As
filed with the Securities and Exchange Commission on May 26, 2021
Securities
Act File No. 333-251349
Investment
Company Act File No. 811-22853
UNITED
STATES
SECURITIES AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM N-2
x REGISTRATION
STATEMENT UNDER THE SECURITIES ACT OF 1933
x Pre-Effective
Amendment No. 2
¨ Post-Effective
Amendment No.
and
x REGISTRATION
STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
x Amendment
No. 19
STONECASTLE
FINANCIAL CORP.
(Exact
Name of Registrant as Specified in Charter)
100
Fillmore Street, Suite 325, Denver, Colorado 80206
(Address of Principal Executive Offices)
Registrant’s
Telephone Number, Including Area Code: (303) 398-2929
Sanjai
Bhonsle
StoneCastle-ArrowMark Asset Management, LLC
100 Fillmore Street, Suite 325, Denver, Colorado 80206
(Name and Address of Agent for Service)
Copies
of communications to:
John
P. Falco, Esq.
Troutman
Pepper Hamilton Sanders LLP
3000
Two Logan Square
18th
and Arch Streets
Philadelphia,
PA 19103
If
the only securities being registered on this Form are being offered pursuant to dividend or interest reinvestment plans, check the following
box ¨
If
any securities being registered on this Form will be offered on a delayed or continuous basis in reliance on Rule 415 under
the Securities Act of 1933 (the “Securities Act”), other than securities offered in connection with dividend or
interest reinvestment plans, check the following box x
If
this Form is a registration statement pursuant to General Instruction A.2 or a post-effective amendment thereto, check the following
box x
If
this Form is a registration statement pursuant to General Instruction B or a post-effective amendment thereto that will become effective
upon filing with the Commission pursuant to Rule 462(e) under the Securities Act, check the following box ¨
If
this Form is a post-effective amendment to a registration statement filed pursuant to General Instruction B to register additional securities
or additional classes of securities pursuant to Rule 413(b) under the Securities Act, check the following box ¨
It
is proposed that this filing will become effective (check appropriate box):
¨ when
declared effective pursuant to Section 8(c) of the Securities Act
Check
each box that appropriately characterizes the Registrant:
x
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Registered Closed-End Fund (closed-end company
that is registered under the Investment Company Act of 1940 (the “Investment Company Act”)).
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¨
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Business
Development Company (closed-end company that intends or has elected to be regulated as a business development company under
the Investment Company Act.
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¨
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Interval
Fund (Registered Closed-End Fund or a Business Development Company that makes periodic repurchase offers under Rule 23c-3 under
the Investment Company Act).
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x
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A.2
Qualified (qualified to register securities pursuant to General Instruction A.2 of this Form).
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¨
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Well-Known
Seasoned Issuer (as defined by Rule 405 under the Securities Act).
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¨
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Emerging
Growth Company (as defined by Rule 12b-2 under the Securities and Exchange Act of 1934).
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¨
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If
an Emerging Growth Company, indicate by check mark if the registrant has elected not to use the extended transition period for complying
with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act.
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¨
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New
Registrant (registered or regulated under the Investment Company Act for less than 12 calendar months preceding this filing).
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CALCULATION
OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
Title of Securities
Being Registered
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Amount Being
Registered
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Proposed Maximum
Aggregate Offering Price (1)
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Amount of
Registration
Fee
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Shares
of Common Stock, $0.001 par value per share
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|
|
|
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|
|
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|
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Shares
of Preferred Stock, $0.001 par value per share
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|
|
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Subscription
Rights
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Debt
Securities
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Total
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$
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150,000,000
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$
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16,365
(2
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)
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(1)
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There
are being registered hereunder such indeterminate number of shares of common stock, preferred
stock, subscription rights and debt securities as shall have an aggregate offering price
not to exceed $150,000,000, less the aggregate dollar amount of all securities previously
issued hereunder. If any debt securities are issued at an original issue discount, then the
offering price of such debt securities shall be in such greater principal amount as shall
result in an aggregated offering price not to exceed $150,000,000, less the aggregate dollar
amount of all securities previously issued hereunder. The securities registered hereunder
also include such indeterminate number of securities of each identified class of securities,
which may be offered from time to time in unspecified numbers and at indeterminate prices,
and as may be issued upon conversion, redemption, repurchase, exchange or exercise of any
securities registered hereunder, including under any applicable anti-dilution provisions
of any of such securities. In addition, the securities being registered hereunder includes
such indeterminate number of securities of each identified class of securities as may be
issuable with respect to the securities being registered hereunder as a result of stock splits,
stock dividends or similar transactions.
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|
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(2)
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Previously
paid.
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The
Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the
Registrant shall file a further amendment that specifically states that this Registration Statement shall thereafter become effective
in accordance with Section 8(a) of the Securities Act or until this Registration Statement shall become effective on such date as the
Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.
The
information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement
filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it
is not soliciting an offer to buy these securities in any state or jurisdiction where the offer or sale is not permitted.
Preliminary
Prospectus Subject to completion, dated May 26, 2021
BASE
PROSPECTUS
$150,000,000
Common
Stock
Preferred Stock
Subscription Rights
Debt Securities
Investment
Company. StoneCastle Financial Corp. (“we,” “us,” “our” or “the Company”)
is a non-diversified, closed-end management investment company under the Investment Company Act of 1940, as amended (the “Investment
Company Act”). We have elected to be treated, and intend to comply with the requirements to qualify annually, as a regulated investment
company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”). We are managed
by StoneCastle-ArrowMark Asset Management, LLC (“StoneCastle-ArrowMark” or the “Adviser”), an investment adviser
that is a wholly-owned subsidiary of ArrowMark Colorado Holdings, LLC (“ArrowMark Partners”).
Investment
Objectives. Our primary investment objective is to provide stockholders with current income, and to a lesser extent capital
appreciation. There can be no assurance that we will achieve our investment objectives.
We
may offer, from time to time, in one or more offerings or series, together or separately, up to $150 million of our common stock, preferred
stock, subscription rights or debt securities, which we refer to, collectively, as the “securities.” We may sell our securities
through underwriters or dealers, “at-the-market” to or through a market maker into an existing trading market or otherwise
directly to one or more purchasers or through agents or through a combination of methods of sale. The identities of such underwriters,
dealers, market makers or agents, as the case may be, will be described in one or more supplements to this prospectus. The securities
may be offered at prices and on terms to be described in one or more supplements to this prospectus. In the event we offer common stock,
the offering price per share of our common stock exclusive of any underwriting commissions or discounts will not be less than the net
asset value (“NAV”) per share of our common stock at the time we make the offering except (1) in connection with a rights
offering to our existing stockholders, (2) with the consent of the majority of our common stockholders and approval of our board
of directors or (3) under such circumstances as the Securities and Exchange Commission (the “SEC”) may permit. See “Risk
Factors” for more information.
IMPORTANT
NOTICE TO SHAREHOLDERS
As
permitted by regulations adopted by the Securities and Exchange Commission, paper copies of the Company's shareholder reports will no
longer be sent by mail, unless you specifically request paper copies of the reports from the Company or from your financial intermediary,
such as a broker-dealer or bank. Instead, the reports will be made available on a website, and you will be notified by mail each time
a report is posted and provided with a website link to access the report.
If
you already elected to receive shareholder reports electronically, you will not be affected by this change and you need not take any
action. You may elect to receive shareholder reports and other communications from the Company or your financial intermediary electronically
by contacting your financial intermediary (such as a broker-dealer or bank); other shareholders may call the Company at (212)-468-5441.
You
may elect to receive all future reports in paper free of charge. You can inform the Company or your financial intermediary that you wish
to continue receiving paper copies of your shareholder reports by contacting your financial intermediary (such as a broker-dealer or
bank); other shareholders may call the Company at (212)-468-5441. Your election to receive reports in paper will apply to all funds held
with the Company complex or your financial intermediary.
Investing
in our securities involves risks. See “Risk Factors” beginning on page 36 of this prospectus.
Neither
the SEC nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful
or complete. Any representation to the contrary is a criminal offense.
The
date of this prospectus is May 26, 2021
Our
common stock is listed on the NASDAQ Global Select Market under the symbol “BANX”. On March 31, 2021, the last reported sale
price of our common stock on the NASDAQ Global Select Market was $19.79 per share, and the estimated net asset value (“NAV”)
of the Company’s common stock was $21.62 per common share, representing a discount to NAV of (9.15%).
This
prospectus sets forth information about us that a prospective investor should know before investing. This prospectus may not be used
to consummate sales of securities by us through underwriters, dealers or agents unless it is accompanied by a prospectus supplement.
You should read this prospectus, any accompanying prospectus supplements, and the documents incorporated by reference herein or therein,
carefully and retain it for future reference. We have filed a Statement of Additional Information, dated May 26, 2021, containing additional
information about us with the SEC, which is incorporated by reference in its entirety into this prospectus. You may request a free copy
of the Statement of Additional Information or our annual and semi-annual reports or make shareholder inquiries or request other information
about us by calling us collect at (212)-468-5441 or by writing to us at 100 Fillmore Street, Suite 325, Denver, Colorado 80206. You can
also obtain, free of charge, a copy of our Statement of Additional Information and our annual and semi-annual reports to stockholders
on our website at www.stonecastle-financial.com. The content contained in, or that can be accessed through, our website is
not a part of this prospectus. You can review and copy the same information free from the SEC’s website at http://www.sec.gov,
on which you may view our Statement of Additional Information, and other materials incorporated by reference to this prospectus and other
information about us. Our common stock does not represent a deposit or obligation of, and is not guaranteed or endorsed by, any
bank or other insured depository institution and is not federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve
Board or any other government agency.
No
dealer, salesperson or other person is authorized to give any information or to represent anything not contained or incorporated by reference
in this prospectus or any accompanying prospectus supplement. You must not rely on any unauthorized information or representations not
contained in this prospectus or any accompanying prospectus supplement as if we had authorized it. We are offering to sell, and seeking
offers to buy, shares of securities only in jurisdictions where offers and sales are permitted. This prospectus and any accompanying
prospectus supplement does not constitute an offer to sell or the solicitation of an offer to buy any security other than the securities
offered by this prospectus and any accompanying prospectus supplement, nor does this prospectus or any accompanying prospectus supplement
constitute an offer to sell or the solicitation of an offer to buy securities by anyone in any jurisdiction in which such offer or solicitation
would be unlawful. The information contained in this prospectus and any accompanying prospectus supplement is accurate only as of the
date of this prospectus and any accompanying prospectus supplement, regardless of the time of delivery of this prospectus, any accompanying
prospectus or any sale of securities.
TABLE
OF CONTENTS
PROSPECTUS
SUMMARY
The
following summary highlights information contained elsewhere in this prospectus. You should read the entire prospectus, including “Risk
Factors,” before making a decision to invest in our securities. This summary may not contain all of the information that you should
consider before investing in the securities of StoneCastle Financial Corp. In the prospectus, unless the context suggests otherwise,
references to “we,” “us,” “Company,” “our company” or “our” refer to StoneCastle
Financial Corp., a Delaware corporation and its subsidiaries; references to “Adviser” mean StoneCastle-ArrowMark Asset Management,
LLC (“StoneCastle-ArrowMark”), a Delaware limited liability company; references to “ArrowMark Partners” or “ArrowMark”
mean ArrowMark Colorado Holdings, LLC, the parent of our Adviser; references to “common stock” or “shares” mean
the common stock of StoneCastle Financial Corp; and references to “securities” mean the common stock, preferred stock, subscription
rights and debt securities of StoneCastle Financial Corp.
The
Company
StoneCastle
Financial Corp. is a non-diversified, closed-end management investment company registered under the Investment Company Act of 1940, as
amended (the “Investment Company Act”). We have elected to be treated, and intend to comply with the requirements to qualify
annually, as a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the
“Code”).
Investment
Objectives
Our
primary investment objective is to provide stockholders with current income, and to a lesser extent, capital appreciation. There can
be no assurance that we will achieve our investment objectives.
Investment
Strategies
We
are focused on income generation, capital preservation, and providing risk-adjusted rates of return. We attempt to achieve our investment
objective through investment in preferred equity, debt and subordinated debt, structured notes and securities, convertible securities,
regulatory capital securities and common equity issued or structured by banks and financial institutions including community banks, larger
regional, national and money center banks domiciled in the United States and foreign and global money center banks. (“banking-related
securities”). See “Banking Sector Focus” and “Regulatory Capital Securities.” We make investments that
will generally be expected to pay us dividends and interest on a current basis and generate capital gains over time. We may seek to enhance
our returns through the use of warrants, options and other equity conversion features. We have a policy to invest, under normal circumstances,
at least 80% of the value of our net assets plus the amount of any borrowings for investment purposes in such banking-related securities.
We
focus our portfolio on making long-term, passive, non-control investments in the banking sector, including “regulatory capital
securities” which are securities issued or structured by banks seeking capital that is treated more favorably under banking regulations
than other types of capital, acquisitions and other refinancing activities Regulatory capital securities are issued or structured by
a bank to maintain or reduce its regulatory capital requirements by transferring certain credit risks to investors. Regulatory capital
securities may be structured in a variety of ways and are highly bespoke to the needs of the bank or other deposit-taking institution
involved. Regulatory capital securities may be in the form of structured notes (e.g., credit-linked notes), contingent convertible securities,
and other structured products or transactions. We intend to continue to direct investments in numerous issuers differentiated by asset
size, business models and geographies. We also may invest in an option strategy that will normally consist of writing (selling) call
options on bank equity securities in our portfolio (“covered calls”). We invest in foreign securities and we are not limited
in the amount of assets we may invest in such foreign securities.
We
indirectly invest in securities issued or structured by banks through structured securities and credit derivatives, including collateralized
loan obligations (CLOs) and credit-linked notes. We currently invest in credit-linked notes for which the performance and payment of
principal and interest is tied to a reference asset such as a pool of loans originated by a bank and held on its balance sheet. We also
invest in equity and junior debt tranches of CLOs, and other debt securitizations, that are collateralized by a portfolio consisting
primarily of unsecured, subordinated loans made to (and, to a lesser extent, unsecured, subordinated debentures and notes issued by)
community banks or savings institutions or their respective holding companies. We may also invest in other securities and instruments
that are related to these investments or that our Adviser believes are consistent with our investment objectives, including senior debt
tranches of CLOs and loan accumulation facilities. These indirect investments provide exposure to and focus on the same types of direct
investments that we make in banking companies and, accordingly, our investments in structured securities (such as credit-linked notes
and CLOs) and credit derivatives that provide exposure to the banking industry are considered an investment in banking securities. The
loans or other assets pledged as collateral in these securitizations may not be publicly rated by any rating agency, and may have greater
credit and liquidity risks than investment-grade corporate obligations that are publicly rated. We believe that the use of such instruments
complements our overall strategy and enhance the diversity of our holdings.
With
the proceeds of future equity offerings we will seek to grow and further diversify our portfolio of investments. We may also incur additional
leverage to the extent permitted by the Investment Company Act. See “Leverage.” Although we normally seek to invest substantially
all of our assets in banking-related securities, we reserve the ability to invest up to 20% of our assets in other types of securities
and instruments.
Additionally,
we may take temporary defensive positions that are inconsistent with our investment strategy in attempting to respond to adverse market,
economic, political or other conditions. If we do so, we may not achieve our investment objective. We may also choose not to take defensive
positions.
Our
Adviser
StoneCastle-ArrowMark
Asset Management, LLC (“StoneCastle-ArrowMark” or the “Adviser”), an SEC-registered investment adviser dedicated
to the banking sector, was newly formed on December 3, 2019 and manages our assets. Our Adviser is registered with the SEC under the
Investment Advisers Act of 1940, as amended (the “Investment Advisers Act”). Our Adviser is wholly-owned by ArrowMark Colorado
Holdings, LLC (together with its affiliates “ArrowMark Partners” or “ArrowMark”). Founded in 2007, ArrowMark
Partners is a 100% privately-owned and SEC-registered investment adviser based in Denver, Colorado. As of December 31, 2020 ArrowMark
managed $23.2 billion in assets on behalf of a broad array of institutional clients and professional asset allocators across alternative
credit and capacity constrained equity strategies, as well as through the $5.5 billion corporate and lending business.
Each
of our Adviser’s investment decisions is reviewed and approved for us by our Adviser’s investment committee, the members
of which may also act as the investment committee for other investment vehicles managed by our Adviser or its affiliates.
Our
Adviser, in addition to its own resources, may access experienced investment professionals and senior investment personnel of ArrowMark
and its affiliates. Our Adviser intends to capitalize on the significant deal origination, credit underwriting, due diligence, investment
structuring, execution, portfolio management and monitoring experience of ArrowMark Partners’ investment professionals. Biographical
information for key members of our Adviser’s investment team is set forth below under “Management—Biographical Information.”
As our investment adviser, our Adviser is obligated to allocate investment opportunities among us and its other clients in accordance
with its allocation policy; however, there can be no assurance that our Adviser will allocate such opportunities to us fairly or equitably
in the short-term or over time.
Banking
Sector Focus
We
pursue our investment objective by taking advantage of a broad spectrum of available investment opportunities in the bank sector, including
securities in U.S. community banks, larger regional, national and money center banks domiciled in the United States, and global money
center banks.
We
invest in public and privately-held community banks located throughout the United States. We consider “community banks” to
be banks, savings associations and their holding companies with less than $10 billion in consolidated assets that serve local markets.
As of December 31, 2020, the community banking sector is a highly fragmented $2.7 trillion industry, comprised of 4,850 banks located
throughout the United States, including underserved rural, semi-rural, suburban and other niche markets. Community banks generally have
simple, straightforward business models and geographically concentrated credit exposure. Community banks typically do not have exposure
to non-U.S. credit and are focused on lending to borrowers in their distinct communities. As a result, we believe that community banks
frequently have a better understanding of the local businesses they finance than larger banking organizations. Many of these community
banks are well established, having been in business on average for more than 75 years, and having survived many economic cycles, including
the most recent financial crisis. We invest directly in community banks differentiated by asset sizes, business models and geographies.
We
also invest in similar securities of larger regional, national and money center banks domiciled in the United States, and global money
center banks.
We
also invest in regulatory capital securities, such as credit-linked notes, consistent with our investment strategy. We typically invest in regulatory capital securities issued by larger,
regulated global money center banks that provide exposure to loans and other credits provided to a diverse range of corporate entities
that were originated by the issuing bank and held on its balance sheet. Banks enter into regulatory capital transactions to optimize capital
ratios, reduce balance sheet concentrations and respond to regulatory changes. For example, through a credit-linked note, the issuing
bank retains meaningful exposure to the underlying collateral pool which aligns the bank with investors and promotes disciplined loan
origination and underwriting standards. Regulatory capital transactions are typically privately negotiated transactions driven by long-term
trusted relationships and only a relatively small group of financial institutions are known to participate. We intend to continue to
direct investments into regulatory capital securities with high quality collateral, as determined by our Advisor, and diversified exposure
that has the potential to generate floating rate current income. The collateral pledged in a regulatory capital transaction may not be
publicly rated by any rating agency, and may have greater credit and liquidity risks than investment-grade corporate obligations that
are publicly rated.
Market
Opportunity
The
Company was formed to support the ongoing capital needs of banks and banking-related institutions. We believe that the banking sector
continues to offer a broad spectrum of available opportunities that are consistent with our investment objective. We believe that the
community banking sector continues to be attractive due to the strong long-term performance of community banks and the general lack of
investment competition from institutional investors. Specifically, the Company seeks investment opportunities in preferred equity, subordinated
debt, structured notes, convertible securities and common equity in the U.S. community bank sector as well as regulatory capital securities
issued by regulated banking institutions. The Company also believes similar investments in securities of larger U.S. banks, and global
money center banks represent attractive market opportunities. Regulatory capital securities will likely increase as an important component
of the Company’s overall investment portfolio. As of December 31, 2020, regulatory capital securities comprised approximately 49%
of the Company’s investment portfolio. As with all investments, investments in regulatory capital securities are subject to several
risks. See, “Risks”.
Recent
Market Disruptions
In
December 2019, a novel strain of coronavirus (also known as “COVID-19”) surfaced in China and has since been detected in
numerous countries, including the United States. COVID-19 spread quickly and has been identified as a global pandemic by the World Health
Organization. In response, governmental authorities have imposed restrictions on travel and the temporary closure of many corporate offices,
retail stores, restaurants, fitness clubs and manufacturing facilities and factories in affected jurisdictions, including, beginning
in March 2020, in the United States. The ongoing spread of COVID-19 has had, and will continue to have, a material adverse impact on
the global economy, including the U.S. economy, as cross border commercial activity and market sentiment have been negatively impacted
by the outbreak and government and other measures seeking to contain its spread. Local, state and federal and numerous non-U.S. governmental
authorities have imposed travel restrictions, business closures and other quarantine measures on service providers and other individuals
that remain in effect on the date of this prospectus. These have resulted in the effective cessation of all business activity deemed
non-essential by such governmental authorities. Periods of market disruption and instability, like the one due to the COVID-19 outbreak,
could severely adversely impact the Company’s investments and significantly reduce the Company’s returns.
With
respect to the banking sector, certain legal and regulatory changes, including the Coronavirus Aid, Relief and Economic Security Act
(CARES Act) and the Consolidated Appropriations Act, provide for certain commercial and consumer protections which have altered and may
continue to alter the profitability of the transactions in which banks engage, such as by allowing borrowers to delay payments on loans
or other obligations and imposing other costs on banks. These laws have also delayed and restricted and may continue to delay or restrict
banks’ ability to realize the value of collateral by, for example, providing temporary foreclosure protection and eviction protection
even when bank customers are in breach of their obligations to a bank. These laws may be extended or increased in scope, and other laws
may be enacted in response to the pandemic that have similar or broader effects on the banks in which we invest. Banks may also be limited
in their ability to realize the value of collateral as a result of court closures and related delays. Moreover, collateral may be liquidated
at prices insufficient to recover the full amount of exposure to a bank as a result of deteriorating economic conditions and volatile
markets. Additionally, other legislative actions related to employee benefits and the treatment of employees have negatively impacted
and may continue to negatively impact the banking sector by increasing administrative, compensation and benefits costs by, for example,
mandating coverage of certain COVID-19 related testing and treatment or mandating additional paid or unpaid leave. Further governmental
action that is taken to mitigate the economic effects of the pandemic, as well as additional compensation or benefit actions taken by
a bank, could adversely affect a bank’s financial condition and results of operations, possibly materially, in other ways that
are not known now. In addition, the Federal Reserve, in response to the pandemic lowered its target for the federal funds rate and has
signaled that it expects to keep interest rates at a low level for through at least 2023. As a result of the high percentage of bank’s
assets and liabilities that are in the form of interest-bearing or interest-related instruments, this change in interest rates has had
and likely will continue to have a material adverse impact on the profitability of the banks in which
the Company invests.
Summary
of Principal Risks
An
investment in our securities involves risk, and we urge you to consult your tax and legal advisors before making an investment in our
securities. You could lose some or all of your investment. See “Risk Factors.” There can be no assurance that we will achieve
our investment objective.
An
investment in our common stock involves significant risks, including:
Risks
Related to Investing in the Banking Sector
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Our
assets will be concentrated in the banking industry, potentially exposing us to greater risks
than companies that invest in multiple sectors.
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We
primarily invest in equity and debt securities issued by banks, subjecting us to unique risks.
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All
of our investments are subject to liquidity risk, but we may face higher liquidity risk if
we invest in debt obligations and other securities that are unrated and issued by banks that
have no corporate rating.
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We
expect to keep our portfolio of securities and investments focused on the bank sector, which
would make us more economically vulnerable in the event of a downturn in the banking industry.
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A
large number of banks may fail during times of economic stress.
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We
expect to keep our portfolio of securities and investments focused on the bank sector including
community banks whose business is subject to greater lending risks than larger banks.
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Risks
Related to Banking Regulations and Banking Investments Affecting Our Business
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The
banking institutions in which we invest, including global money center banks, are subject
to substantial regulations that could adversely affect their ability to operate and the value
of our investments. In addition, geopolitical instability, natural disasters, including outbreaks
of infectious diseases, or in times of significant global market downturns, which may impact
the value of regulatory capital securities or other investments.
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Regulatory
capital securities are subject to several risks. Banking regulators could change or amend
existing banking regulations which could affect the regulatory treatment of regulatory capital
securities, where stricter regulation could make regulatory capital securities less desirable,
or undesirable, for banks to issue, reducing the supply of new investments. Should an adverse
regulatory development occur in the future, it would likely result in the bank issuer of
such securities being able to redeem an investment early, which subjects the Company to reinvestment
risk. Regulatory capital securities remain subject to the same sector specific and other
risks as any banking-related investment that the Company may acquire, including, but not
limited to, credit risk, interest rate risk, currency risk, prepayments, adverse changes
in market value or liquidity and the quality of the loans extended by each bank to its clients.
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We
may become subject to adverse current or future banking regulations.
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Ownership
of our stock by certain types of regulated institutions may subject us to additional regulations.
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Investments
in banking institutions and transactions related to our portfolio investments may require
approval from one or more regulatory authorities.
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If
we were deemed to be a bank holding company or thrift holding company, bank holding companies
or thrift holding companies that invest in us would be subject to certain restrictions and
regulations.
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The
Financial Accounting Standards Board, or FASB, has issued a new credit impairment model,
the Current Expected Credit Loss, or CECL model, which must be implemented by banks and certain
other companies beginning in 2021. Under the CECL model, entities subject to the model will
be required to present certain financial assets carried at amortized cost, such as loans
held for investment and held-to-maturity debt securities, at the net amount expected to be
collected. The measurement of expected credit losses is to be based on information about
past events, including historical experience, current conditions, and reasonable and supportable
forecasts that affect the collectability of the reported amount. This measurement will take
place at the time the financial asset is first added to the balance sheet and periodically
thereafter. This differs significantly from the "incurred loss" model, which delays
recognition until it is probable a loss has been incurred. CECL may create more volatility
in the companies in which we invest, and this in turn could affect the value of our portfolio.
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Risks
Related to Our Investments
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Our
investments will be subject to dividend and interest rate fluctuations, and we are subject
to interest rate risk. In particular, our investments in subordinated or unsecured debt securities
that are perpetual or have maturities in excess of ten years subject us to a high degree
of interest rate risk.
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Most
of our assets will be unrated, illiquid, and their fair value may not be readily determinable.
As a consequence, the Company may be unable to sell such assets at an attractive value for
a period of time, if at all. The assets in which we invest may not be publicly rated by any rating
agency, and may have greater credit and liquidity risks than investment-grade corporate obligations that are publicly rated.
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Our
investments in regulatory capital securities subject us to the risks of underlying bank assets.
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Risks
of credit-linked notes include those risks associated with fixed-income instruments and those
of the underlying reference instrument or credit obligation including but not limited to
market risk, interest rate risk, credit (default) risk, counterparty risk, valuation risk,
foreign security and foreign currency risk.
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We
may acquire CLO equity and junior debt securities that are subordinated to more senior tranches
of CLO debt. CLOs present risks including credit(default), interest rate and prepayment risks.
Investors in CLO securities indirectly bear risks of the collateral held by such CLOs. The
prices of CLOs (and, therefore, the prices of the CLOs’ securities) are influenced
by the same types of political and economic events that affect issuers of securities and
capital markets generally. CLO interests are generally thinly traded or have only a limited
trading market. CLO securities are typically privately offered and sold, even in the secondary
market. As a result, investments in CLO securities are illiquid and the price at which these
securities are sold may be less than the price used to calculate our NAV.CLO equity and junior
debt securities are typically highly levered and, therefore, the junior debt and equity tranches
in which we are currently invested and in which we may invest will be subject to a higher
degree of risk of total loss. The loans or other assets pledged as collateral in a CLO may
not be publicly rated by any rating agency, and may have greater credit and liquidity risks
than investment-grade corporate obligations that are publicly rated.
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Foreign
securities may experience greater price volatility and changes in value. Investments denominated
in foreign currencies as well as currency hedge transactions will be subject to fluctuations
in value.
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Derivatives
transactions may limit our income or result in losses.
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Risks
Related to Our Use of Leverage
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We
currently have a bank loan to finance investments as a form of leverage. We also have authority
to issue preferred stock or engage in reverse repurchase agreements to finance investments.
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Leverage
exaggerates the effects of market downturns or upturns on the NAV and market value of our
common stock, as well as on distributions to holders of our common stock.
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Leverage
can also increase the volatility of our NAV, and expenses related to leverage can reduce
our income.
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In
the case of leverage, if our assets decline in value so that asset coverage requirements
for any borrowings or preferred stock would not be met, we may be prevented from paying distributions,
which could jeopardize our qualification for pass-through tax treatment, make us liable for
excise taxes and/or force us to sell portfolio securities at an inopportune time.
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The
use of leverage through investments such as CLO equity or junior debt securities that inherently
involve leverage, may magnify our risk of loss. CLO equity or junior debt securities are
very highly leveraged, and therefore the CLO securities in which we are currently invested
and in which we intend to invest are subject to a higher degree of loss since the use of
leverage magnifies losses.
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The
Company utilizes a revolving credit agreement with Texas Capital Bank to provide for a maximum
borrowing amount of $62 million and a fee of London Interbank Offered Rate (“LIBOR”)
+2.35%, with a maturity date of May 2022 (the “Credit Facility”). The United
Kingdom’s Financial Conduct Authority had announced plans to phase out the use of LIBOR
by the end of 2021. There is currently no definitive information regarding the future utilization
of LIBOR or of any particular replacement rate. Abandonment of or modifications to LIBOR
could have adverse impacts on newly issued financial instruments and existing financial instruments
which reference LIBOR.
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The
Credit Facility imposes asset coverage requirements, which are more stringent than those
imposed by the Investment Company Act, or by our policies. In addition, we agreed not to
purchase assets not contemplated by the investment policies and restrictions in effect when
the Credit Facility became effective unless changes to these policies and restrictions are
consented to by Texas Capital Bank.
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The
covenants or guidelines under the Credit Facility could impede the Adviser from fully managing
our portfolio in accordance with our investment objectives and policies. Furthermore, non-compliance
with such covenants or the occurrence of other events could lead to the cancellation of the
Credit Facility.
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For
as long as the Credit Facility remains in effect, we may not incur additional debt under
any other facility, except in limited circumstances.
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The
Credit Facility allows us to prepay borrowings under the Credit Facility at any time. We
do not anticipate that such guidelines will have a material adverse effect on the holders
of our common stock or on our ability to achieve our investment objectives. We may also consider
alternative measures of obtaining leverage in the future.
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See “Leverage,” and also “Risk
Factors—Risks Related to Our Use of Leverage,” for further information.
Risks Related to Our Operations
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Our
performance is highly dependent on our Adviser.
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Our
Adviser may rely on assumptions that prove to be incorrect.
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Our
Adviser and its affiliates may serve as investment adviser to other funds, investment vehicles
and investors, which may create conflicts of interest not in the best interest of us or our
stockholders.
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We
may generate low or negative rates of return on capital, and we may not be able to execute
our business plans as expected, if at all.
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Our
business model depends to a significant extent upon strong referral relationships, and our
inability to maintain or develop these relationships, as well as the failure of these relationships
to generate investment opportunities, could adversely affect our business.
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If
we are unable to source investments effectively, we may be unable to achieve our investment
objective.
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Our
quarterly results may fluctuate.
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We
make distributions to our stockholders on a quarterly basis. If the amount of any distribution
exceeds our net investment income or capital gains, then all or a portion of such distribution
could constitute a return of capital to stockholders rather than dividend income for tax
purposes. A return of capital distribution has the effect of lowering stockholders’
basis in their shares, which will result in higher tax liability when the shares are sold,
even if such shares have not increased in value or have, in fact, lost value. In addition
to the tax consequences, such a distribution is a return of a shareholder’s own investment,
but distributed net of Company expenses, and will decrease the funds available for investment
by the Company.
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Financing
arrangements with lenders or preferred shareholders may limit our ability to make dividend
payments to our stockholders.
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We
may change our business strategy and operational policies without stockholder consent (unless
stockholder consent is specifically required by the Investment Company Act), which may result
in a determination to pursue riskier business activities.
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Laws
and regulations may prohibit the banks in which we invest from paying interest and/or dividends
to us.
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Legal
and regulatory changes could occur that may adversely affect us.
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We
may be required to register as a commodity pool operator.
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Market
fluctuations caused by force majeure, terrorism, global pandemics, or certain other acts
may adversely affect our performance. The recent global outbreak of the COVID-19 virus and
the resulting pandemic has disrupted economic markets and the economic impact, duration and
spread of the COVID-19 pandemic remains uncertain at this time. The operational and financial
performance of some of the portfolio banks in which we make investments may be impacted by
COVID-19, which may in turn impact the valuation of our investments and results of our operations.
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Changes
in interest rates may affect our net investment income, reinvestment risk and the probability
of defaults of our investments.
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Risks Related to Our Adviser and/or its
Affiliates
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Our
performance is dependent on our Adviser, and we may not find a suitable replacement if the
management agreement is terminated.
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The
departure or death of any of the members of senior management of our Adviser or ArrowMark
Partners may adversely affect our ability to achieve our business objective; our management
agreement does not require the availability to us of any particular individuals.
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If
our Adviser ceases to be our manager under our management agreement, financial institutions
that provided our credit facilities may not provide future financing to us.
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Our
Adviser’s liability is limited under our management agreement, and we have agreed to
indemnify our Adviser against certain liabilities.
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There
may be potential conflicts of interest between our management and our Adviser, on one hand,
and the interest of our common stockholders, on the other.
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We
are limited in our ability to conduct transactions with affiliates.
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Our
Adviser’s investment committee is not independent from its management.
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We
may compete with our Adviser’s current and future investment vehicles for access to
capital and assets.
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There
may be other conflicts of interest in our relationship with our Adviser and/or its affiliates
that could negatively affect our earnings.
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Our
Adviser’s management of our business is subject to the oversight of our board of directors,
but our board of directors will not approve each business decision made by our Adviser.
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Our
Adviser may be incentivized to incur additional leverage, up to the extent permitted by regulations,
even if additional leverage is not in the best interests of the Company’s stockholders.
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Risks Related to Offerings
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The
price for our common stock may be volatile.
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The
price for our common stock is subject to market risk.
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Future
offerings of debt securities or preferred stock, which would rank senior to our common stock
upon our liquidation, and future offerings of equity securities, which would dilute our existing
stockholders and may be senior to our common stock for the purposes of dividend and liquidating
distributions, may adversely affect the market value of our common stock.
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Risks Related to Taxation
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Despite
our election to be treated as a RIC, we may not be able to meet the requirements to maintain
an election to be treated as a RIC.
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We
will be subject to corporate-level federal income tax on all of our income if we are unable
to maintain RIC status under Subchapter M of the Code.
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Whether
an investment in a RIC is appropriate for a Non-U.S. Stockholder will depend upon the Non-U.S.
Stockholder’s particular circumstances.
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We strongly urge you to review carefully the discussion under “Material
U.S. Federal Income Tax Considerations” and to seek advice based on your particular circumstances from an independent tax advisor.
Competitive Advantages
We believe that our significant focus on the banking
sector provides us with a strong competitive advantage relative to non-specialized investors. We believe that we are well-suited to meet
the capital needs of the banking sector.
Targeted Investment Characteristics
Our business strategy focuses on minimizing risk
by using a disciplined underwriting process for all of our sector investments. Proprietary fundamental research is the basis for all
investment decisions.
With respect to our investments in community banks,
we seek banks that exhibit the following characteristics:
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Experienced
Management. We seek to invest in community banks with management teams or sponsors
that are experienced in running local banking businesses and managing risk. We seek community
banks that have a particular market focus, expertise in that market, and a track record of
success. Further, we actively seek to invest in banks with senior management teams with significant
ties to their local communities.
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Stability
of Earnings. We seek to invest in community banks with the potential to generate
stable cash flows over long periods of time, and therefore we presently seek out institutions
that have a defined lending strategy and predictable sources of interest revenues, stable
sources of deposits and predictable expenses.
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Stability
of Market. We seek to invest in community banks whose core business is conducted
in one or more geographic markets that have sustainable local economies. The market characteristics
we seek include stable or growing employment bases and favorable long-term demographic trends,
among other characteristics.
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Growth
Opportunities. We seek to invest in healthy community banks headquartered in markets
that provide significant organic growth opportunities, or are headquartered in highly fragmented
markets where industry consolidation is likely providing the opportunity for community banks
to grow through acquisitions of smaller competitors.
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Strong
Competitive Position. We focus on community banks that have developed strong market
positions within their respective markets and that are well positioned to capitalize on growth
opportunities. We seek to invest in companies that demonstrate competitive advantages that
should help to protect and potentially expand their market position and profitability. Typically,
we do not expect to invest in newly organized institutions or community banks having highly
speculative business plans
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Visibility
of Exit. When investing in common equity, we seek investments that we expect to result
in an exit opportunity. Exits may come through the conversion of an investment into public
shares; an initial public offering of shares by the bank; the sale of the bank; or the repurchase
of shares by the bank or another financial investor.
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With respect to our investments in regulatory
capital securities, we seek to invest in issues that exhibit the following characteristics:
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Investor
and Issuer Alignment: We seek to invest in regulatory capital securities where the issuing
bank originated the underlying loans with the intention to be held on the bank’s balance
sheet. We seek regulatory capital transactions where the issuing bank retains meaningful
exposure to the underlying collateral pool through a structure that creates alignment with
investors by incentivizing the issuing bank to maintain disciplined underwriting processes
and standards.
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High
Quality Collateral: We generally seek to invest in regulatory capital securities where
the underlying collateral is at or near investment grade at the time of issuance, as determined
by the Advisor.
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Diversified
Exposure: We seek to invest in regulatory capital securities where the underlying collateral
is diversified across geographies, sectors, and individual borrowers. Additionally, we seek
securities that are subject to guidelines which enforce collateral diversification over the
expected life.
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Floating
Rate, Current Income: We seek to invest in regulatory capital securities that have a
floating rate structure to help mitigate interest rate risk.
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Investments
We primarily invest in bank-related securities
including those issued by community banks, other FDIC-insured institutions and regulatory capital transactions. We have an existing pipeline
of potential investments that meet our criteria, consisting primarily of preferred equity, subordinated debt, convertible securities,
structured notes and, to a lesser extent, common equity. We invest in accordance with our Adviser’s investment policy in primarily
the following assets:
Preferred and Common Equity Assets.
We continue to receive capital requests from numerous community banks regarding potential investments initially in amounts ranging from
approximately $3 million to $20 million per investment. Preferred stock may have fixed or variable dividend rates, which may be
subject to rate caps and collars. In connection with our investments, we may also receive options or warrants to purchase common
or preferred equity.
Regardless of the type of capital security, we intend
to invest the majority of our portfolio in institutions that are currently paying dividends or interest on their securities, that our
Adviser believes have the ongoing ability to pay dividends or interest on their securities, and that are not currently a party to any
regulatory enforcement actions that would limit or hinder their ability to pay dividends or interest. While we do not intend to
invest a significant portion of our funds in institutions that do not meet these criteria, we may invest in institutions that our Adviser
believes have the ability to emerge from such conditions, pay any accrued interest or cumulative unpaid dividends at emergence and begin
the normalized payment of interest or dividends in arrears and/or as frequently stipulated by the issuance in question.
From time to time, we may also invest in Tier 2 qualifying
debt securities (long term subordinated debt securities) and other debt securities or hybrid instruments issued by community banks or
their holding companies. Additionally, we may invest in Tier 1 qualifying debt securities. These debt securities may have fixed or floating
interest rates.
Regulatory Capital Securities and Credit-Linked
Notes. We invest in “regulatory capital securities” which are securities issued or structured by banks seeking capital
that is treated more favorably under banking regulations than other types of capital, acquisitions and other refinancing activities.
Regulatory capital securities are issued or structured by a bank to maintain or reduce its regulatory capital requirements by transferring
certain credit risks to investors. Regulatory capital securities may be in the form of structured notes (e.g., credit-linked notes),
contingent convertible securities, and other structured products or transactions. We invest in credit-linked notes which are unsecured
notes linked to loans or other assets held by a bank or other financial institution on its balance sheet. Although the credit-linked
notes are tied to the underlying performance of the assets held by the bank, such credit-linked notes may not be secured by such assets
and we have no direct or indirect ownership of the underlying assets. Thus, as a holder of such credit-linked notes, we would be subject
to counterparty risk of the bank which issues the credit-linked notes (in addition to the risk associated with the assets themselves).
To the extent the relevant bank experiences an insolvency event or goes into receivership, we may not receive payments on the credit-linked
notes, or such payments may be delayed.
Covered
Calls and Other Option Transactions. The Company intends to provide current income from short-term gains earned through
an option strategy which will normally consist of writing (selling) call options on bank equity securities in its portfolio (“covered
calls”). Any premiums received by the Company from writing options may result in short-term capital gains. Writing a covered call
is the selling of an option contract entitling the buyer to purchase an underlying security that the Company owns. When the Company sells
a call option, it generates current income from short-term gains in the form of the premium paid by the buyer of the call option, but
the Company forgoes the opportunity to participate in any increase in the value of the underlying equity security above the exercise
price of the option. The writer of the call option has the obligation, upon exercise of the option, to deliver the underlying security
or currency upon payment of the exercise price during the option period.
Convertible Securities. We may invest
in convertible securities. Convertible securities include any debt securities or preferred stock which may be converted into common stock
or which carry the right to purchase common stock.
Generally, convertible securities entitle us to exchange
the securities for a specified number of shares of common stock, usually of the same company, at specified prices within a certain period
of time.
The terms of any convertible security determine its
ranking in a company’s capital structure. In the case of subordinated convertible debentures, the holders’ claims on assets
and earnings are subordinated to the claims of other creditors, and are senior to the claims of preferred and common shareholders. In
the case of convertible preferred stock, the holders’ claims on assets and earnings are subordinated to the claims of all creditors
and are senior to the claims of common shareholders.
Convertible securities have characteristics similar
to both debt and equity securities. Due to the conversion feature, the market value of convertible securities tends to move together
with the market value of the underlying common stock. As a result, selection of convertible securities, to a great extent, is based on
the potential for capital appreciation that may exist in the underlying stock. The value of convertible securities is also affected by
prevailing interest rates, the credit quality of the issuer, and any call provisions. In some cases, the issuer may cause a convertible
security to convert to common stock. In other situations, it may be advantageous for us to cause the conversion of convertible securities
to common stock. If a convertible security converts to common stock, we may hold such common stock in our portfolio even if we would
not invest in the common stock of such issuer.
We may invest in contingent securities structured
as contingent convertible securities also known as “CoCos”. Contingent convertible securities are typically issued by non-U.S.
banks and are designed to behave like bonds in times of economic health yet absorb losses when a pre-determined trigger event occurs.
A contingent convertible security is a hybrid debt security either convertible into equity at a predetermined share price or written
down in value based on the specific terms of the individual security if a pre-specified trigger event occurs (the “Trigger Event”).
Unlike traditional convertible securities, the conversion of a contingent convertible security from debt to equity is “contingent”
and will occur only in the case of a Trigger Event. Trigger Events vary by instrument and are defined by the documents governing the
contingent convertible security. Such Trigger Events may include a decline in the issuer’s capital below a specified threshold
level, increase in the issuer’s risk weighted assets, the share price of the issuer falling to a particular level for a certain
period of time and certain regulatory events.
Collateralized Loan Obligations and other Structured
Securities. A CLO is a special purpose vehicle that is formed to finance a pool of loans which meet predefined investment
criteria. It generally raises capital by issuing both debt and equity securities. Typically, a CLO will issue various classes, or “tranches,”
of debt broadly categorized as senior and subordinate debt tranches as well as an equity tranche.
CLO securities receive cash flows generated by
underlying collateral according to a defined payment waterfall. Principal and interest payments to CLO debt tranches are typically paid
sequentially, with senior debt tranches receiving cash flows prior to subordinate debt tranches. The risk and return to CLO debt tranches
vary depending upon each tranche’s right to collect cash flows generated by the underlying collateral. CLO debt tranches are generally
rated, with ratings ranging from the highest investment grade to below investment grade, with coupons commensurate with the risk of each
tranche. CLO debt tranches are also generally structured with covenants which, if violated, divert cash flows to the senior tranches
prior to making any interest or principal payments to subordinate debt tranches or equity tranches. The loans or other assets pledged
as collateral in these securitizations may not be publicly rated by any rating agency, and may have greater credit and liquidity risks
than investment-grade corporate obligations that are publicly rated.
Unlike debt securities issued by CLOs, CLO equity
securities are not rated and do not have contractually stated payment schedules. At origination, the weighted average interest rate of
all CLO debt tranches is generally lower than the weighted average interest earned by a CLO’s underlying collateral, resulting
in an interest rate spread. CLO equity securities receive residual cash flows, or the interest spread, generated by the underlying collateral
after obligated payments for CLO debt securities and other expenses of the CLO have been made. CLO equity tranches typically comprise
approximately 10%-20% of total capital raised by a CLO.
CLO equity tranches can generate relatively front-end
loaded cash flows. CLO equity cash flows are also highly dependent on the credit performance of their underlying collateral pool. If
loans within the collateral pool default, the reduced amount of performing collateral leads to lower cash flows available for distribution
through CLO waterfalls, resulting in lower residual cash flows available for equity tranches. Residual cash flows are also impacted by
changes in portfolio spreads for CLO collateral. Declines in spreads on newly issued collateral during the reinvestment period result
in lower residual cash flows available for equity tranches.
Community Funding 2018, LLC (“CF 2018”).
As of December 31, 2020, the Company has invested $20.3 million in the interests of CF 2018, representing all of the outstanding
securities of CF 2018. CF 2018 is a structured financing vehicle that finances, originates and services loans to FDIC-insured community
banks or savings institutions or their respective holding companies (“Obligors”). Such loans are pledged as collateral to
secure loans made to CF 2018 by one more insurance companies (“Lender”) under a credit and security agreement with a final
maturity date in July 2028. The Obligors are generally not publicly rated by any rating agency. The loans held by CF 2018 may have greater
credit and liquidity risks than investment-grade corporate obligations that are publicly rated. These loans are not deposits and are
not insured by the FDIC or any government agency or instrumentality thereof. The Company purchased its interests in CF 2018 with an initial
contribution of cash and securities and subsequent cash contributions. The CF 2018 Interests are unsecured equity interests that do not
bear a stated rate of interest but entitle us to receive distributions on each payment date solely to the extent of excess interest proceeds
and/or principal proceeds, if any. This means that we can only lose the amount that we invested in CF 2018, we are not liable for the
liabilities of CF 2018, and we will not receive distributions from CF 2018 for a period until CF 2018 pays its interest and principal
payments to the Lender for that period.
