Industry Update BDC Burn-Down Analysis: Valuations Are Higher but BDCs Still Look Undervalued

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1 Diversified Financials BDC/PTP North America Equity Research March 30, 2016 Industry Update We split up each of the BDCs portfolios into five different categories: four higher-risk and one lower-risk category. Then we applied different loss rates to each category for two different scenarios: 1) base case and 2) downside case. BDC valuations have trended higher since our last burn-down analysis, but the BDC group still looks undervalued if the U.S continues its slow-growth projections (base case) and fairly valued with recessionary loss rates (downside case). BDCs that screened well on our BDC burn-down analysis were SLRC, ARCC, TCAP, and TCRD. BDCs that did not screen well on our burn-down analysis were FSIC, NMFC and BKCC. This report separates the BDCs portfolios into five categories and applies different loss rates to category for each scenario (base and downside): 1) Energy 2) KBW watchlist investments (ex-energy) 3) Non-accruals (ex-energy) 4) Collateralized loan obligation (CLO) equity 5) Remaining portfolio (portfolio after the riskier assets are removed) The BDC group has traded at an average of 1.03x book value from , which was a very benign credit environment with low losses. Our analysis is trying to pull forward future losses and apply them to the BDCs portfolios and book value today to calculate an estimated book value after we go through a credit cycle (the size of the cycle varies with the scenarios). Historical data would then tell us the BDCs should trade near book value once credit losses have been realized and the near-term expectations of future credit losses are greatly reduced. The current price/book of the group is 86%. Base Case Loss Rate Assumptions: energy (-60%), KBW watchlist investments (-20%), non-accruals (-40%), CLO equity (-5%), and the remaining portfolio (-1%). The remaining portfolio bucket should be fairly healthy because the riskier asset categories have been removed, thus the loss rate should be fairly low on the remaining portfolio bucket. Base Case Results: 4% loss rate on portfolio which translates into 8% decline in book value. When applying the loss rates in our base case, the BDC group is trading at 94% of pro forma BV. Downside Case Loss Rate Assumptions: energy (-80%), KBW watchlist investments (-30%), non-accruals (-50%), CLO equity (-30%), and the remaining portfolio (-3%). Downside Case Results: 8% loss rate on portfolio which translates into 14% decline in book value. When applying the loss rates in our downside case, the BDC group is trading at 100% of pro forma BV. Sector Results: Based on our analysis the BDC group looks undervalued in our base case scenario as the BDCs would be trading meaningfully below book value and meaningfully below historical averages when credit normalized (Exhibit 1). The BDCs look fairly valued in our downside scenario as they are trading near book value and near historical averages (Exhibit 2). BDCs that did screen well on our burn-down analysis: SLRC, ARCC, TCAP, and TCRD. These BDCs have less than 10% of their portfolios in higher-risk asset categories, above-average management teams, and are trading at a meaningful discount to their pro forma book value or to their historical average. BDCs thatdid not screen well on our burn-down analysis: FSIC, NMFC and BKCC. These BDCs have a higher pro forma price/book value multiple relative to their historical price/book value and have 10%+ of their portfolios in higher risk asset categories. There are other reasonable loss rate assumptions that can be made about the BDCs' portfolios. Please contact your KBW salesperson for a copy of the interactive spreadsheet which will allow users to input their own loss rate assumptions for each asset category and automatically updates the pro forma book values. Ryan Lynch, CFA, CPA lynchr@kbw.com Glossary of Terms Keefe, Bruyette & Woods, Inc. does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Please refer to important disclosures and analyst certification information on pages

