Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollar amounts in thousands, except per share amounts, unless otherwise indicated)
The discussion and analysis contained in this section refers to our financial condition, results of operations and cash flows. The information contained in this section should be read in conjunction with the consolidated financial statements and notes thereto in Part II, Item 8 of this Form 10-K, “Financial Statements and Supplementary Data.” This discussion contains forward-looking statements and involves numerous risks and uncertainties, including, but not limited to those described in Part I, Item 1A of this Form 10-K, “Risk Factors.” Our actual results could differ materially from those anticipated by such forward-looking information due to factors discussed under “Risk Factors” and “Cautionary Statement Regarding Forward-Looking Statements” appearing elsewhere in this Form 10-K. The year ended December 31, 2019 presented represents the period from May 30, 2019 (inception) to December 31, 2019.
OVERVIEW
We are an externally managed specialty finance company focused on lending to middle-market companies. We have elected to be regulated as a BDC under the 1940 Act. In addition, for U.S. federal income tax purposes, we have elected to be treated, and intend to comply with the requirements to qualify annually, as a RIC under Subchapter M of the Code.
Our investment objective is to achieve attractive risk-adjusted returns via current income and, to a lesser extent, capital appreciation by investing primarily in directly originated senior secured term loans issued by U.S. middle-market companies backed by financial sponsors. For the purposes of this report, “middle-market companies” refers to companies that, in general, generate annual EBITDA in the range of approximately $15 million to $100 million, which we believe is a useful proxy for cash flow. We intend to achieve our investment objective by investing primarily in directly originated senior secured term loans including first lien senior secured term loans (including unitranche loans) and second lien senior secured term loans, with the balance of our investments expected to be in higher-yielding assets such as mezzanine debt, unsecured debt, equity investments and other opportunistic assets. Typical middle-market senior loans may be issued by middle-market companies in the context of LBOs, acquisitions, debt refinancings, recapitalizations, and other similar transactions. We expect to generate revenues primarily in the form of interest income from investments we hold. In addition, we generate income from dividends on any direct equity investments, capital gains on the sales of loans and debt and equity investments and various other loan origination and other fees.
On September 18, 2020, the SEC granted us exemptive relief (the “Order”) that allows us to enter into certain negotiated co-investment transactions alongside certain Affiliated Investment Accounts (as defined in the Order) in a manner consistent with our investment objective, positions, policies, strategies, and restrictions as well as regulatory requirements and other pertinent factors, subject to compliance with the Order. Pursuant to the Order, we are permitted to co-invest with our affiliates if a “required majority” (as defined in Section 57(o) of the 1940 Act) of our eligible directors make certain conclusions in connection with a co-investment transaction, including that (1) the terms of the transactions, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not involve overreaching in respect of us or our stockholders on the part of any person concerned, and (2) the transaction is consistent with the interests of our stockholders and is consistent with our investment objective and strategies.
RECENT DEVELOPMENTS
Subsequent to December 31, 2020 through March 19, 2021, the Company has closed or the Investment Adviser's Investment Committee has committed/approved approximately $538.0 million of new/add-on investments. This includes transactions for which a formal mandate, letter of intent or a signed commitment have been issued, and therefore the Company believes are likely to close. Of these new commitments, approximately 87.8% were first lien senior secured loans, 11.2% were second lien senior secured loans, and 1.1% were common equity investments. 100% of the senior secured loans were floating rate loans. We remain highly focused on conducting extensive due diligence and leveraging the Morgan Stanley platform. We continue to seek to invest in companies that are led by strong management teams, generate substantial free cash flow, have leading market positions, benefit from sustainable business models, and are well positioned to perform well despite the impact of Coronavirus. We believe the current market environment offers opportunities to seek compelling risk adjusted returns. Our investment pace will depend on several factors including the market environment, deal flow, and the continued impact of Coronavirus.
On January 7, 2021 and March 2, 2021, we delivered capital drawdown notices to our investors relating to the sale of shares of our Common Stock for an aggregate offering price of approximately $35.0 million and approximately $45.0 million, respectively. The sale of approximately 1,726,689 and 2,171,816 shares of our Common Stock closed on January 20, 2021 and March 12, 2021, respectively.
On February 1, 2021, we closed new capital commitments of $50.0 million, which brings our total capital commitments to $1,495.8 million.
