Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended June 30, 2019, for Portman Ridge Finance Corporation (formerly KCAP Financial, Inc., ticker: PTMN). The Company is an externally managed, non-diversified closed-end investment company regulated as a Business Development Company (BDC) and a Regulated Investment Company (RIC). A significant corporate event occurred on April 1, 2019, when the Company completed an "Externalization," transitioning from an internally managed structure to being managed by Sierra Crest Investment Management LLC (an affiliate of BC Partners). This transition involved the resignation of most prior directors and officers and the termination of internal equity incentive plans.
Key Financial Metrics
| Metric | Six Months Ended June 30, 2019 | Six Months Ended June 30, 2018 |
|---|---|---|
| Total Investment Income | $12.7 million | $13.7 million |
| Total Expenses | $14.0 million | $8.7 million |
| Net Investment (Loss) Income | $(1.3) million | $5.0 million |
| Net Realized and Unrealized (Loss) Gain | $(10.5) million | $(3.5) million |
| Net Decrease in Stockholders' Equity from Operations | $(11.8) million | $1.3 million |
| Net Asset Value (NAV) per Share | $3.73 | $4.72 |
| Total Assets | $305.5 million | $285.5 million |
| Total Liabilities | $166.3 million | $127.4 million |
| Debt Outstanding (Par Value) | ~$123 million | ~$100 million |
| Asset Coverage Ratio | 211% | 263% |
Material Changes vs. Prior Period
- Operating Loss: The Company reported a net investment loss of $1.3 million for the six months ended June 30, 2019, compared to net investment income of $5.0 million in the prior year period. This decline was driven by a significant increase in expenses.
- Expense Surge: Total expenses rose to $14.0 million from $8.7 million year-over-year. This increase is primarily attributed to one-time costs associated with the Externalization (approximately $3.4 million) and a non-cash impairment charge of $1.4 million related to the Company's legacy office lease right-of-use asset.
- Realized Losses: Net realized losses on investment transactions were $15.6 million, compared to negligible realized losses in the prior year. This includes a $3.5 million realized loss on the write-down of Asset Manager Affiliates investments following the sale of management subsidiaries.
- Portfolio Composition: The portfolio shifted as the Company sold substantially all of its Asset Manager Affiliates in late 2018. As of June 30, 2019, the fair value of these affiliates was $0. The portfolio is now concentrated in Debt Securities ($175.3 million), CLO Fund Securities ($40.0 million), and Joint Ventures ($40.1 million).
- Liquidity: Cash and restricted cash decreased to $3.7 million from $9.3 million at the beginning of the period, reflecting investment purchases and distributions.
Guidance, Outlook, and Risks
- Management Commentary: Management notes that the transition to external management was completed successfully. The new Adviser (Sierra Crest) has a fee structure including a base management fee (1.50% of gross assets) and an incentive fee (17.50% of income above a 7.00% hurdle). The Adviser has committed to waiving incentive fees for one year to ensure net investment income per share meets a $0.40 threshold.
- Subsequent Event (Merger): On August 1, 2019, the Company announced a definitive agreement to merge with OHA Investment Corporation (OHAI). The combined entity will be externally managed by the Adviser. OHAI stockholders are expected to receive a combination of cash and Portman Ridge shares valued at approximately 108% of OHAI's NAV.
- Risks and Contingencies:
- Valuation Risk: A significant portion of the portfolio (Level III assets) relies on unobservable inputs and management judgment, creating valuation uncertainty.
- Interest Rate Risk: Approximately 78% of the Debt Securities Portfolio is floating rate. While rising rates generally increase income, the Company has fixed-rate debt (6.125% Notes) which creates a spread risk.
- Liquidity and Distributions: The Company is subject to asset coverage requirements. While the Small Business Credit Availability Act lowered the general requirement to 150%, the indenture for the 6.125% Notes prohibits distributions if asset coverage falls below 200%.
- Commitments: The Company has an unfunded commitment of $32.3 million to the BCP Great Lakes Partnership.
Investor Verification Checklist
- Merger Terms: Verify the final terms and closing date of the proposed merger with OHA Investment Corporation and the impact on share count and NAV.
- Expense Run-Rate: Confirm the normalized expense ratio post-Externalization, excluding the one-time $3.4 million transition costs and $1.4 million lease impairment.
- Asset Coverage Covenant: Monitor the asset coverage ratio closely to ensure it remains above 200% to maintain the ability to pay dividends under the 6.125% Notes indenture.
- Portfolio Credit Quality: Review the status of the four investments currently on non-accrual status and the potential for further impairments in the CLO and Debt Securities portfolios.
- Unfunded Commitments: Assess the impact of the $32.3 million unfunded commitment to the BCP Great Lakes Partnership on future liquidity and leverage ratios.