2 Exhibit 1: Base Case Price/Book Value (12/31), Pro Forma P/B, and Relative Valuation Pro-Forma Price/BV 3/30/16 Historical Relative to Stock 12/31/2015 Price / BV Pro-Forma Pro-Forma Price/BV Historical Company Ticker Price BV (12/31 BV) BV Price / BV ( ) Price / BV FS Investment FSIC $9.15 $ % $ % 101% 116% BlackRock Capital BKCC $9.54 $ % $ % 97% 108% New Mountain Finance NMFC $12.70 $ % $ % 102% 107% Golub Capital GBDC $17.25 $ % $ % 110% 101% Hercules Tech. Grow th HTGC $12.05 $ % $ % 126% 100% TCP Capital TCPC $14.78 $ % $ % 107% 98% Triangle Capital TCAP $20.24 $ % $ % 154% 94% THL Credit TCRD $10.82 $ % $ % 101% 94% Apollo Investment AINV $5.44 $ % $ % 95% 92% Ares Capital ARCC $14.59 $ % $ % 104% 90% Solar Capital SLRC $17.14 $ % $ % 96% 87% Pennant Park Investment PNNT $5.99 $ % $ % 99% 79% Medley Capital MCC $6.55 $ % $ % 95% 78% American Capital ACAS $15.17 $ % $ % 101% 78% Fifth Street Capital FSC $4.95 $ % $ % 97% 65% Sub-$300M Market Cap Pennant Park Floating Rate PFLT $11.54 $ % $ % 92% 94% Harvest Capital HCAP $12.00 $ % $ % 93% 93% Capitala Finance CPTA $11.70 $ % $ % 89% 91% Horizon Technology Fin. HRZN $11.33 $ % $ % 93% 89% KCAP Financial KCAP $3.52 $ % $ % 97% 67% 86% 94% 103% 91% More expensive valuation relative to historical P/BV Less expensive relative to historical P/BV Price/BV valuation w hen pulling forward our estimated future losses per our loss rate assumptions. Historical Price/BV the BDCs traded at during a period of benign credit issues. Illustrates w hether or not the BDC s price/pro-forma BV (which is pulling forward estimated future losses) is trading a premium or discount to its historical price/bv in a benign credit environment. Source: Company reports, KBW Research. Please refer to important disclosures and analyst certification information on pages

3 Exhibit 2: Downside Case Price/Book Value (12/31), Pro Forma P/B, and Relative Valuation Pro-Forma Price/BV 3/30/16 Historical Relative to Stock 12/31/2015 Price / BV Pro-Forma Pro-Forma Price/BV Historical Company Ticker Price BV (12/31 BV) BV Price / BV ( ) Price / BV FS Investment FSIC $9.15 $ % $ % 101% 128% New Mountain Finance NMFC $12.70 $ % $ % 102% 116% BlackRock Capital BKCC $9.54 $ % $ % 97% 115% Golub Capital GBDC $17.25 $ % $ % 110% 106% Hercules Tech. Grow th HTGC $12.05 $ % $ % 126% 105% Apollo Investment AINV $5.44 $ % $ % 95% 104% TCP Capital TCPC $14.78 $ % $ % 107% 103% THL Credit TCRD $10.82 $ % $ % 101% 101% Triangle Capital TCAP $20.24 $ % $ % 154% 100% Ares Capital ARCC $14.59 $ % $ % 104% 95% Solar Capital SLRC $17.14 $ % $ % 96% 90% Pennant Park Investment PNNT $5.99 $ % $ % 99% 86% Medley Capital MCC $6.55 $ % $ % 95% 86% American Capital ACAS $15.17 $ % $ % 101% 82% Fifth Street Capital FSC $4.95 $ % $ % 97% 69% Sub-$300M Market Cap Capitala Finance CPTA $11.70 $ % $ % 89% 101% Harvest Capital HCAP $12.00 $ % $ % 93% 96% Pennant Park Floating Rate PFLT $11.54 $ % $ % 92% 96% Horizon Technology Fin. HRZN $11.33 $ % $ % 93% 92% KCAP Financial KCAP $3.52 $ % $ % 97% 76% 86% 100% 103% 97% More expensive valuation relative to historical P/BV Less expensive relative to historical P/BV Price/BV valuation w hen pulling forward our estimated future losses per our loss rate assumptions. Historical Price/BV the BDCs traded at during a period of benign credit issues. Illustrates w hether or not the BDC s price/pro-forma BV (which is pulling forward estimated future losses) is trading a premium or discount to its historical price/bv in a benign credit environment. Source: Company reports, KBW Research. Sector Results The BDC group has traded at 1.03x book value from , which was the time period following the recession when most credit losses had been realized and the credit markets had stabilized (Exhibit 3). So theoretically, if we are in a market where credit is expected to be stable, history would tell us the BDCs should trade near book value. What our analysis is trying to do is pull forward future losses and apply them to the BDCs portfolios and book value today to calculate an estimated book value after we go through a credit cycle (the size of the cycle varies with scenario #1 and scenario #2). Historical data would then tell us the BDCs should trade near book value once credit losses have been realized and the near-term expectations of future credit losses are greatly reduced. If a BDC is trading at meaningful Please refer to important disclosures and analyst certification information on pages

