Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The information in this management's discussion and analysis of financial condition and results of operations relates to Nuveen Churchill Direct Lending Corp., including its wholly-owned subsidiaries (collectively, "we", "us", "our" or the "Company").
The following analysis of our financial condition and results of operations should be read in conjunction with our financial data and our financial statements and the notes thereto contained in Item 8.—Financial Statements and Supplementary Data, in this Annual Report on Form 10-K. See Item 1A.—Risk Factors in this Annual Report on Form 10-K for a discussion of the uncertainties, risks and assumptions associated with these statements.
Overview
We were formed on March 13, 2018, as a limited liability company under the laws of the State of Delaware and converted into a Maryland corporation on June 18, 2019, prior to the commencement of operations. We are a closed-end, externally managed, non-diversified management investment company that has elected to be regulated as a business development company (“BDC”) under Investment Company Act of 1940, as amended (the “1940 Act”). In addition, we intend to elect, and to qualify annually thereafter, to be treated as a regulated investment company (a “RIC”) under the Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”) for the taxable year ending December 31, 2020. Effective June 1, 2020, we changed our name from “Nuveen Churchill BDC, Inc.” to “Nuveen Churchill Direct Lending Corp.”
On December 31, 2019, immediately prior to the BDC election, our wholly owned subsidiary Nuveen Churchill BDC SPV I, LLC (“SPV I”), merged with Churchill Middle Market CLO V Ltd. (the “Predecessor Entity”), leaving SPV I as the surviving entity (the “Merger”). SPV I is a Delaware limited liability company that was formed on November 13, 2019. SPV I had no assets or operations prior to completion of the Merger and as a result, the historical books and records of the Predecessor Entity became the books and records of the surviving entity. The Predecessor Entity was a Cayman exempt limited company and was formed under the laws of the Cayman Islands on November 14, 2017 and commenced operations on January 12, 2018. We have consolidated the investments held in SPV I, in accordance with our consolidation policy.
Our investment objective is to generate attractive risk-adjusted returns primarily through current income by investing primarily in senior secured loans to private equity-owned U.S. middle market companies, which we define as companies with approximately $10.0 million to $100.0 million of earnings before interest, taxes, depreciation and amortization (“EBITDA”). We will focus on privately originated debt to performing U.S. middle market companies, with a portfolio expected to comprise primarily first-lien senior secured debt and unitranche loans (other than last-out positions in unitranche loans). We will also opportunistically invest in junior capital opportunities (second-lien loans, subordinated debt, last-out positions in unitranche loans and equity-related securities).
We have entered into an investment advisory agreement (the “Investment Advisory Agreement”) with Nuveen Churchill Advisors LLC (the “Adviser”), under which the Adviser has delegated substantially all of its day-to-day portfolio management obligations through a sub-advisory agreement (the “Sub-Advisory Agreement” and, together with the Investment Advisory Agreement, the “Advisory Agreements”) with Churchill Asset Management LLC (the “Sub-Adviser” or “Churchill” and, together with the Adviser, the “Advisers”). Under the administration agreement (the “Administration Agreement”) we are provided with certain services by an administrator, Nuveen Churchill Administration LLC (the “Administrator”). The Adviser, Sub-Adviser, and Administrator are all affiliates and subsidiaries of Nuveen, LLC, a wholly owned subsidiary of Teachers Insurance and Annuity Association of America (“TIAA”).
Nuveen Churchill BDC SPV II, LLC (“SPV II”) and Nuveen Churchill BDC SPV III, LLC (“SPV III”) are Delaware limited liability companies that were formed on March 19, 2020 and commenced operations on September 21, 2020, the date of their first investment transaction. SPV II and SPV III primarily invest in first-lien senior secured debt and unitranche loans (other than last-out positions in unitranche loans). SPV II and SPV III are wholly owned subsidiaries of the Company and are consolidated in our consolidated financial statements commencing from the date of their formation.
We will from time to time conduct a private offering of our common stock to “accredited investors” as defined in Rule 501(a) of Regulation D promulgated under the Securities Act of 1933, as amended (the “1933 Act”) in reliance on exemptions from the registration requirements of the 1933 Act (our “Private Offering”). Each investor will purchase shares pursuant to a subscription agreement entered into with us. The initial closing of our Private Offering was held on March 13, 2020 (“Initial Closing”). We expect to hold additional closings (each a “Subsequent Closing”) for a period of 18 months after the Initial Closing (our “Fundraising Period”). Our Fundraising Period may be extended to 24 months after the Initial Closing in the sole discretion of our Board of Directors (our “Board”).
53
COVID-19 Developments
On March 11, 2020, the World Health Organization declared COVID-19 a global pandemic and recommended containment and mitigation measures worldwide. The COVID-19 pandemic has had a significant impact on the U.S. economy. The extent of the impact of the COVID-19 outbreak on the financial performance of our current and future investments will depend on future developments, including the duration and spread of the virus, related advisories and restrictions, and the health of the financial markets and economy as a result of COVID-19, all of which are highly uncertain and cannot be predicted. To the extent our portfolio companies are adversely impacted by the effects of the COVID-19 pandemic, it may have a material adverse impact on our future net investment income, the fair value of our portfolio investments, our financial condition and results of operations and the financial condition of our portfolio companies.
As of December 31, 2020, we were in compliance with our asset coverage requirements under the 1940 Act. In addition, we were not in default of any of the asset coverage requirements under any of our credit facilities as of December 31, 2020. However, any continuing increase in unrealized depreciation of our investment portfolio or further significant reductions in our net asset value, as a result of the effects of the COVID-19 pandemic or otherwise, increases the risk of breaching the relevant covenants.
We will continue to monitor the rapidly evolving situation surrounding the COVID-19 pandemic and guidance from U.S. and international authorities, including federal, state and local public health authorities, and may take additional actions based on their recommendations. In these circumstances, there may be developments outside our control requiring us to adjust our plan of operation. As such, given the dynamic nature of this situation, we cannot reasonably estimate the possible future impact of the COVID-19 pandemic on our financial condition, results of operations or cash flows.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States (“US GAAP”). The preparation of these financial statements requires 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 other factors used in determining such estimates could cause actual results to differ. Management considers the following critical accounting policies important to understanding the financial statements. In addition to the discussion below, our critical accounting policies are further described in the notes to our consolidated financial statements.
