# Barings BDC, Inc.: Form 10-Q for the period ended Jun 30, 2012

- Company: [Barings BDC, Inc.](/companies/bbdc.md) (CIK 1379785)
- Form: 10-Q
- Filed: 2012-08-01
- Accepted by EDGAR: Aug 1, 2012, 16:12 ET
- Period: 2012-06-30
- Accession: 0001193125-12-328792
- Inline XBRL: no
- Main document: https://www.sec.gov/Archives/edgar/data/1379785/000119312512328792/d388704d10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1379785/000119312512328792/

## Management's discussion and analysis

As filed, 59,732 characters.

The following discussion is designed to provide a better understanding of our unaudited consolidated financial statements, including a brief discussion of our business, key factors that impacted our performance and a summary of our operating results. The following discussion should be read in conjunction with the Unaudited Financial Statements and the notes thereto included in Item 1 of this Quarterly Report on Form 10-Q, and the Consolidated Financial Statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2011. Historical results and percentage relationships among any amounts in the financial statements are not necessarily indicative of trends in operating results for any future periods.

### Forward-Looking Statements

Some of the statements in this Quarterly Report constitute forward-looking statements because they relate to future events or our future performance or financial condition. Forward-looking statements may include, among other things, statements as to our future operating results, our business prospects and the prospects of our portfolio companies, the impact of the investments that we expect to make, the ability of our portfolio companies to achieve their objectives, our expected financings and investments, the adequacy of our cash resources and working capital, and the timing of cash flows, if any, from the operations of our portfolio companies. Words such as “expect,” “anticipate,” “target,” “goals,” “project,” “intend,” “plan,” “believe,” “seek,” “estimate,” “continue,” “forecast,” “may,” “should,” “potential,” variations of such words, and similar expressions indicate a forward-looking statement, although not all forward-looking statements include these words. Readers are cautioned that the forward-looking statements contained in this Quarterly Report are only predictions, are not guarantees of future performance, and are subject to risks, events, uncertainties and assumptions that are difficult to predict. Our actual results could differ materially from those implied or expressed in the forward-looking statements for any reason, including the factors discussed herein and in Item 1A entitled “Risk Factors” in Part I of our Annual Report on Form 10-K for the year ended December 31, 2011. Other factors that could cause actual results to differ materially include changes in the economy, risks associated with possible disruption due to terrorism in our operations or the economy generally, and future changes in laws or regulations and conditions in our operating areas. These statements are based on our current expectations, estimates, forecasts, information and projections about the industry in which we operate and the beliefs and assumptions of our management as of the date of this Quarterly Report. We assume no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, unless we are required to do so by law. Although we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, you are advised to consult any additional disclosures that we may make directly to you or through reports that we in the future may file with the SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.

### Overview of Our Business

We are a Maryland corporation which has elected to be treated and operates as an internally managed business development company, or BDC, under the Investment Company Act of 1940, or 1940 Act. Our wholly-owned subsidiaries, Triangle Mezzanine Fund LLLP, or Triangle SBIC, and Triangle Mezzanine Fund II LP, or Triangle SBIC II, are licensed as small business investment companies, or SBICs, by the United States Small Business Administration, or SBA. In addition, Triangle SBIC has also elected to be treated as a BDC under the 1940 Act. We, Triangle SBIC and Triangle SBIC II invest primarily in debt instruments, equity investments, warrants and other securities of lower middle market privately held companies located in the United States.

Our business is to provide capital to lower middle market companies in the United States. We focus on investments in companies with a history of generating revenues and positive cash flows, an established market position and a proven management team with a strong operating discipline. Our target portfolio company has annual revenues between $20.0 million and $200.0 million and annual earnings before interest, taxes, depreciation and amortization, or EBITDA, between $3.0 million and $20.0 million.

We invest primarily in subordinated debt securities secured by second lien security interests in portfolio company assets, coupled with equity interests. On a more limited basis, we also invest in senior debt securities secured by first lien security interests in portfolio companies. Our investments generally range from $5.0 million to $25.0 million per portfolio company. In certain situations, we have partnered with other funds to provide larger financing commitments.

We generate revenues in the form of interest income, primarily from our investments in debt securities, loan origination and other fees and dividend income. Loan origination fees received in connection with our debt investments are recognized as investment income over the life of the loan using the effective interest method or, in some cases, recognized as earned. We also receive fees from our portfolio companies, which are non-recurring in nature. Such fees include loan prepayment penalties, certain investment banking and structuring fees and loan waiver and amendment fees, and are recorded as investment income when received. In addition, we generate revenue in the form of capital gains, if any, on warrants or other equity-related securities that we acquire from our portfolio companies. Our debt investments generally have a term of between three and seven years and typically bear interest at fixed rates between 12.0% and 17.0% per annum. Certain of our debt investments have a form of interest, referred to as payment in kind, or PIK, interest, that is not paid currently but is instead accrued and added to the loan balance and paid at the end of the term. In our negotiations with potential portfolio companies, we generally seek to minimize PIK interest. Cash interest on our debt investments is generally payable monthly; however, some of our debt investments pay cash interest on a quarterly basis. As of both June 30, 2012 and December 31, 2011, the weighted average yield on our outstanding debt investments other than non-accrual debt investments (including PIK interest) was approximately 15.0%. The weighted average yield on all of our outstanding investments (including equity and equity-linked investments but excluding non-accrual debt investments) was approximately 13.8% and 13.9% as of June 30, 2012 and December 31, 2011, respectively. The weighted average yield on all of our outstanding investments (including equity and equity-linked investments and non-accrual debt investments) was approximately 13.6% as of both June 30, 2012 and December 31, 2011.

Triangle SBIC and Triangle SBIC II are eligible to issue debentures to the SBA, which pools these with debentures of other SBICs and sells them in the capital markets at favorable interest rates, in part as a result of the guarantee of payment from the SBA. Triangle SBIC and Triangle SBIC II invest these funds in portfolio companies. We intend to continue to operate Triangle SBIC and Triangle SBIC II as SBICs, subject to SBA approval, and to utilize the proceeds from the issuance of SBA-guaranteed debentures, referred to herein as SBA leverage, to enhance returns to our stockholders.

### Portfolio Composition

The total value of our investment portfolio was $598.4 million as of June 30, 2012, as compared to $507.1 million as of December 31, 2011. As of June 30, 2012, we had investments in 69 portfolio companies with an aggregate cost of $590.9 million. As of December 31, 2011, we had investments in 63 portfolio companies with an aggregate cost of $498.3 million. As of both June 30, 2012 and December 31, 2011, none of our portfolio investments represented greater than 10% of the total fair value of our investment portfolio.

