497 1 v383656_497.htm 497

Filed Pursuant to Rule 497
File No. 333-192770

PROSPECTUS SUPPLEMENT
(to Prospectus dated February 11, 2014)

Fifth Street Finance Corp.

13,250,000 Shares

Common Stock



 

We are offering 13,250,000 shares of our common stock. We are a specialty finance company that lends to and invests in small and mid-sized companies, primarily in connection with investments by private equity sponsors. We invest in securities that are rated below investment grade by rating agencies or that would be rated below investment grade if they were rated. Our investment objective is to maximize our portfolio’s total return by generating current income from our debt investments and capital appreciation from our equity investments.

We are an externally managed, closed-end, non-diversified management investment company that has elected to be treated as a business development company under the Investment Company Act of 1940. We are managed by Fifth Street Management LLC.

Our common stock is listed on the NASDAQ Global Select Market under the symbol “FSC.” As of July 10, 2014 and March 31, 2014, the last reported sale price of our common stock on the NASDAQ Global Select Market was $10.10 and $9.46, respectively. We are required to determine the net asset value per share of our common stock on a quarterly basis. Our net asset value per share of our common stock as of March 31, 2014 was $9.81.



 

Investing in our common stock involves a high degree of risk and should be considered highly speculative. See “Risk Factors” beginning on page 15 of the accompanying prospectus to read about factors you should consider, including the risk of leverage, before investing in our common stock.



 

This prospectus supplement and the accompanying prospectus contain important information about us that a prospective investor should know before investing in our common stock. Please read this prospectus supplement and the accompanying prospectus before investing and keep them for future reference. We file periodic reports, current reports, proxy statements and other information with the Securities and Exchange Commission. This information is available free of charge by contacting us at 10 Bank Street, 12th Floor, White Plains, New York 10606 or by telephone at (914) 286-6800 or on our website at www.fifthstreetfinance.com. Information contained on our website is not incorporated by reference into this prospectus supplement or the accompanying prospectus, and you should not consider that information to be part of this prospectus supplement or the accompanying prospectus. The Securities and Exchange Commission also maintains a website at www.sec.gov that contains information about us.

   
  Per Share   Total
Public offering price   $ 9.95     $ 131,837,500  
Sales load (underwriting discount)(1)   $ 0.14     $ 1,855,000  
Proceeds, before expenses, to us(2)   $ 9.81     $ 129,982,500  

(1) Fifth Street Management LLC has agreed to pay the underwriters a portion of the sales load in an amount equal to $0.8 million, or $0.062 per share (or approximately $0.9 million, or $0.062 per share, if the underwriters’ option to purchase additional shares is exercised in full), which is not reflected in the table above.
(2) We estimate that we will incur approximately $300,000 (or $0.02 per share of the shares sold in this offering) of expenses relating to this offering, resulting in net proceeds, after sales load (underwriting discount) and expenses, to us of approximately $129.7 million.

The underwriters expect to deliver the shares on or about July 15, 2014.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus supplement or the accompanying prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

We have granted the underwriters an option, exercisable at any time until 30 days after the date of this prospectus supplement, to purchase up to 1,987,500 additional shares of our common stock.



 

     
Morgan Stanley    UBS Investment Bank    Deutsche Bank Securities   RBC Capital Markets
SMBC Nikko

The date of this prospectus supplement is July 11, 2014.


 
 

TABLE OF CONTENTS

TABLE OF CONTENTS

PROSPECTUS SUPPLEMENT

PROSPECTUS

 
PROSPECTUS SUMMARY     1  
THE OFFERING     6  
FEES AND EXPENSES     11  
SELECTED FINANCIAL AND OTHER DATA     14  
RISK FACTORS     15  
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS     39  
USE OF PROCEEDS     40  
PRICE RANGE OF COMMON STOCK AND DISTRIBUTIONS     41  
RATIOS OF EARNINGS TO FIXED CHARGES     43  
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS     44  
SENIOR SECURITIES     79  
BUSINESS     80  
PORTFOLIO COMPANIES     91  
MANAGEMENT     102  
PORTFOLIO MANAGEMENT     111  
INVESTMENT ADVISORY AGREEMENT     113  
ADMINISTRATION AGREEMENT     119  
LICENSE AGREEMENT     120  
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS     120  
CONTROL PERSONS AND PRINCIPAL STOCKHOLDERS     122  
DIVIDEND REINVESTMENT PLAN     124  
DESCRIPTION OF OUR CAPITAL STOCK     126  
DESCRIPTION OF OUR DEBT SECURITIES     129  

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ABOUT THIS PROSPECTUS SUPPLEMENT

You should rely only on the information contained in this prospectus supplement and the accompanying prospectus. Neither we nor the underwriters have authorized any other person to provide you with different information from that contained in this prospectus supplement or the accompanying prospectus. If anyone provides you with different or inconsistent information, you should not rely on it. Neither this prospectus supplement nor the accompanying prospectus constitutes an offer to sell, or a solicitation of an offer to buy, any shares of our common stock by any person in any jurisdiction where it is unlawful for that person to make such an offer or solicitation or to any person in any jurisdiction to whom it is unlawful to make such an offer or solicitation. The information contained in this prospectus supplement and the accompanying prospectus is complete and accurate only as of their respective dates, regardless of the time of their delivery or sale of our common stock. Our financial condition, results of operations and/or prospects may have changed since those dates. To the extent required by law, we will amend or supplement the information contained in this prospectus supplement and the accompanying prospectus to reflect any material changes to such information subsequent to the date of this prospectus supplement and the accompanying prospectus and prior to the completion of any offering pursuant to this prospectus supplement and the accompanying prospectus.

This document is in two parts. The first part is this prospectus supplement, which describes the terms of this offering of common stock and also adds to and updates information contained in the accompanying prospectus. The second part is the accompanying prospectus, which gives more general information and disclosure. To the extent the information contained in this prospectus supplement differs from or is additional to the information contained in the accompanying prospectus, you should rely only on the information contained in this prospectus supplement. You should read this prospectus supplement and the accompanying prospectus together with the additional information described under the heading “Available Information” before investing in our common stock.

Forward-Looking Statements

Information contained in this prospectus supplement and the accompanying prospectus may contain forward-looking statements. In addition, forward-looking statements can generally be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “anticipate,” “estimate,” or “continue” or the negative thereof or other variations thereon or comparable terminology. The matters described in “Risk Factors” in the accompanying prospectus and certain other factors noted throughout this prospectus supplement and the accompanying prospectus constitute cautionary statements identifying important factors with respect to any such forward-looking statements, including certain risks and uncertainties that could cause actual results to differ materially from those in such forward-looking statements. The forward-looking statements contained in this prospectus supplement and the accompanying prospectus are excluded from the safe harbor protection provided by Section 27A of the Securities Act of 1933, or the Securities Act. For a list of factors that could affect these forward-looking statements, see “Risk Factors” and “Special Note Regarding Forward-Looking Statements” in the accompanying prospectus.

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PROSPECTUS SUPPLEMENT SUMMARY

This summary highlights some of the information in this prospectus supplement and the accompanying prospectus. It is not complete and may not contain all of the information that is important to you. To understand the terms of the common stock offered pursuant to this prospectus supplement and the accompanying prospectus, you should read the entire prospectus supplement and the accompanying prospectus carefully. Together, these documents describe the specific terms of the shares we are offering. Except as otherwise noted, all information in this prospectus supplement and the accompanying prospectus assumes no exercise of the underwriters’ option to purchase additional shares.

We commenced operations on February 15, 2007 as Fifth Street Mezzanine Partners III, L.P., a Delaware limited partnership. Effective as of January 2, 2008, Fifth Street Mezzanine Partners III, L.P. merged with and into Fifth Street Finance Corp., a Delaware corporation. Unless otherwise noted, the terms “we,” “us,” “our,” the “Company” and “Fifth Street” refer to Fifth Street Mezzanine Partners III, L.P. prior to the merger date and Fifth Street Finance Corp. on and after the merger date. In addition, the terms “Fifth Street Management” and “investment adviser” refer to Fifth Street Management LLC, our external investment adviser.

Fifth Street Finance Corp.

We are a specialty finance company that lends to and invests in small and mid-sized companies, primarily in connection with investments by private equity sponsors. We define small and mid-sized companies as those with annual revenues between $25 million and $250 million. Our investment objective is to maximize our portfolio’s total return by generating current income from our debt investments and capital appreciation from our equity investments. We are externally managed and advised by Fifth Street Management. Fifth Street Management is an affiliate of Fifth Street Capital LLC, a private investment firm founded and managed by our chief executive officer, and Fifth Street Management’s managing partner, Leonard M. Tannenbaum, who has led the investment of over $5 billion in small and mid-sized companies, and the origination of over 180 investment transactions since 1998.

Our investments generally range in size from $10 million to $100 million and are principally in the form of first lien, second lien and subordinated debt investments, which may also include an equity component. We invest in securities that are rated below investment grade by rating agencies or that would be rated below investment grade if they were rated. Below investment grade securities, which are often referred to as “high yield” or “junk,” have predominantly speculative characteristics with respect to the issuer’s capacity to pay interest and repay principal. As of March 31, 2014, 46.7% of our debt portfolio at fair value consisted of debt securities for which issuers were not required to make principal payments until the maturity of such debt securities, which could result in a substantial loss to us if such issuers are unable to refinance or repay their debt at maturity. Although our focus could change we are currently focusing our origination efforts on a prudent mix of first lien, second lien and subordinated loans which we believe will provide superior risk-adjusted returns while maintaining adequate credit protection.

We are an externally managed, closed-end, non-diversified management investment company that has elected to be treated as a business development company under the Investment Company Act of 1940, or the 1940 Act. As a business development company, we are required to comply with regulatory requirements, including limitations on our use of debt. We are permitted to, and expect to, finance our investments through borrowings. However, as a business development company, we are generally only allowed to borrow amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% after such borrowing. The amount of leverage that we employ will depend on our assessment of market conditions and other factors at the time of any proposed borrowing, such as the maturity, covenant package and rate structure of the proposed borrowings, our ability to raise funds through the issuance of shares of our common stock and the risks of such borrowings within the context of our investment outlook. Ultimately, we only intend to use leverage if the expected returns from borrowing to make investments will exceed the cost of such borrowing. As of March 31, 2014, we had a debt to equity ratio (excluding SBA debentures) of 0.84x.

We have also elected to be treated and have qualified, and intend to continue to qualify, for federal income tax purposes as a regulated investment company, or RIC, under Subchapter M of the Internal Revenue Code, or the Code. As a RIC, we generally will not have to pay corporate-level federal income taxes on any

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net ordinary income or realized net capital gains that we distribute to our stockholders if we meet certain source-of-income, distribution and asset diversification requirements.

In addition, we maintain two wholly-owned subsidiaries that are licensed as small business investment companies, or SBICs, and regulated by the Small Business Administration, or the SBA. The SBIC licenses allow us, through our wholly-owned subsidiaries, to issue SBA-guaranteed debentures. We received exemptive relief from the Securities and Exchange Commission, or SEC, to permit us to exclude the debt of our SBIC subsidiaries guaranteed by the SBA from the definition of senior securities in the 200% asset coverage ratio we are required to maintain under the 1940 Act.

The following diagram depicts our organizational structure:

[GRAPHIC MISSING]

(1) The Wells Fargo facility was terminated effective February 21, 2014.

Our Corporate Information

Our principal executive offices are currently located at 10 Bank Street, 12th Floor, White Plains, NY 10606 and our telephone number is (914) 286-6800. We expect to move our principal executive offices to 777 West Putnam Avenue, 3rd Floor, Greenwich, CT 06830 during July 2014. We maintain a website on the Internet at www.fifthstreetfinance.com. Information contained on our website is not incorporated by reference into this prospectus supplement or the accompanying prospectus and you should not consider information contained on our website to be part of this prospectus supplement or the accompanying prospectus.

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Recent Developments

On April 10, 2014, Frank C. Meyer provided notice of his retirement from our Board of Directors and resigned effective as of such date. Our Board of Directors has determined to not fill the vacancy created by Mr. Meyer’s resignation and to decrease the size of the Board of Directors from eight members to seven members.

On July 2, 2014, we invested $50.2 million in SLF JV 1 to facilitate the acquisition of a $156.0 million portfolio of senior secured loans.

On July 7, 2014, our Board of Directors declared a monthly dividend of $0.0917 per share to be paid on September 30, 2014, October 31, 2014 and November 28, 2014 to shareholders of record as of September 15, 2014, October 15, 2014 and November 14, 2014, respectively.

The outstanding balance under the ING facility and Sumitomo facility as of July 9, 2014 was $247.3 million and $51.9 million, respectively.

Our net investment income is estimated to be between $0.24 and $0.26 per share for the quarter ended June 30, 2014.

The preliminary financial data included in this prospectus supplement has been prepared by, and is the responsibility of, our management. PricewaterhouseCoopers LLP has not audited, reviewed, compiled or performed any procedures with respect to the accompanying preliminary financial data. Accordingly, PricewaterhouseCoopers LLP does not express an opinion or any other form of assurance with respect thereto. In addition, these estimates are subject to the completion of our financial closing procedures and are not a comprehensive statement of our financial results for the three months ended June 30, 2014. We advise you that our actual results may differ materially from these estimates as a result of the completion of our financial closing procedures, final adjustments and other developments arising between now and the time that our financial results for the three months ended June 30, 2014 are finalized.

Effective July 14, 2014, our principal executive offices will be located at 777 West Putnam Avenue, 3rd Floor, Greenwich, CT 06830.