Basis of Accounting
The Company is an investment company for the purposes of accounting and financial reporting in accordance with Financial Accounting Standards Board ("FASB") Accounting Standards Codification (“ASC”) Topic 946, Financial Services—Investment Companies (“ASC 946”), and pursuant to Regulation S-X.
Valuation of portfolio investments
Investments are valued in accordance with the fair value principles established by FASB Accounting Standards Codification Topic 820, Fair Value Measurement (“ASC Topic 820”) and in accordance with the 1940 Act. ASC Topic 820’s definition of fair value focuses on the amount that would be received to sell the asset or paid to transfer the liability in the principal or most advantageous, market and prioritizes the use of market-based inputs (observable) over entity-specific inputs (unobservable) within a measurement of fair value.
Value, as defined in Section 2(a)(41) of the 1940 Act, is (i) the market price for those securities for which a market quotation is readily available and (ii) for all other securities and assets, fair value is as determined in good faith by our Board. Because we expect that there typically will not be a readily available market price for our target portfolio investments, we expect that the value of most of our portfolio investments will be their fair value as determined by our Board consistent with a documented valuation policy and consistently applied valuation process. In making these determinations, our Board will receive input from management and the audit committee of the Board (the "Audit Committee"). In addition, our Board has retained one or more independent valuation firms to review the valuation of each portfolio investment for which a market quotation is not available at least once during each 12-month period.
54
Our Board makes this fair value determination on a quarterly basis and in such other instances when a decision regarding the fair value of the portfolio investments is required. Factors considered by our Board as part of the valuation of investments include credit ratings/risk, the portfolio company's current and projected earnings, current and expected leverage, ability to make interest and principal payments, the estimated remaining life of the investment, liquidity, compliance with applicable loan covenants, price to earnings (or other financial) ratios of the portfolio company and other comparable companies, current market yields and interest rate spreads of similar securities as of the measurement date. Other factors taken into account include changes in the interest rate environment and the credit markets, that may affect the price at which similar investments would trade. Our Board may also base its valuation on recent investments and securities with similar structure and risk characteristics. Churchill obtains market data from its ongoing investment purchase efforts, in addition to monitoring transactions that have closed and are announced in industry publications. External information may include (but is not limited to) observable market data derived from the U.S. loan and equity markets. As part of compiling market data as an indication of current market conditions, Churchill may utilize third-party sources.
ASC Topic 820 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. ASC Topic 820 also provides guidance regarding a fair value hierarchy, which prioritizes information used to measure fair value and the effect of fair value measurements on earnings and provides for enhanced disclosures determined by the level within the hierarchy of information used in the valuation. In accordance with ASC Topic 820, these inputs are summarized in the three levels listed below:
• Level 1 - Valuations are based on unadjusted, quoted prices in active markets for identical assets or liabilities that are accessible at the measurement date.
• Level 2 - Valuations are based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly.
• Level 3 - Valuations based on inputs that are unobservable and significant to the overall fair value measurement.
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investment’s level within the fair value hierarchy is based on the lowest level of observable input that is significant to the fair value measurement. The assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the investment.
With respect to investments for which market quotations are not readily available (Level 3), our Board undertakes a multi-step valuation process each quarter, as follows:
i. the quarterly valuation process begins with each portfolio company or investment being initially valued by the professionals of the applicable investment team that are responsible for the portfolio investment;
ii. preliminary valuation conclusions are documented and approved by the applicable investment team’s investment committee;
iii. one or more third-party valuation firms engaged by, or on behalf of, our Board provide positive assurance on portions of the portfolio each quarter (such that each investment is be reviewed by a third-party valuation firm at least once on a rolling 12-month basis), including a review of management’s preliminary valuation and recommendation of fair value;
iv. the Audit Committee reviews the valuations approved by the applicable investment team’s investment committee and, where appropriate, the independent valuation firm(s) and recommends those values to our Board; and
v. our Board discusses the valuations and determines the fair value of each investment in our portfolio in good faith, based on the input of the applicable investment team, and, where appropriate, the respective independent valuation firm(s) and the Audit Committee.
The value assigned to these investments is based upon available information and may fluctuate from period to period. In addition, the value assigned does not necessarily represent the amount that ultimately might be realized upon sale. Due to the inherent uncertainty of valuation, the estimated fair value of investments may differ from the value that would have been used had a ready market for the security existed, and the difference could be material.
As of December 31, 2020 and 2019, all of our portfolio investments were Level 3 investments.
55
Determination of fair value involves subjective judgments and estimates. Accordingly, the notes to our consolidated financial statements express the uncertainty with respect to the possible effect of such valuations, and any change in such valuations, on the consolidated financial statements.
Revenue recognition
Our revenue recognition policies are as follows:
Net realized gains (losses) on investments: Gains or losses on investment transactions are determined on a specific identification basis.
Interest Income: Interest income, including amortization of premium and accretion of discount on loans are recorded on the accrual basis. We accrue interest income based on the effective yield if we expect that, ultimately, we will be able to collect such income.
Other income may include income such as consent, waiver, amendment, unused, and prepayment fees associated with our investment activities as well as any fees for managerial assistance services rendered by us to our portfolio companies. Such fees are recognized as income when earned or the services are rendered. For the years then ended December 31, 2020 and 2019, we earned $257 thousand and $365 thousand, respectively, in other income, primarily related to prepayment and amendment fees.
We may have loans in our portfolio that contain payment-in-kind (“PIK”) provisions. PIK represents interest that is accrued and recorded as interest income at the contractual rates, increases the loan principal on the respective capitalization dates, and is generally due at maturity. As of December 31, 2020, the fair value of the loans in the portfolio with PIK provisions was $9.6 million, which represents approximately 2.9% of our total investments at fair value. As of December 31, 2019, no loans in the portfolio contained PIK provisions.
