Filed Pursuant to Rule 497
File No. 333-162592

Prospectus Supplement

(To Prospectus Dated July 15, 2011)

 

$35,000,000

 

 

PREFERRED STOCK

1,400,000 Shares, 7.125% Series 2016

Liquidation Preference $25 Per Share

 

We are offering 1,400,000 shares of our 7.125% Series 2016 preferred stock, or the “Series 2016 Term Preferred Shares.” We will pay monthly dividends on the Series 2016 Term Preferred Shares at an annual rate of 7.125% of the $25 liquidation preference per share, or $1.7813 per Series 2016 Term Preferred Share per year, on the last business day of each month, commencing on December 30, 2011.

 

We are required to redeem all of the outstanding Series 2016 Term Preferred Shares on December 31, 2016 at a redemption price equal to $25 per share plus an amount equal to accumulated but unpaid dividends, if any, to the date of redemption. We cannot effect any amendment, alteration or repeal of our obligation to redeem all of the Series 2016 Term Preferred Shares on December 31, 2016 without the prior unanimous consent of the holders of Series 2016 Term Preferred Shares. If we fail to maintain an Asset Coverage ratio of at least 200% (as described in this prospectus supplement), we will redeem a portion of the outstanding Series 2016 Term Preferred Shares in an amount at least equal to the lesser of (1) the minimum number of shares of Series 2016 Term Preferred Stock necessary to cause us to meet our required Asset Coverage ratio and (2) the maximum number of Series 2016 Term Preferred Shares that we can redeem out of cash legally available for such redemption. At any time on or after December 31, 2012, at our sole option, we may redeem the Series 2016 Term Preferred Shares at a redemption price per share equal to the sum of the $25 liquidation preference per share plus (i) an initial premium of 1.00% of the liquidation preference (with such premium declining by 0.50% on the first and second anniversaries such that, beginning on December 31, 2014, no premium will be payable in connection with any such optional redemption) and (ii) an amount equal to accumulated but unpaid dividends, if any, on the Series 2016 Term Preferred Shares.

 

Each holder of our Series 2016 Term Preferred Shares (and any other preferred stock we may issue in the future) will be entitled to one vote for each share held by such holder on any matter submitted to a vote of our stockholders, and the holders of all of our outstanding preferred stock and common stock will vote together as a single class. The holders of the Series 2016 Term Preferred Shares (together with any other preferred stock we may issue in the future), voting separately as a class, will elect at least two of our directors and, upon failure to pay dividends for at least two years, will elect a majority of our directors.

 

The Series 2016 Term Preferred Shares will rank equally in right of payment with all other shares of preferred stock that we may issue and will rank senior in right of payment to all of our common stock.

 

The Series 2016 Term Preferred Shares have been approved for listing on the New York Stock Exchange, or the NYSE, under the symbol “GLAD PR A.” Our common stock is traded on the NASDAQ Global Select Market, or NASDAQ, under the symbol “GLAD.” On October 27, 2011, the last sale price of our common stock as reported on NASDAQ was $7.99 per share. The Series 2016 Term Preferred Shares will not be convertible into our common stock or any other security of our company.

 

Investing in our securities involves risks. You could lose some or all of your investment. You should carefully consider each of the factors described under “Risk Factors” beginning on page S-8 of this prospectus supplement and beginning on page 8 of the accompanying prospectus before you invest in the Series 2016 Term Preferred Shares.

 

Neither the Securities and Exchange Commission, or the SEC, nor any state securities commission has approved or disapproved of these securities or determined if this prospectus supplement or the accompanying prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

 

 

 

The underwriters expect to deliver the Series 2016 Term Preferred Shares on or about November 4, 2011.

Janney Montgomery Scott

 

Prospectus Supplement dated October 28, 2011

 

This prospectus supplement, together with the accompanying prospectus, sets forth the information that you should know before investing. You should read the prospectus supplement and accompanying prospectus, which contain important information, before deciding whether to invest in the Series 2016 Term Preferred Shares.

 

We also file annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, proxy statements and other information with the SEC under the Securities Exchange Act of 1934, as amended, or the Exchange Act. You may inspect such reports, proxy statements and other information, as well as the prospectus supplement, and the accompanying prospectus and the exhibits and schedules to the registration statement of which the accompanying prospectus is a part, at the public reference facilities maintained by the SEC at 100 F Street, N.E., Washington, D.C. 20549. You may obtain information about the operation of the public reference facilities by calling the SEC at 1-800-SEC-0330. The SEC maintains a website that contains reports, proxy statements and other information regarding registrants, including us, that file such information electronically with the SEC. The address of the SEC’s website is http://www.sec.gov. You may also obtain copies of such material from the Public Reference Section of the SEC at 100 F Street, N.E., Washington, D.C. 20549, at prescribed rates.

 

You may request a free copy of this prospectus supplement, the accompanying prospectus, our annual reports to stockholders, when available, and other information about us, and make stockholder inquiries by calling (866) 366-5745 or by writing to us at 1521 Westbranch Drive, Suite 200, McLean, Virginia 22102, or from our website (http://www.GladstoneCapital.com). The information contained in, or that can be accessed through, our website is not part of this prospectus supplement or the accompanying prospectus. We make available free of charge on our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. We also furnish to our stockholders annual reports, which include annual financial information that has been examined and reported on, with an opinion expressed, by our independent registered public accounting firm.

 

This prospectus supplement, which describes the specific terms of this offering, also adds to and updates information contained in the accompanying prospectus. The prospectus gives more general information, some of which may not apply to this offering. If the description of this offering varies between this prospectus supplement and the accompanying prospectus, you should rely on the information contained in this prospectus supplement. However, if any statement in one of these documents is inconsistent with a statement in another document having a later date, the statement in the document having the later date modifies or supersedes the earlier statement.

 

The Series 2016 Term Preferred Shares do not represent a deposit or obligation of, and are not guaranteed or endorsed by, any bank or other insured depository institution, and are not federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board or any other government agency.

 

You should rely only on the information contained in this prospectus supplement and the accompanying prospectus in making an investment decision. We have not authorized any other person to provide you with different or inconsistent information. If anyone provides you with different or inconsistent information, you should not rely on it. We are not, and the underwriters are not, making an offer to sell the Series 2016 Term Preferred Shares in any jurisdiction where such an offer or sale is not permitted. The information appearing in this prospectus supplement and in the accompanying prospectus is accurate only as of the dates on their respective covers, regardless of the time of delivery or any sale of the Series 2016 Term Preferred Shares.

 

We expect to deliver the Series 2016 Term Preferred Shares against payment therefor on or about the date specified in the last paragraph of the cover page of this prospectus supplement, which will be the fifth business day following the date of the pricing of the Series 2016 Term Preferred Shares. Under Rule 15c6-1 of the Exchange Act, trades in the secondary market generally settle in three business days, and purchasers who wish to trade the Series 2016 Term Preferred Shares on the date of pricing or the next succeeding business day will be required, by virtue of the fact that the Series 2016 Term Preferred Shares initially will settle in T+5, to specify alternative settlement arrangements to prevent a failed settlement.