As of June 30, 2012 and December 31, 2011, our investment portfolio consisted of the following investments:

| June 30, 2012: | Cost | Percentage of Total Portfolio | Fair Value | Percentage of Total Portfolio |
| --- | ---: | ---: | ---: | ---: |
| Subordinated debt and 2nd lien notes | $469,995,362 | 79% | $457,959,652 | 77% |
| Senior debt and 1st lien notes | 63,342,497 | 11 | 63,164,493 | 11 |
| Equity shares | 46,254,959 | 8 | 56,395,612 | 9 |
| Equity warrants | 9,824,697 | 2 | 19,594,117 | 3 |
| Royalty rights | 1,501,400 | — | 1,290,000 | — |
|  | $590,918,915 | 100% | $598,403,874 | 100% |
| **December 31, 2011:** |  |  |  |  |
| Subordinated debt and 2nd lien notes | $393,830,719 | 79% | $387,169,056 | 76% |
| Senior debt and 1st lien notes | 60,622,827 | 12 | 59,974,195 | 12 |
| Equity shares | 34,741,728 | 7 | 43,972,024 | 9 |
| Equity warrants | 8,272,380 | 2 | 15,043,300 | 3 |
| Royalty rights | 874,400 | — | 920,000 | — |
|  | $498,342,054 | 100% | $507,078,575 | 100% |

29

### Investment Activity

During the six months ended June 30, 2012, the Company made eleven new investments totaling approximately $153.5 million, debt investments in four existing portfolio companies totaling approximately $2.5 million and equity investments in three existing portfolio companies totaling approximately $0.6 million. We had seven portfolio company loans repaid at par totaling approximately $58.8 million and received normal principal repayments and partial loan prepayments totaling approximately $6.4 million in the six months ended June 30, 2012. In addition, we received proceeds related to the sale of certain equity securities totaling $6.2 million and realized gains totaling approximately $3.6 million in the six months ended June 30, 2012.

During the six months ended June 30, 2011, we made ten new investments totaling approximately $86.8 million, debt investments in six existing portfolio companies totaling approximately $49.3 million and three equity investments in existing portfolio companies totaling approximately $0.2 million. We had seven portfolio company loans repaid at par totaling approximately $39.8 million and received normal principal repayments and partial loan prepayments totaling approximately $5.8 million in the six months ended June 30, 2011. In addition, we sold one equity investment in a portfolio company for total proceeds of approximately $16.0 million, resulting in a realized gain totaling approximately $12.2 million.

Total portfolio investment activity for the six months ended June 30, 2012 and 2011 was as follows:

| Six Months Ended June 30, 2012: Subordinated Debt and 2nd Lien Notes Senior Debt and 1st Lien Notes Equity Shares | Equity Warrants | Royalty Rights | Total |
| --- | ---: | ---: | ---: |
| Fair value, beginning of period $387,169,056 $59,974,195 $43,972,024 | $15,043,300 | $920,000 | $507,078,575 |
| New investments 130,886,615 9,161,883 14,343,540 | 1,552,317 | 627,000 | 156,571,355 |
| Proceeds from sales of investments — — (6,222,422) | — | — | (6,222,422) |
| Loan origination fees received (2,109,229) (200,000) — | — | — | (2,309,229) |
| Principal repayments received (58,425,353) (6,792,078) — | — | — | (65,217,431) |
| PIK interest earned 6,208,613 793,355 — | — | — | 7,001,968 |
| PIK interest payments received (2,711,392) (524,851) — | — | — | (3,236,243) |
| Accretion of loan discounts 662,461 149,529 — | — | — | 811,990 |
| Accretion of deferred loan origination revenue 1,422,894 131,832 — | — | — | 1,554,726 |
| Realized gain 230,034 — 3,392,113 | — | — | 3,622,147 |
| Unrealized gain (loss) (5,374,047) 470,628 910,357 | 2,998,500 | (257,000) | (1,251,562) |
| Fair value, end of period $457,959,652 $63,164,493 $56,395,612 | $19,594,117 | $1,290,000 | $598,403,874 |
| Weighted average yield on debt investments at end of period(1) |  |  | 15.0% |
| Weighted average yield on total investments at end of period(1) |  |  | 13.8% |
| Weighted average yield on total investments at end of period |  |  | 13.6% |
| **Six Months Ended June 30, 2011:** **Subordinated Debt and 2nd Lien Notes** **Senior Debt and 1st Lien Notes** **Equity Shares** | **Equity Warrants** | **Royalty Rights** | **Total** |
| Fair value, beginning of period $234,049,688 $44,584,148 $38,719,699 | $7,902,458 | $734,600 | $325,990,593 |
| New investments 121,744,949 9,000,000 3,959,328 | 1,587,612 | — | 136,291,889 |
| Proceeds from sales on investments — — (15,995,056) | — | — | (15,995,056) |
| Loan origination fees received (2,449,172) (240,000) — | — | — | (2,689,172) |
| Principal repayments received (44,419,995) (1,107,219) — | — | — | (45,527,214) |
| PIK interest earned 3,818,691 613,331 — | — | — | 4,432,022 |
| PIK interest payments received (3,062,966) (331,298) — | — | — | (3,394,264) |
| Accretion of loan discounts 467,809 50,528 — | — | — | 518,337 |
| Accretion of deferred loan origination revenue 622,533 88,822 — | — | — | 711,355 |
| Realized gain (loss) 897,234 — 12,166,949 | (83,414) | — | 12,980,769 |
| Unrealized gain (loss) 1,329,176 (549,278) (5,941,284) | 1,191,412 | 50,400 | (3,919,574) |
| Fair value, end of period $312,997,947 $52,109,034 $32,909,636 | $10,598,068 | $785,000 | $409,399,685 |
| Weighted average yield on debt investments at end of period(1) |  |  | 15.1% |
| Weighted average yield on total investments at end of period(1) |  |  | 14.0% |
| Weighted average yield on total investments at end of period |  |  | 13.5% |

(1) Excludes non-accrual debt investments.

