NOTE 5. CORPORATE LOANS AND ALLOWANCE FOR LOAN LOSSES

The Company accounts for loans based on the following categories (i) corporate loans held for investment, which are measured based on their outstanding principal plus or minus unaccreted purchase discounts and unamortized purchase premiums, net of an allowance for loan losses; (ii) corporate loans held for sale, which are measured at lower of cost or estimated fair value; and (iii) corporate loans, at estimated fair value, which are measured at fair value.

The following table summarizes the Company’s corporate loans as of March 31, 2013 (amounts in thousands):

	March 31, 2013
	Corporate Loans			Corporate Loans Held for Sale			Corporate Loans, at Estimated Fair Value			Total Corporate Loans
Principal(1)	$	6,022,573		$	171,321		$	59,539		$	6,253,433
Net unamortized discount	(128,618		)	(45,131		)	(20,202		)	(193,951		)
Total amortized cost	5,893,955			126,190			39,337			6,059,482
Lower of cost or fair value adjustment	—			(18,795		)	—			(18,795		)
Allowance for loan losses	(206,227		)	—			—			(206,227		)
Unrealized gains	—			—			3,704			3,704
Net carrying value	$	5,687,728		$	107,395		$	43,041		$	5,838,164

(1) Principal amount is net of cumulative charge-offs and other adjustments totaling $38.3 million as of March 31, 2013.

The following table summarizes the Company’s corporate loans as of December 31, 2012 (amounts in thousands):

	December 31, 2012
	Corporate Loans			Corporate Loans Held for Sale			Corporate Loans, at Estimated Fair Value			Total Corporate Loans
Principal(1)	$	6,143,599		$	231,231		$	56,931		$	6,431,761
Net unamortized discount	(136,438		)	(88,895		)	(23,277		)	(248,610		)
Total amortized cost	6,007,161			142,336			33,654			6,183,151
Lower of cost or fair value adjustment	—			(14,047		)	—			(14,047		)
Allowance for loan losses	(223,472		)	—			—			(223,472		)
Unrealized gains	—			—			2,225			2,225
Net carrying value	$	5,783,689		$	128,289		$	35,879		$	5,947,857

(1) Principal amount is net of cumulative charge-offs and other adjustments totaling $51.6 million as of December 31, 2012.

Allowance for Loan Losses

As of March 31, 2013 and December 31, 2012, the Company had an allowance for loan losses of $206.2 million and $223.5 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 months ended March 31, 2013 and 2012 (amounts in thousands):

	For the three months ended March 31, 2013			For the three months ended March 31, 2012
Allowance for loan losses:
Beginning balance	$	223,472		$	191,407
Provision for loan losses	11,068			46,498
Charge-offs	(28,313		)	(2,098		)
Ending balance	$	206,227		$	235,807

The following table summarizes the ending balances of the allowance and corporate loans portfolio by basis of impairment method as of March 31, 2013 and December 31, 2012 (amounts in thousands):

	March 31, 2013		December 31, 2012
Allowance for loan losses:
Ending balance: individually evaluated for impairment	$	206,227	$	223,472
Ending balance: collectively evaluated for impairment	—		—
Ending balance: loans acquired with deteriorated credit quality	—		—
	$	206,227	$	223,472
Corporate loans (recorded investment)(1):
Ending balance: individually evaluated for impairment	$	5,914,332	$	6,029,059
Ending balance: collectively evaluated for impairment	—		—
Ending balance: loans acquired with deteriorated credit quality	—		—
	$	5,914,332	$	6,029,059

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

As of March 31, 2013, the allocated component of the allowance for loan losses totaled $86.9 million and relates to investments in certain loans issued by four issuers with an aggregate par amount of $551.8 million and an aggregate recorded investment of $522.1 million. Of the allocated component totaling $86.9 million, $54.5 million related to Texas Competitive Electric Holdings Company LLC (“TXU”), which had an aggregate amortized cost of $311.4 million as of March 31, 2013. As of December 31, 2012, the allocated component of the allowance for loan losses totaled $94.9 million and relates to investments in certain loans issued by six issuers with an aggregate par amount of $484.1 million and an aggregate recorded investment of $445.4 million.