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About the Offering

Common stock offered by us    
    13,250,000 shares
Common stock outstanding prior to this offering    
    139,189,449 shares
Common stock to be outstanding after this offering (assuming no exercise of the underwriters’ option to purchase additional shares)    
    152,439,449 shares
Option to purchase additional shares    
    1,987,500 shares
Use of proceeds    
    We intend to use the net proceeds from this offering to repay debt outstanding under one or more of our credit facilities. However, through reborrowing under our credit facilities, we intend to make investments in small and mid-sized companies (including investments made through our SBIC subsidiaries) in accordance with our investment objective and strategies described in this prospectus supplement and the accompanying prospectus and may also use such funds for general corporate purposes, including for working capital requirements. We will invest any idle funds primarily in high quality, short-term debt securities, consistent with our business development company election and our election to be taxed as a RIC, at yields significantly below those we expect to earn on investments in small and mid-sized companies.
NASDAQ Global Select Market symbol    
    FSC
Investment advisory fees    
    Fifth Street Management serves as our investment adviser. We pay Fifth Street Management a fee for its services under the investment advisory agreement, consisting of two components — a base management fee and an incentive fee. The base management fee is calculated at an annual rate of 2% of our gross assets, which includes any borrowings for investment purposes and excludes cash and cash equivalents (as defined in the notes to our Consolidated Financial Statements). The incentive fee consists of two parts. The first part is calculated and payable quarterly in arrears and equals 20% of our “Pre-Incentive Fee Net Investment Income” for the immediately preceding quarter, subject to a preferred return, or “hurdle,” and a “catch up” feature. For this purpose, “Pre-Incentive Fee Net Investment Income” means interest income, dividend income and any other income (including (i) any other fees (other than fees for providing managerial assistance), such as commitment, origination, structuring, diligence and consulting fees or other fees that we receive from portfolio companies, (ii) any gain realized on the extinguishment of our own debt and (iii) any other income of any kind that we are required to distribute to our stockholders in order to maintain our RIC status) accrued during the fiscal quarter, minus our operating expenses for the quarter (including the base management fee, expenses payable under the administration agreement with FSC CT, Inc., and any interest expense and dividends paid on any issued and outstanding preferred stock, but excluding the incentive fee). Pre-Incentive Fee Net Investment Income includes, in the case of

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    investments with a deferred interest feature (such as original issue discount, debt instruments with PIK interest and zero coupon securities), accrued income that we have not yet received in cash. The second part is determined and payable in arrears as of the end of each fiscal year (or upon termination of the investment advisory agreement) and equals 20% of our “Incentive Fee Capital Gains,” which equals our realized capital gains on a cumulative basis from inception through the end of the year, if any, computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the aggregate amount of any previously paid capital gain incentive fee.
Administration agreement    
    FSC CT, Inc. serves as our administrator. We reimburse FSC CT, Inc. the allocable portion of overhead and other expenses incurred by it in performing its obligations under the administration agreement, including rent and our allocable portion of the costs of compensation and related expenses of our chief financial officer and chief compliance officer and their respective staffs.
Distributions    
    We intend to pay monthly distributions to our stockholders out of assets legally available for distribution. Our distributions, if any, will be determined by our Board of Directors.
   
    Our Board of Directors has declared the following upcoming dividends:
   
   

$0.0833 per share, payable on July 31, 2014 to stockholders of record on July 15, 2014;

   
   

$0.0833 per share, payable on August 29, 2014 to stockholders of record on August 15, 2014;

   
   

$0.0917 per share, payable on September 30, 2014 to stockholders of record on September 15, 2014;

   
   

$0.0917 per share, payable on October 31, 2014 to stockholders of record on October 15, 2014; and

   
   

$0.0917 per share, payable on November 28, 2014 to stockholders of record on November 14, 2014.

Taxation    
    We have elected to be treated and have qualified, and we intend to continue to qualify, for federal income tax purposes as a RIC under Subchapter M of the Code. Accordingly, we generally will not pay corporate-level federal income taxes on any net ordinary income or realized net capital gains that we currently distribute to our stockholders. To maintain our RIC tax treatment, we must meet specified source-of-income and asset diversification requirements and distribute annually at least 90% of our net ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any. Depending on the level of taxable income earned in a tax year, we may choose to carry forward taxable income in excess of current year distributions into the next tax year and pay a 4% excise tax on such income. Any such carryover taxable income must be distributed through a dividend declared prior to timely filing the final tax return related to the year which generated such taxable income in order to avoid corporate-level federal income tax on such amounts.

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Risk factors    
    Your investment in our common stock involves a high degree of risk and should be considered highly speculative. See “Risk Factors” in the accompanying prospectus for a discussion of factors you should carefully consider, including the risk of leverage, before investing in our common stock.

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FEES AND EXPENSES

The following table is intended to assist you in understanding the costs and expenses that an investor in our common stock will bear directly or indirectly. We caution you that some of the percentages indicated in the table below are estimates and may vary. Except where the context suggests otherwise, whenever this prospectus supplement contains a reference to fees or expenses paid by “you,” “us” or “Fifth Street,” or that “we” will pay fees or expenses, stockholders will indirectly bear such fees or expenses as investors in us.

 
Stockholder Transaction Expenses:
        
Sales load (as a percentage of offering price)     1.41 %(1) 
Offering expenses (as a percentage of offering price)     0.23 %(2) 
Dividend reinvestment plan fees     —   (3) 
Total stockholder transaction expenses (as a percentage of offering price)     1.64 % 
Annual Expenses (as a percentage of net assets attributable to common stock):
        
Management fees     5.94 %(4) 
Interest payments on borrowed funds (including other costs of servicing and offering debt securities)     3.62 %(5) 
Other expenses     0.83 %(6) 
Total annual expenses     10.39 %(7) 

(1) Represents the underwriting discount and commission with respect to the shares of our common stock sold by us in this offering. Fifth Street Management has agreed to pay the underwriters a portion of the sales load in an amount equal to 0.62%.
(2) The expenses of this offering payable by us (other than the underwriting discount) are estimated to be approximately $300,000. If the underwriters exercise their option to purchase additional shares in full, the offering expenses borne by our stockholders (as a percentage of the offering price) will be approximately 0.20%.
(3) The expenses of administering our dividend reinvestment plan are included in “other expenses.”
(4) Our “management fees” consist of our base management fee and the incentive fees payable under our investment advisory agreement. The base management fee portion of our “management fees” reflected in the table above is 3.51%, which is calculated based on our net assets as of March 31, 2014 of $1.4 billion (rather than our gross assets), as adjusted for the expected proceeds of this offering. Our base management fee under the investment advisory agreement is calculated at an annual rate of 2% of our gross assets, including borrowings for investment purposes and excluding cash and cash equivalents. For purposes of this table, we have assumed gross assets of $2.6 billion, which equals our gross assets as of March 31, 2014, as adjusted for this offering and any other change in borrowings or issuances of securities since such date, and excluding an assumed cash and cash equivalents balance of $20.0 million.

The incentive fee portion of our “management fees” is 2.43%, which is calculated based on our estimated payment of $36.3 million in incentive fees to our investment adviser over the next 12 months. This calculation assumes that annual incentive fees earned by our investment adviser remain consistent with the incentive fees earned by our investment adviser during the six months ended March 31, 2014. The incentive fee consists of two parts. The first part, which is payable quarterly in arrears, is equal to 20% of the excess, if any, of our “Pre-Incentive Fee Net Investment Income” that exceeds a 2% quarterly (8% annualized) hurdle rate, subject to a “catch up” provision measured at the end of each fiscal quarter. The first part of the incentive fee is computed and paid on income that may include interest that is accrued but not yet received in cash. The operation of the first part of the incentive fee for each quarter is as follows:

no incentive fee is payable to the investment adviser in any fiscal quarter in which our Pre-Incentive Fee Net Investment Income does not exceed the hurdle rate of 2% (the “preferred return” or “hurdle”);
100% of our Pre-Incentive Fee Net Investment Income with respect to that portion of such Pre-Incentive Fee Net Investment Income, if any, that exceeds the hurdle rate but is less than or

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equal to 2.5% in any fiscal quarter (10% annualized) is payable to the investment adviser. We refer to this portion of our Pre-Incentive Fee Net Investment Income (which exceeds the hurdle rate but is less than or equal to 2.5%) as the “catch-up.” The “catch-up” provision is intended to provide our investment adviser with an incentive fee of 20% on all of our Pre-Incentive Fee Net Investment Income as if a hurdle rate did not apply when our Pre-Incentive Fee Net Investment Income exceeds 2.5% in any fiscal quarter; and
20% of the amount of our Pre-Incentive Fee Net Investment Income, if any, that exceeds 2.5% in any fiscal quarter (10% annualized) is payable to the investment adviser (once the hurdle is reached and the catch-up is achieved, 20% of all Pre-Incentive Fee Net Investment Income thereafter is allocated to the investment adviser).

The second part of the incentive fee equals 20% of our “Incentive Fee Capital Gains,” which equals our realized capital gains on a cumulative basis from inception through the end of the year, if any, computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the aggregate amount of any previously paid capital gain incentive fees. The second part of the incentive fee is payable, in arrears, at the end of each fiscal year (or upon termination of the investment advisory agreement, as of the termination date).

(5) “Interest payments on borrowed funds (including other costs of servicing and offering debt securities)” represent our estimated annual interest payments and other costs of servicing and offering our debt securities and relate to borrowings under the ING facility, the Sumitomo facility and our SBA-guaranteed debentures, as well as our unsecured convertible notes (the “Convertible Notes”), 6.125% unsecured notes due 2028 (the “2028 Notes”), 5.875% unsecured notes due 2024 (the “2024 Notes”), the 4.875% unsecured notes due 2019 (the “2019 Notes” and together with the 2028 Notes and 2024 Notes, the “Notes”) and secured borrowings (see note 2 to Capitalization table), as well as any future borrowings. Although we expect our borrowings to fluctuate throughout the year, this item is based on estimated average borrowings of approximately $1.2 billion for the next 12 months. We do not expect to offer debt securities in the next 12 months or incur any expenses related thereto. The amount of leverage that we employ at any particular time will depend on, among other things, our Board of Directors’ assessment of market and other factors at the time of any proposed borrowing.
(6) “Other Expenses” are based on estimated amounts for the current fiscal year.
(7) “Total annual expenses” are presented as a percentage of net assets attributable to stockholders because our stockholders bear all of our fees and expenses.

Example

The following example demonstrates the projected dollar amount of total cumulative expenses that would be incurred over various periods with respect to a hypothetical investment in our common stock. In calculating the following expense amounts, we have assumed that our annual operating expenses, including interest expenses, offering expenses and all other costs related to servicing our borrowings, would remain at the levels set forth in the table above, and that you would pay a sales load of 1.50% (the expected underwriting discount to be paid by us with respect to common stock sold by us in this offering).

       
  1 Year   3 Years   5 Years   10 Years
You would pay the following expenses on a $1,000 investment, assuming a 5% annual return   $ 119     $ 321     $ 520     $ 1,000  

The example and the expenses in the tables above should not be considered a representation of our future expenses, and actual expenses may be greater or less than those shown. While the example assumes, as required by the SEC, a 5% annual return, our performance will vary and may result in a return greater or less than 5%. The income portion of our incentive fee under the investment advisory agreement, which, assuming a 5% annual return, would either not be payable or have an insignificant impact on the expense amounts shown above, is not included in the example. If we achieve sufficient returns on our investments, including through the realization of capital gains, to trigger an incentive fee of a material amount, our expenses, and returns to our investors, would be higher. In addition, while the example assumes reinvestment of all distributions at net asset value, participants in our dividend reinvestment plan will receive a number of shares of our common stock, determined by dividing the total dollar amount of the cash distribution payable to a participant by either (i) the greater of (a) the current net asset value per share of our

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common stock and (b) 95% of the market price per share of our common stock at the close of trading on the payment date fixed by our Board of Directors in the event that we use newly issued shares to satisfy the share requirements of the dividend reinvestment plan or (ii) the average purchase price, excluding any brokerage charges or other charges, of all shares of common stock purchased by the administrator of the dividend reinvestment plan in the event that shares are purchased in the open market to satisfy the share requirements of the dividend reinvestment plan, which may be at, above or below net asset value.

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USE OF PROCEEDS

The net proceeds from our sale of the shares of common stock in this offering are estimated to be approximately $129.7 million, or $149.2 million if the underwriters’ option to purchase additional shares is exercised in full, and after deducting the underwriting discount of $0.14 per share and estimated offering expenses of $300,000 payable by us. Fifth Street Management has agreed to pay another approximately $0.8 million of underwriting discounts and commissions in connection with this offering (or approximately $0.9 million if the underwriters fully exercise their option to purchase additional shares).

We intend to use the net proceeds from this offering to repay debt outstanding under one or more of our credit facilities. However, through reborrowing under our credit facilities, we intend to make investments in small and mid-sized companies (including investments made through our SBIC subsidiaries) in accordance with our investment objective and strategies described in this prospectus supplement and the accompanying prospectus and may use such funds for general corporate purposes, including for working capital requirements. As of July 9, 2014 we had $247.3 million outstanding under the ING facility. The ING facility has a maturity date of August 6, 2018 and bears interest at a rate of LIBOR (1-month) plus 2.25% per annum with no LIBOR floor. As of July 9, 2014, we had $51.9 million outstanding under the Sumitomo facility. The Sumitomo facility bears interest at a rate of LIBOR (1-month) plus 2.25% per annum, with no LIBOR floor, permits us to make new borrowings until September 6, 2016, matures on September 16, 2020 and includes an option for a one-year extension. We anticipate that substantially all of the net proceeds from this offering will be used as described above within three months. We will invest any idle funds primarily in high quality, short-term debt securities, consistent with our business development company election and our election to be taxed as a RIC, at yields significantly below those we expect to earn on investments in small and mid-sized companies. The management fee payable by us to our investment adviser will not be reduced while our assets are invested in these securities unless such securities constitute cash and cash equivalents (as defined in the notes to our Consolidated Financial Statements). Our ability to achieve our investment objective may be limited to the extent that the net proceeds from this offering, pending full investment, are held in lower-yielding interest-bearing deposits or other short-term instruments.

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CAPITALIZATION

The following table sets forth our capitalization as of March 31, 2014:

on an actual basis; and
on an as adjusted basis to reflect the sale of 13,250,000 shares of common stock in this offering at a public offering price of $9.95 per share, less the underwriting discount of $0.14 per share and estimated offering expenses of $300,000 payable by us.

   
  As of March 31, 2014 (unaudited)
(amounts in thousands)   Actual   As Adjusted
Cash and cash equivalents   $ 45,396     $ 45,396  
Long-term debt, including current maturities:
                 
Credit facilities payable     576,681     $ 446,998 (1) 
Convertible notes payable     115,000       115,000  
SBA debentures payable     225,000       225,000  
Secured borrowing     47,760       47,760 (2) 
Notes payable     409,878       409,878  
Total long-term debt(2)     1,374,319       1,244,636  
Net assets:
                 
Common stock, $0.01 par value (250,000 shares authorized; 139,138 shares outstanding actual, 152,388 shares outstanding as adjusted)     1,391       1,524  
Additional paid-in-capital     1,510,547       1,640,097  
Net unrealized appreciation on investments     25,084       25,084  
Net realized loss on investments and interest rate swap     (152,925 )      (152,925 ) 
Accumulated overdistributed net investment income     (18,800 )      (18,800 ) 
Total net assets     1,365,297       1,494,980  
Total capitalization   $ 2,739,616       2,739,616  

(1) We intend to use the net proceeds from this offering to repay debt outstanding under one or more of our credit facilities. See “Use of Proceeds.” As of July 9, 2014, we had credit facilities payable in the amount of $299.2 million due to net repayments under our credit facilities in the amount of $277.5 million subsequent to March 31, 2014. This table has not been adjusted to reflect such net borrowings.
(2) Represents secured borrowings at fair value (proceeds of $47,760 at March 31, 2014). The Company follows the guidance in Accounting Standards Codification Topic 860 Transfers and Servicing when accounting for loan participations and other partial loan sales. See Notes 2 and 15 of the accompanying Notes to Consolidated Financial Statements for additional information.

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SELECTED FINANCIAL AND OTHER DATA

The following selected financial data should be read together with our Consolidated Financial Statements and the related notes and the discussion under “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which are included elsewhere in this prospectus. The financial information as of and for the fiscal years ended September 30, 2009, 2010, 2011, 2012 and 2013, set forth below was derived from our audited Consolidated Financial Statements and related notes. The financial information as of and for the six months ended March 31, 2014 and 2013 was derived from our unaudited Consolidated Financial Statements and related notes. In the opinion of management, all adjustments, consisting solely of normal recurring accruals, considered necessary for the fair presentation of financial statements for the interim periods, have been included. The historical financial information below may not be indicative of our future performance. Our results for the interim period may not be indicative of our results for the full year.