Non-accrual: Generally, when a payment default occurs on a loan in the portfolio, or if management otherwise believes that the issuer of the loan will not be able to make contractual interest payments or principal payments, the Sub-Adviser will place the loan on non-accrual status and we will cease recognizing interest income on that loan until all principal and interest is current through payment or until a restructuring occurs, such that the interest income is deemed to be collectible. However, we remain contractually entitled to this interest. We may make exceptions to this policy if the loan has sufficient collateral value and is in the process of collection. Accrued interest is written off when it becomes probable that the interest will not be collected and the amount of uncollectible interest can be reasonably estimated. As of December 31, 2020 and 2019, there were no loans in the portfolio on non-accrual status.
Investments
Our level of investment activity can and does vary substantially from period to period depending on many factors, including the amount we have available to invest as well as the amount of debt and equity capital available to middle-market companies, the level of merger and acquisition activity in the middle market, the general economic environment and the competitive environment for the types of investments we make.
To qualify as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements. To the extent we continue to qualify as a RIC, we generally will not have to pay corporate-level U.S federal income taxes on any income we distribute to our shareholders.
As a BDC, we are required to comply with certain regulatory requirements. For instance, we are generally required to invest at least 70% of our total assets in “qualifying assets,” including securities of private or thinly traded public U.S. companies, cash, cash equivalents, U.S. government securities and high-quality debt investments that mature in one year or less.
As a BDC, we must not acquire any assets other than “qualifying assets” specified in the 1940 Act unless, at the time the acquisition is made, at least 70% of our total assets are qualifying assets (with certain limited exceptions). Qualifying assets include investments in “eligible portfolio companies.” Under the relevant Securities and Exchange Commission (“SEC”) rules, the term “eligible portfolio company” includes all private companies, companies whose securities are not listed on a national securities exchange, and certain public companies that have listed their securities on a national securities exchange and have a market capitalization of less than $250.0 million. We must be organized in the United States to qualify as a BDC.
56
Revenues
We generate revenue primarily in the form of interest income on debt investments we hold. In addition, we may generate income from dividends on direct equity investments, capital gains on the sales of loans and debt and equity securities. Our debt investments 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 may receive repayments of some of our debt investments prior to their scheduled maturity dates. The frequency or volume of these repayments fluctuates significantly from period to period. Our portfolio activity also may reflect the proceeds of sales of securities. In addition, we may generate revenue in the form of commitment, origination, structuring, diligence, consulting or prepayment fees associated with our investment activities as well as any fees for managerial assistance services rendered by us to the portfolio companies and other investment related income.
Expenses
The Adviser, the Sub-Adviser and their affiliates are responsible for bearing the compensation and routine overhead expenses allocable to personnel providing investment advisory and management services to us. We will bear all other out-of-pocket costs and expenses of its operations and transactions, including those costs and expenses incidental to the provision of investment advisory and management services to us (such as items in the third and fourth bullets listed below).
• our organizational costs;
• calculating net asset value (including the cost and expenses of any independent valuation firm);
• expenses, including travel, entertainment, lodging and meal expenses, incurred by the Advisers, or members of their investment teams, or payable to third parties, in evaluating, developing, negotiating, structuring and performing due diligence on prospective portfolio companies, including such expenses related to potential investments that were not consummated, and, if necessary, enforcing our rights;
• fees and expenses incurred by the Advisers (and their affiliates) or the Administrator (or its affiliates) payable to third parties, including agents, consultants or other advisors, in monitoring financial and legal affairs for us and in conducting research and due diligence on prospective investments and equity sponsors, analyzing investment opportunities, structuring our investments and monitoring investments and portfolio companies on an ongoing basis;
• costs and expenses incurred in connection with the incurrence of leverage and indebtedness, including borrowings, credit facilities, securitizations, margin financing, and including any principal or interest on our borrowings and indebtedness;
• offerings, sales, and repurchases of our shares and other securities;
• fees and expenses payable under any underwriting, dealer manager or placement agent agreements;
• investment advisory fees payable under the Investment Advisory Agreement;
• administration fees and expenses, if any, payable under the Administration Agreement (including payments under the Administration Agreement between us and the Administrator, based upon our allocable portion of the Administrator’s overhead in performing its obligations under the Administration Agreement, including rent and the allocable portion of the cost of our chief financial officer and chief compliance officer, and their respective staffs);
• any applicable administrative agent fees or loan arranging fees incurred with respect to Portfolio Investments by the Advisers, the Administrator or an affiliate thereof;
• costs and expenses incurred in implementing or maintaining third-party or proprietary software tools, programs or other technology;
• transfer agent, dividend agent and custodial fees and expenses;
• federal and state registration fees;
• all costs of registration and listing our shares on any securities exchange;
• federal, state and local taxes;
57
• independent directors’ fees and expenses, including reasonable travel, entertainment, lodging and meal expenses, and any legal counsel or other advisors retained by, or at the discretion or for the benefit of, the independent directors;
• costs of preparing and filing reports or other documents required by the SEC or other regulators, and all fees, costs and expenses related to compliance-related matters and regulatory filings related to our activities and/or other regulatory filings, notices or disclosures of the Advisers and their affiliates relating to us and its activities;
• costs of any reports, proxy statements or other notices to shareholders, including printing costs;
• fidelity bond, directors and officers/errors and omissions liability insurance, and any other insurance premiums;
• direct costs and expenses of administration, including printing, mailing, long distance telephone, copying, secretarial and other staff, independent auditors, tax preparers and outside legal costs;
• proxy voting expenses;
• all expenses relating to payments of dividends or interest or distributions in cash or any other form made or caused to be made by our Board to or on account of holders of our securities, including in connection with any dividend reinvestment plan or direct stock purchase plan;
• costs incurred in connection with the formation or maintenance of entities or vehicles to hold our assets for tax or other purposes;
• the allocated costs incurred by the Advisers and/or the Administrator in providing managerial assistance to those portfolio companies that request;
• allocable fees and expenses associated with marketing efforts on our behalf;
• all fees, costs and expenses of any litigation involving us or our portfolio companies and the amount of any judgments or settlements paid in connection therewith, directors and officers, liability or other insurance (including costs of title insurance) and indemnification (including advancement of any fees, costs or expenses to persons entitled to indemnification) or extraordinary expense or liability relating to our affairs;
• fees, costs and expenses of winding up and liquidating our assets; and
• all other expenses incurred by us, the Advisers or the Administrator in connection with administering our business.