 

TABLE OF CONTENTS

 

Prospectus Supplement

 

 

 

 

 

Prospectus

 

 

PROSPECTUS SUPPLEMENT SUMMARY

	•	the nature, quality and extent of the advisory and other services to be provided to us by the Adviser;
	•	the fee structures of comparable externally managed business development companies that engage in similar investing activities; and
	•	various other matters.

Issuer		Gladstone Capital Corporation
Listing		The Series 2016 Term Preferred Shares have been approved for listing on the NYSE, under the symbol “GLAD PR A.” Trading on the Series 2016 Term Preferred Shares is expected to begin within 30 days after the date of initial delivery of the Series 2016 Term Preferred Shares. Prior to the expected commencement of trading on the NYSE, the underwriters do not intend to make a market in the Series 2016 Term Preferred Shares.
Securities Offered		1,400,000 shares of 7.125% Series 2016 Term Preferred Stock (1,610,000 shares if the underwriters exercise their over-allotment option in full).
Liquidation Preference		$25 per share, plus accrued but unpaid dividends, if any. In the event of any liquidation, dissolution or winding up of our affairs, holders of the Series 2016 Term Preferred Shares will be entitled to receive a liquidation distribution per share equal to $25 per share (which we refer to in this prospectus supplement as the Liquidation Preference), plus an amount equal to all accrued but unpaid dividends, if any, and distributions accumulated to (but excluding) the date fixed for distribution or payment, whether or not earned or declared by us, but excluding interest on any such distribution or payment. See “Description of the Series 2016 Term Preferred Stock — Liquidation Rights.”
Dividends		The Series 2016 Term Preferred Shares will pay a monthly dividend at a fixed annual rate of 7.125% of the Liquidation Preference, or $1.7813 per share per year, which we refer to as the Fixed Dividend Rate. The Fixed Dividend Rate is subject to adjustment under certain circumstances, but will not in any case be lower than the Fixed Dividend Rate.
		Cumulative cash dividends or distributions on each Series 2016 Term Preferred Share will be payable monthly, when, as and if declared, or under authority granted, by our Board of Directors out of funds legally available for such payment. The first dividend period for the Series 2016 Term Preferred Shares will commence on the initial issuance date of such shares upon the closing of this offering, which we refer to as the Date of Original Issue, and will end on December 31, 2011.
Ranking		The Series 2016 Term Preferred Shares are senior securities that constitute capital stock of the Company.
		The Series 2016 Term Preferred Shares rank:
		• senior to the Common Stock in priority of payment of dividends and as to the distribution of assets upon dissolution, liquidation or the winding-up of our affairs; and

		• equal in priority with all other future series of preferred stock we may issue, which we refer to in this prospectus supplement, collectively with the Series 2016 Term Preferred Shares, as the Preferred Stock, as well as any other series of Term Preferred Shares (as such term is defined in the Articles Supplementary, the Term Preferred Stock) as to priority of payment of dividends and as to distributions of assets upon dissolution, liquidation or the winding-up of our affairs.
		We may issue additional shares of Preferred Stock, but we may not issue additional classes of capital stock that rank senior or junior to the Series 2016 Term Preferred Shares (other than Common Stock) as to priority of payment of dividends and as to distribution of assets upon dissolution, liquidation or winding-up of our affairs. We may, however, borrow funds from banks and other lenders so long as the ratio of (1) the value of total assets less the total borrowed amounts to (2) the sum of all senior securities representing indebtedness and the outstanding Series 2016 Term Preferred Shares multiplied by $25 per share, is not greater than 200%.
Term Redemption		We are required to redeem all outstanding Series 2016 Term Preferred Shares on December 31, 2016 at a redemption price equal to the Liquidation Preference plus an amount equal to accumulated but unpaid dividends, if any, on such shares (whether or not earned or declared, but excluding interest on such dividends) to, but excluding, the redemption date. We cannot effect any amendment, alteration or repeal of our obligation to redeem all of the Series 2016 Term Preferred Shares on December 31, 2016 without the prior unanimous vote or consent of holders of the Series 2016 Term Preferred Shares. See “Description of the Series 2016 Term Preferred Stock — Redemption” and “— Voting Rights.”
Mandatory Redemption for Asset Coverage		If we fail to maintain an Asset Coverage ratio (as defined below) of at least 200% as of the close of business on any Business Day on which Asset Coverage is required to be calculated, and such failure is not cured by the close of business on the date that is 30 calendar days following such Business Day (referred to in this prospectus supplement as an Asset Coverage Cure Date), then we are required to redeem, within 90 calendar days of the Asset Coverage Cure Date, shares of Preferred Stock equal to the lesser of (1) the minimum number of shares of Preferred Stock that will result in our having an Asset Coverage ratio of at least 200% and (2) the maximum number of shares of Preferred Stock that can be redeemed out of funds legally available for such redemption. Also, at our sole discretion, we may redeem such number of shares of Preferred Stock (including shares of Preferred Stock required to be redeemed) that will result in our having an Asset Coverage ratio of up to and including 285%. The Preferred Stock to be redeemed may include, at our sole option, any number or proportion of the Series 2016 Term Preferred Shares and other series of Preferred Stock. If the Series 2016 Term Preferred Shares are to be redeemed in such an event, they will be redeemed at a redemption price equal to their liquidation preference per share plus accumulated but unpaid dividends, if any, on such liquidation preference (whether

		or not declared, but excluding, interest on accrued but unpaid dividends, if any) to, but excluding, the date fixed for such redemption.
		Asset Coverage for purposes of our Preferred Stock is a ratio calculated under Section 18(h) of the 1940 Act, as in effect on the date of the Articles Supplementary, and is determined on the basis of values calculated as of a time within two Business Days preceding each determination. We estimate that, on the Date of Original Issue, our Asset Coverage, based on the composition and value of our portfolio as of June 30, 2011, and after giving effect to (1) the issuance of the Series 2016 Term Preferred Shares offered in this offering and (2) the payment of underwriting discounts and commissions of $1.4 million and estimated related offering costs payable by us of $0.5 million, will be 331%. Our net investment income coverage, which is calculated by dividing our net investment income by the amount of distributions to holders of our Common Stock, averaged approximately 91.1% from September 30, 2008 through June 30, 2011. Net investment income coverage has varied each year since our inception, and there is no assurance that historical coverage levels will be maintained. See “Description of the Series 2016 Term Preferred Stock — Asset Coverage.”
Optional Redemption		At any time on or after December 31, 2012, at our sole option, we may redeem the Series 2016 Term Preferred Shares in whole or from time to time, in part, out of funds legally available for such redemption, at a price per share equal to the sum of the Liquidation Preference plus (1) an initial premium of 1.00% of the Liquidation Preference (with such premium declining by 0.5% on the first and second anniversaries such that, by December 31, 2014, there will be no premium payable on any such redemption) and (2) an amount equal to accumulated but unpaid dividends, if any, on such shares (whether or not earned or declared, but excluding interest on such dividends) to, but excluding, the date fixed for such redemption. See “Description of the Series 2016 Term Preferred Stock — Redemption — Optional Redemption.” See “Description of the Series 2016 Term Preferred Stock — Redemption.”
Voting Rights		Except as otherwise provided in our Articles of Amendment and Restatement to the Articles of Incorporation or as otherwise required by law, (1) each holder of Preferred Stock (including the Series 2016 Term Preferred Shares) will be entitled to one vote for each share of Preferred Stock held by such holder on each matter submitted to a vote of our stockholders and (2) the holders of all outstanding Preferred Stock and Common Stock will vote together as a single class; provided that holders of Preferred Stock, voting separately as a class, will elect at least two of our directors and will be entitled to elect a majority of our directors if we fail to pay dividends on any outstanding shares of Preferred Stock in an amount equal to two full years of dividends and continuing during that period until we correct that failure. Preferred Stock holders will also vote separately as a class on any matter that materially and adversely affects any preference, right or power of holders of Preferred Stock. See “Description of the Series 2016 Term Preferred Stock — Voting Rights.”

