Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
We are subject to financial market risks, including changes in interest rates. Changes in interest rates affect both our cost of funding and
the valuation of our investment portfolio. Our risk management systems and procedures are designed to identify and analyze our risk, to set appropriate policies and limits and to continually monitor these risks and limits by means of reliable
administrative and information systems and other policies and programs. In addition, U.S. and global capital markets and credit markets have experienced a higher level of stress due to the global COVID-19
pandemic, which has resulted in an increase in the level of volatility across such markets and a general decline in value of the securities held by us.
In the future, our investment income may also be affected by changes in various interest rates, including LIBOR and prime rates, to the extent
of any debt investments that include floating interest rates. In connection with the COVID-19 pandemic, the U.S. Federal Reserve and other central banks have reduced certain interest rates and LIBOR has
decreased. A prolonged reduction in interest rates will reduce our gross investment income and could result in a decrease in our net investment income if such decreases in LIBOR are not offset by a corresponding increase in the spread over LIBOR
that we earn on any portfolio investments, a decrease in in our operating expenses, including with respect to our income incentive fee, or a decrease in the interest rate of our floating interest rate liabilities tied to LIBOR. As of March 31,
2021 and December 31, 2020, 22 and 22 portfolio companys debt investments, respectively, bore interest at a variable rate, which represented $219.7 million and $230.9 million of our portfolio on a fair value basis, respectively,
and the remainder of our debt portfolio was comprised entirely of fixed rate investments. Our pooled SBA debentures and our Notes bear interest at fixed rates. Our Credit Facility bears interest, at our election, at a rate per annum equal to
(a) 3.00% (or 2.75% if certain conditions are satisfied, including if (x) no equity interests are included in the borrowing base, (y) the contribution to the borrowing base of eligible portfolio investments that are performing first
lien bank loans is greater than or equal to 35%, and (z) the contribution to the borrowing base of eligible portfolio investments that are performing first lien bank loans, performing last out loans, or performing second lien loans is greater
than or equal to 60%) plus the one, two, three or six month LIBOR rate, as applicable, or (b) 2.00% (or 1.75% if the above conditions are satisfied) plus the highest of (A) a prime rate, (B) the Federal Funds rate plus 0.5%,
(C) three month LIBOR plus 1.0%, and (D) zero.
Because we currently borrow, and plan to borrow in the future, money to make
investments, our net investment income is dependent upon the difference between the rate at which we borrow funds and the rate at which we invest the funds borrowed. Accordingly, there can be no assurance that a significant change in market interest
rates will not have a material adverse effect on our net investment income. In periods of rising interest rates, our cost of funds would increase, which could reduce our net investment income if there is not a corresponding increase in interest
income generated by our investment portfolio.
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Table of Contents
The following table shows the approximate annualized increase or decrease in the components
of net investment income due to hypothetical base rate changes in interest rates, assuming no changes in our investments and borrowings as of March 31, 2021 (dollars in millions):
Interest Income
Interest Expense
Increase
Increase
Net Increase
Net Investment
Basis Point Increase (Decrease)
(Decrease) (1) (2)
(Decrease)
(Decrease)
Income (3)
(200)
$
$
$
$
(150)
(100)
(50)
50
0.1
0.1
0.1
100
0.3
0.1
0.2
0.2
150
0.8
0.2
0.6
0.5
200
1.7
0.3
1.4
1.1
250
2.8
0.3
2.5
2.0
300
3.9
0.4
3.5
2.8
(1)
Certain of our variable rate debt investments have a LIBOR interest rate floor, which lessens the impact of
decreases in interest rates.
(2)
Interest income calculated assuming three-month LIBOR rate as of March 31, 2021.
(3)
Includes the impact of income incentive fee at 20.0% on net increase (decrease) in net
interest.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.