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On March 2, 2021, DLF LLC entered into (i) an amendment (the “Second Amendment to CSA”) to the Revolving Credit and Security Agreement, dated as of October 14, 2020, as amended from time to time (the “BNP Funding Facility”), by and among DLF LLC, as the borrower, the Company, as the equityholder and servicer, BNP Paribas, as the administrative agent, U.S. Bank National Association, as the collateral agent, and the lenders party thereto and (ii) amendments to various supporting documentation, including certain fee letters (together with the Second Amendment to CSA, the “Second Amendment”). The Second Amendment, among other things, increased the borrowing capacity under the BNP Funding Facility from $300 million to $600 million, made certain adjustments to the borrowing base calculations, reduced the applicable margin on borrowings to a range during the reinvestment period between 1.95% and 2.75% and, after the reinvestment period, between 2.45% and 3.25%, and reduced the LIBOR (Dollar) floor on borrowings to 0.00%. The other material terms of the BNP Funding Facility remain unchanged.
On March 18, 2021, our Board of Directors declared a distribution of $0.45 per share payable on April 22, 2021 to stockholders on record as of March 18, 2021.
KEY COMPONENTS OF OUR RESULTS OF OPERATIONS
Investments
Our level of investment activity can and does vary substantially from period to period depending on many factors, including the amount of debt available to middle-market companies, the general economic environment and the competitive environment for the type of investments we make.
Revenue
We expect to generate revenue primarily in the form of interest income on debt investments we hold. In addition, we expect to generate income from dividends on direct equity investments, capital gains on the sales of loans and debt and equity securities and various loan origination and other fees. Our debt investments generally have a stated term of five to eight years and generally bear interest at a floating rate usually determined on the basis of a benchmark such as LIBOR. Interest on these debt investments is generally paid quarterly. In some instances, we receive payments on our debt investments based on scheduled amortization of the outstanding balances. In addition, we receive repayments of some of our debt investments prior to their scheduled maturity date. The frequency or volume of these repayments fluctuates significantly from period to period. Our portfolio activity also reflects the proceeds of sales of securities. We may also generate revenue in the form of commitment, origination, amendment, structuring or due diligence fees, fees for providing managerial assistance and consulting fees.
Expenses
Our primary operating expenses include the payment of: (i) investment advisory fees, including base management fees and incentive fees, to our Investment Adviser pursuant to the Investment Advisory Agreement between us and our Investment Adviser; (ii) costs and other expenses and our allocable portion of overhead incurred by our Administrator in performing its administrative obligations under the Administration Agreement between us and our Administrator; and (iii) other operating expenses as detailed below:
• initial organization costs and offering costs incurred prior to the filing of our election to be regulated as a BDC (subject to the expense waiver described below)
• costs associated with our initial private offering;
• costs of any other offerings of our Common Stock and other securities, if any;
• calculating individual asset values and our net asset value (including the cost and expenses of any third-party valuation services);
• out of pocket expenses, including travel expenses, incurred by the Adviser, or members of its investment team or payable to third parties, performing due diligence on prospective portfolio companies and monitoring actual portfolio companies and, if necessary, enforcing our rights;
• base management fee and any incentive fee payable under the Investment Advisory Agreement;
• certain costs and expenses relating to distributions paid by us;
• administration fees payable under the Administration Agreement and any sub-administration agreements, including related expenses;
• debt service and other costs of borrowings or other financing arrangements;
• the allocated costs incurred by the Adviser in providing managerial assistance to those portfolio companies that request it;
• amounts payable to third parties relating to, or associated with, making or holding investments;
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• the costs associated with subscriptions to data service, research-related subscriptions and expenses and quotation equipment and services used in making or holding investments;
• transfer agent and custodial fees;
• costs of hedging;
• commissions and other compensation payable to brokers or dealers;
• any stock exchange listing fees and fees payable to rating agencies;
• cost of effecting any sales and repurchases of our Common Stock and other securities;
• federal and state registration fees;
• U.S. federal, state and local taxes, including any excise taxes;
• independent director fees and expenses;
• costs of preparing financial statements and maintaining books and records, costs of preparing tax returns, costs of Sarbanes-Oxley Act compliance and attestation and costs of filing reports or other documents with the SEC (or other regulatory bodies), and other reporting and compliance costs, including registration and listing fees, and the compensation of professionals responsible for the preparation or review of the foregoing;
• the costs of any reports, proxy statements or other notices to our stockholders (including printing and mailing costs), the costs of any stockholders’ meetings, and costs and expenses of preparation for the foregoing and related matters;
• the costs of specialty and custom software for monitoring risk, compliance and overall investments;
• any fidelity bond required by applicable law;
• any necessary insurance premiums;
• indemnification payments;
• any extraordinary expenses (such as litigation or indemnification payments or amounts payable pursuant to any agreement to provide indemnification entered into by the Company);
• direct fees and expenses associated with independent audits, agency, consulting and legal costs;
• cost of winding up; and
• all other expenses incurred by either the Administrator or us in connection with administering our business, including payments under the Administration Agreement based upon our allocable portion of the compensation paid to our Chief Financial Officer and Chief Compliance Officer and reimbursing third-party expenses incurred by the Administrator in carrying out its administrative services including, but not limited to, the fees and expenses associated with performing compliance functions.