Conversion Rights		The Series 2016 Term Preferred Shares will have no conversion rights.
Use of Proceeds		We intend to use the net proceeds from this offering (after the payment of underwriting discounts and commissions of $1.4 million and estimated expenses of the offering of approximately $0.5 million) to repay a portion of outstanding borrowings on our Credit Facility. See “Use of Proceeds.”
U.S. Federal Income Taxes		Prospective investors are urged to consult their own tax advisors regarding these matters in light of their personal investment circumstances.
		We have elected to be treated, and intend to continue to so qualify each year, as a RIC under Subchapter M of the Code, and we generally do not expect to be subject to U.S. federal income tax.
Risk Factors		Investing in the Series 2016 Term Preferred Shares involves risks. You should carefully consider the information set forth in the sections of this prospectus supplement and the accompanying prospectus entitled “Risk Factors” before deciding whether to invest in our Series 2016 Term Preferred Stock. See “Risk Factors beginning on page S-8 of this prospectus supplement and page 8 of the accompanying prospectus.
Information Rights		During any period in which we are not subject to the reporting requirements of Section 13 or 15(d) of the Exchange Act and any Series 2016 Term Preferred Shares are outstanding, we will provide holders of Series 2016 Term Preferred Shares, without cost, copies of the annual reports on Form 10-K and quarterly reports on Form 10-Q that we would have been required to file with the SEC pursuant to Section 13 or 15(d) of the Exchange Act if we were subject to such provisions.
Redemption and Paying Agent		We have entered into an amendment to our Transfer Agency and Service Agreement with BNY Mellon Shareholder Services, LLC, which we refer to as the Redemption and Paying Agent in this prospectus supplement. Under this amendment, the Redemption and Paying Agent will serve as transfer agent and registrar, dividend disbursing agent and redemption and paying agent with respect to the Series 2016 Term Preferred Shares.

 

You should carefully consider the risks described below, and the risks described in “Risk Factors” beginning on page 8 of the accompanying prospectus, before deciding to invest in the Series 2016 Term Preferred Shares. The risks and uncertainties described below and in the accompanying prospectus are not the only ones we face. Additional risks and uncertainties not presently known to us, or not presently deemed material by us, may also impair our operations and performance and the value of the Series 2016 Term Preferred Shares. If any of the following risks or the risks described in the accompanying prospectus actually occur, our business, financial condition or results of operations could be materially adversely affected, and the value of the Series 2016 Term Preferred Shares may be impaired. If that happens, the trading price of the Series 2016 Term Preferred Shares could decline, and you may lose all or part of your investment.

 

Risks of Investing in Term Preferred Stock

 

An investment in term preferred stock with a fixed interest rate bears interest rate risk.  Term preferred stock pays dividends at a fixed dividend rate. Prices of fixed income investments vary inversely with changes in market yields. The market yields on securities comparable to the Series 2016 Term Preferred Shares may increase, which would likely result in a decline in the secondary market price of the Series 2016 Term Preferred Shares prior to the term redemption date. For additional information concerning dividends on the Series 2016 Term Preferred Shares, see “Description of the Series 2016 Term Preferred Stock — Dividends and Dividend Periods.”

 

There will be no initial secondary trading market due to delayed listing, and even after listing a liquid secondary trading market may not develop.  Because we have no prior trading history for exchange-listed Preferred Stock, we cannot predict the trading patterns of the Series 2016 Term Preferred Shares, including the effective costs of trading the stock. During a period of up to 30 days from the date of this prospectus supplement, the Series 2016 Term Preferred Shares will not be listed on any securities exchange. During this period, the underwriters do not intend to make a market in the Series 2016 Term Preferred Shares. Consequently, an investment in the Series 2016 Term Preferred Shares during this period will be illiquid, and holders of such shares may not be able to sell them during that period as it is unlikely that a secondary market for the Series 2016 Term Preferred Shares will develop. If a secondary market does develop during this period, holders of the Series 2016 Term Preferred Shares may be able to sell such shares only at substantial discounts from the Liquidation Preference. The Series 2016 Term Preferred Shares have been approved for listing on the NYSE. If we are unable to list the Series 2016 Term Preferred Shares on the NYSE or another national securities exchange, holders of such shares may be unable to sell them at all or, if they are able to, only at substantial discounts from the Liquidation Preference. Even if the Series 2016 Term Preferred Shares are listed on the NYSE as anticipated, there is a risk that such shares may be thinly traded, and the market for such shares may be relatively illiquid compared to the market for other types of securities, with the spread between the bid and asked prices considerably greater than the spreads of other securities with comparable terms and features.

 

The Series 2016 Term Preferred Shares will not be rated.  We do not intend to have the Series 2016 Term Preferred Shares rated by any rating agency. Unrated securities usually trade at a discount to similar, rated securities. As a result, there is a risk that the Series 2016 Term Preferred Shares may trade at a price that is lower than they might otherwise trade if rated by a rating agency.

 

The Series 2016 Term Preferred Shares will bear a risk of early redemption by us.  We may voluntarily redeem some or all of the Series 2016 Term Preferred Shares on or after December 31, 2012, and we may be forced to redeem some or all of the Series 2016 Term Preferred Shares to meet regulatory requirements and the Asset Coverage requirements of such shares. Any such redemptions may occur at a time that is unfavorable to holders of the Series 2016 Term Preferred Shares. We may have an incentive to redeem the Series 2016 Term Preferred Shares voluntarily before the Term Redemption Date if market conditions allow us to issue other Preferred Stock or debt securities at a rate that is lower than the Fixed Dividend Rate on the Series 2016 Term Preferred Shares. For further information regarding our ability to redeem the Term Preferred Stock, see “Description of the Series 2016 Term Preferred Stock — Redemption” and “— Asset Coverage.”

Claims of holders of the Series 2016 Term Preferred Shares will be subject to a risk of subordination relative to holders of our debt instruments.  Rights of holders of the Series 2016 Term Preferred Shares will be subordinated to the rights of holders of our indebtedness. Therefore, dividends, distributions and other payments to holders of Term Preferred Shares in liquidation or otherwise may be subject to prior payments due to the holders of our indebtedness. In addition, under some circumstances the 1940 Act may provide debt holders with voting rights that are superior to the voting rights of holders of the Series 2016 Term Preferred Shares.

