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Note 6 - Fair Value
 6 Months Ended
Jun. 30, 2023
Notes to Financial Statements  
Fair Value Disclosures [Text Block]

Note 6. Fair value

 

Prior to July 30, 2022, the Board determined the fair value of the Company’s investments. Pursuant to the amended SEC Rule 2a-5 of the 1940 Act, on July 29, 2022, the Board designated the Advisor as the Company’s “valuation designee.” The Board is responsible for oversight of the valuation designee. The valuation designee has established a Valuation Committee to determine in good faith the fair value of the Company’s investments, based on input from the Advisor’s management and personnel and independent valuation firms which are engaged at the direction of the Valuation Committee to assist in the valuation of certain portfolio investments lacking a readily available market quotation at least once during a trailing twelve-month period. The Valuation Committee determines fair values pursuant to a valuation policy approved by the Board and pursuant to a consistently applied valuation process. This valuation process is conducted at the end of each fiscal quarter, with at least 25% (based on fair value) of the Company’s valuation of portfolio companies lacking readily available market quotations subject to review by an independent valuation firm.

 

The Company uses fair value measurements made by the valuation designee to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. 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. Fair value is best determined based upon quoted market prices. However, in certain instances, there are no quoted market prices for certain assets or liabilities. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the asset or liability.

 

Fair value measurements focus on exit prices in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment.

 

The Company’s fair value measurements are classified into a fair value hierarchy in accordance with ASC Topic 820, Fair Value Measurement, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. The three categories within the hierarchy are as follows:

 

 

Level 1

Quoted prices in active markets for identical assets and liabilities.

 

 

Level 2

Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities in active markets, quoted prices in markets that are not active, and model-based valuation techniques for which all significant inputs are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

 

Level 3

Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

 

Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of the Company’s investments may fluctuate from period to period. Additionally, the fair value of the Company’s investments may differ significantly from the values that would have been used had a ready market existed for such investments and may differ materially from the values that the Company may ultimately realize. Further, such investments are generally subject to legal and other restrictions on resale or otherwise are less liquid than publicly traded securities. If the Company was required to liquidate a portfolio investment in a forced or liquidation sale, the Company could realize significantly less than the value at which the Company has recorded such portfolio investment.

 

Cash and interest receivable: The carrying amount is a reasonable estimate of fair value. These financial instruments are not recorded at fair value on a recurring basis and are categorized as Level 1 within the fair value hierarchy described above.

 

Money market funds:  The carrying amounts are valued at their net asset value as of the close of business on the day of valuation. These financial instruments are recorded at fair value on a recurring basis and are categorized as Level 2 within the fair value hierarchy described above as these funds can be redeemed daily.

 

Debt investments: The fair value of debt investments is estimated by discounting the expected future cash flows using the period end rates at which similar debt investments would be made to borrowers with similar credit ratings and for the same remaining maturities. Significant increases (decreases) in this unobservable input would result in a significantly lower (higher) fair value measurement. These assets are recorded at fair value on a recurring basis and are categorized as Level 3 within the fair value hierarchy described above.

 

Under certain circumstances, the Company  may use an alternative technique to value debt investments that better reflects its fair value such as the use of multiple probability weighted cash flow models when the expected future cash flows contain elements of variability.

 

Warrant investments: The Company values its warrants using the Black-Scholes valuation model incorporating the following material assumptions:

 

 

●

Underlying asset value of the issuer is estimated based on information available, including any information regarding the most recent rounds of borrower funding. Significant increases (decreases) in this unobservable input would result in a significantly higher (lower) fair value measurement.

 

 

●

Volatility, or the amount of uncertainty or risk about the size of the changes in the warrant price, is based on indices of publicly traded companies similar in nature to the underlying company issuing the warrant. A total of seven such indices are used. Significant increases (decreases) in this unobservable input would result in a significantly higher (lower) fair value measurement.