             
(dollars in thousands, except per share amounts)   As of and for the Six Months Ended   As of and for the Year Ended
  March 31, 2014   March 31, 2013   September 30, 2013   September 30, 2012   September 30, 2011   September 30, 2010   September 30, 2009
Statement of Operations data:
                                                              
Total investment income   $ 143,462     $ 106,470     $ 221,612     $ 165,116     $ 125,165     $ 70,538     $ 49,828  
Base management fee, net     25,560       15,637       33,427       23,799       19,656       9,275       5,889  
Incentive fee     17,554       13,640       28,158       22,001       16,782       10,756       7,841  
All other expenses     29,897       21,334       45,074       32,882       23,080       7,483       4,736  
Gain on extinguishment of unsecured convertible notes                       1,571       1,480              
Net investment income     70,451       55,859       114,953       88,005       67,127       43,024       31,362  
Unrealized appreciation (depreciation) on interest rate swap                             773       (773 )       
Realized loss on interest rate swap                             (1,335 )             
Net unrealized appreciation (depreciation) on investments     (8,301 )      (6,659 )      13,397       55,974       (7,299 )      (1,054 )      (10,795 ) 
Net unrealized appreciation on secured borrowing     (10 )                                     
Realized gain (loss) on investments     1,666       478       (26,529 )      (64,578 )      (29,059 )      (18,781 )      (14,373 ) 
Net increase in net assets resulting from operations     63,806       49,678       101,821       79,401       30,207       22,416       6,194  
Per share data:
                                                              
Net asset value per common share at period end     9.81       9.90       9.85       9.92       10.07       10.43       10.84  
Market price at period end     9.46       11.02       10.29       10.98       9.32       11.14       10.93  
Net investment income     0.51       0.56       1.04       1.11       1.05       0.95       1.27  
Net realized and unrealized loss on investments and interest rate swap     (0.05 )      (0.07 )      (0.12 )      (0.11 )      (0.58 )      (0.46 )      (1.02 ) 
Net increase in net assets resulting from operations     0.46       0.49       0.92       1.00       0.47       0.49       0.25  
Dividends paid per share     0.49       0.58       1.15       1.18       1.26       0.96       1.20  

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(dollars in thousands, except per share amounts)   As of and for the Six Months Ended   As of and for the Year Ended
  March 31, 2014   March 31, 2013   September 30, 2013   September 30, 2012   September 30, 2011   September 30, 2010   September 30, 2009
Balance Sheet data at period end:
                                                              
Total investments at fair value   $ 2,684,298     $ 1,748,895     $ 1,893,046     $ 1,288,108     $ 1,119,837     $ 563,821     $ 299,611  
Cash and cash equivalents     45,396       38,169       147,359       74,393       67,644       76,765       113,205  
Other assets     62,621       29,283       31,928       26,501       22,236       11,340       3,071  
Total assets     2,792,315       1,816,347       2,072,333       1,389,002       1,209,717       651,926       415,887  
Total liabilities     1,427,018       765,386       703,461       485,432       481,090       82,754       5,331  
Total net assets     1,365,297       1,050,961       1,368,872       903,570       728,627       569,172       410,556  
Other data:
                                                              
Weighted average yield on debt investments(1)     10.8 %      11.4 %       11.1 %      12.0 %      12.4 %      14.0 %      15.7 % 
Number of investments at period end     124       97       99       78       65       38       28  

(1) Weighted average yield is calculated based upon our debt investments at the end of the period.

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in connection with our Consolidated Financial Statements and the notes thereto included in this prospectus supplement.

The information in this section contains forward-looking statements that involve risks and uncertainties. Please see “Risk Factors” and “Special Note Regarding Forward-Looking Statements” in the accompanying prospectus for a discussion of the uncertainties, risks and assumptions associated with these statements.

All amounts are in thousands, except share and per share amounts, percentages and as otherwise indicated.

Overview

We are a specialty finance company that lends to and invests in small and mid-sized companies, primarily in connection with investments by private equity sponsors. Our investment objective is to maximize our portfolio’s total return by generating current income from our debt investments and capital appreciation from our equity investments.

We were formed as a Delaware limited partnership (Fifth Street Mezzanine Partners III, L.P.) on February 15, 2007. Effective as of January 2, 2008, Fifth Street Mezzanine Partners III, L.P. merged with and into Fifth Street Finance Corp. At the time of the merger, all outstanding partnership interests in Fifth Street Mezzanine Partners III, L.P. were exchanged for 12,480,972 shares of common stock in Fifth Street Finance Corp.

On June 17, 2008, we completed an initial public offering of 10,000,000 shares of our common stock at the offering price of $14.12 per share. Our stock was listed on the New York Stock Exchange until November 28, 2011 when we transferred the listing to the NASDAQ Global Select Market, where it continues to trade under the symbol “FSC.”

Market Conditions

The global economy has experienced economic uncertainty in recent years. Economic uncertainty impacts our business in many ways, including changing spreads, structures and purchase multiples as well as the overall supply of investment capital. See “Risk Factors — Risks Relating to Economic Conditions” in the accompanying prospectus.

Despite the economic uncertainty, we believe our deal pipeline remains robust, with high quality transactions backed by private equity sponsors in small to mid-sized companies. As always, we remain cautious in selecting new investment opportunities, and will only deploy capital in deals which we believe are consistent with our disciplined philosophy of pursuing superior risk-adjusted returns.

We expect to grow the investment portfolio by strategically investing in small and mid-sized companies when and where appropriate, as evidenced by our recent investment activities. Although we believe that we currently have sufficient capital available to fund investments, a prolonged period of market disruptions may cause us to reduce the volume of loans we originate and/or fund, which could have an adverse effect on our business, financial condition and results of operations. In this regard, because our common stock has at times traded at a price below our then current net asset value per share and we are limited in our ability to sell our common stock at a price below net asset value per share, we may be limited in our ability to raise equity capital.

Critical Accounting Policies

Basis of Presentation

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make certain estimates and assumptions affecting amounts reported in the Consolidated Financial Statements. We have identified investment valuation and revenue recognition as our most critical accounting estimates. We continuously evaluate our estimates, including those related to the matters described below. These estimates are based on the information that is

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currently available to us and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ materially from those estimates under different assumptions or conditions. A discussion of our critical accounting policies follows.

Investment Valuation

We are required to report our investments that are not publicly traded or for which current market values are not readily available at fair value. The fair value is deemed to be 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.

In accordance with authoritative accounting guidance, we perform detailed valuations of our debt and equity investments on an individual basis, using bond yield, market and income approaches as appropriate. In general, we utilize a bond yield method for the majority of our investments, as long as it is appropriate. If, in our judgment, the bond yield approach is not appropriate, we may use the market approach, income approach, or, in certain cases, an alternative methodology potentially including market quotations, asset liquidation model, expected recovery model or other alternative approaches.

Under the bond yield approach, we use bond yield models to determine the present value of the future cash flow streams of our debt investments. We review various sources of transactional data, including private mergers and acquisitions involving debt investments with similar characteristics, and assess the information in the valuation process.

Under the market approach, we estimate the enterprise value of the portfolio companies in which we invest. There is no one methodology to estimate enterprise value and, in fact, for any one portfolio company, enterprise value is best expressed as a range of fair values from which we derive a single estimate of enterprise value. To estimate the enterprise value of a portfolio company, we analyze various factors, including the portfolio company’s historical and projected financial results. Typically, private companies are valued based on multiples of EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization), cash flows, net income or revenues. We generally require portfolio companies to provide annual audited and quarterly and monthly unaudited financial statements, as well as annual projections for the upcoming fiscal year.

Under the income approach, we generally prepare and analyze discounted cash flow models based on our projections of the future free cash flows of the business.

Our Board of Directors undertakes a multi-step valuation process each quarter in connection with determining the fair value of our investments:

The quarterly valuation process begins with each portfolio company or investment being initially valued by our finance department;
Preliminary valuations are then reviewed and discussed with principals of the investment adviser;
Separately, independent valuation firms are engaged by our Board of Directors to prepare preliminary valuations on a selected basis and submit the reports to us;
Separately, independent valuation firms are engaged by our Board of Directors to prepare preliminary valuations on a selected basis and submit the reports to us;
Separately, independent valuation firms are engaged by our Board of Directors to prepare preliminary valuations on a selected basis and submit the reports to us;
Our finance department compares and contrasts its preliminary valuations to the preliminary valuations of the independent valuation firms;
Our finance department prepares a valuation report for the Audit Committee of our Board of Directors;
The Audit Committee of our Board of Directors is apprised of the preliminary valuations of the independent valuation firms;

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The Audit Committee of our Board of Directors reviews the preliminary valuations with the portfolio managers of the investment adviser, and our finance department responds and supplements the preliminary valuations to reflect any comments provided by the Audit Committee;
The Audit Committee of our Board of Directors makes a recommendation to the Board of Directors regarding the fair value of the investments in our portfolio; and
Our Board of Directors discusses the valuations and determines the fair value of each investment in our portfolio in good faith.

The fair value of all of our investments at March 31, 2014, and September 30, 2013, was determined by our Board of Directors. Our Board of Directors has authorized the engagement of independent valuation firms to provide us with valuation assistance. We will continue to engage independent valuation firms to provide us with assistance regarding our determination of the fair value of selected portfolio securities each quarter; however, our Board of Directors is ultimately and solely responsible for the valuation of our portfolio investments at fair value as determined in good faith pursuant to our valuation policy and a consistently applied valuation process.

We intend to have a portion of the portfolio valued by an independent third party on a quarterly basis, with a substantial portion being valued over the course of each fiscal year. In certain cases, an independent valuation firm may perform a portfolio company valuation which is reviewed and, where appropriate, relied upon by our Board of Directors in determining the fair value of such investment.

The percentages of our portfolio, at fair value, valued by independent valuation firms each period during the current and two preceding fiscal years were as follows:

 
For the quarter ended September 30, 2011     91.2 % 
For the quarter ended December 31, 2011     89.1 % 
For the quarter ended March 31, 2012     87.3 % 
For the quarter ended June 30, 2012     84.3 % 
For the quarter ended September 30, 2012     79.6 % 
For the quarter ended December 31, 2012     79.5 % 
For the quarter ended March 31, 2013     73.8 % 
For the quarter ended June 30, 2013     76.4 % 
For the quarter ended September 30, 2013     86.5 % 
For the quarter ended December 31, 2013     78.9 % 
For the quarter ended March 31, 2014     80.7 % 

As of March 31, 2014 and September 30, 2013, approximately 96.1% and 91.3%, respectively, of our total assets represented investments in portfolio companies valued at fair value.

Revenue Recognition

Interest and Dividend Income

Interest income, adjusted for accretion of original issue discount, or OID, is recorded on the accrual basis to the extent that such amounts are expected to be collected. We stop accruing interest on investments when it is determined that interest is no longer collectible. Distributions from portfolio companies are recorded as dividend income when the distribution is received.

Fee Income

We receive a variety of fees in the ordinary course of business including servicing, advisory, structuring and prepayment fees, which are classified as fee income and recognized as they are earned.

We have also structured exit fees across certain of our portfolio investments to be received upon the future exit of those investments. Exit fees are payable upon the exit of a debt security. These fees are to be paid to us upon the sooner to occur of (i) a sale of the borrower or substantially all of the assets of the borrower, (ii) the maturity date of the loan or (iii) the date when full prepayment of the loan occurs. The receipt of such fees is contingent upon the occurrence of one of the events listed above for each of the

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investments. A percentage of these fees is included in net investment income over the life of the loan. As of March 31, 2014, we had structured $4.5 million in aggregate exit fees across six portfolio investments upon the future exit of those investments.

Payment-in-Kind (PIK) Interest

Our loans typically contain contractual PIK interest provisions. The PIK interest, which represents contractually deferred interest added to the loan balance that is generally due at the end of the loan term, is generally recorded on the accrual basis to the extent such amounts are expected to be collected. We generally cease accruing PIK interest if there is insufficient value to support the accrual or if we do not expect the portfolio company to be able to pay all principal and interest due. Our decision to cease accruing PIK interest involves subjective judgments and determinations based on available information about a particular portfolio company, including whether the portfolio company is current with respect to its payment of principal and interest on its loans and debt securities; monthly and quarterly financial statements and financial projections for the portfolio company; our assessment of the portfolio company’s business development success, including product development, profitability and the portfolio company’s overall adherence to its business plan; information obtained by us in connection with periodic formal update interviews with the portfolio company’s management and, if appropriate, the private equity sponsor; and information about the general economic and market conditions in which the portfolio company operates. Based on this and other information, we determine whether to cease accruing PIK interest on a loan or debt security. Our determination to cease accruing PIK interest on a loan or debt security is generally made well before our full write-down of such loan or debt security. In addition, if it is subsequently determined that we will not be able to collect any previously accrued PIK interest, the fair value of our loans or debt securities would decline by the amount of such previously accrued, but uncollectible, PIK interest.

For a discussion of risks we are subject to as a result of our use of PIK interest in connection with our investments, see “Risk Factors — Risks Relating to Our Business and Structure — We may have difficulty paying our required distributions if we recognize income before or without receiving cash representing such income,” “— We may in the future choose to pay dividends in our own stock, in which case you may be required to pay tax in excess of the cash you receive” and “— Our incentive fee may induce our investment adviser to make speculative investments” in the accompanying prospectus. In addition, if it is subsequently determined that we will not be able to collect any previously accrued PIK interest, the fair value of our loans or debt securities would decline by the amount of such previously accrued, but uncollectible, PIK interest. The accrual of PIK interest on our debt investments increases the recorded cost basis of these investments in our Consolidated Financial Statements and, as a result, increases the cost basis of these investments for purposes of computing the capital gains incentive fee payable by us to our investment adviser.

To maintain our status as a RIC, PIK income must be paid out to our stockholders in the form of dividends even though we have not yet collected the cash and may never collect the cash relating to the PIK interest. Accumulated PIK interest was $28.9 million and represented 1.1% of the fair value of our portfolio of investments as of March 31, 2014 and $23.9 million or 1.3% as of September 30, 2013. The net increases in loan balances as a result of contractual PIK arrangements are separately identified in our Consolidated Statements of Cash Flows.

Portfolio Composition

Our investments principally consist of loans, purchased equity investments and equity grants in privately-held companies. Our loans are typically secured by a first, second or subordinated lien on the assets of the portfolio company and generally have terms of up to six years (but an expected average life of between three and four years). We are currently focusing our origination efforts on a prudent mix of senior secured and subordinated loans which we believe will provide superior risk-adjusted returns while maintaining adequate credit protection. The mix may change over time based on market conditions and management’s view of where the best risk-adjusted returns are available.