CF 2018 has retained StoneCastle Investment Management,
LLC (the “Servicer”) to perform certain administrative functions pursuant to a servicing agreement dated February 7, 2018
(the “Servicing Agreement”). Pursuant to the terms of the Servicing Agreement, the Servicer, among other things, monitors
and services CF 2018’s collateral loans, provides to the CF 2018’s lenders, collateral administrator and administrative agent
certain information and reviews the reports prepared pursuant to the credit agreement. Under the terms of the Servicing Agreement, Servicer
is entitled to a fee payable in arrears in an amount equal to 0.30% per annum of the sum of the aggregate principal balance of the collateral
loans (excluding any ineligible, defaulted or defaulted loans). This fee is paid directly by CF 2018 to the Servicer. The Servicer has
agreed to remit its fees received under the Servicing Agreement to us so long as we continue to hold all of the interests of CF 2018.
We believe that securitizations such as CF 2018 enable
us to deploy our capital efficiently and to increase our capacity to generate income from providing financing to community banks.
Leverage
We have borrowed funds and expect to continue to
borrow to fund our investment activities, which is also known as utilizing leverage. While we may enter into borrowing arrangements with
banks or other lenders that are unsecured, we currently fund a portion of our investments with a secured debt facility. We will operate
with leverage through recourse and non-recourse collateralized financings, private or public offerings of debt, warehouse facilities,
secured and unsecured bank credit facilities, reverse repurchase agreements and other borrowings. Additionally, we may create one or
more wholly-owned special purpose subsidiaries to facilitate secured borrowing structures.
We have borrowed to fund a portion of our assets
and limit our overall borrowing to meet the limitations set forth under the Investment Company Act. Accordingly, we will limit (i) leverage
from debt securities to one-third of our total assets, including the proceeds of such borrowings, at the time such borrowings are calculated
and (ii) the total aggregate liquidation value and outstanding principal amount of any preferred stock and debt securities to 50%
or less of the amount of our total assets (including the proceeds of debt securities and preferred stock) less liabilities and indebtedness
not represented by our debt securities and preferred stock, each in accordance with the requirements of the Investment Company Act. Although
we have no present intention to do so, we may also operate with leverage by issuing preferred stock.
We seek a leverage ratio, based on a variety of factors
including market conditions and our Adviser’s market outlook, where the rate of return, net of applicable expenses, on the Company’s
investment portfolio investments purchased with leverage exceeds the costs associated with such leverage.
As of December 31, 2020, we incurred leverage
through borrowings under the Credit Facility that permitted the Company to borrow up to $62 million as of that date of which $43.0 million
was committed and drawn. Our asset coverage ratio as of December 31, 2020, was 427%. See “Leverage—Effects of Leverage”
for a description of our credit agreement.
Following the completion of the offering, we may
increase the amount of leverage outstanding. We may incur additional borrowings in order to maintain our desired leverage ratio of 30%.
Leverage creates a greater risk of loss, as well as a potential for more gain, for the common stock than if leverage was not used. Interest
on borrowings may be at a fixed or floating rate, and the interest at a floating rate generally will be based on short-term rates. The
costs associated with our use of leverage, including the issuance of such leverage and the payment of dividends or interest on such leverage,
will be borne entirely by the holders of common stock. As long as the rate of return, net of our applicable expenses, on our investment
portfolio investments purchased with leverage exceeds the costs associated with such leverage, we will generate more return or income
than will be needed to pay such costs. In this event, the excess will be available to pay higher dividends to holders of common stock.
Conversely, if the return on such assets is less than the cost of leverage and our other expenses, the return to the holders of our common
stock will diminish. To the extent that we use leverage, the NAV and market price of our common stock and the yield to holders of common
stock will be more volatile. Our leveraging strategy may not be successful. Our Adviser’s fee is based on “Managed Assets”,
which means our total assets (including cash and cash equivalents and any assets purchased with or attributable to any borrowed funds).
Because our Adviser’s fee is based on Managed Assets, our Adviser’s fee will be higher if we utilize leverage. See “Risks
Related to Our Use of Leverage.”
In order to reduce the interest rate and credit risks
associated with our investments and use of leverage, we expect to utilize derivatives including interest rate swaps, caps, floors and
forward transactions and credit default swaps, total return swaps and credit-linked notes. In addition, we may utilize futures and warrants
in order to hedge against changes in market prices of the securities of the publicly-traded banks in which we invest.
Conflicts of Interest
Our Adviser is subject to certain conflicts of interest
in our management. These conflicts arise primarily from the involvement of our Adviser and its affiliates in other activities that may
conflict with our activities. Our Adviser and its affiliates engage in a broad spectrum of activities. In the ordinary course of their
business activities, they may engage in activities where their interests or the interests of their clients may conflict with our interests
and the interest of the holders of our common stock. Other present and future activities of our Adviser and its affiliates may give rise
to additional conflicts of interest which may have a negative impact on us and the holders of our common stock.
Our Adviser’s compliance department, together
with compliance personnel and resources of ArrowMark, oversees the Adviser’s policies and procedures which are designed to ensure
compliance with the securities laws and to mitigate potential conflicts of interest. The Adviser’s policies and procedures system
emphasize the principle of fair and equitable allocation of appropriate opportunities to our Adviser’s clients over time. As a
result of our Advisor’s allocation policies, we may not be able to invest in all opportunities that are appropriate for us and
this may have the effect of reducing our potential earnings. Although our Adviser has agreed with us that it will allocate opportunities
among its clients pursuant to its written policies and procedures, there is no assurance that these policies and procedures will work
as intended or that we will be allocated our fair share of investment opportunities over time.
Corporate Information
Our principal executive offices are located at 100
Fillmore Street, Suite 325, Denver, CO 80206. Our telephone number is (212)-468-5441.
Adviser Information
The offices of our Adviser are located at 100 Fillmore
Street, Suite 325, Denver, CO 80206. The telephone number for our Adviser is (212)-468-5441.
Who May Want to Invest
Investors should consider their investment goals,
time horizons and risk tolerance before investing in our securities. An investment in our securities is not appropriate for all investors,
and our securities are not intended to be a complete investment program. Our securities are designed as a long-term investment and not
as a trading vehicle. Our securities may be an appropriate investment for investors who are seeking:
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potential recurring
dividend and interest cash flow;
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an investment company
focused primarily on the bank sector;
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an investment company whose
capital structure may be significantly leveraged;
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an investment
company that will invest in preferred equity, subordinated debt, regulatory capital securities, convertible securities and common
equity;
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an investment company that
may be suitable for retirement or other tax-exempt accounts; and
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professional securities selection
and active management by an experienced advisor.
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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 shares of our common stock will bear, directly or indirectly. Other expenses
are estimated and may vary. Except where the context suggests otherwise, whenever this prospectus contains a reference to fees or expenses
paid by “you” or “us” or that “we” will pay fees or expenses, stockholders will indirectly bear such
fees or expenses. We caution you that certain of the indicated percentages in the table below indicating annual expenses are
estimates and may vary.
Stockholder Transaction Expenses (as a percentage
of offering price):
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Sales Load
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--
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(1)
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Offering Expenses
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--
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(2)
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Dividend Reinvestment Plan Expenses
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--
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(3)
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Total Stockholder Transaction Expenses
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--
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(4)
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Annual Expenses (as a percentage of net assets attributable
to common stock):
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Management Fees(5)
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2.55
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%
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Interest payments on borrowed funds(6)
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1.10
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%
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Other Expenses (estimated for the
current fiscal year)(7)
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1.47
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%
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Total
Annual Expenses (8)
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5.12
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%
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(1)
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In the event that the securities to which this prospectus
relates are sold to or through underwriters or agents, a corresponding prospectus supplement
will disclose the applicable sales load.
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(2)
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The related prospectus supplement
will disclose the estimated amount of total offering expenses (which may include offering
expenses borne by third parties on our behalf), the offering price and the offering expenses
borne by us as a percentage of the offering price.
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(3)
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The expenses associated with
the administration of our dividend reinvestment plan are included in “Other Expenses.”
Participants in the dividend reinvestment plan that instruct the plan administrator to sell
shares obtained under the plan may be accessed a $15 transaction fee by the plan administrator
and the proceeds of such sale will be net of brokerage commissions, fees and transaction
costs. For more details about the plan, see “Dividend Reinvestment Plan.”
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(4)
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The related prospectus supplements with disclose the estimated amount of
Total Stockholder Transaction Expenses.
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(5)
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For the purposes of calculating our expenses,
we have assumed the maximum contractual management fee of 1.75% of Managed Assets. See “Management—Management
Agreement.”
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(6)
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We entered into a revolving credit agreement
on June 9, 2014. Interest expense assumes that leverage will represent approximately 30%
of our Managed Assets (as defined under “Management—Management Agreement—Management
Fee”) and charge interest or involve payment at a rate set by an interest rate transaction
at an annual average rate of approximately 2.46% as of February 26, 2021. We have assumed
for purposes of these expense estimates that we will utilize leverage for the entire year.
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(7)
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Pursuant to the management agreement,
our Adviser furnishes us, or arranges for the furnishing of office facilities and clerical
and administrative services necessary for our operation (other than services provided by
our custodian, accounting agent, administrator, dividend and interest paying agent and other
service providers). We bear all expenses incurred in our operations, and we will bear the
expenses related to any future offering. “Other Expenses” above includes all
such costs not borne by our Adviser, which may include but are not limited to overhead costs
of our business, commissions, fees paid to CAB Marketing, LLC and CAB, L.L.C., subsidiaries
of the ABA, as part of our exclusive investment referral and endorsement relationships with
those subsidiaries, fees and expenses connected with our investments and auditing, accounting
and legal expenses. Our agreements with CAB Marketing, LLC and CAB, L.L.C. terminated effective
August 31, 2020, and require an additional payment of $150,000 in the year following termination
in recognition of the trailing benefit of the CAB name license. See “Management—Management
Agreement—Payment of Our Expenses.” “Other Expenses” also includes
Acquired Fund fees and expenses, which expenses are estimated to not exceed one basis point
of our average net assets for the current fiscal year.
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(8)
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Total Annual Expenses may not correlate
to the ratio of expenses to average net assets disclosed in the Company’s annual and
semi-annual reports to stockholders in the financial highlights table, which reflects operating
expenses of the Company and does not include “Acquired Fund” fees and expenses.
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Example
The following example demonstrates the hypothetical
dollar amount of total cumulative expenses that would be incurred over various periods with respect to a hypothetical investment in our
common stock. These amounts are based upon the assumption that our annual operating expenses remain at the levels set forth in the table
above and that the annual return on investments before fees and expenses is 5%.
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1 Year
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3 Years
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5 Years
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10 Years
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You would pay the following expenses on a $1,000
investment, assuming a 5% annual return:
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$
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81
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$
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180
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$
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279
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$
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524
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The purpose of the table and example above
is to assist you in understanding the various costs and expenses that an investor in any future offering will bear directly or indirectly.
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.
Moreover, 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%. In addition, while the
example assumes reinvestment of all distributions at NAV, participants in our dividend reinvestment plan may receive common stock valued
at the market price in effect at that time. This price may be at, above or below NAV. See “Dividend Reinvestment Plan” for
additional information regarding our dividend reinvestment plan.
The “Other Expenses” shown in the table
and related footnote above are based on estimated amounts for our current fiscal year of operation unless otherwise indicated. If we
issue fewer shares of common stock, all other things being equal, certain of these percentages would increase. For additional information
with respect to our expenses, see “Management” and “Dividend Reinvestment Plan.”
FINANCIAL
HIGHLIGHTS
The information in “Financial Highlights” of our most recent
annual shareholder report on Forms N-CSR is incorporated herein by reference.
CAUTIONARY
STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
The matters discussed under “Prospectus Summary,”
“Risk Factors,” “Distribution Policy,” “The Company” and elsewhere in this prospectus, as well as
in future oral and written statements by our management, that are forward-looking statements are based on current management expectations
that involve substantial risks and uncertainties that could cause actual results to differ materially from the results expressed in,
or implied by, these forward-looking statements. Forward-looking statements relate to future events or our future financial performance.
We generally identify forward-looking statements by terminology such as “may,” “will,” “should,”
“expects,” “plans,” “anticipates,” “could,” “intends,” “targets,”
“projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential”
or “continue” or the negative of these terms or other similar words. Important assumptions include our ability to originate
new investments and achieve certain levels of return, the availability to us of additional capital and the ability to maintain certain
debt to asset ratios. In light of these and other uncertainties, the inclusion of a forward-looking statement in this prospectus should
not be regarded as a representation by us that our plans or objectives will be achieved. Statements regarding the following subjects
are forward-looking by their nature:
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our business strategy;
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our ability to use effectively
the proceeds of any future offering and manage our anticipated growth;
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our ability to obtain future
financing arrangements;
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estimates relating to, and
our ability to make, future distributions;
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our ability to
compete in the marketplace;
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market trends;
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projected capital and operating
expenditures, including fees paid to our affiliates; and
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the impact of technology on
our operations and business.
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Our beliefs, assumptions and expectations can change
as a result of many possible events or factors, not all of which are known to us or are within our control. If a change occurs, our business,
financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements.
You should carefully consider these risks before you make an investment decision with respect to our securities, along with the following
factors that could cause actual results to vary from our forward-looking statements:
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the factors referenced
in this prospectus, including those set forth under the sections captioned “Risk Factors” and “The Company;”
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general volatility of the capital
markets and the market price of our common stock;
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changes in our business strategy;
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availability, terms and deployment
of capital;
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availability of qualified personnel;
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changes in the sectors in which
we invest, interest rates or the general economy;
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increased rates of default
and/or decreased recovery rates relating to our investments;
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changes in applicable laws,
rules or regulations;
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our ability to continue to
meet the requirements for treatment as a RIC;
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increased prepayments relating
to our investments; and
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the degree and nature of our
competition.
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Although we believe that the expectations reflected
in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.
You should not place undue reliance on these forward-looking statements, which apply only as of the date of this prospectus. We are not
obligated, and do not undertake an obligation, to update or revise any forward-looking statements, whether as a result of new information,
future events or otherwise.
TRADING
AND NET ASSET VALUE INFORMATION
The following table sets forth, for the quarters
indicated, the highest and lowest prices on the NASDAQ Global Select Market per share of common stock, and the NAV per share and the
premium to or discount from NAV, on the date of each of the high and low market prices. The table also sets forth the number of Shares
traded on the NASDAQ Global Select Market during the respective quarters.
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NAV
per Share on Date of
Market Price(1)
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NASDAQ
Global Select
Market Price Per Share(2)
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Premium/(Discount)
to NAV
on Date of Market Price(3)
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Trading
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During Quarter Ended
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High
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Low
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High
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Low
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High
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Low
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Volume(4)
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March 31, 2019
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$
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21.63
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$
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21.63
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|
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$
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22.43
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|
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$
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19.12
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|
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3.7
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%
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(11.6
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)%
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867,370
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June 30, 2019
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$
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21.80
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$
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21.80
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$
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22.35
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$
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21.00
|
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2.5
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%
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(3.7
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)%
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566,945
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September 30, 2019
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$
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21.75
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$
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21.75
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$
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22.44
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$
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20.62
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3.2
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%
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(5.2
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)%
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702,466
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December 31, 2019
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$
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21.83
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$
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21.83
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$
|
23.92
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|
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$
|
21.86
|
|
|
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9.6
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%
|
|
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(0.1
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)%
|
|
|
1,021,569
|
|
March 31, 2020
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|
$
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19.00
|
|
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$
|
19.00
|
|
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$
|
22.96
|
|
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$
|
9.25
|
|
|
|
20.8
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%
|
|
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(51.3
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)%
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1,914,534
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|
June 30, 2020
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$
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20.27
|
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$
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20.27
|
|
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$
|
18.55
|
|
|
$
|
12.46
|
|
|
|
(8.5
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)%
|
|
|
(38.5
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)%
|
|
|
981,721
|
|
September 30, 2020
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|
$
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20.89
|
|
|
$
|
20.89
|
|
|
$
|
20.09
|
|
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$
|
15.33
|
|
|
|
(3.8
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)%
|
|
|
(26.6
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)%
|
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877,204
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|
December 31, 2020
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|
$
|
21.44
|
|
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$
|
21.44
|
|
|
$
|
21.20
|
|
|
$
|
17.81
|
|
|
|
(1.1
|
)%
|
|
|
(16.9
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)%
|
|
|
845,623
|
|
March 31, 2021
|
|
$
|
21.62
|
|
|
$
|
21.62
|
|
|
$
|
21.00
|
|
|
$
|
19.22
|
|
|
|
(2.9
|
)%
|
|
|
(11.1
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)%
|
|
|
1,058,800
|
|
(1) Based on our computations.
(2) Source: The NASDAQ Global Select Market.
(3) Based on our computations.
(4) Source: Bloomberg.
On March 31, 2021, our estimated per share NAV
was $21.62 and our per share market price was $19.79, representing a 9.15% discount to NAV. As of April 27, 2021, our per share market
price was $19.82, representing a 9.17% discount to such NAV).
We cannot predict whether our common stock will trade
at a premium or discount to NAV in the future. Our issuance of common stock may have an adverse effect on prices for our common stock
in the secondary market by increasing the number of common shares available, which may put downward pressure on the market price for
our common stock.
Shares of closed-end funds frequently trade at a
market price that is less than the value of the net assets attributable to those shares (a “discount”). The possibility that
our shares will trade at a discount from NAV is a risk separate and distinct from the risk that our NAV will decrease. The risk of purchasing
shares of a closed-end fund that might trade at a discount or unsustainable premium is more pronounced for investors who wish to sell
their shares in a relatively short period of time after purchasing them because, for those investors, realization of a gain or loss on
their investments is likely to be more dependent upon the existence of a premium or discount than upon portfolio performance. Our shares
are not redeemable at the request of stockholders. We may repurchase our shares in the open market or in private transactions, although
we have no present intention to do so. Stockholders desiring liquidity may, subject to applicable securities laws, trade their shares
on the NASDAQ Global Select or other markets on which such shares may trade at the then current market value, which may differ from the
then current NAV.
USE
OF PROCEEDS
Unless otherwise specified in a prospectus supplement,
we intend to use substantially all of the proceeds from a sale of our securities, net of expenses, for general corporate purposes, which
may include, making investments in accordance with our investment objective and policies. We anticipate that the proceeds will be invested
promptly as investment opportunities are identified, depending on market conditions and the availability of appropriate securities, and
it is anticipated to take not more than approximately three to six months from the closing of any offering. Pending investment, the proceeds
will be invested in short-term cash-equivalent instruments. Although we anticipate that a substantial portion of the proceeds from any
offering will be invested pursuant to our investment objective and policies, some of the proceeds may be used to make capital gain distributions
required to maintain our tax status as a RIC.
DISTRIBUTION
POLICY
We intend to pay quarterly distributions to our stockholders
in an amount, and on a timely basis, sufficient to obtain and maintain our status as a RIC; investment company taxable income includes,
among other items, dividends, interest and the excess of any net short-term capital gains over net long-term capital losses, reduced
by deductible expenses.
We have elected to be treated, and intend to comply
with the requirements to qualify annually, as a RIC. For federal income tax purposes, as a RIC we are required to distribute substantially
all of our net investment income each year both to avoid federal income tax on our distributed income and to avoid a potential excise
tax. If our ability to make distributions on our common stock is limited, such limitations could, under certain circumstances, impair
our ability to maintain a qualification for taxation as a RIC, which would have adverse consequences for our stockholders. See “Material
U.S. Federal Income Tax Considerations.”
We will pay all dividends
at the discretion of our board of directors, and the dividends we pay will depend on a number of factors, including:
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·
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distribution
requirements under the Investment Company Act and to maintain our status as a RIC.
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·
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our
financial condition; general business conditions; actual results of operations;
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·
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the
timing of the deployment of our capital; debt service requirements;
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·
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availability
of cash distributions;
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·
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our
operating expenses;
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·
|
any
contractual, legal and regulatory restrictions on the payment of distributions by us to our
stockholders including debt covenants imposed by lenders to the Company; and
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|
·
|
other
factors our board of directors in its discretion may deem relevant.
|
If a stockholder’s common stock is registered
directly with us or with a brokerage firm that participates in our dividend reinvestment plan, distributions will be automatically reinvested
in additional common stock under the dividend reinvestment plan unless a stockholder elects to receive distributions in cash. If a stockholder
elects to receive distributions in cash, payment will be made by check. See “Dividend Reinvestment Plan.”
THE
COMPANY
StoneCastle Financial Corp. was organized on February 7,
2013 as a Delaware corporation, established to make investments in the banking sector throughout the United States. The Company invests
in the banks and financial institutions including community banks, larger regional, national and money center banks domiciled in the
United States and foreign and global money center banks.
We are focused on income generation, capital preservation,
and providing risk-adjusted rates of return. We attempt to achieve our investment objective through investment in preferred equity, debt
and subordinated debt, structured notes and securities, convertible securities, regulatory capital securities and common equity issued
or structured by banks and financial institutions including community banks, larger regional, national and money center banks domiciled
in the United States and foreign and global money center banks. (“banking-related securities”). See “Banking Sector
Focus” and “Regulatory Capital Securities.” We make investments that will generally be expected to pay us dividends
and interest on a current basis and generate capital gains over time. We may seek to enhance our returns through the use of warrants,
options and other equity conversion features. We have a policy to invest, under normal circumstances, at least 80% of the value of our
net assets plus the amount of any borrowings for investment purposes in such banking-related securities.
In addition,
as part of its investment strategy, the Company intends to provide current income from short-term gains earned through an option strategy
that will normally consist of writing (selling) call options on bank equity securities in its portfolio (“covered calls”). We
have elected to be treated, and intend to comply with the requirements to qualify annually, as a RIC under Subchapter M of the Code.
Our Adviser
StoneCastle-ArrowMark Asset Management, LLC (“StoneCastle-ArrowMark”),
an SEC-registered investment adviser dedicated to the banking sector, was newly formed on December 3, 2019 and manages our assets. Our
Adviser is registered with the SEC under the Investment Advisers Act of 1940, as amended (the “Investment Advisers Act”).
Our Adviser has access to investment professionals, including from its affiliates, which collectively manage a significant pool of assets
across various sectors, including the banking sector. Our Adviser’s investment philosophy is grounded in disciplined, fundamental,
bottom-up credit and investment analysis.
We intend to continue to use our Adviser’s
existing banking infrastructure to identify attractive investment opportunities and to underwrite and monitor our investment portfolio.
Our Adviser is wholly-owned by ArrowMark Colorado Holdings, LLC. Founded in 2007, ArrowMark Partners is a 100% privately-owned and SEC-registered
investment adviser based in Denver, Colorado. As of December 31, 2020 ArrowMark managed $23.2 billion in assets on behalf of a broad
array of institutional clients and professional asset allocators across alternative credit and capacity constrained equity strategies,
as well as through the $5.5 billion corporate and lending business. ArrowMark’s unique approach provides extensive insights across
the capital structure of financial institutions. ArrowMark has a skilled understanding of how to manage complex risk/reward tradeoffs
through the firm’s process of Risk-First fundamental research. ArrowMark’s team has collective experience navigating multiple
economic climates and market cycles.
Our Adviser’s bank investment platform is
consistent with the Company’s long-term strategy of aligning its investment capabilities to create value for shareholders. Since
ArrowMark Partners’ inception, it has demonstrated a track record of identifying investment opportunities within and related to
the banking sector. The ArrowMark team has the advantage of banking relationships and expertise developed over decades in the investment
industry. Certain members of the ArrowMark team have had prior roles at global financial institutions and broad knowledge of financial
services, banking, and investment management industries. ArrowMark’s ability to continue successful execution of the Company’s
investment goals and strategies is best demonstrated by ArrowMark’s history of banking-related investments, including experience
partnering with larger financial institutions to invest over $2.5 billion in regulatory capital transactions since 2010 and successful
participation in the Federal Reserve’s Term Asset-Backed Securities Loan Facility program, which was a funding facility that helped
market participants meet the credit needs of households and small businesses by supporting the issuance of asset-backed securities.
Each of our Adviser’s investment decisions
is reviewed and approved for us by our Adviser’s investment committee, the members of which may also act as the investment committee
for other investment vehicles managed by our Advisor or its affiliates.
Our Adviser, in addition to its own resources, may
access experienced investment professionals and senior investment personnel of ArrowMark and its affiliates. Our Adviser intends to capitalize
on the significant deal origination, credit underwriting, due diligence, investment structuring, execution, portfolio management and
monitoring experience of ArrowMark Partners’ investment professionals. Biographical information for key members of our Adviser’s
investment team is set forth below under “Management—Biographical Information.” As our investment adviser, our Adviser
is obligated to allocate investment opportunities among us and its other clients in accordance with its allocation policy; however, there
can be no assurance that our Adviser will allocate such opportunities to us fairly or equitably in the short-term or over time.
Banking Sector Focus
We intend to pursue our investment objective by
taking advantage of a broad spectrum of available investment opportunities in the bank sector, including securities in U.S. community
banks, larger U.S. domiciled regional, national and money center banks and global money center banks.
We intend to continue investing in public and privately-held
community banks located throughout the United States. For the purpose of our investment objectives and this prospectus, we define “community
bank” to mean banks, savings associations and their holding companies with less than $10 billion in consolidated assets that serve
local markets. Community banks generally have simple, straight-forward business models and geographically concentrated credit exposure.
Community banks typically do not have exposure to non-U.S. credit and are focused on lending to borrowers in their distinct communities.
As a result, we believe that community banks frequently have a strong understanding of the local businesses they finance. Many of these
community banks are well established, having been in business on average for more than 75 years and have survived many economic cycles,
including the most recent financial crisis. We expect to continue to direct community bank investments in numerous issuers differentiated
by asset sizes, business models and geographies.
We also invest in similar securities of larger
U.S. domiciled banks, global money center banks. Additionally, we intend to continue utilizing regulatory capital securities in the portfolio
consistent with our investment strategy, and may invest over 50% of our portfolio in regulatory capital securities. We typically invest
in regulatory capital securities issued by larger, regulated U.S. and global money center banks that provide exposure to loans and other
credits provided to a diverse range of corporate entities that were originated by the issuing bank and held on its balance sheet. Banks
issue regulatory capital transactions to optimize capital ratios, reduce balance sheet concentrations and respond to regulatory changes.
Through structure of the regulatory capital transaction, the issuing bank retains meaningful exposure to the underlying collateral pool
which helps to promote alignment with investors and incentive to maintain discipline underwriting standards. Regulatory capital transactions
are driven by long-term trusted relationships and only a relatively small group of financial institutions are known to participate. We
intend to continue to direct investments into regulatory capital securities with high quality collateral and diversified exposure that
has the potential to generate floating rate current income.
Market Opportunity
The Company was formed to support the ongoing
capital needs of banks and banking-related institutions. We believe that the banking sector continues to offer a broad spectrum of available
opportunities that are consistent with our investment objective.
We believe that the banking sector, including community
banks, is attractive due to the strong long-term performance of community banks and the general lack of investment competition from institutional
investors. We believe that the environment for investing in banks, including community banks is attractive for the following reasons:
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·
|
Long-Term
Resiliency of Community Banks. The community banking industry has a long history
of resiliency and historically has exhibited a low rate of bank failure. Bank failure means
the closing of a bank by a federal or state banking regulatory agency, generally because
the bank is unable to meet its obligations to depositors and others. According to data from
the FDIC, since 1934, FDIC insured banks and thrifts have failed at an annual rate of 0.35%,
with peak cycle one-year failure rates of 3.22% in 1989 (S&L crisis), 1.96% in 2010 (Great
Recession) and 0.54% in each of 1937 and 1938 (Great Depression). We believe that these figures
are comparable with Baa and Ba Moody’s rated corporate bond default rates, which experienced
an average annual default rate since 1920 of approximately 0.26% for Moody’s Baa-rated
corporate bonds and 1.01% for Ba-rated bonds, with the highest one-year default rates of
1.99% and 11.71%, for Baa-rated and Ba-rated corporate bonds, respectively, as reported in
an Annual Default study released on February 1, 2019.
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Robust Demand for Capital. Regulatory
changes are requiring all banks to hold increased levels of capital. This requirement creates what we believe to be strong demand
for capital in the form of preferred equity, subordinated debt, convertible securities and, to a lesser extent, common equity. Further,
capital is needed to facilitate ongoing consolidation within the banking industry, including acquisitions of failed banks from the
FDIC. Lastly, organic growth of well-positioned institutions also supports demand. Our Adviser estimates that the community banking
sector will require billions of dollars of capital over the next several years to facilitate (i) compliance with heightened
regulatory capital ratios, (ii) acquisition of competitors and failed banks and (iii) organic asset growth. This estimate is
in part based on the size of the trust preferred CDO market and the phase out of trust preferred securities from the definition of
Tier 1 capital.
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Sector
Overlooked by Institutional Capital Providers. We believe that many investors historically
have avoided investing in community banks due to the small size of these banks, their heavy
regulation, the Bank Holding Company Act, which imposes ownership restrictions and the perception
that community banks are riskier than larger financial institutions. In addition, many capital
providers lack the necessary technical expertise to evaluate the quality of the small- and
mid-sized privately-held community banks and lack a network of relationships to identify
attractive opportunities.
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Opportunities
for Investments in Larger Banks Through Regulatory Capital Securities. We intend
to continue to direct investments into regulatory capital securities with high quality collateral
and diversified exposure that has the potential to generate floating rate current income.
Changing regulations and capital requirement needs cause typically larger, global money center
banks to issue such securities. Successful investments in such securities often depends on
long-term trusted relationships. We believe our experience and reputation in the banking
industry will allow us to participate in such investments.
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Competitive Advantages
We believe that our significant focus on the banking
sector provides us with a strong competitive advantage relative to non-specialized investors. We intend to pursue our investment objective
by taking advantage of our considerable experience partnering with larger banks and global money center banks through regulatory capital
transactions. We believe we are uniquely suited to capitalize on this market opportunity in the banking sector for the following reasons:
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Differentiated
Approach. With considerable experience investing in regulatory capital securities since
2010, we have refined a flexible investment process that continues to adapt as the market
and opportunity set evolve allowing us to selectively pursue opportunities aligned with our
investment objectives.
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Pronounced
Sourcing Advantages. Relationships, scale and reputation developed by the team over decades
in the banking industry and ten years of consistent participation in the asset class serve
as a core component of our ability to access regulatory capital securities. Our extensive
sourcing network and relationships with long-term issuers that have been cultivated through
ongoing engagement are supportive of our highly selective investment process.
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Adept
Structuring and Negotiation. Our team is experienced in developing customized transactions
with unique terms that allow us to tailor security structures to a range of collateral types,
issuers and regulatory guidelines. With a focus on mitigating risk, we believe in our ability
to develop the optimal combination of structural attributes, collateral characteristics and
issuer alignment when investing in regulatory capital securities.
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“Risk-First”
Fundamental Research. We place equal emphasis on in-depth fundamental analysis of security
structure, underlying collateral, and the issuer’s underwriting process to develop
a proprietary assessment of collateral risk and the potential for losses. We utilize the
appropriate resources with sector specialization and diverse expertise necessary to perform
loan-level analysis of collateral pools. We have the unique advantage to draw upon the insights
developed through years of regulatory capital investment experience that includes information
from ongoing monitoring of underlying borrowers, transition rates, workouts and recoveries
in historical investments.
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Disciplined
Risk Management. We seek to mitigate unintended risks through thorough due diligence,
conservative asset selection, investment discretion, and disciplined portfolio construction.
Our dynamic investment approach enhances our ability to manage the potential for systemic
and idiosyncratic risks by focusing on multi-layered diversification of collateral, counterparty,
sectors and geographies.
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Experience
in the Community Banking Sector. Since its inception, the Company has focused on investing
in and engaging with the community banking sector. We have extensive experience with the
community banking sector including sourcing, evaluating, executing and managing investments,
including through the use of proprietary software that has been developed and refined over
the past decade to enhance the Company’s investments in the community banking sector.
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ArrowMark
Pipeline. Sourcing capital securities such as regulatory capital securities can be a
barrier to entry for many investors, and requires a network of relationships with large bank
issuers as, historically, capital securities such as regulatory capital securities have been
acquired through privately negotiated bi-lateral transactions. ArrowMark Partners has been
investing in capital securities similar to the regulatory capital securities since 2010 and,
with approximately $3.99 billion invested on behalf of clients in such securities as of March
31, 2021, is an active investor in the sector. ArrowMark Partners has a pipeline of investment
opportunities in Regulatory Capital Securities, a portion of which has been allocated to
the Company. Given ArrowMark Partners’ investment pipeline, regulatory capital securities
will likely increase as a percentage of the Company’s overall investment portfolio
and may constitute more than 50% of the Company’s portfolio.
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Experienced
Management Team. Our investment team is comprised of professionals who have substantial
expertise investing in community banks, and includes former senior bankers, credit officers,
private equity investors, rating agency analysts, bank examiners, fixed income specialists
and attorneys.
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Specialized/Proprietary
Systems. The Adviser’s proprietary analytic systems/database that is dedicated
to analyzing banks (the “RAMPART” systems) currently tracks and analyzes every
bank in the United States and provides our investment professionals with significant operational
leverage, allowing our team to sort through vast amounts of data to screen for potential
investments. We believe that few institutional investors have developed infrastructure comparable
to RAMPART.
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Disciplined
Investment Philosophy and Risk Management. Our Adviser’s senior investment
professionals have substantial experience structuring investments that balance the needs
of banks with appropriate levels of risk control. Our Adviser’s investment approach
for us emphasizes current income and, to a lesser extent, capital appreciation through common
equity, warrants, options and conversion features. Given that a significant portion of our
investments to be fixed income-like (including preferred stock), preservation of capital
is our priority and we seek to minimize downside risk by investing in banks that exhibit
the potential for long-term stability (See “The Company—Investment Process and
Due Diligence”).
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Few
Organized Competitors. We believe that several factors render many U.S. investors
and financial institutions ill-suited to lend to or invest in community banks. Historically,
the relatively small size of individual community banks and certain regulatory requirements
limiting control have deterred many institutional investors, including private equity investors,
from making those investments. We believe that, as a consequence, few institutional investors
have developed and possess the specialized skills and infrastructure to efficiently analyze
and monitor investments in community banks on a large scale. Based on the experience of our
management team, investing in community banks requires specialized skills and infrastructure,
including: (i) the ability to analyze small community banking institutions and the local
economies in which they do business; (ii) specialized systems to analyze and track vast
amounts of bank performance data; (iii) a deep understanding and working relationship
with state and federal regulators that oversee community banks; and (iv) brand awareness
within the community banking industry and a strong reputation as a long-term partner that
understands the needs of community banks to originate investment opportunities successfully.
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Extended Investment Horizon. Unlike
private equity investors, we are not subject to standard periodic capital return requirements. These provisions often force private equity
investors to seek returns on their investments through mergers, public equity offerings or other liquidity events more quickly than they
otherwise might prefer, potentially resulting in a lower overall return to investors. We believe that our flexibility to make investments
with a long-term view, and without the capital return requirements of traditional private investment funds, provides us with the opportunity
to generate attractive returns on invested capital.
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Investments
We primarily invest in bank-related securities
including those securities issued by community banks, other larger FDIC-insured institutions, and global money center banks. We invest
in accordance with our Adviser’s investment policy in primarily the following assets:
Preferred and Common Equity Assets: We
continue to receive capital requests from numerous community banks regarding potential investments initially in amounts ranging from
approximately $1 million to $20 million per investment. Preferred stock may have fixed or variable dividend rates, which may be subject
to rate caps and collars. In connection with our investments, we may also receive options or warrants to purchase common or preferred
equity. We may also purchase common stock of companies listed on recognized exchanges, and may write call options (covered calls) on
equity securities.
Regardless of the type of capital security, we intend
to invest the majority of our portfolio in institutions that are currently paying dividends or interest on their securities, that our
Adviser believes have the ongoing ability to pay dividends or interest on their securities, and that are not currently a party to any
regulatory enforcement actions that would limit or hinder their ability to pay dividends or interest. While we do not intend to invest
a significant portion of our funds in institutions that do not meet these criteria, we may invest in institutions that our Adviser believes
have the ability to emerge from such conditions, pay any accrued interest or cumulative unpaid dividends at emergence and begin the normalized
payment of interest or dividends in arrears and/or as frequently stipulated by the issuance in question.
From time to time, we may also invest in Tier 2 qualifying
debt securities (long-term subordinated debt securities) and other debt securities or hybrid instruments issued by community banks or
their holding companies. Additionally, we may invest in Tier 1 qualifying debt securities. These debt securities may have fixed or floating
interest rates.
Regulatory capital regulations
adopted in response to the Dodd-Frank Act and Basel III require banks to increase their Tier 1 capital and reduce their leverage ratios.
These regulations also generally require that, in order to qualify as Tier 1 capital, preferred stock must be non-cumulative in nature
(only TARP Preferred and certain securities issued by small bank holding companies, defined as holding companies with less than $500
million in consolidated assets, may be cumulative and qualify as Tier 1 capital). Non-cumulative means that dividends are discretionary
and an issuer will have no obligation to pay dividends accrued for a dividend period after the dividend payment date for such period
if the issuer has not declared such dividend for such period, whether or not dividends are declared for any subsequent dividend period.
We expect that the majority of the new issue preferred stock in which we invest will be non-cumulative. While these existing and any
future regulatory capital requirements may cause community banks to raise additional capital, these regulations may make some community
banks less likely to pay dividends on preferred stock and common stock.
In addition, future changes
in regulatory capital regulations may negatively or positively affect our investments and may subject us to additional pre-payment and
capital redeployment risk.
Most of our assets are and, we expect, will be illiquid,
and their fair value may not be readily determinable. Accordingly, there can be no assurance that we will be able to realize the value
at which we carry such assets if we need to dispose of them. As a result, we can provide no assurance that any given asset could be sold
at a price equal to the value at which we carry it. We believe that a majority of the investments we will make will not be rated by a
nationally recognized statistical rating organization (“NRSRO”). If such investments were rated by a NRSRO, we believe they
may be rated below investment grade.
Regulatory Capital Securities. We
may invest in regulatory capital securities issued by various regulated banking institutions. Regulatory capital securities are generally
securities that are issued by a regulated banking institution as an alternative to issuing common equity. The Company believes
that the Regulatory Capital Securities offer a variety of benefits to issuers, including the absence of shareholder dilution, a reduction
of credit risk and improved capital/profitability ratios. We believe that the Regulatory Capital Securities offer the opportunity for
attractive returns relative to the risks taken and to other credit investments currently available. Given the Company’s investment
objective of income and capital preservation, we believe that Regulatory Capital Securities are well suited for its long-term investment
portfolio.
Covered
Calls on Bank Equity Securities and Other Option Transactions. The Company intends to provide current income from short-term
gains earned through an option strategy which will normally consist of writing (selling) call options on bank equity securities in its
portfolio (“covered calls”). Any premiums received by the Company from writing options may result in short-term capital gains.
Writing a covered call is the selling of an option contract entitling the buyer to purchase an underlying security that the Company owns.
When the Company sells a call option, it generates current income from short-term gains in the form of the premium paid by the buyer
of the call option, but the Company forgoes the opportunity to participate in any increase in the value of the underlying equity security
above the exercise price of the option. The writer of the call option has the obligation, upon exercise of the option, to deliver the
underlying security or currency upon payment of the exercise price during the option period.
Convertible Securities: We
may invest in convertible securities. Convertible securities include any debt securities or preferred stock which may be converted into
common stock or which carry the right to purchase common stock.
Generally, convertible securities entitle us to exchange
the securities for a specified number of shares of common stock, usually of the same company, at specified prices within a certain period
of time. The terms of any convertible security determine its ranking in a company’s capital structure. In the case of subordinated
convertible debentures, the holders’ claims on assets and earnings are subordinated to the claims of other creditors and are senior
to the claims of preferred and common shareholders. In the case of convertible preferred stock, the holders’ claims on assets and
earnings are subordinated to the claims of all creditors and are senior to the claims of common shareholders.
Convertible securities have characteristics similar
to both debt and equity securities. Due to the conversion feature, the market value of convertible securities tends to move together
with the market value of the underlying common stock. As a result, selection of convertible securities, to a great extent, is based on
the potential for capital appreciation that may exist in the underlying stock. The value of convertible securities is also affected by
prevailing interest rates, the credit quality of the issuer, and any call provisions. In some cases, the issuer may cause a convertible
security to convert to common stock. In other situations, it may be advantageous for us to cause the conversion of convertible securities
to common stock. If a convertible security converts to common stock, we may hold such common stock in our portfolio even if we would
not invest in the common stock of such issuer.
We may invest in contingent securities structured
as contingent convertible securities also known as “CoCos”. Contingent convertible securities are typically issued by non-U.S.
banks and are designed to behave like bonds in times of economic health yet absorb losses when a pre-determined trigger event occurs.
A contingent convertible security is a hybrid debt security either convertible into equity at a predetermined share price or written
down in value based on the specific terms of the individual security if a pre-specified trigger event occurs (the “Trigger Event”).
Unlike traditional convertible securities, the conversion of a contingent convertible security from debt to equity is “contingent”
and will occur only in the case of a Trigger Event. Trigger Events vary by instrument and are defined by the documents governing the
contingent convertible security. Such Trigger Events may include a decline in the issuer’s capital below a specified threshold
level, increase in the issuer’s risk weighted assets, the share price of the issuer falling to a particular level for a certain
period of time and certain regulatory events.
Contingent convertible securities are subject to
the credit, interest rate, high yield security, foreign security and markets risks associated with bonds and equities, and to the risks
specific to convertible securities in general. Contingent convertible securities are also subject to additional risks specific to their
structure including conversion risk. Because Trigger Events are not consistently defined among contingent convertible securities, this
risk is greater for contingent convertible securities that are issued by banks with capital ratios close to the level specified in the
Trigger Event. In addition, coupon payments on contingent convertible securities are discretionary and may be cancelled by the issuer
at any point, for any reason, and for any length of time. The discretionary cancellation of payments is not an event of default and there
are no remedies to require re-instatement of coupon payments or payment of any past missed payments. Coupon payments may also be subject
to approval by the issuer’s regulator and may be suspended in the event there are insufficient distributable reserves. Due to uncertainty
surrounding coupon payments, contingent convertible securities may be volatile and their price may decline rapidly in the event that
coupon payments are suspended.
Contingent convertible securities typically are structurally
subordinated to traditional convertible bonds in the issuer’s capital structure. In certain scenarios, investors in contingent
convertible securities may suffer a loss of capital ahead of equity holders or when equity holders do not. Contingent convertible securities
are also subject to extension risk. Contingent convertible securities are perpetual instruments and may only be callable at predetermined
dates upon approval of the applicable regulatory authority. There is no guarantee that we will receive return of principal on contingent
convertible securities. Convertible contingent securities are a newer form of instrument and the regulatory environment for these instruments
continues to evolve. Because the market for contingent convertible securities is evolving, it is uncertain how the larger market for
contingent convertible securities would react to a Trigger Event or coupon suspension applicable to a single issuer.
The value of contingent convertible securities is
unpredictable and will be influenced by many factors such as: (i) the creditworthiness of the issuer and/or fluctuations in such issuer’s
applicable capital ratios; (ii) supply and demand for contingent convertible securities; (iii) general market conditions and available
liquidity; and (iv) economic, financial and political events that affect the issuer, its particular market or the financial markets in
general.
Collateralized Loan Obligations and other Structured
Securities. A CLO is a special purpose vehicle that is formed to finance a pool of loans which meet predefined investment
criteria. It generally raises capital by issuing both debt and equity securities. Typically, a CLO will issue various classes, or “tranches,”
of debt broadly categorized as senior and subordinate debt tranches as well as an equity tranche.
CLO securities receive cash flows generated by underlying
collateral according to a defined payment waterfall. Principal and interest payments to CLO debt tranches are typically paid sequentially,
with senior debt tranches receiving cash flows prior to subordinate debt tranches. The risk and return to CLO debt tranches vary depending
upon each tranche’s right to collect cash flows generated by the underlying collateral. CLO debt tranches are generally rated,
with ratings ranging from the highest investment grade to below investment grade, with coupons commensurate with the risk of each tranche.
CLO debt tranches are also generally structured with covenants which, if violated, divert cash flows to the senior tranches prior to
making any interest or principal payments to subordinate debt tranches or equity tranches.
Unlike debt securities issued by CLOs, CLO equity
securities are not rated and do not have contractually stated payment schedules. At origination, the weighted average interest rate of
all CLO debt tranches is generally lower than the weighted average interest earned by a CLO’s underlying collateral, resulting
in an interest rate spread. CLO equity securities receive residual cash flows, or the interest spread, generated by the underlying collateral
after obligated payments for CLO debt securities and other expenses of the CLO have been made. CLO equity tranches typically comprise
approximately 10%-20% of total capital raised by a CLO.
CLO equity tranches can generate relatively front-end
loaded cash flows. CLO equity cash flows are also highly dependent on the credit performance of their underlying collateral pool. If
loans within the collateral pool default, the reduced amount of performing collateral leads to lower cash flows available for distribution
through CLO waterfalls, resulting in lower residual cash flows available for equity tranches. Residual cash flows are also impacted by
changes in portfolio spreads for CLO collateral. Declines in spreads on newly issued collateral during the reinvestment period result
in lower residual cash flows available for equity tranches.
We believe that CLOs and other debt securitizations
enable us to deploy our capital efficiently and to increase our capacity to provide financing to community banks.
Investment Selection
Our Adviser’s investment professionals are
responsible for negotiating, structuring and managing our investments, and operate under the oversight of our board of directors and
the Adviser’s investment committee. Some of our investment professionals may also be members of our board of directors, and may
be subject to conflicts of interest. See “Certain Relationships and Related Party Transactions—Conflicts of Interest Within
ArrowMark Partners.”
Current Yield Plus Growth Potential
We intend to focus on making investments in the bank
sector that generate substantial current income in the form of dividends or interest. See “Risk Factors—Risks Related to
Our Operations.” In the case of investments with fixed dividends or interest, the continuity of these payments is paramount, and
consequently we seek issuers that have business models that we believe will be stable over long periods of time. We also continue to
seek to generate capital gains by investing in banks using various equity strategies, including common equity, warrants, convertible
securities and options. We continue to seek to invest in equity-related instruments in circumstances where we believe a company has the
potential to generate above average growth or is undervalued. To a lesser extent, we may also generate revenue in the form of commitment,
origination or structuring fees.
Target Portfolio Company Characteristics
We have identified several quantitative, qualitative
and relative value criteria that we believe are important in identifying and investing in prospective bank and banking-related securities.
While these criteria provide general guidelines for our investment decisions, each prospective security in which we choose to invest
may not meet all of these criteria. Generally, we intend to utilize our access to information generated by our Adviser’s investment
professionals to identify prospective portfolio companies and to structure investments efficiently and effectively.
Qualified Management Team
We generally require that the community banks we
invest in have management teams that are experienced in running banking businesses and managing risk. We seek management teams that have
expertise in their market, thorough knowledge of the loans held by their institution and a track record of success. Further, we seek
senior management teams with significant ties to their local communities. These management teams may have strong technical, financial,
managerial and operational capabilities, established governance policies and incentive structures to encourage management to succeed
while acting in the best long-term interests of their investors.
