Corporate Loans and Allowance for Loan Losses

9 Months Ended

Sep. 30, 2011

Corporate Loans and Allowance for Loan Losses

Corporate Loans and Allowance for Loan Losses

Note 5. Corporate Loans and Allowance for Loan Losses

The following table summarizes the Company’s corporate loans as of September 30, 2011 and December 31, 2010 (amounts in thousands):

	September 30, 2011									December 31, 2010
	Corporate Loans			Corporate Loans Held for Sale			Total Corporate Loans			Corporate Loans			Corporate Loans Held for Sale			Total Corporate Loans
Principal(1)	$	6,502,493		$	660,399		$	7,162,892		$	6,398,997		$	481,152		$	6,880,149
Net unamortized discount	(195,138		)	(112,756		)	(307,894		)	(332,151		)	(12,776		)	(344,927		)
Total amortized cost	6,307,355			547,643			6,854,998			6,066,846			468,376			6,535,222
Lower of cost or fair value adjustment	—			(47,153		)	(47,153		)	—			(4,748		)	(4,748		)
Allowance for loan losses	(191,407		)	—			(191,407		)	(209,030		)	—			(209,030		)
Net carrying value	$	6,115,948		$	500,490		$	6,616,438		$	5,857,816		$	463,628		$	6,321,444

(1) Principal amount is net of charge-offs and other adjustments totaling $80.4 million and $58.2 million as of September 30, 2011 and December 31, 2010, respectively.

As of September 30, 2011 and December 31, 2010, the Company had an allowance for loan losses of $191.4 million and $209.0 million, respectively. As described in Note 2 to these condensed consolidated financial statements, the allowance for loan losses represents the Company’s estimate of probable credit losses inherent in its loan portfolio as of the balance sheet date. The Company’s allowance for loan losses consists of two components, an allocated component and an unallocated component. The allocated component of the allowance for loan losses consists of individual loans that are impaired. The unallocated component of the allowance for loan losses represents the Company’s estimate of losses inherent, but not identified, in its portfolio as of the balance sheet date.

The following table summarizes the changes in the allowance for loan losses for the Company’s corporate loan portfolio during the three and nine months ended September 30, 2011 and 2010 (amounts in thousands):

	For the three months ended September 30, 2011		For the three months ended September 30, 2010			For the nine months ended September 30, 2011			For the nine months ended September 30, 2010
Allowance for loan losses:
Beginning balance	$	188,874	$	210,218		$	209,030		$	237,308
Provision for loan losses	2,533		8,087			14,194			8,087
Charge-offs	—		(9,275		)	(31,817		)	(36,365		)
Ending balance	$	191,407	$	209,030		$	191,407		$	209,030

The following table summarizes the ending balances of the allowance and corporate loans portfolio by basis of impairment method as of September 30, 2011 and December 31, 2010 (amounts in thousands):

	September 30, 2011		December 31, 2010
Allowance for loan losses:
Ending balance: individually evaluated for impairment	$	191,407	$	207,633
Ending balance: collectively evaluated for impairment	—		—
Ending balance: loans acquired with deteriorated credit quality	—		1,397
	$	191,407	$	209,030
Corporate loans (recorded investment)(1):
Ending balance: individually evaluated for impairment	$	6,330,657	$	6,065,596
Ending balance: collectively evaluated for impairment	—		—
Ending balance: loans acquired with deteriorated credit quality	—		25,007
	$	6,330,657	$	6,090,603

(1)           Recorded investment is defined as amortized cost plus accrued interest.

As of September 30, 2011, the allocated component of the allowance for loan losses totaled $28.5 million and relates to investments in certain loans issued by five issuers with an aggregate par amount of $84.4 million and an aggregate recorded investment of $69.4 million. As of December 31, 2010, the allocated component of the allowance for loan losses totaled $50.1 million and relates to investments in certain loans issued by five issuers with an aggregate par amount of $225.6 million and an aggregate recorded investment of $149.8 million.