The following table summarizes the Company’s recorded investment and unpaid principal balance in impaired loans, as well as the related allowance for credit losses as of March 31, 2013 and December 31, 2012 (amounts in thousands):

	March 31, 2013						December 31, 2012
	Recorded Investment(1)		Unpaid Principal Balance		Related Allowance		Recorded Investment(1)		Unpaid Principal Balance		Related Allowance
With no related allowance recorded	$	—	$	—	$	—	$	6,490	$	19,931	$	—
With an allowance recorded	522,121		551,785		86,944		438,947		464,214		94,863
Total	$	522,121	$	551,785	$	86,944	$	445,437	$	484,145	$	94,863

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

The following table summarizes the Company’s average recorded investment in impaired loans and interest income recognized for the three months ended March 31, 2013 and 2012 (amounts in thousands):

	For the three months ended March 31, 2013				For the three months ended March 31, 2012
	Average Recorded Investment(1)		Interest Income Recognized		Average Recorded Investment(1)		Interest Income Recognized
With no related allowance recorded	$	3,245	$	—	$	—	$	—
With an allowance recorded	480,534		4,274		68,860		803
Total	$	483,779	$	4,274	$	68,860	$	803

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

As of March 31, 2013 and December 31, 2012, 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 (i) other loans held for investment, (ii) corporate loans held for sale and (iii) loans carried at estimated fair value, which are not reflected in the table above. Any of these three classifications may include those loans modified in a TDR, which are typically designated as being non-accrual (see “Troubled Debt Restructurings” section below).

The following table summarizes the Company’s recorded investment in non-accrual loans as of March 31, 2013 and December 31, 2012 (amounts in thousands):

	March 31, 2013		December 31, 2012
Loans held for investment(1)	$	561,550	$	445,437
Loans held for sale	75,608		90,840
Loans at estimated fair value	1,172		—
Total non-accrual loans	$	638,330	$	536,277

(1) Includes $522.1 million of impaired loans held for investment.

For the three months ended March 31, 2013, the amount of interest income recognized using the cash-basis method during the time within the period that the loans were on non-accrual was $8.0 million, which included $4.3 million for impaired loans that were held for investment and $3.7 million for non-accrual loans held for sale. For the three months ended March 31, 2012, the amount of interest income recognized using the cash-basis method during the time within the period that the loans were impaired was $4.4 million, which included $0.8 million for impaired loans that were held for investment and $3.6 million for non-accrual loans held for sale.

The Company did not have any corporate loans past due at both March 31, 2013 and 2012.

The unallocated component of the allowance for loan losses totaled $119.3 million and $128.6 million as of March 31, 2013 and December 31, 2012, 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 March 31, 2013 and December 31, 2012 (amounts in thousands):

Internally Assigned Grade	Capital Hierarchy	Recorded Investment March 31, 2013(1)		Recorded Investment December 31, 2012(1)
High	Senior Secured Loan	$	228,938	$	525,562
	Second Lien Loan	288,237		287,892
	Subordinated	10,452		10,621
		$	527,627	$	824,075
Moderate	Senior Secured Loan	$	882,390	$	826,107
	Second Lien Loan	27,517		27,585
	Subordinated	—		38,374
		$	909,907	$	892,066
Low	Senior Secured Loan	$	3,794,317	$	3,716,831
	Second Lien Loan	55,405		68,917
	Subordinated	104,955		81,733
		$	3,954,677	$	3,867,481
	Total Unallocated	$	5,392,211	$	5,583,622
	Total Allocated	522,121		445,437
	Total Loans Held for Investment	$	5,914,332	$	6,029,059

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

During the three months ended March 31, 2013 and 2012, the Company recorded charge-offs totaling $28.3 million and $2.1 million, respectively, comprised primarily of loans modified in TDRs and loans transferred to loans held for sale, respectively.

Loans Held For Sale and the Lower of Cost or Fair Value Adjustment

As of March 31, 2013 and December 31, 2012, the Company had $107.4 million and $128.3 million of loans held for sale, respectively. During the three months ended March 31, 2013 and 2012, the Company transferred $21.4 million and $46.1 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 months ended March 31, 2013 and 2012, the Company transferred zero and $7.5 million amortized cost amount, respectively, from loans held for sale back to loans held for investment at the lower of cost or estimated fair value. These transfers back to held for investment occurred as the circumstances that led to the initial transfer to held for sale were no longer present. Such circumstances may include deteriorated market conditions often resulting in price depreciation or assets becoming illiquid, changes in restrictions on sales and certain loans amending their terms to extend the maturity, whereby the Company determined that selling the asset no longer met its investment objective and strategy.