Sensitivity Analyses
We typically perform sensitivity analyses to determine
the effects of changes in market conditions on any proposed investment. These sensitivity analyses may include, among other things, simulations
of changes in interest rates, changes in unemployment rates, changes in home prices, changes in economic activity and other events that
would affect the performance of our investment. In general, we do not commit to any proposed investment that will not provide at least
a minimum return under any of these analyses and, in particular, the sensitivity analysis relating to changes in interest rates and unemployment
rates.
Business Combinations
We seek to invest in community banks whose business
models and expected future cash flows make them attractive business combination transaction candidates, either as buyer or seller. These
companies include candidates for strategic acquisition by other industry participants and companies that may conduct an initial public
offering of common stock.
Investment Process and Due Diligence
In conducting due diligence, our Adviser typically
uses and intends to continue to use available public information, including “call reports” and other quarterly filings required
by bank regulators, due diligence questionnaires and discussions with the management teams at the respective institutions. In many cases,
our Adviser will also compile private information obtained pursuant to confidentiality agreements about the institution, its portfolio
of loans and securities, its customers and related deposits, compliance information, regulatory information and any such additional information
that could be necessary to complete its due diligence on the company. Although our Adviser may use research provided by third parties
when available, primary emphasis is placed on proprietary analysis and valuation models conducted and maintained by our Adviser’s
investment professionals.
The due diligence process followed by our Adviser’s
investment professionals is highly detailed and follows a structure they have developed over the past decade. Our Adviser seeks to exercise
discipline with respect to the pricing of its investments and institute appropriate structural protections in our investment agreements
to the extent banking regulations permit. After our Adviser’s investment professionals undertake initial due diligence of a prospective
investment, our Adviser’s investment committee determines whether to approve the initiation of more extensive due diligence. At
the conclusion of the diligence process, our Adviser’s investment committee is informed of critical findings and conclusions. The
due diligence process typically includes many of the following:
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review
of historical and prospective financial information;
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review
of regulatory filings and history of relevant regulatory actions or other legal proceedings
against the institution;
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review
and analysis of financial models and projections;
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analysis
of historical underwriting processes and standards;
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review
of due diligence questionnaires that include detail on loans and other assets;
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interviews
with management and key employees of the prospective bank;
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review
of the prospective bank’s geographic footprint and competitive and economic conditions
within the operating area; and
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review
of contingent liabilities.
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Additional due diligence with respect to any investment
may be conducted on our behalf by our legal counsel and accountants, as well as by other outside advisors and consultants, as appropriate.
Upon the conclusion of the due diligence process,
our Adviser’s investment professionals present a detailed investment proposal to our Adviser’s investment committee. The
investment committee’s policy is that the consent of two of the three members is required to approve the committee’s decision
to invest in a security and the consent of two of the three members is required to sell a security.
Investment Structure for Direct Investments in Banks
Once we have determined that a prospective community bank
is suitable for a newly originated direct investment, we work with the management of that company to structure an investment that the
parties believe is suitable from an economic and regulatory perspective.
We anticipate structuring our direct investments
in a variety of forms to meet our investment criteria and to meet the capital needs of the community banks in which we invest. Banking
is a highly regulated industry and investments in these institutions must be tailored to adhere to various regulatory standards, which
change from time to time.
Typically, FDIC-insured banks are wholly-owned by
a regulated holding company, and the primary asset of the holding company is the stock of the bank(s). We intend to invest in both community
banks and their holding companies.
We anticipate structuring the majority of our direct
investments as preferred equity, subordinated debt, convertible securities and common equity that pay cash dividends and interest on
a recurring or customized basis. In conjunction with our preferred stock (and to a lesser extent, our debt investments), we intend to
obtain warrants or equity conversion options by which we may increase our investments in banks. We do not intend to become regulated
as a bank holding company or savings and loan holding company and intend to structure our investments such that they represent less than
24.9% of any portfolio bank’s equity capital and thereby avoid causing us to be deemed a bank holding company. See “Risk
Factors—Risks Related to Banking Regulations Affecting Our Business.”
The types of securities in which we may invest include,
but are not limited to, the following:
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Preferred
Stock. We anticipate structuring these investments as perpetual preferred stock
to allow our portfolio company issuers to treat our investment in them as Tier 1 capital
under current regulatory capital standards. We believe that nearly all newly issued preferred
stock will be non-cumulative in order for it to qualify as Tier 1 capital of the applicable
portfolio company. Such preferred stock may also include rights to convert the preferred
stock into common stock under specified circumstances and on specified terms. While we do
not intend to invest a significant portion of the proceeds of any future offering in the
preferred stock of institutions that are not current in their dividends, we may invest in
them to some extent if we believe their institutions have the ability to become current in
their dividend payments in the future.
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Subordinated
Debt. We anticipate structuring these investments as subordinated unsecured debt.
Subordinated loans are expected to have maturities often years or longer with no amortization
until loan maturity to allow our portfolio company borrowers to treat the investment as Tier
2-qualifying capital. Under current market conditions, the interest rate on subordinated
loans ranges between 4% to 5.5%, excluding any equity warrants we may receive.
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Common
Stock. We will also seek to make minority common equity investments in publicly-traded
and select privately-held institutions. We will target internal rates of return between 15%-20%,
including dividends. Under market conditions as of the date of this prospectus, the dividend
rate on common stock of community banks ranges between 1-3%.
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Warrants and Options. We
may receive warrants or options to buy minority equity interests in connection with our direct subordinated debt and preferred equity
investments. As a result, as a portfolio company appreciates in value, we may achieve additional investment return from these equity
interests. We may structure such warrants to include provisions protecting our rights as a minority-interest holder. In many cases, we
may also seek to obtain registration rights in connection with these equity interests, which may include demand and “piggyback”
registration rights.
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Investments in Regulatory Capital Securities
The Company may make opportunistic investments
in regulatory capital securities transactions entered into primarily with global money center banks and other deposit-taking institutions,
the objective of which is generally to allow such banks and other deposit-taking institutions to reduce their risk-weighted asset calculations
on portfolios of assets, or otherwise optimize the capital required to be held against such exposures, in order to manage their required
capital.
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Structure
of Regulatory Capital Securities. Regulatory capital securities may be structured
in a variety of ways and are highly bespoke to the needs of the bank or other deposit-taking
institution involved. In many cases, the bank or other deposit-taking institution will establish
a special purpose vehicle (an “SPV”), which will issue credit-linked
notes or other debt instruments (the “notes”) to investors (and
to the bank or deposit-taking institutions itself) for cash. The cash proceeds of the issue
of notes to the investors will often be deposited by the SPV with the bank or other deposit-taking
institution, but they can be deposited elsewhere particularly in situations where the creditworthiness
of the bank or bank’s or other deposit-taking institution is weak. The bank or other
deposit-taking institution will typically retain a portion of credit loss exposures of the
collateral. The remainder of the credit loss exposures will mostly be held by external investors,
such as the Company, via the notes. The bank or other deposit-taking institution makes periodic
payments to the SPV of an amount sufficient for the SPV to pay the required interest and
principal sums on the notes. The amount of interest and principal payable on the notes will
be linked to the credit performance of the collateral.
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Regulatory capital securities may also
be structured as securitizations, where the collateral is actually transferred to the SPV and the payments on the notes are derived directly
from the cash flows arising from the collateral. Regulatory capital securities may also be structured as swaps or similar structure.
In each case, the economics of the transaction are intended to transfer the risk of loss of the referenced credit exposures to the Company
with the bank typically retaining certain exposures as described above. The structure of regulatory capital securities continues to evolve.
In addition to the instruments described
above, the Company may use derivatives instruments such as options, swaps, and index-related derivatives including both listed and over-the-counter
instruments. The Company may invest cash balances in asset-backed securities, money market securities, mortgage-related securities, inflation
protected and other index-linked securities.
Valuation Process
We value our assets in accordance with U.S. GAAP
and rely on multiple valuation techniques, reviewed on a quarterly basis by our board of directors. As most of our investments are not
expected to have market quotations, our board of directors undertakes a multi-step valuation process each quarter, as described below
and as described in more detail in “Net Asset Value” below:
|
·
|
Investment
Team Valuation. Each investment will be valued by the investment professionals of
our Adviser.
|
|
·
|
Third
Party Valuation. We have retained an independent valuation firm to provide a valuation
report for each investment at least once per fiscal year. These reports are provided to our
board of directors.
|
|
·
|
Investment
Committee. The investment committee of our Adviser will review the valuation report
provided by the investment team and the independent valuation firm.
|
|
·
|
Final
Valuation Determination. Our board of directors discusses and reviews the valuations
with our Adviser’s investment committee and, if they choose, with the independent valuation
firm. Our board of directors then determines the fair value of each investment in our portfolio
in good faith.
|
Competition
Our primary competitors in providing financing and
capital to community banks include public and private funds, commercial banks, investment banks, correspondent banks, commercial financing
companies, high net worth individuals, private equity funds and hedge funds. In addition, some of our competitors may have higher risk
tolerances or different risk assumptions, which could allow them to consider a wider variety of investments than us. Also, certain of
our competitors may be better able to hedge against these risks due to having a more diversified portfolio or being registered as a commodity
pool operator. We also believe that many of our competitors are established bank holding companies, which allows them to make investments
that are in excess of 24.9% ownership interest, investments that are not feasible for us since we do not intend to become a bank holding
company. Further, many of our competitors are not subject to the regulatory restrictions that the Investment Company Act imposes on us
as an investment company or to the source-of-income, asset diversification and distribution requirements we intend to satisfy to qualify
as a RIC.
Brokerage Allocation and Other Practices
Because we expect that most of the assets that we
hold will be illiquid, we will generally acquire and dispose of our investments in privately negotiated transactions, and we may use
brokers in the course of our business. Subject to policies established by our board of directors, we do not expect to execute transactions
through any particular broker or dealer, but we will seek to obtain the best net results for us, taking into account such factors as
price (including the applicable brokerage commission or dealer spread), size of order, difficulty of execution, operational facilities
of the firm, the firm’s risk and skill in positioning blocks of securities. While we will generally seek reasonably competitive
trade execution costs, we will not necessarily pay the lowest spread or commission available. Subject to applicable legal requirements,
we may select a broker based partly on brokerage or research services provided to us. In return for such services, we may pay a higher
commission than other brokers would charge if we determine in good faith that such commission is reasonable in relation to the services
provided.
Staffing
The Company does not currently have or expect to
have any employees. Employees of StoneCastle-ArrowMark or its affiliates provide the services necessary for our business. Our executive
officers described under “Management” are employees or principals of our Adviser or StoneCastle Partners, the parent company
of the Company’s prior investment manager, as indicated in the Statement of Additional Information.
Legal Proceedings
Neither Company or the Advisor is currently subject
to any material legal proceedings, nor, to our knowledge, is any material legal proceeding threatened against the Company or the Advisor.
Portfolio Turnover
For the fiscal years ended December 31, 2020 and
2019, our portfolio turnover rate was 60% and 13%, respectively. Portfolio turnover rate is not considered a limiting factor in the execution
of investment decisions for us. A higher turnover rate results in correspondingly greater brokerage commissions and other transactional
expenses that we bear.
LEVERAGE
Use of Leverage
We intend to operate with leverage through recourse
and non-recourse collateralized financings, private or public offerings of debt, warehouse facilities, secured and unsecured bank credit
facilities, reverse repurchase agreements and other borrowings. We may also operate with leverage by issuing preferred stock. Under normal
circumstances, we will not employ leverage above one-third of our total assets at time of incurrence.
The borrowing of money and the issuance of preferred
securities represent the leveraging of our common stock. We do not use leverage unless our board of directors believes that leverage
will serve the best interests of our stockholders. The principal factor used in making this determination is whether the potential return
is likely to exceed the cost of leverage. Therefore, in making the determination whether to use leverage, we must rely on estimates of
leverage costs and expected returns. Actual costs of leverage vary over time depending on interest rates and other factors, and actual
returns vary depending on many factors. We do not anticipate using leverage where the estimated costs of using such leverage and the
ongoing cost of servicing the payment obligations on such leverage exceed the estimated return on the proceeds of such leverage. Our
board of directors will also consider other factors, including whether the current investment opportunities will help us achieve our
investment objectives and strategies.
Leverage creates a greater risk of loss, as well
as potential for more gain, for our common stock than if leverage is not used. Leverage capital would have complete priority upon distribution
of assets on liquidation or otherwise over common stock. We expect to invest the net proceeds derived from any use or issuance of leverage
capital according to the investment objectives and strategies described in this prospectus. As long as our leverage capital is invested
in securities that provide a higher rate of return than the dividend rate or interest rate of the leverage capital after taking its related
expenses into consideration, the leverage will cause our common stockholders to receive a higher rate of income than if we were not leveraged.
Conversely, if the return derived from such securities is less than the cost of leverage (including increased expenses to us), our total
return will be less than if leverage had not been used, and, therefore, the amount available for distribution to our common stockholders
will be reduced. In the latter case, our Adviser in its best judgment nevertheless may determine to maintain our leveraged position if
it expects that the long term benefits to our common stockholders of so doing will outweigh the current reduced return. There is no assurance
that we will be successful in enhancing the level of our total return. The NAV of our common stock will be reduced by the fees and issuance
costs of any leverage capital. There is no assurance that outstanding amounts we borrow may allow prepayment by us prior to final maturity
without significant penalty, but we do not expect any sinking fund or mandatory retirement provisions. Outstanding amounts would be payable
at maturity or such earlier times as we may agree. We may be required to prepay outstanding amounts or incur a penalty rate of interest
in the event of the occurrence of certain events of default. We may be expected to indemnify our lenders, particularly any banks, against
liabilities they may incur related to their loan to us. Utilizing leverage may also restrict our ability to pay dividends, which could
lead to a loss of our RIC status. We may also be required to secure any amounts borrowed from a bank by pledging our investments as collateral.
Leverage creates risk for holders of our common stock,
including the likelihood of greater volatility of our NAV and the value of our shares, and the risk of fluctuations in interest rates
on leverage capital, which may affect the return to the holders of our common stock or cause fluctuations in the distributions paid on
our common stock. The fee paid to our Adviser is calculated on the basis of our Managed Assets, including proceeds from leverage capital.
During periods in which we use leverage, the fee payable to our Adviser is and will be higher than if we did not use leverage. Consequently,
we and our Adviser may have differing interests in determining whether to leverage our assets. Our board of directors monitors our use
of leverage and this potential conflict.
Under the Investment Company Act, we are not permitted
to issue preferred stock unless immediately after such issuance, the value of our total assets (including the proceeds of such issuance)
less all liabilities and indebtedness not represented by senior securities is at least equal to 200% of the total of the aggregate amount
of senior securities representing indebtedness plus the aggregate liquidation value of the outstanding preferred stock. Stated another
way, we may not issue preferred stock that, together with outstanding preferred stock and debt securities, has a total aggregate liquidation
value and outstanding principal amount of more than 50% of the amount of our total assets, including the proceeds of such issuance, less
liabilities and indebtedness not represented by senior securities. In addition, we are not permitted to declare any cash dividend or
other distribution on our common stock, or purchase any of our shares of common stock (through tender offers or otherwise), unless we
would satisfy this 200% asset coverage after deducting the amount of such dividend, distribution or share purchase price, as the case
may be. We may, as a result of market conditions or otherwise, be required to purchase or redeem preferred stock, or sell a portion of
our investments when it may be disadvantageous to do so, in order to maintain the required asset coverage. Furthermore, if we redeem
any preferred stock, it would result in a long-term decrease in cash available to be distributed to holders of our common stock in the
form of dividends. Common stockholders would bear the costs of issuing preferred stock, which may include offering expenses and the ongoing
payment of dividends. Under the Investment Company Act, we may only issue one class of preferred stock.
Under the Investment Company Act, we are not permitted
to issue debt securities or incur other indebtedness constituting senior securities unless, immediately thereafter, the value of our
total assets (including the proceeds of the indebtedness) less all liabilities and indebtedness not represented by senior securities
is at least equal to 300% of the amount of the outstanding indebtedness. Stated another way, we may not issue debt securities in a principal
amount of more than one-third of the amount of our total assets, including the amount borrowed, less all liabilities and indebtedness
not represented by senior securities. We also must maintain this 300% asset coverage for as long as the indebtedness is outstanding.
The Investment Company Act provides that we may not declare any cash dividend or other distribution on common or preferred stock, or
purchase any of our shares of stock (through tender offers or otherwise), unless we would satisfy this 300% asset coverage after deducting
the amount of the dividend, other distribution or share purchase price, as the case may be. If the asset coverage for indebtedness declines
to less than 300% as a result of market fluctuations or otherwise, we may be required to redeem debt securities, or sell a portion of
our investments when it may be disadvantageous to do so. Under the Investment Company Act, we may only issue one class of senior securities
representing indebtedness.
Assuming the utilization of leverage in the amount of 30% of our
total assets and an annual interest rate of 2.46% payable on such leverage (based on market rates as of the date of this prospectus),
the additional income that we must earn (net of debt-related expenses) in order to cover such leverage is approximately $1,546,383. Our
actual costs of leverage may be higher or lower than that assumed in the previous example.
Following the completion of the offering, we may increase the amount of leverage outstanding. We may incur
additional borrowings in order to maintain our desired leverage ratio of 30%. Leverage creates a greater risk of loss, as well as a potential
for more gain, for the common stock than if leverage was not used. Interest on borrowings may be at a fixed or floating rate, and the
interest at a floating rate generally will be based on short-term rates. The costs associated with our use of leverage, including the
issuance of such leverage and the payment of dividends or interest on such leverage, will be borne entirely by the holders of common
stock. As long as the rate of return, net of our applicable expenses, on our investment portfolio investments purchased with leverage
exceeds the costs associated with such leverage, we will generate more return or income than will be needed to pay such costs. In this
event, the excess will be available to pay higher dividends to holders of common stock. Conversely, if the return on such assets is less
than the cost of leverage and our other expenses, the return to the holders of our common stock will diminish. To the extent that we
use leverage, the NAV and market price of our common stock and the yield to holders of common stock will be more volatile. Our leveraging
strategy may not be successful. Because our Adviser’s fee is based on total assets (including any assets acquired with the proceeds
of leverage), our Adviser’s fee will be higher if we utilize leverage. See “Risks Related to Our Use of Leverage.”
Senior Securities
The following table is designed to illustrate
the annual rate of interest on the senior securities. Information in the table below has been audited by Tait, Weller & Baker LLP,
the Company's independent registered public accounting firm. The Company did not have any senior securities outstanding prior to June
9, 2014. Borrowings under the Credit Facility for the fiscal years ended December 31, 2020, 2019, 2018, 2017, 2016, 2015 and 2014 were
as follows:
Class
and Year(a)
|
|
Total
Amount
Outstanding(b)
|
|
|
Asset
Coverage Per
Unit(c)
|
|
|
Average
Market
Value
(excludes Bank
Loans)
|
|
Credit Facility
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal 2013 (as of December 31, 2013)
|
|
|
N/A
|
(d)
|
|
|
N/A
|
(d)
|
|
N/A
|
(d)
|
Fiscal 2014 (as of December 31, 2014)
|
|
$
|
22,500,000
|
|
|
$
|
7,317
|
|
|
N/A
|
|
Fiscal 2015 (as of December 31, 2015)
|
|
$
|
25,000,000
|
|
|
$
|
6,631
|
|
|
N/A
|
|
Fiscal 2016 (as of December 31, 2016)
|
|
$
|
61,500,000
|
|
|
$
|
3,253
|
|
|
N/A
|
|
Fiscal 2017 (as of December 31, 2017)
|
|
$
|
25,750,000
|
|
|
$
|
6,478
|
|
|
N/A
|
|
Fiscal 2018 (as of December 31, 2018)
|
|
$
|
51,000,000
|
|
|
$
|
3,753
|
|
|
N/A
|
|
Fiscal 2019 (as of December 31, 2019)
|
|
$
|
17,700,000
|
|
|
$
|
9,090
|
|
|
N/A
|
|
Fiscal 2020 (as of December 31, 2020)
|
|
$
|
43,000,000
|
|
|
$
|
4,274
|
|
|
N/A
|
|
|
(a)
|
On June 9, 2014, the Company
entered into the Credit Facility, a revolving credit agreement which had an initial aggregate
principal amount of up to $45,000,000 and stated maturity date of June 9, 2019. The interest
rate applicable to borrowings thereunder was generally LIBOR plus an applicable margin of
2.85%. The Credit Facility's commitment was increased to $70 million on January 16, 2015.
The Credit Facility was further amended in May 2017 to reflect a single lender, Texas Capital
Bank, N.A., a reduced rate of LIBOR +2.35% and a maximum borrowing amount of $62 million.
See "Risk Factors - Risks Related to Our Use of Leverage" for a description of
our revolving credit agreement.
|
|
(b)
|
Total amount of each
class of senior securities outstanding at the end of the period.
|
|
(c)
|
The asset coverage ratio
for senior securities representing indebtedness is calculated as our consolidated total assets,
less all consolidated liabilities and indebtedness not represented by senior securities,
divided by senior securities representing indebtedness. This asset coverage ratio is multiplied
by $1,000 to determine the Asset Coverage Per Unit.
|
|
(d)
|
No credit facility was
in place in 2013. The credit facility was put in place during 2014. See (a).
|
Effects of Leverage
The following table is designed to illustrate
the effect of leverage on the return to a holder of our common stock in the amount of approximately 30% of our total assets, assuming
a cost of leverage of 2.46% and hypothetical annual returns of our portfolio of minus 10% to plus 10%. As the table shows, leverage generally
increases the return to holders of common stock when portfolio return is positive and greater than the cost of leverage and decreases
the return when the portfolio return is negative or less than the cost of leverage. The figures appearing in the table are hypothetical
and actual returns may be greater or less than those appearing in the table. See “Risk Factors—Risks Related to Our Use of
Leverage.”
|
|
Assumed Portfolio Return (Net of Expenses)
|
|
|
|
(10%)
|
|
|
(5%)
|
|
|
0%
|
|
|
5%
|
|
|
10%
|
|
Corresponding Common Stock Return
|
|
|
-15.3
|
%
|
|
|
-8.2
|
%
|
|
|
-1.1
|
%
|
|
|
6.1
|
%
|
|
|
13.2
|
%
|
Derivative Transactions
Interest Rate Derivative Transactions. We
may use interest rate transactions such as swaps, caps, floors, forwards, swaptions and rate-linked notes to attempt to reduce the interest
rate risk arising from our investments and use of leverage or to provide exposure to the same types of investments that we make in community
banking companies. The use of interest rate transactions is a highly specialized activity that involves investment techniques and risks
different from those associated with ordinary portfolio security transactions. In an interest rate swap, we would agree to pay to the
other party to the interest rate swap (known as the “counterparty”) a fixed rate payment in exchange for the counterparty
agreeing to pay to us a variable rate payment intended to approximate our variable rate payment obligation on any variable rate borrowings.
The payment obligations would be based on the notional amount of the swap. An interest rate “swaption” is an option to enter
into an interest rate swap. In an interest rate cap, we would pay a premium to the counterparty up to the interest rate cap and, to the
extent that a specified variable rate index exceeds a predetermined fixed rate of interest, would receive from the counterparty payments
equal to the difference based on the notional amount of such cap. In an interest rate floor, we would be entitled to receive, to the
extent that a specified index falls below a predetermined interest rate, payments of interest on a notional principal amount from the
party selling the interest rate floor. In a forward rate agreement, we would be entitled to receive (or be obligated to pay) the difference
between the interest rate on the amount specified in the forward rate agreement and the interest rate on such amount on the date the
agreement expires. A fixed-rate note is a type of debt instrument with a fixed rate of interest (known as the “coupon rate”)
that is payable at specified times before maturity. A floating-rate note will pay us a variable amount on the principal amount of the
note but the note’s value rises when interest rates rise (as opposed to bonds, which decrease in value when interest rates rise).
Depending on the state of interest rates in general,
our use of interest rate transactions could affect our ability to make required interest payments on any outstanding fixed income securities
or preferred stock. To the extent there is a decline in interest rates, the value of the interest rate transactions could decline. If
the counterparty to an interest rate transaction defaults, we would not be able to use the anticipated net receipts under the interest
rate transaction to offset our cost of financial leverage. See “Risk Factors—Risks Related to Our Operations—Derivatives
transactions may limit our income or result in losses.”
We have claimed an exclusion from the definition
of the term “commodity pool operator” under the Commodity Exchange Act of 1936, as amended (“CEA”), pursuant
to Regulation 4.5 under the CEA. So long as we maintain this exclusion, we will not be deemed a commodity pool operator under the CEA,
and we anticipate that neither we nor our Adviser will be subject to regulation or registration as a commodity pool operator or commodity
trading advisor under the CEA. Although we do not currently intend to, if we use commodity futures, commodity option contracts futures
or swaps other than for bona fide hedging purposes, as defined under the CEA regulations, our aggregate initial margin and premiums on
these positions (after taking into account unrealized profits and unrealized losses on any such positions and excluding the amount by
which options that are “in-the-money” at the time of purchase) will not exceed 5% of our NAV. Furthermore, the aggregate
net notional value of commodity futures, commodity option contracts futures and swaps other than for bona fide hedging purposes will
not exceed 100% of our NAV (after taking into account unrealized profits and unrealized losses on any such positions). If, however, we
exceed either of these thresholds, we will no longer qualify for this exclusion and will need to register as a commodity pool operator
(“CPO”) under the CEA. If we were required to register as a CPO, the disclosure and operations of the Company would need
to comply with all applicable regulations governing commodity pools and CPOs. Additionally, if required to register as a CPO, we would
be required to become a member of the National Futures Association (“NFA”) and be subject to the NFA’s rules and bylaws.
Compliance with these additional registration and regulatory requirements would increase the Company’s operating expenses.
Credit Derivative Transactions. We may
utilize credit derivatives, such as credit default swaps, total return swaps or credit-linked notes to “buy” credit protection,
in which case we would attempt to mitigate the risk of default or credit quality deterioration in all or a portion of our portfolio of
bank securities to hedge against changes in the market price of bank securities in which we invest. We may also utilize total return
swaps or credit-linked notes to provide exposure to the same types of investments that we make in community banking companies. A credit
default swap is an agreement between two parties to exchange the credit risk of a particular issuer or reference entity. The Company
does not “sell” credit default swaps. In a credit default transaction, we as buyer would pay periodic fees in return for
payment by the seller which is contingent upon an adverse credit event occurring with respect to the underlying issuer or reference entity.
The seller collects periodic fees from us and profits if the credit of the underlying issuer or reference entity remains stable or improves
while the swap is outstanding, but the seller would be required to pay an agreed upon amount to us as buyer (which may be the entire
notional amount of the swap) in the event of an adverse credit event in the issuer or reference entity. A credit-linked note is structured
as a security with an embedded credit-default swap. Total return swap agreements are contracts in which one party agrees to make periodic
payments to another party based on the change in market value of the assets underlying the contract, which may include a specified security,
basket of securities or securities indices during the specified period, in return for periodic payments based on a fixed or variable
interest rate or the total return from other underlying assets.
Equity Derivative Transactions. We may
engage in equity derivatives transactions, including the use of futures, options and warrants to hedge against changes in the market
prices of bank equity securities in which we invest or to provide exposure to and focus on the same types of investments that we make
in community banking companies. Options, futures and warrants are contracts involving the right to receive or the obligation to deliver
assets or money depending on the performance of one or more underlying assets, instruments or a market or economic index. An option gives
its owner the right, but not the obligation, to buy (“call”) or sell (“put”) a specified amount of a security
at a specified price within a specified time period. We may purchase or sell options on the publicly traded bank equity securities in
which we may invest. When we purchase an over-the-counter option, it increases our credit risk exposure to the counterparty. Futures
are standardized, exchange-traded contracts that obligate a purchaser to take delivery, and a seller to make delivery, of a specific
amount of an asset at a specified future date at a specified price. No price is paid upon entering into a futures contract. Rather, upon
purchasing or selling a futures contract, we would be required to deposit collateral (“margin”) equal to a percentage (generally
less than 10%) of the contract value. Each day thereafter until the futures position is closed, we will pay additional margin representing
any loss experienced as a result of the futures position the prior day or be entitled to a payment representing any profit experienced
as a result of the futures position the prior day. Warrants are securities that entitle the holder to buy the underlying stock of the
issuing company at a fixed exercise price until the expiration date of the warrant.
The banks in which we invest may include, as part
of the consideration of our investment in such banks’ equity or debt securities, a grant of warrants, options and other equity
conversion features by which we may increase our investment in such banks over time. While we may or may not exercise our rights under
such instruments, we may trade in these warrants, options and other equity conversion features or otherwise use them to leverage our
capital. In instances where our derivative transactions may be deemed to create leverage under the Investment Company Act, we will separately
segregate with our custodian cash or high quality liquid investments having a value, at all times through exercise, at least equal to
our potential payment obligations under such derivative transactions or otherwise ensure that the amount of such obligations together
with our other leverage obligations, does not exceed 33% of our total assets. See “Risk Factors—Risks Related to Our Operations.”
Currency Hedging Techniques. We may use currency
hedging techniques, including (a) purchasing and selling currency futures contracts and options thereon, (b) purchasing and selling currency
forward contracts, and (c) engaging in foreign currency exchange transactions on a spot (i.e., cash) basis at the spot rate prevailing
in the foreign currency exchange market. For example, the Company may enter into forward foreign currency exchange contracts to help
protect its holdings against unfavorable changes in currency exchange rates. A forward foreign currency exchange contract is an agreement
to buy or sell a country’s currency at a specific price on a specific date, usually 30, 60 or 90 days in the future. In other words,
the contract guarantees an exchange rate on a given date.
MANAGEMENT
Our board of directors provides the overall supervision
and review of our affairs. Management of our portfolio is the responsibility of our Adviser’s investment committee. Our Adviser’s
investment committee is composed of Sanjai Bhonsle, Karen Reidy, and Kaelyn Abrell. Our Adviser’s investment team, led by Mr. Bhonsle,
a partner of ArrowMark Partners, will be responsible for negotiating, structuring and managing our investments. The investment professionals
of our Adviser and its affiliates have significant experience sourcing, analyzing, investing and managing investments in the banking
sector. For the background of our investment professionals, see “Investment Committee.”
We expect to continue to focus our securities portfolio
on making long-term, passive, non-control investments in the bank sector and banking-related securities. We intend to continue to direct
investments in numerous issuers differentiated by asset sizes, business models and geographies to create a more stable, long-term portfolio
of assets. Our Adviser monitors our portfolio companies and market concentrations and may adjust its underwriting criteria based on market
conditions and portfolio concentrations. Our Adviser’s monitoring operations include sensitivity analyses to determine the effects
of changes in market conditions on our asset portfolio. These analyses may include simulations of changes in interest rates, changes
in economic activity and other events that would affect the forecasted performance of our assets.
Directors and Officers
Our business and affairs are managed under the direction
of our board of directors. Accordingly, our board of directors provides broad supervision over our affairs, including supervision of
the duties performed by our Adviser. Our Adviser is responsible for our day-to-day operations.
Investment Committee
Management of our portfolio is the responsibility
of our Adviser’s investment committee. Our Adviser’s investment committee is currently comprised of Sanjai Bhonsle, Karen
Reidy, and Kaelyn Abrell. The investment committee’s policy is that the consent of two of the three members is required to approve
the committee’s decision to invest in a security and the consent of two of the three members is required to sell a security. Biographical
information about each member of our Adviser’s investment committee is set forth below. See the accompanying Statement of Additional
Information for more information about our investment committee members’ compensation, other accounts managed, and each investment
committee member’s ownership of our securities.
The names, ages and addresses of the members of our
Adviser’s investment committee, together with their principal occupations and other affiliations during the past five years, are
set forth below.
Members of our Investment Committee
Name
|
|
Age
|
|
Position(s) Held with
Company
|
|
Principal Occupation(s)
Last 5 Years
|
|
Other Directorships
Last 5 Years
|
Sanjai Bhonsle
|
|
50
|
|
Class III
Director; Chairman of the Board & Chief Executive Officer; Investment Committee Member
|
|
Partner and
Portfolio Manager at ArrowMark Partners from 2012–Present
|
|
Brown RI Management,
LLC and Affiliates from 2018–Present
|
Karen Reidy
|
|
53
|
|
Class I Director; Investment
Committee Member
|
|
Partner and Portfolio Manager
at ArrowMark Partners from 2008–Present
|
|
Brown RI Management,
LLC and Affiliates from 2018–Present
|
Kaelyn Abrell
|
|
45
|
|
Investment Committee Member
|
|
Partner and Portfolio
Manager at ArrowMark Partners from 2008–Present
|
|
None
|
Biographical Information
The following sets forth certain biographical information
for our investment committee members:
Sanjai Bhonsle. Mr. Bhonsle joined ArrowMark
in October 2012 and serves as Partner and Portfolio Manager for ArrowMark's leveraged loan investments and CLO funds. Prior to joining
ArrowMark, he founded MB Consulting Partners in 2009, where he specialized in financial and operational restructuring advisory to stressed
and distressed middle-market companies. With more than 10 years of restructuring experience, he has led several assignments across various
industries. Mr. Bhonsle was a Senior Portfolio Manager at GSO Capital Partners, a subsidiary of The Blackstone Group, and member of the
Investment and Management Committee (2005-2009). Prior to joining GSO Capital Partners, Mr. Bhonsle was an Assistant Portfolio Manager
for RBC Capital Partners' debt investment group and was a member of the Investment Committee (2001-2005). He also led the group's restructuring
efforts related to distressed investments and represented the firm's interests on creditor committees. From 1999-2001, Mr. Bhonsle was
a Senior Investment Analyst at Indosuez Capital Partners. Mr. Bhonsle received a bachelor's degree in Mechanical Engineering from the
University of Wisconsin — Madison and an MBA from the Eli Broad Graduate School of Management at Michigan State University.
Karen Reidy. Ms. Reidy is a founding Partner
and co-manages ArrowMark's collateralized loan obligation and specialty finance investments and research analyst team. Prior to founding
ArrowMark, Ms. Reidy served as Executive Vice President and Portfolio Manager at Janus capital, managing $10 billion for two strategies:
Janus Balanced Fund and Janus Core Equity Fund, as well as institutional separate accounts (2000-2005). Ms. Reidy was also the Assistant
Portfolio Manager of the Janus Fund (1998-2000). She joined Janus Capital as an equity analyst in 1995. Prior to Janus Capital Group,
she worked at PricewaterhouseCoopers LLC in the audit and mergers and acquisitions departments. Ms. Reidy graduated from the University
of Colorado with a bachelor's degree and holds the Chartered Financial Analyst designation.
Kaelyn Abrell. Ms. Abrell is a Partner
and Portfolio Manager of ArrowMark’s private credit funds and separately managed accounts and leads the firm’s fixed income
efforts in securitized investments, including regulatory capital relief since 2010. Ms. Abrell was also the lead analyst for the firm’s
participation in the Term Asset-Backed Securities Loan Facility (“TALF”) program. Prior to joining ArrowMark in 2008, she
was an analyst at Janus Capital Group where her areas of focus included residential and commercial mortgage-backed securities, asset-backed
securities, and interest rates (2004-2008). Previously, Ms. Abrell worked at Great-West Life where she was Assistant Portfolio Manager
of $5.5 billion in separate account, general account and total return assets with a focus on high quality fixed income securities (1998-2004).
Ms. Abrell graduated from Illinois State University with a bachelor’s degree in Economics and earned an MBA from Indiana University.
Management Agreement
Management Services
StoneCastle-ArrowMark Asset Management, LLC, an investment
adviser that is a wholly-owned subsidiary of ArrowMark Colorado Holdings, LLC, serves as our investment adviser, subject to the overall
supervision and review of our board of directors. Pursuant to a management agreement, our Adviser provides us with investment research,
advice and supervision and furnishes us continuously with an investment program, consistent with our investment objective and policies.
Our Adviser also determines from time to time what securities we shall purchase, and what securities shall be held or sold, what portions
of our assets shall be held uninvested as cash or in other qualified short-term investments or liquid assets, maintains books and records
with respect to all of our transactions and will report to our board of directors on our investments and performance. Our Adviser was
formed in December 2019. Our Adviser’s affiliate, ArrowMark Partners, is a registered investment adviser formed in 2007.
Our Adviser has no full-time employees and relies
on the officers, employees and resources of its affiliated entities. All of the members of the investment committee of our Adviser are
affiliates of, but not employees of, StoneCastle-ArrowMark, and may have other significant responsibilities with ArrowMark Partners and
its subsidiaries.
Our Adviser’s services to us under the management
agreement will not be exclusive, and while it is not currently contemplated, our Adviser is free to furnish the same or similar services
to other entities, including businesses which may directly or indirectly compete with us, so long as our Adviser’s services to
us are not impaired by the provision of such services to others. Our Adviser intends to allocate investment opportunities in a fair and
equitable manner consistent with our investment objectives and strategies so that we will not be disadvantaged in relation to any other
client of the Adviser.
Administration Services
Pursuant to the management agreement, our Adviser
also furnishes us, or arranges for the furnishing of office facilities and clerical and administrative services necessary for our operation
(other than services provided by our custodian, accounting agent, administrator, dividend and interest paying agent and other service
providers). Our Adviser is authorized to cause us to enter into agreements with third parties to provide such services. To the extent
we request, our Adviser:
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oversees
the performance and payment of the fees of our service providers and makes reports and recommendations
to our board of directors such matters as the parties deem desirable;
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responds
to inquiries and otherwise assists such service providers in the preparation and filing of
regulatory reports, proxy statements and stockholder communications, and the preparation
of materials and reports for our board of directors;
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establishes
and oversees the implementation of borrowing facilities or other forms of leverage authorized
by our board of directors; and
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supervises
any other aspect of our administration as may be agreed upon by us and our Adviser.
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Management Fee
Pursuant to the management agreement, we have agreed
to pay our Adviser a fee for the management and administration services described above. The management fee is 0.4375% (1.75% annualized)
of our Managed Assets, calculated and paid quarterly in arrears within fifteen days of the end of each calendar quarter. The term “Managed
Assets” as used in the calculation of the management fee means our total assets (including cash and cash equivalents and any assets
purchased with or attributable to any borrowed funds). The management fee for any partial quarter will be appropriately prorated. Our
Adviser is not paid an incentive fee and does not participate in our profits in its capacity as Adviser.
The Advisor may from time to time waive its advisory
fee and such waivers may include the ability of the Advisor to recoup such fees subject to certain conditions, including that no amounts
may be recouped more than three years from the date of the waiver or reimbursement. Management fees paid to the Advisor for the period
from February 12, 2020 (the date the Adviser succeeded SAM as the Company’s Adviser) to December 31, 2020 were $2,554,062. Management
fees paid to the Company’s prior investment advisor, StoneCastle Asset Management LLC (“SAM”), pursuant to a management
agreement between the Company and SAM dated November 1, 2013, for the period from January 1, 2020 through February 12, 2020, and fiscal
years ended December 31, 2019 and 2018 were respectively, $270,955, $2,989,685 and $3,329,460. See, “Duration and Termination”.
Payment of Our Expenses
StoneCastle-ArrowMark serves as our investment adviser
in accordance with the terms of the management agreement. Subject to the overall supervision of our board of directors, our Adviser manages
our day-to-day operations and provides us with investment management services. Under the terms of the management agreement, StoneCastle-ArrowMark
does and will:
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determine
the composition of our portfolio, the nature and timing of the changes therein and the manner
of implementing such changes;
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identify,
evaluate and negotiate the structure of the investments we make (including performing due
diligence on our prospective portfolio companies);
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close,
monitor and administer the investments we make, including the exercise of any voting or consent
rights; and
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provide
us with such other investment advisory, research and related services as we may, from time
to time, reasonably require for the investment of our assets.
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We bear all expenses not specifically assumed by
our Adviser and incurred in our operations, and we will bear the expenses related to any future offering. We will reimburse our Adviser
to the extent our Adviser pays these expenses. The compensation and allocable routine overhead expenses of all investment professionals
of our Adviser, when and to the extent engaged in providing us investment advisory services, will be provided and paid for by our Adviser
and not us, although we will reimburse our Adviser an amount equal to our allocable portion of overhead and other expenses incurred by
our Adviser in performing its administrative obligations under the management agreement. The fees and expenses borne by us may include,
but are not limited to, the following:
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other
than as provided under “Management Fee” above, expenses of maintaining and continuing
our existence and related overhead, including, to the extent such services are provided by
personnel of our Adviser or its affiliates in performing it administrative obligations, including
without limitation furnishing office space and facilities and administrative and compliance
personnel compensation, training and benefits;
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the
fees, expenses and disbursements of any third party administrator or compliance firm retained
by the Company or the Adviser to provide any of the administrative services referenced above,
to the extent not provided by personnel of the Adviser or its affiliates;
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commissions,
spreads, fees and other expenses connected with the acquisition, holding, monitoring and
disposition of securities and the Company’s other investments, including placement
and similar fees in connection with direct placements entered into by or on behalf of the
Company or any subsidiary thereof, and travel or other expenses incurred in connection with
performing due diligence on its prospective portfolio companies or monitoring and overseeing
its existing portfolio companies;
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auditing,
accounting and legal expenses;
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taxes
and interest; governmental fees;
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expenses
of listing our shares with a stock exchange, and expenses of issue, sale, repurchase and
redemption (if any) of our securities, including expenses of conducting tender offers for
the purpose of repurchasing our securities;
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expenses
of registering and qualifying us and our securities under federal and state securities laws
and of preparing and filing registration statements and amendments for such purposes;
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expenses
of communicating with stockholders, including website expenses and the expenses of preparing,
printing and mailing press releases, reports and other notices to stockholders and of meetings
of stockholders and proxy solicitations therefor;
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expenses
of preparing and filing reports to governmental officers and commissions, including, without
limitation, our periodic report preparation and filing obligations with the SEC;
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association
membership dues;
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fees,
expenses and disbursements of custodians and subcustodians for all services to us (including
without limitation safekeeping of funds, securities and other investments, keeping of books,
accounts and records and determination of NAVs);
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fees,
expenses and disbursements of transfer agents, dividend and interest paying agents, stockholder
servicing agents and registrars for all services to us;
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fees,
expenses and disbursements, including travel expenses, incurred in connection with the marketing
and promotion of the Company, including the fees, expenses and disbursements of any person
with whom the Company (or the Adviser on behalf of the Company) enters into an endorsement
relationship;
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compensation
and expenses of the Company’s Independent Directors;
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pricing,
valuation and other consulting, due diligence or analytical services employed in considering
and valuing our actual or prospective investments;
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all
expenses incurred in leveraging of our assets through a line of credit or other indebtedness
or issuing and maintaining preferred stock;
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all
expenses incurred in connection with our organization and any offering of common or preferred
shares, including underwriting discounts and commissions; and
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such
non-recurring items as may arise, including expenses incurred in litigation, proceedings
and claims and our obligation to indemnify our directors, officers and stockholders with
respect thereto.
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Expenses that are reimbursable to our Adviser are
submitted to the independent members of our board of directors for their approval prior to reimbursement thereof.
Allocation Policy
Our Adviser and its affiliates allocate investment
opportunities among client accounts on a fair and consistent basis, and do not favor any one client or account over any other. In certain
cases, investment opportunities may be made by our Adviser other than on a pro rata basis. In determining to which accounts our Adviser
will allocate investment opportunities, and in determining the shares to allocate to a particular account, our Adviser and its affiliates
do not consider:
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the
levels of fees earned from accounts or the fact that certain accounts may pay performance-based
fees;
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different
compensation payable to portfolio managers based on the performance of certain accounts;
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the
ability of particular clients to send business to or otherwise benefit our Adviser in exchange
for allocations;
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the
identity of account holders (including the fact that certain accounts may be proprietary
or maintained on behalf of investment vehicles that our Adviser sponsors);
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in
the case of allocations of initial public offerings, market movement generally or the performance
of the shares since the execution of the order in question;
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the
prior performance of accounts; or
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whether
an account is new to our Adviser.
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CAB Marketing, LLC and CAB, L.L.C.
We have in the past entered into exclusive investment
referral and endorsement relationships with the CAB Marketing, LLC and CAB, L.L.C., subsidiaries of the ABA. Pursuant to the agreements
governing these relationships, CAB Marketing, LLC assisted us with the promotion and identification of potential investment opportunities.
These agreements, terminated effective August 31,
2020, require an additional payment of $150,000 in the year following termination in recognition of the trailing benefit of the CAB name
license. The ABA and its subsidiaries have not endorsed any future offering, and you should not construe references to them in this prospectus
as such an endorsement.
Duration and Termination
The management agreement with our Adviser initially
became effective on February 12, 2020 and unless earlier terminated, it will continue in effect for an initial period of two years and
from year to year thereafter, but only so long as each continuance is specifically approved by (i) our board of directors or the vote
of a majority of our voting securities and (ii) the vote of a majority of our independent directors. A discussion regarding the basis
for the board’s approval of the management agreement is provided in the Company’s Annual Report to stockholders for the fiscal
year ended December 31, 2019, which is publicly filed with the SEC. The management agreement with our Adviser was approved by our board
of directors on December 5, 2019 and by the Company’s Stockholders by the vote of a majority of the outstanding voting securities
of the Company on February 7, 2020. The management agreement with our Adviser may be terminated at any time, without payment or penalty,
by vote of our board of directors, by vote of a majority of our voting securities, or by our Adviser, in each case on not less than 60
days’ written notice. As required by the Investment Company Act, the management agreement with our Adviser will terminate automatically
in the event of its assignment.
Liability of Adviser and Indemnification
The management agreement provides that our Adviser
will not be liable to us in any way for any default, failure or defect in any of the securities comprising our portfolio if it has satisfied
the duties and the standard of care, diligence and skill set forth in the management agreement. The management agreement further states
that we will indemnify the Adviser for any losses, damages, claims, costs, charges, expenses or liabilities except to the extent such
amounts result from our Adviser’s willful misfeasance, bad faith or gross negligence in the performance of its duties or by reason
of the reckless disregard of its duties and obligations under the management agreement or as otherwise prohibited by applicable law.
As a result, our Adviser may not be liable to us for breaches of its duty of care, diligence or skill.
License Agreement
StoneCastle-ArrowMark has obtained a perpetual, non-exclusive
license to the “StoneCastle” trademark. The Company has agreed to cease using the name “StoneCastle” as part
of the Company’s name, to change its legal name so as to not contain the word “StoneCastle” or any variant thereof
(and, if required, shall use best efforts to obtain consent of the stockholders of the Company with respect to the foregoing), and to
cease using the related “StoneCastle” logo if the Company ceases, for any reason, to employ the Adviser or one of its approved
affiliates as the Company’s investment adviser. Future names adopted by the Company for itself, insofar as such names include any
trademark of the Adviser or any mark with the potential for confusion with the Adviser may only be used by the Company with the approval
of the Adviser.
RISK
FACTORS
An investment in our securities involves a high
degree of risk. You should carefully consider the following information, together with the other information contained in this prospectus,
before investing in our securities. In connection with the forward-looking statements that appear in this prospectus, you should also
carefully review the cautionary statement referred to above under “Cautionary Statement Concerning Forward-Looking Statements.”
Risks Related to Investing in Banking Sector
Our assets will be concentrated in the banking
industry, potentially exposing us to greater risks than companies that invest in multiple sectors.