We will reimburse the Administrator or its affiliates for amounts paid or costs borne that properly constitute Company expenses as set forth in the Administration Agreement or otherwise. We expect our general and administrative expenses to be relatively stable or to decline as a percentage of total assets during periods of asset growth and to increase during periods of asset declines.
PORTFOLIO, INVESTMENT ACTIVITY AND RESULTS OF OPERATIONS
As of December 31, 2020, we had investments in thirty-six portfolio companies across nineteen industries. Based on fair value as of December 31, 2020, 99.8% of our debt portfolio was invested in debt bearing a floating interest rate, which primarily are subject to interest rate floors. Approximately 95.2% of our debt portfolio at fair value had a LIBOR floor. The weighted average LIBOR floor across our floating-rate portfolio was approximately 1.0% as of December 31, 2020. These floors allow us to mitigate (to a degree) the impact of spread widening on the valuation of our investments. As of December 31, 2020, our weighted average total yield of debt securities at amortized cost was 7.5%. Weighted average yields include the effect of accretion of discounts and amortization of premiums and are based on interest rates as of December 31, 2020.
During the period from May 30, 2019 (inception) to December 31, 2019, we had no investment activities. We commenced our investment operations on January 31, 2020.
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Our investment activities for the year ended December 31, 2020 is presented below (information presented herein is at amortized cost unless otherwise indicated):
For the year ended December 31, 2020
New Investments Committed/Purchased
Gross Principal Balance (1)
$ 948,731
Investments, at Cost
Investments, beginning of period —
New investments purchased 714,658
Net accretion of discount on investments (2)
3,615
Net realized gain (loss) on investments 2,154
Investments sold or repaid (88,954)
Investments, end of period $ 631,473
Principal amount of investments funded
First lien debt $ 678,879
Second lien debt 55,000
Unsecured debt 1,509
Common equity (3)
1,450
Total $ 736,838
Principal amount of investments sold or repaid
First lien debt $ 90,106
Total $ 90,106
As of December 31, 2020
Weighted average yield on debt and income producing investments, at cost (4)
7.5 %
Weighted average yield on debt and income producing investments, at fair value (4)
7.4 %
Number of portfolio companies 36
Percentage of debt investments bearing a floating rate 99.8 %
Percentage of debt investments bearing a fixed rate 0.2 %
(1) Includes new investment commitments, excluding sale/repayments and including unfunded investment commitments.
(2) Includes capitalized PIK interest.
(3) Represents dollar amount of common equity funded.
(4) Computed as (a) the annual stated spread, plus applicable Prime/LIBOR or Floor, as applicable, plus the annual accretion of discounts, as applicable, on accruing debt securities, divided by (b) total debt investments (at fair value or cost, as applicable) included in such securities. Actual yields earned over the life of each investment could differ materially from the yields presented herein.
The distribution of our portfolio on the Adviser's Internal Risk Rating System as of December 31, 2020 is as follows (dollar amounts in thousands):
December 31, 2020
Fair Value % of Portfolio Number of Portfolio Companies
Risk rating 1 $ 31,230 4.9 % 1
Risk rating 2 605,751 95.1 % 35
$ 636,981 100.0 % 36
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CONSOLIDATED RESULTS OF OPERATIONS
We were formed on May 30, 2019 and commenced our investment operations on January 31, 2020. The following table represents our operating results (dollar amounts in thousands):
For the year ended December 31, 2020 From May 30, 2019 (inception) to December 31, 2019
Total investment income $ 21,903 $ —
Less: Net expenses 11,268 1,156
Net investment income 10,635 (1,156)
Net change in unrealized appreciation (depreciation) 5,508 —
Net realized gain (loss) 2,154 —
Net increase (decrease) in net assets resulting from operations $ 18,297 $ (1,156)
Investment Income
Investment income was as follows (dollar amounts in thousands):
For the year ended December 31, 2020 From May 30, 2019 (inception) to December 31, 2019
Interest income $ 20,278 $ —
Other income 1,625 —
Total investment income $ 21,903 $ —
For the year ended December 31, 2020, total investment income was driven by our deployment of capital and invested balance of investments. The size of our investment portfolio at fair value was $637.0 million as of December 31, 2020 and, as of such date, all our debt investments were income-producing.
Interest income on our debt investments is dependent on the composition and credit quality of the portfolio. Generally, we expect the portfolio to generate predictable quarterly interest income based on the terms stated in each loan’s credit agreement. As of December 31, 2020, and for the year then ended, all of our first and second lien debt investments were performing and current on their interest payments.
