We seek to provide our investors attractive, risk-adjusted returns over the long-term primarily through current income, while seeking to preserve our capital, by selectively constructing and actively managing a leveraged portfolio composed primarily of diversified investments in first lien and second lien floating rate loans to large market, U.S. based companies (collectively, “Leveraged Loans”). We also invest in debt and equity tranches of CLOs collateralized primarily by Leveraged Loans. We are externally managed by Ivy Hill Asset Management, L.P., a portfolio company of Ares Capital Corporation (NASDAQ:ARCC), a publicly traded specialty finance company that provides one-stop solutions to meet the distinct and underserved needs of private middle-market companies across diverse industries.
We intend to achieve our objective by selectively constructing and actively managing a leveraged portfolio composed primarily of diversified investments in Leveraged Loans. We also invest in debt and equity tranches of CLOs collateralized primarily by Leveraged Loans. In addition to these assets, we may selectively invest in loans issued by middle-market companies, mezzanine and unitranche loans and high yield bonds. Additionally, we may from time to time hold or invest in equity or other debt or equity securities generally arising from a restructuring of Leveraged Loan positions previously held by us.
Leveraged Loans are primarily issued by U.S. based large market private companies, but may be issued by public companies, thinly-traded companies, middle-market companies, and/or non-U.S. companies. Issuers typically use Leveraged Loans to refinance existing debt, finance acquisitions or leveraged buyouts, to pay dividends, and for other general corporate purposes.
Investors typically classify the Leveraged Loan market by issuer size. S&P defines large market loans as loans from issuers with earnings before interest, taxes, depreciation and amortization (“EBITDA”) of greater than $50 million and middle market loans as loans from issuers with EBITDA of less than $50 million. Under normal market conditions, we intend to have a majority of our Leveraged Loan portfolio invested in loans issued by large market companies, but we will also invest in loans issued by middle market companies.
Leveraged Loans pay interest based on a floating rate typically calculated as a spread over a market index. Interest rates are periodically reset to reflect changes in market index rates. LIBOR is generally used as the market index rate for Leveraged Loans, and some Leveraged Loans include provisions defining a minimum market index rate. Spreads are typically expressed in basis points and are defined at origination and may be adjusted over the life of a loan to account for changes in a borrower’s credit profile according to predefined credit covenants. Market spreads vary according to market dynamics. Leveraged Loans are generally structured with limited amortization and quarterly interest payments and are typically collateralized by a company’s assets such as land, buildings or equipment.
Leveraged Loans may be structured with various lien priorities on underlying collateral, with the market primarily split between first lien loans and second lien loans. Principal payments of second lien loans are generally paid after payments to first lien loans or other loans with seniority in priority of payments. As a result, second lien loans generally have a higher spread compared to first lien loans. The market for second lien loans is significantly smaller and less liquid than the market for first lien loans.
We intend to concentrate our investment activities in Leveraged Loans issued by companies with robust free cash flows, defensible market positions, and attractive market dynamics.
A CLO is a special purpose vehicle that is formed to finance a pool of assets which meet predefined investment criteria. A CLO generally raises capital by issuing both debt and equity securities. Typically, a CLO will issue various classes, or “tranches,” of debt broadly categorized as senior and subordinate debt tranches as well as an equity tranche.
Unlike debt securities issued by CLOs, CLO equity securities are not rated and do not have contractually stated payment schedules. At origination, the weighted average interest rate of all CLO debt tranches is generally lower than the weighted average interest earned by a CLO’s underlying collateral, resulting in an interest rate spread. CLO equity securities receive residual cash flows, or the interest spread, generated by the underlying collateral after obligated payments for CLO debt securities have been made.
We intend to leverage prudently our investment portfolio to increase potential returns to our stockholders. We intend to finance our assets, subject to market conditions, through a combination of financing arrangements, including but not limited to, warehouse facilities, securitizations and term financing facilities. We also intend to finance our assets through additional issuance of equity securities and/or debt securities. Our Manager’s selection of funding alternatives will be restricted in that we may not enter into funding transactions that would cause our asset coverage ratio to fall below 200%, as defined in the 1940 Act.
Our assets are generally exposed to interest rate and credit risk. We intend to limit our exposure to interest rate risk by primarily investing in floating rate assets. However, investing in floating rate investments does not eliminate interest rate risk as interest rate spreads could narrow or widen, for a variety of reasons including credit changes, minimum market rates and other structural considerations, thereby impacting the net amount we earn on our investments and/or the value of our stockholders’ equity. To the extent we seek to finance our investments with debt we will seek to limit our exposure to additional interest rate risk by primarily financing our floating rate assets with floating rate borrowings. However, financing our assets with floating rate borrowings does not eliminate interest rate risk and may expose us to additional interest rate risk.
We generally manage credit risk through our robust underwriting process and active portfolio management. Under certain circumstances, we may on a limited basis utilize additional risk management techniques designed to reduce or further limit portfolio risks. These techniques may include various hedging activities such as forward contracts, options, interest rate and credit default swaps, caps, collars and floors, to the extent permitted under the 1940 Act.
On a limited basis, we may hold investments denominated in foreign currencies which would expose us to fluctuations in exchange rates. We may utilize risk management techniques such as hedging to reduce or further limit our exposure to foreign currency exchange rate risk. These techniques may include entering into forward currency or option contracts.
We are externally managed and advised by our Manager pursuant to the terms of a management agreement. Our Manager is responsible for administering our business activities and day-to-day operations, subject to the supervision and oversight of our Board of Directors. Our Manager is Ivy Hill Asset Management, L.P., a portfolio company of ARCC. All of our officers and the members of our Manager’s senior investment team are employees of either Ivy Hill Asset Management, L.P., Ares Capital Management, LLC, or Ares Operations LLC.
We do not have any employees. Our Manager has entered into an administrative services agreement with Ares Operations LLC pursuant to which it will have access to their employees, including senior management, operations, financial accounting, compliance, legal, accounting, treasury, investor relations and information technologies staffs, and their infrastructure, operations and business relationships, to enable our Manager to perform its obligations under the management agreement. We will not pay any of these individuals any cash or equity-based compensation. Rather, we will pay our Manager a management fee pursuant to the management agreement.