The following table summarizes the Company’s recorded investment in impaired loans and the related allowance for credit losses for the three and nine months ended September 30, 2011 (amounts in thousands):

For the three months ended September 30, 2011	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded	$	—	$	—	$	—	$	—	$	—
With an allowance recorded	69,420		84,443		28,474		62,982		633
Total	$	69,420	$	84,443	$	28,474	$	62,982	$	633

For the nine months ended September 30, 2011	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded	$	—	$	—	$	—	$	4,055	$	—
With an allowance recorded	69,420		84,443		28,474		78,993		1,672
Total	$	69,420	$	84,443	$	28,474	$	83,048	$	1,672

The following table summarizes the Company’s recorded investment in impaired loans and the related allowance for credit losses for the year ended December 31, 2010 (amounts in thousands):

For the year ended December 31, 2010	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded	$	16,219	$	83,215	$	—	$	12,873	$	2,853
With an allowance recorded	133,566		142,377		50,112		133,014		8,256
Total	$	149,785	$	225,592	$	50,112	$	145,887	$	11,109

As of September 30, 2011 and December 31, 2010, the allocated component of the allowance for loan losses included all impaired loans. While all of the Company’s impaired loans are on non-accrual status, the Company’s non-accrual loans also include those held for sale that are measured at the lower of cost or fair value and are not reflected in the table above.

As of September 30, 2011, the Company had loans on non-accrual status with total recorded investment of $171.3 million, which included $69.4 million of impaired loans that were held for investment and $101.9 million of non-accrual loans held for sale. The amount of interest income recognized using the cash-basis method during the time within the period that the loans were non-accrual was $4.0 million and $9.7 million for the three and nine months ended September 30, 2011, respectively, which included $0.6 million for impaired loans that were held for investment and $3.4 million for non-accrual loans held for sale for the three months ended September 30, 2011 and $1.7 million for impaired loans that were held for investment and $8.0 million for non-accrual loans held for sale for the nine months ended September 30, 2011. As of December 31, 2010, the Company had loans on non-accrual status with total recorded investment of $165.1 million, which included $149.8 million of impaired loans that were held for investment and $15.3 million of non-accrual loans held for sale. The amount of interest income recognized using the cash-basis method during the time within the period that the loans were impaired was $4.1 million and $11.1 million for the three and nine months ended September 30, 2010, respectively.

The Company did not have any corporate loans past due at September 30, 2011 or December 31, 2010.

The unallocated component of the allowance for loan losses totaled $162.9 million and $158.9 million as of September 30, 2011 and December 31, 2010, respectively. As described in Note 2 to these condensed consolidated financial statements, the Company estimates the unallocated components of the allowance for loan losses through a comprehensive review of its loan portfolio and identifies certain loans that demonstrate possible indicators of impairments, including credit quality indicators. The following table summarizes how the Company determines internally assigned grades related to credit quality based on a combination of concern as to probability of default and the seniority of the loan in the issuer’s capital structure as of September 30, 2011 and December 31, 2010 (amounts in thousands):

Internally Assigned Grade	Capital Hierarchy	Recorded Investment September 30, 2011 (1)		Recorded Investment December 31, 2010 (1)
High	Senior Secured Loan	$	922,482	$	945,435
	Second Lien Loan	311,757		389,981
	Subordinated	14,460		—
		$	1,248,699	$	1,335,416
Moderate	Senior Secured Loan	$	665,306	$	494,433
	Second Lien Loan	—		38,448
	Subordinated	6,900		4,431
		$	672,206	$	537,312
Low	Senior Secured Loan	$	4,147,964	$	3,829,458
	Second Lien Loan	83,400		137,182
	Subordinated	108,968		101,450
		$	4,340,332	$	4,068,090
	Total Unallocated	$	6,261,237	$	5,940,818
	Total Allocated	69,420		149,785
	Total Loans Held for Investment	$	6,330,657	$	6,090,603

(1)           Recorded investment is defined as amortized cost plus accrued interest.

