offering requirement. Pursuant
to its terms, and unless earlier terminated as described below, the
Administration Agreement will remain in effect from year-to-year if approved
annually by a majority of our directors who are not "interested persons" (as
defined in Section 2(a)(19) of the 1940 Act) of the Company or Medley Capital
LLC , and either the holders of a majority of our outstanding voting securities
or our board of directors. Most recently, on April 3, 2020 , the board of
directors approved the renewal of the Administration Agreement for an additional
one-year term at a board meeting. Medley Capital LLC is reimbursed for
administrative expenses it incurs on our behalf in performing its obligations.
Such costs are reasonably allocated to us on the basis of assets, revenues, time
records or other reasonable methods. We do not reimburse Medley Capital LLC for
any services for which it receives a separate fee or for rent, depreciation,
utilities, capital equipment or other administrative items allocated to a
controlling person of Medley Capital LLC .
If any of our contractual obligations discussed above are terminated, our costs
may increase under any new agreements that we enter into as replacements. We
would also likely incur expenses in locating alternative parties to provide the
services we expect to receive under the Investment Advisory Agreement and the
Administration Agreement. Any new investment advisory agreement would also be
subject to approval by our stockholders.
Off-Balance Sheet Arrangements
On
OnSeptember 29, 2017 , Arbor entered into the Fifth Amended Confirmation Letter Agreement with Citibank. The Fifth Amended Confirmation Agreement reduced the maximum portfolio notional (determined at the time each such loan becomes subject to the TRS) from$300,000,000 to$180,000,000 , through incremental reductions of$60,000,000 onOctober 3, 2017 and$20,000,000 on each ofNovember 3, 2017 ,December 3, 2017 andJanuary 3, 2018 . The Fifth Amended Confirmation Agreement also decreased the interest rate payable to Citibank from LIBOR plus 1.65% per annum to LIBOR plus 1.60% per annum. Other than the foregoing, the Fifth Amended Confirmation Agreement did not change any of the other material terms of the TRS. OnJuly 22, 2019 , the TRS with Citibank was terminated. The TRS with Citibank enabled Arbor to obtain the economic benefit of the loans underlying the TRS, despite the fact that such loans were not directly held or otherwise owned by Arbor, in return for an interest-type payment to Citibank. Accordingly, the TRS is analogous to Arbor utilizing leverage to acquire loans and incurring an interest expense to a lender.SIC Advisors acted as the investment manager of Arbor and had discretion over the composition of the basket of loans underlying the TRS. The terms of the TRS were governed by an ISDA 2002 Master Agreement, the Schedule thereto and Credit Support Annex to such Schedule, and the Confirmation exchanged thereunder, between Arbor and Citibank, which collectively established the TRS, and are collectively referred to herein as the "TRS Agreement". Transactions in TRS contracts during the years endedDecember 31, 2020 , 2019 and 2018 were as follows: 2020 2019 2018
Interest income and settlement from TRS $ -
- (9,632,900 ) (2,943,401 )
Net realized gains/(loss) on TRS $ - $
(9,323,512 )
Net change in unrealized appreciation/(depreciation) on TRS $ -$ 6,524,904 $ (1,170,036 ) 42
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The Company held no derivative positions as of the year ended
The following table shows the volume of the Company's derivative transactions
for the years ended
2020 2019 2018
Average notional par amount of contracts (1) $ -
(1) Average notional amount is based on the average month end balances for the
years ended
of notional contract amounts held during each year.
On March 27, 2015 , the Company and Great American Life Insurance Company
("GALIC") entered into a limited liability company operating agreement to
co-manage Sierra Senior Loan Strategy JV I LLC ("Sierra JV"). All portfolio and
other material decisions regarding Sierra JV must be submitted to Sierra JV's
board of managers, which is comprised of four members, two of whom are selected
by the Company and the other two are selected by GALIC. The Company has
concluded that it does not operationally control Sierra JV. As the Company does
not operationally control Sierra JV, it does not consolidate the operations of
Sierra JV within the consolidated financial statements. As a practical
expedient, the Company uses NAV to determine the fair value of its investment in
Sierra JV; therefore, this investment has been presented as a reconciling item
within the fair value hierarchy (see Note 4).