The Company recorded a $4.7 million net charge to earnings for the three months ended March 31, 2013 for the lower of cost or estimated fair value adjustment for certain loans held for sale, which had a carrying value of $107.4 million as of March 31, 2013. Comparatively, the Company reduced the lower of cost or market valuation allowance by $10.4 million for the three months ended March 31, 2012 for certain loans held for sale, which had a carrying value of $297.7 million as of March 31, 2012.

Defaulted Loans

As of March 31, 2013, the Company did not have any corporate loans that were in default. As of December 31, 2012, the Company held two corporate loans that were in default with a total amortized cost of $50.4 million from one issuer and were included in the loans that comprised the allocated component of the Company’s allowance for loan losses.

Troubled Debt Restructurings

The recorded investment balance of TDRs totaled $65.6 million related to four TDRs and $25.5 million related to one TDR at March 31, 2013 and December 31, 2012, respectively. Loans whose terms have been modified in a TDR are typically placed on non-accrual status, but can be moved to accrual status when, among other criteria, payment in full of all amounts due under the restructured terms is expected and the borrower has demonstrated a sustained period of repayment performance, typically six months. As of March 31, 2013 and December 31, 2012, $65.6 million and $25.5 million of TDRs were included in non-accrual loans, respectively (see “Allowance for Loan Losses” section above). As of March 31, 2013 and December 31, 2012, the allowance for loan losses included specific reserves of $1.9 million and $0.5 million related to TDRs, respectively. As of March 31, 2013, there were no commitments to lend additional funds to the borrowers whose loans had been modified in a TDR.

The following table presents the aggregate balance of loans by loan class whose terms have been modified in a TDR during the three months ended March 31, 2013 and 2012. There were three new TDRs during the three months ended March 31, 2013 and no loans were modified in a TDR during the three months ended March 31, 2012. The modifications in the first quarter of 2013 involved conversions of the loans into one of the following: (i) new term loans with extended maturities and fixed, rather than floating, interest rates, (ii) equity carried at estimated fair value, (iii) or a combination of equity and loans carried at estimated fair value. The modification involving an extension of maturity date was for an additional four-year period with a higher coupon.

	Three months ended March 31, 2013					Three months ended March 31, 2012
	Number of loans	Pre-modification outstanding recorded investment(1)		Post-modification outstanding recorded investment(1)(2)		Number of loans	Pre-modification outstanding recorded investment(1)		Post-modification outstanding recorded investment(1)
Troubled debt restructurings:
Loans held for investment	2	$	68,358	$	39,430	—	$	—	$	—
Loans held for sale	—	—		—		—	—		—
Loans at estimated fair value	1	1,670		1,229		—	—		—
Total	3	$	70,028	$	40,659	—	$	—	$	—

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

(2) Excludes equity received from the TDRs with an estimated fair value of $2.1 million.

Prior to the restructurings, two of the new TDRs described above were already identified as impaired and had specific allocated reserves, while the third was a loan carried at estimated fair value. Upon restructuring the two impaired loans held for investment, the difference between the recorded investment of the pre-modified loans and the estimated fair value of the new assets was charged-off against the allowance for loan losses. The TDRs resulted in $26.8 million of charge-offs for the three months ended March 31, 2013, which comprised 95% of the total $28.3 million of charge-offs recorded during the first quarter of 2013.

As of March 31, 2013, no loans modified as TDRs were in default within a twelve month period subsequent to their original restructuring.

The Company modified $1.0 billion and $457.1 million amortized cost of corporate loans during the three months ended March 31, 2013 and 2012, respectively, that did not qualify as TDRs. These modifications involved changes in existing rates and maturities to prevailing market rates/maturities for similar instruments and did not qualify as TDRs 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.

Concentration Risk

The Company’s corporate loan portfolio has certain credit risk concentrated in a limited number of issuers. As of March 31, 2013, approximately 48% 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, TXU and Modular Space Corporation, which combined represented $996.7 million or approximately 16% of the aggregated amortized cost basis of the Company’s corporate loans. As of December 31, 2012, approximately 46% 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, TXU and Modular Space Corporation, which combined represented $1.0 billion, or approximately 16% of the aggregated amortized cost basis of the Company’s corporate loans.

Pledged Assets

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 and corporate loans held for sale pledged as collateral as of March 31, 2013 and December 31, 2012 (amounts in thousands):

	As of March 31, 2013		As of December 31, 2012
Pledged as collateral for collateralized loan obligation secured debt and junior secured notes to affiliates	$	5,836,459	$	5,804,026
Total	$	5,836,459	$	5,804,026

As of March 31, 2013 and December 31, 2012, no corporate loans, at estimated fair value were pledged as collateral for the Company’s borrowings.