During the period from May 30, 2019 (inception) to December 31, 2019, we had no investment income and had not commenced our investment operations.
Expenses
The Company is responsible for investment expenses, legal expenses, auditing fees and other expenses related to the Company’s operations. During the year ended December 31, 2020 and the period from May 30, 2019 (inception) to December 31, 2019, we incurred total expenses of $13,176 (before expense waivers of $1,908) and $1,235 (before expense waiver of $79), respectively, towards organization costs, directors’ fee and other general expenses.
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Expenses were as follows (dollar amounts in thousands):
For the year ended December 31, 2020 From May 30, 2019 (inception) to December 31, 2019
Interest expense $ 3,725 $ —
Management fees 2,238 —
Income based incentive fees 2,517 —
Capital gains incentive fees 1,341 —
Professional fees 1,654 66
Organization and offering costs 676 1,079
Directors' fees 349 43
Administrative service fees 183 —
General and other expenses 493 47
Total expenses 13,176 1,235
Expense waiver (Note 3) (230) (79)
Management fees waiver (Note 3) (1,678) —
Net expenses $ 11,268 $ 1,156
For the year ended December 31, 2020, net expenses were primarily comprised of interest expense of $3,725, gross base management fees of $2,238, income based incentive fees of $2,517, capital gains incentive fees of $1,341, administrative service expenses of $183, professional fees of $1,654, fees to independent directors of $349, organization and offering costs of $676 and other expenses of $493; offset by management fee waivers and expense waivers by the Investment Adviser of $1,678 and $230, respectively.
During the period from May 30, 2019 (inception) to December 31, 2019, net expenses were primarily comprised of professional fees of $66, fees to independent directors of $43, organization costs of $1,079 and other expenses of $47; offset by expense waivers by the Investment Adviser of $79.
Interest expense for the year ended December 31, 2020 was driven by approximately $114.4 million of average borrowings (at an average effective interest rate, of 1.93%), under our CIBC Subscription Facility related to borrowings for investments and expenses. There was no interest expense incurred during the period from May 30, 2019 (inception) to December 31, 2019.
Professional fees include legal, audit, tax, valuation, and other professional fees incurred related to the management of our Company. Administrative service fees represent fees paid to the Administrator for our allocable portion of the cost of certain of our executive officers that perform duties for us. Other general and administrative expenses include insurance, filing, research, subscriptions and other costs. Organization costs and offering costs include expenses incurred in our initial formation and our offering of stock.
As of December 31, 2020, expense support includes the management fee waiver of $1,678 and excess organization and offering costs of $230 that the Adviser has committed to pay. As of December 31, 2019, expense support includes excess organization and offering costs of $79 that the Adviser has committed to pay. Excess organization and offering costs are subject to reimbursement to the Adviser at a future date. See “ Item 8. Consolidated Financial Statements—Notes to Consolidated Financial Statements—Note 3. ”
Income Taxes, Including Excise Taxes
We have elected to be treated as a RIC under Subchapter M of the Code, and we intend to operate in a manner so as to continue to qualify for the tax treatment applicable to RICs. To qualify for tax treatment as a RIC, we must, among other things, distribute to our stockholders in each taxable year generally at least 90% of the sum of our ICTI, as defined by the Code (without regard to the deduction for dividends paid), and net tax-exempt income for that taxable year. To maintain our tax treatment as a RIC, we, among other things, intend to make the requisite distributions to our stockholders, which generally relieve us from corporate-level U.S. federal income taxes.
Net Realized Gain (Loss) and Unrealized Gain (Loss) on Investments
For the year ended December 31, 2020, net realized gain on our investments was $2.2 million.
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We determine the fair value of our portfolio investments quarterly and any changes in fair value are recorded as unrealized gains or losses. For the year ended December 31, 2020, net change in unrealized gain on our investments was $5.5 million.
For the period from May 30, 2019 (inception) to December 31, 2019, there were no realized gain (loss) or changes in unrealized gains/losses on investments since the Company commenced operations on January 31, 2020.
For the year ended December 31, 2020 From May 30, 2019 (inception) to December 31, 2019
Net realized gain (loss):
Non-controlled/non-affiliated investments $ 2,154 $ —
Net change in unrealized appreciation (depreciation):
Non-controlled/non-affiliated investments 5,508 —
Net realized and unrealized gain (loss) $ 7,662 $ —
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FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
We generate cash from the net proceeds of offerings of our Common Stock, net borrowings from our credit facilities, and through cash flows from operations, including investment sales and repayments as well as income earned on investments and cash equivalents. Details of our credit facilities are described in “ —Debt ” below. We may from time to time enter into new credit facilities, increase the size of existing credit facilities or issue debt securities. Any such incurrence or issuance would be subject to prevailing market conditions, our liquidity requirements, contractual and regulatory restrictions and other factors.