During the three and nine months ended September 30, 2011, the Company transferred $129.3 million and $817.9 million amortized cost amount, respectively, of loans from held for investment to held for sale. During the three and nine months ended September 30, 2010, the Company transferred $187.0 million and $936.1 million amortized cost amount, respectively, of loans from held for investment to held for sale. The transfers of certain loans to held for sale were due to the Company’s determination that credit quality of a loan in relation to its expected risk-adjusted return no longer met the Company’s investment objective and the determination by the Company to reduce or eliminate the exposure for certain loans as part of its portfolio risk management practices. Also, during the three and nine months ended September 30, 2011, the Company transferred $88.1 million and $377.0 million amortized cost amount, respectively, from loans held for sale back to loans held for investment as the circumstances that led to the initial transfer to held for sale were no longer present. Also, during the three and nine months ended September 30, 2010, the Company transferred  $192.2 million and $272.2 million amortized cost amount, respectively, from loans held for sale back to loans held for investment as the circumstances that led to the initial transfer to held for sale were no longer present.

During the three and nine months ended September 30, 2011, the Company recorded charge-offs totaling zero and $31.8 million, respectively, comprised primarily of loans transferred to loans held for sale. During the three and nine months ended September 30, 2010, the Company recorded charge-offs totaling $9.3 million and $36.4 million, respectively, comprised primarily of loans transferred to loans held for sale.

As of September 30, 2011, the Company had $500.5 million of loans held for sale, an increase of $36.9 million from December 31, 2010, due to additional loans the Company determined it had the intention of selling. The Company recorded a $43.8 million and $56.2 million net charge to earnings during the three and nine months ended September 30, 2011, respectively, for the lower of cost or estimated fair value adjustment for certain loans held for sale which had a carrying value of $500.5 million as of September 30, 2011. The Company reduced the lower of cost or estimated fair value allowance by $8.8 million and recorded a $21.4 million net charge to earnings during the three and nine months ended September 30, 2010, respectively, for the lower of cost or estimated fair value adjustment for certain loans held for sale.

As of September 30, 2011, the Company had no corporate loans in default. As of December 31, 2010, the Company held corporate loans that were in default with a total amortized cost of $18.6 million from one issuer. The majority of corporate loans in default during 2010 were included in the loans for which the allocated component of the Company’s allowance for losses was related to, or for which the Company determined were loans held for sale as of December 31, 2010.

The Company did not modify any loans that qualified as troubled debt restructurings during the three and nine months ended September 30, 2011 and 2010. The Company did modify zero and $1.2 billion amortized cost of corporate loans during the three and nine months ended September 30, 2011, respectively. The Company modified $200.8 million and $464.3 million amortized cost of corporate loans during the three and nine months ended September 30, 2010, respectively. These modifications involved changes in existing rates and maturities to prevailing market rates/maturities for similar instruments and did not qualify as troubled debt restructurings as the respective borrowers were neither experiencing financial difficulty nor were seeking (nor granted) a concession as part of the modification. In addition, these modifications of non-troubled debt holdings were accomplished with modified loans that were not substantially different from the loans prior to modification.

The Company’s corporate loan portfolio has certain credit risk concentrated in a limited number of issuers. As of September 30, 2011, approximately 47% of the total amortized cost basis of the Company’s corporate loan portfolio was concentrated in twenty issuers, with the three largest concentrations of corporate loans in loans issued by U.S. Foodservice, Texas Competitive Electric Holdings Company LLC and Modular Space Corporation, which combined represented $1.0 billion, or approximately 14% of the aggregated amortized cost basis of the Company’s corporate loans. As of December 31, 2010, approximately 51% of the total amortized cost basis of the Company’s corporate loan portfolio was concentrated in twenty issuers, with the three largest concentrations of corporate loans in loans issued by Texas Competitive Electric Holdings Company LLC, Modular Space Corporation, and U.S. Foodservice, which combined represented $1.1 billion, or approximately 16% of the aggregated amortized cost basis of the Company’s corporate loans.

Note 7 to these condensed consolidated financial statements describes the Company’s borrowings under which the Company has pledged loans for borrowings. The following table summarizes the amortized cost of corporate loans held for sale and corporate loans pledged as collateral as of September 30, 2011 and December 31, 2010 (amounts in thousands):

	As of September 30, 2011		As ofDecember 31, 2010
Pledged as collateral for collateralized loan obligation secured debt and junior secured notes to affiliates	$	6,569,246	$	6,152,924
Total	$	6,569,246	$	6,152,924