### Non-Accrual Assets

Generally, when interest and/or principal payments on a loan become past due, or if we otherwise do not expect the borrower to be able to service its debt and other obligations, we will place the loan on non-accrual status and will generally cease recognizing interest income on that loan for financial reporting purposes until all principal and interest have been brought current through payment or due to a restructuring such that the interest income is deemed to be collectible. As of December 31, 2011, the fair value of our non-accrual assets was approximately $7.6 million, which comprised 1.5% of the total fair value of our portfolio, and the cost of our non-accrual assets was approximately $11.0 million, which comprised 2.2% of the total cost of our portfolio. As of June 30, 2012, the fair value of our non-accrual assets was approximately $2.9 million, which comprised 0.5% of the total fair value of our portfolio, and the cost of our non-accrual assets was approximately $9.4 million, which comprised 1.6% of the total cost of our portfolio.

Our non-accrual assets as of June 30, 2012 are as follows:

#### Gerli and Company

In November 2008, we placed our debt investment in Gerli and Company, or Gerli, on non-accrual status. As a result, under generally accepted accounting principles in the United States, or U.S. GAAP, we no longer recognize interest income on our debt investment in Gerli for financial reporting purposes. During the first quarter of 2011, we restructured our investment in Gerli. As a result of the restructuring, we received a new note from Gerli with a face amount of $3.0 million and a fair value of approximately $2.3 million and preferred stock with a liquidation preference of $0.4 million. In addition, in the second quarter of 2012, we invested $250,000 in a Gerli senior subordinated note. Under the terms of the notes, interest on the notes is payable only if Gerli meets certain covenants, which they were not compliant with as of June 30, 2012. In the six months ended June 30, 2012, we recognized unrealized depreciation on our debt investments in Gerli of approximately $0.4 million. As of June 30, 2012, the cost of our debt investments in Gerli was $3.3 million and the fair value was $1.8 million.

#### Fire Sprinkler Systems, Inc.

In October 2008, we placed our debt investment in Fire Sprinkler Systems, Inc., or Fire Sprinkler Systems, on non-accrual status. As a result, under U.S. GAAP, we no longer recognize interest income on our debt investment in Fire Sprinkler Systems for financial reporting purposes. In the six months ended, June 30, 2012, we recorded unrealized depreciation of $0.5 million on our debt investment in Fire Sprinkler Systems. As of June 30, 2012, the cost of our debt investment in Fire Sprinkler Systems was $3.0 million and the fair value of such investment was $0.1 million.

#### Equisales, LLC

In May 2012, we placed our debt investment in Equisales, LLC, or Equisales, on non-accrual status. As a result, under U.S. GAAP, we no longer recognize interest income on our debt investment in Equisales for financial reporting purposes. In the six months ended, June 30, 2012, we recorded unrealized depreciation of $2.1 million on our debt investment in Equisales. As of June 30, 2012, the cost of our debt investment in Equisales was $3.2 million and the fair value of such investment was $1.0 million.

In addition to our non-accrual assets, as of June 30, 2012, we had, on a fair value basis, approximately $20.1 million of debt investments, or 3.4% of the total fair value of our portfolio, which were current with respect to scheduled principal and interest payments, but which were carried at less than cost. The cost of these assets as of June 30, 2012 was approximately $28.5 million, or 4.8% of the total cost of our portfolio. Included in these amounts as of June 30, 2012 are two assets (our subordinated notes to Home Physicians, LLC and Home Physicians Holdings, LP) that are on non-accrual only with respect to the PIK interest component of the loan.

### Results of Operations

### Comparison of three months ended June 30, 2012 and June 30, 2011

#### Investment Income

For the three months ended June 30, 2012, total investment income was $22.0 million, a 34% increase from $16.4 million of total investment income for the three months ended June 30, 2011. This increase was primarily attributable to an increase in total loan interest income (including PIK interest income) due to a net increase in our portfolio investments from June 30, 2011, to June 30, 2012, partially offset by a decrease in non-recurring fee income of approximately $1.2 million. Non-recurring fee income was approximately $1.0 million for the three months ended June 30, 2012 as compared to $2.2 million for the three months ended June 30, 2011.

#### Expenses

For the three months ended June 30, 2012, expenses increased by 28% to $7.9 million from $6.2 million for the three months ended June 30, 2011. The increase in expenses was attributable to a $1.4 million increase in interest and other financing fees and a $0.3 million increase in general and administrative expenses. The increase in interest and other financing fees is primarily related to interest on our 7.00% Senior Notes due 2019, or Senior Notes, of approximately $1.2 million in the quarter ended June 30, 2012. The increase in general and administrative expenses in the quarter ended June 30, 2012 was primarily related to increased salary and incentive compensation costs, as well as increased non-cash compensation expenses.

#### Net Investment Income

As a result of the $5.5 million increase in total investment income and the $1.7 million increase in expenses, net investment income increased by 37% to $14.1 million for the three months ended June 30, 2012 as compared to net investment income of $10.2 million for the three months ended June 30, 2011.

#### Net Increase/Decrease in Net Assets Resulting from Operations

In the three months ended June 30, 2012 we realized a gain on the sale of one control investment of approximately $0.8 million, gains on the sales of two non-control/non-affiliate investments totaling approximately $2.6 million and a gain on the repayment of one non-control/non-affiliate investment totaling approximately $0.2 million. In addition, during the three months ended June 30, 2012, we recorded net unrealized depreciation of investments totaling approximately $2.0 million, comprised of unrealized appreciation on 30 investments totaling approximately $7.8 million, unrealized depreciation on 18 investments totaling approximately $6.8 million and unrealized depreciation reclassification adjustments related to the realized gains noted above totaling $3.0 million.

In the three months ended June 30, 2011, we realized a gain on the sale of one control investment of approximately $12.2 million, a loss on the disposal of one control investment of $0.1 million, and gains on the repayments of two non-control/non-affiliate investments totaling approximately $0.8 million. In addition, during the three months ended June 30, 2011, we recorded net unrealized depreciation of investments totaling approximately $8.7 million, comprised of unrealized appreciation on 20 investments totaling approximately $4.7 million, unrealized depreciation on 13 investments totaling approximately $2.2 million and unrealized depreciation reclassification adjustments related to the realized gains noted above totaling $11.1 million.

As a result of these events, our net increase in net assets from operations was $15.6 million for the three months ended June 30, 2012 as compared to a net increase in net assets from operations of $14.5 million for the three months ended June 30, 2011.

### Comparison of six months ended June 30, 2012 and June 30, 2011

#### Investment Income

For the six months ended June 30, 2012, total investment income was $41.1 million, a 42% increase from $28.8 million of total investment income for the six months ended June 30, 2011. This increase was primarily attributable to an increase in total loan interest income (including PIK interest income) due to a net increase in our portfolio investments from June 30, 2011, to June 30, 2012, partially offset by a decrease in non-recurring fee income of approximately $1.3 million. Non-recurring fee income was approximately $1.4 million for the six months ended June 30, 2012 as compared to $2.7 million for the six months ended June 30, 2011.

