Investor Insights

May 2018 Investor Report

Published: May 4, 2018Updated: April 25, 2019

Over the last few months, we have spent a significant amount of time discussing economic and market issues while refraining from commenting on legislation passed on Capitol Hill. While much of our analyses involve matters that can be political or controversial, they do impact our investments. Recently, a law was passed that has an impact on investing and some of our investments in particular; the “Small Business Credit Availability Act.” The Small Business Credit Availability Act (SBCA) allows for certain financial firms to move their asset coverage requirements for senior securities from 200 percent to 150 percent. We believe this is a material development and one we will monitor closely. At present all of our bonds in these types of companies are either voluntarily staying at the 200 percent asset coverage ratio OR are moving to the new 150 percent coverage ratio. However, our specific bonds allow us to maintain our original asset coverage ratio due to existing restrictive covenants. The following is a recent press release pertaining to this situation circulated by one of our most widely held bonds (6.125 percent Notes due 2022 – Symbol: KCAPL) in KCAP Financial (we wish to draw your attention to the underlined portion of the company statement):

Reduction in Asset Coverage Ratio Effective March 29, 2019

“On March 29, 2018, our Board of Directors, including a “required majority” (as such term is defined in Section 57(o) of the 1940 Act) of the Board, approved the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act, as amended by the Small Business Credit Availability Act (the “SBCA”). As a result, our asset coverage requirements for senior securities will be changed from 200 percent to 150 percent, effective as of March 29, 2019. However, pursuant to covenants in the indentures governing our 7.375 percent Notes due 2019 and 6.125 percent Notes due 2022 (Symbol: KCAPL) we are limited in our ability to make distributions if our asset coverage ratio is below 200 percent at the time we declare a distribution. As a result, despite the SBCA, we will continue to be prohibited by the indentures governing the Notes from making distributions on our common stock if our asset coverage ratio falls below 200 percent.”

Despite the KCAPL’s move to match legislation to lower asset coverage requirement to 150 percent, which takes effect in March 2019. The indentures of our bonds only allow distribution to shareholders if the asset coverage ratio is at least 200 percent. This covenant is powerful. As long as our bond position in KCAP Financial is outstanding, the asset coverage ratio remains at 200 percent minimum, so the new 150 percent asset coverage ratio is irrelevant as a bondholder in this case. We have noticed many other businesses take advantage of the new leverage rules (and for them it makes sense as the management teams of these companies will certainly make more in salary and bonuses), but we will not invest new capital in these entities.

As always, please feel free to reach out to us with any questions that you may have. We are grateful for the trust that you place in us.