 

We are subject to risks related to the general credit crisis and related liquidity risks.  General market uncertainty and extraordinary conditions in the credit markets may impact the liquidity of our investment portfolio. In turn, during extraordinary circumstances, this uncertainty could impact our distributions and/or ability to redeem the Series 2016 Term Preferred Shares in accordance with their terms. Further, there may be market imbalances of sellers and buyers of Series 2016 Term Preferred Shares during periods of extreme illiquidity and volatility in the credit markets. Such market conditions may lead to periods of thin trading in any secondary market for the Series 2016 Term Preferred Shares and may make valuation of the Series 2016 Term Preferred Shares uncertain. As a result, the spread between bid and ask prices is likely to increase significantly such that an investor in the Series 2016 Term Preferred Shares may have difficulty selling his or her shares. Less liquid and more volatile trading environments could also result in sudden and significant valuation declines in the Series 2016 Term Preferred Shares.

 

Holders of the Series 2016 Term Preferred Shares will be subject to inflation risk.  Inflation is the reduction in the purchasing power of money resulting from the increase in the price of goods and services. Inflation risk is the risk that the inflation-adjusted, or “real,” value of an investment in Term Preferred Stock or the income from that investment will be worth less in the future. As inflation occurs, the real value of the Series 2016 Term Preferred Shares and dividends payable on such shares declines.

 

Holders of the Series 2016 Term Preferred Shares will bear reinvestment risk.  Given the five-year term and potential for early redemption of the Series 2016 Term Preferred Shares, holders of such shares may face an increased reinvestment risk, which is the risk that the return on an investment purchased with proceeds from the sale or redemption of the Series 2016 Term Preferred Shares may be lower than the return previously obtained from the investment in such shares.

 

Holders of Series 2016 Term Preferred Shares will bear dividend risk.  We may be unable to pay dividends on the Series 2016 Term Preferred Shares under some circumstances. The terms of our indebtedness preclude the payment of dividends in respect of equity securities, including the Series 2016 Term Preferred Shares, under certain conditions.

 

We face Asset Coverage risks in our investment activities.  The Asset Coverage that we maintain on the Term Preferred Stock will be based upon a calculation of the value of our portfolio holdings. A large percentage of our portfolio investments are, and we expect will continue to be, in the form of securities that are not publicly traded. The fair value of securities and other investments that are not publicly traded is generally not readily determinable. Our Board of Directors has established an investment valuation policy and consistently applied valuation procedures to determine the fair value of these securities on a quarterly basis. The procedures for the determination of value of many of our debt securities rely on opinions of value submitted to us by Standard & Poor’s Securities Evaluations, Inc., or SPSE, the use of internally developed discounted cash flow, or DCF, methodologies, or internal methodologies based on the total enterprise value, or TEV, of the issuer, which we use for certain of our equity investments. SPSE will only evaluate the debt portion of investments for which we specifically request an evaluation, and SPSE may decline to provide requested evaluations for any reason in its sole discretion.

 

A portion of our assets are, and will continue to be, comprised of equity securities that are valued based on internal assessment using valuation methods approved by our Board of Directors, without the input of SPSE or any other third-party evaluator. While we believe that our equity valuation methods reflect those regularly used as standards by other professionals in our industry who value equity securities, the determination of fair value for securities that are not publicly traded necessarily involves an exercise of subjective judgment, whether or not we obtain the recommendations of an independent third-party evaluator.

Our use of these fair value methods is inherently subjective and is based on estimates and assumptions regarding each security. In the event that we are required to sell a security, we may ultimately sell for an amount materially less than the estimated fair value calculated by us or SPSE, or determined using TEV or the DCF methodology. As a result, a risk exists that the Asset Coverage attributable to the Preferred Stock, including the Series 2016 Term Preferred Shares, may be materially lower than what is calculated based upon the fair valuation of our portfolio securities in accordance with our valuation policies. See “Risk Factors — Risks Related to Our Investments — Because a large percentage of the loans we make and equity securities we receive when we make loans are not publicly traded, there is uncertainty regarding the value of our privately held securities that could adversely affect our determination of our net asset value” on page 15 of the accompanying prospectus.

 

There is a risk of delay in our redemption of the Series 2016 Term Preferred Shares, and we may fail to redeem such securities as required by their terms.  We will generally make investments in private companies whose securities are not traded in any public market. Substantially all of the investments we presently hold and the investments we expect to acquire in the future are, and will be, subject to legal and other restrictions on resale and will otherwise be less liquid than publicly traded securities. The illiquidity of our investments may make it difficult for us to obtain cash equal to the value at which we record our investments quickly if a need arises. If we are unable to obtain sufficient liquidity prior to the Term Redemption Date, we may be forced to engage in a partial redemption or to delay a required redemption. If such a partial redemption or delay were to occur, the market price of the Series 2016 Term Preferred Shares might be adversely affected.

 

We finance our investments with borrowed money and senior securities, which will magnify the potential for gain or loss on amounts invested and may increase the risk of investing in us.  The following table illustrates the effect of leverage on returns from an investment in our common stock assuming various annual returns on our portfolio, net of expenses. The calculations in the table below are hypothetical and actual returns may be higher or lower than those appearing in the table below.

 

 

 

 

Based on our outstanding indebtedness of $92.2 million as of June 30, 2011 and the effective annual interest rate of 5.5% as of that date, our investment portfolio at fair value would have been required to experience an annual return of at least 2.7% to cover annual interest payments on the outstanding debt.

 

Other Risks

 

In addition to regulatory limitations on our ability to raise capital, our Credit Facility contains various covenants which, if not complied with, could accelerate our repayment obligations under the facility, thereby materially and adversely affecting our liquidity, financial condition, results of operations and ability to pay distributions.

 

We will have a continuing need for capital to finance our loans. We are party to the Credit Facility, which provides us with a revolving credit line facility of $137.0 million, of which $92.2 million was drawn as of June 30, 2011. The Credit Facility permits us to fund additional loans and investments as long as we are within the conditions set forth in the credit agreement. As a result of the Credit Facility, we are subject to certain limitations on the type of loan investments we make, including restrictions on geographic concentrations, sector concentrations, loan size, dividend payout, payment frequency and status, and average life. The credit agreement also requires us to comply with other financial and operational covenants, which require us

to, among other things, maintain certain financial ratios, including asset and interest coverage and a minimum net worth. As of September 30, 2010, we were in compliance with these covenants; however, our continued compliance with these covenants depends on many factors, some of which are beyond our control. Current market conditions have forced us to write down the value of a portion of our assets as required by the 1940 Act and fair value accounting rules. These are not realized losses, but constitute adjustment in asset values for purposes of financial reporting and for collateral value for the Credit Facility. As assets are marked down in value, the amount we can borrow on the Credit Facility decreases.