4 discount to book value today, it is likely due to the market s expectations of the future near-term credit losses to book value. Currently, the BDC group is trading at 0.86x book value. If we run our base case scenario where we apply meaningful loss rates to the BDCs energy, watchlist, non-accruals, and CLO equity investments, it creates a total loss rate of -4% and reduces book value by -8%. When applying the loss rates in our base case scenario, the BDC group is trading at 0.94x pro forma book value. Thus when applying our base case scenario and pulling forward reasonable losses in the BDCs portfolios, the BDCs are trading at a meaningful discount to pro forma book value and discount to their historical averages. If after we pull forward future credit losses, the BDCs are still trading at a discount to book value, it means one of two things: 1) the BDC group is trading for less than intrinsic value and is undervalued, or 2) our loss rate assumptions are too low. Our analysis also includes a downside scenario that includes our loss rate assumptions if the U.S. economy goes into a recession. In our downside scenario, we increase loss rates across all categories. In this we estimate a total loss rate of -8% and a reduction to book value by -14%. When applying the loss rates in our downside scenario, the BDC group is trading at 1.00x pro forma book value. See Exhibit 4 for loss rate and price/book value summary. Based on our analysis, the BDC group looks undervalued in our base case scenario and fairly valued in our recession scenario. The BDC group is trading meaningfully below book value in our base case scenario, which includes pulling forward a meaningful increase in portfolio losses. The BDC group is trading near book value when we apply the substantial loss rates, which are supposed to mirror a recessionary environment in our downside scenario. Please refer to important disclosures and analyst certification information on pages

5 Exhibit 3: BDC Historical Price/Book Value Multiple 1.2x 1.1x The BDC group has traded at an average of 1.03x P/BV from x 0.9x 0.8x 0.7x Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Source: FactSet. Exhibit 4: Total Loss Rates and Price/Book Value Total Portfolio Loss Rate Total Book Value Loss Pro-Forma Price/Book Value Base Dow nside Case Case -4% -8% -8% -14% 0.94x 1.00x Source: KBW Research. Individual Results This burn-down analysis is a good tool to screen for relative value within the sector. It is important to note this is just one screening tool used to search for undervalued or overvalued names. There are many other factors that should be considered when deciphering whether a name is undervalued/overvalued but this screen can be used as a good starting point. Please refer to important disclosures and analyst certification information on pages

6 BDCs that did screen well: SLRC, ARCC, TCAP, and TCRD. These BDCs have less than 10% of their portfolios in higher-risk asset categories, above-average management teams, and are trading at a meaningful discount to book value or to their historical average. There are other BDCs who are trading at lower pro forma price/book multiples, but these BDCs either have 10%+ exposure to higher risk asset classes or are thought to be run by below-average management teams. See Exhibit 5 for pro forma price/book value multiples with percentage of exposure to higher-risk asset categories. BDCs that did not screen well: FSIC, NMFC and BKCC. These BDCs all trade above 1.0x price/pro forma book value and at a higher price/pro forma book value multiple relative to their historical price/book value. Additionally, all three of these names have 10%+ of their portfolios in higher-risk asset categories, with all having 8%-9% of their portfolios in energy-related investments, which we would consider the riskiest investment category or industry in today s environment. FSIC screens the poorest on our burn-down analysis with a valuation that is meaningfully higher than anyone in our coverage. FSIC is trading at a current price/book of 1.01x and a price/pro forma book of 1.17x. FSIC has a high exposure to both energy investments (9% of portfolio) and KBW watchlist investments (6% of portfolio), which is creating a big reduction to our pro forma book value. Additionally, FSIC is trading at a higher price/book multiple (1.01x) versus the group (0.94x). FSIC is trading at a meaningful premium to group with significantly higher exposure to these riskier asset categories. We believe FSIC is garnering some premium due to its high-quality management team and the perception of a higher-quality energy portfolio, but overall it is a bit of an outlier in our burn-down analysis. We believe all three of the BDCs that screen poorly have above-average management teams which may be part of the reason these BDCs are trading with a higher valuation on our burn-down screen. This item important to note is that this report is making some broad-based assumptions on loss rates across the BDC space. This analysis does not differentiate the credit quality within each asset class for each BDC, but is rather applying the same loss rate to each asset category for each BDC across our coverage. The main driver of the total loss rate for each BDC will depend on the amount of exposure to these higher-risk asset classes we have identified. We fully understand that over time not every asset class will produce the same loss rate across every BDC, and some higher-quality BDCs may outperform our assumptions and some lower-quality BDCs may underperform our assumptions. As such, this scenario analysis could produce results where some BDCs that normally trade with higher valuations may appear overvalued; however, the valuation could be justified due to other circumstances like historically great credit quality (i.e., GBDC), being internally managed (i.e., TCAP, HTGC), etc. Please refer to important disclosures and analyst certification information on pages