Companies in the group of
industries related to banks and diversified financials are often subject to extensive governmental regulation and intervention, which
may adversely affect the scope of their activities, the prices they can charge and the amount of capital they must maintain. Governmental
regulation may change frequently and may have significant adverse consequences for companies in the group of industries related to banks
and diversified financials, including effects not intended by such regulation. The impact of recent or future regulation in various countries
on any individual financial company or on the industries as a whole cannot be predicted. A focus on community banks may make the Company
more economically vulnerable in the event of a downturn in the banking industry. Community banks may face heightened risks of failure
during times of economic downturns than larger banks. Community banks may also be subject to greater lending risks than larger banks.
Certain risks may impact
the value of investments in the group of industries related to banks and diversified financials more severely than those of investments
outside these industries, including the risks associated with companies that operate with substantial financial leverage. Companies in
the group of industries related to banks and diversified financials may also be adversely affected by increases in interest rates and
loan losses, decreases in the availability of money or asset valuations, credit rating downgrades and adverse conditions in other related
markets.
The group of industries
related to banks and diversified financials is also a target for cyber attacks and may experience technology malfunctions and disruptions.
In recent years, cyber attacks and technology failures have become increasingly frequent and have caused significant losses.
Risks specific to the bank and diversified financial
group of industries also may include:
Asset
quality and credit risk. When financial institutions loan money, commit to loan money or enter into a
letter of credit or other contract with a counterparty, they incur credit risk, or the risk of losses if their borrowers do not repay
their loans or their counterparties fail to perform according to the terms of their contract. The companies in which the Company will
invest offer a number of products which expose them to credit risk, including loans, leases and lending commitments, derivatives, trading
account assets and assets held-for-sale. Financial institutions allow for and create loss reserves against credit risks based
on an assessment of credit losses inherent in their credit exposure (including unfunded credit commitments). This process, which is critical
to their financial results and condition, requires difficult, subjective and complex judgments, including forecasts of economic conditions
and how these economic predictions might impair the ability of their borrowers to repay their loans. As is the case with any such assessments,
there is always the chance that the financial institutions in which the Company invests will fail to identify the proper factors or that
they will fail to accurately estimate the impacts of factors that they identify. Failure to identify credit risk factors or the impact
of credit factors may result in increased non-performing assets, which will result in increased loss reserve provisioning and
reduction in earnings. Poor asset quality can also affect earnings through reduced interest income which can impair a bank’s ability
to service debt obligations or to generate sufficient income for equity holders. Bank failure may result due to inadequate loss reserves,
inadequate capital to sustain credit losses or reduced earnings due to non-performing assets. The Company will not have control
over the asset quality of the financial institutions in which the Company will invest, and these institutions may experience substantial
increases in the level of their non-performing assets which may have a material adverse impact on the Company’s investments.
Capital
risk. A bank’s capital position is extremely important to its overall financial condition and serves
as a cushion against losses. U.S. banking regulators have established specific capital requirements for regulated banks. Federal banking
regulators proposed amended regulatory capital regulations in response to the Dodd-Frank Act and the international capital and liquidity
requirements set forth by the Basel Committee on Banking Supervision (“Basel III”) protocols which would impose even more
stringent capital requirements. In the event that a regulated bank falls below certain capital adequacy standards, it may become subject
to regulatory intervention including, but not limited to, being placed into a FDIC-administered receivership or conservatorship. The
regulatory provisions under which the regulatory authorities act are intended to protect depositors. The deposit insurance fund and the
banking system are not intended to protect shareholders or other investors in other securities issued by a bank or its holding company.
The effect of inadequate capital can have a potentially adverse consequence on the institution’s financial condition, its ability
to operate as a going concern and its ability to operate as a regulated financial institution and may have a material adverse impact
on the Company’s investments.
Earnings
risk. Earnings are the primary means for financial institutions to generate capital to support asset growth,
to provide for loan losses and to support their ability to pay dividends to shareholders. The quantity as well as the quality of earnings
can be affected by excessive or inadequately managed credit risk that may result in losses and require additions to loss reserves, or
by high levels of market risk that may unduly expose an institution’s earnings to volatility in interest rates. The quality of
earnings may also be diminished by undue reliance on extraordinary gains, nonrecurring events, or favorable tax effects. Future earnings
may be adversely affected by an inability to forecast or control funding and operating expenses, net interest margin compression improperly
executed or ill-advised business strategies, or poorly managed or uncontrolled exposure to other risks. Deficient earnings
can result in inadequate capital resources to support asset growth or insufficient cash flow to meet the financial institution’s
near-term obligations. Under certain circumstances, this may result in the financial institution being required to suspend operations
or the imposition of a cease-and-desist order by regulators which could potentially impair the Company’s investments.
Management
risk. The ability of management to identify, measure, monitor and control the risks of an institution’s
activities and to ensure a financial institution’s safe, sound and efficient operation in compliance with applicable laws and regulations
are critical. Depending on the nature and scope of an institution’s activities, management practices may need to address some or
all of the following risks: credit, market, operating, reputation, strategic, compliance, legal, liquidity and other risks. The
Company will not have direct or indirect control over the management of the financial institutions in which the Company will invest and,
given the Company’s long-term investment strategy, it is likely that the management teams and their policies may change. The inability
of management to operate their financial institution in a safe, sound and efficient manner in compliance with applicable laws and regulations,
or changes in management of financial institutions in which the Company invests, may have an adverse impact on the Company’s investment.
Litigation
risk. Financial institutions face significant legal risks in their businesses, and the volume of claims
and amount of damages and penalties claimed in litigation and regulatory proceedings against financial institutions remain high. Substantial
legal liability or significant regulatory action against the companies in which the Company invests could have material adverse financial
effects or cause significant reputational harm to these companies, which in turn could seriously harm their business prospects. Legal
liability or regulatory action against the companies in which the Company invests could have material adverse financial effects on the
Company and adversely affect the Company’s earnings and book value.
Market
risk. The financial institutions in which the Company will invest are directly and indirectly affected
by changes in market conditions. Market risk generally represents the risk that values of assets and liabilities or revenues will be
adversely affected by changes in market conditions. Market risk is inherent in the financial instruments associated with the operations
and activities including loans, deposits, securities, short-term borrowings, long-term debt, trading account assets and liabilities and
derivatives of the financial institutions in which the Company will invest. Market risk includes, but is not limited to, fluctuations
in interest rates, equity and futures prices, and changes in the implied volatility of interest rates, equity and futures prices and
price deterioration or changes in value due to changes in market perception or actual credit quality of the issuer. Accordingly, depending
on the instruments or activities impacted, market risks can have wide ranging, complex adverse effects on the operations and overall
financial condition of the financial institutions in which the Company will invest as well as adverse effects on the Company’s
results from operations and overall financial condition.
Monetary
policy risk. Monetary policies have had, and will continue to have, significant effects on the operations
and results of financial institutions. There can be no assurance that a particular financial institution will not experience a material
adverse effect on its net interest income in a changing interest rate environment. Factors such as the liquidity of the global financial
markets, and the availability and cost of credit may significantly affect the activity levels of customers with respect to the size,
number and timing of transactions. Fluctuation in interest rates, which affect the value of assets and the cost of funding liabilities,
are not predictable or controllable, may vary and may impact economic activity in various regions.
Competition. The
group of industries related to banks and diversified financials, including the banking sector, is extremely competitive, and it is expected
that the competitive pressures will increase. Merger activity in the financial services industry has resulted in and is expected to continue
to result in, larger institutions with greater financial and other resources that are capable of offering a wider array of financial
products and services. The group of industries related to banks and diversified financials has become considerably more concentrated
as numerous financial institutions have been acquired by or merged into other institutions. The majority of financial institutions in
which the Company will invest will be relatively small with significantly fewer resources and capabilities than larger institutions;
this size differential puts them at a competitive disadvantage in terms of product offering and access to capital. Technological advances
and the growth of e-commerce have made it possible for non-financial institutions and non-bank financial
institutions to offer products and services that have traditionally been offered by banking and other financial institutions. It is expected
that the cross-industry competition and inter-industry competition will continue to intensify and may be adverse to the financial institutions
in which the Company invests.
Regulatory
risk. Financial institutions, including community banks, are subject to various state and federal banking
regulations that impact how they conduct business, including but not limited to how they obtain funding, their ability to operate and
the value of the Company’s investments. Changes to these regulations could have an adverse effect on their operations and operating
results and the Company’s investments. The Company expects to make long-term investments in financial institutions that are subject
to various state and federal regulations and oversight. Congress, state legislatures and the various bank regulatory agencies frequently
introduce proposals to change the laws and regulations governing the banking industry in response
to the Dodd-Frank Act, Consumer Financial Protection Bureau (the “CFPB”) rulemaking or otherwise. The likelihood and timing
of any proposals or legislation and the impact they might have on the Company’s investments in financial institutions affected
by such changes cannot be determined and any such changes may be adverse to the Company’s investments. Ownership of the stock of
certain types of regulated banking institutions may subject the Company to additional regulations. Investments in banking institutions
and transactions related to the Company’s investments may require approval from one or more regulatory authorities. If the Company
were deemed to be a bank holding company or thrift holding company, bank holding companies or thrift holding companies that invest in
the Company would be subject to certain restrictions and regulations.
We may invest in equity and debt securities issued by banks,
subjecting us to unique risks.
We expect to invest in securities issued by banks
that qualify as Tier 1 or Tier 2 capital for regulatory capital purposes. These investments may consist primarily of preferred equity
as well as subordinated debt, convertible securities and, to a lesser extent, common equity.
Equity, unlike debt securities, does not have a stated
maturity and it is uncertain when, if ever, we will receive our invested amounts or expected returns on such investments. During our
holding period, the only source of investment income on such common equity securities may be dividend income or valuation gains. New
financial products continue to be developed, and we may invest in any products that may be developed to the extent that such investment
is consistent with our business plan.
Certain of these securities, particularly debt securities
and certain hybrid capital instruments, may be long-dated in nature and may contain provisions that enable the issuing institution to
defer payment of interest or dividends without resulting in bankruptcy or default. Furthermore, even though an institution has the financial
capacity to make such payments, regulatory approval may be withheld to make such payment, and in the absence of such approval, the issuing
institution will not be able to make such interest or dividend payment to us. The longer-term nature of these instruments limits the
liquidity of these instruments and may increase the risk of holding these investments.
Investments in holding companies generally subject
investors to increased risks because holding companies generally hold all their assets in their subsidiaries and are dependent on distributions
from their subsidiaries to service their interest obligations and for ultimate principal repayment. In the event of a default or a bankruptcy,
holders of securities issued by holding companies may suffer from increased losses or lower recoveries and may be subordinated to securities
issued directly by the holding company’s subsidiaries.
All of our investments are subject to liquidity
risk, but we may face higher liquidity risk if we invest in debt obligations and other securities that are unrated and issued by banks
that have no corporate rating.
All of our investments are subject to
liquidity risk, however, we are likely to invest in debt obligations that are unrated and that are issued by banks that have no
corporate rating by a nationally recognized statistical rating organization. In such cases, there may not be an active market for
these securities and our investments may be subject to significant liquidity risk in the event we are required to sell such
investments. The assets in which we invest may not be publicly rated by any rating agency, and may have greater credit and liquidity risks than investment-grade
corporate obligations that are publicly rated.
We expect to manage a portfolio of securities,
focused on the banking sector, which would make us more economically vulnerable in the event of a downturn in the banking industry.
Our portfolio normally consists of preferred equity,
subordinated debt, regulatory capital securities, debt securities, credit-linked notes and common equity investments in U.S. and foreign
domiciled banks. These investments are subject to the risk factors affecting the banking industry, and that could cause a general market
decline in the value of bank stocks. Individual banks, as well as the banking industry in general, may be adversely affected by negative
economic and market conditions throughout the United States or in the local economies in which banks operate, including negative conditions
caused by recent disruptions in the financial markets. In addition, changes in trade, monetary and fiscal policies and laws, including
interest rate policies of the Board of Governors of the Federal Reserve System, may have an adverse impact on banks’ loan portfolios
and allowances for loan losses. As a result, we may experience higher rates of default with respect to our bank investments in the event
of a downturn in the banking industry. Also, losses could occur in individual investments held by us because of specific circumstances
related to each bank. These factors could have a material adverse effect on our financial condition, results of operations or liquidity.
A large number of banks may fail during times of significant
economic stress.
According to data from the FDIC, since 1934, banks
and thrifts have failed at an annual rate of 0.35%, with peak cycle one-year failure rates of 3.22% in 1989 (S&L crisis), 1.96% in
2010 (Great Recession) and 0.54% in each of 1937 and 1938 (Great Depression). Bank failure means the closing of a bank by a federal or
state banking regulatory agency, generally because the bank is unable to meet its obligations to depositors and others. However, despite
the low percentage of banks that have failed compared to the number of banks in the U.S. during the relevant time period, during periodic
times of significant economic stress, bank earnings decline and a significant number of banks may fail. For instance, during the savings
and loan crisis during the 1980s through 1992, there were a total of 2,870 failures out of 14,364 FDIC-insured banks in existence on
December 31, 1980. From January 1, 2008 through December 9, 2020, which includes the most recent financial crisis, there were
549 failures, most of which were community banks, out of approximately 8,534 FDIC-insured banks in existence on December 31, 2007,
with the highest one-year failure rate of 3.22% in 1989 for the savings and loan crisis and 1.96% in 2010 for the most recent financial
crisis. The number of failed community banks since 2007 was highest in certain regions in which real estate values declined disproportionately
more than the national average, including Florida, Georgia, Illinois and California.
According to the FDIC Quarterly Banking Profile
dated March 31, 2021, 52 of 5,033 FDIC-insured banks were included on the FDIC’s list of “Problem Institutions.” While
historically, only a small fraction of banks on the list of “Problem Institutions” fail and only 8 FDIC-insured banks failed
in 2017, as of December 31, 2017 (representing an approximate annualized failure rate of only 0.14%, which is similar to the average
annual rate of default for Baa3 Corporate Credit since 1934), some level of additional bank failure is likely. We intend to invest the
majority of our portfolio in institutions that are currently paying dividends or interest on their securities, that have the ability
to pay dividends or interest on the securities they issue, and/or that are not a party to regulatory enforcement actions that would limit
or hinder their payment of dividends or interest or otherwise demonstrate that they are in troubled condition. We believe that such institutions
are unlikely to be included in the FDIC’s list of “Problem Institutions” and are less likely to fail than many of their
peers. Nevertheless, it is possible that some portion of the community banks in which we invest may fail, particularly if the U.S. economy
stagnates or another financial crisis occurs. If we invest in banks that fail, we are likely to lose most or all of our investment in
such institutions.
We expect to manage a portfolio of securities,
focused on the bank market, with investments in community banks whose business is subject to greater lending risks than larger banks.
Community banks have different lending risks than
larger banks. They provide services to their local communities. Their ability to diversify their economic risks is limited by their own
local markets and economies. They lend primarily to small to medium-sized businesses, professionals and individuals which may expose
them to greater lending risks than those of banks that are lending to larger, better-capitalized businesses with longer operating histories.
They manage their credit exposure through careful monitoring of loan applicants and loan concentrations in particular industries, and
through loan approval and review procedures. They have established evaluation processes designed to determine the adequacy of their allowances
for loan losses. Although these evaluation processes use historical and other objective information, the classification of loans and
the establishment of loan losses is an estimate based on experience, judgment and expectations regarding their borrowers, the economies
in which they and their borrowers operate, as well as the judgment of their regulators. We cannot assure you that their loan loss reserves
will be sufficient to absorb future loan losses or prevent a material adverse effect on their business, financial condition or results
of operations.
Risks Related to Banking Regulations and Banking Investments Affecting
Our Business
The following summary does not purport to be a comprehensive
description of all of the federal and state statutes and regulations which govern U.S. banking institutions that may be relevant to a
decision to invest in the Company. The statutes or regulations discussed are only brief summaries of those provisions which are, in their
entirety, complex and subject to interpretation. Further, the statutes or regulations governing the U.S. banking system and the interpretation
thereof are subject to change. In addition, it does not purport to deal with all of the consequences applicable to investors in regulated
financial institutions. Each prospective investor is strongly urged to consult its own legal advisors with respect to the consequences
under applicable regulatory regimes governing banking institutions and investors therein of the purchase and ownership of common stock
in the Company.
The banking institutions in which we will invest
are subject to substantial regulations that could adversely affect their ability to operate and the value of our investments.
We invest substantially all of our assets in banks
and their holding companies and therefore our portfolio investments are subject to existing and potential new regulations that may be
adverse to them. Banking institutions, including banks and savings and loan associations, holding companies thereof, and their subsidiaries
and affiliates (collectively, “banking institutions”) are highly regulated entities that are subject to extensive regulatory
and legal restrictions and limitations and to supervision, examination and enforcement by state and federal regulatory authorities. In
addition, the banking crisis in the United States that began in 2007 has resulted in increased regulations, and we anticipate that further
regulations will be implemented in the future. The laws and regulations affecting banks, and the interpretations thereof, are subject
to material changes, and any such changes may adversely impact portfolio investments and could result in the Company facing material
losses or having to divest some or all of its investments under adverse market conditions. As a result of the extensive federal and state
restrictions and limitations, supervision and enforcement, banking institutions have less operational flexibility and are generally subject
to greater regulatory risks than companies in other industries that are less regulated.
Numerous and Extensive Regulations. There
are various federal statutes that regulate U.S. banking institutions, including, the Bank Holding Company Act of 1956, the Federal Deposit
Insurance Act, the Federal Reserve Act, the National Bank Act, the Home Owners’ Loan Act of 1933 (the “HOLA”), the
Securities Act, the Securities Exchange Act of 1934 (the “Exchange Act”), the Investment Advisers Act and the Investment
Company Act. These federal statutes have been amended, often materially, over the years and may continue to be amended in the future,
and the consequences of such future amendments may be materially adverse to the Company’s investments or the financial services
industry in general. In addition to these various federal statutes, federal regulatory agencies, including among others the Federal Reserve
Board, the Office of the Comptroller of the Currency (the “OCC”), the FDIC and the CFPB, together in certain cases with state
banking regulatory agencies (individually, a “Regulatory Agency” or, collectively, the “Regulatory Agencies”),
have adopted regulations and guidelines which are subject to interpretation, and which continue to be amended and revised and such amendments
and revisions or a change in interpretation of existing regulations or guidelines may be materially adverse to the Company’s portfolio
companies or the financial services industry in general. Much of the regulatory framework that has been developed is intended to protect
depositors, the FDIC and the banking system in general and, as such, stockholders in such regulated institutions may be disadvantaged,
in some cases materially, by amendments and revisions to such statutes, regulations or guidelines, or interpretations thereof, or by
the enforcement of such statutes and regulations by Regulatory Agencies.
Adverse consequences, including without limitation
civil penalties, fines, suspension or termination of deposit insurance, may result in the event that any banking institution fails to
comply with applicable rules or regulations. These rules and regulations are complex and are subject to interpretation and
may be subject to change, which imposes compliance risk on the entities that are subject to these rules and may be adverse to the
Company.
In addition, banking institutions are subject to
various quantitative judgments by Regulatory Agencies, which may include subjective judgments regarding credit risk, interest rate and
liquidity risk, operational risk and other factors, including subjective judgments on the “safety” or “soundness”
of an institution.
Capital Adequacy Requirements and Regulatory
Capital Securities.
Capital Adequacy Requirements. Banking
institutions are required to meet certain capital adequacy guidelines or rules that involve assessments of their assets and liabilities,
including contingent and off-balance sheet items and other items which may be based on subjective inputs, as determined by the Regulatory
Agencies. The Federal Reserve Board has established minimum capital adequacy requirements that are calculated in relation to assets and
various off-balance sheet exposures. The Dodd-Frank Act imposes more stringent capital requirements on bank holding companies and savings
and loan holding companies by, among other things, applying consolidated capital requirements to savings and loan holding companies,
imposing leverage ratios on bank holding companies and savings and loan holding companies and prohibiting new trust preferred issuances
from counting as Tier 1 capital. In addition, in response to the Dodd-Frank Act requirements and the Basel III protocols, the Regulatory
Agencies have proposed more stringent capital requirements that, if adopted in their current form, would apply to community banks. These
restrictions may significantly limit the future capital strategies of community banks.
Non-compliance with capital adequacy requirements
may result in limitations on operations or other orders, which may be materially adverse to the financial institutions in which we invest.
If a depository institution fails to meet certain capital adequacy standards or requirements (such institution is referred to as an “undercapitalized
institution” if it is not well capitalized or adequately capitalized), the appropriate Regulatory Agency may be required by law
to take one or more actions with respect to such undercapitalized institution. These actions may include requiring the institution to
issue new shares, merge with another depository institution, restrict the rates of interest such institution pays on deposits, restrict
asset growth, terminate certain activities or forcing it to divest of certain or all of its subsidiaries, dismiss certain directors or
officers, place the depository institution into an FDIC-administered receivership or conservatorship or take any other action that, in
the Regulatory Agency’s judgment, will resolve the problems of the institution at the least possible loss to the FDIC.
Regulatory Capital Securities Risk. The
Company’s investments in regulatory capital securities are subject to several risks. Where regulators feel the scale, scope of
spirit of a bank’s regulatory capital relief strategy has become overly aggressive, they might enforce stricter regulation that
makes the strategy more costly or impractical for the bank. Under the terms governing the Company’s investments or potential investments
in regulatory capital securities, it is expected that adverse regulatory developments may result in the bank being able to terminate
the Company’s regulatory capital securities investments early, which subjects the Company to reinvestment risk. Another risk relates
to the inherent information asymmetry in such regulatory capital securities investments, whereby the bank selling the regulatory capital
securities normally would have better knowledge of those assets than the Company and, as result, may only make higher risk assets available
for investment. Finally, there is a risk of deterioration of the loan portfolio due to poor underwriting of the bank or extrinsic factors
such as weak economic conditions that could adversely affect the value of the regulatory capital securities.
We may become subject to adverse current or future banking regulations.
We will seek to structure our investments to avoid
being regulated by various banking authorities. Therefore, we do not currently expect to be regulated by any state or federal banking
regulatory bodies and will have significant flexibility with respect to the manner in which we operate. However, if we are deemed to
have acquired control of one or more banking institutions, we would become a bank holding company subject to the Bank Holding Company
Act and the regulations thereunder or a savings and loan holding company subject to the HOLA and the regulations thereunder. While the
rules for bank holding companies and savings and loan holding companies vary, the Federal Reserve Board will generally find that
we control a banking institution if we own 25% or more of any class of voting securities or 33% or more of the total equity (voting or
non-voting) of a banking institution; or if we own 10% or more of the voting stock of the banking institution and we have representation
on the board of directors of the banking institution or other indicia of control (such as control in any manner of the election of a
majority of the institution’s directors, or a determination by the regulator that we have the power to direct, or directly or indirectly
to exercise a controlling influence over, the management or policies of the banking institution). There is a presumption of non-control
if we own or control less than 5% of the outstanding shares of any class of voting securities. If we are deemed to have acquired control
of one or more banking institutions:
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we
would become subject to supervision and examination by the applicable Regulatory Agencies,
including the Federal Reserve Board;
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the
Federal Reserve Board would subject us to periodic reporting requirements applicable to bank
holding companies or savings and loan holding companies; and
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we
would become subject to restrictions on non-banking activities (i.e. any activity other than
banking or managing or controlling banks or performing services for its subsidiaries) applicable
to bank holding companies and savings and loan holding companies, including restrictions
on acquiring direct or indirect ownership or control of more than 5% of any class of voting
securities of any company engaged in non-bank activities. We would only be permitted to engage
in, or acquire an interest in companies that engage in, activities that the Federal Reserve
Board has determined to be incidental to the activity of banking or managing or controlling
banks to a limited extent. These restricted activities include, among other activities, owning
and operating a savings association, escrow company, trust company or insurance agency; acting
as an investment or financial advisor, or providing securities brokerage services; and, in
the case of a financial holding company or unitary savings and loan holding company, activities
that are financial in nature, incidental to financial activities or complementary to a financial
activity, such as lending activities, insurance and underwriting equity securities. In addition
to restrictions on permissible activities and investments, bank holding companies, financial
holding companies, and their subsidiary banks are prohibited from entering into certain tying
arrangements in connection with extension of credit, lease, sale of property or provision
of any services should the Federal Reserve Board find the arrangement resulting in anti-competitive
practices.
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In addition, if we were deemed to be in control of
a bank which is not “well capitalized” or not “well managed” as defined by the relevant Regulatory Agency, the
Federal Reserve Board and certain other Regulatory Agencies would have the authority to impose various limitations or regulatory actions
on us, including:
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limitations
on our ability to pay dividends or distributions to our stockholders;
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forced
divestiture of certain of our investments deemed by such Regulatory Agency as in danger of
becoming insolvent and as posing significant risk to the undercapitalized institution;
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requiring
us to provide financial support to the portfolio bank under the Federal Reserve Board’s
“source of strength” doctrine when we would otherwise be disinclined to do so
or when we would consider itself unable to do so, which could force us to satisfy such obligation
through divesture of other assets or through raising additional funds from existing stockholders
or third-party investors; and
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the
imposition by the FDIC of “cross-guarantee” liability upon any commonly controlled
insured depository institutions for deposit insurance losses incurred by the FDIC. A depository
institution’s liability under the cross-guarantee provision is generally senior to
(i) obligations to stockholders or (ii) any obligation or liability owed to any
affiliate of such depository institution. Thus, portfolio companies that are insured depository
institutions may be subject to such cross-guarantee liability with respect to other portfolio
companies that are also insured depository institutions.
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Ownership of our stock by certain types of regulated institutions
may subject us to additional regulations.
If a bank holding company or savings and loan holding
company stockholder is deemed to control us, we would be subject to the “umbrella” supervision of the Federal Reserve Board
and potentially other regulatory agencies and such supervision may expose us to the regulatory burdens discussed above and to additional
expenses or limitations in carrying out its investment objective, which may be materially adverse to the holders of our common stock.
In the event that a bank holding company or savings and loan holding company stockholder is deemed to control us, it would have to obtain
prior approval or non-objection of the Federal Reserve Board whenever the Company acquires, directly or indirectly, more than 5% of any
class of voting securities of a U.S. bank or of a non-bank financial company (unless, in the case of a non-bank financial company, such
bank holding company stockholders is a financial holding company). In the event that a bank holding company or savings and loan holding
company stockholder controls us, we could not, without prior approval of the Federal Reserve Board, acquire more than 5% of any class
of voting securities of any non-financial company, unless the bank holding company stockholder that controls us is a financial holding
company; however, if each bank holding company stockholder that controls us is a financial holding company, we could make any investment
in any non-financial company (but not in a bank or non-bank financial company) pursuant to the Bank Holding Company Act. If a bank holding
company stockholder or savings and loan holding company controls us, then any direct or indirect investment by us in more than 5% of
any class of voting securities of a foreign company (including a foreign bank) would have to comply with the provisions promulgated by
the Federal Reserve Board.
Investments in banking institutions and transactions
related to our portfolio investments may require approval from one or more regulatory authorities.
We would be required to seek prior approval from
the Federal Reserve Board in order to acquire control of more than 5% of the outstanding shares of any class of voting securities or
25% or more of the total equity (voting and non-voting) or other controlling interests of a bank, bank holding company or financial holding
company. In addition, bank holding companies (but, not financial holding companies) are required to obtain approval prior to purchasing
25% or more of the total equity of a non-bank financial company.
We would be required to seek prior approval from
the Federal Reserve Board or the OCC if we proposed to acquire control of a savings and loan association or a savings and loan holding
company.
If we were deemed to be a bank holding company
or savings and loan holding company, bank holding companies or savings and loan holding companies that invest in us will be subject to
certain restrictions and regulations.
If we were deemed to be a bank holding company or
savings and loan holding company, a bank holding company or savings and loan holding company stockholder could acquire less than 5% of
any class of our stock, and less than 25% of our total equity, without Federal Reserve Board approval, provided that such bank holding
company or savings and loan holding company stockholder does not control us. If we made controlling investments, directly or indirectly
in a U.S. bank, then any bank holding company or savings and loan holding company stockholder that acquires more than 5% of any class
of voting interests or 25% of our total equity would be required to receive prior written approval of the Federal Reserve Board before
acquiring such interests. Bank holding company or savings and loan holding company stockholders that are not financial holding companies
may be required to obtain prior approval from the Federal Reserve Board prior to acquiring more than 5% of any class of voting interests
or 25% of our total equity if we make non-controlling or controlling investments in non-bank financial companies.
Each prospective investor that is or may become a
bank holding company or financial holding company or savings and loan holding company is strongly urged to consult its own legal advisors
with respect to the consequences under applicable regulatory regimes regarding banking institutions and investors therein of the purchase
and ownership of our shares.
New FASB CECL regulations may create volatility
in our earnings and the level of our allowance for credit losses.
The Financial Accounting Standards Board, or FASB,
has issued a new credit impairment model, the Current Expected Credit Loss, or CECL model, which must be implemented by banks and certain
other companies beginning in 2021. Under the CECL model, entities subject to the model will be required to present certain financial
assets carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, at the net amount expected
to be collected. The measurement of expected credit losses is to be based on information about past events, including historical experience,
current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement
will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly
from the "incurred loss" model, which delays recognition until it is probable a loss has been incurred. CECL may create more
volatility in the companies in which we invest, and this in turn could affect the value of our portfolio.
Risks Related to Our Investments
Our investments will be subject to dividend and interest rate
fluctuations, and we may incur interest rate risk.
Our investments are likely to include preferred
stock with variable dividend rates and may include debt or hybrid instruments with floating interest rates, credit-linked notes and equity
and junior debt tranches issued by a CLO or similar issuer. Variable rate and floating rate investments earn interest at rates that adjust
from time to time (typically monthly) based upon an index. The amount of income we receive from our investments may fluctuate based upon
changes in interest rates and, in a declining and/or low interest rate environment, these investments will produce less income, which
will impact our operating performance. Fixed dividend rate and interest rate investments, however, do not have adjusting rates and the
relative value of the fixed cash flows from these investments may decrease as prevailing interest rates rise or increase as prevailing
interest rates fall, causing potentially significant changes in our NAV. We may employ various hedging strategies to limit the effects
of changes in interest rates (and in some cases credit spreads), including engaging in interest rate swaps, caps, floors and other interest
rate derivative products. No strategy can completely insulate us from the risks associated with interest rate changes, and there is a
risk that our strategies may provide no protection at all and will potentially compound the impact of changes in interest rates. Hedging
transactions involve certain additional risks such as counterparty risk, leverage risk, the legal enforceability of hedging contracts,
the early repayment of hedged transactions and the risk that unanticipated and significant changes in interest rates may cause a significant
loss of basis in the instrument and a change in current period expense. We cannot assure you that we will be able to enter into hedging
transactions or that such hedging transactions will adequately protect us against the foregoing risks.
Most of our assets will be illiquid, and their fair value may
not be readily determinable.
It is expected
that a substantial portion of the securities and instruments in which the Company invests will not trade on any exchange and will be
illiquid. The Company may also invest in restricted securities. Investments in restricted securities could have the effect of increasing
the amount of the Company’s assets invested in illiquid securities if qualified institutional buyers are unwilling to purchase
these securities.
Illiquid
and restricted securities may be difficult to dispose of at a fair price at the times when the Company believes it is desirable to do
so. The market price of illiquid and restricted securities generally is more volatile than that of more liquid securities, which may
adversely affect the price that the Company pays for or recovers upon the sale of such securities. Illiquid and restricted securities
are also more difficult to value, especially in challenging markets. The Adviser’s judgment may play a greater role in the valuation
process. Investment of the Company’s assets in illiquid and restricted securities may restrict the Company’s ability to take
advantage of market opportunities. To dispose of an unregistered security, the Company, where it has contractual rights to do so, may
have to cause such security to be registered. A considerable period may elapse between the time the decision is made to sell the security
and the time the security is registered, thereby enabling the Company to sell it. Contractual restrictions on the resale of securities
vary in length and scope and are generally the result of a negotiation between the issuer and acquiror of the securities. In either case,
the Company would bear market risks during that period.
Certain
fixed-income instruments are not readily marketable and may be subject to restrictions on resale. Fixed-income instruments may not be
listed on any national securities exchange and no active trading market may exist for certain of the fixed-income instruments
in which the Company will invest. Where a secondary market exists, the market for some fixed-income instruments may be subject to irregular
trading activity, wide bid/ask spreads and extended trade settlement periods. In addition, dealer inventories of certain securities are
at historic lows in relation to market size, which indicates a potential for reduced liquidity as dealers may be less able to “make
markets” for certain fixed-income securities.
Our investments in regulatory capital securities subject us to
the risks of underlying bank assets.
We invest in “regulatory capital securities”
which are securities issued or structured by banks seeking capital that is treated more favorably under banking regulations than other
types of capital, acquisitions and other refinancing activities. Regulatory capital securities are issued or structured by a bank to
maintain or reduce its regulatory capital requirements by transferring certain credit risks to investors. Regulatory capital securities
may be in the form of structured notes (e.g., credit-linked notes), contingent convertible securities, and other structured products
or transactions. We invest in credit-linked notes which are unsecured notes linked to loans or other assets held by a bank or other financial
institution on its balance sheet. Although the credit-linked notes are tied to the underlying performance of the assets held by the bank,
such credit-linked notes may not be secured by such assets and we have no direct or indirect ownership of the underlying assets. Thus,
as a holder of such credit-linked notes, we would be subject to counterparty risk of the bank which issues the credit-linked notes (in
addition to the risk associated with the assets themselves). To the extent the relevant bank experiences an insolvency event or goes
into receivership, we may not receive payments on the credit-linked notes, or such payments may be delayed.
Risks
of Credit-linked Notes.
A credit-linked
note is a security structured and issued by an issuer, which may be a bank, broker or special purpose vehicle. The performance and payment
of principal and interest is tied to that of a reference asset which may be a particular pool of loans, security, basket of securities,
credit default swap, basket of credit default swaps, or index. The reference asset may be denominated in foreign currency. Risks of credit-linked
notes include those risks associated with the underlying reference asset including but not limited to market risk, interest rate risk,
credit risk, default risk and foreign currency risk. In the case of a credit-linked notes created with credit default swaps, the structure
will be “funded” such that the par amount of the security will represent the maximum loss that could be incurred on the investment
and no leverage is introduced. An investor in a credit-linked note also bears counterparty risk or the risk that the issuer of the credit-linked
note will default or become bankrupt and not make timely payment of principal and interest of the structured security. Should the issuer
default or declare bankruptcy, the credit-linked note holder may not receive any compensation. In return for these risks, the credit
linked note holder receives a higher yield. As with most derivative instruments, valuation of a credit-linked note may be difficult due
to the complexity of the security and the reference asset.
The Company
currently invests in credit-linked notes that are structured as unsecured notes linked to loans or other assets held by a bank
or other financial institution on its balance sheet. Although the credit-linked notes are tied to the underlying performance of the assets
held by the bank, such credit-linked notes may not be secured by such assets and we have no direct or indirect ownership of the underlying
assets. Thus, as a holder of such credit-linked notes, we would be subject to counterparty risk of the bank which issues the credit-linked
notes (in addition to the risk associated with the assets themselves). To the extent the relevant bank experiences an insolvency event
or goes into receivership, we may not receive payments on the credit-linked notes, or such payments may be delayed.
Risks
of Collateralized Loan Obligations (“CLOS”) and Collateralized Debt Obligations (“CDOS”).
CLOs and
CDOs are typically privately offered and sold, and thus, are not registered under the securities laws, which means less information about
the security may be available as compared to publicly offered securities and only certain institutions may buy and sell them. As a result,
investments in CDOs may be characterized by the Company as illiquid securities. An active dealer market may exist for CDOs that can be
resold in Rule 144A transactions, but there can be no assurance that such a market will exist or will be active enough for the Company
to sell such securities. In addition to the typical risks associated with fixed-income securities and asset-backed securities, CDOs carry
other risks including, but not limited to: (i) the possibility that distributions from collateral securities will not be adequate
to make interest or other payments; (ii) the risk that the collateral may default, decline in value or quality, or be downgraded
by a rating agency; (iii) the Company may invest in tranches of CDOs that are subordinate to other tranches, diminishing the likelihood
of payment; (iv) the structure and complexity of the transaction and the legal documents could lead to disputes among investors
regarding the characterization of proceeds; (v) risk of forced “fire sale” liquidation due to technical defaults such
as coverage test failures; and (vi) the CDO’s manager may perform poorly.
Additional Risks Related to Investments in
CLOs. The CLOs and other CDOs in which the Company may invest are Structured Products. Holders of Structured Products bear risks
of the underlying assets and are subject to counterparty risk.
The Company may have
the right to receive payments only from the structured product, and generally does not have direct rights against the issuer or the entity
that sold the assets to be securitized. While certain Structured Products enable the investor to acquire interests in a pool of securities
without the brokerage and other expenses associated with directly holding the same securities, investors in Structured Products generally
pay their share of the structured product’s administrative and other expenses. Although it is difficult to predict whether the
prices of assets underlying Structured Products will rise or fall, these prices (and, therefore, the prices of Structured Products) will
be influenced by the same types of political and economic events that affect issuers of securities and capital markets generally. If
the issuer of a structured product uses shorter-term financing to purchase longer-term securities, the issuer may be forced to sell its
securities at below-market prices if it experiences difficulty in obtaining short-term financing, which may adversely affect the value
of the Structured Products owned by the Company.
Certain structured products
may be thinly traded or have a limited trading market. Structured Products are typically privately offered and sold. As a result, investments
in Structured Products may be characterized by the Company as illiquid securities. In addition to the general risks associated with fixed-income
securities discussed herein, Structured Products carry additional risks, including, but not limited to: (i) the possibility that
distributions from collateral securities will not be adequate to make interest or other payments; (ii) the quality of the collateral
may decline in value or default; (iii) the possibility that the investments in Structured Products are subordinate to other classes or
tranches thereof; and (iv) the complex structure of the security may not be fully understood at the time of investment and may produce
disputes with the issuer or unexpected investment results.
In the event of a bankruptcy or insolvency of
an issuer or borrower of a loan that we hold or of an underlying asset held by a CLO or other vehicle in which we invest, a court or
other governmental entity may determine that our claims or those of the relevant CLO are not valid or not entitled to the treatment we
expected when making our initial investment decision.
Various laws enacted for the protection of debtors
may apply to the underlying assets in our investment portfolio. The information in this and the following paragraph represents a brief
summary of certain points only, is not intended to be an extensive summary of the relevant issues and is applicable with respect to U.S.
issuers and borrowers only. The following is not intended to be a summary of all relevant risks. Similar avoidance provisions to those
described below are sometimes available with respect to non-U.S. issuers or borrowers, and there is no assurance that this will be the
case which may result in a much greater risk of partial or total loss of value in that underlying asset.
If a court in a lawsuit brought by an unpaid creditor
or representative of creditors of an issuer or borrower of underlying assets, such as a trustee in bankruptcy, were to find that such
issuer or borrower did not receive fair consideration or reasonably equivalent value for incurring the indebtedness constituting such
underlying assets and, after giving effect to such indebtedness, the issuer or borrower (1) was insolvent; (2) was engaged in a business
for which the remaining assets of such issuer or borrower constituted unreasonably small capital; or (3) intended to incur, or believed
that it would incur, debts beyond our ability to pay such debts as they mature, such court could decide to invalidate, in whole or in
part, the indebtedness constituting the underlying assets as a fraudulent conveyance, to subordinate such indebtedness to existing or
future creditors of the issuer or borrower or to recover amounts previously paid by the issuer or borrower in satisfaction of such indebtedness.
In addition, in the event of the insolvency of an issuer or borrower of underlying assets, payments made on such underlying assets could
be subject to avoidance as a “preference” if made within a certain period of time (which may be as long as one year under
U.S. Federal bankruptcy law or even longer under state laws) before insolvency.
Foreign Securities and Currency Risk.
The adoption of new international banking and
insurance guidelines may cause uncertainty or disruptions in the global banking industry. Adverse conditions in the global banking industry
and credit markets may adversely impact the value of our investments to the extent we make investments in global financial institutions.
Investments in securities of foreign issuers involve special risks not usually associated with investing in securities of U.S. companies,
including political and economic considerations, such as greater risks of expropriation and nationalization, confiscatory taxation, the
potential difficulty of repatriating funds, social, political and economic instability and adverse diplomatic developments; the possibility
of the imposition of withholding or other taxes on dividends, interest, capital gain or other income; the small size of the securities
markets in such countries and the low volume of trading, resulting in potential lack of liquidity and in price volatility; fluctuations
in the rate of exchange between currencies and costs associated with currency conversion; and certain government policies that may restrict
the Company’s investment opportunities. In addition, there may be different types of, and lower quality, information available
about a foreign company than a U.S. company. There is also less regulation, generally, of the securities markets in many foreign countries
than there is in the United States, and such markets may not provide the same protections available in the United States. Corporate governance
standards may be lower in foreign markets. With respect to certain countries there may be the possibility of political, economic or social
instability, the imposition of trading controls, import duties or other protectionist measures, various laws enacted for the protection
of creditors, greater risks of nationalization or diplomatic developments which could materially adversely affect the Company’s
investments in those countries. The Company’s investment in foreign countries may also be subject to withholding or other taxes,
which may be significant and may reduce the Company’s returns.
Brokerage commissions, custodial services and
other costs relating to investment in international securities markets may be more expensive than in the United States. In addition,
clearance and settlement procedures may be different in foreign countries and, in certain markets, such procedures have been unable to
keep pace with the volume of securities transactions, thus making it difficult to conduct such transactions.
Derivatives transactions may limit our income
or result in losses.
The
Company’s derivative investments have risks, including the imperfect correlation between the value of such instruments and the
underlying asset, rate or index, which creates the possibility that the loss on such instruments may be greater than the gain in the
value of the underlying asset, rate or index; the loss of principal; the possible default of the other party to the transaction;
and illiquidity of the derivative investments. If a counterparty becomes bankrupt or otherwise fails to perform its obligations under
a derivative contract due to financial difficulties, the Company may experience significant delays in obtaining any recovery under the
derivative contract in a bankruptcy or other reorganization proceeding, or may not recover at all. In addition, in the event of the insolvency
of a counterparty to a derivative transaction, the derivative contract would typically be terminated at its fair market value. If the
Company is owed this fair market value in the termination of the derivative contract and its claim is unsecured, the Company will be
treated as a general creditor of such counterparty, and will not have any claim with respect to the underlying security. Certain of the
derivative investments in which the Company may invest may, in certain circumstances, give rise to a form of financial leverage, which
may magnify the risk of owning such instruments. The ability to successfully use derivative investments depends on the ability of the
Adviser to predict pertinent market movements, which cannot be assured. In addition, amounts paid by the Company as premiums and cash
or other assets held in margin accounts with respect to the Company’s derivative investments would not be available to the Company
for other investment purposes, which may result in lost opportunities for gain.
The derivative instruments and techniques
that the Company may principally use include:
Futures. A
futures contract is a standardized agreement to buy or sell a specific quantity of an underlying instrument at a specific price at a
specific future time. The value of a futures contract tends to increase and decrease in tandem with the value of the underlying instrument.
Depending on the terms of the particular contract, futures contracts are settled through either physical delivery of the underlying instrument
on the settlement date or by payment of a cash settlement amount on the settlement date. A decision as to whether, when and how to use
futures involves the exercise of skill and judgment and even a well-conceived futures transaction may be unsuccessful because of market
behavior or unexpected events. In addition to the derivatives risks discussed above, the prices of futures can be highly volatile, using
futures can lower total return, and the potential loss from futures can exceed the Company’s initial investment in such contracts.
Covered
Calls on Bank Equity Securities and Other Option Transactions. There are several risks associated with
transactions in options on securities. For example, there are significant differences between the securities and options markets that
could result in an imperfect correlation between these markets, causing a given covered call option transaction not to achieve its objectives.
A decision as to whether, when and how to use covered calls (or other options) on bank equity securities involves the exercise of skill
and judgment, and even a well-conceived transaction may be unsuccessful because of market behavior or unexpected events. The use of options
may require the Company to sell portfolio securities at inopportune times or for prices other than current market values, may limit the
amount of appreciation the Company can realize on an investment, or may cause the Company to hold a security it might otherwise sell.
As the writer of a covered call option on bank equity securities, the Company forgoes, during the option’s life, the opportunity
to profit from increases in the market value of the security covering the call option above the exercise price of the call option, but
has retained the risk of loss should the price of the underlying security decline. Although such loss would be offset in part by the
option premium received, in a situation in which the price of a particular bank equity security on which the Company has written a covered
call option declines rapidly and materially or in which prices in general on all or a substantial portion of the stocks on which the
Company has written covered call options decline rapidly and materially, the Company could sustain material depreciation or loss in its
net assets to the extent it does not sell the underlying securities (which may require it to terminate, offset or otherwise cover its
option position as well). The writer of an option has no control over the time when it may be required to fulfill its obligation as a
writer of the option. Once an option writer has received an exercise notice, it cannot effect a closing purchase transaction in order
to terminate its obligation under the option and must deliver the underlying security at the exercise price.
There can
be no assurance that a liquid market will exist when the Company seeks to close out an option position. Reasons for the absence of a
liquid secondary market for exchange-traded options include the following: (i) there may be insufficient trading interest; (ii) restrictions
may be imposed by an exchange on opening transactions or closing transactions or both; (iii) trading halts, suspensions or other restrictions
may be imposed with respect to particular classes or series of options; (iv) unusual or unforeseen circumstances may interrupt normal
operations on an exchange; (v) the trading facilities of an exchange or the Options Clearing Corporation (the “OCC”) may
not be adequate to handle current trading volume; or (vi) the relevant exchange could, for economic or other reasons, decide or be compelled
at some future date to discontinue the trading of options (or a particular class or series of options). If trading were discontinued,
the secondary market on that exchange (or in that class or series of options) would cease to exist. However, outstanding options on that
exchange that had been issued by the OCC as a result of trades on that exchange would continue to be exercisable in accordance with their
terms. The Company’s ability to terminate OTC options may be more limited than with exchange-traded options and may involve the
risk that counterparties participating in such transactions will not fulfill their obligations. If the Company were unable to close out
a covered call option that it had written on a bank equity security, it would not be able to sell the underlying security unless the
option expired without exercise.
The hours
of trading for options may not conform to the hours during which the underlying securities are traded. To the extent that the options
markets close before the markets for the underlying securities, significant price and rate movements can take place in the underlying
markets that cannot be reflected in the options markets. Call options are marked to market daily and their value will be affected by
changes in the value of and dividend rates of the underlying common stocks, an increase in interest rates, changes in the actual or perceived
volatility of the stock market and the underlying common stocks and the remaining time to the options’ expiration. Additionally,
the exercise price of an option may be adjusted downward before the option’s expiration as a result of the occurrence of certain
corporate events affecting the underlying bank equity security, such as extraordinary dividends, stock splits, merger or other extraordinary
distributions or events. A reduction in the exercise price of an option would reduce the Company’s capital appreciation potential
on the underlying security.