 

In particular, depreciation in the valuation of our assets, which valuation is subject to changing market conditions that remain very volatile, affects our ability to comply with these covenants. As of June 30, 2011, our net assets were $217.5 million and we currently estimate that our net assets had declined to approximately $212.8 million as of September 30, 2011, down from $249.2 million as of September 30, 2010, primarily as a result of unrealized depreciation over the nine months. The minimum net worth covenant contained in the credit agreement requires our net assets to be at least $200.0 million. Given the continued deterioration in the capital markets, the cumulative unrealized depreciation in our portfolio may increase in future periods and threaten our ability to comply with the minimum net worth covenant and other covenants under the Credit Facility. Accordingly, there are no assurances that we will continue to comply with these covenants. Under the Credit Facility, we are also required to maintain our status as a BDC under the 1940 Act and as a RIC under the Code. Our failure to satisfy these covenants could result in foreclosure by our lenders, which would accelerate our repayment obligations under the facility and thereby have a material adverse effect on our business, liquidity, financial condition, results of operations and ability to pay distributions to our stockholders.

 

All statements contained in this prospectus supplement or the accompanying prospectus, other than historical facts, may constitute “forward-looking statements.” These statements may relate to future events or our future performance or financial condition. In some cases, you can identify forward-looking statements by terminology such as “may,” “might,” “believe,” “will,” “provided,” “anticipate,” “future,” “could,” “growth,” “plan,” “intend,” “expect,” “should,” “would,” “if,” “seek,” “possible,” “potential,” “likely” or the negative of such terms or comparable terminology. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. Such factors include:

 

 

We caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, after the date of this prospectus supplement or the accompanying prospectus.

 

We estimate that the net proceeds to us of this offering will be approximately $33.1 million, after deducting the payment of underwriting discounts and commissions of $1.4 million and estimated offering expenses of $0.5 million payable by us. We intend to use the net proceeds from this offering to repay a portion of our outstanding borrowings under the Credit Facility. Our Credit Facility matures on March 15, 2012 and, as of June 30, 2011, was accruing interest at an annual rate equal to the London Interbank Offered Rate, or LIBOR (subject to a minimum rate 1.5%), plus a premium of 3.75%. As of June 30, 2011, $92.2 million was drawn on the Credit Facility.

 

We have granted the underwriters the right to purchase up to 210,000 additional Series 2016 Term Preferred Shares at the public offering price, less underwriting discounts and commissions, within 30 days of the date of this prospectus supplement solely to cover over-allotments, if any. If the underwriters exercise such option in full, the estimated net proceeds to us will be $38.1 million. We anticipate that substantially all of the net proceeds of this offering will be utilized in the manner described above within three months of the completion of such offering. Pending such utilization, we intend to invest the net proceeds of the offering primarily in cash, cash equivalents, U.S. government securities and other high-quality debt investments that mature in one year or less from the date of investment, consistent with the requirements for continued qualification as a RIC for federal income tax purposes.

 

 

Computation of Pro Forma Ratio of Earnings to
Combined Fixed Charges and Preferred Dividends for
      the Nine Months ended June 30, 2011
    After Adjustment for issuance of Preferred Stock

 

 

The following table sets forth our capitalization as of June 30, 2011:

 

 

 

 

 

The following are our outstanding classes of securities as of June 30, 2011:

 

 

We have derived the selected financial information presented in the first table below as of September 30, 2010 and 2009 and for the fiscal years ended September 30, 2010, 2009 and 2008 from our audited consolidated financial statements included in the base prospectus. We have derived the selected financial information presented in the first table below as of and for the nine months ended June 30, 2011 and 2010 from our unaudited consolidated financial statements included in this prospectus supplement. The selected financial information presented in the first table below as of September 30, 2008, 2007 and 2006 and for the fiscal years ended September 30, 2007 and 2006 is derived from our audited consolidated financial statements that are not included in this prospectus supplement or the accompanying prospectus. The information included in the second table below is unaudited.

 

You should read this data together with our consolidated financial statements and notes to such financial statements presented elsewhere in this prospectus supplement and the accompanying prospectus, as well as the information under “Prospectus Supplement Summary — Recent Operating Results” and “Interim Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this prospectus supplement and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the accompanying prospectus for more information.

 

 

 

 

 

 

(Dollar amounts in thousands, except per share data or unless otherwise indicated)

 

You should read the following analysis of our financial condition and results of operations in conjunction with our condensed consolidated financial statements and the related notes contained elsewhere in this prospectus supplement and in the accompanying prospectus.

 

OVERVIEW

 

Investment Highlights

 

Purchases:  During the nine months ended June 30, 2011, we extended $101.1 million of investments to twenty-five new portfolio companies and $17.6 million of investments to existing portfolio companies through revolver draws or the additions of new term notes or equity investments, for total investments of $118.7 million.

 

Repayments:  During the nine months ended June 30, 2011, six borrowers made unscheduled payoffs in the aggregate amount of $26.8 million, and we experienced contractual amortization, revolver repayments and received principal payments ahead of schedule in the aggregate amount of $13.0 million, for total principal repayments of $39.8 million.

 

Sales:  During the nine months ended June 30, 2011, we sold one Non-Control/Non-Affiliate investment and partially sold one of our Control investments for aggregate net proceeds of $0.8 million.

 

RESULTS OF OPERATIONS

 

Comparison of the Nine Months Ended June 30, 2011 to the Nine Months Ended June 30, 2010

 

 

 

NM = Not Meaningful

Investment Income

 

Interest income from our investments in debt securities decreased for the nine months ended June 30, 2011, as compared to the nine months ended June 30, 2010, for several reasons. The level of interest income from investments is directly related to the balance, at cost, of the interest-bearing investment portfolio outstanding during the period multiplied by the weighted average yield. The weighted average cost basis of our interest-bearing investment portfolio during the nine months ended June 30, 2011 was approximately $277.9 million, compared to approximately $304.2 million for the prior year period, primarily due to increased principal repayments subsequent to June 30, 2010. This decrease in interest income was partially offset by an increase to the annualized weighted average yield on our interest-bearing investment portfolio for the nine months ended June 30, 2011, which was 11.2%, compared to 10.9% for the prior year period. The weighted average yield varies from period to period based on the current stated interest rate on interest-bearing investments. The increase in the weighted average yield on our portfolio for the nine months ended June 30, 2011 resulted primarily from the repayment of loans with lower stated interest rates and the restructuring of certain loans into higher interest rate loans, partially offset by the purchase of syndicated loans, which generally bear lower interest rates than our existing proprietary debt investments. During the nine months ended June 30, 2011, six investments were on non-accrual, for an aggregate of approximately $30.7 million at cost, or 8.2% of the aggregate cost of our investment portfolio, and during the prior year period, six investments were on non-accrual, for an aggregate of approximately $29.4 million at cost, or 9.5% of the aggregate cost of our investment portfolio.