7 Exhibit 5: Base Case Pro Forma Price/Book Multiple with Percentage of Exposure to Higher-Risk Asset Categories Source: KBW Research. Pro-Forma Price/BV Relative to % of Portfolio in Higher Pro-Forma Historical Risk Asset Company Ticker Price / BV Price / BV Categories FS Investment FSIC 117% 116% 17% BlackRock Capital BKCC 105% 108% 12% New Mountain Finance NMFC 109% 107% 11% Golub Capital GBDC 111% 101% 1% Hercules Tech. Grow th HTGC 126% 100% 4% TCP Capital TCPC 105% 98% 5% Triangle Capital TCAP 145% 94% 7% THL Credit TCRD 95% 94% 9% Apollo Investment AINV 87% 92% 21% Ares Capital ARCC 94% 90% 4% Solar Capital SLRC 84% 87% 1% Pennant Park Investment PNNT 78% 79% 13% Medley Capital MCC 75% 78% 14% American Capital ACAS 79% 78% 13% Fifth Street Capital FSC 63% 65% 6% Sub-$300M Market Cap Pennant Park Floating Rate PFLT 86% 94% 2% Harvest Capital HCAP 86% 93% 3% Capitala Finance CPTA 81% 91% 11% Horizon Technology Fin. HRZN 83% 89% 0% KCAP Financial KCAP 65% 67% 19% 94% 91% 9% Background BDCs trade below book value primarily for two reason: 1) investors believe the manager will not generate a sufficient return on equity (ROE), or 2) the investment portfolio is going to be worth less in the future versus its fair value today, meaning investors expect the portfolio is going to experience writedowns and/or realized losses in the future. We are going to focus our discussion on the later point: fear of potential future writedowns/losses. BDC stock prices and valuations have been under pressure for the past 1.5 years. Throughout 2015, the BDC group traded down partly due to fears of energy exposure in their portfolios. Additionally, a lot of investors we spoke with didn t specifically know when, but feared a credit cycle was coming since we have been about six years removed from the last cycle. The sell-off in the high-yield bond market only Please refer to important disclosures and analyst certification information on pages

8 advanced investors fears and continued to push BDC stock prices lower. In 2016, the credit markets started off trending lower but have since reversed and are actually in positive territory for the year and equity markets have done the same. This has resulted in a slightly positive total return for the BDC group of 3%. However, this positive return is coming off very low levels and BDC stock prices still remain at a significant discount to historical levels. This is likely due to investors fears that some form of a credit cycle is coming. Remember, BDCs are taking the credit risk of the U.S. middle-market businesses and they tend to sell off as investors fear a credit cycle is coming and/or the U.S. economy could go into a recession. Additionally, energy prices have continued to trade at very low levels in 2016 from a historical standpoint, which could results in credit losses for those BDCs with exposure to energy, regardless whether or not there is a broad-based U.S. recession. Scenarios Due to credit/recession fears, investors are pricing in significant future credit losses in the BDCs portfolios via trading their stock price significantly below book value. As such, we wanted to apply some loss rates to different asset categories/investment strategies in the BDCs portfolio to quantify the losses and provide two scenarios to the BDCs portfolios. Base case scenario: the U.S. economy continues its pace of slow growth, energy prices remain at their current low prices, and credit markets (ex-energy) stabilize at current levels with an uptick in defaults/losses. Downside Scenario: the U.S. economy falls into a recession, energy prices continue lower, and credit markets continue to decline with defaults/losses experience during the great recession. Basically, our base case scenario is a reasonable scenario to the BDCs portfolios based on current markets conditions with an expectation of normalizing (higher) credit losses. Our downside scenario is a reasonable downside scenario if the U.S. falls into a recession and credit losses increasing substantially (Exhibit 6). Exhibit 6: Base Case and Downside Scenarios Source: KBW Research. Base Case Scenario - Dow nside Scenario - Dow nside assuming current Dow nside assuming US market conditions persist goes into a recession U.S. Economy 1-2% Grow th Negative Grow th Energy Prices Remain at Current Depressed Levels / Low er Energy Prices / Big Spike in Big Spike in Defaults and Losses Defaults and Losses Credit Markets Prices Stabilize / Increasing Defaults Low er Credit Markets / Substantial & Losses Increase in Defaults & Losses Portfolio Categories In each scenario we have split up each of the BDCs portfolios into five different groups: energy, KBW watchlist investments (ex-energy), non-accruals (ex-energy), CLO equity, and the remaining portfolio. Each of these different portfolio groups have different levels of risk and potential loss rates. We have chosen to group the portfolios the way we did because each group (excluding the remaining portfolio group) comprises the higher-risk assets classes that are at a greater risk of experiencing losses in the Please refer to important disclosures and analyst certification information on pages