Limitation
on Covered Call Writing Risk. The number of covered call options on bank equity securities the Company can
write is limited by the number of shares of the corresponding common stock the Company holds. Furthermore, the Company’s covered
call options on bank equity securities and other options transactions will be subject to limitations
established by each of the exchanges, boards of trade or other trading facilities on which such options are traded. These limitations
govern the maximum number of options in each class which may be written or purchased by a single investor or group of investors acting
in concert, regardless of whether the options are written or purchased on the same or different exchanges, boards of trade or other trading
facilities or are held or written in one or more accounts or through one or more brokers. As a result, the number of covered call options
on bank equity securities that the Company may write or purchase may be affected by options written or purchased by it and other investment
advisory clients of the Adviser. An exchange, board of trade or other trading facility may order the liquidation of positions found to
be in excess of these limits, and it may impose certain other sanctions.
Swaps. A
swap contract is an agreement between two parties pursuant to which the parties exchange payments at specified dates on the basis of
a specified notional amount, with the payments calculated by reference to specified securities, indexes, reference rates, currencies
or other instruments. Most swap agreements provide that when the period payment dates for both parties are the same, the payments are
made on a net basis (i.e., the two payment streams are netted out, with only the net amount paid by one party to the other). The Company’s
obligations or rights under a swap contract entered into on a net basis will generally be equal only to the net amount to be paid or
received under the agreement, based on the relative values of the positions held by each counterparty. Swap agreements are particularly
subject to counterparty credit, liquidity, valuation, correlation and leverage risk. Certain standardized swaps are now subject to mandatory
central clearing requirements and others are now required to be exchange-traded. While central clearing and exchange-trading are intended
to reduce counterparty and liquidity risk, they do not make swap transactions risk-free. Swaps could result in losses if interest rate
or foreign currency exchange rates or credit quality changes are not correctly anticipated by the Company or if the reference index,
security or investments do not perform as expected. The Company’s use of swaps may include those based on the credit of an underlying
security, commonly referred to as “credit default swaps.” Where the Company is the buyer of a credit default swap contract,
it would be entitled to receive the par (or other agreed-upon) value of a referenced debt obligation from the counterparty to the contract
only in the event of a default or similar event by a third party on the debt obligation. If no default occurs, the Company would have
paid to the counterparty a periodic stream of payments over the term of the contract and received no benefit from the contract. When
the Company is the seller of a credit default swap contract, it receives the stream of payments but is obligated to pay an amount equal
to the par (or other agreed-upon) value of a referenced debt obligation upon the default or similar event of that obligation. The use
of credit default swaps can result in losses if the Company’s assumptions regarding the creditworthiness of the underlying obligation
prove to be incorrect. The Company will “cover” its swap positions by segregating an amount of cash and/or liquid securities
as required by the 1940 Act and applicable SEC interpretations and guidance from time to time. In cases where the Company is the writer,
or seller, of a swap agreement, the segregated amount will be equal to the full, un-netted amount of the Company’s contractual
obligation (the “notional amount”).
Risks Related to Our Use of Leverage
We will continue to operate with leverage, which may adversely
affect our return on our assets and may reduce cash available distribution.
We will continue to operate with leverage, which
we may incur in the form of recourse and non-recourse collateralized financings, private or public offerings of debt, warehouse facilities,
secured and unsecured bank credit facilities, repurchase agreements or other borrowings.
We currently have a bank loan to finance investments
as a form of leverage. We also have authority to issue preferred stock or engage in reverse repurchase agreements to finance investments.
Leverage exaggerates the effects of market downturns or upturns on the NAV and market value of our common stock, as well as on distributions
to holders of common stock. Leverage can also increase the volatility of the Company’s NAV, and expenses related to leverage can
reduce the Company’s income. In the case of leverage, if our assets decline in value so that applicable asset coverage requirements
for any borrowings or preferred stock would not be met, the Company may be prevented from paying distributions, which could jeopardize
its qualification for pass-through tax treatment, make it liable for excise taxes and/ or force it to sell portfolio securities at an
inopportune time.
As noted above, the Company utilizes a revolving
credit agreement with Texas Capital Bank, N.A. (“Texas Capital Bank”) (the Credit Facility”). The terms of the Credit
Facility were last amended in May 2017, to provide for a maximum borrowing amount of $62 million and a fee of London Interbank Offered
Rate (“LIBOR”) +2.35%, with a maturity date of May 2022. The Credit Facility contains customary covenants, negative covenants
and default provisions, including covenants that limit our ability to incur additional debt or consolidate or merge into or with any
person, other than as permitted, or sell, lease or otherwise transfer, directly or indirectly, all or substantially all of its assets.
Prior to the May 2017 amendment, the Credit Facility had been with a syndicate of financial institutions that was led by Texas Capital
Bank, it had a five-year term maturing in June 2019, was priced at a term of 1, 2 or 3-month LIBOR plus 2.85%, and permitted us to borrow
up to $70.0 million. As of December 31, 2020, $43.0 million was committed and drawn on the Credit Facility. The United Kingdom’s
Financial Conduct Authority had announced plans to phase out the use of LIBOR by the end of 2021. However, on November 18, 2020,
ICE Benchmark Administration Limited (“IBA”), the LIBOR administrator, announced that it will consult on its intention to
cease publication of euro, sterling, Swiss franc and yen LIBORs after December 31, 2021, and on November 30, 2020, IBA announced
that it will issue a consultation on extending the discontinuation date for U.S. dollar LIBOR to June 30, 2023. Acknowledging IBA’s
announcement regarding U.S. dollar LIBOR, the Federal Reserve Board , the Federal Deposit Insurance Corporation and the Office of the
Comptroller of the Currency noted that extending the publication of U.S. dollar LIBOR until June 30, 2023 would allow most
legacy U.S. dollar LIBOR contracts to mature before LIBOR experiences disruptions and cautioned that banks entering into new contracts
that use U.S. dollar LIBOR as a reference rate after December 31, 2021 would create safety and soundness risks. Therefore, banks
are encouraged to cease entering into new contracts that use U.S. dollar LIBOR as a reference rate as soon as practicable and in any
event by December 31, 2021. There is currently no definitive information regarding the future utilization of LIBOR or of any particular
replacement rate. Abandonment of or modifications to LIBOR could have adverse impacts on newly issued financial instruments and existing
financial instruments which reference LIBOR.
Although we have no present intention to do so,
we may also operate with leverage by issuing preferred stock. Any form of leverage may include contractual terms that are unfavorable
to our stockholders, including limitations on our ability to declare and distribute dividends. Such terms will likely also contain restrictive
covenants that impose asset coverage requirements, voting right requirements and restrictions on the composition of our assets, and limit
the use of our investment techniques and strategies, any or all of which may have an adverse effect on us and our ability to pay dividends.
If we are unable to repay or refinance maturing debt on the date it is due, we may be forced to seek other sources of capital to repay
the maturing debt that may be expensive or dilutive to existing stockholders. To the extent that we are unable to find additional financing
or extend or refinance our debt when it becomes due and we do not have sufficient cash to redeem such debt, we may be required to liquidate
assets that are illiquid and difficult to sell for fair value and the sale of assets may occur at a time when it would not otherwise
be desirable to do so. Failure to meet any contractual term set forth by our lenders, including maturity, may result in a default, a
forced sale of assets or reduced operational flexibility, or a significant loss or complete loss for our stockholders.
Leverage is a speculative technique that may adversely
affect our earnings or book value. If the return on assets acquired with borrowed funds or other leveraged proceeds does not exceed the
cost of the leverage and our cost of operations, the use of leverage could cause us to lose money.
Successful use of leverage depends on our Adviser’s
ability to predict or hedge correctly cash flows generated by our assets, which depends upon default rates, interest rates, refinancing
and prepayment rates, timing of recoveries and various other factors. Our actual use of leverage may vary depending on our ability to
obtain credit facilities and the lender’s and rating agencies’ estimate of the stability of our cash flows. The return on
our assets and cash available for distribution to our stockholders may be reduced by changes in market conditions that cause the cost
of these financings to increase relative to the income that can be derived from our assets. Defaults and lower than expected recoveries,
as well as delays in recoveries on defaults, could rapidly erode our equity. Debt service payments will reduce cash flow available for
distributions to stockholders. In addition, lenders from whom we may borrow money or holders of our debt securities will have claims
on our assets that are superior to the claims of our common stockholders, and we may grant a security interest in our assets when we
undertake leverage. In the case of a liquidation event, those lenders or note holders would receive proceeds before our common stockholders.
Financing arrangements with lenders or preferred stockholders
may limit our ability to make dividend payments to our stockholders.
We depend on the ability of our operations to
generate positive cash-flow measured as the positive difference between the yield on our assets and the cost of our funds. Because we
use leverage to increase our return on equity, we may be subject to contractual operational limitations, including limitations on our
ability to make dividends to our stockholders. If, as a consequence of these various limitations and restrictions, we are unable to generate
sufficient funds for distributions from our assets or we are not in compliance with the terms of our debt agreements or any new series
of preferred stock, we may not be able to make expected dividend payments.
Risks Related to Our Operations
We depend upon key personnel of our Adviser, ArrowMark Partners
and their affiliates
We are an externally managed investment company,
and therefore we do not have any internal management capacity or employees. We depend on the diligence, expertise and business relationships
of the senior management of our Adviser and its affiliates to achieve our investment objective. We expect that our Adviser will evaluate,
negotiate, structure, close and monitor our investments in accordance with the terms of the management agreement.
Our Adviser is an affiliate of ArrowMark Partners
and, in turn, depends upon access to the investment professionals and other resources of ArrowMark Partners and its affiliates to fulfill
its obligations to us under the management agreement. Our Adviser also depends upon ArrowMark Partners to obtain access to deal flow
generated by the professionals of ArrowMark Partners. ArrowMark Partners and its affiliates also provide our Adviser with resources necessary
to fulfill these obligations, including by making available to the Adviser experienced investment professionals and access to the senior
investment personnel of ArrowMark Partners for purposes of evaluating, negotiating, structuring, closing and monitoring our investments.
We depend upon the senior professionals of ArrowMark
Partners and its affiliates to maintain relationships with potential sources of investment opportunities, and we intend to rely to a
significant extent upon these relationships to provide us with potential investment opportunities. We cannot assure you that these individuals
will continue to directly or indirectly provide investment advice to us. If these individuals, including the members of our investment
committee, do not maintain their existing relationships with our affiliates, maintain existing relationships or develop new relationships
with other sources of investment opportunities, we may not be able to grow our investment portfolio. In addition, individuals with whom
the senior professionals of ArrowMark Partners or its affiliates have relationships are not obligated to provide us with investment opportunities.
Therefore, we cannot assure you that such relationships will generate investment opportunities for us.
Our Adviser may rely on assumptions that
prove to be incorrect.
We will employ strategies which depend upon the
reliability, accuracy and analyses of our Adviser’s analytical models. To the extent such models (or the assumptions underlying
them) do not prove to be correct, we may not perform as anticipated, which could result in material losses. All models ultimately depend
upon the judgment of the investment professionals and the assumptions embedded in the models. To the extent that, with respect to any
investment, the judgment or assumptions are incorrect, we can suffer material losses. The models that our management team uses to assess
and control our risk exposures reflect assumptions about the degrees of correlation or lack thereof among prices of various asset classes
or other market indicators, and in times of market stress or other unforeseen circumstances previously uncorrelated indicators may become
correlated, or conversely previously correlated indicators may move in different directions. These types of market movements may at times
limit the effectiveness of any hedging strategies that we may employ and cause us to incur material losses.
Our Adviser and its affiliates may serve
as investment adviser to other funds, investment vehicles and investors, which may create conflicts of interest not in the best interest
of us or our stockholders.
As of December 31, 2020 our Adviser and its affiliates
managed $23.2 billion in assets on behalf of a broad array of institutional clients and professional asset allocators across alternative
credit and capacity constrained equity strategies, as well as through the $5.5 billion corporate and lending business. Our Adviser
may advise clients in addition to us in the future. Our Adviser and its affiliates intend to allocate investment opportunities and collective
expenses among their respective clients fairly and equitably and in accordance with their allocation policies.
We may generate low or negative rates of
return on capital, and we may not be able to execute our business plans as quickly as expected, if at all.
We anticipate that it may take up to six months
to utilize fully the net proceeds received from any future offering; however, we may take longer to utilize such proceeds fully. This
six-month period and any additional delay may result from a lack of attractive investment opportunities or from competition with other
market participants for investments in the banking sector. We may initially invest the proceeds from any future offering in cash, cash
equivalents, securities issued or guaranteed by the U.S. government or its instrumentalities or agencies, high-quality, short-term money
market instruments, short-term debt securities, certificates of deposit, bankers’ acceptances and other bank obligations, commercial
paper or other liquid fixed income securities. Because these temporary investments may generate lower projected returns than our core
business strategy, we may experience lower returns during this period, which may result in low distributions in this initial period,
or possibly no distributions at all.
Our business model depends to a significant
extent upon strong referral relationships, and our inability to maintain or develop these relationships, as well as the failure of these
relationships to generate investment opportunities, could adversely affect our business.
We expect that our Adviser and its affiliates
will maintain their relationships with intermediaries, financial institutions, investment bankers, commercial bankers, financial advisors,
attorneys, accountants, consultants and other individuals within their networks, and we will rely to a significant extent upon these
relationships to provide us with potential investment opportunities. If our Adviser fails to maintain its existing relationships or develop
new relationships with sources of investment opportunities, we will not be able to grow our investment portfolio. In addition, individuals
with whom our Adviser and its affiliates have relationships are not obligated to provide us with investment opportunities, and, therefore,
there is no assurance that such relationships will generate investment opportunities for us.
If we are unable to source investments effectively, we may be
unable to achieve our investment objective.
Our ability to achieve our investment objective
depends on our Adviser’s ability to identify, evaluate and invest in suitable securities that meet our investment criteria. Accomplishing
this result on a cost-effective basis is largely a function of our Adviser’s marketing capabilities, management of the investment
process, ability to provide efficient services and access to financing sources on acceptable terms. Failure to manage our future growth
effectively could have a material adverse effect on our business, financial condition and results of operations.
Our results may fluctuate from period to period.
We could experience fluctuations in our operating
results from one fiscal period to the next due to a number of factors, including the return on our investments expenses, variations in
and the timing of the recognition of realized and unrealized gains or losses, the degree to which we encounter competition in our markets
and general economic conditions. Restrictions and provisions in any future credit facilities, debt securities or other leverage instruments
may also limit our ability to make distributions. As a result of these factors, results for any period should not be relied upon as being
indicative of performance in future periods.
We make distributions to our stockholders
on a quarterly basis.
If the amount of any distribution exceeds our
net investment income or capital gains, then all or a portion of such distribution could constitute a return of capital to stockholders
rather than dividend income for tax purposes. A return of capital distribution has the effect of lowering stockholders’ basis in
their shares, which will result in higher tax liability when the shares are sold, even if such shares have not increased in value or
have, in fact, lost value. In addition to the tax consequences, such a distribution is a return of a shareholder’s own investment,
but distributed net of Company expenses, and will decrease the funds available for investment by the Company.
If our Adviser is unable to manage our investments effectively,
we may be unable to achieve our investment objective.
Our ability to achieve our investment objective
depends on our ability to manage and grow our business. This depends, in turn, on our Adviser’s ability to identify, invest in
and monitor companies that meet our investment criteria. The achievement of our investment objectives on a cost-effective basis will
depend upon our Adviser’s execution of our investment process, its ability to provide competent, attentive and efficient services
to us and our access to leverage on acceptable terms. Our Adviser has substantial responsibilities under the management agreement. Our
future success will depend on the continued service of the senior management team of our Adviser and the personnel of its affiliates
who are made available to our Adviser. These persons are engaged in other business activities, which could distract them, divert their
time and attention or otherwise cause them not to dedicate a significant portion of their time to our investments, which could slow our
rate of investment. Any failure to manage our business and our future growth effectively could have a material adverse effect on our
business, financial condition, results of operations and cash flows. In addition, to the extent that our assets continue to grow, our
Adviser may have to source additional personnel, and to the extent it is unable to source qualified individuals, our growth may be adversely
affected.
We may not replicate the historical results
achieved by other entities managed or sponsored by members of our investment committee or by ArrowMark Partners or its affiliates.
Our primary focus in making investments generally
differs from that of many of the investment funds, accounts or other investment vehicles that are or have been managed by members of
our investment committee or sponsored by ArrowMark Partners or its affiliates. In addition, investors in our common stock do not acquire
an interest in any such investment funds, accounts or other investment vehicles that are or have been managed by members of our investment
committee or sponsored by ArrowMark Partners or its affiliates. We cannot assure you that we will replicate the historical results achieved
by members of the investment committee, and we caution you that our investment returns could be substantially lower than the returns
achieved by them in prior periods. Additionally, all or a portion of the prior results may have been achieved in particular market conditions
which may never be repeated. Moreover, current or future market volatility and regulatory uncertainty may have an adverse impact on our
future performance.
Our investment portfolio is recorded at
fair value, with our board of directors having final responsibility for overseeing, reviewing and approving, in good faith, our estimate
of fair value and, as a result, there is uncertainty as to the value of our investments.
Unlike publicly traded
common stock which trades on national exchanges, there is no central place or exchange for some of the Company’s investments to
trade. Due to the lack of centralized information and trading, the valuation of loans or fixed-income instruments may carry more risk
than that of common stock. Uncertainties in the conditions of the financial market, unreliable reference data, lack of transparency and
inconsistency of valuation models and processes may lead to inaccurate asset pricing. In addition, other market participants may value
securities differently than the Company. As a result, the Company may be subject to the risk that when an instrument is sold in the market,
the amount received by the Company is less than the value of such loans or fixed income instruments carried on the Company’s books.
Stockholders should recognize
that valuations of illiquid assets involve various judgments and consideration of factors that may be subjective. As a result, the NAV
of the Company, as determined based on the fair value of its investments, may vary from the amount ultimately received by the Company
from its investments.
Our board of directors has engaged the services
of a nationally recognized independent valuation firm to help it determine the value of each investment for which a market price is not
available. Our board of directors also reviews valuations of such investments provided by the Adviser. Furthermore, we rely heavily on
the investment committee of our Adviser in making determinations of the fair value of our investments. Our board of directors regularly
reviews and evaluates our valuation methodology and any such valuation service it uses and the historical accuracy of such valuation
methodologies. Our board of directors also reviews valuations of such investments provided by the Adviser and assigns the valuation it
determines to best represent the fair value of such investments.
We may compete with a number of other prospective investors for
desirable investment opportunities.
While we believe that there is presently a general
lack of investment competition for investment opportunities in the community banking sector from institutional investors including publicly
traded investment companies, hedge funds and private equity funds, such investors do exist. In addition, competition among institutional
investors and investment managers for any bank related investments may increase significantly. While the competitive landscape for investors
in regulatory capital securities has broadened modestly over the last ten years, the core investor base remains relatively concentrated
due to the relatively high barriers to entry facing new investors. In addition to established competitors, new competitors may be established
at any time. Increasing competitive conditions may adversely impact our ability to meet our business objectives, which in turn could
adversely impact our ability to meet debt service obligations or make dividend payments to our stockholders. Some of our competitors
may have a lower cost for borrowing funds than us or greater access to funding sources not available to us.
We may, in certain circumstances permitted
by law, change our business strategy and operational policies without stockholder consent, which may result in a determination to pursue
riskier business activities.
With majority consent of our board of directors,
we may change our business strategy for how we invest in bank sector opportunities at any time without the consent of our stockholders
(unless stockholder consent is specifically required by the Investment Company Act), which could result in our acquiring subsidiaries
or assets that are different from, and possibly riskier than, the strategy described in this prospectus. For example, we could change
our strategy to focus to a greater extent on investing in common stock rather than preferred stock, subordinated debt and convertible
securities. However, we will endeavor to notify investors of any such material change in business strategy and operational policies no
later than our subsequent semi-annual or annual report, as applicable, filed with the SEC. A change in our business strategy may increase
our exposure to interest rate, mark to market risks or other risks. Our board of directors will determine our operational policies and
may amend or revise our policies, including our policies with respect to our investments, operations, indebtedness, capitalization and
distributions or approve transactions that deviate from these policies, without a vote of, or notice to, our stockholders (unless stockholder
consent is specifically required by the Investment Company Act). Operational policy changes could adversely affect the market price of
our common stock and our ability to make distributions to our stockholders.
Laws and regulations may prohibit the banks in which we invest
from paying interest and/or dividends to us.
Dividend payments by banks are subject to legal
and regulatory limitations imposed by applicable state and federal bank regulatory agencies. For instance, banks will be prohibited from
paying cash dividends to their stockholders or holding company parents to the extent that any such payment would reduce the bank’s
capital below required capital levels. To the extent these regulatory capital requirements are increased, banks may find it more difficult
to declare and pay dividends on the preferred stock they have issued and, to the extent that such preferred stock is non-cumulative,
may be more reluctant to declare such dividends. Regulatory approval may also be required for a bank to declare a dividend if the total
of all dividends declared by it in any calendar year exceeds the total of the bank’s net profits for that year combined with its
retained net profits of the preceding two years, less any required transfer to surplus or a fund for the retirement of any preferred
stock. The ability of banks to pay dividends will also depend upon other factors, including their debt and equity structure, earnings
and financial condition, need for capital, and other factors, including economic conditions, and tax considerations. To the extent we
invest in the holding companies of banks, the only funds available for the payment of dividends on the capital stock of the holding company
may be the cash and cash equivalents held by the holding company, dividends paid by the bank to the holding company and borrowings. The
banks in which we invest may be constrained in their ability to pay dividends by these factors.
Legal and regulatory changes could occur that may adversely affect
us.
U.S. and non-U.S. government
agencies and other regulators regularly adopt new regulations and legislatures enact new statutes that affect the investments held by
the Company, the strategies used by the Company or the level of regulation or taxation that applies to the Company. For example, the
Tax Cuts and Jobs Act of 2017, among other things, significantly changed the taxation of business entities (including by significantly
lowering corporate tax rates), the deductibility of interest expense, and the timing in which certain income items are recognized (potentially
including, in certain cases, income from debt and other financial instruments). These statutes and regulations may impact the investment
strategies, performance, costs and operations of the Company or the taxation of its shareholders.
Changes in government
legislation, regulation and/or intervention may change the way the Adviser or the Company is regulated, affect the expenses incurred
directly by the Company and the value of its investments and limit and/or preclude the Company’s ability to implement, or increase
the Company’s costs associated with implementing, its investments strategies. Changes to tax laws and regulations may also result
in certain tax consequences for the Company and/or investors. Government regulation may change frequently and may have significant adverse
consequences. Moreover, government regulation may have unpredictable and unintended effects. In addition to exposing the Company to potential
new costs and expenses, additional regulation or changes to existing regulation may also require changes to the Company’s investment
practices. The Adviser cannot predict the effects of any new governmental regulation that may be implemented, and there can be no assurance
that any new governmental regulation will not adversely affect the Company’s ability to achieve its respective investment objective.
We may be required to register as a commodity pool operator.
We have claimed an exclusion from the definition
of the term “commodity pool operator” pursuant to Regulation 4.5 under the CEA with respect to the Company. While we currently
expect that our activities will remain within the scope of the exclusion, if we change our hedging and risk management strategies, we
may be required to register under the CEA as a commodity pool operator, and the Adviser may be required to register under the CEA as
a commodity trading adviser, each of which would increase our regulatory and compliance costs and expenses.
Market fluctuations caused by force majeure, terrorism or certain
other events may adversely affect our performance.
In addition to historic market risks, our performance
may be adversely affected by market fluctuations resulting from certain risks which are unprecedented in nature or magnitude and therefore
not amenable to existing risk management techniques which are based on modeling past events and assigning probabilities to the recurrence
of those events. Such events include, without limitation, catastrophic acts of terror, imposition or declaration of martial law, mass
disruption of telecommunications facilities, pandemics resulting from bio-terror attacks or outbreaks of fatal disease, cyber-terror
and terrorist attacks on financial markets, exchanges and payments systems and acts of providence.
Conditions, caused by the novel coronavirus (COVID-19)
global pandemic that emerged in December 2019, have continued and, combined with declining business and consumer confidence and increased
unemployment, have precipitated a deep economic recession and fears of a possible depression. It is difficult to predict how long these
conditions will continue, whether they will continue to deteriorate and which markets, products and businesses will continue to be adversely
affected. The success of the Company may depend on the recovery of the economy and such markets and there is no assurance that these
conditions will stabilize or improve so as to allow the Adviser to pursue attractive investment opportunities.
Changes in interest rates may affect our net investment income,
reinvestment risk and the probability of defaults of our investments.
Rising interest
rates tend to extend the duration of securities, making them more sensitive to changes in interest rates. The value of longer-term securities
generally changes more in response to changes in interest rates than shorter-term securities. As a result, in a period of rising interest
rates, securities may exhibit additional volatility and may lose value.
Risks Related to Our Adviser and/or its Affiliates
Our performance is dependent on our Adviser, and we may not find
a suitable replacement if the management agreement is terminated.
Some of our executive officers are also executive
officers of our Adviser or its affiliates. We have no separate facilities, employees or management and rely on our Adviser, which has
significant discretion as to the implementation of our operating policies and strategies. We will depend on our Adviser and its affiliates
for certain services including administrative and business advice. We are subject to the risk that our Adviser will terminate the management
agreement and that no suitable replacement will be found. Investors who are not willing to rely on our Adviser or ArrowMark Partners
should not invest in our common stock. The employees, systems and facilities of our Adviser and ArrowMark Partners may be utilized by
other funds and companies advised by them or their affiliates. Our Advisor may not have sufficient access to such employees, systems
and facilities in order to comply with its obligations under the management agreement. We believe that our success depends to a significant
extent upon the experience of the executive officers, portfolio managers and employees of ArrowMark or its affiliates, whose employment
is not guaranteed.
The departure or death of any of the members
of senior management of our Adviser or ArrowMark Partners may adversely affect our ability to achieve our business objective; our management
agreement does not require the availability to us of any particular individuals.
We depend on the diligence, skill and network of
business contacts of the employees of our Adviser and ArrowMark Partners and its affiliates, whose investment professionals will evaluate,
negotiate, structure, close and monitor our assets. Our future success depends on the continued service of the management team of the
Adviser and ArrowMark Partners and its affiliates, and that continued service is not guaranteed. The management agreement does not obligate
that any particular individual’s services be made available to us. The departure, death or disability of any of the members of
the management of the Adviser or ArrowMark Partners could have a material adverse effect on our ability to achieve our business objective.
If our Adviser ceases to be our manager under
our management agreement, financial institutions that provided our credit facilities may not provide future financing to us.
The financial institutions that will finance our
investments pursuant to credit facilities or reverse repurchase agreements arranged by our Adviser may require that our Adviser serve
as our manager as a condition to making continued advances to us under these credit facilities. Additionally, if our Adviser ceases to
be our adviser, each of these financial institutions under these credit facilities may terminate their facility and their obligation
to advance funds to us in order to finance our future investments. If our Adviser ceases to be our manager for any reason and we are
not able to obtain financing under these credit facilities, our growth maybe limited and our earnings and book value may be adversely
affected.
Our Adviser’s liability is limited under
our management agreement, and we have agreed to indemnify our Adviser against certain liabilities.
Pursuant to our management agreement with our Adviser,
its affiliates and their officers, directors, managing members, members and employees will not be liable to us, our directors, or our
stockholders for acts performed in accordance with and pursuant to our management agreement, except by reason of acts constituting willful
misconduct, bad faith or gross negligence, or as otherwise required by applicable law.
Pursuant to our management agreement, we will indemnify
our Adviser, its affiliates and their officers, directors, managing members, members, employees and certain other parties against all
losses, expenses and costs or damages arising out of or in connection with actions of such indemnified party or failure to act on the
part of such indemnified party all in connection with our investment activities or in respect of our management agreement or the services
provided by our manager or ArrowMark Partners to us, in the absence of willful misfeasance, gross negligence or bad faith. See “Management—Management
Agreement.”
There may be potential conflicts of interest
between our management or Adviser, on one hand, and the interest of our common stockholders, on the other.
Our Adviser is subject to certain conflicts of interest
in our management. These conflicts will arise primarily from the involvement of our Adviser and its affiliates in other activities that
may conflict with our activities. Our Adviser and its affiliates engage in a broad spectrum of activities. In the ordinary course of
their business activities, they may engage in activities where their interests or the interests of their clients may conflict with our
interests and the interests of the holders of our common stock. Other present and future activities of our Adviser and its affiliates
may give rise to additional conflicts of interest which may have a negative impact on us.
Our Adviser’s compliance department and legal
department will oversee its conflict-resolution system. The program places particular emphasis on the principle of fair and equitable
allocation of appropriate opportunities and of common fees and expenses to our Adviser’s clients over time. As a result of our
Adviser’s allocation policies, we may not be able to invest in all opportunities that are appropriate for us and this may have
the effect of reducing our potential earnings. Although our Adviser has agreed with us that it will allocate opportunities, fees and
expenses among its clients pursuant to its written policies and procedures, there is no assurance that these policies and procedures
will work as intended or that we will be allocated our fair share of investment opportunities over time or appropriately allocated the
fees and expenses of the Adviser.
We are limited in our ability to conduct transactions
with affiliates.
The Investment Company Act imposes restrictions on
transactions we can conduct with our affiliates. These restrictions prohibit us from buying or selling any security directly from or
to any portfolio company of a registered investment company or private equity fund managed by StoneCastle-ArrowMark, ArrowMark Partners
or any of their respective affiliates. These restrictions also prohibit certain “joint” transactions with certain of our
affiliates, which could include investments in the same portfolio company (whether at the same or different times). These limitations
may limit the scope of investment opportunities that would otherwise be available to us.
Our Adviser’s investment committee is
not independent from its management.
Our Adviser’s investment committee is comprised
exclusively of our affiliated persons, and they are the same individuals who manage our assets. The individuals comprising our Adviser’s
investment committee may have inherent conflicts of interest with the holders of common stock, since they also advise other investment
companies affiliated with us. We cannot guarantee that the investment opportunities provided to us will have better results than investment
opportunities provided to our affiliates.
We may compete with our Adviser’s current
and future investment vehicles for access to capital and assets.
Our Adviser and its affiliates may sponsor or manage
additional investment funds in the future. Although these funds may have different business objectives and operate differently than we
do, we may nonetheless compete with these funds for capital or assets or for access to the benefits that we expect our Adviser to provide
to us.
There may be other conflicts of interest in
our relationship with our Adviser and/or its affiliates that could negatively affect our earnings.
Our Adviser and/or its affiliates manage, sponsor
and invest in other secured borrowings via special purpose vehicles, investment funds, hedge funds and separate accounts and may in the
future sponsor additional investment funds and other investments in community banks, commercial loans, municipal debt and other targeted
assets in the community banking sector, and some of the members of our board of directors and officers or members of our Adviser’s
investment committee may serve as officers and/or directors of these other entities. This may give rise to conflicts of interest, including
that certain assets appropriate for us may also be appropriate for one or more of these entities, and our Adviser may decide to allocate
a particular opportunity other than to us. Our Adviser will often make asset purchase and sale decisions for us and any subsidiaries
at the same time as asset purchase and sale decisions are being made for other affiliated entities for which our Adviser or one of our
Adviser’s affiliates is the investment adviser, in which case our Adviser will face conflicts in the allocation of business opportunities.
Our Adviser and/or its affiliates may also engage in additional management and investment opportunities in the future which may compete
with us for business opportunities.
The restrictive covenants that would govern our potential
secured borrowings may have greater limitations on the disposition and reinvestment of assets than do other accounts managed by our Adviser.
This may result in dispositions and reinvestments not being able to be made on as advantageous a basis as our Adviser may be able to
achieve for such other accounts and such other dispositions and reinvestments may adversely affect the price at which such assets can
be sold or purchased on our behalf.
Our Adviser’s management of our business
is subject to the oversight of our board of directors, but our board of directors will not approve each business decision made by our
Adviser.
Our Adviser is authorized to follow a very broad
business approach, including the selection of the amount and form of leverage we will employ. Our policies do not impose any limitations
on the types of investments within the banking sector and, as a result, we cannot predict with any certainty the percentage of our assets
that will be in each category. We may change our business strategy and policies for how we invest in banking-related securities without
a vote of stockholders. Our board of directors will periodically review our business approach and our assets. However, our board of directors
will not review each proposed purchase. In addition, in conducting periodic reviews, our board of directors will rely primarily on information
provided to it by our Adviser.
Our Adviser may be incentivized to incur additional
leverage, up to the extent permitted by regulations.
Our Adviser’s management fee is based on our
gross assets at the end of each quarter, not net of any leverage that we incur. Our Adviser therefore may be incentivized to increase
our leverage within regulatory limits in order to increase our asset value.
Additional leverage may pose risks that could adversely
affect our results of operations and our ability to declare and pay dividends. See “Leverage” and “Risk Factors—Risks
Related to our Operations.”
Our Adviser can resign on not
less than 60 days’ notice, and we may not be able to find a suitable replacement within that time, resulting in a disruption in
our operations that could adversely affect our financial condition, business and results of operations.
Our Adviser has the right, under the management agreement,
to resign at any time upon not less than 60 days’ written notice, whether we have found a replacement or not. If our Adviser resigns,
we may not be able to find a new investment adviser or hire internal management with similar expertise and ability to provide the same
or equivalent services on acceptable terms within 60 days, or at all. If we are unable to do so quickly, our operations are likely to
experience a disruption, our financial condition, business and results of operations as well as our ability to pay distributions are
likely to be adversely affected and the market price of our shares may decline. In addition, the coordination of our internal management
and investment activities is likely to suffer if we are unable to identify and reach an agreement with a single institution or group
of executives having the expertise possessed by our Adviser and its affiliates. Even if we are able to retain comparable management,
whether internal or external, the integration of such management and their lack of familiarity with our investment objective may result
in additional costs and time delays that may adversely affect our business, financial condition, results of operations and cash flows.
Risks Related to Offerings
The price for our common stock may be volatile.
The trading price of our common stock following any
future offering may fluctuate substantially. The price of our common stock that will prevail in the market after any future offering
may be higher or lower than the price you pay and the liquidity of our common stock may be limited, in each case depending on many factors,
some of which are beyond our control and may not be directly related to our operating performance. These factors include the following:
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changes
in the value of our portfolio of investments;
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price
and volume fluctuations in the overall stock market from time to time;
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significant
volatility in the market price and trading volume of securities of similar investment companies;
our dependence on the banking sector and changes in conditions relating to that sector; our
inability to deploy or invest our capital;
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fluctuations
in interest rates;
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any
shortfall in revenue or net income or any increase in losses from levels expected by investors
or securities analysts;
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operating
performance of companies comparable to us;
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changes
in regulatory policies with respect to investment companies;
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our
ability to borrow money or obtain additional capital;
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losing
RIC status under the Code;
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actual
or anticipated changes in our earnings or fluctuations in our operating results or changes
in the expectations of securities analysts;
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general
economic conditions and trends;
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departures
of key personnel; and
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exchange-related
technological disruptions.
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Shares of closed-end investment companies often trade at a discount
to their net asset value.
We cannot predict the prices at which our common
stock will trade. Although our common stock is listed on the NASDAQ Global Select Market, an active trading market for our shares may
not be sustained. In the absence of an active trading market for our common stock, investors may not be able to sell their common stock
at or above the offering price or our NAV.
Shares of closed-end investment companies have in
the past frequently traded at discounts to their NAV and our common stock may also be discounted in the market. This characteristic is
a risk separate and distinct from the risk that our NAV could decrease as a result of our investment activities and may be greater for
investors expecting to sell their shares in a relatively short period following completion of any future offering. We cannot assure you
whether our common stock will trade above, at or below our NAV. Whether investors will realize gains or losses upon the sale of our common
stock will depend entirely upon whether the market price of our common stock at the time of sale is above or below the investor’s
purchase price for our common stock. Because the market price of our common stock is affected by factors such as NAV, distribution levels
(which are dependent, in part, on expenses), supply of and demand for our common stock, stability of distributions, trading volume of
our common stock, general market and economic conditions, and other factors beyond our control, we cannot predict whether our common
stock will trade at, below or above NAV or at, below or above the offering price. In addition, if shares of our common stock trade below
their NAV, we will generally not be able to issue additional shares of common stock at their market price without first obtaining the
approval of our stockholders and our independent directors to such issuance.
Future offerings of debt securities or preferred
stock, which would rank senior to our common stock upon our liquidation, and future offerings of equity securities, which would dilute
our existing stockholders and may be senior to our common stock for the purposes of dividend and liquidating distributions, may adversely
affect the market value of our common stock.
If you purchase our common stock in any future offering,
the price that you pay will be greater than the NAV per share of common stock immediately following any future offering. This discrepancy
is in large part due to the expenses we will incur in connection with the consummation of any future offering. In the future, we may
attempt to increase our capital resources by making offerings of debt or additional offerings of equity securities, including offerings
of preferred stock, the terms of which may be determined in the discretion of our board of directors. Upon liquidation, holders of our
debt securities and holders of our preferred stock and lenders with respect to other borrowings will receive a distribution of our available
assets prior to the holders of our common stock. Additional equity offerings may dilute the holdings of our existing stockholders or
reduce the market price of our common stock, or both. Our preferred stock, if issued, could have a preference on liquidating distributions
or a preference on dividend payments that could limit our ability to make a dividend distribution to the holders of our common stock.
Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control,
we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, holders of our common stock bear the risk of
our future offerings reducing the market value of our common stock and diluting their holdings of shares in us.
Risks Related to Taxation
We may not be able to meet the requirements to maintain RIC status.
In order to qualify as a RIC, we must be registered
as a management company under the Investment Company Act at all times during each taxable year and meet an income test, a diversification/asset
test and certain distribution requirements. Failure to meet the income test and the diversification/asset test requirements could result
in the discontinuance of our treatment as a RIC, which would increase our tax expense and could adversely affect our NAV, results of
operations and ability to distribute dividends.
We will be subject to corporate-level federal
income tax on all of our income if we are unable to maintain RIC status under Subchapter M of the Code.
If we fail to qualify for or maintain RIC status
for any reason, and we do not qualify for certain relief provisions under the Code, we would be subject to corporate-level federal income
tax (and any applicable state and local taxes) and our stockholders would be subject to the federal income tax rules that apply
to stockholders in a regular, or “C,” corporation. The conversion from a RIC to a regular, or “C,” corporation
could have a materially adverse tax impact on us and our stockholders in the taxable year in which RIC status is lost and in future taxable
years. Further, if we seek to re-establish RIC status after operating as a regular, or “C,” corporation, because we will
have operated as a regular corporation, we would have to distribute to our stockholders our pre-election earnings and may also be taxed
on the gain in appreciated assets that we hold when we re-elect to be a RIC.
Whether an investment in a RIC is appropriate
for a Non-U.S. Stockholder will depend upon the Non-U.S. Stockholder’s particular circumstances.
Code section 871(k) provides certain “look-through”
treatment to Non-U.S. Stockholders (as defined in “Material U.S. Federal Income Tax Considerations”), permitting interest-related
dividends and short-term capital gains not to be subject to U.S. withholding tax. It should also be noted that withholding would still
apply (generally at a 30% rate or lower applicable treaty rate) to the extent that distributions are from the Company’s dividend
income, interest income from non-U.S. sources or foreign currency gains. We strongly urge you to review carefully the discussion
under “Material U.S. Federal Income Tax Considerations” and to seek advice based on your particular circumstances from an
independent tax advisor.
DETERMINATION
OF NET ASSET VALUE
We will determine and publish the NAV of our common
stock on at least a quarterly basis and at such other times as our board of directors may determine. Our NAV equals the value of our
total assets (the value of the securities held plus cash or other assets, including interest accrued but not yet received, dividends
declared but not yet received), less: all of our liabilities and including (i) accrued expenses; (ii) accumulated and unpaid
dividends on any outstanding preferred stock; (iii) the aggregate liquidation preference of any outstanding preferred stock; (iv) accrued
and unpaid interest payments on any outstanding indebtedness; (v) the aggregate principal amount of any outstanding indebtedness;
and (vi) any distributions payable on our common stock. The NAV per share of common stock equals our NAV divided by the number of
outstanding shares of common stock.
We will determine fair value of our assets and liabilities
in accordance with valuation procedures that our board of directors adopts. Generally, we seek to obtain market quotes from independent
parties for each of our investments. Our board of directors has engaged the services of one or more regionally or nationally recognized
independent valuation firms to help it determine the value of each investment for which a market price is not available. Our board of
directors also reviews valuations of such investments provided by the Adviser. Securities for which market quotations are readily available
shall be valued at “market value.” If a market value cannot be obtained or if our Adviser determines that the value of a
security as so obtained does not represent a fair value as of the measurement date (due to a significant development subsequent to the
time its price is determined or otherwise), fair value for the security shall be determined pursuant to the methodologies established
by our board of directors. Our board of directors regularly reviews and evaluates our valuation methodology and any such valuation service
it uses and the historical accuracy of such valuation methodologies. Our board of directors also reviews valuations of such investments
provided by the Adviser and assigns the valuation it determines to best represent the fair value of such investments.
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The
fair value for publicly-traded equity securities and equity-related securities will be determined
by using readily available market quotations from the principal market, if available. For
equity and equity-related securities that are freely tradable and listed on a securities
exchange or over the counter market, fair value will be determined using the last sale price
on that exchange or over-the-counter market on the measurement date. If the security is listed
on more than one exchange, we will use the price of the exchange that we consider to be the
principal exchange on which the security is traded. If a security is traded on the measurement
date, then the last reported sale price on the exchange or OTC market on which the security
is principally traded, up to the time of valuation, will be used. If there were no reported
sales on the security’s principal exchange or OTC market on the measurement date, then
the average between the last bid price and last asked price, as reported by the pricing service,
will be used. We will obtain direct written broker-dealer quotations if a security is not
traded on an exchange or quotations are not available from an approved pricing service.
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An
equity security of a publicly traded company acquired in a private placement transaction
is subject to restrictions on resale that can affect the security’s liquidity and fair
value. Such securities that are convertible into publicly traded common stock or securities
that may be sold pursuant to Rule 144 shall generally be valued based on the fair value
of the freely tradable common stock counterpart, less an applicable discount. Generally,
the discount will initially be equal to the discount at which we purchased the securities.
To the extent that such securities are convertible or otherwise become freely tradable within
a time frame that may be reasonably determined, an amortization schedule may be determined
for the discount.
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Our
board of directors uses the services of one or more regionally or nationally recognized independent
valuation firms to aid it in determining the fair value of these securities. The methods
for valuing these securities may include: fundamental analysis (sales, income or earnings
multiples, etc.), discounts from market prices of similar securities, purchase price
of securities, subsequent private transactions in the security or related securities, or
discounts applied to the nature and duration of restrictions on the disposition of the securities,
as well as a combination of these and other factors. Because such valuations, and particularly
valuations of private securities and private companies, are inherently uncertain, may fluctuate
over short periods of time, and may be based on estimates, our determinations of fair value
may differ materially from the values that would have been used if a ready market for these
securities existed. Our NAV could be adversely affected if our determinations regarding the
fair value of our investments were materially higher than the values that we ultimately realize
upon the disposal of such securities.
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Fixed
income securities (other than the short-term securities as described below) are valued by
(i) using readily available market quotations based upon the last updated sale price
or a market value from an approved pricing service generated by a pricing matrix based upon
yield data for securities with similar characteristics; or (ii) by obtaining a direct
written broker-dealer quotation from a dealer who has made a market in the security. A fixed
income security acquired in a private placement transaction without registration is subject
to restrictions on resale that can affect the security’s liquidity and fair value.
Among the various factors that can affect the value of a privately placed security are (i) whether
the issuing company has freely trading fixed income securities of the same maturity and interest
rate (either through an initial public offering or otherwise); (ii) whether the company
has an effective registration statement in place for the securities; and (iii) whether
a market is made in the securities.
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Short-term
securities, including bonds, notes, debentures and other fixed income securities and money
market instruments such as certificates of deposit, commercial paper, bankers’ acceptances
and obligations of domestic and foreign banks, with remaining maturities of 60 days or less,
for which reliable market quotations are readily available are valued on an amortized cost
basis at current market quotations as provided by an independent pricing service or principal
market maker. Short-term securities normally will be valued at amortized cost unless market
condition or other factors lead to a determination of fair value at a different amount.
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Other
assets, including equity investments for which there is no market, will be valued at market
value pursuant to written valuation procedures adopted by our board of directors, or if a
market value cannot be obtained (including with respect to classes of investments noted above)
or if our Adviser determines that the value of a security as so obtained does not represent
a fair value as of the measurement date (due to a significant development subsequent to the
time its price is determined or otherwise), fair value shall be determined pursuant to the
methodologies established by our board of directors. In making these determinations, our
board of directors has engaged an independent valuation firm to assist in determining the
fair value of our investments. The methods for valuing these investments may include fundamental
analysis, discounts from market prices of similar securities, purchase price of securities,
subsequent private transactions in the security or related securities, or discounts applied
to the nature and duration of restrictions on the disposition of the securities, as well
as a combination of these and other factors. We intend for such a third-party valuation firm
to provide valuation advice with respect to approximately 25% of our investment portfolio
each quarter.
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Valuations of public company securities determined
pursuant to fair value methodologies will be presented to our board of directors or a designated committee thereof for approval at the
next regularly scheduled board meeting. See “Risk Factors—Risks Related to Our Adviser and/or its Affiliates.”
DIVIDEND
REINVESTMENT PLAN
We have a dividend reinvestment plan for our stockholders.
Our plan is an “opt out” dividend reinvestment plan. As a result, if a stockholder’s shares are registered directly
with us or with a brokerage firm that participates in our dividend reinvestment plan (the “Plan”) through the facilities
of the Depository Trust Company (“DTC”), and such stockholder’s account is coded for dividend reinvestment by such
brokerage firm, all distributions are automatically reinvested for stockholders by Computershare Trust Company, N.A., as Plan agent (the
“Plan Agent”), in additional common stock (unless a stockholder is ineligible or elects otherwise). If a stockholder opts
out of the Plan, such stockholder’s account is not coded dividend reinvestment by such brokerage firm, and such stockholder receives
distributions in cash. If a stockholder’s shares are registered with a brokerage firm that does not participate in the Plan through
the facilities of DTC, a stockholder will need to ask its investment professional to determine what arrangements can be made to set up
its account to participate in the Plan if desired, and, until such arrangements are made, a stockholder receives distributions in cash.
In the case that newly issued shares of our common
stock are used to implement the Plan, the number of shares of common stock to be delivered to a participating stockholder is determined
by dividing the total dollar amount of the dividends payable to such stockholder by 97% of the average market prices per share of common
stock at the close of regular trading on the NASDAQ Global Select Market (or such other exchange or quotation system on which the common
stock is primarily traded) for the five trading days immediately prior to the valuation date fixed by our board of directors. In the
case that shares repurchased on the open market are used to implement the Plan, the number of shares of common stock to be delivered
to a participating stockholder is determined by dividing the total dollar amount of the dividends payable to such stockholder by the
weighted average purchase price, without deduction for transaction processing fees such as brokerage commissions and other related costs,
of all such shares purchased by the Plan Agent on the open market in connection with such distribution.