As of December 31, 2020 , Sierra JV had total capital commitments of $124.6
million , with the Company providing $110.1 million and GALIC providing $14.5
million . As of December 31, 2019 , Sierra JV had total capital commitments of
$116.0 million , with the Company providing $101.5 million and GALIC providing
$14.5 million . As of December 31, 2020 , approximately $124.5 million was funded
relating to these commitments of which $110.1 million was from the Company. As
of December 31, 2019 , approximately $105.2 million was funded relating to these
commitments of which $92.1 million was from the Company. The Company does not
have the right to withdraw any of their respective capital commitment, unless in
connection with a transfer of its membership interests. The Company may transfer
full membership interests as long as it is approved by all members and
transferred in a transaction exempt from the registration requirements of the
Securities Act or applicable state securities laws.
Sierra JV entered into a Senior Secured Revolving Credit Facility Agreement, as
amended (the "JV Facility") with Deutsche Bank, AG,
On
On
OnOctober 28, 2019 , the JV Facility reinvestment period was further extended fromOctober 28, 2019 toMarch 31, 2020 and the interest rate was modified from bearing an interest rate of LIBOR (with a 0.00% floor) + 2.50% per annum to LIBOR (with a 0.00% floor) + 2.75% per annum. OnMarch 31, 2020 , the total commitment under the JV Facility was reduced to$240.0 million from$250.0 million and the reinvestment period was extended fromMarch 31, 2020 toApril 30, 2020 . OnApril 30, 2020 , the total commitment under the JV Facility was reduced to$200.0 million from$240.0 million , the reinvestment period was extended fromApril 30, 2020 toJuly 31, 2020 , the maturity date was extended toJuly 31, 2023 and the interest rate was modified from bearing an interest rate of LIBOR (with a 0.00% floor) + 2.75% per annum to LIBOR (with a 0.50% floor) + 3.15% per annum. OnJuly 29, 2020 , the total commitment under the JV Facility was reduced to$175.0 million from$200.0 million , the reinvestment period was extended fromJuly 31, 2020 toApril 30, 2021 and the maturity date was extended toApril 30, 2024 . Additionally, the interest rate was modified from bearing an interest rate of LIBOR (with a 0.50% floor) + 3.15% per annum to LIBOR (with a 0.50% floor) + 3.25% per annum. The JV Facility is secured substantially by all of Sierra JV's assets, subject to certain exclusions set forth in the JV Facility. As ofDecember 31, 2020 andDecember 31, 2019 , there was$124.7 million and$204.9 million outstanding under the JV Facility, respectively. We have determined that the Sierra JV is an investment company under ASC 946; however, in accordance with such guidance, we generally will not consolidate its 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. As we do not operationally control Sierra JV, we do not consolidate our interest in the Sierra JV. Distributions We have elected, and intend to qualify annually, to be treated forU.S. federal income tax purposes, as a RIC under Subchapter M of the Code. To maintain RIC tax treatment, we must, among others things, distribute at least 90% of our net ordinary income and net short-term capital gains in excess of net long-term capital losses, if any, to our stockholders. In order to avoid certainU.S. federal excise taxes imposed on RICs, we must distribute during each calendar year an amount at least equal to the sum of: (i) 98.0% of our ordinary income for the calendar year, (ii) 98.2% of our capital gains in excess of capital losses for the one-year period generally ending onOctober 31 of the calendar year (unless an election is made by us to use our taxable year) and (iii) any ordinary income and net capital gains that we recognized for preceding years, but were not distributed during such years, and on which we paid noU.S. federal income tax. While we intend to distribute any income and capital gains in the manner necessary to minimize imposition of the 4%U.S. federal excise tax, sufficient amounts of our taxable income and capital gains may not be distributed to avoid entirely the imposition of the tax. In that event, we will be liable for the tax only on the amount by which we do not meet the foregoing distribution requirement. We currently intend to distribute net capital gains (i.e., net long-term capital gains in excess of net short-term capital losses), if any, at least annually out of the assets legally available for such distributions. However, we may decide in the future to retain such capital gains for investment and elect to treat such gains as deemed distributions to you. If this happens, you will be treated