 

Other income decreased for the nine months ended June 30, 2011, as compared to the prior year period, primarily due to success fees earned in the aggregate of $1.7 million from exits in Doe & Ingalls Management LLC, Tulsa Welding School, ActivStyle Acquisition Co., Saunders & Associates, Visual Edge Technology, Inc. and a prepayment by Northern Contours, Inc. of their success fee, and prepayment fees in the aggregate of $0.5 million from ActiveStyle Acquisition Co., ACE Expediters, Inc. and VantaCore during the nine months ended June 30, 2010, partially offset by the receipts in the aggregate of $1.0 million in settlements related, in part, to US Healthcare Communications, Inc. and Badanco Acquisition Corp., and success fees in the aggregate of $0.6 million from our exits in Pinnacle Treatment Centers, Inc. and Interfilm Holdings, Inc. during the nine months ended June 30, 2011.

 

The following tables list the interest income from investments for our five largest portfolio company investments during the respective periods:

 

 

 

Operating Expenses

 

Operating expenses, net of credits from our Adviser for fees earned and voluntary and irrevocable waivers applied to the base management and incentive fees, decreased for the nine months ended June 30, 2011, as compared to the prior year period. This reduction was primarily due to a decrease in interest expense subsequent to June 30, 2010, and the amortization of deferred financing fees incurred in connection with the Credit Facility during the nine months ended June 30, 2010, coupled with a decrease in the base management fee and professional fees, which were partially offset by an increase in the incentive fee during the nine months ended June 30, 2011.

 

Interest expense decreased for the nine months ended June 30, 2011, as compared to the prior year period, primarily due to decreased borrowings under the Credit Facility in the first six months of the current fiscal year and the reversal of $0.6 million of a minimum earnings shortfall fee during the nine months ended June 30, 2011. The weighted average balance outstanding on the Credit Facility during the nine months ended June 30, 2011, was approximately $32.6 million, as compared to $56.9 million in the prior year period, a decrease of 42.7%. On November 22, 2010, we amended the Credit Facility to provide that advances bear interest at LIBOR subject to a minimum annual rate of 1.5%, plus 3.75%. Under our prior credit facility and our pre-amended Credit Facility, advances generally bore interest at LIBOR subject to a minimum annual rate of 2.0%, plus 4.5%. In addition to the lower interest rate, the Amendment removed the annual minimum earnings shortfall fee to the committed lenders.

 

Amortization of deferred financing fees decreased for the nine months ended June 30, 2011, as compared to the prior year period, due to significant one-time costs related to the termination of our prior credit facility and transition to the Credit Facility, resulting in increased amortization of deferred financing fees during the nine months ended June 30, 2010, when compared to the nine months ended June 30, 2011.

 

Professional fees decreased for the nine months ended June 30, 2011, as compared to the prior year period, primarily due to legal fees incurred in connection with troubled loans during the nine months ended June 30, 2010.

 

The base management fee decreased for the nine months ended June 30, 2011, as compared to the prior year period, which is reflective of holding less total assets subject to the base management fee, compared to the prior year period. The incentive fee earned by our Adviser increased for the nine months ended June 30, 2011, as compared to the prior year period, primarily due to decreased interest expense, partially offset by a decrease in interest income earned. The incentive fee earned during the prior year period was due in part to

other income generated from multiple exits. The base management and incentive fees are computed quarterly and are summarized in the following table:

 

 

 

 

Net Realized Gain (Loss) on Investments

 

There were $3 in net realized gains for the nine months ended June 30, 2011, primarily due to realized gains from unamortized discounts on exits during the period, partially offset by realized losses in connection with workout expenditures related to the Sunshine Media Holdings restructure. Net realized losses on investments for the nine months ended June 30, 2010 was $2.9 million, which consisted of $4.3 million of losses from the Kinetek Acquisition Corp and Wesco Holdings, Inc. syndicated loan sales, Western Directories, Inc. write-off and CCS, LLC payoff, offset in part by a $1.4 million gain from ACE Expediters, Inc. payoff.

 

Net Unrealized (Depreciation) Appreciation on Investments

 

Net unrealized (depreciation) appreciation on investments is the net change in the fair value of our investment portfolio during the reporting period, including the reversal of previously-recorded unrealized appreciation or depreciation when gains and losses are actually realized. During the nine months ended June 30, 2011, we recorded net unrealized depreciation on investments in the aggregate amount of $34.8 million. During the prior year period, we recorded net unrealized appreciation on investments in the aggregate amount of $3.5 million, which included the reversal of $6.3 million in unrealized appreciation related to the payoff of Wesco Holdings, Inc., Kinetek Acquisition Corp and Western Directories, Inc. Excluding reversals, we had $2.8 million in net unrealized depreciation for the nine months ended June 30, 2010. The net

unrealized appreciation (depreciation) across our investments for the nine months ended June 30, 2011 was as follows:

 

 

The largest driver of our net unrealized depreciation for the nine months ended June 30, 2011 was the depreciation in each of Sunshine Media Holdings and Newhall Holdings Inc., primarily due to portfolio company performance and certain comparable multiples, partially offset by appreciation in Defiance Integrated Technologies, Inc., which was as a result of an improvement in portfolio company performance and in certain comparable multiples.

The unrealized appreciation (depreciation) across our investments for the nine months ended June 30, 2010 was as follows:

 

 

 

 

Excluding reversals, a general increase in our net unrealized depreciation for the nine months ended June 30, 2010 was experienced by our control investments, partially offset by increased unrealized appreciation in our Non-Control/Non-Affiliate portfolio of debt holdings, based on increases in market comparables and improved portfolio company performance.

 

Over our entire investment portfolio, we recorded an aggregate net unrealized depreciation of approximately $36.4 million on our debt positions for the nine months ended June 30, 2011, while our equity holdings experienced an aggregate net unrealized appreciation of approximately $1.6 million. At June 30, 2011, the fair value of our investment portfolio was less than its cost basis by approximately $75.9 million, or 79.8% of cost, as compared to $41.1 million, or 86.2%, of cost at September 30, 2010, representing net unrealized depreciation of $34.8 million for the period. We believe that our aggregate investment portfolio was valued at a depreciated value primarily due to reduced performance by certain portfolio companies and the general

instability of the loan markets and resulting decrease in market multiples relative to where multiples were when we originated such investments in our portfolio. The unrealized depreciation of our investments does not have an impact on our current ability to pay distributions to stockholders; however, it may be an indication of future realized losses, which could ultimately reduce our income available for distribution to stockholders.

 

Net Unrealized Appreciation on Borrowings

 

Net unrealized appreciation on borrowings represents the net change in the fair value of our line of credit borrowings during the reporting period, including the reversal of previously recorded unrealized appreciation or depreciation when gains and losses are realized. We elected to apply ASC 825, “Financial Instruments,” which requires us to apply a fair value methodology to the Credit Facility. We estimated the fair value of the Credit Facility using a combination of estimates of value provided by an independent third party and our own assumptions in the absence of observable market data, including estimated remaining life, credit party risk, current market yield and interest rate spreads of similar securities as of the measurement date. The Credit Facility was fair valued at $92.7 million as of June 30, 2011.

