Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The economic effects of the COVID-19 outbreak has introduced significant volatility in the financial markets. The U.S. Federal Reserve and other central banks have reduced certain interest rates and LIBOR has decreased. In addition, in a prolonged low interest rate environment, including a reduction of LIBOR to zero, our net interest margin will be compressed and adversely affect our operating results. For additional information concerning the COVID-19 outbreak and its potential impact on our business and our operating results, see “ Part I - 1A. Risk Factors” .
We are subject to financial market risks, including changes in interest rates. Changes in interest rates affect both our cost of funding and the valuation of our investment portfolio. As of December 31, 2020, 96% of our debt investments bore interest at floating interest rates and 4% of our debt investments bore fixed interest rates, at fair value. The interest rates on our debt investments bearing floating interest rates are usually based on a floating LIBOR, and the debt investments typically contain interest rate re-set provisions that adjust applicable interest rates to current rates on a periodic basis. A significant portion of our loans that are subject to the floating LIBOR rates are also subject to a minimum base rate, or floor, that we charge on our loans if the current market rates are below the respective floors. As of December 31, 2020, a substantial amount of our floating rate loans were based on a floating LIBOR, subject to a floor.
As of December 31, 2020, our outstanding SBA debentures and Unsecured Notes bore interest at a fixed rate. Our PWB Credit Facility and BNP Facility had floating interest rate provisions based on the Prime Rate and LIBOR, with effective interest rates of 6.50% and 5.53%, respectively.
Assuming that the consolidated balance sheet as of December 31, 2020, were to remain constant and that we took no actions to alter our existing interest rate sensitivity, the following tables show the annualized impact of hypothetical base rate changes in interest rates (in thousands):
Basis point increase Interest income Interest expense Net change
25 $ 96 $ (84) $ 12
50 206 (163) 43
75 342 (243) 99
100 828 (323) 505
125 1,417 (402) 1,015
Basis point decrease Interest income Interest expense (1)
Net change
25 $ (110) $ 70 $ (40)
50 n/m (2) n/m (2) n/m (2)
75 n/m (2) n/m (2) n/m (2)
100 n/m (2) n/m (2) n/m (2)
125 n/m (2) n/m (2) n/m (2)
(1) At December 31, 2020, our PWB Credit Facility contained a 5.25% interest rate floor, and therefore a decline in the Prime Rate would not materially impact interest expense. The BNP Facility does not contain an interest rate floor.
(2) Not meaningful.
Although we believe that the foregoing analysis is indicative of our sensitivity to interest rate changes as of December 31, 2020, it does not adjust for potential changes in the credit market, credit quality, size and composition of the assets in our portfolio, and other business developments, including borrowings under our credit facility, that could affect net increase in net assets resulting from operations, or net income. Accordingly, no assurances can be given that actual results would not differ materially from the statement above.
We are subject to financial market risks, including changes in interest rates. Changes in interest rates affect both our cost of funding and the valuation of our investment portfolio. Our risk management systems and procedures are designed to identify and analyze our risk, to set appropriate policies and limits and to continually monitor these risks and limits by means of reliable administrative and information systems and other policies and programs. Our investment portfolio and investment income may be affected by changes in various interest rates, including LIBOR and the Prime Rate.
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