Stockholders who elect not to participate in the
Plan will receive all distributions payable in cash paid by check mailed directly to the stockholder of record (or, if the shares are
held in street or other nominee name, then to such nominee) by Computershare Trust Company, N.A., as dividend paying agent. Participation
in the Plan is completely voluntary and may be terminated or resumed at any time without penalty by giving notice in writing to, or by
calling, the Plan Agent. Stockholders may elect not to participate in the Plan by notifying the Plan Agent in writing so that it is received
by the Plan Agent no later than 5 days prior to the applicable dividend record date. Any such election will remain in effect until the
stockholder notifies the Plan Agent in writing of the withdrawal of such election, which withdrawal must be received by the Plan Agent
no later than 5 days prior to the applicable dividend record date. A stockholder that holds its shares through a broker or other nominee
must make any such election or termination through its broker or nominee.
Whenever we declare a distribution payable in cash,
non-participants in the Plan will receive cash, and participants in the Plan will receive the equivalent in common stock.
We will use primarily newly-issued common stock to
implement the Plan, whether our shares are trading at a premium or at a discount to NAV. However, we reserve the right to instruct the
Plan Agent to purchase shares in the open market in connection with its obligations under the Plan. Such purchases may be effected through
an affiliated or unaffiliated broker-dealer as selected by the Plan agent. The broker-dealer may charge transaction processing fees such
as brokerage commissions and other related costs in addition to any compensation received by the Plan Agent.
We cannot establish the number of shares of our common
stock to be outstanding after giving effect to payment of the dividend or other distribution until the value per share at which additional
shares will be issued has been determined and elections of our stockholders have been tabulated. Stockholders who do not elect to receive
dividends in shares of common stock will experience dilution over time. The level of discount would depend on various factors, including
the proportion of our stockholders who participate in the plan, the level of premium or discount at which our shares are trading and
the amount of the dividend payable to a stockholder.
The Plan Agent will maintain all stockholders’
accounts in the Plan and will furnish written confirmation of each acquisition made for the participant’s account as soon as practicable,
but in no event later than 60 days after the date thereof. Shares in the account of each Plan participant will be held by the Plan Agent
in non-certificated form in the Plan Agent’s name or that of its nominee, and each stockholder’s proxy will include those
shares purchased or received pursuant to the Plan. The Plan Agent will forward all proxy solicitation materials to participants and vote
proxies for shares held pursuant to the Plan in accordance with the instructions of the participants.
There will be no brokerage charges with respect to
shares issued directly by us as a result of distributions payable in shares. If the participant elects to have the Plan Agent sell part
or all of his or her common stock and remit the proceeds, such participant will be charged his or her pro rata share of brokerage commissions,
fees and transaction costs incurred for the transaction, and the Plan Agent is entitled to deduct a $15 transaction fee. The automatic
reinvestment of distributions will not relieve participants of any federal, state or local income tax that may be payable (or required
to be withheld) on such distributions. The Plan proceeds to non-U.S. persons may be subject to withholding tax. See “Material U.S.
Federal Income Tax Considerations.”
Experience under the Plan may indicate that changes
are desirable. Accordingly, we reserve the right to amend or terminate the Plan if in the judgment of our board of directors such a change
is warranted. We may terminate the Plan upon notice in writing mailed to each participant at least 60 days prior to the effective date
of the termination. Upon any termination, the Plan Agent will cause a certificate or certificates to be issued for the full shares held
by each participant under the Plan and cash adjustment for any fraction of a share of common stock at the then current market value of
the common stock to be delivered to him, her or it. If preferred, a participant may request the sale of all of the common stock held
by the Plan Agent in his or her Plan account in order to terminate participation in the Plan. If such participant elects in advance of
such termination to have the Plan Agent sell part or all of his or her shares, the Plan Agent is authorized to deduct from the proceeds
the brokerage commissions, fees and transaction costs incurred for the transaction. If a participant has terminated his or her participation
in the Plan but continues to have common stock registered in his or her name, he or she may re-enroll in the Plan at any time by notifying
the Plan Agent in writing at the address below. The terms and conditions of the Plan may be amended by us at any time, except when necessary
or appropriate to comply with applicable law or the rules or policies of the SEC or any other regulatory authority, only by mailing
to each participant appropriate written notice at least 30 days prior to the effective date thereof. The amendment shall be deemed to
be accepted by each participant unless, prior to the effective date thereof, the Plan Agent receives notice of the termination of the
participant’s account under the Plan. Any such amendment may include an appointment by the Plan Agent of a successor Plan Agent,
subject to the prior written approval of the successor Plan Agent by us.
All correspondence concerning the Plan should be
directed to Computershare Trust Company, N.A., 250 Royall Street, Canton, Massachusetts 02021.
PLAN
OF DISTRIBUTION
We may offer, from time to time, in one or more offerings
or series, up to $150 million of our common stock, preferred stock, debt securities or subscription rights to purchase shares of our
common stock, in one or more underwritten public offerings, at-the-market offerings, negotiated transactions, block trades, best efforts
or a combination of these methods. We may sell the securities through underwriters or dealers, directly to one or more purchasers, including
existing stockholders in a rights offering, through agents or through a combination of any such methods of sale. Any underwriter or agent
involved in the offer and sale of the securities will be named in the applicable prospectus supplement. A prospectus supplement or supplements
will also describe the terms of the offering of the securities, including: the purchase price of the securities and the proceeds, if
any, we will receive from the sale; any over-allotment options under which underwriters may purchase additional securities from us; any
agency fees or underwriting discounts and other items constituting agents’ or underwriters’ compensation; the public offering
price; any discounts or concessions allowed or re-allowed or paid to dealers; and any securities exchange or market on which the securities
may be listed. Only underwriters named in the prospectus supplement will be underwriters of the securities offered by the prospectus
supplement.
The distribution of the securities may be effected
from time to time in one or more transactions at a fixed price or prices, which may be changed, at prevailing market prices at the time
of sale, at prices related to such prevailing market prices, or at negotiated prices, provided, however, that the offering price per
share of our common stock, less any underwriting commissions or discounts, must equal or exceed the net asset value per share of our
common stock at the time of the offering except (1) in connection with a rights offering to our existing stockholders, (2) offerings
completed within one year of the receipt of consent of the majority of our common stockholders or (3) under such circumstances as
the SEC may permit. The price at which securities may be distributed may represent a discount from prevailing market prices.
In connection with the sale of the securities, underwriters
or agents may receive compensation from us or from purchasers of the securities, for whom they may act as agents, in the form of discounts,
concessions or commissions. Our common stockholders will indirectly bear such fees and expenses as well as any other fees and expenses
incurred by us in connection with any sale of securities. Underwriters may sell the securities to or through dealers and such dealers
may receive compensation in the form of discounts, concessions or commissions from the underwriters and/or commissions from the purchasers
for whom they may act as agents. Underwriters, dealers and agents that participate in the distribution of the securities may be deemed
to be underwriters under the Securities Act, and any discounts and commissions they receive from us and any profit realized by them on
the resale of the securities may be deemed to be underwriting discounts and commissions under the Securities Act. Any such underwriter
or agent will be identified and any such compensation received from us will be described in the applicable prospectus supplement. The
maximum aggregate commission or discount to be received by any member of the Financial Industry Regulatory Authority or independent broker-dealer
will not be greater than 8% of the gross proceeds of the sale of securities offered pursuant to this prospectus and any applicable prospectus
supplement. We may also reimburse the underwriter or agent for certain fees and legal expenses incurred by it.
Any underwriter may engage in over-allotment, stabilizing
transactions, short-covering transactions and penalty bids in accordance with Regulation M under the Exchange Act. Over-allotment involves
sales in excess of the offering size, which create a short position. Stabilizing transactions permit bids to purchase the underlying
security so long as the stabilizing bids do not exceed a specified maximum price. Syndicate-covering or other short-covering transactions
involve purchases of the securities, either through exercise of the over-allotment option or in the open market after the distribution
is completed, to cover short positions. Penalty bids permit the underwriters to reclaim a selling concession from a dealer when the securities
originally sold by the dealer are purchased in a stabilizing or covering transaction to cover short positions. Those activities may cause
the price of the securities to be higher than it would otherwise be. If commenced, the underwriters may discontinue any of the activities
at any time.
We may sell securities directly or through agents
we designate from time to time. We will name any agent involved in the offering and sale of securities and we will describe any commissions
we will pay the agent in the prospectus supplement. Unless the prospectus supplement states otherwise, our agent will act on a best-efforts
basis for the period of its appointment.
Unless otherwise specified in the applicable prospectus
supplement, each class or series of securities will be a new issue with no trading market. We may elect to list any other class or series
of securities on any exchanges, but we are not obligated to do so. We cannot guarantee the liquidity of the trading markets for any securities.
Under agreements that we may enter, underwriters,
dealers and agents who participate in the distribution of shares of our securities may be entitled to indemnification by us against certain
liabilities, including liabilities under the Securities Act, or contribution with respect to payments that the agents or underwriters
may make with respect to these liabilities. Underwriters, dealers and agents may engage in transactions with, or perform services for,
us in the ordinary course of business.
If so indicated in the applicable prospectus supplement,
we will authorize underwriters or other persons acting as our agents to solicit offers by certain institutions to purchase our securities
from us pursuant to contracts providing for payment and delivery on a future date. Institutions with which such contracts may be made
include commercial and savings banks, insurance companies, pension funds, investment companies, educational and charitable institutions
and others, but in all cases such institutions must be approved by us. The obligations of any purchaser under any such contract will
be subject to the condition that the purchase of our securities shall not at the time of delivery be prohibited under the laws of the
jurisdiction to which such purchaser is subject. The underwriters and such other agents will not have any responsibility in respect of
the validity or performance of such contracts. Such contracts will be subject only to those conditions set forth in the prospectus supplement,
and the prospectus supplement will set forth the commission payable for solicitation of such contracts.
We may enter into derivative transactions with third
parties, or sell securities not covered by this prospectus to third parties in privately negotiated transactions. If the applicable prospectus
supplement indicates, in connection with those derivatives, the third parties may sell securities covered by this prospectus and the
applicable prospectus supplement, including in short sale transactions. If so, the third party may use securities pledged by us or borrowed
from us or others to settle those sales or to close out any related open borrowings of stock, and may use securities received from us
in settlement of those derivatives to close out any related open borrowings of stock. The third parties in such sale transactions will
be underwriters and, if not identified in this prospectus, will be identified in the applicable prospectus supplement.
In order to comply with the securities laws of certain
states, if applicable, our securities offered hereby will be sold in such jurisdictions only through registered or licensed brokers or
dealers.
DESCRIPTION
OF SECURITIES
The following descriptions of our securities,
certain provisions of Delaware law and certain provisions of our certificate of incorporation and our bylaws are summaries and are qualified
by reference to Delaware law and our certificate of incorporation and bylaws, copies of which are available from us
upon request.
General
Our certificate of incorporation provides that
our board of directors (without any further vote or action by our stockholders) may cause us to issue up to 40,000,000 shares of common
stock, par value $0.001 per share, and up to 10,000,000 shares of undesignated preferred stock, par value $0.001 per share. As of the
date of this prospectus, there are 6,572,212 shares of common stock outstanding and no shares of preferred stock outstanding. All references
to “stock” or “shares” herein refer to common stock, unless otherwise indicated. Each share of common stock has
equal voting, dividend, distribution and liquidation rights. The shares outstanding are, and, when issued, the shares offered by this
prospectus will be, fully paid and non-assessable. Shares are not redeemable and have no preemptive, conversion or cumulative voting
rights. The number of shares outstanding as of December 31, 2020 was 6,565,413.
The following information regarding our authorized
shares is as of April 27, 2021.
Title of Class
|
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Amount
Authorized
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|
|
Amount
Held by
the Company for
its Account
|
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Amount
Outstanding
(Exclusive of Amount
Held by the Company
for its Account)
|
|
Common
Stock, par value $0.001
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|
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40,000,000
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0
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6,572,212
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Preferred
Stock, par value $0.001
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|
|
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10,000,000
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|
|
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0
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0
|
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Common Stock
Voting Rights
The holders of common stock are entitled to one vote
per share held of record on all matters submitted to a vote of our stockholders. Generally, except with respect to extraordinary corporate
transactions, certain amendments to our certificate of incorporation, any amendment to our bylaws, liquidation and the election and removal
of directors, all matters to be voted on by our stockholders must be approved by a majority (or, in the case of election of directors,
by a plurality) of the votes cast by all common stock present in person or represented by proxy. Removal of directors for cause must
be approved by at least a majority of the votes entitled to be cast by our stockholders generally in the election of directors. See “—Certificate
of Incorporation and Bylaws—Amendment of Our Certificate of Incorporation and Bylaws” for a discussion of approval rights
with regard to such amendments.
Dividend Rights
Holders of common stock share ratably (based on the
number of shares of common stock held) in any dividend declared by our board of directors out of funds legally available therefor, subject
to any statutory or contractual restrictions on the payment of dividends and to any restrictions on the payment of dividends imposed
by the terms of any preferred stock we may issue in the future.
Preemptive Rights
No holder of common stock is entitled to preemptive,
redemption or conversion rights, sinking fund or cumulative voting rights.
Liquidation Rights
Upon our dissolution, liquidation or winding up,
after payment in full of all amounts required to be paid to creditors and to the holders of preferred stock having liquidation preferences,
if any, the holders of our common stock are entitled to receive an equal amount per share of all our remaining assets available for distribution.
Listing
Our common stock is traded on the NASDAQ Global Select
Market under the ticker symbol “BANX.”
Preferred Stock
Under our certificate of incorporation, our board
of directors (without any further vote or action by our stockholders) is authorized to provide for the issuance from time to time of
up to 10,000,000 shares of preferred stock consisting of one or more classes or series of preferred stock. Unless required by law or
by any stock exchange, if applicable, any such authorized preferred stock will be available for issuance without further action by our
common stockholders. Our board of directors is authorized to fix the number of shares, the relative powers, preferences and rights, and
the qualifications, limitations or restrictions applicable to each class or series thereof by resolution authorizing the issuance of
such class or series. As of the date of this prospectus, no preferred stock is outstanding and we have no current plans to issue any
preferred stock.
We may issue a series of preferred stock that could,
depending on the terms of the series, impede or discourage an acquisition attempt or other transaction that some, or a majority, of holders
of common stock might believe to be in their best interests or in which holders of common stock might receive a premium for their common
stock.
The Investment Company Act requires that the total
aggregate liquidation value and outstanding principal amount of all our preferred stock and debt securities not exceed 50% of the amount
of our total assets (including the proceeds of preferred stock and debt securities) less liabilities and indebtedness not represented
by our preferred stock and debt securities.
Subscription Rights
The following is a general description of the terms
of the subscription rights we may issue from time to time. Particular terms of any subscription rights we offer will be described in
the prospectus supplement relating to such subscription rights. We will not offer transferable subscription rights to our stockholders
at a price equivalent to less than the then current net asset value per share of common stock, taking into account underwriting commissions
and discounts, unless we first file a post-effective amendment that is declared effective by the SEC with respect to such issuance and
the common stock to be purchased in connection with the rights represents no more than one-third of our outstanding common stock at the
time such rights are issued.
We may issue subscription rights to our stockholders
to purchase common stock. Subscription rights may be issued independently or together with any other offered security and may or may
not be transferable by the person purchasing or receiving the subscription rights. In connection with any subscription rights offering
to our stockholders, we may enter into a standby underwriting, backstop or other arrangement with one or more persons pursuant to which
such persons would purchase any offered securities remaining unsubscribed for after such subscription rights offering. In connection
with a subscription rights offering to our stockholders, we would distribute certificates evidencing the subscription rights and a prospectus
supplement to our stockholders on the record date that we set for receiving subscription rights in such subscription rights offering.
Our common stockholders will indirectly bear all of the expenses incurred by us in connection with any subscription rights offerings,
regardless of whether any common stockholder exercises any subscription rights.
A prospectus supplement will describe the particular
terms of any subscription rights we may issue, including the following:
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the
period of time the offering would remain open (which shall be open a minimum number of days
such that all record holders would be eligible to participate in the offering and shall not
be open longer than 120 days);
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·
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the
title and aggregate number of such subscription rights;
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·
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the
exercise price for such subscription rights (or method of calculation thereof);
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·
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the
currency or currencies, including composite currencies, in which the price of such subscription
rights may be payable;
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·
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if
applicable, the designation and terms of the securities with which the subscription rights
are issued and the number of subscription rights issued with each such security or each principal
amount of such security;
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·
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the
ratio of the offering (which, in the case of transferable rights, will require a minimum
of three shares to be held of record before a person is entitled to purchase an additional
share);
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·
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the
number of such subscription rights issued to each stockholder;
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·
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the
extent to which such subscription rights are transferable and the market on which they may
be traded if they are transferable;
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·
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the
date on which the right to exercise such subscription rights shall commence, and the date
on which such right shall expire (subject to any extension);
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·
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if
applicable, the minimum or maximum number of subscription rights that may be exercised at
one time;
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·
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the
extent to which such subscription rights include an over-subscription privilege with respect
to unsubscribed securities and the terms of such over-subscription privilege;
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·
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any
termination right we may have in connection with such subscription rights offering;
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·
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the
terms of any rights to redeem, or call such subscription rights;
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·
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information
with respect to book-entry procedures, if any;
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·
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the
terms of the securities issuable upon exercise of the subscription rights;
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·
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the
material terms of any standby underwriting, backstop or other purchase arrangement that we
may enter into in connection with the subscription rights offering;
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·
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if
applicable, a discussion of certain material U.S. federal income tax considerations applicable
to the issuance or exercise of such subscription rights; and
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|
·
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any
other terms of such subscription rights, including exercise, settlement and other procedures
and limitations relating to the transfer and exercise of such subscription rights.
|
Each subscription right will entitle the holder of
the subscription right to purchase for cash or other consideration such amount of shares of common stock at such subscription price as
shall in each case be set forth in, or be determinable as set forth in, the prospectus supplement relating to the subscription rights
offered thereby. Subscription rights may be exercised as set forth in the prospectus supplement beginning on the date specified therein
and continuing until the close of business on the expiration date for such subscription rights set forth in the prospectus supplement.
After the close of business on the expiration date, all unexercised subscription rights will become void.
Upon receipt of payment and the subscription rights
certificate properly completed and duly executed at the corporate trust office of the subscription rights agent or any other office indicated
in the prospectus supplement we will forward, as soon as practicable, the shares of common stock purchasable upon such exercise. If less
than all of the rights represented by such subscription rights certificate are exercised, a new subscription certificate will be issued
for the remaining rights. Prior to exercising their subscription rights, holders of subscription rights will not have any of the rights
of holders of the securities purchasable upon such exercise. To the extent permissible under applicable law, we may determine to offer
any unsubscribed offered securities directly to persons other than stockholders, to or through agents, underwriters or dealers or through
a combination of such methods, as set forth in the applicable prospectus supplement.
Debt Securities
We may issue debt securities in one or more series.
The specific terms of each series of debt securities will be described in the particular prospectus supplement relating to that series.
The prospectus supplement may or may not modify the general terms found in this prospectus and will be filed with the SEC. For a complete
description of the terms of a particular series of debt securities, you should read both this prospectus and the prospectus supplement
relating to that particular series. As required by federal law for all bonds and notes of companies that are publicly offered, the debt
securities are governed by a document called an “indenture.” An indenture is a contract between us and a financial institution
acting as trustee on your behalf and is subject to and governed by the Trust Indenture Act of 1939, as amended. The trustee has two main
roles. First, the trustee can enforce your rights against us if we default. There are some limitations on the extent to which the trustee
acts on your behalf, described in the second paragraph under “—Events of Default—Remedies if an Event of Default Occurs.”
Second, the trustee performs certain administrative duties for us with respect to our debt securities.
Under the 1940 Act, we may only issue one class of
senior securities representing indebtedness, which in the aggregate, may represent no more than 33 1/3% of our managed assets. A prospectus
supplement and indenture (a summary of the expected terms of which is attached as Appendix A to the statement of additional information)
relating to any debt securities will include specific terms relating to the offering. These terms are expected to include the following:
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the
form and title of the security;
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the
aggregate principal amount of the securities;
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the
interest rate of the securities;
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·
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the
maturity dates on which the principal of the securities will be payable;
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any
changes to or additional events of default or covenants;
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any
optional or mandatory redemption provisions;
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·
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identities
of, and any changes in trustees, paying agents or security registrar; and
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·
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any
other terms of the securities.
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The debt securities may be secured or unsecured obligations.
Unless the prospectus supplement states otherwise, principal (and premium, if any) and interest, if any, will be paid by us in immediately
available funds.
Interest
Unless otherwise stated in a prospectus supplement,
debt securities will bear interest as generally determined by the Board of Directors, as more fully described in the related prospectus
supplement. Interest on debt securities shall be payable when due as described in the related prospectus supplement. If we do not pay
interest when due, it will trigger an event of default and we will be restricted from declaring dividends and making other distributions
with respect to our common shares and preferred shares.
Limitations
Under the requirements of the 1940 Act, immediately
after issuing any senior securities representing indebtedness, we must have an asset coverage of at least 300%. Asset coverage means
the ratio which the value of our total assets, less all liabilities and indebtedness not represented by senior securities, bears to the
aggregate amount of senior securities representing indebtedness. Other types of borrowings also may result in our being subject to similar
covenants in credit agreements.
Event of Default and Acceleration of Maturity of Debt Securities;
Remedies
Unless stated otherwise in the related prospectus
supplement, any one of the following events are expected to constitute an “event of default” for that series under the indenture:
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default
in the payment of any interest upon a series of debt securities when it becomes due and payable
and the continuance of such default for 30 days;
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·
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default
in the payment of the principal of, or premium on, a series of debt securities at its stated
maturity;
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·
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default
in the performance, or breach, of any covenant or warranty of ours in the indenture, and
continuance of such default or breach for a period of 90 days after written notice has been
given to us by the trustee;
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·
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certain
voluntary or involuntary proceedings involving us and relating to bankruptcy, insolvency
or other similar laws;
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·
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if,
on the last business day of each of twenty-four consecutive calendar months, the debt securities
have a 1940 Act asset coverage of less than 100%; or
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·
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any
other “event of default” provided with respect to a series, including a default
in the payment of any redemption price payable on the redemption date.
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Upon the occurrence and continuance of an event of
default, the holders of a majority in principal amount of a series of outstanding debt securities or the trustee may declare the principal
amount of that series of debt securities immediately due and payable upon written notice to us. A default that relates only to one series
of debt securities does not affect any other series and the holders of such other series of debt securities are not entitled to receive
notice of such a default under the indenture. Upon an event of default relating to bankruptcy, insolvency or other similar laws, acceleration
of maturity occurs automatically with respect to all series. At any time after a declaration of acceleration with respect to a series
of debt securities has been made, and before a judgment or decree for payment of the money due has been obtained, the holders of a majority
in principal amount of the outstanding debt securities of that series, by written notice to us and the trustee, may rescind and annul
the declaration of acceleration and its consequences if all events of default with respect to that series of debt securities, other than
the non-payment of the principal of that series of debt securities which has become due solely by such declaration of acceleration, have
been cured or waived and other conditions have been met.
Liquidation Rights
In the event of (a) any insolvency or bankruptcy
case or proceeding, or any receivership, liquidation, reorganization or other similar case or proceeding in connection therewith, relative
to us or to our creditors, as such, or to our assets, or (b) any liquidation, dissolution or other winding up of the Company, whether
voluntary or involuntary and whether or not involving insolvency or bankruptcy, or (c) any assignment for the benefit of creditors
or any other marshalling of assets and liabilities of ours, then (after any payments with respect to any secured creditor of ours outstanding
at such time) and in any such event the holders of debt securities shall be entitled to receive payment in full of all amounts due or
to become due on or in respect of all debt securities (including any interest accruing thereon after the commencement of any such case
or proceeding), or provision shall be made for such payment in cash or cash equivalents or otherwise in a manner satisfactory to the
holders of the debt securities, before the holders of any common or preferred stock of the Company are entitled to receive any payment
on account of any redemption proceeds, liquidation preference or dividends from such shares. The holders of debt securities shall be
entitled to receive, for application to the payment thereof, any payment or distribution of any kind or character, whether in cash, property
or securities, including any such payment or distribution which may be payable or deliverable by reason of the payment of any other indebtedness
of ours being subordinated to the payment of the debt securities, which may be payable or deliverable in respect of the debt securities
in any such case, proceeding, dissolution, liquidation or other winding up event.
Unsecured creditors of ours may include, without
limitation, service providers including our custodian, administrator, broker-dealers and the trustee, pursuant to the terms of various
contracts with us. Secured creditors of ours may include without limitation parties entering into any interest rate swap, floor or cap
transactions, or other similar transactions with us that create liens, pledges, charges, security interests, security agreements or other
encumbrances on our assets.
A consolidation, reorganization or merger of the
Company with or into any other company, or a sale, lease or exchange of all or substantially all of our assets in consideration for the
issuance of equity securities of another company shall not be deemed to be a liquidation, dissolution or winding up of the Company.
Voting Rights
Debt securities have no voting rights, except to
the extent required by law or as otherwise provided in the Indenture relating to the acceleration of maturity upon the occurrence and
continuance of an event of default. In connection with any other borrowings (if any), the 1940 Act does in certain circumstances grant
to the lenders certain voting rights in the event of default in the payment of interest on or repayment of principal.
Market
Our debt securities are not likely to be listed on
an exchange or automated quotation system. The details on how to buy and sell such securities, along with the other terms of the securities,
will be described in a prospectus supplement. We cannot assure you that any market will exist for our debt securities or if a market
does exist, whether it will provide holders with liquidity.
Book-Entry, Delivery and Form
Unless otherwise stated in the related prospectus
supplement, the debt securities will be issued in book-entry form and will be represented by one or more notes in registered global form.
The global notes will be deposited with the trustee as custodian for The Depositary Trust Company (“DTC”) and registered
in the name of Cede & Co., as nominee of DTC. DTC will maintain the notes in designated denominations through its book-entry
facilities.
Under the expected terms of the indenture, we and
the trustee may treat the persons in whose names any notes, including the global notes, are registered as the owners thereof for the
purpose of receiving payments and for any and all other purposes whatsoever. Therefore, so long as DTC or its nominee is the registered
owner of the global notes, DTC or such nominee will be considered the sole holder of outstanding notes under the indenture. We or the
trustee may give effect to any written certification, proxy or other authorization furnished by DTC or its nominee.
A global note may not be transferred except as a
whole by DTC, its successors or their respective nominees. Interests of beneficial owners in the global note may be transferred or exchanged
for definitive securities in accordance with the rules and procedures of DTC. In addition, a global note may be exchangeable for
notes in definitive form if:
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DTC
notifies us that it is unwilling or unable to continue as a depository and we do not appoint
a successor within 60 days;
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·
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we,
at our option, notify the trustee in writing that we elect to cause the issuance of notes
in definitive form under the indenture; or
|
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·
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an
event of default has occurred and is continuing.
|
In each instance, upon surrender by DTC or its nominee
of the global note, notes in definitive form will be issued to each person that DTC or its nominee identifies as being the beneficial
owner of the related notes.
Under the expected terms of the indenture, the holder
of any global note may grant proxies and otherwise authorize any person, including its participants and persons who may hold interests
through DTC participants, to take any action which a holder is entitled to take under the indenture.
Transfer Agent and Registrar
The transfer agent and registrar for our common stock
is Computershare Trust Company, N.A.
Certificate of Incorporation and Bylaws
Organization and Duration
We were formed on February 7, 2013 as StoneCastle
Financial Corp. and will remain in existence until dissolved in accordance with our certificate of incorporation.
Purpose
Under our certificate of incorporation, we are permitted
to engage in any business activity that lawfully may be conducted by a corporation organized under Delaware law and, in connection therewith,
to exercise all of the rights and powers conferred upon us pursuant to the agreement relating to such business activity.
Duties of Officers and Directors
Our certificate of incorporation provides that, except
as may otherwise be provided by the certificate of incorporation or by our bylaws, our property, affairs and business shall be managed
under the direction of our board of directors. Pursuant to our bylaws, our board of directors has the power to elect or appoint our officers
and such officers have the authority to exercise the powers and perform the duties specified in our bylaws or as may be specified by
our board of directors or delegated by our chief executive officer.
Our certificate of incorporation provides that we
indemnify our directors and officers for acts or omissions to the fullest extent permitted by law. Under the Delaware General Corporation
Law (“DGCL”), a corporation can only indemnify directors and officers for acts or omissions if the director or officer acted
in good faith, in a manner he reasonably believed to be in the best interests of the corporation and, in a criminal action, if the officer
or director had no reasonable cause to believe his conduct was unlawful.
Size and Election of Board of Directors
Our certificate of incorporation and bylaws provide
that the number of directors may be established, increased or decreased by our board of directors but may not be fewer than one. Our
certificate of incorporation will provide that our board of directors is divided into three classes. Each class of directors will hold
office for a three-year term. The initial members of the three classes have staggered terms of one, two and three years, respectively.
At each annual meeting of our stockholders, the successors to the class of directors whose terms expire at such meeting will be elected
to hold office for a term expiring at the annual meeting of stockholders held in the third year following the year of their election
and until their successors are duly elected and qualified. Except as may be provided by our board of directors in setting the terms of
any class or series of preferred stock, any and all vacancies on our board of directors may be filled only by the affirmative vote of
a majority of the remaining directors in office, even if the remaining directors do not constitute a quorum, and any director elected
to fill a vacancy shall serve for the remainder of the full term of the directorship in which such vacancy occurred and until a successor
is elected and qualifies.
Removal of Members of Our Board of Directors
The DGCL provides that directors may be removed,
but only for cause, by an affirmative vote of at least a majority of the votes entitled to be cast by our stockholders generally in the
election of our directors. Our certificate of incorporation states that directors may be removed at any time, but only for cause, by
at least two-thirds of the votes entitled to be cast by our stockholders generally in the election of our directors.
Advance Notice of Director Nominations and New Business
Our certificate of incorporation provides that special
meetings of stockholders may only be called by our board of directors, the chairman of our board of directors or our chief executive
officer.
Our bylaws provide that with respect to an annual
meeting of stockholders, nominations of persons for election to our board of directors and the proposal of business to be considered
by stockholders may be made only (i) pursuant to our notice of the meeting, (ii) by or at the direction of our board of directors
or the chairman of the board of directors or (iii) by any stockholder who is entitled to vote at the meeting and has complied with
the advance notice procedures set forth in our bylaws. Our bylaws provide that with respect to special meetings of our stockholders,
only the business specified in our notice of meeting may be brought before the meeting. Nominations of persons for election to our board
of directors may be made only (i) pursuant to our notice of the meeting, (ii) by or at the direction of our board of directors
or (iii) provided that our board of directors has determined that directors shall be elected at the meeting, by any
stockholder who is entitled to vote at the meeting and has complied with the advance notice procedures set forth in our bylaws.
The purpose of requiring stockholders to give advance
notice of nominations and other proposals is to afford our board of directors the opportunity to consider the qualifications of the proposed
nominees or the advisability of the other proposals and, to the extent considered necessary by our board of directors, to inform stockholders
and make recommendations regarding the nominations or other proposals. The advance notice procedures also permit a more orderly procedure
for conducting our stockholder meetings.
Limitations on Liability and Indemnification of Our Directors and
Officers
Our certificate of incorporation provides that our
directors will not be liable to us or our stockholders for monetary damages for breach of fiduciary duty as a director to the fullest
extent permitted by the DGCL. Our bylaws provide that our directors, officers, employees and agents, as well as persons serving as a
director, officer, partner, trustee, member, manager, employee or agent of another enterprise at our request, will be indemnified, and
may have their expenses of defense advanced, in each case to the full extent permitted under the DGCL.
The DGCL empowers a corporation to indemnify any
person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding,
whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation) by reason of the
fact that the person is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the
corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise,
against expenses (including attorneys’ fees), judgments, fines and amounts paid in settlement actually and reasonably incurred
by the person in connection with such action, suit or proceeding if (i) such person acted in good faith, (ii) in a manner such
person reasonably believed to be in or not opposed to the best interests of the corporation and (iii) with respect to any criminal
action or proceeding, such person had no reasonable cause to believe the person’s conduct was unlawful.
The DGCL further empowers a corporation to indemnify
any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in
the right of the corporation to procure a judgment in its favor by reason of the fact that the person is or was a director, officer,
employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent
of another corporation, partnership, joint venture, trust or other enterprise against expenses (including attorneys’ fees) actually
and reasonably incurred by such person in connection with the defense or settlement of such action or suit if such person acted in good
faith and in a manner the person reasonably believed to be in, or not opposed to, the best interests of the corporation, and except that
no indemnification may be made in respect of any claim, issue or matter as to which such person has been adjudged to be liable to the
corporation unless and only to the extent that the Delaware Court of Chancery or the court in which such action or suit was brought determines
upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly
and reasonably entitled to indemnity for such expenses which the Delaware Court of Chancery or such other court deems proper.
To the extent a present or former director or officer
is successful in the defense of any action, suit or proceeding noted above, or in defense of any claim, issue or matter therein, such
person will be indemnified against expenses (including attorneys’ fees) actually and reasonably incurred by such person in connection
with such action, suit or proceeding. We are further authorized to pay expenses incurred by an officer or director in advance of the
final disposition of a proceeding upon our receipt of an undertaking by or on behalf of the person to whom the advance will be made,
to repay the advances if it is ultimately determined that he or she was not entitled to indemnification.
Amendment of Our Certificate of Incorporation and Bylaws
Amendments to our certificate of incorporation may
be proposed only by or with the consent of our board of directors. To adopt a proposed amendment, our board of directors is required
to seek written approval of the holders of the number of shares required to approve the amendment or call a meeting of our stockholders
to consider and vote upon the proposed amendment. Generally, an amendment must be approved by at least a majority of the votes entitled
to be cast by our stockholders generally in the election of directors and, in general, to the extent that such amendment would have a
material adverse effect on the holders of any class or series of shares, by the holders of a majority of the holders of such class or
series. Amendments pertaining to removal of directors, indemnification of directors or amendment of certain provisions of the certificate
of incorporation or any provision of the bylaws, however, require the approval of the holders of two-thirds of our voting stock then
outstanding.
Our board of directors has the power to adopt, alter
or repeal our bylaws. Our certificate of incorporation provides that our stockholders may adopt, alter or repeal our bylaws upon approval
of at least two-thirds of the common stock then outstanding.
Merger, Sale or Other Disposition of Assets
Our board of directors is generally prohibited, without
the prior approval of at least a majority of the votes entitled to be cast by our stockholders generally in the election of directors,
from causing us to, among other things, sell, exchange or otherwise dispose of all or substantially all of our assets in a single transaction
or a series of related transactions, or approving on our behalf the sale, exchange or other disposition of all or substantially all of
our assets, provided that our board of directors may mortgage, pledge, hypothecate or grant a security interest in all
or substantially all of our assets without the approval of any stockholder.
Termination and Dissolution
Our existence is perpetual unless we are dissolved
as provided by the DGCL.
Books and Reports
We are required to keep appropriate books of our
business at our principal offices. The books will be maintained for both tax and financial reporting purposes a basis that permits the
preparation of financial statements in accordance with US GAAP. For financial reporting purposes and tax purposes, our fiscal year and
our tax year are the calendar year, unless otherwise determined by our board of directors in accordance with the Code.
We are required to file periodic reports, proxy statements
and other information with the SEC. This information will be available at the SEC’s public reference room in Washington, D.C. and
on the SEC’s website at www.sec.gov.
Anti-Takeover Effects of Our Certificate of Incorporation and Bylaws
The following is a summary of certain provisions
of our certificate of incorporation and bylaws that may be deemed to have an anti-takeover effect and may delay, deter or prevent a tender
offer or takeover attempt that a stockholder might consider to be in its best interest, including those attempts that might result in
a premium over the market price for the interests held by stockholders.
Authorized but Unissued Stock
Our certificate of incorporation provides for authorized
but unissued shares that our board of directors may use without the approval of any holders of our shares. Future issuances of common
and preferred stock may be utilized for a variety of purposes, including future public offerings to raise additional capital, acquisitions
and employee benefit plans. Our ability to issue additional shares and other equity securities could render more difficult or discourage
an attempt to obtain control over us by means of a proxy contest, tender offer, merger or otherwise.
Delaware Business Combination Statute—Section 203
Some provisions of the DGCL law may delay or prevent
a transaction that would cause a change in our control. Section 203 of the DGCL, which restricts certain business combinations with
interested stockholders in certain situations, generally applies to a corporation unless otherwise set forth in the corporation’s
certificate of incorporation. We have not opted out of Section 203. In general, this statute prohibits a publicly held Delaware corporation
from engaging in a business combination with an interested stockholder for a period of three years after the date of the transaction
by which that person became an interested stockholder, unless the business combination is approved in a prescribed manner. For purposes
of Section 203, a business combination includes a merger, asset sale or other transaction resulting in a financial benefit to the
interested stockholder, and an interested stockholder is a person who, together with affiliates and associates, owns, or within three
years prior, did own, 15% or more of voting stock.
Classified Board of Directors
Our board of directors is divided into three classes
of directors serving staggered three-year terms, with the term of office of only one of the three classes expiring each year. A classified
board of directors may render a change in control of us or removal of our incumbent management more difficult. This provision could delay
for up to two years the replacement of a majority of our board of directors. We believe, however, that the longer time required to elect
a majority of a classified board of directors helps to ensure the continuity and stability of our management and policies.
Number of Directors; Removal; Vacancies
Our certificate of incorporation provides that the
number of directors will be set only by our board of directors in accordance with our bylaws. Our bylaws provide that a majority of our
entire board of directors may at any time increase or decrease the number of directors. Under the DGCL, unless the certificate of incorporation
provides otherwise (which our certificate of incorporation does not), directors on a classified board of directors such as our board
of directors may be removed only for cause by a majority vote of our stockholders. Under our certificate of incorporation and bylaws,
any vacancy on our board of directors, including a vacancy resulting from an enlargement of our board of directors, may be filled only
by vote of a majority of the directors then in office. The limitations on the ability of our stockholders to remove directors and fill
vacancies could make it more difficult for a third-party to acquire, or discourage a third-party from seeking to acquire, control of
us.
Advance Notice Bylaw
Our bylaws provide that, in order for any matter
to be considered properly brought before a meeting or for a stockholder to nominate a candidate for director, a stockholder must comply
with requirements regarding advance notice to us, including the timing of such notice and the information that such notice must contain.
Our certificate of incorporation provides that stockholders may not act by written consent without a meeting of stockholders. These provisions
could delay until the next stockholders’ meeting stockholder actions which are favored by the holders of a majority of our outstanding
voting securities. These provisions may also discourage another person or entity from making a tender offer for our common stock, because
such person or entity, even if it acquired a majority of our outstanding voting securities, would be able to take action as a stockholder
(such as electing new directors or approving a merger) only at a duly called stockholders meeting, and not by written consent. Furthermore,
stockholders do not have the ability to call a special meeting.
Amendment of Our Certificate of Incorporation and Bylaws
The DGCL generally provides that the affirmative
vote of a majority of the shares entitled to vote on any matter is required to amend a corporation’s certificate of incorporation
or bylaws, unless a corporation’s certificate of incorporation or bylaws requires a greater percentage. Under our certificate of
incorporation, the affirmative vote of the holders of at least 66 2/3% of the shares of our capital stock entitled to vote will be required
to amend or repeal any of the provisions of our bylaws or certain provisions of our certificate of incorporation. In addition, our certificate
of incorporation permits our board of directors to amend or repeal our bylaws by a majority vote of the board of directors.
MATERIAL
U.S. FEDERAL INCOME TAX CONSIDERATIONS
The following is a general summary of certain
material U.S. federal income tax considerations relating to the acquisition, holding and disposition of our common stock. For purposes
of this section, under the heading “Material U.S. Federal Income Tax Considerations,” references to “we,” “us”
or “our” mean only StoneCastle Financial Corp. and not any subsidiaries or other lower-tier entities that we may organize
or invest in, except as otherwise indicated. This summary is based upon the Code, the regulations promulgated by the U.S. Treasury Department
(“Treasury regulations”), current administrative interpretations and practices of the U.S. Internal Revenue Service (the
“IRS”) and judicial decisions, all as currently in effect and all of which may be subject to differing interpretations or
to change, possibly with retroactive effect. No advance ruling has been or will be sought from the IRS regarding any matter discussed
in this summary. Therefore, no assurance can be given that the IRS would not assert, or that a court would not sustain, a position contrary
to any of the tax consequences described below. This summary does not purport to discuss all aspects of U.S. federal income taxation
to us or stockholders and in particular does not discuss those issues that may be important to stockholders subject to special tax rules,
such as:
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former
U.S. citizens or long-term residents subject to Code section 877 or section 877A;
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entities
subject to the U.S. anti-inversion rules;
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persons
who mark-to-market our common stock;
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subchapter
S corporations;
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U.S.
Stockholders (as defined below) whose functional currency is not the U.S. Dollar;
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financial
institutions;
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holders
who receive our common stock through the exercise of employee stock options or otherwise
as compensation;
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holders
who hold our common stock through tax-advantaged accounts (such as an individual retirement
account (an “IRA”), a 401(k) plan account or other qualified retirement account);
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persons
holding our common stock as part of a “straddle,” “hedge,” “conversion
transaction,” “synthetic security” or other integrated investment; and
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tax-exempt
organizations.
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If an entity or arrangement treated as a partnership
for U.S. federal income tax purposes holds our common stock, the U.S. federal income tax treatment of a partner in such partnership generally
will depend upon the status of the partner and the activities of such partnership. A partner of a partnership holding our common stock
should consult its own tax advisor regarding the U.S. federal income tax consequences to the partner of the acquisition, ownership and
disposition of our common stock by the partnership.
This summary assumes that stockholders will hold
our common stock as capital assets, which generally means as property held for investment. This discussion addresses only the U.S. income
tax consequences of an investment by U.S. Stockholders, and therefore, does not address U.S. estate and gift tax rules, U.S. state or
local taxation, the alternative minimum tax, excise taxes, transfer taxes or foreign taxes.
This summary does not discuss the consequences of
an investment in our preferred stock, subscription rights or debt securities. The U.S. federal income tax consequences of such an investment
will be discussed in a relevant prospectus supplement.
For purposes of the following discussion, a “U.S.
Stockholder” is a stockholder that is (i) a citizen or individual resident of the United States, (ii) a corporation (or
other entity taxable as a corporation) created or organized under the laws of the United States or any state thereof or the District
of Columbia, (iii) an estate, the income of which is subject to U.S. federal income taxation regardless of its source or (iv) a
trust if (a) a U.S. court can exercise primary supervision over the trust’s administration and one or more U.S. persons are
authorized to control all substantial decisions of the trust or (b) it has a valid election in effect under applicable Treasury
regulations to be treated as a U.S. person. A “Non-U.S. Stockholder” is a person that is neither a U.S. Stockholder nor an
entity treated as a partnership for U.S. federal income tax purposes.
THE U.S. FEDERAL INCOME TAX TREATMENT OF OUR STOCKHOLDERS
DEPENDS IN SOME INSTANCES ON DETERMINATIONS OF FACT AND INTERPRETATIONS OF COMPLEX PROVISIONS OF U.S. FEDERAL INCOME TAX LAW. IN ADDITION,
THE TAX CONSEQUENCES OF HOLDING OUR COMMON STOCK TO ANY PARTICULAR STOCKHOLDER WILL DEPEND ON THE STOCKHOLDER’S PARTICULAR TAX
CIRCUMSTANCES. YOU ARE URGED TO CONSULT YOUR TAX ADVISOR REGARDING THE U.S. FEDERAL, STATE, LOCAL AND FOREIGN INCOME AND OTHER TAX CONSEQUENCES
TO YOU, IN LIGHT OF YOUR PARTICULAR CIRCUMSTANCES, OF HOLDING AND DISPOSING OF OUR COMMON STOCK.
Qualification as a RIC
We have elected to be treated, and intend to comply
with the requirements to qualify annually, as a RIC under Subchapter M of the Code. In order to qualify as a RIC, we must be registered
as a management company under the Investment Company Act at all times during each taxable year and meet (i) an income test, and
(ii) a diversification/asset test. By qualifying as a RIC, we generally will not be subject to tax on that portion of our investment
company taxable income and net realized capital gain provided we meet certain distribution requirements. Failure to meet the income test
or the diversification/asset test would disqualify us from RIC tax treatment for the entire year. However, in certain situations we may
be able to take corrective action which would allow us to remain qualified as a RIC.
The Income Test. At least 90% of our
gross income in each taxable year must be derived from dividends; interest; payments with respect to securities loans; gains from the
sale or other disposition of stock, securities or foreign currencies; other income (including gains from options, futures or forward
contracts) derived with respect to our business of investing in such stock, securities or currencies; or net income from a “qualified
publicly traded partnership.”
The Diversification/Asset Test. At the
end of each quarter of our taxable year, at least 50% of the value of our assets must be invested in cash and cash items (such as receivables);
U.S. government securities; securities of other RICs; and securities of other issuers, provided that no investment in any such issuer
exceeds 5% of the value of our assets or 10% of the issuer’s outstanding voting securities. In addition, at the end of each quarter
of our taxable year, generally no more than 25% of the value of our assets may be invested in (i) the securities (other than U.S.
government securities or the securities of other RICs) of any one issuer, (ii) the securities (other than the securities of other
RICs) of any two or more issuers that we control (i.e., ownership of 20% or more of the total combined voting power of all classes of
stock entitled to vote) and that are engaged in the same or related trades or businesses or (iii) the securities of one or more
qualified publicly traded partnerships.
Taxation of a RIC
RICs generally are not subject to U.S. corporate
income tax on the part of their net ordinary income and net realized capital gains that they distribute to their stockholders, provided
that they comply with the requirements to be a RIC and meet applicable distribution requirements.
Distribution Requirements. In any fiscal
year in which we distribute at least 90% of the sum of (i) our investment company taxable income (which includes, among other items,
dividends, interest and the excess of any net short-term capital gain over net long-term capital loss and other taxable income, other
than any net capital gain (excess of net long-term capital gain over net short-term capital loss), reduced by deductible expenses) determined
without regard to the deduction for dividends paid, and (ii) our net tax-exempt interest, if any (the excess of our gross tax-exempt
interest over certain disallowed deductions), we generally will not be subject to U.S. federal income tax on our investment company taxable
income and net capital gains that we timely distribute to our stockholders; instead, our stockholders will be taxed on such distributions
as more fully described herein. To the extent that we retain any investment company taxable income or net capital gain, we will be subject
to U.S. federal income tax. We may choose to retain our net capital gains for investment and pay the associated federal corporate income
tax.