58
Portfolio and investment activity
Portfolio Composition
Our portfolio and investment activity for the years ended December 31, 2020 and 2019 is presented below (information presented herein is at amortized cost unless otherwise indicated) (dollar amounts in thousands):
For the Years Ended December 31,
2020 2019
Investments:
Total investments, beginning of period $ 178,754 $ 162,201
Purchase of investments 211,223 107,122
Proceeds from principal repayments and sales of investments (51,942) (91,273)
Payment-in-kind interest 16 —
Amortization of premium/accretion of discount, net 278 214
Net realized gain (loss) on investments 409 490
Total investments, end of period $ 338,738 $ 178,754
Portfolio companies at beginning of period 46 41
Number of new portfolio companies 24 19
Number of exited portfolio companies (9) (14)
Portfolio companies at end of period 61 46
59
As of December 31, 2020 and 2019, our investments consisted of the following (dollar amounts in thousands):
December 31, 2020 December 31, 2019
Amortized Cost Fair Value % of Fair Value Amortized Cost Fair Value % of Fair Value
First-Lien Term Loans $ 326,933 $ 323,427 96.47 % $ 178,754 $ 178,780 100.00 %
Subordinated Debt 9,722 9,749 2.91 % — — —
Equity Investments 2,083 2,083 0.62 % — — —
Total $ 338,738 $ 335,259 100.00 % $ 178,754 $ 178,780 100.00 %
Largest portfolio company investment $ 14,758 $ 14,967 4.46 % $ 6,887 $ 6,943 3.88 %
Average portfolio company investment $ 5,553 $ 5,496 1.64 % $ 3,886 $ 3,887 2.17 %
The industry composition of our portfolio as a percentage of fair value as of December 31, 2020 and 2019 were as follows:
Industry Composition December 31, 2020 December 31, 2019
Aerospace & Defense 5.7 % 4.6 %
Automotive 1.1 3.8
Banking, Finance, Insurance, Real Estate 7.3 10.0
Beverage, Food & Tobacco 7.0 1.6
Capital Equipment 2.6 2.3
Chemicals, Plastics, & Rubber 0.7 1.4
Construction & Building 1.2 2.4
Consumer Goods: Durable 3.3 7.1
Consumer Goods: Non-durable 7.7 7.5
Containers, Packaging & Glass 9.8 5.2
Energy: Electricity — 0.5
Healthcare & Pharmaceuticals 0.8 4.5
High Tech Industries 17.4 23.9
Hotel, Gaming & Leisure 0.8 —
Media: Advertising, Printing & Publishing 0.9 —
Media: Diversified & Production 2.1 —
Retail 2.6 5.0
Road and Rail — 1.2
Services: Business 15.4 7.7
Services: Consumer 3.4 1.5
Telecommunications 3.7 7.4
Transportation: Cargo 5.9 2.4
Utilities: Electric 0.6 —
Total 100.0 % 100.0 %
60
The weighted average yields of our investments as of December 31, 2020 and 2019 were as follows:
December 31, 2020 December 31, 2019
Weighted average yield on debt and income producing investments, at cost 6.60 % 6.84 %
Weighted average yield on debt and income producing investments, at fair value 6.67 % 6.84 %
Percentage of debt investments bearing a floating rate 99.41 % 100.00 %
Percentage of debt investments bearing a fixed rate 0.59 % — %
The weighted average yield of our debt and income producing securities is not the same as a return on investment for our shareholders but, rather, relates to our investment portfolio and is calculated before the payment of all of our and our subsidiaries’ fees and expenses. The weighted average yield was computed using the effective interest rates as of each respective date, including accretion of original issue discount. There can be no assurance that the weighted average yield will remain at its current level.
Asset Quality
In addition to various risk management and monitoring tools, we use the Advisers’ investment rating system to characterize and monitor the credit profile and expected level of returns on each investment in our portfolio. Each investment team intends to utilize a systematic, consistent approach to credit evaluation, with a particular focus on an acceptable level of debt repayment and deleveraging under a “base case” set of projections (the “Base Case”), which reflects a more conservative estimate than the set of projections provided by a prospective portfolio company, which the Advisers refer to as the “Management Case.” The following is a description of the conditions associated with each investment rating:
1. Performing - Superior: Borrower is performing significantly above Management Case.
2. Performing - High: Borrower is performing at or near the Management Case (i.e., in a range slightly below to slightly above).
3. Performing - Low Risk: Borrower is operating well ahead of the Base Case to slightly below the Management Case.
4. Performing - Stable Risk: Borrower is operating at or near the Base Case (i.e., in a range slightly below to slightly above). This is the initial rating assigned to all new borrowers.
5. Performing - Management Notice: Borrower is operating below the Base Case. Adverse trends in business conditions and/or industry outlook are viewed as temporary. There is no immediate risk of payment default and only a low to moderate risk of covenant default.
6. Watch List - Low Maintenance: Borrower is operating below the Base Case, with declining margin of protection. Adverse trends in business conditions and/or industry outlook are viewed as probably lasting for more than a year. Payment default is still considered unlikely, but there is a moderate to high risk of covenant default.
7. Watch List - Medium Maintenance: Borrower is operating well below the Base Case, but has adequate liquidity. Adverse trends are more pronounced than in Internal Risk Rating 6 above. There is a high risk of covenant default, or it may have already occurred. Payments are current, although subject to greater uncertainty, and there is a moderate to high risk of payment default.
8. Watch List - High Maintenance: Borrower is operating well below the Base Case. Liquidity may be strained. Covenant default is imminent or may have occurred. Payments are current, but there is a high risk of payment default. Negotiations to restructure or refinance debt on normal terms may have begun. Further significant deterioration appears unlikely and no loss of principal is currently anticipated.