9 current environment or if the U.S. goes into a recession. Exhibit 7 shows the loss rates we applied to each asset category. Exhibit 7: Base Case and Downside Scenario Loss Rates Loss Rates Portfolio Category Base Dow nside Energy -60% -80% KBW Watchlist -20% -30% Non-Accruals -40% -50% CLO Equity -5% -30% Remaining Portfolio -1% -3% Total Portfolio Loss Rate Based on Individual Inputs -4% -8% Total Book Value Loss -8% -14% Source: KBW Research. Loss Rates Energy: Benchmarking the loss rate in the energy positions in the BDCs portfolio is very difficult considering the performance is likely tied to energy prices and few individuals have been able to correctly forecast oil prices recently (we do not know of anyone who forecast oil prices falling from $100+ to below $30). We do know that right now energy prices are at very low levels and the consensus is that they are going to slowly trend higher but remain at relatively low levels from a historical standpoint. This is not good for energy companies as we believe most E&P companies will struggle with oil below $50/barrel. We have assumed the energy portfolios will have substantial loss rates in both our base case and downside scenarios. As such, for our analysis we are assuming -60% loss rates for the energy sector in our base case and -80% loss rates in our downside case. We feel both of these assumptions are conservative. For example, one way to think about the loss rates in the base case scenario is that we are essentially saying every energy company in the BDCs portfolios are going default/go to bankruptcy (100% default rate) and everything is going to be wiped out except 40% (40% recovery rate) of value. The average energy investment has already been marked down 20% (trading at 80% of the BDC s cost basis). Watchlist (ex-energy): As a reminder, our KBW credit watchlist identifies companies that have a fair value mark substantially below cost. We generate this list in order to identify investments that are showing signs of stress and as such, are at a higher risk of further writedowns or being placed on nonaccrual. As these investments are already at a higher risk of additional losses, we are applying a base case scenario loss rate of -20% and a downside scenario loss rate of -30%. One key factor to remember is that BDC investments are fair-value marked on a quarterly basis so these stressed investments have already received writedowns in their fair value. For example, if a watchlist loan is marked at 50% of cost today and is eventually exited at 60% of cost, this would result in an overall gain to the BDC s book value Please refer to important disclosures and analyst certification information on pages

10 since the original 50% unrealized writedown was already reflected in the BDC s book value. Conversely, if the loan was exited/sold at 40% of cost, only a small net loss would be recorded. Non-Accruals (ex-energy): Non-accrual loans are companies that have stopped making interest payments or the BDC has stopped recording income due to the weakening fundamentals at the company. We believe these companies are at a higher risk of additional writedowns/losses and we are applying a base case scenario loss rate of -40% and a downside scenario loss rate of -50%. As mentioned above, because BDCs fair value their investments every quarter, these non-accrual investments have likely already received sizeable writedowns in their fair value. CLO Equity: CLO equity investments can be very volatile but historically have produced attractive returns. During the great recession, CLO equity prices traded down to very low levels, but ultimately most of these investments generated positive total returns. See Exhibit 8 for historical CLO equity internal rates of return (IRRs). CLO equity traded down significantly during the great recession as cash flows to some CLO equity tranches were shut off and used to purchase additional collateral (loans) for the CLO. CLO equity investors did not like having their cash flow stopped; however, this cash flow was used to buy additional leveraged loans trading at substantial discounts which ultimately created more assets and cash flow to support the CLO, which allow most CLOs to generate a solid return over the coming years. Having given some background surrounding our thoughts on CLO equity, we are modeling in a -5% loss rate for our base case and a -30% loss rate for our downside scenario. Leveraged loan prices traded up 2% in 1Q16, so it is unlikely that there will be meaningful losses in in CLO equity in 1Q16. It is possible that CLO equity values could trade lower than our loss rate assumptions in a scenario where leveraged loans trade lower but BDCs should not be forced sellers of these assets and should be able to hold these investments throughout a credit cycle if needed and earn the fundamental return generated by the CLO equity investment. We are comfortable with our loss rates given the historical performance of the CLO equity investments in Exhibit 8. Please refer to important disclosures and analyst certification information on pages