forU.S. federal income tax purposes as if you had received an actual distribution of the capital gains that we retain and reinvested the net after tax proceeds in us. In this situation, you would be eligible to claim a tax credit (or, in certain circumstances, a tax refund) equal to your allocable share of the tax we paid on the capital gains deemed distributed to you. We can offer no assurance that we will continue to achieve results that will permit the payment of any cash distributions and, if we issue senior securities, we may be prohibited from making distributions if doing so causes us to fail to maintain the asset coverage ratios stipulated by the 1940 Act or if distributions are limited by the terms of any of our borrowings. OnJuly 31, 2020 , our board of directors temporarily suspended the monthly distributions on the shares of the Company's common stock. OnOctober 22, 2020 , our board of directors determined to reinstate the monthly distributions on the shares of the Company's common stock. Any distributions to our stockholders paid by the Company is subject to our board of directors' discretion and applicable legal restrictions and take into account our results of operations, our general financial condition, general economic conditions, or other factors prohibit us from declaring a distribution. Any distributions to our stockholders will be declared out of assets legally available for distribution. From time to time, but not less than quarterly, we will review our accounts to determine whether distributions to our stockholders are appropriate. We have not established limits on the amount of funds we may use from available sources to make distributions. From the commencement of our offering throughSeptember 30, 2016 , a portion of our distributions were comprised in part of expense support payments made bySIC Advisors that were subject to repayment by us within three years of the date of such support payment. The Expense Support Agreement expired onDecember 31, 2016 and the Company's contingent obligation to repay eligible reimbursements toSIC Advisors expired onSeptember 30, 2019 . The purpose of this arrangement was to cover distributions to stockholders so as to ensure that the distributions did not constitute a return of capital for GAAP purposes. In the future, we may have distributions which could be characterized as a return of capital. Such distributions are not based on our investment performance and can only be sustained if we achieve positive investment performance in future periods. There can be no assurance that we will achieve the performance necessary to make distributions and at historical levels in the future.SIC Advisors has no obligation to enter into a renewed expense support agreement. Our distributions may exceed our earnings, which we refer to as a return of capital. As a result, a portion of the distributions we make may represent a return of capital. Our use of the term "return of capital" merely means distributions in excess of our earnings and as such may constitute a return on your individual investments and does not mean a return on capital. Therefore stockholders are advised that they should be aware of the differences with our use of the term "return of capital" and "return on capital." 43
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The following table reflects the cash distributions per share that the Company has declared or paid to its stockholders during 2020, 2019 and 2018. Stockholders of record as of each respective record date were entitled to receive the distribution.
Record Date Payment Date Amount per share January 15 and 31, 2018 January 31, 2018 0.2667 February 15 and 28, 2018 February 28, 2018 0.2667 March 15 and 30, 2018 March 30, 2018 0.2667 April 13 and 30, 2018 April 30, 2018 0.2667 May 15 and 31, 2018 May 31, 2018 0.2667 June 15 and 29, 2018 June 29, 2018 0.2667 July 13 and 13, 2018 July 31, 2018 0.2667 August 15 and 31, 2018 August 31, 2018 0.2667 September 14 and 28, 2018 September 28, 2018 0.2667 October 15 and 31, 2018 October 31, 2018 0.2667 November 15 and 30, 2018 November 30, 2018 0.2667 December 14 and 31, 2018 December 31, 2018 0.2667 January 25, 2019 January 31, 2019 0.05334 February 11, 2019 February 28, 2019 0.05334 March 11, 2019 March 29, 2019 0.05334 April 29, 2019 April 30, 2019 0.05334 May 30, 2019 May 31, 2019 0.05334 June 27, 2019 June 28, 2019 0.05334 July 30, 2019 July 31, 2019 0.05334 August 29, 2019 August 30, 2019 0.05334 September 27, 2019 September 30, 2019 0.05334 October 30, 2019 October 31, 2019 0.05334 November 28, 2019 November 29, 2019 0.05334 December 30, 2019 December 31, 2019 0.05334 January 30, 2020 January 31, 2020 0.03500 February 27, 2020 February 28, 