As of December 31, 2020, we had approximately $11.3 million of cash, which taken together with our approximately $66.2 million and $300.0 million of availability under the CIBC Subscription Facility and the BNP Funding Facility (subject to borrowing base availability), respectively, and our approximately $1,148.4 million of uncalled capital commitments to purchase shares of Common Stock, or capital commitments, we expect to be sufficient for our investing activities and to conduct our operations in the near term.
Equity
As of December 31, 2020, we had received aggregate capital commitments of approximately $1,445.8 million, of which $200.0 million was from an affiliate of the Investment Adviser.
During the year ended December 31, 2020, we issued six capital calls to our stockholders. As a result, the total shares issued and proceeds received related to capital drawdowns delivered pursuant to the Subscription Agreements for the year ended December 31, 2020 were as follows (dollar amounts in millions):
Share Issuance Date Shares Issued Amount
February 5, 2020 2,874,810 $ 57.50
March 27, 2020 2,410,313 44.95
June 26, 2020 769,194 14.95
August 11, 2020 2,002,070 39.98
September 28, 2020 3,504,634 69.99
December 1, 2020 3,410,138 69.98
Total 14,971,159 $ 297.35
During the period from May 30, 2019 (inception) to December 31, 2019, we received seed capital of $35 from and issued 1,750 shares to MS Credit Partners Holdings.
Distributions and Dividend Reinvestment
The following table summarizes our distributions declared and payable for the year ended December 31, 2020:
Date Declared Record Date Payment Date Per Share Amount Total Amount
June 19, 2020 June 19, 2020 July 15, 2020 $ 0.29 $ 1,533
September 24, 2020 September 24, 2020 October 22, 2020 0.40 3,228
December 29, 2020 December 29, 2020 January 27, 2021 0.61 (1) 9,165
Total Distributions $ 1.30 $ 13,926
(1) Includes a special distribution of $0.18 per share.
We adopted an “opt in” dividend reinvestment plan (“DRIP”). As a result, our stockholders who elect to “opt in” to the DRIP will have their cash dividends or distributions automatically reinvested in additional shares of Common Stock, rather than receiving cash. Stockholders who receive distributions in the form of shares of Common Stock will generally be subject to the same U.S. federal, state and local tax consequences as if they received cash distributions; however, those stockholders will not receive cash with which to pay any applicable taxes. Shares issued under the DRIP will not reduce an investor’s outstanding capital commitment.
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The following table summarizes DRIP shares issued and amounts for the year ended December 31, 2020:
Payment Date DRIP Shares Value DRIP Shares Issued
July 15, 2020 $ 227 11,668
October 22, 2020 796 39,848
Total $ 1,023 51,516
Debt
Our outstanding debt obligations were as follows (dollar amounts in thousands):
December 31, 2020
Aggregate Principal Committed Outstanding Principal Unused Portion (1)
CIBC Subscription Facility $ 400,000 $ 333,850 $ 66,150
BNP Funding Facility 300,000 — 300,000
Total $ 700,000 $ 333,850 $ 366,150
(1) The unused portion (subject to borrowing base availability) is the amount upon which commitment fees, if any, are based.
CIBC Subscription Facility
On December 31, 2019, we entered into the CIBC Subscription Facility with CIBC Bank USA as administrative agent and arranger. During the year ended December 31, 2020, we amended the CIBC Subscription Facility by increasing the total commitment amount to $400.0 million. As of December 31, 2020, the CIBC Subscription Facility allows us to borrow up to $400.0 million at any one time outstanding, subject to certain restrictions, including availability under the borrowing base, which is based on unused capital commitments. The amount of permissible borrowings under the CIBC Subscription Facility may be increased to up to an aggregate amount of $500 million with the consent of the lenders. The CIBC Subscription Facility has a maturity date of December 31, 2022.
The CIBC Subscription Facility bears interest at a rate at our election of either (i) the per annum one-, two-, or three-month LIBOR, divided by a number determined by subtracting from 1.00 the then stated maximum reserve percentage for determining reserves to be maintained by member banks of the Federal Reserve System for Eurocurrency funding or liabilities, plus 1.65% or (ii) the prime rate plus 0.65%, as calculated under the CIBC Subscription Facility. The CIBC Subscription Facility is secured by the unfunded commitments of certain of our investors. We have made customary representations and warranties and are required to comply with various covenants, reporting requirements and other customary requirements for similar credit facilities. Borrowings under the CIBC Subscription Facility are subject to the leverage restrictions contained in the 1940 Act, as amended, or the 1940 Act.