11 Exhibit 8: Distribution of Projected CLO Equity IRRs for U.S. Cash Flow CLOs: Vintages 4% IRRs over 15% Positive IRRs up to 15% CLOs with negative equity returns CLOs with positive equity returns 96% Source: Eagle Point Credit, Citi Research. Remaining Portfolio: Because we have removed and applied separate loss rates to most of the higherrisk categories in the BDCs portfolio, the remaining portfolio should be fairly healthy. We estimate the BDC group has a historical cumulative loss rate of approximately 3.9%. Because our base case scenario does not include a recession and the remaining portfolio should be very healthy, we are using a 1% loss rate on the remaining portfolio category. If we separate those BDCs who were around before the great recession, their cumulative loss rate was 5.4%. Given that we have already separated out the riskiest portions of the BDCs portfolios from this category and it is unlikely that the next recession will be as deep as the last one, we are applying a -3% loss rate the remaining portfolio in our downside scenario. Exhibit 9: Historical BDC Loss Rates Source: Company reports, KBW Research Cumulative Loss Rate Full BDC Coverage -3.9% BDCs w ho IPO'ed Before -5.4% the Great Recession Please refer to important disclosures and analyst certification information on pages

12 We want to be clear: there are plenty of different reasonable assumptions that can be made as to the future performance of the U.S economy, energy, and credit markets and the corresponding loss rates in the BDCs portfolios. We have simply provided our base case and downside scenarios. Additionally, we are applying the same loss rates across the BDC space. We are not differentiating the credit quality of the portfolio for each BDC, but are rather applying the same loss rates to each BDC across our coverage depending on the BDCs exposure to a particular higher-risk asset classes we have identified. We fully understand that over time not every asset class will produce the same loss rate across every BDC and some higher-quality BDCs may outperform our assumptions and some lower-quality BDC may underperform out assumptions. That is why it is important for investors to fully understand the quality of management team and historical track of a BDC before investing in a BDC just because it looks undervalued. Appendix Exhibit 10: Percentage of Portfolio Exposure to Each Category Watchlist Non-Accruals Remaining Company Ticker Energy (ex-energy) (ex-energy) CLOs Portfolio Total American Capital ACAS 2% 1% 3% 8% 87% 100% Apollo Investment AINV 13% 5% 0% 3% 79% 100% Ares Capital ARCC 3% 0% 1% 0% 96% 100% BlackRock Capital BKCC 9% 2% 1% 0% 88% 100% Fifth Street Capital FSC 2% 1% 4% 0% 94% 100% FS Investment FSIC 9% 6% 0% 2% 83% 100% Golub Capital GBDC 0% 1% 0% 0% 99% 100% Hercules Tech. Grow th HTGC 0% 1% 3% 0% 96% 100% Medley Capital MCC 5% 7% 2% 0% 86% 100% New Mountain Finance NMFC 8% 4% 0% 0% 89% 100% Pennant Park Investment PNNT 10% 2% 1% 0% 87% 100% Solar Capital SLRC 0% 1% 0% 0% 99% 100% TCP Capital TCPC 3% 3% 0% 0% 95% 100% THL Credit TCRD 6% 0% 2% 2% 91% 100% Triangle Capital TCAP 4% 1% 1% 0% 93% 100% Sub-$300M Market Cap Capitala Finance CPTA 9% 0% 2% 0% 89% 100% Harvest Capital HCAP 0% 1% 1% 1% 97% 100% Horizon Technology Fin. HRZN 0% 0% 0% 0% 100% 100% KCAP Financial KCAP 2% 3% 0% 13% 81% 100% Pennant Park Floating Rate PFLT 1% 0% 0% 0% 98% 100% Source: Company reports, KBW Research. % of Portfolio 4% 2% 1% 1% 91% 100% Please refer to important disclosures and analyst certification information on pages

13 Exhibit 11: Percentage of Book Value Exposure to Each Asset Category Watchlist Non-Accruals Remaining Company Ticker Energy (ex-energy) (ex-energy) CLOs Portfolio Total American Capital ACAS 2% 1% 3% 8% 90% 104% Apollo Investment AINV 23% 9% 0% 6% 140% 178% Ares Capital ARCC 5% 1% 1% 0% 168% 175% BlackRock Capital BKCC 13% 2% 2% 0% 131% 148% Fifth Street Capital FSC 3% 2% 7% 0% 173% 184% FS Investment FSIC 17% 10% 0% 4% 151% 182% Golub Capital GBDC 0% 1% 1% 0% 185% 187% Hercules Tech. Grow th HTGC 0% 2% 5% 0% 160% 167% Medley Capital MCC 10% 14% 4% 0% 170% 198% New Mountain Finance NMFC 14% 6% 0% 0% 161% 181% Pennant Park Investment PNNT 19% 4% 1% 0% 170% 195% Solar Capital SLRC 0% 1% 0% 0% 147% 149% TCP Capital TCPC 4% 4% 0% 0% 155% 164% THL Credit TCRD 10% 0% 3% 4% 163% 180% Triangle Capital TCAP 8% 3% 2% 0% 179% 192% Sub-$300M Market Cap Capitala Finance CPTA 19% 0% 4% 0% 197% 220% Harvest Capital HCAP 0% 2% 1% 2% 155% 160% Horizon Technology Fin. HRZN 0% 0% 0% 0% 156% 157% KCAP Financial KCAP 5% 5% 0% 25% 154% 190% Pennant Park Floating Rate PFLT 2% 0% 0% 0% 123% 125% Source: Company reports, KBW Research. % of Book Value 8% 3% 2% 2% 157% 172% Please refer to important disclosures and analyst certification information on pages

