MFIC

Business Context and Reporting Period

Company: Apollo Investment Corporation (AIC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2012
Business Overview: AIC is a closed-end, externally managed business development company (BDC) and regulated investment company (RIC). It invests primarily in senior secured loans, subordinated debt, and equity of private middle-market companies. As of September 30, 2012, the portfolio consisted of 69 companies, with 37% in senior secured loans, 52% in subordinated debt, and 11% in equity/warrants.

Key Financial Metrics

Material Changes vs. Prior Period

• Income Decline: Gross investment income decreased to $164.2 million for the six months ended September 30, 2012, compared to $188.6 million in the prior year period. This was primarily due to a smaller portfolio base and a slight decline in yields as the portfolio was repositioned up the capital structure.
• Expense Reduction: Total expenses dropped to $81.0 million (six months 2012) from $95.4 million (six months 2011). This reduction was driven by a smaller asset base, lower average debt outstanding, and voluntary fee waivers by the investment adviser.
• Realized Losses: Net realized losses were $59.4 million for the six months ended September 30, 2012, compared to $66.1 million in the prior year. Significant losses included $42.8 million from the exit of New Omaha Holdings Co-Invests L.P. and a $9.9 million foreign exchange loss from the sale of AB Acquisitions.
• Unrealized Gains: The company reported a net change in unrealized appreciation of $37.6 million for the six months ended September 30, 2012, a significant improvement from the $294.3 million unrealized depreciation reported in the same period in 2011. This was driven by improved portfolio company performance and market conditions.

Guidance, Outlook, and Risks

• Capital Resources: AIC maintains a $1.14 billion Senior Secured Facility with $675.3 million of unused capacity as of September 30, 2012. The facility matures in May 2016.
• Recent Financing: On October 9, 2012 (subsequent to the period end), AIC issued $150 million in 6.625% senior unsecured notes due 2042. Proceeds were used to repay indebtedness under the Senior Secured Facility.
• Dividends: The Board declared a dividend of $0.20 per share for the third fiscal quarter of 2013, payable January 4, 2013. For the six months ended September 30, 2012, total dividends paid were $81.2 million ($0.40 per share).
• Fee Waivers: The investment adviser waived base management and incentive fees associated with a $50 million equity issuance in April 2012 for a one-year period.
• Risks: Key risks include interest rate fluctuations (AIC has significant floating-rate assets and liabilities), credit risk of portfolio companies, and the requirement to distribute at least 90% of taxable income to maintain RIC status, which may require distributing non-cash income (PIK).

Investor Verification Checklist

• Debt Covenants: Verify continued compliance with the Senior Secured Facility covenants, specifically the asset coverage ratio (minimum 2.0:1.0) and minimum stockholders' equity requirements.
• PIK Income: Review the level of Payment-in-Kind (PIK) income ($8.8 million for the six months ended Sep 30, 2012) to assess the cash flow available for dividends versus accrued non-cash income.
• Portfolio Concentration: Assess exposure to specific industries (Business Services 8.4%, Education 8.1%, Diversified Service 8.0%) and the impact of any single portfolio company's distress.
• Valuation Methodology: Note that 100% of investments are categorized as Level 3 (unobservable inputs), relying on broker quotes and internal models, which introduces valuation subjectivity.
• Subsequent Debt Issuance: Confirm the impact of the $150 million note issuance in October 2012 on leverage ratios and interest expense in the next reporting period.