 

 

●

The risk-free interest rates are derived from the U.S. Treasury yield curve. The risk-free interest rates are calculated based on a weighted average of the risk-free interest rates that correspond closest to the expected remaining life of the warrant.

 

 

●

Other adjustments, including a marketability discount on private company warrants, are estimated based on management’s judgment about the general industry environment.

 

 

●

Historical portfolio experience on cancellations and exercises of the Company’s warrants are utilized as the basis for determining the estimated time to exit of the warrants in each financial reporting period. Warrants may be exercised in the event of acquisitions, mergers or initial public offerings, and cancelled due to events such as bankruptcies, restructuring activities or additional financings. These events cause the expected remaining life assumption to be shorter than the contractual term of the warrants. Significant increases (decreases) in this unobservable input would result in significantly higher (lower) fair value measurement.

 

Under certain circumstances the Company may use an alternative technique to value warrants that better reflects the warrants’ fair value, such as an expected settlement of a warrant in the near term or a model that incorporates a put feature associated with the warrant. The fair value may be determined based on the expected proceeds to be received from such settlement or based on the net present value of the expected proceeds from the put option.

 

The fair value of the Company’s warrants held in publicly traded companies is determined based on inputs that are readily available in public markets or can be derived from information available in public markets. Therefore, the Company has categorized these warrants as Level 2 within the fair value hierarchy described above. The fair value of the Company’s warrants held in private companies is determined using both observable and unobservable inputs and represents management’s best estimate of what market participants would use in pricing the warrants at the measurement date. Therefore, the Company has categorized these warrants as Level 3 within the fair value hierarchy described above. These assets are recorded at fair value on a recurring basis.

 

Equity investments: The fair value of an equity investment in a privately held company is initially the face value of the amount invested. The Company adjusts the fair value of equity investments in private companies upon the completion of a new third-party round of equity financing. The Company may make adjustments to fair value, absent a new equity financing event, based upon positive or negative changes in a portfolio company’s financial or operational performance. Significant increases (decreases) in this unobservable input would result in a significantly higher (lower) fair value measurement. The Company has categorized these equity investments as Level 3 within the fair value hierarchy described above. The fair value of an equity investment in a publicly traded company is based upon the closing public share price on the date of measurement. Therefore, the Company has categorized these equity investments as Level 1 within the fair value hierarchy described above. These assets are recorded at fair value on a recurring basis.

 

Other investments: Other investments are valued based on the facts and circumstances of the underlying contractual agreement. The Company currently values these contractual agreements using a multiple probability weighted cash flow model as the contractual future cash flows contain elements of variability. Significant changes in the estimated cash flows and probability weightings would result in a significantly higher or lower fair value measurement. The Company has categorized these other investments as Level 3 within the fair value hierarchy described above. These other investments are recorded at fair value on a recurring basis.

 

The following tables detail the investments that are carried at fair value and measured at fair value on a recurring basis as of June 30, 2023 and  December 31, 2022 and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine the fair value:

 

  

June 30, 2023

 
  

Level 1

  

Level 2

  

Level 3

  

Total

 
  

(In thousands)

 

Debt investments

 $—  $—  $683,309  $683,309 

Warrant investments

  —   1,107   24,376   25,483 

Other investments

  —   —   1,300   1,300 

Equity investments

  1,040   —   4,259   5,299 

Total investments

 $1,040  $1,107  $713,244  $715,391 
 
  

December 31, 2022

 
  

Level 1

  

Level 2

  

Level 3

  

Total

 
  

(In thousands)

 

Debt investments

 $—  $—  $686,458  $686,458 

Warrant investments

  —   3,567   26,145   29,712 

Other investments

  —   —   1,300   1,300 

Equity investments

  140   —   2,416   2,556 

Total investments

 $140  $3,567  $716,319  $720,026 

 

The following tables provide a summary of quantitative information about the Company’s Level 3 fair value measurements of the Company’s investments as of June 30, 2023 and  December 31, 2022. In addition to the techniques and inputs noted in the table below, according to the Company’s valuation policy, the Company may also use other valuation techniques and methodologies when determining its fair value measurements.