14 Exhibit 12: Asset Category and Total Book Value Writedown in Base Case Source: Company reports, KBW Research. % Book Value Impact Dow nside to Dow nside to Dow nside to Total Dow nside to Watchlist Non-Accruals Dow nside to Remaining BV Company Ticker Energy (ex-energy) (ex-energy) CLO Equity Portfolio Writedow n American Capital ACAS -1% 0% -1% 0% -1% -4% Apollo Investment AINV -14% -2% 0% 0% -1% -17% Ares Capital ARCC -3% 0% -1% 0% -2% -5% BlackRock Capital BKCC -8% 0% -1% 0% -1% -10% Fifth Street Capital FSC -2% 0% -3% 0% -2% -7% FS Investment FSIC -10% -2% 0% 0% -2% -14% Golub Capital GBDC 0% 0% 0% 0% -2% -3% Hercules Tech. Grow th HTGC 0% 0% -2% 0% -2% -4% Medley Capital MCC -6% -3% -2% 0% -2% -12% New Mountain Finance NMFC -8% -1% 0% 0% -2% -11% Pennant Park Investment PNNT -12% -1% 0% 0% -2% -15% Solar Capital SLRC 0% 0% 0% 0% -1% -2% TCP Capital TCPC -3% -1% 0% 0% -2% -5% THL Credit TCRD -6% 0% -1% 0% -2% -9% Triangle Capital TCAP -5% -1% -1% 0% -2% -8% Sub-$300M Market Cap Capitala Finance CPTA -12% 0% -2% 0% -2% -15% Harvest Capital HCAP 0% 0% 0% 0% -2% -2% Horizon Technology Fin. HRZN 0% 0% 0% 0% -2% -2% KCAP Financial KCAP -3% -1% 0% -1% -2% -7% Pennant Park Floating Rate PFLT -1% 0% 0% 0% -1% -2% -5% -1% -1% 0% -2% -8% Please refer to important disclosures and analyst certification information on pages

15 Exhibit 13: Asset Category and Total Book Value Writedown in Downside Case Source: Company reports, KBW Research. % Book Value Impact Dow nside to Dow nside to Dow nside to Total Dow nside to Watchlist Non-Accruals Dow nside to Remaining BV Company Ticker Energy (ex-energy) (ex-energy) CLO Equity Portfolio Writedow n American Capital ACAS -1% 0% -1% -2% -3% -8% Apollo Investment AINV -18% -3% 0% -2% -4% -27% Ares Capital ARCC -4% 0% -1% 0% -5% -10% BlackRock Capital BKCC -11% -1% -1% 0% -4% -16% Fifth Street Capital FSC -2% -1% -3% 0% -5% -11% FS Investment FSIC -14% -3% 0% -1% -5% -22% Golub Capital GBDC 0% 0% 0% 0% -6% -7% Hercules Tech. Grow th HTGC 0% -1% -3% 0% -5% -8% Medley Capital MCC -8% -4% -2% 0% -5% -19% New Mountain Finance NMFC -11% -2% 0% 0% -5% -18% Pennant Park Investment PNNT -15% -1% -1% 0% -5% -22% Solar Capital SLRC 0% 0% 0% 0% -4% -5% TCP Capital TCPC -4% -1% 0% 0% -5% -9% THL Credit TCRD -8% 0% -2% -1% -5% -16% Triangle Capital TCAP -7% -1% -1% 0% -5% -14% Sub-$300M Market Cap Capitala Finance CPTA -15% 0% -2% 0% -6% -23% Harvest Capital HCAP 0% 0% -1% -1% -5% -6% Horizon Technology Fin. HRZN 0% 0% 0% 0% -5% -5% KCAP Financial KCAP -4% -2% 0% -8% -5% -18% Pennant Park Floating Rate PFLT -1% 0% 0% 0% -4% -5% -6% -1% -1% -1% -5% -14% Please refer to important disclosures and analyst certification information on pages