2020 0.03500 March 30, 2020 March 31, 2020 0.03500 October 29, 2020 October 30, 2020 0.01000 November 27, 2020 November 30, 2020 0.01000 December 30, 2020 December 31, 2020 0.01000 We have adopted an "opt in" distribution reinvestment plan pursuant to which common stockholders may elect to have the full amount of any cash distributions reinvested in additional shares of our common stock. As a result, if we declare a cash distribution, stockholders that have "opted in" to our distribution reinvestment plan will have their distribution automatically reinvested in additional shares of our common stock rather than receiving cash dividends. Stockholders who receive distributions in the form of shares of common stock will be subject to the same federal, state and local tax consequences as if they received cash distributions. Each year a statement on Internal Revenue Service Form 1099-DIV (or such successor form) identifying the source of the distribution (i.e., paid from ordinary income, paid from net capital gain on the sale of securities, or a return of capital) will be mailed to our stockholders. The tax basis of shares must be reduced by the amount of any return of capital distributions, which will result in an increase in the amount of any taxable gain (or a reduction in any deductible loss) on the sale of shares. Related Party Transactions We have entered into an Investment Advisory Agreement withSIC Advisors in which our senior management holds an equity interest and were party to the Expense Support Agreement throughDecember 31, 2016 , the date on which such agreement expired. Members of our senior management also serve as principals of other investment managers affiliated withSIC Advisors that do, and may in the future, manage investment funds, accounts or other investment vehicles with investment objectives similar to ours. We have entered into an Administration Agreement withMedley Capital LLC , pursuant to whichMedley Capital LLC furnishes us with administrative services necessary to conduct our day-to-day operations.Medley Capital LLC is reimbursed for administrative expenses it incurs on our behalf. We do not reimburseMedley Capital LLC for any services for which it receives a separate fee or for rent, depreciation, utilities, capital equipment or other administrative items allocated to a controlling person ofMedley Capital LLC .Medley Capital LLC is an affiliate ofSIC Advisors . We have entered into a license agreement withSIC Advisors under whichSIC Advisors has agreed to grant us a non-exclusive, royalty-free license to use the name "Sierra" for specified purposes in our business. Under the license agreement, we will have a right to use the "Sierra" name, subject to certain conditions, for so long asSIC Advisors or one of its affiliates remains our investment adviser. Other than with respect to this limited license, we will have no legal right to the "Sierra" name. Opportunities for co-investments may arise whenSIC Advisors or an affiliated adviser becomes aware of investment opportunities that may be appropriate for the Company and other clients or affiliated funds. The Company obtained an exemptive order from theSEC onNovember 25, 2013 (the "Prior Exemptive Order"). OnMarch 29, 2017 , the Company,SIC Advisors and certain other affiliated funds and investment advisers received an exemptive order (the "Exemptive Order") that supersedes the Prior Exemptive Order and allows affiliated registered investment companies to participate in co-investment transactions with us that would otherwise have been prohibited under Section 17(d) and 57(a)(4) and Rule 17d-1. OnOctober 4, 2017 , the Company,SIC Advisors and certain of our affiliates received an exemptive order that supersedes the Exemptive Order (the "Current Exemptive Order") and allows, in addition to the entities already covered by the Exemptive Order,Medley LLC and its subsidiary,Medley Capital LLC , to the extent they hold financial assets in a principal capacity, and any direct or indirect, wholly- or majority-owned subsidiary ofMedley LLC that is formed in the future, to participate in co-investment transactions with us that would otherwise be prohibited by either or both of Sections 17(d) and 57(a)(4) of the 1940 Act. 44
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Table of Contents Management Fee
We pay
The base management fee is calculated at an annual rate of 1.75% of our gross assets and is payable quarterly in arrears. The incentive fee consists of:
? An incentive fee on net investment income ("subordinated incentive fee on
income") is calculated and payable quarterly in arrears and is based upon
pre-incentive fee net investment income for the immediately preceding quarter.