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A summary of the composition of our investment portfolio at cost and fair value as a percentage of total investments is shown in the following tables:

   
  March 31, 2014   September 30, 2013
Cost:
                 
Senior secured debt     83.97 %      78.33 % 
Subordinated debt     10.74       15.76  
Collateralized loan obligation (“CLO”) debt     1.11       1.59  
Purchased equity     3.72       3.86  
Equity grants     0.20       0.23  
Limited partnership interests     0.26       0.23  
Total     100.00 %      100.00 % 
Fair Value:
                 
Senior secured debt     83.24 %      77.53 % 
Subordinated debt     10.71       15.65  
CLO debt     1.10       1.56  
Purchased equity     4.45       4.74  
Equity grants     0.25       0.30  
Limited partnership interests     0.25       0.22  
Total     100.00 %      100.00 % 

The industry composition of our portfolio at cost and fair value as a percentage of total investments was as follows:

   
  March 31, 2014   September 30, 2013
Cost:
                 
Healthcare services     14.83 %      14.35 % 
Education services     10.57       8.97  
Oil & gas equipment services     9.07       4.06  
Diversified support services     8.63       9.15  
Advertising     6.84       8.28  
Internet software & services     5.97       5.87  
Specialized finance     4.74       6.68  
IT consulting & other services     3.60       4.43  
Leisure facilities     3.21       0.00  
Pharmaceuticals     3.07       2.77  
Airlines     3.07       1.32  
Healthcare equipment     2.90       3.79  
Specialty stores     2.51       3.68  
Human resources & employment services     2.37       3.49  
Data processing & outsourced services     2.26       1.25  
Industrial machinery     2.00       0.91  
Apparel, accessories & luxury goods     1.63       1.53  
Construction & engineering     1.26       1.75  
Air freight & logistics     1.25       0.90  
Leisure products     1.22       2.54  
Household products     1.12       1.60  
Asset management & custody banks     1.11       1.59  
Consumer electronics     1.08       0.00  

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  March 31, 2014   September 30, 2013
Home improvement retail     1.07       1.54  
Application software     0.83       0.69  
Food distributors     0.67       0.99  
Research & consulting services     0.65       0.94  
Other diversified financial services     0.51       2.25  
Specialty chemicals     0.51       1.08  
Security & alarm services     0.50       0.71  
Healthcare technology     0.49        
Multi-sector holdings     0.26       0.20  
Systems software     0.12        
Auto parts & equipment     0.06       1.78  
Thrift & mortgage finance     0.02       0.01  
Environmental & facilities services           0.47  
Construction materials           0.39  
Building products           0.04  
Total     100.00 %      100.00 % 
Fair Value:
                 
Healthcare services     14.89 %      14.47 % 
Education services     10.54       8.90  
Oil & gas equipment services     8.98       4.04  
Diversified support services     8.58       9.04  
Advertising     6.77       8.18  
Internet software & services     6.07       6.03  
Specialized finance     4.91       6.57  
IT consulting & other services     3.60       4.43  
Leisure facilities     3.20       0.01  
Airlines     3.17       1.29  
Pharmaceuticals     3.12       2.79  
Healthcare equipment     2.92       3.74  
Specialty stores     2.46       3.65  
Human resources & employment services     2.37       3.45  
Data processing & outsourced services     2.27       1.23  
Industrial machinery     2.02       0.96  
Construction & engineering     1.54       2.16  
Apparel, accessories & luxury goods     1.44       1.46  
Leisure products     1.26       2.64  
Asset management & custody banks     1.10       1.56  
Household products     1.10       1.55  
Home improvement retail     1.08       1.51  
Consumer electronics     1.07        
Air freight & logistics     0.93       0.74  
Application software     0.85       0.71  
Food distributors     0.67       0.99  
Research & consulting services     0.65       0.95  
Other diversified financial services     0.51       2.22  
Specialty chemicals     0.50       1.06  
Security & alarm services     0.49       0.69  

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  March 31, 2014   September 30, 2013
Healthcare technology     0.48        
Multi-sector holdings     0.24       0.21  
Systems software     0.12        
Auto parts & equipment     0.08       1.90  
Thrift & mortgage finance     0.02       0.01  
Environmental & facilities services           0.43  
Construction materials           0.39  
Building products           0.04  
Total     100.00 %      100.00 % 

Portfolio Asset Quality

We employ a ranking system to assess and monitor the credit risk of our investment portfolio. We rank all investments on a scale from 1 to 4. The system is intended to reflect the performance of the borrower’s business, the collateral coverage of the loan, and other factors considered relevant to making a credit judgment. We have determined that there should be an individual ranking assigned to each tranche of securities in the same portfolio company where appropriate. This may arise when the perceived risk of loss on the investment varies significantly between tranches due to their respective seniority in the capital structure.

Investment Ranking 1 is used for investments that are performing above expectations and/or capital gains are expected.
Investment Ranking 2 is used for investments that are performing substantially within our expectations, and whose risks remain materially consistent with the potential risks at the time of the original or restructured investment. All new investments are initially ranked 2.
Investment Ranking 3 is used for investments that are performing below our expectations and for which risk has materially increased since the original or restructured investment. The portfolio company may be out of compliance with debt covenants and may require closer monitoring. To the extent that the underlying agreement has a PIK interest provision, investments with a ranking of 3 are generally those on which we are not accruing PIK interest.
Investment Ranking 4 is used for investments that are performing substantially below our expectations and for which risk has increased substantially since the original or restructured investment. Investments with a ranking of 4 are those for which some loss of principal is expected and are generally those on which we are not accruing cash interest.

The following table shows the distribution of our investments on the 1 to 4 investment ranking scale at fair value as of March 31, 2014 and September 30, 2013:

           
  March 31, 2014   September 30, 2013
Investment Ranking   Fair
Value
  % of Portfolio   Leverage Ratio   Fair
Value
  % of Portfolio   Leverage
Ratio
1   $ 112,521       4.20 %      2.67     $ 122,769       6.49 %      2.67  
2     2,557,461       95.27       4.79       1,770,277       93.51       4.70  
3     14,316       0.53       NM (1)                   
4                                    
Total   $ 2,684,298       100.00 %      4.69     $ 1,893,046       100.00 %      4.57  

(1) Due to operating performance this ratio is not measurable and, as a result, is excluded from the total portfolio calculation.

We may from time to time modify the payment terms of our investments, either in response to current economic conditions and their impact on certain of our portfolio companies or in accordance with tier pricing provisions in certain loan agreements. As of March 31, 2014, we had modified the payment terms of our investments in 17 portfolio companies. Such modified terms may include increased PIK interest provisions

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and reduced cash interest rates. These modifications, and any future modifications to our loan agreements, may limit the amount of interest income that we recognize from the modified investments, which may, in turn, limit our ability to make distributions to our stockholders.

Loans and Debt Securities on Non-Accrual Status

As of March 31, 2014 and September 30, 2013, there were no investments on which we had stopped accruing cash and/or PIK interest and OID income. As of March 31, 2013, we had stopped accruing cash and/or PIK interest on three investments, including two that had not paid all of their scheduled cash interest payments for the period ended March 31, 2013.

The percentages of our debt investments at cost and fair value by accrual status for the periods ended March 31, 2014, September 30, 2013 and March 31, 2013 were as follows:

                       
                       
  March 31, 2014   September 30, 2013   March 31, 2013
     Cost   % of Debt Portfolio   Fair
Value
  % of Debt Portfolio   Cost   % of Debt Portfolio   Fair
Value
  % of Debt Portfolio   Cost   % of Debt Portfolio   Fair
Value
  % of Debt Portfolio
Accrual   $ 2,547,864       100.00 %    $ 2,551,371       100.00 %    $ 1,779,201       100.00 %    $ 1,793,463       100.00 %    $ 1,645,425       97.43 %    $ 1,666,161       98.83 % 
PIK non-accrual                                                     6,203       0.37              
Cash non-accrual(1)                                                     37,224       2.20       19,733       1.17  
Total   $ 2,547,864       100.00 %    $ 2,551,371       100.00 %    $ 1,779,201       100.00 %    $ 1,793,463       100.00 %    $ 1,688,852       100.00 %    $ 1,685,894       100.00 % 

(1) Cash non-accrual status is inclusive of PIK and other noncash income, where applicable.

The non-accrual status of our portfolio investments as of March 31, 2014, September 30, 2013 and March 31, 2013 was as follows:

     
  March 31, 2014   September 30, 2013   March 31, 2013
Coll Materials Group LLC(1)                 Cash non-accrual  
Eagle Hospital Physicians, Inc.                 Cash non-accrual  
Trans-Trade, Inc. – Term Loan B(1)                 PIK non-accrual  

(1) We did not hold this investment at March 31, 2014 or September 30, 2013. See “— Discussion and Analysis of Results and Operations — Comparison of the three and six months ended March 31, 2014 and March 31, 2013 — Realized Gain (Loss) on Investments” for a discussion of our recent realization events.

Income non-accrual amounts for the three and six months ended March 31, 2014 and March 31, 2013 were as follows:

       
  Three months ended March 31, 2014   Three months ended March 31, 2013   Six months ended March 31, 2014   Six months ended March 31, 2013
Cash interest income   $     $ 1,008     $     $ 1,008  
PIK interest income           191             615  
OID income                        
Total   $     $ 1,199     $     $ 1,623  

Discussion and Analysis of Results and Operations

Results of Operations

The principal measure of our financial performance is the net increase (decrease) in net assets resulting from operations, which includes net investment income (loss), net realized gain (loss) and net unrealized appreciation (depreciation). Net investment income is the difference between our income from interest, dividends, fees, and other investment income and total expenses. Net realized gain (loss) on investments is the difference between the proceeds received from dispositions of portfolio investments and their stated costs. Net unrealized appreciation (depreciation) is the net change in the fair value of our investment portfolio.

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Comparison of the three and six months ended March 31, 2014 and March 31, 2013

Total Investment Income

Total investment income includes interest income on our investments, fee income and other investment income. Fee income consists principally of loan and arrangement fees, administrative fees, unused fees, amendment fees, advisory fees, structuring fees, exit fees, prepayment fees and waiver fees. Other investment income consists primarily of dividend income received from certain of our equity investments.

Total investment income for the three months ended March 31, 2014 and March 31, 2013 was $72.1 million and $54.7 million, respectively. For the three months ended March 31, 2014, this amount primarily consisted of $59.5 million of interest income from portfolio investments (which included $5.5 million of PIK interest) and $12.5 million of fee income. For the three months ended March 31, 2013, this amount primarily consisted of $41.7 million of interest income from portfolio investments (which included $4.0 million of PIK interest) and $11.9 million of fee income.

Total investment income for the six months ended March 31, 2014 and March 31, 2013 was $143.5 million and $106.5 million, respectively. For the six months ended March 31, 2014, this amount primarily consisted of $113.6 million of interest income from portfolio investments (which included $11.1 million of PIK interest) and $29.6 million of fee income. For the six months ended March 31, 2013, this amount primarily consisted of $80.3 million of interest income from portfolio investments (which included $7.8 million of PIK interest) and $24.7 million of fee income.

The increase in our total investment income for the three and six months ended March 31, 2014 as compared to the three and six months ended March 31, 2013 was primarily attributable to higher average levels of outstanding debt investments, which was principally due to a net increase of 22 debt investments in our portfolio and fee income related to investment activity, partially offset by amortization repayments received on our debt investments and a decrease in the weighted average yield of our debt investments from 11.4% to 10.8% during the year-over-year period.

Expenses

Expenses for the three months ended March 31, 2014 and March 31, 2013 were $37.9 million and $25.4 million, respectively. Expenses increased for the three months ended March 31, 2014, as compared to the three months ended March 31, 2013 by $12.5 million. This was due primarily to increases in:

Base management fee, which was attributable to a 53.5% increase in the fair value of the investment portfolio due to an increase in net investment fundings in the year-over-year period;
Incentive fee, which was attributable to a 17.7% increase in pre-incentive fee net investment income for the year-over-year period; and
Interest expense, which was attributable to a 96.4% increase in the weighted average debt outstanding for the year-over-year period.

Expenses for the six months ended March 31, 2014 and March 31, 2013 were $73.0 million and $50.6 million, respectively. Expenses increased for the six months ended March 31, 2014 as compared to the six months ended March 31, 2013 by $22.4 million. This was due primarily to increases in:

Base management fee, which was attributable to the increase in the fair value of the investment portfolio discussed above;
Incentive fee, which was attributable to a 26.6% increase in pre-incentive fee net investment income for the year-over-year period; and
Interest expense, which was attributable to a 84.9% increase in the weighted average debt outstanding for the year-over-year period.

Gain on Extinguishment of Convertible Notes

During the six months ended March 31, 2014 and March 31, 2013, we did not repurchase any of our unsecured convertible notes (“Convertible Notes”) in the open market. In previous periods, we recognized a gain on repurchasing Convertible Notes at a discount. Because this net gain was included in the amount that

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must be distributed to our stockholders in order for us to maintain our RIC status and is classified as a component of net investment income in our Consolidated Statements of Operations, such net gain was included in “Pre-Incentive Fee Net Investment Income” for purposes of the payment of the income incentive fee to the investment adviser under our investment advisory agreement. Paying an incentive fee on this type of net gain is permissible under our investment advisory agreement, but because such a fee was not specifically detailed in the investment advisory agreement, we obtained the approval of our Board of Directors to pay such fees. This type of net gain, and corresponding income incentive fee, may occur again in the future. Any repurchase of our 2019 Notes, 2024 Notes or 2028 Notes (as each is defined below) at a discount will be treated in a similar manner.

Net Investment Income

As a result of the $17.4 million increase in total investment income and the $12.5 million increase in total expenses, net investment income for the three months ended March 31, 2014 reflected a $4.9 million, or 16.8%, increase compared to the three months ended March 31, 2013.

As a result of the $37.0 million increase in total investment income and the $22.4 million increase in total expenses, net investment income for the six months ended March 31, 2014 reflected a $14.6 million, or 26.1%, increase compared to the six months ended March 31, 2013.

Realized Gain (Loss) on Investments

Realized gain (loss) is the difference between the proceeds received from dispositions of portfolio investments and their stated costs. Realized losses may also be recorded in connection with our determination that certain investments are considered worthless securities and/or meet the conditions for loss recognition per the applicable tax rules.

During the six months ended March 31, 2014, we recorded investment realization events, including the following:

In October and December 2013, we received payments of $3.2 million from Stackpole Powertrain International Holding, L.P. related to the sale of our equity investment. A realized gain of $2.2 million was recorded on this transaction;
In October 2013, we received a payment of $8.9 million from Harden Healthcare, LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on the transaction;
In October 2013, we received a payment of $4.0 million from Capital Equipment Group, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on the transaction. We also received an additional $0.9 million in connection with the sale of our common equity investment, realizing a gain of $0.6 million;
In November 2013, we received a payment of $10.0 million from IG Investments Holdings, LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on the transaction;
In November 2013, we received a payment of $15.7 million from CTM Group, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on the transaction;
In December 2013, we received a payment of $0.4 million in connection with the exit of our debt investment in Saddleback Fence and Vinyl Products, Inc. A realized loss of $0.3 million was recorded on this transaction;
In December 2013, we received a payment of $7.2 million from Western Emulsions, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on the transaction;
In January 2014, we received a payment of $5.1 million from BMC Acquisition, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on the transaction;

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In February 2014, we received a payment of $17.8 million from Ikaria Acquisition, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on the transaction;
In February 2014, we received a payment of $30.8 million from Dexter Axle Company in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on the transaction;
In March 2014, we received a payment of $9.9 million from Vestcom International, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on the transaction; and
During the six months ended March 31, 2014, we received payments of $231.3 million in connection with syndications of debt investments to other investors and sales of debt investments in the open market and recorded a net realized loss of $1.0 million.