During the year ended December 31, 2020, we borrowed $612.4 million and repaid $278.5 million under the CIBC Subscription Facility. As of December 31, 2020, we had $333.9 million outstanding under the CIBC Subscription Facility. As of December 31, 2019, we had no amount borrowed under the CIBC Subscription Facility. As of December 31, 2020 and December 31, 2019, we had $66.2 million and $100.0 million, respectively, of available capacity under the CIBC Subscription Facility.
As of December 31, 2020 and December 31, 2019, we were in compliance with all covenants and other requirements of the CIBC Subscription Facility.
BNP Funding Facility
On October 14, 2020, DLF LLC entered into a Revolving Credit and Security Agreement (the “Credit and Security Agreement”) with DLF LLC, as the borrower, BNP, as the administrative agent and lender, the Company, as the equityholder and as the servicer, and U.S. Bank National Association, as collateral agent, pursuant to which BNP has agreed to extend credit to DLF LLC in an aggregate principal amount up to $300 million at any one time outstanding (the “BNP Funding Facility”).
The BNP Funding Facility is a revolving funding facility with a reinvestment period ending October 14, 2023 and a final maturity date of October 14, 2025. Subject to certain conditions, the reinvestment period and final maturity are both subject to a one-year extension. Advances under the BNP Funding Facility are available in U.S. dollars, pound sterling, Euro or Canadian dollars, and subject to certain exceptions, the interest charged on the BNP Funding Facility is based on LIBOR (Dollar), LIBOR (GBP), EURIBOR or CDOR, as applicable (or, if LIBOR (Dollar) is not available, a benchmark replacement or a “base rate” (which is the greater of a prime rate and the federal funds rate plus 0.50%), as applicable), plus a margin that generally ranges between 2.25% and
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3.25% (depending on the types of assets such advances relate to), with a weighted average margin floor for all classes of advances of (i) 2.80% during the reinvestment period and (ii) 3.30% following the reinvestment period, with specific margins for non-U.S. dollar advances as set forth in the Credit and Security Agreement.
The obligations of DLF LLC under the BNP Funding Facility are secured by all of the assets held by DLF LLC, including certain loans to be sold or transferred by the Company to DLF LLC pursuant to the terms of the Purchase and Sale Agreement (the “Purchase and Sale Agreement” and, together with the Credit and Security Agreement, the “Agreements”) between the Company and DLF LLC entered into in connection with the BNP Funding Facility, pursuant to which the Company will sell to DLF LLC certain loans it has originated or acquired or will originate or acquire (the “Loans”) from time to time. Under the Agreements, the Company and DLF LLC, as applicable, have made representations and warranties regarding the Loans, as well as their businesses, and are required to comply with various covenants, servicing procedures, limitations on disposition of Loans, reporting requirements and other customary requirements for similar revolving funding facilities. The Credit and Security Agreement includes usual and customary events of default for revolving funding facilities of this nature, including allowing BNP, upon a default, to accelerate and foreclose on the Loans and to pursue the rights under the Loans directly with the obligors thereof. In connection with the entry into the BNP Funding Facility, DLF LLC also entered into various supporting documentation, including an account control agreement.
During the year ended December 31, 2020, we had no amount borrowed under the BNP Funding Facility.
As of December 31, 2020, we were in compliance with all covenants and other requirements of the BNP Funding Facility, as well as the leverage restrictions contained in the 1940 Act.
OFF BALANCE SHEET ARRANGEMENTS
In the ordinary course of our business, we enter into contracts or agreements that contain indemnifications or warranties. Future events could occur which may give rise to liabilities arising from these provisions against us. We believe that the likelihood of such an event is remote; however, the maximum potential exposure is unknown. No accrual has been made in our financial statements as of December 31, 2020 and December 31, 2019 in Part II, Item 8 of this Form 10-K, for any such exposure.
We have in the past and may in the future become obligated to fund commitments such as revolving credit facilities, bridge financing commitments, or delayed draw commitments.
As of December 31, 2020, we had delayed draw and revolving senior secured loans with an aggregate of $206.5 million of unfunded commitments. We had no unfunded commitments to fund delayed draw and revolving senior secured loans as of December 31, 2019.
Other Commitments and Contingencies
From time to time, we may become a party to certain legal proceedings incidental to the normal course of our business. As of December 31, 2020, management is not aware of any material pending or threatened litigation relating to us.
CONTRACTUAL OBLIGATIONS
A summary of our contractual payment obligations under our credit facilities as of December 31, 2020 is as follows (dollar amounts in thousands):
Payments Due by Period
Total Less
than
1 year 1-3 years 3-5
years After 5
years
CIBC Subscription Facility $ 333,850 $ — $ 333,850 $ — $ —
BNP Funding Facility — — — — —
Total Contractual Obligations $ 333,850 $ — $ 333,850 $ — $ —
As of December 31, 2019, we did not have any contractual payment obligations under our credit facilities.