#### Expenses

For the six months ended June 30, 2012, expenses increased by 38% to $14.8 million from $10.7 million for the six months ended June 30, 2011. The increase in expenses was attributable to a $2.6 million increase in interest and other financing fees and a $1.5 million increase in general and administrative expenses. The increase in interest and credit facility fees is related to (i) interest on our 7.00% Senior Notes due 2019, or Senior Notes, of approximately $1.6 million for the six months ended June 30, 2012, (ii) credit facility fees of approximately $0.2 million for the six months ended June 30, 2012, (iii) increased amortization of deferred financing fees related to costs associated with the Senior Notes and (iii) higher weighted-average rates on outstanding SBA-guaranteed debentures for the six months ended June 30, 2012 as compared to weighted-average rates on outstanding SBA-guaranteed debentures for the six months ended June 30, 2011. The increase in general and administrative expenses for the six months ended June 30, 2012 was primarily related to increased salary and incentive compensation costs, as well as increased non-cash compensation expenses.

#### Net Investment Income

As a result of the $12.2 million increase in total investment income and the $4.1 million increase in expenses, net investment income increased by 45% to $26.2 million for the six months ended June 30, 2012 as compared to net investment income of

$18.1 million for the six months ended June 30, 2011.

#### Net Increase/Decrease in Net Assets Resulting from Operations

In the six months ended June 30, 2012 we realized, a gain on the sale of one control investment of approximately $0.8 million, gains on the sales of two non-control/non-affiliate investments totaling approximately $2.6 million and a gain on the repayment of one non-control/non-affiliate investment totaling approximately $0.2 million. In addition, during the six months ended June 30, 2012, we recorded net unrealized depreciation of investments totaling approximately $1.4 million, comprised of 1) unrealized appreciation on 32 investments totaling approximately $12.2 million and 2) unrealized depreciation on 18 investments totaling approximately $10.6 million and 3) unrealized depreciation reclassification adjustments related to the realized gains noted above totaling $3.0 million.

In the six months ended June 30, 2011, we realized a gain on the sale of one control investment of approximately $12.2 million, a loss on the disposal of one control investment of $0.1 million, and gains on the repayments of two non-control/non-affiliate investments totaling approximately $0.8 million. In addition, during the six months ended June 30, 2011, we recorded net unrealized depreciation of investments totaling approximately $4.1 million, comprised of 1) unrealized appreciation on 21 investments totaling approximately $11.0 million, 2) unrealized depreciation on 17 investments totaling approximately $3.9 million and 3) an $11.1 million unrealized depreciation reclassification adjustment related to the realized gains noted above.

During both the six months ended June 30, 2012 and 2011, we recognized losses on extinguishment of debt of approximately $0.2 million related to prepayments of SBA-guaranteed debentures.

As a result of these events, our net increase in net assets from operations was $28.2 million for the six months ended June 30, 2012 as compared to a net increase in net assets from operations of $26.9 million for the six months ended June 30, 2011.

### Liquidity and Capital Resources

We believe that our current cash and cash equivalents on hand, our available leverage under our line of credit and our anticipated cash flows from operations will be adequate to meet our cash needs for our daily operations for at least the next twelve months.

In the future, depending on the valuation of Triangle SBIC’s assets and Triangle SBIC II’s assets pursuant to SBA guidelines, Triangle SBIC and Triangle SBIC II may be limited by provisions of the Small Business Investment Act of 1958, and SBA regulations governing SBICs, from making certain distributions to Triangle Capital Corporation that may be necessary to enable Triangle Capital Corporation to make the minimum required distributions to its stockholders and qualify as a RIC.

#### Cash Flows

For the six months ended June 30, 2012, we experienced a net increase in cash and cash equivalents in the amount of $26.9 million. During that period, our operating activities used $65.6 million in cash, consisting primarily of new portfolio investments of $156.6 million, partially offset by repayments received from portfolio companies of approximately $71.4 million. In addition, financing activities provided $92.5 million of cash, consisting primarily of proceeds from a public common stock offering of $77.1 million and net proceeds from a public offering of Senior Notes of $66.7 million, partially offset by cash dividends paid in the amount of $24.8 million, repayments of SBA-guaranteed debentures of $10.4 million, and a repayment of borrowings under the Credit Facility of $15.0 million. At June 30, 2012, we had $93.7 million of cash and cash equivalents on hand.

For the six months ended June 30, 2011, we experienced a net increase in cash and cash equivalents in the amount of $13.4 million. During that period, our operating activities used $55.4 million in cash, consisting primarily of new portfolio investments of $136.3 million, partially offset by repayments received from portfolio companies and proceeds from the sale of investments totaling $61.5 million. In addition, financing activities provided $68.9 million of cash, consisting primarily of proceeds from a public common stock offering of $63.0 million, borrowings under SBA-guaranteed debentures payable of $31.1 million, offset by cash dividends paid in the amount of $13.8 million, repayments of SBA-guaranteed debentures of $9.5 million and financing fees paid in the amount of $1.2 million. At June 30, 2011, we had $68.2 million of cash and cash equivalents on hand.

#### Financing Transactions

Due to Triangle SBIC’s and Triangle SBIC II’s status as licensed SBICs, Triangle SBIC and Triangle SBIC II have the ability to issue debentures guaranteed by the SBA at favorable interest rates. Under the Small Business Investment Act and the SBA rules applicable to SBICs, an SBIC (or group of SBICs under common control) can have outstanding at any time debentures guaranteed by the SBA up to two times (and in certain cases, up to three times) the amount of its regulatory capital, which generally is the amount raised from private investors. As of June 30, 2012, the maximum statutory limit on the dollar amount of outstanding debentures guaranteed by the SBA issued by a single SBIC is $150.0 million and by a group of SBICs under common control is $225.0 million.

Debentures guaranteed by the SBA have a maturity of ten years, with interest payable semi-annually. The principal amount of the debentures is not required to be paid before maturity but may be pre-paid at any time, without penalty.

As of June 30, 2012, Triangle SBIC has issued $139.6 million of SBA-guaranteed debentures and has the current capacity to issue up to the statutory maximum of $150.0 million, subject to SBA approval. As of June 30, 2012, Triangle SBIC II has issued $75.0 million in face amount of SBA-guaranteed debentures. In addition to the one-time 1.0% fee on the total commitment from the SBA, the Company also pays a one-time 2.425% fee on the amount of each debenture issued (2.0% for SBA LMI debentures). These fees are capitalized as deferred financing costs and are amortized over the term of the debt agreements using the effective interest method. The weighted average interest rate for all SBA-guaranteed debentures as of June 30, 2012 was 4.76%.