 

Net (Decrease) Increase in Net Assets Resulting from Operations

 

For the nine months ended June 30, 2011, we realized a net decrease in net assets resulting from operations of $20.6 million as a result of the factors discussed above. For the nine months ended June 30, 2010, we realized a net increase in net assets resulting from operations of $12.6 million. Our net (decrease) increase in net assets resulting from operations per basic and diluted weighted average common share for the nine months ended June 30, 2011 and June 30, 2010 were $(0.98) and $0.60, respectively.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Operating Activities

 

Net cash used in operating activities for the nine months ended June 30, 2011 was $63.4 million and consisted primarily of disbursements of $118.6 million in investments, partially offset by principal repayments of $39.9 million and net unrealized depreciation of $34.8 million. Net cash provided by operating activities for the nine months ended June 30, 2010 was $70.0 million and consisted primarily of principal repayments of $56.9 million.

 

At June 30, 2011, we had investments in equity of, loans to, or syndicated participations in, 57 private companies with an aggregate cost basis of approximately $375.2 million. At September 30, 2010, we had investments in equity of, loans to, or syndicated participations in, 39 private companies with an aggregate cost basis of approximately $298.2 million. The following table summarizes our total portfolio investment activity during the nine months ended June 30, 2011 and 2010:

 

The following table summarizes the contractual principal repayments and maturity of our investment portfolio by fiscal year, assuming no voluntary prepayments, at June 30, 2011.

 

 

Financing Activities

 

Net cash provided by financing activities for the nine months ended June 30, 2011 was $63.5 million and consisted primarily of net borrowings from the Credit Facility of $75.4 million, partially offset by distributions to stockholders of $13.3 million. Net cash used in financing activities for the nine months ended June 30, 2010 was $68.8 million and mainly consisted of net payments on the Credit Facility of $54.1 million, distributions to stockholders of $13.3 million and $1.4 million in financing fees related to the Credit Facility.

 

Distributions

 

To qualify as a RIC and, therefore, avoid corporate level tax on the income we distribute to our stockholders, we are required under Subchapter M of the Code to distribute at least 90% of our ordinary income and short-term capital gains to our stockholders on an annual basis. In accordance with these requirements, we declared and paid monthly cash distributions of $0.07 per common share for each of April, May and June 2011. In July 2011, our Board of Directors declared a monthly distribution of $0.07 per common share for each of July, August and September 2011. We declared these distributions based on our estimates of net taxable income for the fiscal year.

 

For the quarter ended June 30, 2011, please refer to “— Section 19(a) Notice” below for estimated tax characterization. For the fiscal year ended September 30, 2010, which includes the three months ended June 30, 2010, our distribution payments were approximately $17.7 million. We declared these distributions based on our estimates of net taxable income for the fiscal year. Our investment pace was slower than expected and, consequently, our net taxable income was lower than our original estimates. Of the distributions declared during fiscal 2010, 4.4% were treated as a return of capital to our stockholders, with the remaining portion being treated as ordinary income.

 

Section 19(a) Notice

 

Our Board of Directors estimates the source of the distributions at the time of their declaration, as required by Section 19(a) of the 1940 Act. On a monthly basis, if required under Section 19(a), we post a Section 19(a) notice through the Depository Trust Company’s Legal Notice System and also send to our registered stockholders a written Section 19(a) notice along with the payment of distributions for any payment which includes a distribution estimated to be paid from any source other than accumulative net investment income during the fiscal year. The estimates of the source of the distribution are interim estimates based on accounting principles generally accepted in the United States, or GAAP, that are subject to revision, and the exact character of the distributions for tax purposes cannot be determined until our books and records are finalized for the calendar year. Following the calendar year end, after we have determined definitive

information, if we have made distributions of taxable income (or return of capital), we will deliver a Form 1099-DIV to our stockholders specifying such amount and the tax characterization of such amount. Therefore, these estimates are made solely to comply with the requirements of Section 19(a) of the 1940 Act and should not be relied upon for tax reporting or any other purposes and could differ significantly from the actual character of distributions for tax purposes.

 

Equity

 

On October 20, 2009, we filed a registration statement on Form N-2 (File No. 333-162592), that was declared effective by the SEC on January 28, 2010, and we filed a fourth post-effective amendment to such registration statement on July 13, 2011, which was declared effective by the SEC on July 15, 2011. The registration statement permits us to issue, through one or more transactions, up to an aggregate of $300 million in securities, consisting of common stock, preferred stock, subscription rights, debt securities and warrants to purchase common stock, including through a combined offering of such securities.

 

We anticipate issuing equity securities to obtain additional capital in the future. However, we cannot determine the terms of any future equity issuances or whether we will be able to issue equity on terms favorable to us, or at all. Additionally, when our common stock is trading below NAV per share, as it has consistently traded for the last two years, we face regulatory constraints under the 1940 Act on our ability to obtain additional capital in this manner. Generally, the 1940 Act provides that we may not issue and sell our common stock at a price below our NAV per share, other than to our then existing stockholders pursuant to a rights offering, without first obtaining approval from our stockholders and our independent directors. As of June 30, 2011, our NAV per share was $10.34 and as of August 2, 2011, our closing market price was $8.86 per share. To the extent that our common stock trades at a market price below our NAV per share, we will generally be precluded from raising equity capital through public offerings of our common stock, other than pursuant to stockholder approval or a rights offering. The Asset Coverage requirement of a business development company under the 1940 Act effectively limits our ratio of debt to equity to 1:1. To the extent that we are unable to raise capital through the issuance of equity, our ability to raise capital through the issuance of debt may also be inhibited to the extent of our regulatory debt to equity ratio limits.

 

At our annual meeting of stockholders held on February 17, 2011, our stockholders approved a proposal which authorizes us to sell shares of our common stock at a price below our then current NAV per share subject to certain limitations (including that the cumulative number of shares issued and sold pursuant to such authority does not exceed 25% of our then outstanding common stock immediately prior to each such sale) for a period of one year from the date of approval, provided that our Board of Directors makes certain determinations prior to any such sale. We have not issued any common stock since February 2008.

 

On May 17, 2010, we and our Adviser entered into an Equity Distribution Agreement with BB&T Capital Markets, a division of Scott & Stringfellow, LLC, or the Agent, under which we may, from time to time, issue and sell through the Agent up to 2.0 million shares, which we refer to as the Shares, of our common stock based upon instructions from us (including, at a minimum, the number of Shares to be offered, the time period during which sales are requested to be made, any limitation on the number of Shares that may be sold in any one day and any minimum price below which sales may not be made). Sales of Shares through the Agent, if any, will be executed by means of either ordinary brokers’ transactions on NASDAQ in accordance with Rule 153 under the Securities Act or such other sales of the Shares as shall be agreed by us and the Agent. The compensation payable to the Agent for sales of Shares with respect to which the Agent acts as sales agent will equal 2.0% of the gross sales price of the Shares for amounts of Shares sold pursuant to the Agreement. To date, we have not issued any shares pursuant to this Agreement.