CRITICAL ACCOUNTING POLICIES
The preparation of our financial statements requires us 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
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determining such estimates could cause actual results to differ. Our critical accounting policies, including those relating to the valuation of our investment portfolio, are described below. The critical accounting policies should be read in connection with “ Risk Factors ” in Part I, Item 1A of this Form 10-K.
Valuation
We conduct the valuation of assets at all times consistent with GAAP and the 1940 Act. Our Board of Directors, with the assistance of our Audit Committee, determines the fair value of our assets, for assets with a daily public market, and for assets with no readily available public market, on at least a quarterly basis, in accordance with the terms of Topic 820 of the Financial Accounting Standards Board's Accounting Standards Codification, as amended, Fair Value Measurement (“ASC 820”). Valuation procedures are set forth in more detail below.
ASC 820 defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” Fair value is a market-based measurement, not an entity-specific measurement. For some assets and liabilities, observable market transactions or market information might be available. For other assets and liabilities, observable market transactions and market information might not be available. However, the objective of a fair value measurement in both cases is the same—to estimate the price when an orderly transaction to sell the asset or transfer the liability would take place between market participants at the measurement date under current market conditions (that is, an exit price at the measurement date from the perspective of a market participant that holds the asset or owes the liability).
For further information on the fair value hierarchies, our framework for determining fair value, and the composition of our portfolio, see “ Note 5 to the Consolidated Financial Statements in Part II, Item 8. Consolidated Financial Statements and Supplementary Data ” of this Form 10-K .
Securities that are illiquid or for which the pricing source does not provide a valuation or methodology or provides a valuation or methodology that, in the judgment of the Adviser or our Board of Directors, does not represent fair value, each is valued as of the measurement date using all techniques appropriate under the circumstances and for which sufficient data is available. These valuation techniques may vary by investment but include comparable public market valuations, comparable precedent transaction valuations and discounted cash flow analyses. The process used to determine the applicable value is as follows:
(1) each portfolio company or investment is initially valued by the investment professionals responsible for the portfolio investment using a standardized template designed to approximate fair market value based on observable market inputs and updated credit statistics and unobservable inputs;
(2) preliminary valuation conclusions are documented and reviewed by a valuation committee comprised of members of our Adviser’s senior management;
(3) our Board of Directors engages one independent third-party valuation firm to provide positive assurance on a portion of our illiquid investments each quarter (such that each illiquid investment will be reviewed by an independent valuation firm at least once on a rolling twelve-month basis) including review of management's preliminary valuation and conclusion of fair value;
(4) our Audit Committee reviews the assessments of the Adviser and the independent third-party valuation firm and provide our Board of Directors with recommendations with respect to the fair value of each investment in our portfolio; and
(5) our Board of Directors discusses the valuation recommendations of our Audit Committee and determine the fair value of each investment in our portfolio in good faith based on the input of the Adviser and, where applicable, the third-party valuation firm.
The fair value is generally determined based on the assessment of the following factors, as relevant:
• the nature and realizable value of any collateral;
• call features, put features and other relevant terms of debt;
• the portfolio company's leverage and ability to make payments;
• the portfolio company's public or “private letter” credit ratings;
• the portfolio company's actual and expected earnings and cash flow;
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• prevailing interest rates for like securities and expected volatility in future interest rates;
• the markets in which the issuer does business and recent economic and/or market events; and
• comparisons to publicly traded securities.
Investment performance data utilized will be the most recently available as of the measurement date which in many cases may reflect up to a one quarter lag in information.
Our Board of Directors is ultimately responsible for the determination, in good faith, of the fair value of our portfolio investments.
Determination of fair value involves subjective judgments and estimates. Accordingly, the notes to our financial statements will express the uncertainty with respect to the possible effect of such valuations, and any change in such valuations, on our financial statements.
RELATED PARTY TRANSACTIONS
Investment Advisory Agreement
In October 2019, the Company’s Board of Directors, including a majority of the directors who are not “interested persons” as defined in Section 2(a)(19) of the 1940 Act (the “Independent Directors”), approved the Investment Advisory Agreement between the Company and the Investment Adviser, which was effective November 25, 2019, in accordance with, and on the basis of an evaluation satisfactory to such directors as required by, Section 15(c) of the 1940 Act. See “Item 8. Consolidated Financial Statements and Supplementary Data—Notes to Consolidated Financial Statements—Note 3. Related Party Transactions.”