In May 2011, we entered into a three-year senior secured credit facility (the “Credit Facility”) with an initial commitment of $50.0 million. In November 2011, we closed an expansion of the Credit Facility from $50.0 million to $75.0 million, which included the addition of one new lender. The purpose of the Credit Facility is to provide additional liquidity in support of future investment and operational activities. The Credit Facility was arranged by BB&T Capital Markets and Fifth Third Bank and has an accordion feature which allows for an increase in the total loan size up to $90.0 million and also contains two one-year extension options, bringing the total potential commitment and funding period to five years from the closing date. The Credit Facility, which is structured to operate like a revolving credit facility, is secured primarily by Triangle Capital Corporation’s assets, excluding the assets of Triangle SBIC and Triangle SBIC II.

Borrowings under the Credit Facility bear interest, subject to our election, on a per annum basis equal to (i) the applicable base rate plus 1.95% or (ii) the applicable LIBOR rate plus 2.95%. The applicable base rate is equal to the greater of (i) prime rate, (ii) the federal funds rate plus 0.5% or (iii) the adjusted one-month LIBOR plus 2.0%. We pay unused commitment fees of 0.375% per annum, which are included in “Interest and credit facility fees” on our Consolidated Statement of Operations. As of June 30, 2012, the Company had no borrowings outstanding under the Credit Facility.

In March 2012, we issued $69.0 million of Senior Notes. The Senior Notes mature on March 15, 2019, and may be redeemed in whole or in part at any time or from time to time at our option on or after March 15, 2015. The Senior Notes bear interest at a rate of 7.00% per year payable quarterly on March 15, June 15, September 15 and December 15 of each year, beginning June 15, 2012. The net proceeds from the sale of the Senior Notes, after underwriting discounts and offering expenses, were approximately $66.7 million.

#### Distributions to Stockholders

We have elected to be treated as a RIC under Subchapter M of the Internal Revenue Code of 1986, as amended, or the “Code,” and intend to make the required distributions to our stockholders as specified therein. In order to qualify as a RIC and to obtain RIC tax benefits, we must meet certain minimum distribution, source-of-income and asset diversification requirements. If such requirements are met, then we are generally required to pay income taxes only on the portion of our taxable income and gains we do not distribute (actually or constructively) and certain built-in gains. We have historically met our minimum distribution requirements and continually monitor our distribution requirements with the goal of ensuring compliance with the Code.

The minimum distribution requirements applicable to RICs require us to distribute to our stockholders each year at least 90% of our investment company taxable income, or “ICTI,” as defined by the Code. Depending on the level of ICTI earned in a tax year, we may choose to carry forward ICTI in excess of current year distributions into the next tax year and pay a 4% excise tax on such excess. Any such carryover ICTI must be distributed before the end of the next tax year through a dividend declared prior to filing the final tax return related to the year which generated such ICTI.

ICTI generally differs from net investment income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses. We may be required to recognize ICTI in certain circumstances in which we do not receive cash. For example, if we hold debt obligations that are treated under applicable tax rules as having original issue discount (such as debt instruments issued with warrants), we must include in ICTI each year a portion of the original issue discount that accrues over the life of the obligation, regardless of whether cash representing such income is received by us in the same taxable year. We may also have to include in ICTI other amounts that we have not yet received in cash, such as (i) PIK interest income and (ii) interest income from investments that have been classified as non-accrual for financial reporting purposes. Interest income on non-accrual investments is not recognized for financial reporting purposes, but generally is recognized in ICTI. Because any original issue discount or other amounts accrued will be included in our ICTI for the year of accrual, we may be required to make a distribution to our stockholders in order to satisfy the minimum distribution requirements, even though we will not have received and may not ever receive any corresponding cash amount. ICTI also excludes net unrealized appreciation or depreciation, as investment gains or losses are not included in taxable income until they are realized.

#### Current Market Conditions

Beginning in 2008, the debt and equity capital markets in the United States were severely impacted by significant write-offs in the financial services sector relating to subprime mortgages and the re-pricing of credit risk in the broadly syndicated bank loan market, among other factors. These events, along with the deterioration of the housing market, led to an economic recession in the U.S. and abroad. Banks, investment companies and others in the financial services industry reported significant write-downs in the fair value of their assets, which led to the failure of a number of banks and investment companies, a number of distressed mergers and acquisitions, the government take-over of the nation’s two largest government-sponsored mortgage companies, the passage of the $700 billion Emergency Economic Stabilization Act of 2008 in October 2008 and the passage of the American Recovery and Reinvestment Act of 2009, or the Stimulus Bill, in February 2009. These events significantly impacted the financial and credit markets and reduced the availability of debt and equity capital for the market as a whole, and for financial firms in particular. Notwithstanding recent gains across both the equity and debt markets, the market continues to remain volatile due to the uncertainty surrounding the United States’ rapidly increasing national debt, European economic conditions, the automatic federal spending reductions, expiration of tax cuts at year-end and continuing global economic malaise, causing these conditions to possibly reoccur in the future and continue for a prolonged period of time. Although we have been able to secure access to additional liquidity, including our recent public offerings of common stock and debt securities, increased leverage available through the SBIC program as a result of the Stimulus Bill and our $75.0 million Credit Facility, there is no assurance that debt or equity capital will be available to us in the future on favorable terms, or at all.

### Recent Developments

In July 2012, we invested $5.3 million in subordinated debt and equity of Empire Facilities Management Group, Inc. (“Empire”), a retail, restaurant, and commercial facilities maintenance and management company offering single-source facilities solutions across the continental United States, Hawaii, Alaska, Puerto Rico, Canada, and the Virgin Islands. Under the terms of the investment, Empire will pay interest on the subordinated debt at a rate of 13% per annum.

In July 2012, we invested $9.5 million in subordinated debt and equity of DataSource Incorporated (“DataSource”), a provider of outsourced print supply chain management services, including production, sourcing, and fulfillment of print marketing materials. Under the terms of the investment, DataSource will pay interest on the subordinated debt at a rate of 14.0% per annum.

In July 2012, we invested $10.0 million in subordinated debt and equity of All Aboard America! Holdings, Inc. (“All Aboard”), a large regional motor coach operator that provides commuter, charter, sightseeing, and scheduled route services in both the southwestern and southern United States. Under the terms of the investment, All Aboard will pay interest on the subordinated debt at a rate of 15% per annum.

