SARATOGA INVESTMENT CORP. 10-K

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK SUTHERLAND TO UPDATE Our business activities contain elements of market risk. We consider the fluctuation in interest rates to be our principal market risk. Managing this risk is essential to our business. Accordingly, we have systems and procedures designed to identify and analyze our risks, to establish appropriate policies and thresholds and to continually monitor this risk and thresholds by means of administrative and information technology systems and other policies and processes. Interest rate risk is defined as the sensitivity of our current and future earnings to interest rate volatility, including relative changes in different interest rates, variability of spread relationships, the difference in re-pricing intervals between our assets and liabilities and the effect that interest rates may have on our cash flows. Changes in the general level of interest rates can affect our net interest income, which is the difference between the interest income earned on interest earning assets and our interest expense incurred in connection with our interest-bearing debt and liabilities. Changes in interest rates can also affect, among other things, our ability to acquire leveraged loans, high yield bonds and other debt investments and the value of our investment portfolio. Our investment income is affected by fluctuations in various interest rates, including SOFR and the prime rate. Substantially all of our portfolio is, and we expect will continue to be, comprised of floating rate investments that utilize SOFR or an alternate rate. The Federal Reserve held interest rates steady in the first quarter of 2025, following three consecutive rate reductions in the third and fourth quarter of 2024. The Federal has indicated that there may be additional rate cuts in the future; however, future reductions to benchmark rates are not certain. In a rising interest rate environment, our cost of funds would increase, which could reduce our net investment income if there is not a corresponding increase in interest income generated by our investment portfolio. It is possible that the Federal Reserve’s tightening cycle could result in a recession in the United States, which would likely decrease interest rates. A prolonged reduction in interest rates will reduce our gross investment income and could result in a decrease in our net investment income if such decreases in base rates, such as SOFR, are not offset by corresponding increases in the spread over such base rates that we earn on any portfolio investments, a decrease in in our operating expenses, including with respect to our income incentive fee, or a decrease in the interest rate of our floating interest rate liabilities. Our interest expense is affected by fluctuations in SOFR on our Encina Credit Facility. In addition, all of our assets have been transitioned from LIBOR to an acceptable replacement rate, such as SOFR. At February 28, 2025, we had $741.4 million of borrowings outstanding. In addition, as of February 28, 2025, there were $32.5 million borrowings outstanding under the Encina Credit Facility and $20.0 million borrowings outstanding under the Live Oak Credit Facility as of February 28, 2025. As of February 28, 2025, on a fair value basis, approximately 2.6% of our debt investments bea r interest at a fixed-rate and approximately 97.4% of our debt investments bear interest at a floating rate. As of February 28, 2025, 100% of our floating rate debt investments are subject to interest rate floors. Additionally, both the Encina Credit Facility and the Live Oak Credit Facility are subject to a floating interest rate and is currently paid based on floating Term SOFR rate. We have analyzed the potential impact of changes in interest rates on interest income from investments. Assuming that our investments as of February 28, 2025 were to remain constant for a full fiscal year and no actions were taken to alter the existing interest rate terms, a hypothetical change of a 1.0% increase in interest rates would cause a corresponding increase of approximately $8.8 million to our interest income. Conversely, a hypothetical change of a 1.0% decrease in interest rates would cause a corresponding decrease of approximately $8.7 million to our interest income. Changes in interest rates would have no impact to our current interest and debt financing expense, as all our borrowings except for our credit facility are fixed rate, and our credit facility is currently undrawn. Although management believes that this measure is indicative of our sensitivity to interest rate changes, it does not adjust for potential changes in credit quality, size and composition of the assets on the statements of assets and liabilities and other business developments that could magnify or diminish our sensitivity to interest rate changes, nor does it account for divergences in SOFR and the commercial paper rate, which have historically moved in tandem but, in times of unusual credit dislocations, have experienced periods of divergence. Accordingly, no assurances can be given that actual results would not materially differ from the potential outcome simulated by this estimate. For further information, the following table shows the approximate annualized increase or decrease in the components of net investment income due to hypothetical base rate changes in interest rates, assuming no changes in our investments and borrowings as of February 28, 2025. Increase (Increase) Increase Increase Increase Basis (Decrease) Decrease (Decrease) in Net (Decrease) in Net (Decrease) in Net Point in Interest in Interest Investment Investment Investment Change Income Expense Income Income* Income per Share ($ in thousands) -100 $ (8,731 ) $ 525 $ (8,206 ) $ (6,565 ) $ (0.43 ) -50 (4,367 ) 263 (4,104 ) (3,283 ) (0.22 ) -25 (2,185 ) 131 (2,054 ) (1,643 ) (0.11 ) 25 2,195 (131 ) 2,064 1,651 0.11 50 4,390 (263 ) 4,127 3,302 0.22 100 8,780 (525 ) 8,255 6,604 0.43 200 17,561 (1,050 ) 16,511 13,209 0.87 300 26,341 (1,575 ) 24,766 19,813 1.30 400 35,121 (2,100 ) 33,021 26,417 1.74 * Adjusts Net Interest Income for the impact of the first incentive fee on Net Investment Income The table above assumes no defaults or prepayments by portfolio companies over the next twelve months. The hypothetical results would also be impacted by the changes in the amount of debt outstanding under our Encina Credit Facility, with an increase (decrease) in the debt outstanding under the Encina Credit Facility resulting in an (increase) decrease in the hypothetical interest expense. 106 ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Our consolidated financial statements are annexed to this Annual Report beginning on page F-1. In addition, the Financial Statements of Saratoga Investment Corp. CLO 2013-1, Ltd. are annexed to this Annual Report beginning on page S-1. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.