Base Management Fee
The base management fee is calculated at an annual rate of 1.0% of our average gross assets at the end of the two most recently completed calendar quarters, including assets purchased with borrowed funds or other forms of leverage but excluding cash and cash equivalents. Prior to an Exchange Listing, the Adviser has agreed to irrevocably waive the portion of the base management fee in excess of 0.25% of our average gross assets calculated in accordance with the Investment Advisory Agreement, which waived base management fees are not subject to recoupment by the Adviser. For services rendered under the Investment Advisory Agreement, the base management fee will be payable quarterly in arrears.
Incentive Fee
The incentive fee has two parts. The first part is determined and paid quarterly based on our pre-incentive fee net investment income and the second part is determined and payable in arrears based on net capital gains as of the end of each calendar year or upon termination of the Investment Advisory Agreement.
Pre-incentive fee net investment income is defined as interest income, dividend income and any other income accrued during the calendar quarter, minus operating expenses for the quarter, including the base management fee, expenses payable under the Administration Agreement, any interest expense and distributions paid on any issued and outstanding preferred stock, but excluding the incentive fee. Pre-incentive fee net investment income does not include any realized capital gains, realized capital losses or unrealized capital appreciation or depreciation.
Pre-incentive fee net investment income includes, in the case of investments with a deferred interest feature (such as debt instruments with pay-in-kind interest and zero coupon securities), accrued income that Company has not yet received in cash. The Adviser is not obligated to return to us the incentive fee it receives on payment-in-kind ("PIK") interest that is later determined to be uncollectible in cash. Pre-incentive fee net investment income does not include any realized capital gains, realized capital losses or unrealized capital appreciation or depreciation.
Pursuant to the Investment Advisory Agreement, the Company pays the Adviser an incentive fee with respect to our pre-incentive fee net investment income as follows:
• No incentive fee based on pre-incentive fee net investment income in any calendar quarter in which our pre-incentive fee net investment income does not exceed a hurdle rate of 1.50% (6% annualized);
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• 100% of pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment income, if any, that exceeds the hurdle rate but is less than 1.82% in any calendar quarter (7.2728% annualized). We refer to this portion of the pre-incentive fee net investment income (which exceeds the hurdle rate but is less than 1.8182%) as the "catch-up." The "catch-up" is meant to provide the Adviser with approximately 17.5% of our pre-incentive fee net investment income as if a hurdle rate did not apply if this net investment income exceeds 1.8182% in any calendar quarter; and
• 17.5% of the pre-incentive fee net investment income, if any, that exceeds 1.82% in any calendar quarter (7.2728% annualized), which reflects that once the hurdle rate is reached and the catch-up is achieved, 17.5% of all pre-incentive fee net investment income is paid to the Adviser.
The second part of the incentive fee is determined on realized capital gains calculated and payable in arrears in cash as of the end of each calendar year or upon the termination of the Investment Advisory Agreement in an amount equal to 17.5% of the realized capital gains, if any, on a cumulative basis from the date of our election to be regulated as a business development company through the end of a given calendar year or upon the termination of the Investment Advisory Agreement, computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the aggregate amount of any previously paid capital gain incentive fees (the “Cumulative Capital Gains”).
Administration Agreement
On October 14, 2019, the Company’s Board of Directors approved an administration agreement (the “Administration Agreement”) between the Company and the Administrator. Pursuant to the Administration Agreement, the Administrator provides services and receives reimbursements equal to an amount that reimburses the Administrator for its costs and expenses and the Company’s allocable portion of overhead incurred by the Administrator in performing its obligations under the Administration Agreement, including the Company’s allocable portion of the compensation paid to our Chief Compliance Officer and Chief Financial Officer. Reimbursement under the Administration Agreement occurs quarterly in arrears. See “ Item 8. Consolidated Financial Statements and Supplementary Data—Notes to Consolidated Financial Statements—Note 3. Related Party Transactions. ”
Placement Fees
On August 30, 2019, the Company entered into a placement agent agreement (the “Placement Agent Agreement”) with Morgan Stanley Distribution Inc. (the “Paying Agent”), Morgan Stanley Smith Barney LLC (the “Placement Agent”) and the Investment Adviser. Under the terms of the Placement Agent Agreement, the Placement Agent and certain of its affiliates will assist in the placement of Common Stock in the Company’s Private Offering. The Company is not liable for any payments to the Placement Agent pursuant to the Placement Agent Agreement, which payments will be made by the Investment Adviser and, to the extent the Paying Agent receives any payments, from the Paying Agent.
MS Credit Partners Holdings Investment
MS Credit Partners Holdings, Inc., a wholly owned subsidiary of Morgan Stanley and an affiliate of the Adviser has made an aggregate capital commitment of $200.0 million to the Company as of December 31, 2020. As of December 31, 2020 and December 31, 2019, MS Credit Partners Holdings’ total capital commitment represented approximately 14% and 20% of aggregate capital commitments received, respectively.