9. Watch List - Possible Loss: At the current level of operations and financial condition, the borrower does not have the ability to service and ultimately repay or refinance all outstanding debt on current terms. Liquidity is strained. Payment default may have occurred or is very likely in the short term unless creditors grant some relief. Loss of principal is possible.
10. Watch List - Probable Loss: At the current level of operations and financial condition, the borrower does not have the ability to service and ultimately repay or refinance all outstanding debt on current terms. Payment default is very likely or may have already occurred. Liquidity is extremely limited. The prospects for improvement in the borrower’s situation are sufficiently negative that loss of some or all principal is probable.
The Sub-Adviser monitors and, when appropriate, changes the investment rating assigned to each investment in our portfolio. Each investment team will review the investment ratings in connection with monthly or quarterly portfolio reviews.
61
The following table shows the investment ratings of the investments in our portfolio (dollar amounts in thousands):
December 31, 2020 December 31, 2019
Fair Value % of Portfolio Number of Portfolio Companies Fair Value % of Portfolio Number of Portfolio Companies
1 $ — — % — $ — — % —
2 — — — — — —
3 — — — — — —
4 315,246 94.0 56 178,780 100.0 % 46
5 2,381 0.7 1 — — —
6 17,632 5.3 4 — — —
7 — — — — — —
8 — — — — — —
9 — — — — — —
10 — — — — — —
Total $ 335,259 100.0 % 61 $ 178,780 100.0 % 46
As of December 31, 2020, one portfolio company with a fair value of $2.4 million was downgraded to an Internal Risk Rating of 5 and four portfolio companies with an aggregate fair value of $17.6 million were downgraded to an Internal Risk Rating of 6 due to changes in financial condition and performance of the respective portfolio companies as a result of the COVID-19 pandemic.
62
Results of Operations
Results comparisons are for the years ended December 31, 2020 and 2019. Results of the Predecessor Entity for the period from January 12, 2018 (Commencement of Operations) through December 31, 2018 can be found in Item 2 of the Company’s registration statement on Form 10 filed on January 29, 2020, which is incorporated by reference herein.
Operating results for the years ended December 31, 2020 and 2019 were as follows (dollars amounts in thousands):
For the Years Ended December 31,
2020 2019
Investment Income
Interest income $ 13,018 $ 15,031
Payment-in-kind interest income 28 —
Other income 257 365
Total investment income 13,303 15,396
Expenses
Interest and debt financing expenses 4,486 6,746
Management fees 1,522 1,568
Professional fees 1,299 247
Organization expenses — 1,705
Directors' fees 383 23
Administration fees 534 64
Other general and administrative expenses 288 318
Total expenses before expense support 8,512 10,671
Expense support (See Note 4 )
(424) (1,696)
Net expenses after expense support 8,088 8,975
Net investment income before excise taxes $ 5,215 6,421
Excise taxes — 4
Net investment income after excise taxes $ 5,215 $ 6,417
Net Realized and Change in Unrealized Gains (Losses)
Net realized gains (losses) $ 409 $ 490
Net change in unrealized gains (losses) (3,479) 378
Total net realized and change in unrealized gains (losses) (3,070) 868
Net increase (decrease) in net assets resulting from operations $ 2,145 $ 7,285
Net increase (decrease) in net assets resulting from operations can vary from period to period as a result of various factors, including the level of new investment commitments, expenses, the recognition of realized gains and losses, and changes in unrealized appreciation and depreciation on the investment portfolio.
63
Investment income
Investment income, attributable to interest and fees on our debt investments decreased to $13.3 million for the year ended December 31, 2020 from $15.4 million for the year ended December 31, 2019, primarily as a result of the decrease in our investment activity in the first quarter of 2020 due to the pending effectiveness of our Registration Statement with the SEC and during the second quarter of 2020 due to the onset of the COVID-19 pandemic. Our investment activity began to increase towards the end of the third quarter of 2020 and continued to increase in the fourth quarter of 2020. We expect our portfolio to continue to grow as we raise additional capital through the Private Offering of our common stock and expect our investment income to grow commensurately. The COVID-19 pandemic has and may continue to negatively impact our portfolio growth and may have a negative impact on the liquidity of certain of our portfolio companies, which in turn could restrict their ability to make interest payments.
Expenses
Total expenses before expense support decreased to $8.5 million for the year ended December 31, 2020 from $10.7 million for the year ended December 31, 2019. The decrease in interest and debt financing expenses for the year ended December 31, 2020 compared to the year ended December 31, 2019 was due to a decrease in the usage of the SPV I Financing Facility and a decrease in the LIBOR rate of all of our financing facilities.
Historical operating expenses do not reflect the increased allocation of certain professional fees, administrative and other expenses that have been incurred following the election to become a BDC. Accordingly, the operating expenses incurred during the year ended December 31, 2020 are not comparable to the operating expenses prior to the Merger and our election to become a BDC.
The expense support amount represents the amount of expenses paid by the Adviser on our behalf in accordance with the Expense Support Agreement (defined further below). These expenses are subject to reimbursement by us in accordance with the terms of the Expense Support Agreement.
The follow table presents a cumulative summary of the Expense Payments and Reimbursement Payments since our commencement of operations (dollars amounts in thousands):
As of Expense Payments by Adviser Reimbursement Payments to Adviser Unreimbursed Expense Payments
December 31, 2020 $ 2,403 $ — $ 2,403
December 31, 2019 1,696 — 1,696
Net realized gain (loss) and Net change in unrealized appreciation (depreciation) on investments
The net realized gain on investments decreased to $409 thousand for the year ended December 31, 2020 from $490 thousand for the year ended December 31, 2019, due to gains or losses on repayment and/or sales activity during the periods.
We recorded a net change in unrealized depreciation of $(3.5) million for the year ended December 31, 2020, compared to net unrealized appreciation of $378 thousand for the year ended December 31, 2019, which reflects the net change in the fair value of our investment portfolio relative to its cost basis over the period.