In July 2012, we invested $7.2 million in subordinated debt and equity of Eckler Holdings, Inc. (“Eckler’s”), a large multi-channel marketer of restoration parts and accessories for classic and enthusiast cars and trucks. Under the terms of the investment, Eckler’s will pay interest on the subordinated debt at a rate of 15% per annum.

In July 2012, we invested $10.0 million in subordinated debt and equity of My Alarm Center, LLC, (“Alarm Center”), a provider of billing, account management, technical service/repair, and call center operation services for security alarm contracts. Under the terms of the investment, Alarm Center will pay interest on the subordinated debt at a rate of 14.5% per annum.

### Critical Accounting Policies and Use of Estimates

The preparation of our unaudited financial statements in accordance with U.S. GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses for the periods covered by such financial statements. We have identified investment valuation and revenue recognition as our most critical accounting estimates. On an on-going basis, we evaluate our estimates, including those related to the matters described below. These estimates are based on the information that is currently available to us and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ materially from those estimates under different assumptions or conditions. A discussion of our critical accounting policies follows.

### Investment Valuation

The most significant estimate inherent in the preparation of our financial statements is the valuation of investments and the related amounts of unrealized appreciation and depreciation of investments recorded. We have established and documented processes and methodologies for determining the fair values of portfolio company investments on a recurring basis in accordance with the 1940 Act and FASB ASC Topic 820, *Fair Value Measurements and Disclosures,* or ASC Topic 820. Under ASC Topic 820, a financial instrument is categorized within the ASC Topic 820 valuation hierarchy based upon the lowest level of input to the valuation process that is significant to the fair value measurement. The three levels of valuation inputs established by ASC Topic 820 are as follows:

*Level 1 Inputs –* quoted prices (unadjusted) in active markets for identical assets or liabilities.

*Level 2 Inputs –* include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

*Level 3 Inputs –* include inputs that are unobservable and significant to the fair value measurement.

Our investment portfolio is comprised of debt and equity instruments of privately held companies for which quoted prices or other inputs falling within the categories of Level 1 and Level 2 are not available. Therefore, we determine the fair value of our investments in good faith using level 3 inputs, pursuant to a valuation policy and process that is established by our management with the assistance of certain third-party advisors and subsequently approved by our Board of Directors. There is no single standard for determining fair value in good faith, as fair value depends upon the specific circumstances of each individual investment. The recorded fair values of our investments may differ significantly from fair values that would have been used had an active market for the securities existed. In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different than the valuations currently assigned.

Our valuation process is led by our executive officers and managing directors. The valuation process begins with a quarterly review of each investment in our investment portfolio by our executive officers and our investment committee. Valuations of each portfolio security are then prepared by our investment professionals, who have direct responsibility for the origination, management and monitoring of each investment. Under our valuation policy, each investment valuation is subject to (i) a review by the lead investment officer responsible for the portfolio company investment and (ii) a peer review by a second investment officer or executive officer. Generally, any investment that is valued below cost is subjected to review by one of our executive officers. After the peer review is complete, we engage two independent valuation firms, Duff & Phelps, LLC and Lincoln Partners Advisors LLC (collectively, the “Valuation Firms”), to provide third-party reviews of certain investments, as described further below. In addition, all investment valuations are provided to our independent registered public accounting firm in connection with quarterly review procedures and the annual audit of our financial statements. Finally, the Board of Directors has the responsibility for reviewing and approving, in good faith, the fair value of our investments in accordance with the 1940 Act.

The Valuation Firms provide third party valuation consulting services to us which consist of certain limited procedures that we identified and requested the Valuation Firms to perform (hereinafter referred to as the “Procedures”). The Procedures are performed with respect to each portfolio company at least once in every calendar year and for new portfolio companies, at least once in the twelve-month period subsequent to the initial investment. In addition, the Procedures are generally performed with respect to a portfolio company when there has been a significant change in the fair value of the investment. In certain instances, we may determine that it is not cost-effective, and as a result is not in our stockholders’ best interest, to request the Valuation Firms to perform the Procedures on one or more portfolio companies. Such instances include, but are not limited to, situations where the fair value of the investment in the portfolio company is determined to be insignificant relative to the total investment portfolio.

The total number of investments and the percentage of our portfolio on which the Procedures were performed are summarized below by period:

| For the quarter ended: | Total companies | Percent of total investments at fair value(1) |
| --- | ---: | ---: |
| March 31, 2011 | 11 | 34% |
| June 30, 2011 | 13 | 26% |
| September 30, 2011 | 11 | 31% |
| December 31, 2011 | 12 | 22% |
| March 31, 2012 | 10 | 19% |
| June 30, 2012 | 14 | 21% |

(1) Exclusive of the fair value of new investments made during the quarter.

Upon completion of the Procedures, the Valuation Firms concluded that, with respect to each investment reviewed by each Valuation Firm, the fair value of those investments subjected to the Procedures appeared reasonable. Our Board of Directors is ultimately responsible for determining the fair value of our investments in good faith.

### Investment Valuation Inputs

Under ASC Topic 820, fair value is 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. For our portfolio securities, fair value is generally the amount that we might reasonably expect to receive upon the current sale of the security. Under ASC Topic 820, the fair value measurement assumes that the sale occurs in the principal market for the security, or in the absence of a principal market, in the most advantageous market for the security. Under ASC Topic 820, if no market for the security exists or if we do not have access to the principal market, the security should be valued based on the sale occurring in a hypothetical market. The securities in which we invest are generally only purchased and sold in merger and acquisition transactions, in which case the entire portfolio company is sold to a third-party purchaser. As a result, unless we have the ability to control such a transaction, the assumed principal market for our securities is a hypothetical secondary market. The level 3 inputs to our valuation process reflect management’s best estimate of the assumptions that would be used by market participants in pricing the investment in a transaction in a hypothetical secondary market.

#### Enterprise Value Waterfall Approach

In valuing equity securities (including warrants), we estimate fair value using an “Enterprise Value Waterfall” valuation model. We estimate the enterprise value of a portfolio company and then allocate the enterprise value to the portfolio company’s securities in order of their relative liquidation preference. In addition, the model assumes that any outstanding debt or other securities that are senior to our equity securities are required to be repaid at par. Additionally, the Company estimates the fair value of a limited number of its debt securities using the Enterprise Value Waterfall approach in cases where the Company does not expect to receive full repayment.