No subordinated incentive fee on income is payable in any calendar quarter in
which pre-incentive fee net investment income does not exceed a quarterly
return to stockholders of 1.75% per quarter on our net assets at the end of
the immediately preceding fiscal quarter, or the preferred quarterly return.
All pre-incentive fee net investment income, if any, that exceeds the
preferred quarterly return, but is less than or equal to 2.1875% of net assets
at the end of the immediately preceding fiscal quarter in any quarter, will be
payable to
incentive fee on income as the catch up. It is intended to provide an
incentive fee of 20% on pre-incentive fee net investment income when
pre-incentive fee net investment income exceeds 2.1875% of net assets at the
end of the immediately preceding quarter in any quarter. For any quarter in
which our pre-incentive fee net investment income exceeds 2.1875% of net
assets at the end of the immediately preceding quarter, the subordinated
incentive fee on income shall equal 20% of the amount of pre-incentive fee net
investment income, because the preferred return and catch up will have been
achieved.
? A capital gains incentive fee will be earned on realized investments and shall
be payable in arrears as of the end of each calendar year during which the
Investment Advisory Agreement is in effect. If the Investment Advisory
Agreement is terminated, the fee will become payable as of the effective date
of such termination. The capital gains incentive fee is based on our realized
capital gains on a cumulative basis from inception, computed net of all
realized capital losses and unrealized capital depreciation on a cumulative
basis, which we refer to as "net realized capital gains." The capital gains
incentive fee equals 20% of net realized capital gains, less the aggregate
amount of any previously paid capital gains incentive fee.
Under the terms of the Investment Advisory Agreement, SIC Advisors bears all
organizational and offering expenses on our behalf. Since June 2, 2014 , the date
that we raised $300 million in gross proceeds in connection with the sale of
shares of our common stock, SIC Advisors was no longer obligated to bear, pay or
otherwise be responsible for any ongoing organizational and offering expenses on
our behalf, and we were responsible for paying or otherwise incurring all such
organizational and offering expenses. Pursuant to the terms of the Investment
Advisory Agreement, we had agreed to reimburse SIC Advisors for any such
organizational and offering expenses incurred by SIC Advisors not to exceed
1.25% of the gross subscriptions raised by us over the course of the offering
period, which was initially scheduled to terminate two years from the initial
offering date, unless extended. On July 2, 2018 , the Company's board of
directors determined to terminate the Company's offering effective as of July
31, 2018 .
Critical Accounting Policies
This discussion of our expected operating plans is based upon our expected
consolidated financial statements, which will be prepared in accordance with
U.S. generally accepted accounting principles ("GAAP"). The preparation of these
consolidated financial statements will require our management to make estimates
and assumptions that affect the reported amounts of assets, liabilities,
revenues and expenses. Changes in the economic environment, financial markets
and any other parameters used in determining such estimates could cause actual
results to differ. In addition to the discussion below, we will describe our
critical accounting policies in the notes to our future consolidated financial
statements.
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Valuation of Investments
We apply fair value accounting to all of its financial instruments in accordance
with the 1940 Act and ASC Topic 820 - Fair Value Measurements and Disclosures
("ASC 820"). ASC 820 defines fair value, establishes a framework used to measure
fair value and requires disclosures for fair value measurements. In accordance
with ASC 820, we have categorized its financial instruments carried at fair
value, based on the priority of the valuation technique, into a three-level fair
value hierarchy as identified below and discussed in Note 4.
• Level 1 - Quoted prices are available in active markets for identical
investments as of the reporting date. Publicly listed equities and publicly
listed derivatives will be included in Level 1. In addition, securities sold,
but not yet purchased and call options will be included in Level 1. We will
not adjust the quoted price for these investments, even in situations where we
hold a large position and a sale could reasonably affect the quoted price.
• Level 2 - Pricing inputs are other than quoted prices in active markets, which
are either directly or indirectly observable as of the reporting date, and
fair value is determined through the use of models or other valuation
methodologies. In certain cases, debt and equity securities are valued on the
basis of prices from an orderly transaction between market participants
provided by reputable dealers or pricing services. In determining the value of
a particular investment, pricing services may use certain information with
respect to transactions in such investments, quotations from dealers, pricing
matrices, market transactions in comparable investments, and various
relationships between investments. Investments which are generally expected to
be included in this category include corporate bonds and loans, convertible
debt indexed to publicly listed securities, and certain over-the-counter
derivatives.