16 Companies Mentioned in This Report American Capital, Ltd. (ACAS: $15.17, Market Perform) Apollo Investment Corp. (AINV: $5.44, Outperform) Ares Capital Corporation (ARCC: $14.59, Outperform) BlackRock Capital Investment Corporation (BKCC: $9.54, Market Perform) Capitala Finance Corp. (CPTA: $11.70, Market Perform) Fifth Street Finance Corp. (FSC: $4.95, Market Perform) FS Investment Corporation (FSIC: $9.15, Market Perform) Golub Capital BDC, Inc. (GBDC: $17.25, Market Perform) Harvest Capital Credit Corporation (HCAP: $12.00, Outperform) Horizon Technology Finance Corporation (HRZN: $11.33, Market Perform) Hercules Capital, Inc. (HTGC: $12.05, Outperform) KCAP Financial, Inc. (KCAP: $3.52, Market Perform) Medley Capital Corporation (MCC: $6.55, Outperform) New Mountain Finance Corporation (NMFC: $12.70, Market Perform) PennantPark Floating Rate Capital Ltd. (PFLT: $11.54, Market Perform) PennantPark Investment Corp (PNNT: $5.99, Market Perform) Solar Capital Ltd. (SLRC: $17.14, Market Perform) Triangle Capital Corporation (TCAP: $20.24, Outperform) TCP Capital Corp. (TCPC: $14.78, Outperform) THL Credit, Inc. (TCRD: $10.82, Outperform) IMPORTANT DISCLOSURES RESEARCH ANALYST CERTIFICATION: I, Ryan Lynch, CFA, CPA, hereby certify that the views expressed in this research report accurately reflect my personal views about the subject company and its securities. I also certify that I have not been, and will not be receiving direct or indirect compensation in exchange for expressing the specific recommendation in this report. Analysts Compensation: The equity research analysts responsible for the preparation of this report receive compensation based upon various factors, including the quality and accuracy of research, client feedback, competitive factors, and overall firm revenues, which include revenues from, among other business units, Institutional Equities and Investment Banking. COMPANY SPECIFIC DISCLOSURES For disclosures pertaining to recommendations or estimates made on a security mentioned in this report, please see the most recently published company report or visit our global disclosures page on our website at or see the section below titled "Disclosure Information" for further information on how to obtain these disclosures. AFFILIATE DISCLOSURES This report has been prepared by Keefe, Bruyette & Woods, Inc. ( KBWI ) and/or its affiliate Stifel Nicolaus Europe Limited ( SNEL ), also trading as Keefe, Bruyette & Woods Europe ( KBW Europe ); collectively KBW. Both KBWI and KBW Europe are affiliates of Stifel Financial Corp. KBWI is regulated by FINRA and the United States Securities and Exchange Commission, is a member of NYSE, and its headquarters is located at 787 7th Avenue, New York, NY Stifel Nicolaus Europe Limited, also trading as Keefe, Bruyette & Woods Europe, is registered in England and Wales, no and its registered office is 4th Floor, 150 Cheapside, London EC2V 6ET. Stifel Nicolaus Europe Limited, also trading as Keefe, Bruyette & Woods Europe, is authorised and regulated by the Financial Conduct Authority (FCA) in the UK entered on the FCA s register, no and is a member of the London Stock Exchange. Disclosures in the Important Disclosures section referencing KBW include one or all affiliated entities unless otherwise specified. Registration of non-u.s. Analysts: Any non-u.s. Research Analyst employed by a non-u.s. affiliate of KBWI contributing to this report is not registered/qualified as research analyst with FINRA and/or the NYSE and may not be an associated person of KBWI and therefore may not be subject to FINRA Rule 2241 or NYSE Rule 472 restrictions on communications with a subject company, public appearances, and trading securities held by a research analyst account. Disclosure Information: For current company-specific disclosures, please write to one of the KBW entities: For U.S. Research: Keefe, Bruyette & Woods, Inc. Research Department, 787 7th Avenue, 4th Floor, New York, NY For European Research: The Compliance Officer, Stifel Nicolaus Europe Limited, 4th Floor, 150 Cheapside, London EC2V 6ET. Or visit our website at KBW has arrangements in place to manage conflicts of interest including information barriers between the Research Department and certain other business groups. As a result, KBW does not disclose certain client relationships with, or compensation received from, such companies in its research reports. Distribution of Ratings/IB Services KBW *IB Serv./Past 12 Mos. Please refer to important disclosures and analyst certification information on pages

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