To estimate the enterprise value of the portfolio company, we primarily use a valuation model based on a transaction multiple, which generally is the original transaction multiple, and measures of the portfolio company’s financial performance. In addition, we consider other factors, including but not limited to (i) offers from third-parties to purchase the portfolio company, (ii) the implied value of recent investments in the equity securities of the portfolio company, (iii) publicly available information regarding recent sales of private companies in comparable transactions and, (iv) when management believes there are comparable companies that are publicly traded, a review of these publicly traded companies and the market multiple of their equity securities.

The significant Level 3 inputs to the Enterprise Value Waterfall model are (i) an appropriate transaction multiple and (ii) a measure of the portfolio company’s financial performance, which generally is either earnings before interest, taxes, depreciation and amortization, as adjusted, or Adjusted EBITDA, or revenues. Such inputs can be based on historical operating results, projections of future operating results, or a combination thereof. The operating results of a portfolio company may be unaudited, projected or pro forma financial information and may require adjustments for certain non-recurring items. In determining the operating results input, we utilize the most recent portfolio company financial statements and forecasts available as of the valuation date. Management also consults with the portfolio company’s senior management to obtain updates on the portfolio company’s performance, including information such as industry trends, new product development, loss of customers and other operational issues. Additionally, we consider some or all of the following factors:

- financial standing of the issuer of the security;
- comparison of the business and financial plan of the issuer with actual results;
- the size of the security held as it relates to the liquidity of the market for such security;
- pending public offering of common stock by the issuer of the security;
- pending reorganization activity affecting the issuer, such as merger or debt restructuring;
- ability of the issuer to obtain needed financing;
- changes in the economy affecting the issuer;
- financial statements and reports from portfolio company senior management and ownership;
- the type of security, the security’s cost at the date of purchase and any contractual restrictions on the disposition of the security;
- special reports prepared by analysts;
- information as to any transactions or offers with respect to the security and/or sales to third parties of similar securities;
- the issuer’s ability to make payments and the type of collateral;
- the current and forecasted earnings of the issuer;
- statistical ratios compared to lending standards and to other similar securities; and
- other pertinent factors.

Fair value measurements using the Enterprise Value Waterfall model can be sensitive to significant changes in one or more of the inputs. A significant increase in either the transaction multiple, Adjusted EBITDA or revenues for a particular equity security would result in a higher fair value for that security.

#### Income Approach

In valuing debt securities, we utilize an “Income Approach” model that considers factors including, but not limited to, (i) the stated yield on the debt security, (ii) the portfolio company’s current trailing twelve months, or TTM Adjusted EBITDA as compared to the portfolio company’s historical or projected Adjusted EBITDA as of the date the investment was made and the portfolio company’s anticipated Adjusted EBITDA for the next twelve months of operations, (iii) the portfolio company’s current Leverage Ratio (defined as the portfolio company’s total indebtedness divided by Adjusted EBITDA) as compared to its Leverage Ratio as of the date the investment was made, (iv) publicly available information regarding current pricing and credit metrics for similar proposed and executed investment transactions of private companies and (v) when management believes a relevant comparison exists, current pricing and credit metrics for similar proposed and executed investment transactions of publicly traded debt. In addition, we use a risk rating system to estimate the probability of default on the debt securities and the probability of loss if there is a default. This risk rating system covers both qualitative and quantitative aspects of the business and the securities held.

We consider the factors above, particularly any significant changes in the portfolio company’s results of operations and leverage, and develop an expectation of the yield that a hypothetical market participant would require when purchasing the debt investment (the “Required Rate of Return”). The Required Rate of Return, along with the Leverage Ratio and Adjusted EBITDA are the significant Level 3 inputs to the Income Approach model. For investments where the Leverage Ratio and Adjusted EBITDA have not fluctuated significantly from the date the investment was made or have not fluctuated significantly from management’s expectations as of the date the investment was made, and where there have been no significant fluctuations in the market pricing for such investments, we may conclude that the Required Rate of Return is equal to the stated rate on the investment and therefore, the debt security is appropriately priced. In instances where we determine that the Required Rate of Return is different from the stated rate on the investment, we discount the contractual cash flows on the debt instrument using the Required Rate of Return in order to estimate the fair value of the debt security.

Fair value measurements using the Income Approach model can be sensitive to significant changes in one or more of the inputs. A significant increase (decrease) in the Required Rate of Return or Leverage Ratio inputs for a particular debt security may result in a lower (higher) fair value for that security. A significant increase (decrease) in the Adjusted EBITDA input for a particular debt security may result in a higher (lower) fair value for that security.

The fair value of our royalty rights are calculated based on specific provisions contained in the pertinent operating or royalty agreements. The determination of the fair value of such royalty rights is not a significant component of our valuation process.

### Revenue Recognition

#### Interest and Dividend Income

Interest income, adjusted for amortization of premium and accretion of original issue discount, is recorded on the accrual basis to the extent that such amounts are expected to be collected. Generally, when interest and/or principal payments on a loan become past due, or if we otherwise do not expect the borrower to be able to service its debt and other obligations, we will place the loan on non-accrual status and will generally cease recognizing interest income on that loan for financial reporting purposes until all principal and interest have been brought current through payment or due to a restructuring such that the interest income is deemed to be collectible. The cessation of recognition of such interest will negatively impact the reported fair value of the investment. We write off any previously accrued and uncollected interest when it is determined that interest is no longer considered collectible. Dividend income is recorded on the ex-dividend date.

We may have to include in our ICTI, interest income, including amortization of original issue discount, or OID, from investments that have been classified as non-accrual for financial reporting purposes. Interest income on non-accrual investments is not recognized for financial reporting purposes, but generally is recognized in ICTI. As a result, we may be required to make a distribution to our stockholders in order to satisfy the minimum distribution requirements to maintain our RIC status, even though we will not have received and may not ever receive any corresponding cash amount. Additionally, any loss recognized by us for federal income tax purposes on previously accrued interest income will be treated as a capital loss.

#### Fee Income

Origination, facility, commitment, consent and other advance fees received in connection with loan agreements, or “loan origination fees,” are recorded as deferred income and recognized as investment income over the term of the loan. Upon prepayment of a loan, any unamortized loan origination fees are recognized as investment income. In the general course of our business, we receive certain fees from portfolio companies, which are non-recurring in nature. Such fees include loan prepayment penalties, certain investment banking and structuring fees and loan waiver and amendment fees, and are recorded as investment income when received.

#### Payment-in-Kind Interest (PIK)

We currently hold, and we expect to hold in the future, some loans in our portfolio that contain a PIK interest provision. PIK interest, computed at the contractual rate specified in each loan agreement, is periodically added to the principal balance of the loan, rather than being paid to us in cash, and is recorded as interest income. Thus, the actual collection of PIK interest may be deferred until the time of debt principal repayment.