• Level 3 - Pricing inputs are unobservable for the investment and include
situations where there is little, if any, market activity for the investment.
The inputs into the determination of fair value require significant judgment
or estimation. Investments that are expected to be included in this category
are our private portfolio companies.
Fair value is a market-based measure considered from the perspective of the
market participant who holds the financial instrument rather than an entity
specific measure. Therefore, when market assumptions are not readily available,
our own assumptions are set to reflect those that management believes market
participants would use in pricing the financial instrument at the measurement
date.
Investments for which market quotations are readily available are valued at such
market quotations, which are generally obtained from an independent pricing
service or multiple broker-dealers or market makers. We weight the use of
third-party broker quotes, if any, in determining fair value based on our
understanding of the level of actual transactions used by the broker to develop
the quote and whether the quote was an indicative price or binding offer.
However, debt investments with remaining maturities within 60 days that are not
credit impaired are valued at cost plus accreted discount, or minus amortized
premium, which approximates fair value. Investments for which market quotations
are not readily available are valued at fair value as determined by our board of
directors based upon input from management and third party valuation firms.
Because these investments are illiquid and because there may not be any directly
comparable companies whose financial instruments have observable market values,
these loans are valued using a fundamental valuation methodology, consistent
with traditional asset pricing standards, that is objective and consistently
applied across all loans and through time.
We use third-party valuation firms to assist the board of directors in the
valuation of its portfolio investments. The valuation reports generated by the
third-party valuation firms consider the evaluation of financing and sale
transactions with third parties, expected cash flows and market based
information, including comparable transactions, performance multiples, and
movement in yields of debt instruments, among other factors. Based on market
data obtained from the third-party valuation firms, we use a combined market
yield analysis and an enterprise model of valuation. In applying the market
yield analysis, the value of our loans are determined based upon inputs such as
the coupon rate, current market yield, interest rate spreads of similar
securities, the stated value of the loan, and the length to maturity. In
applying the enterprise model, we use a waterfall analysis which takes into
account the specific capital structure of the borrower and the related seniority
of the instruments within the borrower's capital structure into consideration.
To estimate the enterprise value of the portfolio company, we weigh some or all
of the traditional market valuation methods and factors based on the individual
circumstances of the portfolio company in order to estimate the enterprise
value. The methodologies for performing investments may be based on, among other
things: valuations of comparable public companies, recent sales of private and
public comparable companies, discounting the forecasted cash flows of the
portfolio company, third party valuations of the portfolio company, considering
offers from third parties to buy the company, estimating the value to potential
strategic buyers and considering the value of recent investments in the equity
securities of the portfolio company. For non-performing investments, we may
estimate the liquidation or collateral value of the portfolio company's assets
and liabilities using an expected recovery model. We may estimate the fair value
of warrants based on a model such as the Black-Scholes model or simulation
models or a combination thereof.
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We undertake a multi-step valuation process each quarter when valuing investments for which market quotations are not readily available, as described below:
• our quarterly valuation process begins with each portfolio investment being
initially valued by the valuation professionals;
• conclusions are then documented and discussed with senior management; and
• an independent valuation firm engaged by our board of directors prepares an
independent valuation report for approximately one third of the portfolio
investments each quarter on a rotating quarterly basis on non fiscal year-end
quarters, such that each of these investments will be valued by an independent
valuation firm at least twice per annum when combined with the fiscal year-end
review of all the investments by independent valuation firms.
In addition, all of our investments are subject to the following valuation process:
• management reviews preliminary valuations and their own independent
assessment;
• the audit committee of our board of directors reviews the preliminary
valuations of senior management and independent valuation firms; and
• our board of directors discusses valuations and determines the fair value of
each investment in our portfolio in good faith based on the input of SIC
Advisors, the respective independent valuation firms and the audit committee.