 

The following table is not intended to be all-inclusive, but rather provides information on the significant Level 3 inputs as they relate to the Company’s fair value measurements as of June 30, 2023:

 

June 30, 2023

 
  

Fair

 

Valuation Techniques/

 

Unobservable

   

Weighted

 

Investment Type

 

Value

 

Methodologies

 

Input

 

Range

 

Average(1)

 
     

(Dollars in thousands, except per share data)

      

Debt investments

 $611,524 

Discounted Expected Future Cash Flows

 

Hypothetical Market Yield

 

11% – 24%

  14%
              
   71,785 

Multiple Probability Weighted Cash Flow Model

 

Probability Weighting

 

5% - 100%

  50%
              

Warrant investments

  24,314 

Black-Scholes Valuation Model

 

Price Per Share

 

0.000 –1,89999

 $59.21 
       

Average Industry Volatility

 

28%

  28%
       

Marketability Discount

 

20%

  20%
       

Estimated Time to Exit (in years)

 1 to 5  3 
   62 

Expected Proceeds

 

Price Per Share

 $0.25 $0.25 
              

Other investments

  1,300 

Multiple Probability Weighted Cash Flow Model

 

Discount Rate

 

25%

  25%
       

Probability Weighting

 

100%

  100%
              

Equity investments

  4,259 

Last Equity Financing

 

Price Per Share

 

$0.03– $215.03

 $27.56 
              

Total Level 3 investments

 $713,244          

 

(1)

Weighted average is calculated by multiplying (a) the unobservable input for each investment in the investment type by (b) (1) the fair value of the related investment in the investment type divided by (2) the total fair value of the investment type.

 

The following table is not intended to be all-inclusive, but rather provides information on the significant Level 3 inputs as they relate to the Company’s fair value measurements as of December 31, 2022:

 

December 31, 2022

 
  

Fair

 

Valuation Techniques/

 

Unobservable

   

Weighted

 

Investment Type

 

Value

 

Methodologies

 

Input

 

Range

 

Average(1)

 
     

(Dollars in thousands, except per share data)

      

Debt investments

 $669,617 

Discounted Expected Future Cash Flows

 

Hypothetical Market Yield

 3% – 22%  14%
              
   16,545 

Multiple Probability Weighted Cash Flow Model

 

Probability Weighting

 10% - 75%  31%
              
   296 

Convertible Note Analysis

 

Price Per Share

 $168.93 $168.93 
              

Warrant investments

  26,145 

Black-Scholes Valuation Model

 

Price Per Share

 

0.000 –1.89999

 $58.52 
       

Average Industry Volatility

 28%  28%
       

Marketability Discount

 20%  20%
       

Estimated Time to Exit (in years)

 1 to 5  3 
              

Other investments

  1,300 

Multiple Probability Weighted Cash Flow Model

 

Discount Rate

 25%  25%
       

Probability Weighting

 100%  100%
              

Equity investments

  2,416 

Last Equity Financing

 

Price Per Share

 

$1.00– $215.03

 $26.93 
              

Total Level 3 investments

 $716,319          

 

(1)

Weighted average is calculated by multiplying (a) the unobservable input for each investment in the investment type by (b) (1) the fair value of the related investment in the investment type divided by (2) the total fair value of the investment type.