To maintain our status as a RIC, PIK interest, which is a non-cash source of income, is included in our taxable income and therefore affects the amount we are required to pay to stockholders in the form of dividends, even though we have not yet collected the cash. Generally, when current cash interest and/or principal payments on a loan become past due, or if we otherwise do not expect the borrower to be able to service its debt and other obligations, we will place the loan on non-accrual status and will generally cease recognizing PIK interest income on that loan for financial reporting purposes until all principal and interest have been brought current through payment or due to a restructuring such that the interest income is deemed to be collectible. We write off any previously accrued and uncollected PIK interest when it is determined that the PIK interest is no longer collectible.

We may have to include in our ICTI, PIK interest income from investments that have been classified as non-accrual for financial reporting purposes. Interest income on non-accrual investments is not recognized for financial reporting purposes, but generally is recognized in ICTI. As a result, we may be required to make a distribution to our stockholders in order to satisfy the minimum distribution requirements, even though we will not have received and may not ever receive any corresponding cash amount.

### Recently Issued Accounting Standards

In May 2011, the FASB issued ASU No. 2011-04, *Fair Value Measurements* (Topic 820), *Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs*, or ASU 2011-04. ASU 2011-04 clarifies the application of existing fair value measurement and disclosure requirements, changes the application of some requirements for measuring fair value and requires additional disclosure for fair value measurements categorized in Level 3 of the fair value hierarchy. ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011. We adopted this standard on January 1, 2012. The adoption of ASU 2011-04 did not have a material impact on our process for measuring fair values or on our financial statements, other than the inclusion of additional required disclosures.

### Off-Balance Sheet Arrangements

We currently have no off-balance sheet arrangements.

## Market risk

As filed, 5,752 characters.

During 2011 and the first six months of 2012, the United States economy continued to show modest improvements; however, during the third quarter of 2011, the financial markets experienced increased volatility and economic indicators suggested a further slowdown of the United States and European economies potentially leading to another recession. A prolonged slowdown in economic activity would likely have an adverse effect on a number of the industries in which some of our portfolio companies operate, and on certain of our portfolio companies as well. In addition, the recent sovereign debt crises may continue to impact the broader financial and credit markets and may continue to reduce the availability of debt and equity capital for the market as a whole and financial firms in particular.

During 2010, we experienced a $10.9 million increase in the fair value of our investment portfolio related to unrealized appreciation of investments. In 2011, we experienced a $6.4 million increase in the fair value of our investment portfolio related to unrealized appreciation of investments and in the first six months of 2012, we experienced a $1.4 million decrease in the fair value of our investment portfolio related to unrealized depreciation of investments.

As of June 30, 2012, the fair value of our non-accrual assets was approximately $2.9 million, which comprised approximately 0.5% of the total fair value of our portfolio, and the cost of our non-accrual assets was approximately $9.4 million, or 1.6% of the total cost of our portfolio.

In addition to these non-accrual assets, as of June 30, 2012, we had, on a fair value basis, approximately $20.1 million of debt investments, or 3.4% of the total fair value of our portfolio, which were current with respect to scheduled principal and interest payments, but which were carried at less than cost. The cost of these assets as of June 30, 2012 was approximately $28.5 million, or 4.8% of the total cost of our portfolio. Included in these amounts as of June 30, 2012 are two assets (our subordinate notes to Home Physicians, LLC and Home Physicians Holdings, LP) that are on non-accrual only with respect to the PIK interest component of the loan.

The volatile and stressed conditions of the equity and debt markets may continue for a prolonged period of time or worsen in the future. To the extent that recessionary conditions recur, the economy remains stagnate, any further downgrades to the U.S. government’s sovereign credit rating occur, the European credit crisis continues, or the economy fails to return to pre-recession levels, the financial position and results of operations of certain of the middle-market companies in our portfolio could be further affected adversely, which ultimately could lead to difficulty in our portfolio companies meeting debt service requirements and lead to an increase in defaults. There can be no assurance that the performance of our portfolio companies will not be further impacted by economic conditions, which could have a negative impact on our future results.

In addition, we are subject to interest rate risk. Interest rate risk is defined as the sensitivity of our current and future earnings to interest rate volatility, 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 and originate loans and securities and the value of our investment portfolio. Our investment income is affected by fluctuations in various interest rates, including LIBOR and prime rates. We regularly measure exposure to interest rate risk and determine whether or not any hedging transactions are necessary to mitigate exposure to changes in interest rates. As of June 30, 2012, we were not a party to any hedging arrangements.

As of June 30, 2012, approximately 97.2%, or $518.6 million (at cost) of our debt portfolio investments bore interest at fixed rates and approximately 2.8%, or $14.7 million (at cost) of our debt portfolio investments bore interest at variable rates, which are either Prime-based or LIBOR-based. A 200 basis point increase or decrease in the interest rates on our variable-rate debt investments would increase or decrease, as applicable, our investment income by approximately $0.3 million on an annual basis. All of our pooled SBA-guaranteed debentures and our Senior Notes bear interest at fixed rates. Our Credit Facility bears interest, subject to our election, on a per annum basis equal to (i) the applicable base rate plus 1.95% or (ii) the applicable LIBOR rate plus 2.95%. The applicable base rate is equal to the greater of (i) prime rate, (ii) the federal funds rate plus 0.5% or (iii) the adjusted one-month LIBOR plus 2.0%.

Because we currently borrow, and plan to borrow in the future, money to make investments, our net investment income is dependent upon the difference between the rate at which we borrow funds and the rate at which we invest the funds borrowed. Accordingly, there can be no assurance that a significant change in market interest rates will not have a material adverse effect on our net investment income. In periods of rising interest rates, our cost of funds would increase, which could reduce our net investment income if there is not a corresponding increase in interest income generated by our investment portfolio.

## Controls and procedures

As filed, 1,813 characters.

### Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Our Chief Executive Officer and Chief Financial Officer carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on the evaluation of these disclosure controls and procedures, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective. It should be noted that any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events. Because of these and other inherent limitations of control systems, there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

### Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting during the second quarter of 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

## Risk factors

As filed, 613 characters.

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I., “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, which could materially affect our business, financial condition or operating results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

Filed Aug 1, 2012.
Source: SEC EDGAR, the filing index for accession 0001193125-12-328792. Last ingested by Listed: Nov 9, 2026, 19:13 ET. No prices; not investment advice.