During the six months ended March 31, 2013, we recorded investment realization events, including the following:

In October 2012, we received a payment of $4.2 million from Rail Acquisition Corp. in full satisfaction of all obligations related to the revolving loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
In October 2012, we received a payment of $5.4 million from Bojangles in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
In October 2012, we received a payment of $21.9 million from Blue Coat Systems, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
In October 2012, we received a payment of $9.9 million from Insight Pharmaceuticals LLC in full satisfaction of all obligations related to the first lien loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
In November 2012, we received a payment of $8.5 million from SolutionSet, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
In January 2013, we received a cash payment of $30.2 million from NDSSI Holdings, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction. The Company also received an additional $3.0 million in connection with the sale of its preferred equity investment (including accumulated PIK of $0.9 million), realizing a gain or $0.1 million;
In January 2013, we received a cash payment of $44.6 million from Welocalize, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
In February 2013, we received a cash payment of $14.6 million from Edmentum, Inc. in full satisfaction of all obligations under the first lien loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;
In February 2013, we received a cash payment of $7.1 million from Advanced Pain Management Holdings, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
In March 2013, we received a cash payment of $10.0 million from eResearch Technology, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction;

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In March 2013, we received a cash payment of $15.0 million from AdVenture Interactive Corp. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;
In March 2013, we received a cash payment of $19.5 million from idX Corporation in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par (plus additional fees) and no realized gain or loss was recorded on this transaction; and
During the six months ended March 31, 2013, we received payments of $54.0 million in connection with partial sales of debt investments in the open market and recorded a net realized gain of $0.5 million.

Net Unrealized Appreciation (Depreciation) on Investments

Net unrealized appreciation or depreciation is the net change in the fair value of our investments during the reporting period, including the reversal of previously recorded unrealized appreciation or depreciation when gains or losses are realized.

During the three months ended March 31, 2014, we recorded net unrealized depreciation of $2.6 million. This consisted of $8.6 million of net unrealized depreciation on debt investments, offset by $5.9 million of net unrealized appreciation on equity investments and $0.1 million of net reclassifications to realized losses (resulting in unrealized appreciation). During the three months ended March 31, 2013, we recorded net unrealized appreciation of $2.7 million. This consisted of $6.1 million of net unrealized appreciation on equity investments, offset by $1.4 million of net reclassifications to realized gains on debt and equity investments (resulting in unrealized depreciation) and $2.0 million of net unrealized depreciation on debt investments.

During the six months ended March 31, 2014, we recorded net unrealized depreciation of $8.3 million. This consisted of $10.4 million of net unrealized depreciation on debt investments and $2.6 million of net reclassifications to realized gains (resulting in unrealized depreciation), offset by $4.7 million of net unrealized appreciation on equity investments. During the six months ended March 31, 2013, we recorded net unrealized depreciation of $6.7 million. This consisted of $15.1 million of net unrealized depreciation on debt investments and $2.3 million of net reclassifications to realized gains (resulting in unrealized depreciation), offset by $10.7 million of net unrealized appreciation on equity investments.

Financial Condition, Liquidity and Capital Resources

Cash Flows

We have a number of alternatives available to fund the growth of our investment portfolio and our operations, including, but not limited to, raising equity, increasing debt and funding from operational cash flow. Additionally, we may reduce investment size by syndicating a portion of any given transaction. We intend to fund our future distribution obligations through operating cash flow or with funds obtained through future equity and debt offerings or credit facilities, as we deem appropriate.

For the six months ended March 31, 2014, we experienced a net decrease in cash and cash equivalents of $102.0 million. During that period, we used $756.2 million of cash in operating activities, primarily for the funding of $1.1 billion of investments and net revolvers, partially offset by $322.3 million of principal payments, PIK payments and sale proceeds received and $70.5 million of net investment income. During the same period, cash provided by financing activities was $654.2 million, primarily consisting of $244.4 million of proceeds from the issuance of our 4.875% unsecured notes due 2019 (the “2019 Notes”), $43.3 million of net borrowings of SBA debentures, $47.8 million of proceeds from secured borrowings and $388.7 million of net borrowings under our credit facilities, partially offset by $62.2 million of cash distributions paid and $4.8 million of repurchases of common stock under our dividend reinvestment program.

For the six months ended March 31, 2013, we experienced a net decrease in cash and cash equivalents of $36.2 million. During that period, we used $406.8 million of cash in operating activities, primarily for the funding of $735.5 million of investments and net revolvers, partially offset by $280.0 million of principal payments, PIK payments and sale proceeds received and $55.9 million of net investment income. During the same period, cash provided by financing activities was $370.6 million, primarily consisting of $151.7 million of proceeds from issuances of our common stock, $31.8 million of net borrowings of SBA debentures,

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$172.3 million of net borrowings under our credit facilities and $75.0 million of proceeds from the issuance of the 5.875% unsecured notes due 2024 (the “2024 Notes”), partially offset by $53.6 million of cash distributions paid, $0.5 million of offering costs paid and $3.4 million of deferred financing costs paid.

As of March 31, 2014, we had $45.3 million in cash and cash equivalents, portfolio investments (at fair value) of $2.68 billion, $19.0 million of interest and fees receivable, $225.0 million of SBA debentures payable, $576.7 million of borrowings outstanding under our credit facilities, $115.0 million of Convertible Notes payable, $409.9 million of unsecured notes payable, $47.8 million of secured borrowings and unfunded commitments of $221.4 million.

As of September 30, 2013, we had $147.4 million in cash and cash equivalents, portfolio investments (at fair value) of $1.89 billion, $10.4 million of interest and fees receivable, $181.8 million of SBA debentures payable, $188.0 million of borrowings outstanding under our credit facilities, $115.0 million of Convertible Notes payable, $161.3 million of unsecured notes payable and unfunded commitments of $149.5 million.

Other Sources of Liquidity

We intend to continue to generate cash primarily from cash flows from operations, including interest earned, future borrowings (including secured borrowings relating to senior secured debt investments) and future offerings of securities. Our primary use of funds is investments in our targeted asset classes and cash distributions to holders of our common stock. We maintain a universal shelf registration statement that allows for the public offering and sale of our common stock, debt securities and warrants to purchase such securities. We may from time to time issue securities pursuant to the shelf registration statement or otherwise pursuant to private offerings. The issuance of debt or equity securities will depend on future market conditions, funding needs and other factors and there can be no assurance that any such issuance will occur or be successful. In the future, we may also securitize a portion of our investments in first and second lien senior loans or unsecured debt or other assets. To securitize loans, we would likely create a wholly-owned subsidiary and contribute a pool of loans to the subsidiary. We would then sell interests in the subsidiary on a non-recourse basis to purchasers and we would retain all or a portion of the equity in the subsidiary. We may also from time to time enter into joint ventures with other investors to invest in similar securities.

Although we expect to fund the growth of our investment portfolio through the net proceeds from future equity offerings, including our dividend reinvestment plan, and issuances of senior securities or future borrowings to the extent permitted by the 1940 Act, our plans to raise capital may not be successful. In this regard, because our common stock has at times traded at a price below our then-current net asset value per share and we are limited in our ability to sell our common stock at a price below net asset value per share, we may be limited in our ability to raise equity capital.

In addition, we intend to distribute between 90% and 100% of our taxable income to our stockholders in order to satisfy the requirements applicable to RICs under Subchapter M of the Internal Revenue Code. See “Regulated Investment Company Status and Dividends” below. Consequently, we may not have the funds or the ability to fund new investments, to make additional investments in our portfolio companies, to fund our unfunded commitments to portfolio companies or to repay borrowings. In addition, the illiquidity of our portfolio investments may make it difficult for us to sell these investments when desired and, if we are required to sell these investments, we may realize significantly less than their recorded value.

As a business development company, under the 1940 Act, we generally are not permitted to incur indebtedness unless immediately after such borrowing we have an asset coverage for total borrowings of at least 200% (i.e., the amount of debt may not exceed 50% of the value of our assets). This requirement limits the amount that we may borrow. As of March 31, 2014, we were in compliance with this requirement. The amount of leverage that we employ will depend on our assessment of market conditions and other factors at the time of any proposed borrowing, such as the maturity, covenant package and rate structure of the proposed borrowings, our ability to raise funds through the issuance of shares of our common stock and the risks of such borrowings within the context of our investment outlook. Ultimately, we only intend to use leverage if the expected returns from borrowing to make investments will exceed the cost of such borrowing. To fund growth in our investment portfolio in the future, we anticipate needing to raise additional capital from various sources, including the equity markets and the securitization or other debt-related markets, which may or may not be available on favorable terms, if at all.

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Significant Capital Transactions That Have Occurred Since October 1, 2012

The following table reflects the dividend distributions per share that our Board of Directors has declared, including shares issued under our DRIP, on our common stock since October 1, 2012:

           
Date Declared   Record Date   Payment Date   Amount per Share   Cash Distribution   DRIP Shares Issued   DRIP Shares Value
January 14, 2013     March 15, 2013       March 29, 2013     $ 0.0958     $ 9.1 million       100,802     $ 1.1 million  
January 14, 2013     April 15, 2013       April 30, 2013       0.0958       10.3 million       111,167        1.2 million  
January 14, 2013     May 15, 2013       May 31, 2013       0.0958       10.3 million       127,152        1.3 million  
May 6, 2013     June 14, 2013       June 28, 2013       0.0958       10.5 million       112,821        1.1 million  
May 6, 2013     July 15, 2013       July 31, 2013       0.0958       10.2 million       130,944        1.3 million  
May 6, 2013     August 15, 2013       August 30, 2013       0.0958       10.3 million       136,052        1.3 million  
August 5, 2013     September 13, 2013       September 30, 2013       0.0958       10.3 million       135,027        1.3 million  
August 5, 2013     October 15, 2013       October 31, 2013       0.0958       11.9 million       142,320        1.4 million  
August 5, 2013     November 15, 2013       November 29, 2013       0.0958       12.0 million       145,063 (1)       1.4 million  
November 21, 2013     December 13, 2013       December 30, 2013       0.05        6.3 million       69,291 (1)       0.6 million  
November 21, 2013     January 15, 2014       January 31, 2014       0.0833       10.5 million       114,033 (1)       1.1 million  
November 21, 2013     February 14, 2014       February 28, 2014       0.0833       10.5 million       110,486 (1)       1.1 million  
November 21, 2013     March 14, 2014       March 31, 2014       0.0833       11.0 million       64,748 (1)       0.6 million  
November 21, 2013     April 15, 2014       April 30, 2014       0.0833       10.5 million       120,604 (1)       1.1 million  
November 21, 2013     May 15, 2014       May 30, 2014       0.0833                             
February 6, 2014     June 16, 2014       June 30, 2014       0.0833                             
February 6, 2014     July 15, 2014       July 31, 2014       0.0833                             
February 6, 2014     August 15, 2014       August 29, 2014       0.0833                             

(1) Shares were purchased on the open market and distributed.

The following table reflects share transactions that occurred from October 1, 2012 through March 31, 2014:

       
Date   Transaction   Shares   Public Offering Price   Gross Proceeds
December 7, 2012     Public offering(1)       14,725,000     $ 10.68     $ 157.3 million  
April 2013     Public offering(1)       14,435,253       10.85        156.5 million  
September 26, 2013     Public offering(1)       17,643,000       10.31        181.9 million  

(1) Includes the underwriters' partial exercise of their over-allotment option.

Borrowings

SBIC Subsidiaries

Through wholly-owned subsidiaries, we sought and obtained two licenses from the SBA to operate SBIC subsidiaries. Specifically, on February 3, 2010, our wholly-owned subsidiary, Fifth Street Mezzanine Partners IV, L.P. (“FSMP IV”), received a license, effective February 1, 2010, from the SBA to operate as an SBIC under Section 301(c) of the Small Business Investment Act of 1958. On May 15, 2012, our wholly-owned subsidiary, Fifth Street Mezzanine Partners V, L.P. (“FSMP V”), received a license, effective May 10, 2012, from the SBA to operate as an SBIC. SBICs are designated to stimulate the flow of private equity capital to eligible small businesses. Under SBA regulations, SBICs may make loans to eligible small businesses and invest in the equity securities of small businesses.

The SBIC licenses allow our SBIC subsidiaries to obtain leverage by issuing SBA-guaranteed debentures, subject to the issuance of a capital commitment by the SBA and other customary procedures. SBA-guaranteed debentures are non-recourse, interest only debentures with interest payable semi-annually and have a ten year maturity. The principal amount of SBA-guaranteed debentures is not required to be paid prior to maturity but may be prepaid at any time without penalty. The interest rate of SBA-guaranteed debentures is fixed at the time of issuance at a market-driven spread over U.S. Treasury Notes with 10-year maturities.

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SBA regulations currently limit the amount that an SBIC subsidiary may borrow to a maximum of $150 million when it has at least $75 million in regulatory capital. Affiliated SBICs are permitted to issue up to a combined maximum amount of $225 million when they have at least $112.5 million in regulatory capital. As of March 31, 2014, FSMP IV had $75 million in regulatory capital and $150 million in SBA-guaranteed debentures outstanding, which had a fair value of $133.3 million. These debentures bear interest at a weighted average interest rate of 3.567% (excluding the SBA annual charge), as follows:

     
Rate Fix Date   Debenture Amount   Fixed Interest Rate   SBA Annual Charge
September 2010   $ 73,000       3.215 %      0.285 % 
March 2011     65,300       4.084       0.285  
September 2011     11,700       2.877       0.285  

As of March 31, 2014, FSMP V had $37.5 million in regulatory capital and $75.0 million in SBA-guaranteed debentures outstanding, which had a fair value of $62.8 million. These debentures bear interest at a weighted average interest rate of 2.835% (excluding the SBA annual charge), as follows:

     
Rate Fix Date   Debenture Amount   Fixed Interest Rate   SBA Annual Charge
March 2013   $ 31,750       2.351 %      0.804 % 
March 2014     43,250       3.191       0.804  

As a result, the $225.0 million of SBA-guaranteed debentures held by our SBIC subsidiaries carry a weighted average interest rate of 3.323% as of March 31, 2014.

For the three and six months ended March 31, 2014, we recorded interest expense of $2.0 million and $4.0 million, respectively, related to the SBA-guaranteed debentures of both SBIC subsidiaries.