 

Borrowings: The Key Facility and the NYL Facility approximate fair value due to the variable interest rate of the facilities and are categorized as Level 2 within the fair value hierarchy described above. Additionally, the Company considers its creditworthiness in determining the fair value of such borrowings. The fair value of the fixed-rate 2026 Notes (as defined in Note 7) is based on the closing public share price on the date of measurement. On June 30, 2023, the closing price of the 2026 Notes on the New York Stock Exchange was $23.35 per note and had an aggregate fair value of $53.7 million. Therefore, the Company has categorized this borrowing as Level 1 within the fair value hierarchy described above. The fair value of the fixed-rate 2027 Notes (as defined in Note 7) is based on the closing public share price on the date of measurement. On June 30, 2023, the closing price of the 2027 Notes on the New York Stock Exchange was $24.14 per note and had an aggregate fair value of $55.5 million. Therefore, the Company has categorized this borrowing as Level 1 within the fair value hierarchy described above. Based on market quotations on June 30, 2023, the 2019 Asset-Backed Notes were trading at par value, or $30.8 million, and are categorized as Level 3 within the fair value hierarchy described above. Based on market quotations on June 30, 2023, the 2022 Asset-Backed Notes were trading at par value, or $100.0 million, and are categorized as Level 3 within the fair value hierarchy described above. These borrowings are not recorded at fair value on a recurring basis.

 

Off-balance-sheet instruments: Fair values for off-balance-sheet lending commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standings. Therefore, the Company has categorized these instruments as Level 3 within the fair value hierarchy described above.

 

The following table shows a reconciliation of the beginning and ending balances for Level 3 assets measured at fair value on a recurring basis for the three months ended June 30, 2023:

 

  

Three months ended June 30, 2023

 
  

Debt

  

Warrant

  

Equity

  

Other

     
  

Investments

  

Investments

  

Investments

  

Investments

  

Total

 
  

(In thousands)

 

Level 3 assets, beginning of period

 $684,554  $24,638  $2,915  $1,300  $713,407 

Purchase of investments

  40,545   —   —   —   40,545 

Warrants and equity received and classified as Level 3

  —   515   89   —   604 

Principal payments received on investments

  (24,740)  —   —   —   (24,740)

Payment-in-kind interest on investments

  950   —   —   —   950 

Proceeds from sale of investments

  (528)  (1,458)  —   —   (1,986)

Net realized (loss) gain on investments

  (17,672)  1,287   (127)  —   (16,512)

Unrealized appreciation (depreciation) included in earnings

  2,118   (606)  (1,307)  —   205 

Transfer out of Level 3

  —   —   (111)  —   (111)

Transfer out of debt investments

  (2,800)  —   2,800   —   — 

Other

  882   —   —   —   882 

Level 3 assets, end of period

 $683,309  $24,376  $4,259  $1,300  $713,244 

 

During the three months ended June 30, 2023, there was one transfer out of Level 3. The one transfer out of Level 3 related to equity held in one portfolio company with an aggregate fair value of $0.1 million that was transferred to Level 1 upon the portfolio company becoming a public company.

 

The following table shows a reconciliation of the beginning and ending balances for Level 3 assets measured at fair value on a recurring basis for the three months ended June 30, 2022:

 

  

Three months ended June 30, 2022

 
  

Debt

  

Warrant

  

Equity

  

Other

     
  

Investments

  

Investments

  

Investments

  

Investments

  

Total

 
  

(In thousands)

 

Level 3 assets, beginning of period

 $492,194  $21,645  $203  $200  $514,242 

Purchase of investments

  158,985   —   250   —   159,235 

Warrants received and classified as Level 3

  —   669   —   —   669 

Principal payments received on investments

  (73,096)  —   —   (232)  (73,328)

Proceeds from sale of investments

  (21,750)  (396)  —   —   (22,146)

Net realized gain (loss) on investments

  —   239   —   (1,168)  (929)

Unrealized (depreciation) appreciation included in earnings

  (3,797)  3,010   —   1,400   613 

Other

  (976)  —   —   —   (976)

Level 3 assets, end of period

 $551,560  $25,167  $453  $200  $577,380 

 

During the three months ended June 30, 2022, there were no transfers in or out of Level 3.