Amounts not distributed on a timely basis in accordance
with a calendar year distribution requirement are subject to a nondeductible 4% excise tax at the RIC level. To avoid the tax, we must
distribute during each calendar year an amount at least equal to the sum of (i) 98% of our taxable ordinary income (taking into
account certain deferrals and elections) for the calendar year, (ii) 98.2% of our capital gains in excess of our capital losses
(adjusted for certain ordinary losses) for the one-year period ending on the last day of our taxable year (or October 31st, if applicable)
and (iii) certain undistributed amounts from the prior year on which we paid no U.S. federal income tax. While we intend to distribute
any income and capital gain in the manner necessary to minimize imposition of the 4% excise tax, there can be no assurance that sufficient
amounts of our taxable income and capital gain will be distributed to avoid entirely the imposition of the tax. In that event, we will
be liable for the tax only on the amount by which we do not meet the foregoing distribution requirement.
A RIC is limited in its ability to deduct expenses
in excess of its “investment company taxable income” (which is, generally, ordinary income plus the excess of realized net
short-term capital gains over realized net long-term capital losses). If our expenses in a given year exceed our investment company taxable
income, we would experience a net operating loss for that year. However, a RIC is not permitted to carry forward net operating losses
to subsequent years and such net operating losses do not pass through to its stockholders. In addition, expenses can be used only to
offset investment company taxable income, not net capital gain (excess of net long-term capital gain over net short-term capital loss).
A RIC may not use any net capital losses (that is, realized capital losses in excess of realized capital gains) to offset the RIC’s
investment company taxable income, but may carry forward such losses, and use them to offset capital gains, indefinitely. Due to these
limits on the deductibility of expenses and net capital losses, we could for tax purposes have aggregate taxable income that we are required
to distribute and that is taxable to our stockholders even if such income is greater than the aggregate net income we actually earned
during those years.
Similarly, we may be required to recognize taxable
income in circumstances in which we do not receive cash. For example, if we hold debt obligations that are treated under applicable tax
rules as having original issue discount (such as debt instruments with payment-in-kind interest or, in certain cases, increasing
interest rates or that were issued with warrants), we must include in income each year a portion of the original issue discount that
accrues over the life of the obligation, regardless of whether cash representing such income is received by us in the same taxable year.
Because any original issue discount accrued will be included in our investment company taxable income for the year of accrual, we may
be required to make a distribution to our stockholders in order to satisfy the distribution requirements, even though we will not have
received any corresponding cash amount.
Purchase of Our Stock. Prior to purchasing
our stock, the impact of dividends or distributions which are expected to be or have been declared, but not paid, should be carefully
considered. Any dividend or distribution declared shortly after a purchase of our stock prior to the record date will have the effect
of reducing the per share net asset value by the per share amount of the dividend or distribution, and to the extent the distribution
consists of taxable income, the purchasing stockholder will be taxed on the taxable portion of the dividend or distribution received
even though some or all of the amount distributed is effectively a return of capital. This is called “buying a dividend.”
To avoid “buying a dividend,” check our distribution dates before you invest.
Taxation of a U.S. Stockholder
Distributions. Distributions by a RIC
generally are taxable to U.S. Stockholders as ordinary income or capital gains.
Distributions of our “investment company taxable
income” (which is, generally, our ordinary income plus net short-term capital gains in excess of net long-term capital losses)
will be taxable as ordinary income to U.S. Stockholders to the extent of our current or accumulated earnings and profits, whether paid
in cash or reinvested in additional shares of common stock. However, distributions to noncorporate stockholders attributable to dividends
received by us from U.S. and certain foreign corporations will generally be eligible for the maximum federal capital gains tax rate of
20% applicable to qualified dividend income, as long as certain other requirements are met. For these lower rates to apply, the noncorporate
stockholders must have owned our shares for at least 61 days during the 121-day period beginning 60 days before the ex-dividend date
and we must also have owned the underlying stock for this same period beginning 60 days before the ex-dividend date for the stock. The
amount of our distributions that otherwise qualify for these lower rates may be reduced as a result of our securities lending activities
or a high portfolio turnover rate and may also be reduced as a result of certain derivative transactions entered into by us.
Distributions derived from our dividend income that
would be eligible for the dividends received deduction if we were not a RIC may be eligible for the dividends received deduction for
corporate stockholders. The dividends received deduction, if available, is reduced to the extent the shares with respect to which the
dividends are received are treated as debt-financed under federal income tax law and is eliminated if the shares are deemed to have been
held for less than a minimum period, generally 46 days. The dividends received deduction also may be reduced as a result of our securities
lending activities or a high portfolio turnover rate or as a result of certain derivative transactions entered into by us.
Distributions of our net capital gains (which is
generally our net long-term capital gains in excess of net short-term capital losses) properly designated by us as “capital gain
dividends” will be taxable to a non-corporate U.S. Stockholder as long-term capital gains which are generally subject to the federal
capital gains tax rate, to the extent of our current or accumulated earnings and profits, regardless of the U.S. Stockholder’s
holding period for his, her or its stock and regardless of whether paid in cash or reinvested in additional stock. Distributions in excess
of our earnings and profits first will be treated as a return of capital. A return of capital is not taxable but will reduce a U.S. Stockholder’s
adjusted tax basis in our stock and, after the adjusted basis is reduced to zero, the amount of the distribution in excess of our earnings
and profits and the U.S. Stockholder’s adjusted tax basis will constitute capital gains to such U.S. Stockholder. Such capital
gain will be long-term capital gain and thus will be generally taxed at the federal capital gains tax rate, if the distributions are
attributable to stock held for more than one year by a non-corporate U.S. Stockholder.
If we designate any of our retained capital gains
as a deemed distribution, we will pay tax on the retained amount, and each U.S. Stockholder will be required to include the U.S. Stockholder’s
share of the deemed distribution in income as if it had been actually distributed to the U.S. Stockholder. The U.S. Stockholder may be
entitled to claim a credit equal to the U.S. Stockholder’s allocable share of the tax paid thereon by us. The amount of the deemed
distribution net of such tax will be added to the U.S. Stockholder’s tax basis for his, her or its common stock. Because we expect
to pay tax on any retained capital gains at the regular corporate tax rate, and because that rate generally is less than the maximum
rate currently payable by non-corporate U.S. Stockholders on long-term capital gains, the amount of tax that non-corporate U.S. Stockholders
will be treated as having paid and for which they will receive a credit may not exceed the tax they owe on the retained net capital gain.
A stockholder that is not subject to U.S. federal income tax or otherwise required to file a federal income tax return would be required
to file a federal income tax return on the appropriate form in order to claim a refund for the taxes we paid. In order to utilize the
deemed distribution approach, we must provide written notice to our stockholders prior to the expiration of 60 days after the close of
the relevant taxable year.
For purposes of determining (i) whether the
distribution requirements are satisfied for any year and (ii) the amount of capital gain dividends paid for that year, we may, under
certain circumstances, elect to treat a dividend that is paid during the following taxable year as if it had been paid during the taxable
year in question. If we make such an election, the U.S. Stockholder will still be treated as receiving the dividend in the taxable year
in which the distribution is made. However, any dividend declared by us in October, November or December of any calendar year,
payable to stockholders of record on a specified date in such a month and actually paid during January of the following year, will
be treated as if it had been received by our U.S. Stockholders on December 31 of the year in which the dividend was declared.
Sale of Stock. Upon the sale, exchange
or other taxable disposition of our common stock, a U.S. Stockholder generally will recognize capital gain or loss equal to the difference
between the amount realized on the sale, exchange or other taxable disposition and the U.S. Stockholder’s adjusted tax basis in
our stock. Any such capital gain or loss will generally be a long-term capital gain or loss if the U.S. Stockholder has held the stock
for more than one year at the time of disposition and such shares of common stock are held as capital assets. Otherwise, the gain or
loss would be classified as short-term capital gain or loss except as otherwise noted herein. However, any capital loss arising from
the sale or disposition of shares of our common stock held for six months or less (determined by applying the holding period rules contained
in Code Section 852(b)(4)(C)) will be treated as long-term capital loss to the extent of the amount of capital gain dividends received,
or undistributed capital gain deemed received, with respect to such stock. In addition, all or a portion of any capital loss arising
from the sale or disposition of shares of our common stock may be disallowed to the extent the U.S. Stockholder acquires other shares
of our common stock (through reinvestment of dividends or otherwise) within 30 days before or after the sale or disposition. In such
case, any disallowed loss is generally added to the U.S. Stockholder’s adjusted tax basis of the acquired stock.
Long-term capital gains of non-corporate U.S. Stockholders
are generally subject to the U.S. federal capital gains rate. Capital losses generally are deductible only against capital gains except
that individuals may deduct up to $3,000 of capital losses against ordinary income.
Dividend Reinvestment Plan. Under the
dividend reinvestment plan, if a U.S. Stockholder’s common stock is registered directly with us or with a brokerage firm that participates
in our Plan, the U.S. Stockholder will have all cash distributions automatically reinvested in additional shares of common stock unless
the U.S. Stockholder opts out of the dividend reinvestment plan. See “Dividend Reinvestment Plan.” Any distributions reinvested
under the Plan will nevertheless remain taxable to the U.S. Stockholder. To the extent that a U.S. Stockholder receives distributions
in the form of additional shares of our common stock purchased in the market, the U.S. Stockholder should be treated for U.S. federal
income tax purposes as receiving a distribution in an amount equal to the amount of money that the stockholders receiving cash distributions
will receive, and should have a cost basis in the shares received equal to such amount. To the extent that a U.S. stockholder receives
a distribution in newly issued shares of our common stock, the U.S. stockholder should be treated as receiving a distribution equal to
the fair market value of the shares received on the date of the distribution, and should have a cost basis in the shares received equal
to such amount. The additional shares of common stock will have a new holding period commencing on the day following the day on which
the stock is credited to the U.S. Stockholder’s account.
Tax on Net Investment Income. Non-corporate
U.S. Stockholders whose income exceeds certain thresholds are subject to an additional 3.8% Medicare contribution tax on “net investment
income,” subject to certain limitations and exceptions. For this purpose, net investment income generally includes dividends, interest
and long-term capital gains from the sale or other disposition of stock, such as our common stock. U.S. Stockholders should consult
their tax advisors regarding the effect, if any, of this tax on their ownership and disposition of our stock.
Taxation of a Non-U.S. Stockholder
Distributions. Distributions by us will
be treated as dividends for U.S. federal income tax purposes to the extent paid from our current or accumulated earnings and profits
(as determined under U.S. federal income tax principles). Dividends paid to a Non-U.S. Stockholder generally will be subject to U.S.
withholding tax at a 30% rate or a reduced rate specified by an applicable income tax treaty. If a Non-U.S. Stockholder is eligible for
a reduced rate of withholding tax under an applicable tax treaty, the Non-U.S. Stockholder will be required to provide an applicable
IRS Form W-8 certifying its entitlement to benefits under the treaty in order to obtain a reduced rate of withholding tax. However,
if the distributions are effectively connected with a U.S. trade or business of the Non-U.S. Stockholder (or, if an income tax treaty
applies, attributable to a permanent establishment in the United States of the Non-U.S. Stockholder), then the distributions will be
subject to U.S. federal income tax at the rates applicable to U.S. persons, plus, in certain cases where the Non-U.S. Stockholder is
a corporation, a branch profits tax at a 30% rate (or lower rate provided in an applicable treaty). If the Non-U.S. Stockholder is subject
to such U.S. income tax on a distribution, then we are not required to withhold U.S. federal tax if the Non-U.S. Stockholder complies
with applicable certification and disclosure requirements. Special certification requirements apply to a Non-U.S. Stockholder
that is a foreign partnership or a foreign trust, and such entities are urged to consult their own tax advisors.
Code section 871(k) provides certain “look-through”
treatment to Non-U.S. Stockholders, permitting interest-related dividends and short-term capital gains not to be subject to U.S. withholding
tax.
If the amount of a distribution exceeds our current
and accumulated earnings and profits, such excess will be treated for U.S. federal income tax purposes as a tax-free return of capital
to the extent of the Non-U.S. Stockholder’s tax basis in our common stock. To the extent that any distribution received by a Non-U.S.
Stockholder exceeds the Non-U.S. Stockholder’s tax basis in our common stock and our current and accumulated earnings and profits,
the excess will be treated as gain from the sale of the common stock and will be taxed as described in “Sales of Stock” below.
Sales of Stock. A Non-U.S. Stockholder
generally will not be subject to U.S. federal income tax on gain realized on the sale, exchange or other non-redemption disposition of
our common stock, unless (i) the gain is effectively connected with a trade or business of the Non-U.S. Stockholder in the United
States (or, if the Non-U.S. Stockholder is eligible for the benefits of a U.S. tax treaty, the gain is attributable to a permanent establishment
in the United States of the Non-U.S. Stockholder); (ii) the Non-U.S. Stockholder is an individual who is present in the United States
for 183 days or more in the taxable year of disposition and who has a “tax home” in the United States; or (iii) we are
or have been a U.S. real property holding corporation at any time within the five-year period preceding the date of disposition of our
common stock or, if shorter, within the period during which the Non-U.S. Stockholder has held our common stock. Generally, a corporation
is a U.S. real property holding corporation if the fair market value of its U.S. real property interests, as defined in the Code and
applicable Treasury regulations, equals or exceeds 50% of the aggregate fair market value of its worldwide real property interests and
its other assets used or held for use in a trade or business. We do not expect to be treated as a U.S. real property holding corporation.
Dividend Reinvestment Plan. Under the
dividend reinvestment plan, if a Non-U.S. Stockholder’s common stock is registered directly with us or with a brokerage firm that
participates in our Plan, the Non-U.S. Stockholder will have all cash distributions automatically reinvested in additional shares unless
the Non-U.S. Stockholder opts out of the Plan. If the distribution is a distribution of our investment company taxable income, is not
designated by us as a short-term capital gain dividend or interest-related dividend (if applicable and to the extent that the temporary
“look-through” rule described above is extended), and is not effectively connected with a U.S. trade or business of
the Non-U.S. Stockholder (or, if required by an applicable income tax treaty, is not attributable to a U.S. permanent establishment of
the Non-U.S. Stockholder), the amount distributed (to the extent of our current or accumulated earnings and profits) will be subject
to withholding of federal income tax at a 30% rate (or lower rate provided by an applicable income tax treaty) and only the net after-tax
amount will be reinvested in our shares. If the distribution is effectively connected with a U.S. trade or business of the Non-U.S. Stockholder
(and, if required by an applicable income tax treaty, is attributable to a U.S. permanent establishment of the Non-U.S. Stockholder),
the full amount of the distribution generally will be reinvested in our common stock and will nevertheless be subject to federal income
tax at the ordinary income rates applicable to U.S. persons. The Non-U.S. Stockholder will have an adjusted tax basis in the additional
shares of our common stock purchased through the plan equal to the amount of the reinvested distribution. The additional shares of our
common stock will have a new holding period commencing on the day following the day on which the shares of our common stock are credited
to the Non-U.S. Stockholder’s account.
FATCA
Pursuant to the Foreign Account Tax Compliance Act
(“FATCA”), a 30% withholding tax generally is imposed on payments of interest and dividends to (i) foreign financial institutions
including non-U.S. investment funds and (ii) certain other foreign entities, unless the foreign financial institution or foreign entity
provides the withholding agent with documentation sufficient to show that it is compliant with FATCA (generally by providing the Company
with a properly completed IRS Form W-8BEN or IRS Form W-8BEN-E, as applicable). If the payment is subject to the 30% withholding tax
under FATCA, a non-U.S. shareholder will not be subject to the 30% withholding tax described above on the same income. Under proposed
regulations, FATCA withholding on the gross proceeds of share redemptions and certain capital gain distributions, scheduled to take effect
beginning January 1, 2019, has been eliminated. Such proposed regulations are subject to change. Shareholders are urged and advised to
consult their own tax advisors regarding the application of the FATCA reporting and withholding regime to their own tax situation.
Because of the fact-specific impact of the applicable
U.S. tax rules and their interaction with tax treaties, Non-U.S. Stockholders are urged to consult their own tax advisor regarding
the U.S. federal tax consequences of the holding, sale, exchange or other disposition of our common stock.
Backup Withholding
We are required in certain circumstances to backup
withhold on certain payments paid to non-corporate stockholders of our common stock who do not furnish us with their correct taxpayer
identification number (in the case of individuals, their social security number) and certain certifications, or who are otherwise subject
to backup withholding. Backup withholding is not an additional tax. Any amounts withheld from payments made to you may be refunded or
credited against your U.S. federal income tax liability, if any, provided that the required information is furnished to the IRS.
Foreign Bank and Financial Accounts and Foreign Financial Asset Reporting
Requirement
A U.S. Stockholder that owns directly or indirectly
more than 50% by vote or value of our common stock is urged and advised to consult its own tax advisor regarding its filing obligations
with respect to IRS Form FinCEN 114, Report of Foreign Bank and Financial Accounts. Also, under certain rules, subject to exceptions,
individuals (and, to the extent provided in forthcoming future Treasury regulations, certain domestic entities) must report annually
their interests in “specified foreign financial assets” on their U.S. federal income tax returns. It is currently unclear
whether and under what circumstances stockholders would be required to report their indirect interests in our “specified foreign
financial assets” (if any) under these new rules.
U.S. Stockholders may be subject to substantial penalties
for failure to comply with these reporting requirements. U.S. Stockholders are urged and advised to consult their own tax advisors
to determine whether these reporting requirements are applicable to them.
Tax Shelter Reporting Regulations
Under Treasury regulations, if a U.S. Stockholder
recognizes a loss of $2 million or more for an individual U.S. Stockholder or $10 million or more for a corporate U.S. Stockholder, the
U.S. Stockholder must file with the IRS a disclosure statement on IRS Form 8886. The fact that a loss is reportable under these
regulations does not affect the legal determination of whether the taxpayer’s treatment of the loss is proper. U.S. Stockholders
are urged and advised to consult their own tax advisors to determine the applicability of these regulations in light of their individual
circumstances.
Failure to Qualify or Maintain Status as a RIC
If, in any taxable year, we fail to qualify as a
RIC, we would be taxed in the same manner as a regular, or “C,” corporation and our stockholders would be taxed as stockholders
in such a regular, or “C,” corporation. As a “C” corporation, we would be subject to U.S. federal income tax
on our taxable income at the graduated rates applicable to corporations, currently at a flat rate of 21%, and our shareholders will be
taxed on any distributions as described above.
THE PRECEDING DISCUSSION IS MERELY A SUMMARY OF
CERTAIN MATERIAL U.S. FEDERAL INCOME TAX CONSIDERATIONS OF AN INVESTMENT IN OUR COMMON STOCK AND DOES NOT PURPORT TO BE COMPLETE IN ANY
RESPECT. THIS SUMMARY IS PROVIDED FOR GENERAL INFORMATION ONLY AND SHOULD NOT BE CONSIDERED TAX ADVICE OR RELIED ON BY AN INVESTOR. ANY
PROSPECTIVE INVESTOR CONSIDERING AN INVESTMENT IN OUR COMMON STOCK IS STRONGLY URGED TO CONSULT ITS OWN TAX ADVISORS REGARDING THE CONSEQUENCES
OF SUCH AN INVESTMENT IN LIGHT OF SUCH INVESTOR'S PARTICULAR CIRCUMSTANCES.
CERTAIN
ERISA CONSIDERATIONS
The following is a general summary of certain
considerations applicable to an investment in us by an employee benefit plan subject to ERISA (as defined below) or Section 4975
of the Code.
The Employee Retirement Income Security Act of 1974,
as amended (“ERISA”), and the Code, impose certain requirements on “employee benefit plans” (as defined in Section 3(3) of
ERISA) subject to Title I of ERISA, or Section 4915 of the Code, including 401(k) plans, Keogh Plans of self-employed individuals and
individual retirement accounts (“IRAs”) and including entities whose underlying assets include the assets of such plans (each,
a “Benefit Plan” and collectively, “Benefit Plans”), and on those persons who are fiduciaries with respect to
Benefit Plans. Section 406 of ERISA and Section 4975 of the Code prohibit certain transactions that involve the assets of Benefit
Plans and certain persons (referred to as “parties in interest” or “disqualified persons”) having certain relationships
to such Benefit Plans, except to the extent that a statutory or administrative exemption applies. A party in interest or disqualified
person who engages in a non-exempt prohibited transaction may be subject to excise taxes and other penalties and liabilities under ERISA
and Section 4975 of the Code.
ERISA, as well as a regulation promulgated by the
U.S. Department of Labor, as modified by Section 3(42) of ERISA (the “DOL Plan Asset Regulation”), generally provides
as relevant here that, when a Benefit Plan acquires an equity interest in an entity that is issued by an investment company registered
under the Investment Company Act, the Benefit Plan’s assets include the equity interest, but not, solely by reason of such investment,
any of the underlying assets of the entity.
Even if our assets are not “plan assets”
for purposes of the fiduciary responsibility and prohibited transaction rules under ERISA or Section 4975 of the Code, a prohibited
transaction could arise in connection with a Benefit Plan’s acquisition of our common stock. Consequently, the fiduciary of a Benefit
Plan contemplating an investment in our common stock in the offering should consider, for example, whether we, any other person associated
with the issuance of our common stock or any of their affiliates, is or might become a “party in interest” or “disqualified
person” with respect to the Benefit Plan, and, if so, whether an exemption from such prohibited transaction rules is needed
and is applicable.
Each purchaser of our common stock in the offering
will be deemed to have represented, warranted and agreed that its purchase and holding of our common stock do not and will not constitute
or result in a non-exempt prohibited transaction under Section 406 of ERISA or Section 4975 of the Code.
THE PRECEDING DISCUSSION IS MERELY A SUMMARY OF
CERTAIN ERISA AND CODE IMPLICATIONS OF AN INVESTMENT IN OUR COMMON STOCK AND DOES NOT PURPORT TO BE COMPLETE IN ANY RESPECT AND MAY BE
AFFECTED BY FUTURE PUBLICATION OF REGULATIONS AND RULINGS. ANY PROSPECTIVE INVESTOR CONSIDERING AN INVESTMENT IN OUR COMMON STOCK IS
STRONGLY URGED TO CONSULT ITS OWN LEGAL, TAX AND OTHER ADVISORS REGARDING THE CONSEQUENCES OF SUCH AN INVESTMENT UNDER ERISA AND SECTION 4972
OF THE CODE IN LIGHT OF SUCH INVESTOR’S PARTICULAR CIRCUMSTANCES.
CLOSED-END
FUND STRUCTURE
We are registered as a non-diversified, closed-end
management investment company under the Investment Company Act, commonly referred to as a “closed-end investment company.”
Closed-end management investment companies differ from open-end management investment companies (commonly referred to as “mutual
funds”) in that closed-end investment companies generally list their shares for trading on a stock exchange and do not redeem their
stock at the request of the stockholder. This means that if a stockholder wishes to sell shares of a closed-end management investment
company, he or she must trade them on the market like any other stock at the prevailing market price at that time. In a mutual fund,
if the stockholder wishes to sell shares of the company, the mutual fund will redeem, or buy back, the shares at NAV. Mutual funds also
generally offer new shares on a continuous basis to new investors, and closed-end management investment companies generally do not. The
continuous inflows and outflows of assets in a mutual fund can make it difficult to manage investments. By comparison, closed-end management
investment companies are generally able to stay more fully invested in securities that are consistent with their investment objectives
and also have greater flexibility to make certain types of investments and to use certain investment strategies, such as financial leverage
and investments in illiquid securities.
When shares of closed-end management investment companies
are traded, they frequently trade at a discount to their NAV.
See “Risk Factors—Risks Related to Offerings.”
This characteristic of shares of closed-end management investment companies is a risk separate and distinct from the risk that the closed-end
management investment company’s NAV may decrease as a result of investment activities. Our conversion to an open-end mutual fund
would require an amendment to our Charter. Our shares of common stock are listed on the NASDAQ Global Select Market under the symbol
“BANX.”
INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM
We have selected Tait, Weller & Baker LLP as
our independent registered public accounting firm. Their principal business address is 50 South 16th Street, Suite 2900,
Philadelphia, PA 19102.
ADMINISTRATOR,
CUSTODIAN, TRANSFER AND DIVIDEND PAYING AGENT AND REGISTRAR
BNY Mellon Investment Servicing (US) Inc., 4400 Computer
Drive, Westborough, Massachusetts 01581, serves as our administrator.
The Bank of New York Mellon, located at 2 Hanson
Place, Brooklyn, New York 11217, serves as our custodian.
Computershare Trust Company, N.A., 250 Royall Street,
Canton, Massachusetts 02021, is the transfer agent and registrar for our common stock and serves as our dividend paying agent.
LEGAL
MATTERS
Certain legal matters in connection with any future
offering will be passed upon for us by Troutman Pepper Hamilton Sanders LLP, Philadelphia, Pennsylvania.
INCORPORATION
BY REFERENCE
This prospectus is part
of a registration statement that we have filed with the SEC. We are allowed to “incorporate by reference” the information
that we file with the SEC, which means that we can disclose important information to you by referring you to those documents. The information
incorporated by reference is considered to comprise a part of this prospectus from the date we file that document. Any reports filed
by us with the SEC before the date that any offering of any Securities by means of this prospectus and any applicable prospectus supplement
is terminated will automatically update and, where applicable, supersede any information contained in this prospectus or incorporated
by reference in this prospectus.
We incorporate by reference
into this prospectus our filings listed below and any future filings that we may file with the SEC under Section 13(a), 13(c), 14 or
15(d) of the Securities Exchange Act of 1934, until all of the Securities offered by this
prospectus and any applicable prospectus supplement have been sold or we otherwise terminate the offering of these securities; provided,
however, that information “furnished” under Item 2.02 or Item 7.01 of Form 8-K or other information “furnished”
to the SEC which is not deemed filed is not incorporated by reference in this prospectus and any applicable prospectus supplement. Information
that we file with the SEC will automatically update and may supersede information in this prospectus, any applicable prospectus supplement
and information previously filed with the SEC.
This prospectus
and any applicable prospectus supplement incorporate by reference the documents set forth below that have previously been filed with
the SEC:
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·
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Our
current reports on Form 8-K, filed with the SEC on December 9, 2019, February 13, 2020, February 14, 2020, February 27, 2020, May 7, 2020, August 6, 2020, November 12, 2020, March 1, 2021
and May 13, 2021.
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To obtain a copy of these
filings, see “Available Information,” or you may request a copy of these filings (other than exhibits, unless the exhibits
are specifically incorporated by reference into these documents) at no cost by writing or calling the following address and telephone
number:
StoneCastle-ArrowMark Asset
Management, LLC
100 Fillmore Street, Suite 325
Denver, Colorado 80206
(212)-468-5441
You should rely only on
the information incorporated by reference or provided in this prospectus or any prospectus supplement. We have not authorized anyone
to provide you with different or additional information, and you should not rely on such information if you receive it. We are not making
an offer of or soliciting an offer to buy, any securities in any state or other jurisdiction where such offer or sale is not permitted.
You should not assume that the information in this prospectus or in the documents incorporated by reference is accurate as of any date
other than the date on the front of this prospectus or those documents.
The information in this statement of additional
is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities
and Exchange Commission is effective. This statement of additional information is not an offer to sell these securities and it
is not soliciting an offer to buy these securities in any state or jurisdiction where the offer or sale is not permitted.
Preliminary Statement of Additional Information
Subject to completion, dated May 26, 2021
STONECASTLE FINANCIAL CORP.
STATEMENT OF ADDITIONAL INFORMATION
In this Statement of Additional
Information (“SAI”), unless the context suggests otherwise, references to “we,” “us,” “Company,”
“our company” or “our” refer to StoneCastle Financial Corp., a Delaware corporation and its subsidiaries. We
are a non-diversified, closed-end management investment company. References to “Adviser” mean StoneCastle-ArrowMark Asset
Management, LLC (“StoneCastle-ArrowMark”), a Delaware limited liability company; references to “ArrowMark Partners”
mean ArrowMark Colorado Holdings, LLC, the parent of our Adviser; and references to “common stock” or “shares”
mean the common stock of StoneCastle Financial Corp.
This SAI, relating to
our securities, does not constitute a prospectus, but should be read in conjunction with our prospectus dated May 26, 2021. This SAI
does not include all information that a prospective investor should consider before purchasing common stock, and investors should obtain
and read our prospectus prior to purchasing common stock. You may obtain a copy of the prospectus from us without charge by calling (212)-468-5441.
You also may obtain a copy of our prospectus on the Securities and Exchange Commission’s (the “SEC”) web site (http://www.sec.gov).
Capitalized terms used but not defined in this SAI have the meanings ascribed to them in the prospectus. This SAI is dated May 26, 2021.
No person has been authorized to give any information
or to make any representations not contained in the prospectus or in this SAI in connection with the offering made by the prospectus,
and, if given or made, such information or representations must not be relied upon as having been authorized by us. The prospectus and
this SAI do not constitute an offering by us in any jurisdiction in which such offering may not lawfully be made. Capitalized terms not
defined herein have the meanings assigned to such terms in the prospectus.
TABLE OF CONTENTS
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Page
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DISCUSSION
OF MANAGEMENT’S OPERATIONS
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S-1
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INVESTMENT
RESTRICTIONS
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S-4
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MANAGEMENT
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S-5
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CERTAIN
RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
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S-12
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PORTFOLIO
MANAGERS
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S-14
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PORTFOLIO
TRANSACTIONS AND BROKERAGE
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S-15
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SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
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S-16
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PROXY
VOTING POLICIES
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S-16
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FINANCIAL
STATEMENTS
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S-17
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INCORPORATION
BY REFERENCE
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S-17
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ADDITIONAL
INFORMATION
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S-17
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DISCUSSION OF MANAGEMENT’S
OPERATIONS
Overview
StoneCastle Financial Corp. was organized on February 7,
2013 as a Delaware corporation, established to make investments in support of the ongoing capital needs of bank and banking-related institutions.
The Company invests in banks and financial institutions including community banks, larger regional, national and money center banks domiciled
in the United States and foreign and global money center banks.
Our primary investment objective is to provide
stockholders with current income and, to a lesser extent, capital appreciation.
We are focused on income generation, capital preservation,
and providing risk-adjusted rates of return. We attempt to achieve our investment objective through investment in preferred equity, debt
and subordinated debt, structured notes and securities, convertible securities, regulatory capital securities and common equity issued
or structured by banks and financial institutions including community banks, larger regional, national and money center banks domiciled
in the United States and foreign and global money center banks. (“banking-related securities”). We make investments that
will generally be expected to pay us dividends and interest on a current basis and generate capital gains over time. We may seek to enhance
our returns through the use of warrants, options and other equity conversion features. We have a policy to invest, under normal circumstances,
at least 80% of the value of our net assets plus the amount of any borrowings for investment purposes in such banking-related securities.
We make investments that will generally be expected
to pay us dividends and interest on a current basis and generate capital gains over time. We may seek to enhance our returns through
the use of warrants, options and other equity conversion features. We have elected to be treated, and intend to comply with the requirements
to qualify annually, as a RIC under Subchapter M of the Code. We do not expect to be regulated as a bank holding company or a savings
and loan holding company by the Federal Reserve.
Revenues
We intend to generate revenue in the form of dividends
on dividend-paying equity securities as well as interest payable on the debt investments that we hold. In addition, we intend to generate
revenue in the form of capital gains through equity securities, warrants, options and other equity interests. We expect to invest the
majority of our assets in preferred equity, subordinated debt, regulatory capital securities, convertible securities and common equity
that pay cash dividends and interest on a recurring or customized basis. We may invest in unsecured debt issued by community banks, and
we currently expect these investments to have maturities in excess of ten years to enable our borrowers to obtain favorable regulatory
capital treatment. We currently intend to structure our investments to provide for quarterly dividend and interest payments. To meet
certain regulatory requirements of the banks in which we invest, we may structure investments to provide that dividends may be deferrable
on a cumulative or non-cumulative basis. Because only TARP Preferred and certain securities issued by small bank holding companies, defined
as holding companies with less than $500 million in consolidated assets, may be cumulative and qualify as Tier 1 capital, we expect that
the majority of the new issue preferred stock in which we invest will be non-cumulative. However, investors should be aware that up to
100% of our portfolio may consist of non-cumulative preferred equity securities or may consist of a substantial amount of cumulative
preferred equity securities, or any combination in between these scenarios. Based upon management’s prior experience, we may receive
up-front fee revenue from bank issuers in connection with newly originated securities. Such fees may range from 0% to 3% of the amount
we invest and will be paid in cash or in kind. We also may receive fee income from underlying banks in connection with our investments.
See “—Fee Income.”
Expenses
Our primary operating expenses will include the payment
of management fees and operating expenses, including a portion of any overhead expenses of the Adviser and its affiliates that are allocable
to us by our Adviser upon its reasonable determination that such expenses provided a benefit to us Our management fees compensate our
Adviser for its investment advisory and management services. The management fees are limited to a fixed percentage of our assets. Pursuant
to the management agreement, our Adviser also furnishes, or arranges for the furnishing of us with office facilities and clerical, administrative
services necessary for our operation (other than services provided by our custodian, accounting agent, administrator, dividend and interest
paying agent, transfer agent and other service providers). We bear all expenses not specifically assumed by our Adviser and incurred
in our operations, and we bear the expenses related to any future offering. We expect to reimburse our Adviser to the extent these expenses
are paid by our Adviser. See “Management—Management Agreement—Payment of Our Expenses.” We may also pay a portion
of the fee income that we receive from community banks in connection with our investments in them to one or more unaffiliated brokers
for introducing us to such opportunities. Our Adviser is not paid an incentive fee and does not participate in our profits in its capacity
as Adviser. See “Management—Management Agreement.”
Certain affiliates of our Adviser, however, may participate
in our profits to the extent of their ownership of common stock. See “Certain Relationships and Related Party Transactions.”
We may, but are not required to, enter into interest
rate hedging agreements to hedge interest rate risk associated with any indebtedness we may incur. Such hedging activities, subject to
compliance with our exemption from registration under the Commodity Exchange Act of 1936, as amended (the “CEA”), may include
the use of interest rate transactions such as swaps, caps, floors, repurchase agreements and reverse repurchase agreements. We will bear
any costs incurred in entering into and settling such contracts. There is no assurance that any hedging strategy we may employ will be
successful. See “Risk Factors—Risks Related to Our Operations.”
Financial Condition, Liquidity and Capital Resources
We generate cash primarily from: (i) the net
proceeds of offering our common stock and (ii) cash flows from operations, including interest earned from the temporary investment
of cash. We also fund a portion of our investments through borrowings from banks or other lenders. In the future, we may also fund a
portion of our investments by creating a wholly-owned subsidiary to facilitate secured borrowing structures. We believe that the use
of special purpose entities to hold our assets will permit us to potentially obtain less expensive leverage than we might otherwise be
able to obtain because it will facilitate our ability to obtain favorable ratings, which in turn may reduce the cost of leverage. However,
the lenders to these special purpose entities typically impose substantial restrictions on the assets contained in such special purpose
entities such as restrictions on our ability to encumber them. There can be no assurances that a wholly-owned subsidiary will be able
to obtain more favorable borrowing terms. We do not expect to incur such indebtedness through special purpose entities until we have
substantially invested the proceeds of any future offering in securities that meet our investment objective. Our primary use of funds
has been and will continue to be to make investments in companies, pay expenses and pay cash dividends to our stockholders.
Distribution Policy
We intend to pay quarterly distributions to our stockholders
in an amount, and on a timely basis, sufficient to obtain and maintain our status as a RIC. Investment company taxable income includes,
among other items, dividends, interest and the excess of any net short-term capital gains over net long-term capital losses, reduced
by deductible expenses.
We have elected to be treated and intend to comply
with the requirements to qualify annually as an RIC. For federal income tax purposes, as a RIC we are required to distribute substantially
all of our net investment income each year both to avoid federal income tax on our distributed income and to avoid a potential excise
tax. If our ability to make distributions on our common stock is limited, such limitations could, under certain circumstances, impair
our ability to maintain a qualification for taxation as a RIC, which would have adverse consequences for our stockholders. See “Material
U.S. Federal Income Tax Considerations.”
Contractual Obligations
We have entered into a management agreement with
our Adviser pursuant to which our Adviser has agreed to: (i) serve as our investment adviser in exchange for the consideration set
forth therein; and (ii) furnish us with the facilities and administrative services necessary to conduct our day-to-day operations
and to provide on our behalf managerial assistance to certain of our portfolio companies. See “Management—Management Agreement.”
Payments under the management agreement consist of
a management fee based on a percentage of the value of our Managed Assets, as well as reimbursement of expenses of the Adviser. The compensation
and allocable routine overhead expenses of all investment professionals of our Adviser and its staff, when and to the extent engaged
in providing us investment advisory services, are provided and paid for by our Adviser or one of its affiliates and not us, although
we may reimburse our Adviser an amount equal to our allocable portion of overhead and other expenses incurred by our Adviser in performing
its obligations under the management agreement. See “Management—Management Agreement—Management Fee” and “Management—Management
Agreement—Payment of our Expenses.”
The management agreement with our Adviser was initially
approved by our board of directors on December 5, 2020. A discussion regarding the basis for the board’s approval of the management
agreement is provided in the Company’s Annual Report to stockholders for the fiscal year ended December 31, 2019. The management
agreement, which was also approved by our stockholders on February 7, 2020, continues in effect for a period of two years from that date
and thereafter must be approved annually by our board of directors. The management agreement with our Adviser may be terminated at any
time, without payment or penalty, by vote of our board of directors, by vote of a majority of our voting securities, or by our Adviser,
in each case on not less than 60 days’ written notice. As required by the Investment Company Act, the management agreement with
our Adviser will terminate automatically in the event of its assignment. See “Management” and “Portfolio Management.”
We have a perpetual, non-exclusive license to the
“StoneCastle” trademark on a non-exclusive, royalty-free basis. We have the right to use the “StoneCastle” name
so long as our Adviser or one of its approved affiliates remains our investment adviser.
Critical Accounting Policies
The preparation of our financial statements in conformity
with accounting principles generally accepted in the United States (or “US GAAP”) requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of
the financial statements and revenues and expenses during the period reported. Actual results could differ from those estimates.
Valuation of Portfolio Investments
The preparation of our financial statements requires
us to estimate the value of our investments and the related amounts of unrealized appreciation and depreciation of investments recorded.
We invest primarily in illiquid securities, including debt and equity securities of primarily privately-held or thinly-traded public
companies, and regulatory capital securities. Our investments generally are subject to restrictions on resale and in the case of privately-held
companies, generally, will have no established trading market. We value all of our privately-held investments at fair value. We determine
fair value of our privately-held investments to be the amount for which an investment could be exchanged in an orderly disposition over
a reasonable period of time between willing parties, other than in a forced or liquidation sale. If market quotations become readily
available for an investment, we will use such market quotations to value the investment.
We have engaged regionally or nationally recognized
independent valuation firms to assist in determining the fair value of our investments that do not have readily available market prices
or quotations. In the event an investment does not have a readily determinable price, our board of directors reviews valuations from
one or more regionally or nationally recognized independent valuation firms along with a valuation provided by our Adviser. Our board
of directors regularly reviews and evaluates our valuation methodology and any such valuation service it uses and the historical accuracy
of such valuation methodologies. Our board of directors reviews all valuation recommendations (including those provided by our Adviser)
and assigns the valuation it determines to best represent the fair value for such investment. The methods for valuing these investments
may include fundamental analysis, market prices of similar securities, purchase price of securities, subsequent private transactions
in the security or related securities, discounted cash flow analysis, multiple analysis, or discounts applied to the nature and duration
of restrictions on the disposition of the securities, as well as a combination of these and other factors. Because such valuations, and
particularly valuations of privately-held securities and private companies, are inherently uncertain, may fluctuate over short periods
of time, and may be based on estimates, our determinations of fair value have, and may in the future differ materially from the values
that would have been used if a ready market for these securities existed. Our NAV could be adversely affected if our determinations regarding
the fair value of our investments were materially higher than the values that we ultimately realize upon the disposal of such securities.
Our preferred and common equity investments as well
as our equity-related investments (including warrants and options) in portfolio companies (collectively, “Equity Investments”)
for which there is no liquid public market are valued at fair value, which are determined using a range of valuation techniques. The
determined fair values generally are discounted to account for restrictions on resale and minority ownership positions. The value of
our Equity Investments in public companies for which market quotations are readily available will be based upon the closing public market
price on the measurement date. Securities with sale restrictions will typically be valued at a discount from the public market value
of the security. Our board of directors may consider other methods of accounting to value our investments as appropriate in conformity
with US GAAP.
Dividend and Interest Income
We record dividend income on the ex-dividend date.
We record interest income, which reflects the amortization of premiums and includes accretion of discounts for financial reporting purposes,
on an accrual basis. To the extent we receive dividends that are eligible for qualified dividend income treatment (if received by a noncorporate
holder) or the dividends received deduction (if received by a corporate holder), we report such information to our stockholders so that
they can take advantage of the preferential income tax rules that would apply to the portion of our distributions that correspond
to such income.
Fee Income
Fee income includes our fees, if any, for due diligence,
structuring, commitment and facility fees, and fees, if any, for transaction services, consulting services and management services rendered
to portfolio companies and other third parties. We recognize commitment and facility fees for debt generally as income over the life
of the underlying loan, and we recognize commitment and facility fees for perpetual stock generally as income in the year the investment
is consummated. We recognize due diligence, structuring, transaction service, consulting and management service fees generally as income
when services are rendered.
INVESTMENT RESTRICTIONS
The restrictions listed below are policies of the
Company. Except as described herein, the Company may not alter these policies without the approval of the holders of a majority of its
outstanding shares. For purposes of the foregoing, “a majority of the outstanding shares” means (i) 67% or more of such
shares present at a meeting, if the holders of more than 50% of such shares are present or represented by proxy, or (ii) more than
50% of such shares, whichever is less. Unless otherwise indicated, all limitations applicable to our investments (as stated below and
elsewhere in the prospectus and this SAI) apply only at the time a transaction is entered into. Any subsequent change in the percentage
of our assets invested in certain securities or other instruments resulting from market fluctuations or other changes in our total assets,
will not require us to dispose of an investment.
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1.
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We
may borrow money, make loans or issue senior securities to the fullest extent permitted by the Investment Company Act, the rules or
regulations thereunder or applicable orders of the SEC, as such statute, rules, regulations or orders may be amended from time to
time.
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2.
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Except
with respect to the banking industry, no more than 25% of our total assets may be invested in a particular industry or group of industries.
Securities issued or guaranteed by the U.S. Government or its agencies or instrumentalities or securities issued by other investment
companies are not considered to represent an industry.
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3.
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We
may purchase or sell commodities, commodities contracts, futures contracts and related options, options, forward contracts or real
estate to the fullest extent permitted by the Investment Company Act, the rules or regulations thereunder or applicable orders
of the SEC, as such statute, rules, regulations or orders may be amended from time to time.
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4.
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We
may underwrite securities to the fullest extent permitted by the Investment Company Act, the rules or regulations thereunder
or applicable orders of the SEC, as such statute, rules, regulations or orders may be amended from time to time.
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The investment restrictions set forth above limit
our ability to engage in certain practices and purchase securities and other instruments other than as permitted by, or consistent with,
the Investment Company Act. Relevant limitations of the Investment Company Act as they presently exist are described below. These limitations
are based either on the Investment Company Act itself, the rules or regulations thereunder or applicable orders of the SEC. In addition,
interpretations and guidance provided by the SEC staff may be taken into account, where deemed appropriate by the Company, to determine
if a certain practice or the purchase of securities or other instruments is permitted by the Investment Company Act, the rules or
regulations thereunder or applicable orders of the SEC. As a result, the foregoing investment policies may be interpreted differently
over time as the statute, rules, regulations or orders (or, if applicable, interpretations) that relate to the meaning and effect of
these policies change, and no stockholder vote will be required or sought.
Investment Restriction (1). Under the Investment
Company Act, we may only borrow up to one-third of the value of our total assets. For more information on leverage and the risks relating
thereto, see “Leverage” in the prospectus.
The Investment Company Act also restricts the ability
of closed-end investment companies to lend. Under the Investment Company Act, we may only make loans if expressly permitted to do so
by our investment policies, and we may not make loans to persons who control us or are under common control with us. Thus, the Investment
Company Act effectively prohibits us from making loans to certain persons when conflicts of interest or undue influence are most likely
present. We may, however, make other loans which, if made, would expose stockholders to additional risks, such as the failure of the
other party to repay the loan. We retain the flexibility to make loans to the extent permitted by our investment policies, other than
loans of securities, which will be limited to 33 1/3% of our total assets.
The ability of a closed-end investment company to
issue senior securities is subject to various limitations under the Investment Company Act that restrict, for instance, the amount, timing,
and form of senior securities that may be issued. Certain portfolio management/leveraging techniques, such as reverse repurchase agreements,
credit default swaps, futures contracts, dollar rolls, the purchase of securities on margin, short sales, or the writing of puts on portfolio
securities, may be considered senior securities unless appropriate steps are taken to segregate our assets or otherwise cover its obligations.
To the extent we cover our commitment under these transactions, including by the segregation of liquid assets, such instrument will not
be considered a “senior security”, and therefore will not be subject to the 300% asset coverage requirement otherwise applicable
to borrowings by us (or, as the case may be, the 200% asset coverage requirement applicable to preferred stock). The Company will typically
cover its current obligations resulting from these portfolio management/leveraging techniques consistent with the guidelines established
by the Commission. Accordingly, the Company will typically segregate, earmark, set aside or otherwise offset its obligations resulting
from such techniques.
Although we have no present intention to do
so, we may also issue any class of senior security that is a stock. Under the Investment Company Act, the issuance of any other type
of senior security by a closed-end investment company is subject to a requirement that provision is made that, (i) if on the last
business day of each of 12 consecutive calendar months the asset coverage with respect to the senior security is less than 100%, the
holders of such securities voting as a class shall be entitled to elect at least a majority of our board of directors, with such voting
right to continue until the asset coverage for such class of senior security is at least 110% on the last business day of each of 3 consecutive
calendar months or, (ii) if on the last business day of each of 24 consecutive calendar months the asset coverage for such class
of senior security is less than 100%, an event of default shall be deemed to have occurred.
Under the Investment Company Act, a “senior
security” does not include any promissory note or evidence of indebtedness where such loan is for temporary purposes only and in
an amount not exceeding 5% of the value of the total assets of the issuer at the time the loan is made. A loan is presumed to be for
temporary purposes if it is repaid within sixty days and is not extended or renewed.
Investment Restriction (2). We have a policy
to invest 25% or more of our total assets in the banking industry. Accordingly, because we concentrate in a particular industry, we are
exposed to greater risks because our performance is largely dependent on the performance of the banking industry. For purposes of determining
compliance with Investment Restriction (2), we will not consider portfolio investments held by other investment companies in which we
invest.