 

Revolving Credit Facility

 

On March 15, 2010, we entered into the Credit Facility. BB&T and ING also joined the Credit Facility as committed lenders. Subject to certain terms and conditions, the Credit Facility may be expanded up to $202.0 million through the addition of other committed lenders to the facility. On the Amendment Date, we amended the Credit Facility. Prior to the Amendment Date, advances under the Credit Facility bore interest at

LIBOR, subject to a minimum annual rate of 2.0%, plus 4.5%, with an annual commitment fee of 0.5% on undrawn amounts. Effective as of the Amendment Date, advances under the Credit Facility bear interest at LIBOR, subject to a minimum annual rate of 1.5%, plus 3.75%, with an annual commitment fee of 0.5% on undrawn amounts when the facility is drawn more than 50% and 1.0% annually on undrawn amounts when the facility is drawn less than 50%. In addition, effective as of the Amendment Date, we are no longer obligated to pay an annual minimum earnings shortfall fee to the committed lenders, which was calculated as the difference between the weighted average of borrowings outstanding under the Credit Facility and 50.0% of the commitment amount of the Credit Facility, multiplied by 4.5% annually, less commitment fees paid during the year. As of the Amendment Date, we paid a $0.7 million fee.

 

As of June 30, 2011, there was a cost basis of approximately $92.2 million of borrowings outstanding under the Credit Facility at an average interest rate of 5.25%. As of August 2, 2011, there was a cost basis of approximately $102.5 million of borrowings outstanding. We expect that the Credit Facility will allow us to increase the rate of our investment activity and grow the size of our investment portfolio. Available borrowings are subject to various constraints imposed under the Credit Facility, based on the aggregate loan balance pledged by us. Interest is payable monthly during the term of the Credit Facility. The Credit Facility matures on March 15, 2012, and, if not renewed or extended by this date, all unpaid principal and interest will be due and payable on March 15, 2013. In addition, if the Credit Facility is not renewed on or before March 15, 2012, we will be required to use all principal collections from the pledged loans to pay outstanding principal on the Credit Facility.

 

The Credit Facility contains covenants that require Business Loan to maintain its status as a separate entity, prohibit certain significant corporate transactions (such as mergers, consolidations, liquidations or dissolutions), and restrict material changes to our credit and collection policies. The facility requires a minimum of 20 obligors in the borrowing base and also limits payments of distributions. As of June 30, 2011, Business Loan had 41 obligors and we complied with all of the Credit Facility covenants.

 

Contractual Obligations and Off-Balance Sheet Arrangements

 

We were not a party to any signed term sheets for potential investments as of June 30, 2011. However, we have certain lines of credit and capital commitments with our portfolio companies that have not been fully drawn or called, respectively. Since these commitments have expiration dates, and we expect many will never be fully drawn or called, the total commitment amounts do not necessarily represent future cash requirements. We estimate the fair value of these unused and uncalled commitments as of June 30, 2011 and September 30, 2010 to be nominal.

 

In accordance with GAAP, the unused and uncalled portions of these commitments are not recorded on the accompanying Condensed Consolidated Statements of Assets and Liabilities. The following table summarizes the nominal dollar balance of unused line of credit commitments, uncalled capital commitments and guarantees as of June 30, 2011 and September 30, 2010:

 

 

The following table shows our contractual obligations as of June 30, 2011:

 

 

 

The following table lists the risk ratings for all proprietary loans in our portfolio at June 30, 2011 and September 30, 2010, representing approximately 68.6% and 93.2%, respectively, of all loans in our portfolio at fair value at the end of each period:

 

 

For syndicated loans that are currently rated by an NRSRO, we risk rate such loans in accordance with the risk rating systems of major risk rating organizations, such as those provided by an NRSRO. The following table lists the risk ratings for all syndicated loans in our portfolio that were rated by an NRSRO at June 30, 2011 and September 30, 2010, representing approximately 24.8% and 4.3%, respectively, at fair value of all loans in our portfolio at the end of each period:

 

 

The following table lists the risk ratings for all syndicated loans that were not rated by an NRSRO. As of June 30, 2011 and September 30, 2010, these loans represented 6.6% and 2.5%, respectively, at fair value of all loans in our portfolio at the end of each period:

 

 

Investment Income Recognition

 

Interest income, adjusted for amortization of premiums and acquisition costs and for the accretion of discounts, is recorded on the accrual basis to the extent that such amounts are expected to be collected. Generally, when a loan becomes 90 days or more past due or if our qualitative assessment indicates that the debtor is unable to service its debt or other obligations, we will place the loan on non-accrual status and cease recognizing interest income on that loan until the borrower has demonstrated the ability and intent to pay contractual amounts due. However, we remain contractually entitled to this interest. Interest payments received on non-accrual loans may be recognized as income or applied to the cost basis depending upon management’s judgment. Non-accrual loans are restored to accrual status when past due principal and interest are paid and in management’s judgment, are likely to remain current, or due to a restructuring such that the interest income is deemed to be collectible. As of June 30, 2011, two Non-Control/Non-Affiliate investments and four Control investments were on non-accrual with an aggregate cost basis of approximately $30.7 million, or 8.2% of the cost basis of all loans in our portfolio. As of September 30, 2010, two Non-Control/Non-Affiliate investments

and four Control investments were on non-accrual with an aggregate cost basis of approximately $29.9 million, or 10.0% of the cost basis of all loans in our portfolio.

 

As of June 30, 2011, we had loans in our portfolio which contain a PIK provision. The PIK interest, computed at the contractual rate specified in each loan agreement, is added to the principal balance of the loan and recorded as income. To maintain our status as a RIC, this non-cash source of income must be paid out to stockholders in the form of distributions, even though we have not yet collected the cash. We recorded PIK income of $4 and $12 for the three and nine months ended June 30, 2011, respectively, as compared to $4 and $62 for the three and nine months ended June 30, 2010, respectively.

 

We also transfer past due interest to the principal balance as stipulated in certain loan amendments with portfolio companies. We transferred past due interest to the principal balance of $0 and $0.2 million for the three and nine months ended June 30, 2011, respectively, as compared to $0.8 million and $1.2 million for the three and nine months ended June 30, 2010, respectively.

 

As of June 30, 2011, we had 25 OID loans. We recorded OID income of $64 and $117 for the three and nine months ended June 30, 2011, respectively, as compared to $8 and $10 for the three and nine months ended June 30, 2010, respectively.

 

We record success fees upon receipt. Success fees are contractually due upon a change of control in a portfolio company and are recorded in Other income in the accompanying Condensed Consolidated Statements of Operations. We recorded $0.6 million of success fees during the nine months ended June 30, 2011, which resulted from the exits of Pinnacle Treatment Centers, Inc. and Interfilm Holdings, Inc. During the nine months ended June 30, 2010, we received $1.7 million in success fees from the exits of ActivStyle Acquisition Co., Saunders & Associates, Visual Edge Technology, Inc., Tulsa Welding School, and the prepayment of success fees from Doe & Ingalls Management LLC and Northern Contours, Inc.

 

The following table sets forth certain information as of June 30, 2011 regarding each portfolio company in which we held a debt or equity security as of such date. All such investments were made in accordance with our investment policies and procedures described in this prospectus supplement and in the accompanying prospectus.