Due to the inherent uncertainty of determining the fair value of investments
that do not have a readily available market value, the fair value of our
investments may differ significantly from the values that would have been used
had a readily available market value existed for such investments, and the
differences could be material.
Our investments in subordinated notes are carried at fair value, which is based
on a discounted cash flow model. The discounted cash flow model models both the
underlying collateral ("assets") and the liabilities of the CLO capital
structure. The discounted cash flow model uses a set of assumptions including
projected default rates, recovery rates, reinvestment rates and prepayment rates
in order to arrive at estimated cash flows of the assets. The discounted cash
flow model distributes the asset cash flows to the liability structure based on
the payment priorities and discounts them back using appropriate market discount
rates based on discount rates for comparable CLOs. The assumptions are based on
available market data as well as management estimates. Additional data is used
to validate the results from the discounted cash flow method, such as analysis
of relevant data observed in the CLO market, review of quotes, where available,
recent acquisitions and observable transactions in the subordinated notes, among
other factors.
The SEC recently adopted new Rule 2a-5 under the 1940 Act, which establishes
requirements for determining fair value in good faith for purposes of the 1940
Act. We will comply with the new rule's valuation requirements on or before the
SEC's compliance date in 2022.
Revenue Recognition
We record interest income on an accrual basis to the extent that we expect to
collect such amounts. For loans and debt securities with contractual PIK
interest, which represents contractual interest accrued and added to the
principal balance, we generally will not accrue PIK interest for accounting
purposes if the portfolio company valuation indicates that such PIK interest is
not collectible. We do not accrue as a receivable interest on loans and debt
securities or accounting purposes if we have reason to doubt our ability to
collect such interest. Original issue discounts, market discounts, or premiums
are accreted or amortized using the effective interest method as interest
income. We record prepayment premiums on loans and debt securities as fee
income. Dividend income, if any, is recognized on an accrual basis to the extent
that we expect to collect such amount.
Net Realized Gains or Losses and Net Change in Unrealized Appreciation or Depreciation
We measure net realized gains or losses by the difference between the net
proceeds from the repayment or sale and the amortized cost basis of the
investment, without regard to unrealized appreciation or depreciation previously
recognized. Net change in unrealized appreciation or depreciation reflects the
change in portfolio investment values during the reporting period, including any
reversal of previously recorded unrealized appreciation or depreciation, when
gains or losses are realized.
Payment-in-Kind Interest
We have investments in our portfolio that contain a PIK interest provision. Any
PIK interest is added to the principal balance of such investments and is
recorded as income, if the portfolio company valuation indicates that such PIK
interest is collectible. In order to maintain our RIC tax treatment,
substantially all of this income must be paid out to stockholders in the form of
dividends, even if we have not collected any cash.
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Table of ContentsU.S. Federal Income Taxes We have elected, and intend to qualify annually, to be treated forU.S. federal income tax purposes as a RIC under Subchapter M of the Code. As a RIC, we generally will not have to pay corporate-levelU.S. federal income taxes on any ordinary income or capital gains that we timely distribute to our stockholders from our tax earnings and profits. To obtain and maintain our RIC tax treatment, we must, among other things, meet specified source-of-income and asset diversification requirements and distribute annually at least 90% of our ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any. Recent Developments OnJanuary 21, 2021 , the Board of Directors declared a series of monthly distributions for January, February andMarch 2021 in the amount of$0.010 per share. Stockholders of record as of each respective monthly record date will be entitled to receive the distribution. Below are the details for each respective distribution: Record Date Payment Date Amount per share January 28, 2021 January 29, 2021 $ 0.010 February 25, 2021 February 26, 2021 0.010 March 30, 2021 March 31, 2021 0.010 OnJanuary 27, 2021 ,Massachusetts Mutual Life Insurance Company ("MassMutual") announced it has entered into a definitive agreement with American Financial Group, Inc. to purchase its wholly owned subsidiary, GALIC. The transaction is expected to close in the second quarter of 2021, subject to regulatory and other necessary approvals. Upon the close of the transaction, GALIC will operate as an independent subsidiary of MassMutual. The Company is in the process of assessing the impact, if any, that the foregoing will have on Sierra JV's investment activity and operations.
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