The total net loss for the year ended December 31, 2020, was primarily related to the overall financial markets decline, which directly impacted the prices of our portfolio investments. The fair value of our portfolio investments throughout 2020 was negatively impacted by a widening credit spread environment and a decline in financial performance of the portfolio companies due to the COVID-19 pandemic. The fair values of our portfolio investments in certain industries that experienced heightened effects of the COVID-19 pandemic, such as Services: Consumer, were most impacted.
Management continues to monitor the impact of the COVID-19 pandemic on the portfolio, which may incur additional unrealized depreciation in the future to the extent that the credit risk of our portfolio companies increases as a result of deterioration in their financial conditions.
64
Liquidity and capital resources
Our liquidity and capital resources are generated primarily from the proceeds of capital drawdowns of our privately placed capital commitments, cash flows from income earned from our investments and principal repayments, and our Financing and Subscription Facilities (each as defined below). The primary uses of our cash are (i) purchases of investments in portfolio companies, (ii) funding the cost of our operations (including fees paid to our Adviser), (iii) debt service, repayment and other financing costs of our borrowings and (iv) cash distributions to the holders of our shares.
We are generally permitted, under specified conditions, to issue multiple classes of indebtedness and one class of stock senior to our shares if our asset coverage, as defined in the 1940 Act, is at least equal to 150%, if certain requirements are met. In connection with our organization, our Board and TIAA (as our initial shareholder) authorized us to adopt the 150% asset coverage ratio. As of December 31, 2020 and December 31, 2019, our asset coverage ratio was 182.0% and 155.9%.
Cash and restricted cash as of December 31, 2020, taken together with our uncalled capital commitments of $191.3 million, is expected to be sufficient for our investing activities and to conduct our operations in the near term. As of December 31, 2020, we had $121.1 million available under our SPV I Financing Facility (as defined below), $111.8 million available under our SPV II Financing Facility (as defined below) and $12.5 million available under our Subscription Facility (as defined below).
For the year ended December 31, 2020, our cash and cash equivalents balance increased by $9.2 million. During that period, $152.1 million was used for operating activities, primarily due to investment purchases of $211.2 million, offset by $51.9 million in repayments and sales of investments in portfolio companies. During the same period, $161.3 million was provided by financing activities, consisting primarily of proceeds from issuance of common shares of $95.0 million, proceeds from secured borrowings of $147.7 million and repayments of secured borrowings of $74.0 million.
For the year ended December 31, 2019, our cash balance increased by $1.2 million. During that period, we used $18.0 million in cash towards operating activities, primarily due to new investments in portfolio companies of $107.1 million, partially offset by $91.3 million in repayments and sales of investments in portfolio companies. During the same period, we generated $19.2 million from financing activities, consisting primarily of proceeds from the issuance of the Predecessor Entity's Preference Shares (as defined below), the issuance of 50 Shares in connection with our formation and 3,310,540 Shares in connection with the consummation of the Merger, and borrowings partially offset by distributions and share redemptions.
Equity
Subscriptions and Drawdowns
Our authorized stock consists of 500,000,000 shares of stock, par value $0.01 per share, all of which are initially designated as common stock. On December 19, 2019, we issued our initial 50 shares to TIAA in connection with our formation. The Predecessor Entity authorized the issuance of up to 497,500,000 redeemable Preference Shares (“Preference Shares”), par value of U.S. $0.0001 per share. The Predecessor Entity issued its Preference Shares to one preference shareholder, TIAA. On December 31, 2019, as a result of the Merger, the Preference Shares issued by the Predecessor Entity were converted and exchanged for 3,310,540 shares of our common stock. As of December 31, 2020, TIAA owned 3,310,590 shares of our common stock.
On March 13, 2020, we held our Initial Closing and entered into subscription agreements with a number of investors providing for the private placement of our shares. We have held several Subsequent Closings since the Initial Closing. Under the terms of the subscription agreements, investors are required to fund drawdowns to purchase our shares of common stock up to the amount of their respective capital commitment each time we deliver a drawdown notice. As of December 31, 2020, we had received capital commitments totaling $352.6 million ($191.3 million remaining undrawn) of which $100.0 million ($33.8 million remaining undrawn) is from TIAA, an affiliated entity of the Company.
65
The following table summarizes total shares issued and proceeds received related to capital activity from inception to December 31, 2020 (dollar amounts in thousands, except per share data):
Date Shares Issued Proceeds Received Issuance Price per Share
November 6, 2020 1,870,660 $35,000 $18.71
October 16, 2020 1,057,641 $20,000 $18.91
August 6, 2020 1,105,425 $20,000 $18.09
May 7, 2020 1,069,522 $20,000 $18.70
December 31, 2019 3,310,540 $66,211 $20.00
December 19, 2019 50 $1 $20.00
Dividends and Distributions
To the extent that we have taxable income available, we intend to make quarterly distributions to our common shareholders. Dividends and distributions to common shareholders are recorded on the applicable record date. The amount to be distributed is determined by our Board each quarter and is generally based upon the taxable earnings estimated by management and available cash. Net realized capital gains, if any, will generally be distributed at least annually, although we may decide to retain such capital gains for investment.
We have adopted a dividend reinvestment plan under which shareholders will automatically receive dividends and other distributions in cash unless they elect to have their dividends and other distributions reinvested in additional shares. As a result of adopting such a plan, if our Board authorizes, and we declare, a cash dividend or distribution, shareholders that have “opted in” to our dividend reinvestment plan will have their cash distributions automatically reinvested in additional shares rather than receiving cash.
The following table summarizes the dividends declared from inception through December 31, 2020:
Date Declared Record Date Payment Date Dividend per Share
December 29, 2020 December 29, 2020 January 18, 2021 $0.28
November 4, 2020 November 4, 2020 November 11, 2020 $0.23
August 4, 2020 August 4, 2020 August 11, 2020 $0.28
April 16, 2020 April 16, 2020 April 21, 2020 $0.17
The following table reflects the shares issued pursuant to the dividend reinvestment plan during the year ended December 31, 2020:
Date Declared Record Date Payment Date Shares Issued
November 4, 2020 November 4, 2020 November 11, 2020 98
August 4, 2020 August 4, 2020 August 11, 2020 34
Income Taxes
We intend to elect to be treated, and to comply with the requirements to qualify annually, as a RIC under the Code. If we qualify as a RIC, we will not be taxed on our investment company taxable income or realized net capital gains, to the extent that such taxable income or gains are distributed, or deemed to be distributed, to shareholders on a timely basis.
Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses, and generally excludes net unrealized appreciation or depreciation until realized. Dividends declared and paid by us in a year may differ from taxable income for that year as such dividends may include the distribution of current year taxable income or the distribution of prior year taxable income carried forward into and distributed in the current year. Distributions also may include returns of capital.
To qualify for RIC tax treatment, we must, among other things, distribute, with respect to each taxable year, at least 90% of our investment company net taxable income (i.e., our net ordinary income and our realized net short-term capital gains in excess of realized net long-term capital losses, if any). If we qualify as a RIC, we will also be subject to a federal excise tax, based on distribution requirements of our taxable income on a calendar year basis.
66
We intend to distribute to our shareholders between 90% and 100% of our annual taxable income (which includes our taxable interest and fee income). We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of these distributions from time to time. We cannot assure shareholders that they will receive any distributions or distributions at a particular level.
SPV I Financing Facility
The Predecessor Entity borrowed funds under a credit agreement (the “Agreement”) executed on October 23, 2018. The Agreement was originally executed among the Predecessor Entity, Nuveen Alternatives Advisors LLC, as the original collateral manager to the Predecessor Entity, TIAA, as the sole preference shareholder (the “Preference Shareholder”), and Wells Fargo Bank, N.A., as lender (the “Lender”) and administrative agent. As part of the Agreement, the Predecessor Entity issued to the Lender a $175 million variable funding note ("SPV I Financing Facility"). Effective on the date of the Merger, the Agreement with the Lender was transferred to SPV I and the borrowings under the Agreement were assumed by SPV I. See Note 5 to the consolidated financial statements in Part II, Item 8 of this Form 10-K for more information on our debt.
The amount of the borrowings under the SPV I Financing Facility equals the amount of the outstanding advances. Each borrowing bears an interest rate of daily LIBOR, plus the applicable margin per annum. In addition, there is an annual commitment fee and an unused commitment fee per annum on the undrawn amount. On October 28, 2020, we amended the SPV I Financing Facility. The amendment increased the maximum facility amount available from $175 million to $275 million and extended the reinvestment period to October 28, 2023 and the maturity date to October 28, 2025, among other changes. The SPV I Financing Facility, as so amended, also requires us to maintain an asset coverage ratio at least equal to 1.50:1.00. Advances under the SPV I Financing Facility may be prepaid and reborrowed at any time during the reinvestment period, however any termination or reduction of the facility amount prior to the second anniversary of the amendment date (subject to certain exceptions) is subject to a commitment reduction fee of 2% (during the first year following the amendment date) or 1% (during the second year).
As of December 31, 2020, the SPV I Financing Facility bears interest at daily LIBOR plus 2.50% per annum. The SPV I Financing Facility also includes certain financial covenants related to liquidity and other maintenance covenants.
Subscription Facility
On September 10, 2020, we entered into a revolving credit agreement (the ‘‘Subscription Facility’’) with Sumitomo Mitsui Banking Corporation (“SMBC”), as the administrative agent for certain secured parties, the syndication agent, the lead arranger, the book manager, the letter of credit issuer and the lender.
The Subscription Facility has a maximum facility amount of $30 million subject to availability under the "Borrowing Base". Borrowing Base is calculated based on the unfunded capital commitments of certain investors that have subscribed to purchase shares of the Company, to the extent the capital commitments of such investors have also been approved by SMBC for inclusion in the Borrowing Base and meet certain additional criteria. The Subscription Facility bears interest at a rate of LIBOR plus 1.75% per annum. We also will pay an unused commitment fee of 0.25% per annum on the unused commitments.
The Subscription Facility will mature upon the earliest of: (a) September 10, 2021 (b) the date upon which the administrative agent declares the obligations under the Subscription Facility due and payable after the occurrence and during the continuance of an event of default; (c) the date of the occurrence of an event of default pursuant to the Subscription Facility, (d) the date upon which the Company terminates the commitments pursuant to the Subscription Facility; or (e) 45 days prior to any capital call termination event (which shall include, without limitation, a listing of our shares on a national securities exchange (an "Exchange Listing")).
The Subscription Facility is structured as a revolving credit facility secured by the capital commitments of the Company’s subscribed investors and certain related assets. The Subscription Facility contains certain customary affirmative and negative covenants and events of default.
67
SPV II Financing Facility
On November 24, 2020, SPV II entered into a senior secured revolving credit facility (the “SPV II Financing Facility” and, together with the SPV I Financing Facility (the "Financing Facilities")) with SMBC, as the administrative agent, the collateral agent and the lender.
The maximum amount for the SPV II Financing Facility is $150 million (the “Maximum Facility Amount”). Under the SPV II Financing Facility, which matures on November 24, 2025, the lender has agreed to extend credit to SPV II in an aggregate principal amount up to the Maximum Facility Amount. SPV II’s ability to draw under the Facility is scheduled to terminate on November 24, 2023. As of December 31, 2020, the SPV II Financing Facility bears interest at one-month LIBOR plus 2.50% per annum.
SPV II has pledged all of its assets to the collateral agent to secure its obligations under the facility. Both the Company and SPV II have made customary representations and warranties and are required to comply with various covenants, reporting requirements and other customary requirements for similar facilities.