We have received exemptive relief from the SEC to permit us to exclude the debt of our SBIC subsidiaries guaranteed by the SBA from the definition of senior securities in the 200% asset coverage test under the 1940 Act. This allows us increased flexibility under the 200% asset coverage test by permitting us to borrow up to $225 million more than we would otherwise be able to absent the receipt of this exemptive relief.

Wells Fargo Facility

On November 16, 2009, we and Fifth Street Funding, LLC, a consolidated wholly-owned bankruptcy remote special purpose subsidiary (“Funding”), entered into a Loan and Servicing Agreement (“Wells Agreement”) with respect to a revolving credit facility (as subsequently amended, the “Wells Fargo facility”) with Wells Fargo Bank, National Association (“Wells Fargo”), as successor to Wachovia Bank, National Association (“Wachovia”), Wells Fargo Securities, LLC, as administrative agent, each of the additional institutional and conduit lenders party thereto from time to time, and each of the lender agents party thereto from time to time.

The Wells Fargo facility permitted up to $150 million of borrowings (subject to collateral requirements) with an accordion feature allowing for future expansion of the facility up to a total of $250 million, and borrowings under the facility bore interest at a rate equal to LIBOR (1-month) plus 2.50% per annum, with no LIBOR floor. The maturity date of the Wells Fargo facility was April 25, 2016.

The Wells Fargo facility provided for the issuance from time to time of letters of credit for the benefit of our portfolio companies. The letters of credit were subject to certain restrictions, including a borrowing base limitation and an aggregate sublimit of $15.0 million.

In connection with the Wells Fargo facility, we concurrently entered into (i) a Purchase and Sale Agreement with Funding, pursuant to which we have sold and will continue to sell to Funding certain loan assets we have originated or acquired, or will originate or acquire and (ii) a Pledge Agreement with Wells Fargo, pursuant to which we pledged all of our equity interests in Funding as security for the payment of Funding’s obligations under the Wells Agreement and other documents entered into in connection with the Wells Fargo facility. Funding was formed for the sole purpose of entering into the Wells Fargo facility and has no other operations.

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The Wells Agreement and related agreements governing the Wells Fargo facility required both Funding and us to, among other things (i) make representations and warranties regarding the collateral as well as each of our businesses, (ii) agree to certain indemnification obligations and (iii) comply with various covenants, servicing procedures, limitations on acquiring and disposing of assets, reporting requirements and other customary requirements for similar credit facilities, including a prepayment penalty in certain cases. The Wells Fargo facility agreements also included usual and customary default provisions such as the failure to make timely payments under the facility, a change in control of Funding, and the failure by Funding or us to materially perform under the Wells Agreement and related agreements governing the facility, which, if not complied with, could have accelerated repayment under the facility.

The Wells Fargo facility was secured by all of the assets of Funding, and all of our equity interest in Funding. We used the Wells Fargo facility to fund a portion of our loan origination activities and for general corporate purposes. Each loan origination under the facility was subject to the satisfaction of certain conditions. Our borrowings under the Wells Fargo facility bore interest at a weighted average interest rate of 2.686% for the six months ended March 31, 2014. For the three and six months ended March 31, 2014, we recorded interest expense of $1.0 million and $1.8 million, respectively related to the Wells Fargo facility.

Effective February 21, 2014, we, together with Funding, terminated the Wells Fargo facility. In connection therewith, the Amended and Restated Loan and Servicing Agreement and other related documents governing the Wells Fargo facility were also terminated. As such, we have no borrowing capacity under the Wells Fargo facility as of March 31, 2014. Upon termination of the Wells Fargo facility, we accelerated the $0.7 million remaining unamortized fee balance into interest expense.

ING Facility

On May 27, 2010, we entered into a secured syndicated revolving credit facility (as subsequently amended, the “ING facility”) pursuant to a Senior Secured Revolving Credit Agreement (“ING Credit Agreement”) with certain lenders party thereto from time to time and ING Capital LLC, as administrative agent. The ING facility allows us to request letters of credit from ING Capital LLC, as the issuing bank.

As of March 31, 2014, the ING facility permitted up to $650 million of borrowings with an accordion feature allowing for future expansion of the facility up to a total of $800 million, and borrowings under the facility bore interest at a rate equal to LIBOR (1-, 2-, 3- or 6-month, at our option) plus 2.25% per annum, with no LIBOR floor, assuming we maintain our current credit rating. Unless extended, the period during which we may make and reinvest borrowings under the facility will expire on August 6, 2017 and the maturity date of the facility is August 6, 2018.

The ING facility is secured by substantially all of our assets, as well as the assets of our wholly-owned subsidiary, FSFC Holdings, Inc. (“Holdings”), and our indirect wholly-owned subsidiary, Fifth Street Fund of Funds LLC (“Fund of Funds”), subject to certain exclusions for, among other things, equity interests in any of our SBIC subsidiaries and equity interests in Funding and Fifth Street Funding II, LLC (which is defined and discussed below) as further set forth in a Guarantee, Pledge and Security Agreement (“ING Security Agreement”) entered into in connection with the ING Credit Agreement, among FSFC Holdings, Inc., ING Capital LLC, as collateral agent, and us. None of our SBIC subsidiaries, Funding or Fifth Street Funding II, LLC is party to the ING facility and their respective assets have not been pledged in connection therewith. The ING facility provides that we may use the proceeds and letters of credit under the facility for general corporate purposes, including acquiring and funding leveraged loans, mezzanine loans, high-yield securities, convertible securities, preferred stock, common stock and other investments.

Pursuant to the ING Security Agreement, Holdings and Fund of Funds guaranteed the obligations under the ING Security Agreement, including our obligations to the lenders and the administrative agent under the ING Credit Agreement. Additionally, we pledged our entire equity interest in Holdings and Holdings pledged its entire equity interest in Fund of Funds to the collateral agent pursuant to the terms of the ING Security Agreement.

The ING Credit Agreement and related agreements governing the ING facility required Holdings, Fund of Funds and us to, among other things (i) make representations and warranties regarding the collateral as well as each of our businesses, (ii) agree to certain indemnification obligations, and (iii) agree to comply with

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various affirmative and negative covenants and other customary requirements for similar credit facilities. The ING facility documents also include usual and customary default provisions such as the failure to make timely payments under the facility, the occurrence of a change in control, and the failure by us to materially perform under the ING Credit Agreement and related agreements governing the facility, which, if not complied with, could accelerate repayment under the facility, thereby materially and adversely affecting our liquidity, financial condition and results of operations.

Each loan or letter of credit originated under the ING facility is subject to the satisfaction of certain conditions. We cannot be assured that we will be able to borrow funds under the ING facility at any particular time or at all. As of March 31, 2014, we had $515.3 million of borrowings outstanding under the ING facility, which had a fair value of $515.3 million. Our borrowings under the ING facility bore interest at a weighted average interest rate of 2.691% for the six months ended March 31, 2014. For the three and six months ended March 31, 2014, we recorded interest expense of $3.6 million and $6.4 million, respectively, related to the ING facility.

Sumitomo Facility

On September 16, 2011, Fifth Street Funding II, LLC, a consolidated wholly-owned bankruptcy remote, special purpose subsidiary (“Funding II”), entered into a Loan and Servicing Agreement (“Sumitomo Agreement”) with respect to a seven-year credit facility (“Sumitomo facility”) with Sumitomo Mitsui Banking Corporation (“SMBC”), an affiliate of Sumitomo Mitsui Financial Group, Inc., as administrative agent, and each of the lenders from time to time party thereto.

As of March 31, 2014, the Sumitomo facility permitted up to $125 million of borrowings (subject to collateral requirements), and borrowings under the facility bore interest at a rate of LIBOR (1-month) plus 2.25% per annum, with no LIBOR floor. Unless extended, the period during which we may make and reinvest borrowings under the facility will expire on September 16, 2016, and the maturity date of the facility is September 16, 2020, with an option for a one-year extension.

In connection with the Sumitomo facility, we concurrently entered into a Purchase and Sale Agreement with Funding II, pursuant to which we will sell to Funding II certain loan assets we have originated or acquired, or will originate or acquire.

The Sumitomo Agreement and related agreements governing the Sumitomo facility required both Funding II and us to, among other things (i) make representations and warranties regarding the collateral as well as each of our businesses, (ii) agree to certain indemnification obligations, and (iii) comply with various covenants, servicing procedures, limitations on acquiring and disposing of assets, reporting requirements and other customary requirements for similar credit facilities, including a prepayment penalty in certain cases. The Sumitomo facility agreements also include usual and customary default provisions such as the failure to make timely payments under the facility, a change in control of Funding II, and the failure by Funding II or us to materially perform under the Sumitomo Agreement and related agreements governing the Sumitomo facility, which, if not complied with, could accelerate repayment under the facility, thereby materially and adversely affecting our liquidity, financial condition and results of operations. Funding II was formed for the sole purpose of entering into the Sumitomo facility and has no other operations.

The Sumitomo facility is secured by all of the assets of Funding II. Each loan origination under the facility is subject to the satisfaction of certain conditions. We cannot be assured that Funding II will be able to borrow funds under the Sumitomo facility at any particular time or at all. As of March 31, 2014, we had $61.4 million of borrowings outstanding under the Sumitomo facility. Our borrowings under the Sumitomo facility bore interest at a weighted average interest rate of 2.514% for the six months ended March 31, 2014. For the three and six months ended March 31, 2014, we recorded interest expense of $0.6 million and $1.1 million, respectively, related to the Sumitomo facility.

As of March 31, 2014, except for assets that were funded through our SBIC subsidiaries, substantially all of our assets were pledged as collateral under the ING facility or the Sumitomo facility. With respect to the assets funded through our SBIC subsidiaries, the SBA, as a creditor, will have a superior claim to the SBIC subsidiaries’ assets over our stockholders.

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The following table describes significant financial covenants with which we must comply under the ING facility on a quarterly basis. The Sumitomo facility does not require us to comply with significant financial covenants:

       
Facility   Financial Covenant   Description   Target Value   Reported Value(1)
ING facility   Minimum shareholders’ equity   Net assets shall not be less than the greater of (a) 40% of total assets; and (b) $825 million plus 50% of the aggregate net proceeds of all sales of equity interests after August 6, 2013   $913 million   $1,370 million
     Asset coverage ratio   Asset coverage ratio shall not be less than 2.10:1   2.10:1   2.63:1
     Interest coverage ratio   Interest coverage ratio shall not be less than 2.50:1   2.50:1   5.22:1

(1) As contractually required, we report financial covenants based on the last filed quarterly or annual report, in this case our Form 10-Q for the quarter ended December 31, 2013. We were also in compliance with all financial covenants under these credit facilities based on the financial information contained in our Form 10-Q for the quarter ended March 31, 2014.

We and our SBIC subsidiaries are also subject to certain regulatory requirements relating to our borrowings. For a discussion of such requirements, see “Business — Regulation — Business Development Company Regulations” and “— Small Business Investment Company Regulations” in the accompanying prospectus.

The following table reflects material credit facility and SBA debenture transactions that have occurred since October 1, 2009. Amounts available and drawn are as of March 31, 2014.

               
               
Facility   Date   Transaction   Total Facility Amount   Upfront fee Paid   Total Facility Availability   Amount Drawn   Remaining Availability   Interest Rate
Wells Fargo facility   11/16/2009   Entered into credit facility   $50 million   $0.8 million                  LIBOR + 4.00%
     5/26/2010   Expanded credit facility   100 million   0.9 million                  LIBOR + 3.50%
     2/28/2011   Amended credit facility   100 million   0.4 million                  LIBOR + 3.00%
     11/30/2011   Amended credit facility   100 million                    LIBOR + 2.75%
     4/23/2012   Amended credit facility   150 million   1.2 million                  LIBOR + 2.75%
     6/20/2013   Amended credit facility   150 million                 LIBOR(3) + 2.50%
     2/21/2014   Terminated credit facility               
ING facility   5/27/2010   Entered into credit facility    90 million   0.8 million                  LIBOR + 3.50%
     2/22/2011   Expanded credit facility   215 million   1.6 million                  LIBOR + 3.50%
     7/8/2011   Expanded credit facility   230 million   0.4 million                  LIBOR + 3.00%/3.25%
     2/29/2012   Amended credit facility   230 million   1.5 million                  LIBOR + 3.00%/3.25%
     11/30/2012   Amended credit facility   385 million   2.2 million                  LIBOR + 2.75%
     1/7/2013   Expanded credit facility   445 million   0.3 million                  LIBOR + 2.75%
     8/6/2013   Amended credit facility   480 million   1.8 million                  LIBOR + 2.25%
     10/22/2013   Expanded credit facility   605 million   0.7 million                  LIBOR + 2.25%
     1/30/2014   Expanded credit facility   650 million   0.1 million   $650 million   $515 million   $135 million   LIBOR(4) + 2.25%

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Facility   Date   Transaction   Total Facility Amount   Upfront fee Paid   Total Facility Availability   Amount Drawn   Remaining Availability   Interest Rate
SBA   2/16/2010   Received capital
commitment
   75 million   0.8 million                    
     9/21/2010   Received capital
commitment
  150 million   0.8 million                    
     7/23/2012   Received capital
commitment
  225 million   0.8 million   225 million   225 million     3.323%(2)
Sumitomo facility   9/16/2011   Entered into credit facility   200 million   2.5 million                  LIBOR + 2.25%
     10/30/2013   Reduced credit facility   125 million     73 million(1)   61 million   12 million   LIBOR(3) + 2.25%

(1) Availability to increase upon our decision to further collateralize the facility
(2) Weighted average interest rate of locked debentures (excludes the SBA annual charge)
(3) 1-month
(4) 1-, 2-, 3- or 6-month, at our option

Convertible Notes

On April 12, 2011, we issued $152 million unsecured convertible notes (“Convertible Notes”), including $2 million issued to Leonard M. Tannenbaum, our Chief Executive Officer. The Convertible Notes were issued pursuant to an Indenture, dated April 12, 2011 (the “Indenture”), between us and Deutsche Bank Trust Company Americas, as trustee (the “Trustee”).

The Convertible Notes mature on April 1, 2016 (the “Maturity Date”), unless previously converted or repurchased in accordance with their terms. The Convertible Notes bear interest at a rate of 5.375% per annum payable semiannually in arrears on April 1 and October 1 of each year. The Convertible Notes are our unsecured obligations and rank senior in right of payment to our existing and future indebtedness that is expressly subordinated in right of payment to the Convertible Notes; equal in right of payment to our existing and future unsecured indebtedness that is not so subordinated; effectively junior in right of payment to any of our secured indebtedness (including existing unsecured indebtedness that we later secure) to the extent of the value of the assets securing such indebtedness; and structurally junior to all existing and future indebtedness (including trade payables) incurred by our subsidiaries or financing vehicles.