 

 

The following table shows a reconciliation of the beginning and ending balances for Level 3 assets measured at fair value on a recurring basis for the six months ended June 30, 2023:

 

  

Six months ended June 30, 2023

 
  

Debt

  

Warrant

  

Equity

  

Other

     
  

Investments

  

Investments

  

Investments

  

Investments

  

Total

 
  

(In thousands)

 

Level 3 assets, beginning of period

 $686,458  $26,145  $2,416  $1,300  $716,319 

Purchase of investments

  87,543   —   10   —   87,553 

Warrants and equity received and classified as Level 3

  —   656   89   —   745 

Principal payments received on investments

  (64,496)  —   —   —   (64,496)

Payment-in-kind interest on investments

  2,154   —   —   —   2,154 

Proceeds from sale of investments

  (7,036)  (1,470)  —   —   (8,506)

Net realized (loss) gain on investments

  (17,665)  1,146   (127)  —   (16,646)

Unrealized depreciation included in earnings

  (2,448)  (2,096)  (1,118)  —   (5,662)

Transfer out of Level 3

  —   —   (111)  —   (111)

Transfer out of debt investments

  (3,095)  (5)  3,100   —   — 

Other

  1,894   —   —   —   1,894 

Level 3 assets, end of period

 $683,309  $24,376  $4,259  $1,300  $713,244 

 

During the six months ended June 30, 2023, there was one transfer out of Level 3. The one transfer out of Level 3 related to equity held in one portfolio company with an aggregate fair value of $0.1 million that was transferred to Level 1 upon the portfolio company becoming a public company.

 

The change in unrealized depreciation included in the consolidated statement of operations attributable to Level 3 investments still held at June 30, 2023 includes $13.1 million in unrealized depreciation on debt investments, $1.9 million in unrealized depreciation on warrant investments and $1.3 million in unrealized depreciation on equity investments.

 

The following table shows a reconciliation of the beginning and ending balances for Level 3 assets measured at fair value on a recurring basis for the six months ended June 30, 2022:

 

  

Six months ended June 30, 2022

 
  

Debt

  

Warrant

  

Equity

  

Other

     
  

Investments

  

Investments

  

Investments

  

Investments

  

Total

 
  

(In thousands)

 

Level 3 assets, beginning of period

 $437,317  $19,837  $203  $200  $457,557 

Purchase of investments

  253,470   —   250   —   253,720 

Warrants received and classified as Level 3

  —   1,477   —   —   1,477 

Principal payments received on investments

  (87,191)  —   —   (282)  (87,473)

Proceeds from sale of investments

  (43,000)  (426)  —   —   (43,426)

Net realized gain (loss) on investments

  —   269   —   (1,168)  (899)

Unrealized (depreciation) appreciation included in earnings

  (6,967)  4,010   —   1,450   (1,507)

Other

  (2,069)  —   —   —   (2,069)

Level 3 assets, end of period

 $551,560  $25,167  $453  $200  $577,380 

 

During the six months ended June 30, 2022, there were no transfers in or out of Level 3.

 

The change in unrealized depreciation included in the consolidated statement of operations attributable to Level 3 investments still held at June 30, 2022 includes $7.0 million in unrealized depreciation on debt investments and $4.7 million in unrealized appreciation on warrant investments.

 

The Company discloses fair value information about financial instruments, whether or not recognized in the consolidated statement of assets and liabilities, for which it is practicable to estimate that value. Certain financial instruments are excluded from the disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

 

The fair value amounts have been measured as of the reporting date and have not been reevaluated or updated for purposes of these financial statements subsequent to that date. As such, the fair values of these financial instruments subsequent to the reporting date may be different than amounts reported.

 

As of June 30, 2023 and  December 31, 2022, all of the balances of all the Company’s financial instruments were recorded at fair value, except for the Company’s borrowings, as previously described.

 

Market risk

 

The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Company’s financial instruments will change when interest rate levels change, and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new debt investments and by investing in securities with terms that mitigate the Company’s overall interest rate risk.