Contractual Obligations
The following tables show the contractual maturities of our debt obligations as of December 31, 2020 and 2019 (dollar amounts in thousands):
Payments Due by Period
As of December 31, 2020 Total Less than 1 Year 1 to 3 years 3 to 5 years More than 5 Years
Financing Facility - SPV I $ 146,135 $ — $ — $ 146,135 $ —
Subscription Facility 17,500 17,500 — — —
Financing Facility - SPV II 28,547 — — 28,547 —
Total debt obligations $ 192,182 $ 17,500 $ — $ 174,682 $ —
Payments Due by Period
As of December 31, 2019 Total Less than 1 Year 1 to 3 years 3 to 5 years More than 5 Years
Financing Facility - SPV I $ 118,435 $ — $ 118,435 $ — $ —
Total debt obligations $ 118,435 $ — $ 118,435 $ — $ —
Related-Party Transactions
We have entered into a number of business relationships with affiliated or related parties, including the following:
• the Investment Advisory Agreement;
• the Sub-Advisory Agreement;
• the Administration Agreement; and
• the Expense Support Agreement
In addition to the aforementioned agreements, the Advisers, us, and certain other funds and accounts sponsored or managed by either of the Advisers and/or their affiliates were granted an order (the “Order”) that permits us greater flexibility than the 1940 Act permits to negotiate the terms of co-investments if our Board determines that it would be advantageous for us to co-invest with other accounts sponsored or managed by either of the Advisers or their respective affiliates in a manner consistent with our investment objective, positions, policies, strategies and restrictions as well as regulatory requirements and other pertinent factors.
Expense Support Agreement
We have entered into an expense support and conditional reimbursement agreement (the “Expense Support Agreement”) with the Adviser. The Adviser may pay certain of our expenses (each, an “Expense Payment”), provided that no portion of the payment will be used to pay any of our interest expense. Such Expense Payment will be made in any combination of cash or other immediately available funds no later than forty-five days after a written commitment from the Adviser to pay such expense, and/or by an offset against amounts due from us to the Adviser or its affiliates.
68
Following any calendar quarter in which Available Operating Funds (as defined below) exceed the cumulative distributions accrued to our shareholders based on distributions declared with respect to record dates occurring in such calendar quarter (such amount referred to as the “Excess Operating Funds”), we shall pay such Excess Operating Funds, or a portion thereof (each, a “Reimbursement Payment”), to the Adviser until such time as all Expense Payments made by the Adviser to us within three years prior to the last business day of such calendar quarter have been reimbursed. "Available Operating Funds" means the sum of (i) net investment income (including net realized short-term capital gains reduced by net realized long-term capital losses), (ii) net capital gains (including the excess of net realized long-term capital gains over net realized short-term capital losses) and (iii) dividends and other distributions paid to us on account of investments in portfolio companies (to the extent such amounts listed in clause (iii) are not included under clauses (i) and (ii) above). The amount of the Reimbursement Payment for any calendar quarter shall equal the lesser of (i) the Excess Operating Funds in such quarter and (ii) the aggregate amount of all Expense Payments made by the Adviser to us within three years prior to the last business day of such calendar quarter that have not been previously reimbursed by us to the Adviser.
No Reimbursement Payment will be made for any quarter if: (1) the annualized rate (based on a 365-day year) of regular cash distributions per share of common stock declared by our Board exclusive of returns of capital, distribution rate reductions due to any fees (including to a transfer agent) payable in connection with distributions, and any declared special dividends or distributions (the “Effective Rate of Distributions Per Share”) declared by us at the time of such Reimbursement Payment is less than the Effective Rate of Distributions Per Share at the time the Expense Payment was made to which such Reimbursement Payment relates, or (2) our Operating Expense Ratio (as defined below) at the time of such Reimbursement Payment is greater than the Operating Expense Ratio at the time the Expense Payment was made to which such Reimbursement Payment relates. The “Operating Expense Ratio” is calculated by dividing Operating Expenses (as defined below), less organizational and offering expenses, base management and incentive fees owed to the Adviser, and interest expense, by our net assets. “Operating Expenses” means all of our operating costs and expenses incurred, as determined in accordance with US GAAP. The Adviser may waive its right to receive all or a portion of any Reimbursement Payment in any particular calendar quarter, so that such Reimbursement Payment may be reimbursable in a future calendar quarter.
Off-Balance Sheet Arrangements
In the ordinary course of its business, we enter into contracts or agreements that contain indemnifications or warranties. As of December 31, 2020 and 2019, our off-balance sheet arrangements consisted of the following unfunded commitments (dollar amounts in thousands):
Portfolio Company December 31, 2020 December 31, 2019
Anne Arundel $ 631 $ —
Arotech 3,514 —
B2B Packaging 178 —
Blackbird Purchaser Inc — 640
Brillio LLC 500 1,000
Cornerstone Advisors of Arizona LLC 216 —
Diligent Corporation 503 —
Gabriel Partners LLC 1,429 —
Heartland Home Services 2,637 —
NJEye LLC 2,277 351
North Haven Spartan US Holdco LLC — 1,228
Output Services Group Inc — 24
PCF Insurance 9,868 —
Resource Label Group LLC 1,043 —
SEKO Global Logistics 907 —
Spectrio II 2,941 —
TailWind Randy's LLC 317 500
Tinuiti 1,961 —
Unified Physician Management LLC — 432
Warrior Acquisition Inc 622 —
Total unfunded commitments $ 29,544 $ 4,175
69
Recent Accounting Standard Updates
The FASB issued ASU 2020-04, Reference Rate Reform (Topic 848), Facilitation of the Effects of Reference Rate Reform on Financial Reportin g in March 2020. This new update provides temporary optional expedients and exceptions to the US GAAP guidance on contract modifications and hedge accounting to ease the financial reporting burdens of the expected market transition from the London Interbank Offered Rate ("LIBOR") and other interbank offered rates to alternative reference rates, such as the Secured Overnight Financing Rate. Entities can elect not to apply certain modification accounting requirements to contracts affected by what the guidance calls reference rate reform, if certain criteria are met. This guidance is effective upon issuance and generally can be applied through December 31, 2022. The Company is currently evaluating the impact of adopting ASU 2020-04.
Recent Developments
On January 15, 2021, we held a Subsequent Closing and entered into subscription agreements with additional investors for total commitments of $81.9 million.
On February 25, 2021, we delivered a drawdown notice to our shareholders relating to the issuance of 785,751 shares of our common stock, par value $0.01 per share, for an aggregate offering price of $15.0 million. The shares are were issued on March 11, 2021.
On March 10, 2021, we held a Subsequent Closing and entered into subscription agreements with additional investors for total commitments of $48.2 million.
70