Prior to the close of business on the business day immediately preceding January 1, 2016, holders may convert their Convertible Notes only under certain circumstances set forth in the Indenture, such as during specified periods when our shares of common stock trade at more than 110% of the then applicable conversion price or the Convertible Notes trade at less than 98% of their conversion value. On or after January 1, 2016 until the close of business on the business day immediately preceding the Maturity Date, holders may convert their Convertible Notes at any time. Upon conversion, we will deliver shares of our common stock. The conversion rate was initially, and currently is, 67.7415 shares of common stock per $1,000 principal amount of Convertible Notes (equivalent to a conversion price of approximately $14.76 per share of common stock). The conversion rate is subject to customary anti-dilution adjustments, including for any cash dividends or distributions paid on shares of our common stock in excess of a monthly dividend of $0.1066 per share, but will not be adjusted for any accrued and unpaid interest. In addition, if certain corporate events occur prior to the Maturity Date, the conversion rate will be increased for converting holders. Based on the current conversion rate, the maximum number of shares of common stock that would be issued upon conversion of the $115.0 million Convertible Notes outstanding at March 31, 2014 is 7,790,273. If we deliver shares of common stock upon a conversion at the time our net asset value per share exceeds the conversion price in effect at such time, our stockholders may incur dilution. In addition, our stockholders will experience dilution in their ownership percentage of our common stock upon our issuance of common stock in connection with the conversion of our Convertible Notes and any dividends paid on our common stock will also be paid on shares issued in connection with such conversion after such issuance. The shares of common stock issued upon a conversion are not subject to registration rights.

We may not redeem the Convertible Notes prior to maturity. No sinking fund is provided for the Convertible Notes. In addition, if certain corporate events occur in respect to us, holders of the Convertible Notes may require us to repurchase for cash all or part of their Convertible Notes at a repurchase price equal

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to 100% of the principal amount of the Convertible Notes to be repurchased, plus accrued and unpaid interest through, but excluding, the required repurchase date.

The Indenture contains certain covenants, including covenants requiring us to provide financial information to the holders of the Convertible Notes and the Trustee if we cease to be subject to the reporting requirements of the Securities Exchange Act of 1934. These covenants are subject to limitations and exceptions that are described in the Indenture. We may repurchase the Convertible Notes in accordance with the 1940 Act and the rules promulgated thereunder. Any Convertible Notes repurchased by us may, at our option, be surrendered to the Trustee for cancellation, but may not be reissued or resold by us. Any Convertible Notes surrendered for cancellation will be promptly canceled and no longer outstanding under the Indenture. During the six months ended March 31, 2014 or March 31, 2013, we did not repurchase any of the Convertible Notes in the open market.

For the three and six months ended March 31, 2014, we recorded interest expense of $1.7 million and $3.4 million, respectively, related to the Convertible Notes.

As of March 31, 2014, there were $115.0 million Convertible Notes outstanding, which had a fair value of $122.6 million.

2019 Notes

On February 26, 2014, we issued $250.0 million in aggregate principal amount of our 4.875% unsecured notes due 2019 (the “2019 Notes”) for net proceeds of $244.6 million after deducting original issue discount of $1.4 million, underwriting commissions and discounts of $3.7 million and offering costs of $0.3 million.

The 2019 Notes were issued pursuant to an indenture, dated April 30, 2012, as supplemented by the third supplemental indenture, dated February 26, 2014 (collectively, the “2019 Notes Indenture”), between us and the Trustee. The 2019 Notes are our general unsecured obligations that rank senior in right of payment to all of our existing and future indebtedness that is expressly subordinated in right of payment to the 2019 Notes. The 2019 Notes rank equally in right of payment with all of our existing and future liabilities that are not so subordinated. The 2019 Notes effectively rank junior to any of our secured indebtedness (including unsecured indebtedness that we later secure) to the extent of the value of the assets securing such indebtedness. The 2019 Notes rank structurally junior to all existing and future indebtedness (including trade payables) incurred by our subsidiaries, financing vehicles or similar facilities.

Interest on the 2019 Notes is paid semi-annually on March 1 and September 1, at a rate of 4.875% per annum. The 2019 Notes mature on March 1, 2019 and may be redeemed in whole or in part at any time or from time to time at our option prior to maturity.

The 2019 Notes Indenture contains certain covenants, including covenants requiring our compliance with (regardless of whether we are subject to) the restrictions on dividends, distributions and purchase of capital stock set forth in Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act, as well as covenants requiring us to provide financial information to the holders of the 2019 Notes and the Trustee if we cease to be subject to the reporting requirements of the Securities Exchange Act of 1934. These covenants are subject to limitations and exceptions that are described in the 2019 Notes Indenture. We may repurchase the 2019 Notes in accordance with the 1940 Act and the rules promulgated thereunder. In addition, holders of the 2019 Notes can require us to repurchase the 2019 Notes at 100% of their principal amount upon the occurrence of a certain change of control events as described in the 2019 Notes Indenture. The 2019 Notes are issued in minimum denominations of $2,000 and integral multiples of $1,000 in excess thereof. During the six months ended March 31, 2014, we did not repurchase any of the 2019 Notes in the open market.

For the three and six months ended March 31, 2014, we recorded interest expense of $1.2 million related to the 2019 Notes.

As of March 31, 2014, there were $250.0 million of 2019 Notes outstanding, which had a fair value of $256.0 million.

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2024 Notes

On October 18, 2012, we issued $75.0 million in aggregate principal amount of our 5.875% 2024 Notes for net proceeds of $72.5 million after deducting underwriting commissions of $2.2 million and offering costs of $0.3 million.

The 2024 Notes were issued pursuant to an indenture, dated April 30, 2012, as supplemented by the first supplemental indenture, dated October 18, 2012 (collectively, the “2024 Notes Indenture”), between us and the Trustee. The 2024 Notes are our unsecured obligations and rank senior in right of payment to our existing and future indebtedness that is expressly subordinated in right of payment to the 2024 Notes; equal in right of payment to our existing and future unsecured indebtedness that is not so subordinated; effectively junior in right of payment to any of our secured indebtedness (including existing unsecured indebtedness that we later secure) to the extent of the value of the assets securing such indebtedness; and structurally junior to all existing and future indebtedness (including trade payables) incurred by our subsidiaries or financing vehicles. Interest on the 2024 Notes is paid quarterly in arrears on January 30, April 30, July 30 and October 30, at a rate of 5.875% per annum. The 2024 Notes mature on October 30, 2024 and may be redeemed in whole or in part at any time or from time to time at our option on or after October 30, 2017. The 2024 Notes are listed on the New York Stock Exchange under the trading symbol “FSCE” with a par value of $25.00 per share.

The 2024 Notes Indenture contains certain covenants, including covenants requiring our compliance with (regardless of whether we are subject to) the asset coverage requirements set forth in Section 18(a)(1)(A) as modified by Section 61(a)(1) of the 1940 Act and with the restrictions on dividends, distributions and purchase of capital stock set forth in Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act, as well as covenants requiring us to provide financial information to the holders of the 2024 Notes and the Trustee if we cease to be subject to the reporting requirements of the Securities Exchange Act of 1934. These covenants are subject to limitations and exceptions that are described in the 2024 Notes Indenture. We may repurchase the 2024 Notes in accordance with the 1940 Act and the rules promulgated thereunder. Any 2024 Notes repurchased by us may, at our option, be surrendered to the Trustee for cancellation, but may not be reissued or resold by us. Any 2024 Notes surrendered for cancellation will be promptly canceled and no longer outstanding under the 2024 Notes Indenture. During the six months ended March 31, 2014 and March 31, 2013, we did not repurchase any of the 2024 Notes in the open market.

For the three and six months ended March 31, 2014, we recorded interest expense of $1.2 million and $2.3 million, respectively, related to the 2024 Notes.

As of March 31, 2014, there were $75.0 million 2024 Notes outstanding, which had a fair value of $74.0 million.

2028 Notes

In April and May 2013, we issued $86.3 million in aggregate principal amount of our 6.125% unsecured notes due 2028 (the “2028 Notes”) for net proceeds of $83.4 million after deducting underwriting commissions of $2.6 million and offering costs of $0.3 million. The proceeds included the underwriters’ full exercise of their overallotment option.

The 2028 Notes were issued pursuant to an indenture, dated April 30, 2012, as supplemented by the second supplemental indenture, dated April 4, 2013 (collectively, the “2028 Notes Indenture”), between us and the Trustee. The 2028 Notes are our unsecured obligations and rank senior in right of payment to our existing and future indebtedness that is expressly subordinated in right of payment to the 2028 Notes; equal in right of payment to our existing and future unsecured indebtedness that is not so subordinated; effectively junior in right of payment to any of our secured indebtedness (including existing unsecured indebtedness that we later secure) to the extent of the value of the assets securing such indebtedness; and structurally junior to all existing and future indebtedness (including trade payables) incurred by our subsidiaries or financing vehicles. Interest on the 2028 Notes is paid quarterly in arrears on January 30, April 30, July 30 and October 30, at a rate of 6.125% per annum. The 2028 Notes mature on April 30, 2028 and may be redeemed in whole or in part at any time or from time to time at our option on or after April 30, 2018. The 2028 Notes are listed on the NASDAQ Global Select Market under the trading symbol “FSCFL” with a par value of $25.00 per share.

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The 2028 Notes Indenture contains certain covenants, including covenants requiring our compliance with (regardless of whether we are subject to) the asset coverage requirements set forth in Section 18(a)(1)(A) as modified by Section 61(a)(1) of the 1940 Act, as well as covenants requiring us to provide financial information to the holders of the 2028 Notes and the Trustee if we cease to be subject to the reporting requirements of the Securities Exchange Act of 1934. These covenants are subject to limitations and exceptions that are described in the 2028 Notes Indenture. We may repurchase the 2028 Notes in accordance with the 1940 Act and the rules promulgated thereunder. Any 2028 Notes repurchased by us may, at our option, be surrendered to the Trustee for cancellation, but may not be reissued or resold by us. Any 2028 Notes surrendered for cancellation will be promptly canceled and no longer outstanding under the 2028 Notes Indenture. During the six months ended March 31, 2014, we did not repurchase any of the 2028 Notes in the open market.

For the three and six months ended March 31, 2014, we recorded interest expense of $1.3 million and $2.7 million, respectively, related to the 2028 Notes.

As of March 31, 2014, there were $86.3 million of 2028 Notes outstanding, which had a fair value of $82.6 million.

Secured Borrowings

We follow the guidance in ASC 860 when accounting for loan participations and other partial loan sales. Such guidance requires a participation or other partial loan sale to meet the definition of a “participating interest,” as defined in the guidance, in order for sale treatment to be allowed. Participations or other partial loan sales which do not meet the definition of a participating interest remain on our Consolidated Statement of Assets and Liabilities and the proceeds are recorded as a secured borrowing until the definition is met. Secured borrowings are carried at fair value to correspond with the related investments, which are carried at fair value.

As of March 31, 2014, secured borrowings at fair value totaled $47.8 million and the fair value of the loans that are associated with these secured borrowings was $136.4 million. These secured borrowings were the result of the completion of partial loan sales of two senior secured debt investments totaling $47.8 million during the three months ended March 31, 2014 that did not meet the definition of a participating interest. As a result, sale treatment was not allowed and these partial loan sales were treated as secured borrowings. During the six months ended March 31, 2014, there were no repayments on secured borrowings.

As of March 31, 2014, there were $47.8 million of secured borrowings outstanding, which had a fair value of $47.8 million.

For the three and six months ended March 31, 2014, we recorded interest expense of $0.2 million related to the secured borrowings.

Total interest expense for the three and six months ended March 31, 2014 was $12.8 million and $23.0 million, respectively. Total interest expense for the three and six months ended March 31, 2013 was $7.8 million and $14.9 million, respectively.

Off-Balance Sheet Arrangements

We may be a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of our portfolio companies. As of March 31, 2014, our only off-balance sheet arrangements consisted of $221.4 million of unfunded commitments, which was comprised of $195.7 million to provide debt financing to certain of our portfolio companies and $25.7 million related to unfunded limited partnership interests. As of September 30, 2013, our only off-balance sheet arrangements consisted of $149.5 million, which was comprised of $126.8 million to provide debt financing to certain of our portfolio companies and $22.7 million related to unfunded limited partnership interests. Such commitments are subject to our portfolio companies’ satisfaction of certain financial and nonfinancial covenants and involve, to varying degrees, elements of credit risk in excess of the amount recognized in our Consolidated Statement of Assets and Liabilities and are not reflected on our Consolidated Statement of Assets and Liabilities.

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A summary of the composition of unfunded commitments (consisting of revolvers, term loans and limited partnership interests) as of March 31, 2014 and September 30, 2013 is shown in the table below:

   
  March 31, 2014   September 30, 2013
Lift Brands Holdings, Inc.   $ 16,000     $  
BMC Software Finance, Inc.     15,000        
Desert NDT, LLC     15,000        
Drugtest, Inc.     10,900       20,000  
RP Crown Parent, LLC     10,000       9,000  
P2 Upstream Acquisition Co.     10,000        
Deltek, Inc.     9,880       8,667  
Pingora MSR Opportunity Fund I, LP (limited partnership interest)     9,337       9,792  
InMotion Entertainment Group, LLC     8,273        
Yeti Acquisition, LLC     6,500       7,500  
ISG Services, LLC     6,000       6,000  
Thing5, LLC     6,000        
Med-Data, Incorporated     6,000        
I Drive Safely, LLC     5,000       5,000  
Adventure Interactive, Corp.     5,000       5,000  
First American Payment Systems, LP     5,000       5,000  
Reliance Communications, LLC     5,000       2,750  
All Web Leads, Inc.     5,000        
OnCourse Learning Corporation     4,750        
Integrated Petroleum Technologies, Inc.     4,678        
Discovery Practice Management, Inc.     4,589       1,000  
World 50, Inc.     4,000       4,000  
Refac Optical Group     3,600       8,000  
Charter Brokerage, LLC     3,467       4,000  
Phoenix Brands Merger Sub LLC     3,429       3,429  
American Cadastre, LLC     2,780        
OmniSYS Acquisition Corporation     2,500        
First Choice ER, LLC(1)     2,157        
Teaching Strategies, LLC     2,000       5,000  
Chicago Growth Partners III, LP (limited partnership interest)     2,000       2,000  
CPASS Acquisition Company     1,750       2,500  
Moelis Capital Partners Opportunity Fund I-B, LP (limited partnership interest)     1,700        
Olson + Co., Inc.     1,673       2,105  
Tailwind Capital Partners II, LP (limited partnership interest)     1,622        
Beecken Petty O'Keefe Fund IV, LP (limited partnership interest)     1,609       2,000  
Riverside Fund V, LP (limited partnership interest)     1,582       1,712  
SPC Partners V, LP (limited partnership interest)     1,572        
CCCG, LLC     1,520       1,520  
Enhanced Recovery Company, LLC     1,500       3,500  
Sterling Capital Partners IV, LP (limited partnership interest)     1,398       1,528  
Milestone Partners IV, LP (limited partnership interest)     1,291       1,414  
Ansira Partners, Inc.     1,190       1,190  
Personable Holdings, Inc.     1,142       3,409  
Psilos Group Partners IV, LP (limited partnership interest)     1,000       1,000  

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  March 31, 2014   September 30, 2013
Total Military Management, Inc.     857        
2Checkout, Inc.     850       2,850  
Genoa Healthcare Holdings, LLC     833       1,000  
HealthDrive Corporation     734       734  
Garretson Firm Resolution Group, Inc.     644        
Bunker Hill Capital II (QP), LP (limited partnership interest)     639       786  
Riverlake Equity Partners II, LP (limited partnership interest)     564       638  
ACON Equity Partners III, LP (limited partnership interest)     482       671  
Baird Capital Partners V, LP (limited partnership interest)     351       351  
Riverside Fund IV, LP (limited partnership interest)     322       287  
TransTrade Operators, Inc.     255        
RCP Direct, LP (limited partnership interest)     250       524  
Eagle Hospital Physicians, Inc.     233       1,867  
HealthEdge Software, Inc.           5,000  
Mansell Group, Inc.           2,000  
Physicians Pharmacy Alliance, Inc.           2,000  
Miche Bag, LLC           1,500  
BMC Acquisition, Inc.           1,250  
Total   $ 221,403     $ 149,474  

(1) In addition to its revolving commitment, we have extended a $175.0 million delayed draw term loan facility to First Choice ER, LLC. Specific amounts are made available to the borrower as certain financial requirements are satisfied. As of March 31, 2014, the total amount available to the borrower under this delayed draw facility was $16.1 million, and the facility was undrawn as of this date.

Contractual Obligations

The following table reflects information pertaining to our debt outstanding under the SBA debentures payable, the Wells Fargo facility(1), the ING facility, the Sumitomo facility, our Convertible Notes, our 2024 Notes, 2028 Notes, our 2019 Notes and secured borrowings:

       
  Debt Outstanding
as of
September 30,
2013
  Debt Outstanding
as of
March 31,
2014
  Weighted Average Debt Outstanding
for the Six Months Ended March 31,
2014
  Maximum Debt Outstanding
for the Six Months Ended March 31,
2014
SBA debentures payable   $  181,750     $ 225,000     $  203,391     $ 225,000  
Wells Fargo facility(1)     20,000             35,363       55,072  
ING facility     168,000       515,250       343,926       515,250  
Sumitomo facility           61,431       63,421       83,500  
Convertible Notes     115,000       115,000       115,000       115,000  
2024 Notes     75,000       75,000       75,000       75,000  
2028 Notes     86,250       86,250       86,250       86,250  
2019 Notes           250,000       45,330       250,000  
Secured borrowings           47,750       7,692       47,750  
Total debt   $ 646,000     $ 1,375,681     $ 975,373     $ 1,385,877  

(1) Effective February 21, 2014, the Company, together with Funding, terminated the Wells Fargo facility.

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The following table reflects our contractual obligations arising from the SBA debentures payable, the Wells Fargo facility, the ING facility, the Sumitomo facility, our Convertible Notes, our 2024 Notes, our 2028 Notes, our 2019 Notes and secured borrowings:

         
  Payments due by period as of March 31, 2014
     Total   < 1 year   1 – 3 years   3 – 5 years   > 5 years
SBA debentures payable   $ 225,000     $     $     $     $ 225,000  
Interest due on SBA debentures     68,788       8,744       17,749       17,725       24,570  
ING facility     515,250                   515,250        
Interest due on ING facility     54,607       12,559       25,118       16,930        
Sumitomo facility     61,431                   61,431        
Interest due on Sumitomo facility     6,598       1,477       2,955       2,166        
Convertible Notes     115,000             115,000              
Interest due on Convertible Notes     12,396       6,181       6,215              
Secured Borrowings     47,750                   47,750        
Interest due on secured borrowings     9,504       2,300       4,600       2,604        
2024 Notes     75,000                         75,000  
Interest due on 2024 Notes     46,670       4,406       8,813       8,813       24,638  
2028 Notes     86,250                         86,250  
Interest due on 2028 Notes     74,451       5,283       10,566       10,566       48,036  
2019 Notes     250,000                   250,000        
Interest due on 2019 Notes     59,970       12,188       24,375       23,407        
Total   $ 1,708,665     $ 53,138     $ 215,391     $ 956,642     $ 483,494  

Regulated Investment Company Status and Dividends

We elected, effective as of January 2, 2008, to be treated as a RIC under Subchapter M of the Code. As long as we qualify as a RIC, we will not be taxed on our investment company taxable income or realized net capital gains, to the extent that such taxable income or gains are distributed, or deemed to be distributed, to stockholders on a timely basis.

Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses, and generally excludes net unrealized appreciation or depreciation until realized. Dividends declared and paid by us in a year may differ from taxable income for that year as such dividends may include the distribution of current year taxable income or the distribution of prior year taxable income carried forward into and distributed in the current year. Distributions also may include returns of capital.

To maintain RIC tax treatment, we must, among other things, distribute, with respect to each taxable year, at least 90% of our investment company net taxable income (i.e., our net ordinary income and our realized net short-term capital gains in excess of realized net long-term capital losses, if any). As a RIC, we are also subject to a federal excise tax, based on distribution requirements of our taxable income on a calendar year basis (e.g., calendar year 2013). We anticipate timely distribution of our taxable income in accordance with tax rules; however, we incurred a de minimis U.S. federal excise tax for calendar year 2010. We did not incur a federal excise tax for calendar years 2011 and 2012 and do not expect to incur a federal excise tax for the calendar year 2013. We may incur a federal excise tax in future years.

We intend to distribute to our stockholders between 90% and 100% of our annual taxable income (which includes our taxable interest and fee income). However, we are partially dependent on our SBIC subsidiaries for cash distributions to enable us to meet the RIC distribution requirements. Our SBIC subsidiaries may be limited by the Small Business Investment Act of 1958, and SBA regulations governing SBICs, from making certain distributions to us that may be necessary to enable us to maintain our status as a RIC. We may have to request a waiver of the SBA’s restrictions for our SBIC subsidiaries to make certain distributions to maintain our RIC status. We cannot assure you that the SBA will grant such waiver. Also, the covenants under the Wells Fargo facility and Sumitomo facility could, under certain circumstances, restrict Funding and Funding II

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from making distributions to us and, as a result, hinder our ability to satisfy the distribution requirement. Similarly, the covenants contained in the ING facility may prohibit us from making distributions to our stockholders, and, as a result, could hinder our ability to satisfy the distribution requirement. In addition, we may retain for investment some or all of our net taxable capital gains (i.e., realized net long-term capital gains in excess of realized net short-term capital losses) and treat such amounts as deemed distributions to our stockholders. If we do this, our stockholders will be treated as if they received actual distributions of the capital gains we retained and then reinvested the net after-tax proceeds in our common stock. Our stockholders also may be eligible to claim tax credits (or, in certain circumstances, tax refunds) equal to their allocable share of the tax we paid on the capital gains deemed distributed to them. To the extent our taxable earnings for a fiscal taxable year fall below the total amount of our dividend distributions for that fiscal year, a portion of those distributions may be deemed a return of capital to our stockholders.

We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of these distributions from time to time. In addition, we may be limited in our ability to make distributions due to the asset coverage test for borrowings applicable to us as a business development company under the 1940 Act and due to provisions in our credit facilities and debt instruments. If we do not distribute a certain percentage of our taxable income annually, we will suffer adverse tax consequences, including possible loss of our status as a RIC. We cannot assure stockholders that they will receive any distributions or distributions at a particular level.

In accordance with certain applicable Treasury regulations and private letter rulings issued by the Internal Revenue Service, a RIC may treat a distribution of its own stock as fulfilling its RIC distribution requirements if each stockholder may elect to receive his or her entire distribution in either cash or stock of the RIC, subject to a limitation that the aggregate amount of cash to be distributed to all stockholders must be at least 20% of the aggregate declared distribution. If too many stockholders elect to receive cash, each stockholder electing to receive cash must receive a pro rata amount of cash (with the balance of the distribution paid in stock). In no event will any stockholder, electing to receive cash, receive less than 20% of his or her entire distribution in cash. If these and certain other requirements are met, for U.S federal income tax purposes, the amount of the dividend paid in stock will be equal to the amount of cash that could have been received instead of stock. We have no current intention of paying dividends in shares of our stock in accordance with these Treasury regulations or private letter rulings.

Related Party Transactions

We have entered into an investment advisory agreement with Fifth Street Management LLC, our investment adviser. Fifth Street Management LLC is controlled by Leonard M. Tannenbaum, its managing member and the chairman of our Board of Directors and our chief executive officer. Pursuant to the investment advisory agreement, fees payable to our investment adviser equal to (a) a base management fee of 2.0% of the value of our gross assets, which includes any borrowings for investment purposes and excludes cash and cash equivalents, and (b) an incentive fee based on our performance. The incentive fee consists of two parts. The first part is calculated and payable quarterly in arrears and equals 20% of our “Pre-Incentive Fee Net Investment Income” for the immediately preceding quarter, subject to a preferred return, or “hurdle,” and a “catch up” feature. The second part is determined and payable in arrears as of the end of each fiscal year (or upon termination of the investment advisory agreement) and equals 20% of our “Incentive Fee Capital Gains,” which equals our realized capital gains on a cumulative basis from inception through the end of the year, if any, computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the aggregate amount of any previously paid capital gain incentive fee. The investment advisory agreement may be terminated by either party without penalty upon no fewer than 60 days’ written notice to the other. During the three and six months ended March 31, 2014, we incurred fees of $22.0 million and $43.1 million, respectively, under the investment advisory agreement. For the three months ended March 31, 2014, the Investment Adviser voluntarily agreed to waive the portion of the base management fee attributable to assets funded with proceeds from secured borrowings, which resulted in a waiver of $0.2 million. For the three months ended March 31, 2013, the Investment Adviser voluntarily agreed to waive the portion of the base management fee attributable to certain new investments that closed prior to quarter end, which resulted in a waiver of $1.3 million.

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Pursuant to the administration agreement entered into as of January 1, 2014 with FSC CT, Inc., which is controlled by Mr. Tannenbaum, FSC CT, Inc. furnishes us with the facilities and administrative services necessary to conduct our day-to-day operations, including equipment, clerical, bookkeeping and recordkeeping services at such facilities. In addition, FSC CT, Inc. will assist us in connection with the determination and publishing of our net asset value, the preparation and filing of tax returns and the printing and dissemination of reports to our stockholders. We will reimburse our allocable portion of overhead and other expenses incurred in performing the obligations under the administration agreement, including a portion of the rent and the compensation of our chief financial officer and chief compliance officer and their respective staffs. The administration agreement may be terminated by either party without penalty upon no fewer than 60 days’ written notice to the other. The administration agreement with FSC CT, Inc. has terms substantially similar to the terms of our prior administration agreement with FSC, Inc. During the three and six months ended March 31, 2014, we have incurred expenses of $1.5 million and $3.2 million, respectively, under the administration agreement.

We have also entered into a license agreement with Fifth Street Capital LLC pursuant to which Fifth Street Capital LLC has agreed to grant us a non-exclusive, royalty-free license to use the name “Fifth Street.” Under this agreement, we will have a right to use the “Fifth Street” name, for so long as Fifth Street Management LLC or one of its affiliates remains our investment adviser. Other than with respect to this limited license, we will have no legal right to the “Fifth Street” name. Fifth Street Capital LLC is controlled by Mr. Tannenbaum, its managing member.

Recent Developments

On May 2, 2014, one new lender joined the ING facility and one existing lender increased its commitment, increasing our borrowing capacity to $670 million from $650 million.

On May 2, 2014, we and Trinity Universal Insurance Company (“Trinity”), a subsidiary of Kemper Corporation, entered into a limited liability company agreement to co-manage Senior Loan Fund JV I, LLC (“SLF JV I”). We and Trinity have committed to provide $100 million of subordinated notes and equity to the joint venture, with us providing $87.5 million and Trinity providing $12.5 million. In addition, SLF JV I intends to seek up to $200 million in third party financing. SLF JV I is expected to invest in middle market and other corporate debt securities.

Recently Issued Accounting Standards

See Note 2 to the Consolidated Financial Statements for a description of recent accounting pronouncements, including the expected dates of adoption and the anticipated impact on the Consolidated Financial Statements.

Quantitative and Qualitative Disclosures about Market Risk.

We are subject to financial market risks, including changes in interest rates. Changes in interest rates may affect both our cost of funding and our interest income from portfolio investments, cash and cash equivalents and idle funds investments. Our risk management systems and procedures are designed to identify and analyze our risk, to set appropriate policies and limits and to continually monitor these risks and limits by means of reliable administrative and information systems and other policies and programs. Our investment income will be affected by changes in various interest rates, including LIBOR and prime rates, to the extent our debt investments include floating interest rates. In addition, our investments are carried at fair value as determined in good faith by our Board of Directors in accordance with the 1940 Act (See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies — Investment Valuation”). Our valuation methodology utilizes discount rates in part in valuing our investments, and changes in those discount rates may have an impact on the valuation of our investments.

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As of March 31, 2014, 74.0% of our debt investment portfolio (at cost and fair value) bore interest at floating rates. The composition of our floating rate debt investments by cash interest rate floor (excluding PIK) as of March 31, 2014 and September 30, 2013 was as follows:

       
  March 31, 2014   September 30, 2013
     Fair
Value
  % of Floating Rate Portfolio   Fair
Value
  % of Floating Rate Portfolio
Under 1%   $ 137,435       7.28 %    $ 115,659       9.57 % 
1% to under 2%     1,669,244       88.39       1,007,366       83.35  
2% to under 3%     49,938       2.64       48,649       4.03  
3% and over     31,818       1.69       36,913       3.05  
Total   $ 1,888,435       100.00 %    $ 1,208,587       100.00 % 

Based on our Consolidated Statement of Assets and Liabilities as of March 31, 2014, the following table shows the approximate annualized increase (decrease) in components of net assets resulting from operations of hypothetical base rate changes in interest rates, assuming no changes in our investment and capital structure.

     
Basis point increase(1)   Interest income   Interest expense   Net increase (decrease)
500   $ 73,800     $ (31,000 )    $ 42,800  
400     54,900       (24,700 )      30,200  
300     36,000       (18,500 )      17,500  
200     17,300       (12,200 )      5,100  
100     1,700       (6,000 )      (4,300 ) 

(1) A decline in interest rates would not have a material impact on our Consolidated Financial Statements.

We regularly measure exposure to interest rate risk. We assess interest rate risk and manage our interest rate exposure on an ongoing basis by comparing our interest rate sensitive assets to our interest rate sensitive liabilities. Based on this review, we determine whether or not any hedging transactions are necessary to mitigate exposure to changes in interest rates. The following table shows a comparison of the interest rate base for our interest-bearing cash and outstanding investments, at principal, and our outstanding borrowings as of March 31, 2014 and September 30, 2013:

       
  March 31, 2014   September 30, 2013
     Interest Bearing Cash and Investments   Borrowings   Interest Bearing Cash and Investments   Borrowings
Money market rate   $ 45,396     $     $ 147,359     $  
Prime rate     18,185             2,886        
LIBOR
                                   
1-month     62,677       576,681       57,604       188,000  
3-month     1,809,906       47,750       1,143,068        
Fixed rate     664,817       749,878       582,340       458,000  
Total   $ 2,600,981     $ 1,374,309     $ 1,933,257     $ 646,000  

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