Investment Restriction (3). This restriction
would permit investment in commodities, commodities contracts, futures contracts and related options, options, forward contracts or real
estate to the extent permitted under the Investment Company Act. Commodities, as opposed to commodity futures, represent the actual underlying
bulk goods, such as grains, metals and foodstuffs. Real estate-related instruments include real estate investment trusts, commercial
and residential mortgage-backed securities, and real estate financings, and such instruments are generally sensitive to factors such
as changes in real estate values and property taxes, interest rates, the cash flow of underlying real estate assets, overbuilding, and
the management skill and creditworthiness of the issuer. Because we have elected to be treated, and intend to comply with the requirements
to qualify annually, as a RIC under Subchapter M of the Code, our ability to invest in commodities and commodity related instruments
may be further limited. For example, gains from the disposition of commodities will not be considered qualifying income for purposes
of satisfying the income test applicable to RICs. Also, the U.S. Internal Revenue Service has issued a revenue ruling which holds that
income derived from commodity-linked swaps is not qualifying income for purposes of such test. As such, our ability to utilize investments
in commodities and commodity index-linked swaps as part of our investment strategy is limited to a maximum of 10 percent of our gross
income.
MANAGEMENT
Board of Directors
Our business and affairs are managed under
the direction of our board of directors. Accordingly, our board of directors provides broad supervision over our affairs, including supervision
of the duties performed by our Adviser. Our Adviser is responsible for our day-to-day operations. The names, ages and addresses of our
directors and officers and specified employees of our Adviser, together with their principal occupations and other affiliations during
the past five years, are set forth below. Each director and officer will hold office for the term to which he is elected and until his
successor is duly elected and qualifies, or until he resigns or is removed in the manner provided by law. Our board of directors consists
of six directors who are not “interested persons” (as defined in the Investment Company Act) of our Adviser or its affiliates
and two directors who are “interested persons.” Our directors who are not interested persons are also independent pursuant
to the NASDAQ stock exchange listing standards, and we refer to them as “independent directors.” We refer to the directors
who are “interested persons” (as defined in the Investment Company Act) are referred to as “interested directors.”
Under our certificate of incorporation, the board of directors is divided into three classes. Each class of directors will hold office
for a three-year term. However, the initial members of the three classes have initial terms of one, two and three years, respectively.
At each annual meeting of our stockholders, the successors to the class of directors whose terms expire at such meeting will be elected
to hold office for a term expiring at the annual meeting of stockholders held in the third year following the year of their election
and until their successors are duly elected and qualified.
Independent
Directors
Name(1)
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|
Age
|
|
Position(s) Held with
Company
|
|
Term
End
|
|
Principal Occupation(s)
Last 5 Years
|
|
Number
of
Portfolios in Fund
Complex Overseen
by Fund Director
|
|
Other Directorships
Last 5 Years
|
Guy
M. Arnold
|
|
53
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|
Class
III Director
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2022
|
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Manager
at GMA Holdings, LLC from 2013–2015; Chief Operating Officer and President of Real Estate at Hunt Companies, Inc. from 2015–Present
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1
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Director
of Meridian Funds from 2015 — Present; Director of MidFirst Bank, Director of The Children's Hospital of Colorado Finance Committee
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|
|
|
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|
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|
|
|
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John
Scott Emrich
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|
53
|
|
Class
III Director
|
|
2022
|
|
Director
of Meridian Funds from 2010–Present; Director of Destra Funds from 2015–Present
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1
|
|
Director
of Meridian Funds from 2010–Present; Director of Destra Funds from 2015–Present
|
|
|
|
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|
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Alan
Ginsberg
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59
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|
Class
I Director, Chairman of Audit Committee
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2023
|
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Independent
Consultant and Strategic Adviser to public and private companies from March 2021 - Present; Managing Director Barclays Bank August
2017 – February 2021
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1
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External
Advisory Board of Peabody Museum at Yale University
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|
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Emil
W. Henry, Jr.
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|
60
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|
Class
I Director, Member of Audit Committee and Lead Independent Director
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2023
|
|
CEO
and Founder of Tiger Infrastructure Partners
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1
|
|
Director
of Easterly Government Properties, Director of numerous private companies that are Tiger Infrastructure portfolio companies; Director
of Colonnade Acquisition Corp. I and II from July 2020 - Present
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|
|
|
|
|
|
|
|
|
|
|
|
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Michael
Stolper
|
|
75
|
|
Class
II Director
|
|
2021
|
|
Financial
Advisor at Stolper & Co. from 1975–2017
|
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1
|
|
Director
of Meridian Funds from 1985 — Present; Director of Windowpane Funds (one portfolio)
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|
|
|
|
|
|
|
|
|
|
|
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Michael
P. Van Praag.
|
|
62
|
|
Class
II Director
|
|
2021
|
|
Private
Investor, 2017 to Present; Senior VP, JPMorgan Chase Bank, N.A. from 1981-2017
|
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1
|
|
None
|
Interested Directors
Name(1)
|
|
Age
|
|
Position(s) Held with
Company
|
|
Term
End
|
|
Principal Occupation(s)
Last 5 Years
|
|
Number
of
Portfolios in Fund
Complex Overseen
by Fund Director
|
|
Other Directorships
Last 5 Years
|
Sanjai
Bhonsle
|
|
50
|
|
Chairman,
Class III Director
|
|
2022
|
|
Chief
Executive Officer of StoneCastle Financial Corp. from February 2020 to present. Partner and Portfolio Manager at ArrowMark
Partners from 2012–Present
|
|
1
|
|
Brown
RI Management, LLC and Affiliates from 2018–Present
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Karen
L. Reidy
|
|
53
|
|
Class
I Director
|
|
2023
|
|
Partner
and Portfolio Manager at ArrowMark Partners from 2012–Present
|
|
1
|
|
Brown
RI Management, LLC and Affiliates from 2018–Present
|
(1) The business address of each Director is
c/o StoneCastle Financial Corp.,100 Fillmore Street, Suite 325, Denver, CO 80206
Responsibilities of the Board of Directors
Our board of directors is responsible under
applicable state law for overseeing generally our management and operations. Our board of directors oversees our operations by, among
other things, meeting at its regularly scheduled meetings and as otherwise needed with our management and evaluating the performance
of our service providers including our Adviser, our custodian and our transfer agent. As part of this process, our directors consult
with our independent auditors and may consult with their own separate independent counsel.
Our directors review our financial statements,
performance, net asset value and market price and the relationship between them, as well as the quality of the services being provided
to us. As part of this process, our directors review our fees and expenses in light of the nature, quality and scope of the services
being received while also seeking to ensure that we continue to have access to high quality services in the future.
Our board of directors has four regularly scheduled
meetings each year, and additional meetings may be scheduled as needed. In addition, our board of directors has a standing Audit Committee
and a standing Nominating and Governance Committee that each meet periodically and whose responsibilities are described below.
For the fiscal year ended December 31,
2020, each director attended at least 75% of the aggregate number of meetings of the board of directors and the committees for which
he or she was eligible. We do not have a formal policy regarding attendance by directors at annual meetings of stockholders.
The Audit Committee and the Nominating and
Governance Committee are each composed of all directors who have been determined not to be “interested persons” of us, our
Adviser or their affiliates within the meaning of the Investment Company Act, and who are “independent” as defined in the
NASDAQ stock exchange listing standards, and is chaired by an independent director. The board of directors in its discretion from time
to time may establish ad hoc committees.
The appointment of Mr. Bhonsle as Chairman
reflects the board of director’s belief that his experience, familiarity with the our day-to-day operations and access to individuals
with responsibility for our management and operations provides the board of directors with insight into our business and activities and,
with his access to appropriate administrative support, facilitates the efficient development of meeting agendas that address our business,
legal and other needs and the orderly conduct of board meetings. Emil Henry serves as lead independent director. The Chairman develops
agendas for board meetings in consultation with the lead independent director and presides at all meetings of the board of directors.
The lead independent director, among other things, chairs executive sessions of the independent directors, serves as a spokesperson for
the independent directors and serves as a liaison between the independent directors and our management between board meetings. The independent
directors regularly meet outside the presence of management and are advised by independent legal counsel. The board of directors also
has determined that its leadership structure, as described above, is appropriate in light of our size and complexity, the number of independent
directors and the general oversight responsibility of the board of directors. The board of directors also believes that its leadership
structure not only facilitates the orderly and efficient flow of information to the independent directors from management, including
our Adviser, but also enhances the independent and orderly exercise of its responsibilities.
Biographical Information
The following sets forth certain biographical
information for our independent directors (the “Independent Directors”):
Guy M. Arnold. Mr. Arnold has extensive
leadership experience in the financial services industry, having held leadership positions at various investment management firms for
over 20 years. As President of Dividend Capital Diversified Property Fund, Mr. Arnold oversaw all aspects of a $2.9 billion real estate
investment trust ("REIT") and he is currently the Owner and Manager of GMA Holdings, LLC a commercial real estate investment
firm. Mr. Arnold also served as a member of the Board of Directors for Steele Street Bank & Trust and is a member of the Board of
Directors of the Children's Hospital of Colorado Finance Committee. Mr. Arnold received his Bachelor of Arts degree from the University
of Virginia and has been working in the financial services industry since his graduation in 1990.
John Scott Emrich. Mr. Emrich has significant
experience in the investment management and financial services industry. Mr. Emrich served as a financial analyst or portfolio manager
for over 13 years for various investment advisory firms. For four years, Mr. Emrich served on the board of directors for Iroquois Valley
Farms, an organic farmland REIT. Prior to such positions he also performed business valuations and appraisal analyses at KPMG Peat Marwick,
an accounting firm. Mr. Emrich is the founder and CEO of Red Earth Finance, LLC.
Alan Ginsberg. Mr. Ginsberg has more
than 36 years of experience in providing financial advisory services to financial institutions. Mr. Ginsberg began his investment banking
career at Salomon Brothers Inc. in 1983, followed by being a key member of a group that moved to UBS Financial Services Inc. in 1995
and to Donaldson, Lufkin & Jenrette in 1998. He remained at DLJ through the merger with Credit Suisse First Boston until 2004, when
he was recruited to Head HSBC Bank USA's Financial Institutions Group Americas, remaining there until mid-2006. Following HSBC, Mr. Ginsberg
was a senior member of the Banc of America Securities Financial Institutions Group. He previously served as a Managing Director of Barclay's
and has advised on more than 70 strategic transactions and advisory assignments during his tenure as an investment banker. Mr. Ginsberg
received his B.A. in Economics from Yale University. He currently serves on Yale's Peabody Museum Advisory Board, and he served as a
Senior Advisor to StoneCastle Partners from 2010 until May 2013.
Emil W. Henry, Jr. Mr. Henry is the
CEO and Founder of Tiger Infrastructure Partners, a private equity firm focused on infrastructure investment opportunities. Prior to
founding Tiger Infrastructure Partners, he was Global Head of the Lehman Brothers Private Equity Infrastructure businesses, where he
oversaw global infrastructure investments. In 2005, Mr. Henry was appointed Assistant Secretary of the Treasury for Financial Institutions
by the President of the United States. Until his departure in 2007, he was a key advisor to two Treasury Secretaries on economic, legislative
and regulatory matters affecting U.S. financial institutions and markets. Before joining the Treasury, Mr. Henry was a partner of Gleacher
Partners LLC, an investment banking and investment management firm, where he served as Chairman of Asset Management, and Managing Director,
and where he oversaw the firm's investment activities. Mr. Henry began the formative part of his career at Morgan Stanley in the mid-1980s
in that firm's merchant banking arm where he executed management buyouts for Morgan Stanley's flagship private equity fund. He holds
an M.B.A. from Harvard Business School and a B.A. in Economics from Yale University.
Michael Stolper. Mr. Stolper provides
board financial advisory and brokerage business experience serving as the President of Stolper & Co., Inc., an investment adviser
for over 35 years. Based upon his years of experience, he possesses a keen understanding of the securities industry and the regulatory
framework applicable to it, including the Funds. Mr. Stolper was formerly a director of Janus Capital, BDI Investment Company and The
Pasadena Group of Mutual Funds. He was the Founder and President of Seaport Ventures, an SBIC. He also holds a Master of Arts degree
in Finance.
Michael P. Van Praag. Mr. Van Praag
has an extensive background in the financial industry as a JPMorgan Chase executive with over 35 years of experience in banking, commercial
lending, cash management, treasury services and capital markets. Based upon his depth of experience, Mr. Van Praag possesses a keen understanding
of the securities industry and banking-related activity that is of direct relevance to BANX's investment strategy. He also holds a Master
of Business Administration degree in Banking and Finance.
The following sets forth certain biographical
information for our Interested Directors:
Sanjai Bhonsle. Mr. Bhonsle joined ArrowMark
in October 2012 and serves as Partner and Portfolio Manager for ArrowMark's leveraged loan investments and CLO funds. Prior to joining
ArrowMark, he founded MB Consulting Partners in 2009, where he specialized in financial and operational restructuring advisory to stressed
and distressed middle-market companies. With more than 10 years of restructuring experience, he has led several assignments across various
industries. Mr. Bhonsle was a Senior Portfolio Manager at GSO Capital Partners, a subsidiary of The Blackstone Group, and member of the
Investment and Management Committee (2005-2009). Prior to joining GSO Capital Partners, Mr. Bhonsle was an Assistant Portfolio Manager
for RBC Capital Partners' debt investment group and was a member of the Investment Committee (2001-2005). He also led the group's restructuring
efforts related to distressed investments and represented the firm's interests on creditor committees. From 1999-2001, Mr. Bhonsle was
a Senior Investment Analyst at Indosuez Capital Partners. Mr. Bhonsle received a bachelor's degree in Mechanical Engineering from the
University of Wisconsin — Madison and an MBA from the Eli Broad Graduate School of Management at Michigan State University.
Karen L. Reidy. Ms. Reidy is a founding
Partner and co-manages ArrowMark's collateralized loan obligation and specialty finance investments and research analyst team. Prior
to founding ArrowMark, Ms. Reidy served as Executive Vice President and Portfolio Manager at Janus capital, managing $10 billion for
two strategies: Janus Balanced Fund and Janus Core Equity Fund, as well as institutional separate accounts (2000-2005). Ms. Reidy was
also the Assistant Portfolio Manager of the Janus Fund (1998-2000). She joined Janus Capital as an equity analyst in 1995. Prior to Janus
Capital Group, she worked at PricewaterhouseCoopers LLC in the audit and mergers and acquisitions departments. Ms. Reidy graduated from
the University of Colorado with a bachelor's degree and holds the Chartered Financial Analyst designation.
Audit Committee
The audit committee (“Audit Committee”)
of our board of directors is responsible for selecting, engaging and discharging our independent accountants, reviewing the plans, scope
and results of the audit engagement with our independent accountants, approving professional services provided by our independent accountants
(including compensation therefor), reviewing the independence of our independent accountants, overseeing our accounting and reporting
processes, overseeing the quality and integrity of our financial statements and the independent audit thereof and reviewing the adequacy
of our internal controls over financial reporting. The members of the Audit Committee are Messrs. Emrich, Ginsberg and Van Praag,
all of whom are independent directors and none of whom are interested persons in the Company. Mr. Emrich serves as the chairperson
of the Audit Committee. The board of directors has determined that each of Mr. Emrich, Ginsberg and Van Praag is an “audit
committee financial expert” as defined under SEC rules. During the period from January 1, 2020 through December 31, 2020,
the Audit Committee met four times.
Nominating Committee
The functions of the nominating committee
(“Nominating Committee”) are (i) to identify individuals qualified to become Directors of the Company in the event that
a position is vacated or created; (ii) to select, or to recommend that the Board select, the Director nominees for each annual meeting
of the stockholders; (iii) to set any necessary standards or qualifications for service as a Director of the Company; (iv) to make recommendations
concerning the continuing education of the Directors on matters relating to their activities as Directors; (v) to oversee the periodic
Director self-assessment; (vi) to periodically review and make recommendations regarding Independent Director compensation; to undertake
such matters from time to time relating to Board nominations or governance of the Company as the Nominating Committee shall deem appropriate;
(viii) to periodically liaise with the Company’s Chief Compliance Officer and (ix) to oversee the contract review process, including
the review of the Company’s investment advisory agreement and contracts with any affiliated service providers. In addition, the
Nominating Committee will consider corporate governance issues that arise from time to time, and develop appropriate recommendations
for the Board, giving appropriate weight to relevant factors including industry “leading practices.” The Nominating Committee
will review and report to the Board regarding any actual or potential conflicts of interest involving any Director and determine whether
such Director may vote on any issue as to which there may be a conflict. In addition, the Nominating Committee will review all related-party
transactions and determine whether such transactions are appropriate for the Company to undertake. The Nominating Committee is comprised
of Messrs. Arnold, Henry and Stolper. Mr. Stolper serves as the chairperson of the Nominating Committee. During the period from
January 1, 2020 through December 31, 2020, the Nominating Committee met four times.
Risk Oversight
The board of directors’ role in our risk
oversight reflects its responsibility under applicable state law to oversee generally, rather than to manage, our operations. In line
with this oversight responsibility, our board of directors receives reports and makes inquiry as needed regarding the nature and extent
of significant risks we face (including investment, compliance and valuation risks) that potentially could have a materially adverse
impact on our business operations, investment performance or reputation. The board of directors relies upon our management (including
our investment committee) and Chief Compliance Officer, who reports directly to the board of directors, and our Adviser to assist them
in identifying and understanding the nature and extent of such risks and determining whether, and to what extent, such risks may be eliminated
or mitigated. In addition to reports and other information received from our management and our Adviser regarding our investment program
and activities, the board of directors as part of their risk oversight efforts meet regularly and as needed with our Chief Compliance
Officer to discuss, among other things, risk issues and issues regarding our policies, procedures and controls. Our board of directors
may be assisted in performing aspects of its role in risk oversight by the audit committee, nominating and governance committee and such
other standing or special committees as may be established from time to time by the board of directors. For example, the audit committee
regularly meets with our independent public accounting firm to review, among other things, reports on our internal controls for financial
reporting. Our board of directors believes that not all risks that may affect us can be identified, that it may not be practical or cost-effective
to eliminate or mitigate certain risks, that it may be necessary to bear certain risks (such as investment-related risks) to achieve
our goals, and that the processes, procedures and controls employed to address certain risks may be limited in their effectiveness. As
a result of the foregoing and other factors, the board of directors’ risk management oversight is subject to substantial limitations.
Security Ownership of Directors and Members
of Investment Committee
The following table shows the dollar range
of equity securities owned by our directors and investment committee in us as of December 31, 2020. As of the date of this SAI, there
were no other investment companies that are considered to be in the same family of investment companies.
Name of Director
|
|
Dollar Range of Equity
Securities in the Company
|
|
Aggregate Dollar Range of Equity
Securities in All Registered Investment
Companies Overseen by the Director in
the Family of Investment Companies
|
Independent
Directors
|
|
|
|
|
Guy
M. Arnold
|
|
$50,001
– $100,000
|
|
$50,001
– $100,000
|
John
Scott Emrich
|
|
$10,001
– $50,000
|
|
$10,001
– $50,000
|
Alan
Ginsberg
|
|
None
|
|
None
|
Emil
W. Henry, Jr.
|
|
Over
$100,000
|
|
Over
$100,000
|
Michael
Stolper
|
|
$50,001
– $100,000
|
|
$50,001
– $100,000
|
Michael
P. Van Praag
|
|
Over
$100,000
|
|
Over
$100,000
|
Interested
Directors
|
|
|
|
|
Sanjai
Bhonsle(1)
|
|
$10,001
– $50,000
|
|
$10,001
– $50,000
|
Karen
L. Reidy(1)
|
|
None
|
|
None
|
Investment
Committee
|
|
|
|
|
Kaelyn
Abrell(2)
|
|
None
|
|
None
|
(1) Also a member of the Company’s investment
committee.
(2) Ms. Abrell is not a Director but is a member
of the Company’s investment committee. The Company is required to show the dollar ranges of the investment committee members’
beneficial ownership of securities in the Company.
None of the independent directors nor their
family members owned beneficially or of record securities issued by our Adviser, or any person directly or indirectly controlling, controlled
by, or under common control with Adviser as of the date of this SAI.
Compensation Table
During the fiscal year ended December 31,
2020, the Board held seven meetings. Each Director of the Company attended at least 75% of the meetings of the Board and of any Committee
of which he or she was a member. The compensation paid by the Company to the Independent Directors for the fiscal year ended December 31,
2020 is set forth below. No compensation is paid by the Company to the Interested Directors. No officers of the Company received compensation
from the Company. The Company did not reimburse the Independent Directors for out-of-pocket expenses incurred in attending the Board
and Committee meetings for the year ended December 31, 2020.
|
|
Aggregate
Compensation
from the
Company(1)
|
|
|
Pension
or
Retirement
Benefits
Accrued
as Part of
Company
Expenses
|
|
Estimated
Annual Benefits
Upon
Retirement
|
|
Total
Compensation
From Company
and Complex Paid
to Directors
|
|
Independent
Directors
|
|
|
|
|
|
|
|
|
|
|
|
|
Guy
M. Arnold(1)
|
$
|
|
62,500
|
|
|
None
|
|
None
|
$
|
|
62,500
|
|
John
Scott Emrich(1)
|
$
|
|
72,500
|
|
|
None
|
|
None
|
$
|
|
72,500
|
|
Alan
Ginsberg
|
$
|
|
66,651
|
|
|
None
|
|
None
|
$
|
|
66,651
|
|
Emil
Henry, Jr.
|
$
|
|
75,500
|
|
|
None
|
|
None
|
$
|
|
75,500
|
|
Clara
Miller(2)
|
$
|
|
1,500
|
|
|
None
|
|
None
|
$
|
|
1,500
|
|
Michael
Stolper(1)
|
$
|
|
62,500
|
|
|
None
|
|
None
|
$
|
|
62,500
|
|
Michael
Van Praag(1)
|
$
|
|
62,500
|
|
|
None
|
|
None
|
$
|
|
62,500
|
|
Interested
Directors(3)
|
|
|
|
|
|
|
|
|
|
|
|
|
Sanjai
Bhonsle(1)
|
|
|
None
|
|
|
None
|
|
None
|
|
|
None
|
|
Karen
Reidy(1)
|
|
|
None
|
|
|
None
|
|
None
|
|
|
None
|
|
(1) Elected as director
on February 12, 2020.
(2) Retired as a director on February 12,
2020.
(3) Interested directors are not compensated
by us for their service as directors.
Officers
Our executive officers are chosen each year
at a regular meeting of the board of directors to hold office until their respective successors are duly elected and qualified, or until
he resigns or is removed in the manner provided by law. Unless otherwise indicated, the address of each officer is 100 Fillmore Street,
Suite 325, Denver, Colorado 80206. Our executive officers currently are:
Name
|
|
Age
|
|
|
Position(s) Held with
Company
|
|
Term Served
|
|
Principal Occupation(s) Last 5 Years
|
Sanjai Bhonsle
|
|
|
50
|
|
|
Chairman and Chief Executive Officer
|
|
Since
February 2020
|
|
Partner and Portfolio Manager of ArrowMark Partners, 2013
to Present
|
Patrick J. Farrell
|
|
|
61
|
|
|
Chief Financial Officer
|
|
Since
April 2014
|
|
Chief Financial Officer of StoneCastle Partners, LLC from
April 2014 to Present.
|
Richard A. Grove
|
|
|
52
|
|
|
Chief Compliance Officer
|
|
Since
February 2020
|
|
Chief Compliance Officer of ArrowMark Colorado Holdings,
LLC.; formerly Chief Operating Officer, ArrowMark Colorado Holdings, LLC.; Vice President, Secretary and Chief Compliance Officer
of Meridian Fund, Inc.
|
David Lentinello
|
|
|
59
|
|
|
Secretary
|
|
Since
February 2020
|
|
Controller of StoneCastle Partners, LLC Since 2013
|
The following sets forth certain biographical
information for our executive officers who are not directors:
Patrick J. Farrell. Chief Financial
Officer. Mr. Farrell has over 30 years of hands-on management experience in finance and accounting, specifically focused on domestic
and offshore mutual funds, bank deposit account programs, investment advisory and broker dealer businesses. Prior to joining StoneCastle
Partners as Chief Financial Officer in February 2014, Mr. Farrell was CFO/COO of the Emerging Managers Group, L.P., a specialty asset
management firm focused on offshore mutual funds. Prior to that, Mr. Farrell was CFO at Reserve Management, where he oversaw all financial
activities for the company. Earlier in his career, he held financial positions at Lexington Management, Drexel Burnham, Alliance Capital
and New York Life Investment Management, all focused on investment advisory and mutual fund activities. He began his career at Peat Marwick
Mitchell & Co. Mr. Farrell holds a B.S. in Business Administration-Accounting from Manhattan College. Mr. Farrell is a Certified
Public Accountant in New York State and a member of the American Institute of Certified Public Accountants.
Richard A. Grove. Rick is the Chief
Compliance Officer at ArrowMark Partners. He was previously Vice President and Chief Compliance Officer for Black Creek Global Advisors
(2007-2008). Prior to that position, Rick served as Vice President and Chief Compliance Officer for Madison Capital Management (2005-2007),
Assistant Vice President and Director of Compliance at Janus Capital Group (1993-2005), and Fund Accountant for Oppenheimer Funds (1992-1993).
Rick graduated from the University of Wyoming with a bachelor's degree in Accounting.
David Lentinello. Secretary. Mr. Lentinello
has over 35 years of hands-on operational and management experience in the area of finance and accounting, specifically focused in domestic
equity and fixed income mutual funds, money market funds, separately managed accounts, private equity and private debt funds. Prior to
Joining StoneCastle Partners as Fund Controller in 2013, Mr. Lentinello was Director of Fund Administration and Accounting at Reserve
Management and held similar positions at J.P. Morgan Chase, Morgan Stanley Asset Management and Drexel Burnham Lambert. Mr. Lentinello
received his Masters degree in Corporate Finance from Adelphi University and his undergraduate degree in Accounting from Saint Francis
college.
Codes of Ethics
Pursuant to Rule 17j-l under the Investment
Company Act, we and our Adviser have each adopted codes of ethics that permit their respective personnel to invest in securities for
their own accounts, including securities that may be purchased or held by us. All personnel must place the interests of clients first
and avoid activities, interests and relationships that might interfere with the duty to make decisions in the best interests of the clients.
All personal securities transactions by employees must adhere to the requirements of the codes and must be conducted in such a manner
as to avoid any actual or potential conflict of interest, the appearance of such a conflict, or the abuse of an employee’s position
of trust and responsibility.
Copies of our codes of ethics and our Adviser’s code of
ethics are on file with the SEC. You can review and copy these codes of ethics on the SEC’s website (http://www.sec.gov).
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
Management Agreement
We have entered into the management agreement
with our Adviser, an entity in which certain of our officers and directors have ownership and financial interests. Our Adviser’s
services to us under the management agreement are not exclusive, and our Adviser is free to furnish the same or similar services to other
entities, including businesses that may directly or indirectly compete with us so long as our Adviser’s services to us are not
impaired by the provision of such services to others. It is thus possible that our Adviser might allocate investment opportunities to
other entities, and thus might divert attractive investment opportunities away from us. However, our Adviser intends to allocate investment
opportunities consistent with our investment objectives and strategies in a fair and equitable manner in accordance with its allocation
policy. See “Management—Management Agreement.”
Fees to be Earned by ArrowMark Partners
and its Affiliates from Community Banks, Including Some or All of the Community Banks in which we Invest
Brokers affiliated with ArrowMark Partners
may provide investment leads to us, and we may pay a portion of the fee income that we receive from community banks in connection with
our investments in such banks to one or more affiliated brokers. Based upon management’s prior experience, we may receive up-front
fee revenue from the community bank issuers in connection with newly originated securities. Such fees typically range from 0% to 3% of
the amount we invest and may be paid in cash or in kind. Furthermore, entities affiliated with ArrowMark Partners may receive fees from
us or from issuers in which we invest in respect of structuring investments that we may make. Other affiliates of ArrowMark that exist
today, or that may exist in the future, may provide products or service to community banks.
Indemnification Agreements
To the fullest extent permitted by law, we
have indemnified our directors and officers if they are made, or threatened to be made, a party to any action or proceeding (including
an action by or in the right of an affiliate), whether civil or criminal, by reason of the fact that any of them is or was a director
or officer of our company, or was serving at our request as a director or officer of another corporation, partnership, joint venture,
trust, employee benefit plan or other enterprise in any capacity, against any judgments, fines, amounts paid in settlement and reasonable
expenses which they incur. We may also advance the expenses of such persons in any such action or proceeding. We intend to maintain liability
insurance covering our directors and officers.
Conflicts of Interest Within ArrowMark Partners
Our Adviser and ArrowMark Partners may manage
funds and accounts other than ours that have similar investment objectives. The investment policies, adviser compensation arrangements
and other circumstances of ours may vary from those of these other funds and accounts. Accordingly, conflicts may arise regarding the
allocation of investments or opportunities among us and those other accounts. In certain cases, investment opportunities may be made
available to us by our Adviser other than on a pro rata basis. For example, we may desire to retain an asset at the same time that one
or more of those other funds or accounts desires to sell, or we may not have additional capital to invest at the same time as such other
funds and accounts. Our Adviser intends to allocate investment opportunities to us and those other funds and accounts in a manner that
they believe, in their good faith judgment and based upon their fiduciary duties, to be appropriate considering a variety of factors
such as the investment objectives, size of transaction, investable assets, alternative investments potentially available, prior allocations,
liquidity, maturity, expected holding period, diversification, lender covenants and other limitations of ours and other funds or accounts.
To the extent that investment opportunities are suitable for us and for one of these other funds or accounts, our Adviser intends to
allocate investment opportunities pro rata among us and them based on the amount of funds each then has available for such investment,
taking into account these factors.
There may be situations in which one or more
funds or accounts managed by our Adviser or its affiliates might invest in different securities issued by the same company. It is possible
that if the target company’s financial performance and condition deteriorates such that one or both investments are or could be
impaired, our Adviser might face a conflict of interest given the difference in seniority of the respective investments. In such situations,
our Adviser would review the conflict on a case-by-case basis and implement procedures consistent with its fiduciary duties to enable
it to act fairly to each of its clients in the circumstances. Any steps by our Adviser will take into consideration the interests of
each of the affected clients, the circumstances giving rise to the conflict, the procedural efficacy of various methods of addressing
the conflict and applicable legal requirements.
Furthermore, two of the members of our Adviser’s
investment committee are also members of our board of directors. Due to our board composition, it is more likely that our board of directors
will approve investments made by the Adviser’s investment committee and that our board of directors will value our investments
consistent with the valuation recommendations of our Adviser’s investment committee. The board of directors utilizes the services
of one or more regionally or nationally recognized independent valuation firms to help it determine the value of each investment for
which a market price is not available. The board of directors will also review valuations of such investments provided by the Adviser.
The board of directors regularly reviews and evaluates our valuation methodology and any such valuation service it uses and the historical
accuracy of such valuation methodologies. The board of directors also reviews valuations of such investments provided by the Adviser
and assigns the valuation it determines to best represent the fair value of such investments.
Leverage creates risk for holders of our common
stock, including the likelihood of greater volatility of our NAV and the value of our shares, and the risk of fluctuations in interest
rates on leverage capital, which may affect the return to the holders of our common stock or cause fluctuations in the distributions
paid on our common stock. The fee paid to our Adviser is calculated on the basis of our Managed Assets, including proceeds from leverage
capital. During periods in which we use leverage, the fee payable to our Adviser will be higher than if we did not use leverage. Consequently,
we and our Adviser may have differing interests in determining whether to leverage our assets. Certain members of our board of directors
also serve as investment professionals for our Adviser, which may create inherent conflicts of interest.
Approval of Conflicts
Our board of directors, including a majority
of our directors who are independent, is responsible for reviewing and approving the terms of all transactions between us and our Adviser
or its affiliates or any member of our board of directors, including (when applicable) the economic, structural and other terms of our
investments and investment transactions and the review of any investment decisions that may present potential conflicts of interest among
our Adviser and its affiliates, on one hand, and us, on the other. Our board of directors, including a majority of our directors who
are independent, is also responsible for reviewing our Adviser’s performance and the fees and expenses that we pay to our Adviser.
In addition, expenses that are reimbursable to our Adviser will be submitted to the independent members of our board of directors for
their approval prior to reimbursement thereof. In addition, our Adviser’s compliance department and legal department will oversee
its conflict-resolution system. The program places particular emphasis on the principle of fair and equitable allocation of appropriate
opportunities and of common fees and expenses to our Adviser’s clients over time. Our Adviser has agreed with us that it will allocate
opportunities, fees and expenses among its clients pursuant to its written policies and procedures.
PORTFOLIO MANAGERS
Day-to-day management of our portfolio is the
responsibility of our Adviser’s investment committee. Our Adviser’s investment committee is currently comprised of Sanjai
Bhonsle, Karen Reidy, and Kaelyn Abrell. The investment committee’s policy is that the consent of two of the three members is required
to approve the committee’s decision to invest in a security and the consent of two of the three members is required to sell a security.
Unless otherwise indicated, the information
below is provided as of the date of this SAI. The table below identifies the number of accounts (other than for us) for which the members
of our investment committee have day-to-day management responsibilities and the total assets in such accounts, within each of the following
categories: registered investment companies, other pooled investment vehicles and other accounts. Where the named individual has been
assigned primary responsibility, or is a member of a committee that has been assigned primary responsibly, for oversight of another pooled
investment vehicle or other account, that vehicle/account has been allocated to that individual for disclosures purposes. For each category,
the number of accounts and total assets in the accounts where fees are based on performance is also indicated as of December 31, 2020.
Name of
Portfolio
Manager or
Team Member
|
|
Type of
Accounts
|
|
Total No.
of Accounts
Managed
|
|
|
Total
Assets
|
|
|
No. of
Accounts
where
Advisory Fee
is Based on
Performance
|
|
|
Total Assets
in Accounts
where
Advisory
Fee is Based
on
Performance
|
|
Sanjai Bhonsle
|
|
Registered
Investment Companies:
|
|
|
0
|
|
|
$
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
Other
Pooled Investment Vehicles:
|
|
|
0
|
|
|
$
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
Other
Accounts:
|
|
|
16
|
|
|
$
|
5,107,685,236.83
|
|
|
|
4
|
|
|
$
|
1,141,500,000.00
|
|
Karen L. Reidy
|
|
Registered Investment
Companies:
|
|
|
0
|
|
|
$
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
Other
Pooled Investment Vehicles:
|
|
|
0
|
|
|
$
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
Other
Accounts:
|
|
|
16
|
|
|
$
|
5,107,685,236.83
|
|
|
|
4
|
|
|
$
|
1,141,500,000.00
|
|
Kaelyn Abrell
|
|
Registered Investment
Companies:
|
|
|
1
|
|
|
$
|
18,205,881.92
|
|
|
|
-
|
|
|
|
-
|
|
|
|
Other Pooled Investment
Vehicles:
|
|
|
9
|
|
|
$
|
2,796,195,551.92
|
|
|
|
9
|
|
|
$
|
2,796,195,551.92
|
|
|
|
Other Accounts:
|
|
|
0
|
|
|
$
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Biographical information about each member
of our Adviser’s investment committee is set forth in the Prospectus under Management.
Investment Committee Compensation
With respect to the compensation of the investment
committee members, our standard compensation includes competitive base salaries, employee benefits, and a retirement plan. In addition,
employees are eligible for bonuses. These are structured to closely align the interests of employees with those of ArrowMark Partners,
and are determined by the professional’s job function and performance as measured by a formal review process. All bonuses are completely
discretionary. Because the Adviser utilizes a team approach in managing the assets of its clients, the overall success of the firm is
a key component in determining compensation of investment committee members. Because investment committee members may be responsible
for multiple accounts (including ours) with similar investment strategies, they are compensated on the performance of the aggregate group
of similar accounts, rather than a specific account. A smaller portion of a bonus payment is derived from factors that include client
service, business development, length of service to our Adviser, management or supervisory responsibilities, contributions to developing
business strategy and overall contributions to our Adviser’s business.
Investment Committee Member Securities Ownership
The securities ownership of the members of
our investment committee is shown in the table above providing securities ownership for the Company’s board of directors.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Our Adviser is responsible for decisions to
buy and sell securities for us, the selection of brokers and dealers to effect the transactions and the negotiation of prices and any
brokerage commissions. When we purchase securities listed on a stock exchange, those transactions will be effected through brokers who
charge a commission for their services. We also may invest in securities that are traded principally in the over-the-counter market.
In the over-the-counter market, securities generally are traded on a “net” basis with dealers acting as principal for their
own accounts without a stated commission, although the price of such securities usually includes a mark-up to the dealer. Securities
purchased in underwritten offerings generally include, in the price, a fixed amount of compensation for the manager, underwriter and
dealer. We also purchase securities including fixed income securities directly from an issuer, in which case no commissions or discounts
will be paid.
Payments of commissions to brokers who are
our affiliates (or “affiliated persons” of such persons, as defined under the Investment Company Act) will be made in accordance
with Rule 17e-l under the Investment Company Act.
Commissions paid on such transactions would
be commensurate with the rate of commissions paid on similar transactions to brokers that are not so affiliated.
Our Adviser may, consistent with our interests,
select brokers on the basis of the research, statistical and pricing services they provide to us and our Adviser’s other clients.
Such research, statistical and pricing services must provide lawful and appropriate assistance to our Adviser’s investment decision-making
process in order for such research, statistical and pricing services to be considered by our Adviser in selecting a broker. These research
services may include information on securities markets, the economy, individual companies, pricing information, research products and
services and such other services as may be permitted from time to time by Section 28(e) of the Exchange Act. Information and research
received from such brokers will be in addition to, and not in lieu of, the services required to be performed by our Adviser under its
contract. A commission paid to such brokers may be higher than that which another qualified broker would have charged for effecting the
same transaction, provided that our Adviser determines in good faith that such commission is reasonable in terms either of the transaction
or the overall responsibility of our Adviser to us and its other clients and that the total commissions paid by us will be reasonable
in relation to the benefits to us over the long-term. The advisory fees that we pay to our Adviser will not be reduced as a consequence
of our Adviser’s receipt of brokerage and research services. To the extent that portfolio transactions are used to obtain such
services, the brokerage commissions paid by us will exceed those that might otherwise be paid by an amount which cannot be presently
determined. Such services generally may be useful and of value to our Adviser in serving one or more of its other clients and, conversely,
such services obtained by the placement of brokerage business of other clients generally would be useful to our Adviser in carrying out
its obligations to us. While such services are not expected to reduce the expenses of our Adviser, our Adviser would, through use of
the services, avoid the additional expenses that would be incurred if it should attempt to develop comparable information through their
own staff.
One or more of the other investment companies
or accounts that our Adviser manages may own from time to time some of the same investments as us. Investment decisions for us are made
independently from those of other investment companies or accounts; however, from time to time, the same investment decision may be made
for more than one company or account. When two or more companies or accounts seek to purchase or sell the same securities, the securities
actually purchased or sold will be allocated among the companies and accounts on a good faith equitable basis by our Adviser in its discretion
in accordance with the accounts’ various investment objectives. In some cases, this system may adversely affect the price or size
of the position obtainable for us. In other cases, however, our ability to participate in volume transactions may produce better execution
for us. It is the opinion of our board of directors that this advantage, when combined with the other benefits available due to our Adviser’s
organization, outweigh any disadvantages that may be said to exist from exposure to simultaneous transactions.
For the fiscal years ended December 31,
2020, 2019 and 2018, we paid brokerage commissions of $0, $3,865 and $9,050, respectively. No brokerage commissions were paid to broker-dealers
that were affiliated persons of the Adviser (“affiliated brokers”) in connection with portfolio transactions.
For the fiscal years ended December 31,
2020, 2019 and 2018, our portfolio turnover rates were 60%, 13% and 30%, respectively. The Company experienced higher portfolio turnover
during the fiscal year ended December 31, 2020 due to increased trading activity and reinvested proceeds of securities called or redeemed.
It is not our policy to engage in transactions with the objective of seeking profits from short-term trading. Because it is difficult
to predict accurately portfolio turnover rates, actual turnover may be significantly higher or lower. Higher portfolio turnover results
in increased costs, including brokerage commissions, dealer mark-ups and other transaction costs on the sale of securities and on the
reinvestment in other securities.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS
Persons or organizations beneficially owning
25% or more of our outstanding shares could be presumed to “control” us. As a result, those persons or organizations could
have the ability to take action without the consent or approval of other stockholders. As of April 27, 2021 Cede & Co. held approximately
99.9% of our outstanding voting securities. Cede & Co. is the nominee name for The Depository Trust Company, a large clearing house
that holds shares in its name for banks, brokers and institutions in order to expedite the sale and transfer of stock.
To the knowledge of the Company and the
Board, no stockholder(s), or “group” as that term is defined in Section 13(d) of the Securities Exchange Act of 1934, as
amended (the “1934 Act”), was the beneficial owner of more than 5% of a class of the Company’s outstanding Common Shares
through the date of this prospectus, except that, based on Schedule 13G filings through the Record Date, the following information with
respect to beneficial ownership of more than 5% of the outstanding voting shares has been reported:
Title of Class
|
|
|
Name and Address
|
|
Percentage
Ownership
of Fund
|
|
|
Total
Number
of Shares
|
|
Shares of Beneficial
Interest
|
|
|
Punch & Associates Investment Management,
Inc. 701 France Ave So., Suite 300 Edina, MN 55435
|
|
|
8.40
|
%
|
|
|
551,334
|
|
Additionally, as of the same date, our directors
and officers owned individually and together approximately 0.53% of our outstanding shares.
PROXY VOTING POLICIES
We, along with our Adviser, have adopted proxy
voting policies and procedures (the “Proxy Policy”) that we believe are reasonably designed to ensure that proxies are voted
in our best interests and the best interests of our stockholders. Subject to its oversight, our board of directors has delegated responsibility
for implementing the Proxy Policy to our Adviser.
In the event requests for proxies are received
to vote equity securities on routine matters, such as ratification of auditors, the proxies usually will be voted in accordance with
the recommendation of our management unless our Adviser determines it has a conflict or our Adviser determines there are other reasons
not to vote in accordance with the recommendation of our management. On non-routine matters, such as elections of directors, amendments
to governing instruments, proposals relating to compensation, corporate governance proposals and stockholder proposals, our Adviser will
vote, or abstain from voting if deemed appropriate, on a case-by-case basis in a manner it believes to be in the best economic interest
of our stockholders. In the event requests for proxies are received with respect to fixed income securities, our Adviser will vote on
a case-by-case basis in a manner it believes to be in the best economic interest of our stockholders.
Our chief executive officer will be responsible
for monitoring our actions and ensuring that (i) proxies are received and forwarded to the appropriate decision makers, and (ii) proxies
are voted in a timely manner upon receipt of voting instructions. We are not responsible for voting proxies we do not receive, but we
will make reasonable efforts to obtain missing proxies. Our chief executive officer will implement and execute procedures designed to
identify and monitor potential conflicts of interest that could affect the proxy voting process, including (i) significant client relationships,
(ii) other potential material business relationships and (iii) material personal and family relationships. All decisions regarding proxy
voting will be determined by our Adviser’s investment committee and will be executed by our chief executive officer. Every effort
will be made to consult with the investment committee member and/or analyst covering the security. We may determine not to vote a particular
proxy if the costs and burdens exceed the benefits of voting (e.g., when securities are subject to loan or to share blocking restrictions).
If a request for proxy presents a conflict
of interest between our stockholders, on one hand, and our Adviser, the underwriters or any of our or their respective affiliated persons,
on the other hand, our management may (i) disclose the potential conflict to our board of directors and obtain consent or (ii) establish
an ethical wall or other informational barrier between the persons involved in the conflict and the persons making the voting decisions.
Information regarding how the Company voted
proxies relating to portfolio securities during the most recent 12-month period ended June 30 is available without charge, upon request,
by calling (212)-468-5441; and on the SEC’s website at http://www.sec.gov.
FINANCIAL STATEMENTS
The audited financial statements and notes
thereto in our Annual Report to Stockholders for the year ended December 31, 2020 (the “Annual Report”), are incorporated
by reference into this SAI. The 2020 financial statements included in the Annual Report were audited by Tait, Weller & Baker LLP,
the Company’s independent registered public accounting firm, whose report thereon is also incorporated herein by reference. No
other parts of the Annual Report are incorporated by reference herein and such other parts are not part of our registration statement,
the SAI, or the prospectus.
Copies of our annual and semi-annual reports
may be obtained without charge, upon request, by writing to StoneCastle Financial Corp., 100 Fillmore Street, Suite 325, Denver, Colorado
80206 or calling us at (212)-468-5441or on our website at http://ir.stonecastle-financial.com/financial-information/annual-reports.
INCORPORATION BY REFERENCE
As noted in the Prospectus, we are allowed
to “incorporate by reference” the information that we file with the SEC, which means that we can disclose important information
to you by referring you to those documents. The information incorporated by reference is considered to be part of the Prospectus, the
SAI or the Prospectus Supplement, as applicable, and later information that we file with the SEC will automatically update and supersede
this information.
ADDITIONAL INFORMATION
We have filed with the SEC a Registration Statement
on Form N-2 relating to the securities offered hereby. Our prospectus and this SAI do not contain all of the information set forth in
the Registration Statement, including any exhibits and schedules thereto. Please refer to the Registration Statement for further information
about us and our securities. Statements contained in our prospectus and this SAI as to the contents of any contract or other document
referred to are not necessarily complete and in each instance reference is made to the copy of such contract or other document filed
as an exhibit to a Registration Statement, each such statement being qualified in all respects by such reference.
PART C
OTHER INFORMATION
Item 25. Financial Statements and
Exhibits
1. Financial
Statements:
Part A
Financial Highlights are incorporated
by reference to the Registrant’s December 31, 2020 Annual Report (audited) on Form N-CSR as filed with the SEC on March 1, 2021
Part B
Financial Statements for the Company
are incorporated by reference to the Registrant’s December 31, 2020 Annual Report (audited) on Form N-CSR as filed with the SEC
on March 1, 2021.
(1)
|
Incorporated
by reference to Pre-Effective Amendment No. 2 to Registrant’s Registration Statement on Form N-2 (File No. 333-189307)
as filed with the Commission on September 16, 2013.
|
(2)
|
Incorporated
by reference to Registrant’s Registration Statement on Form N-2 (File No. 333-197689) as filed with the Commission
on July 29, 2014.
|
(3)
|
Incorporated
by reference to Pre-Effective Amendment No. 1 to Registrant’s Registration Statement on Form N-2 (File No. 333-204417)
as filed with the Commission on March 29, 2016.
|
(4)
|
Incorporated
by reference to Post-Effective Amendment No. 4 to Registrant’s Registration Statement on Form N-2 (File No. 333-204417)
as filed with the Commission on August 13, 2018.
|
(5)
|
Incorporated
by reference to Registrant’s Registration Statement on Form N-2 (File No. 333-251349) as filed with the Commission
on December 14, 2020.
|
(6)
|
Incorporated by reference to Registrant’s
Pre-Effective Amendment No. 1 to its Registration Statement on Form N-2 (File No. 333-251349) as
filled with the Commission on April 30, 2021.
|
Item 26. Marketing Arrangements
Information contained under the heading “Plan
of Distribution” in this Registration Statements is incorporated hereby by reference.
Item 27. Other Expenses of Issuance
and Distribution
The following table sets forth the estimated
expenses to be incurred in connection with the issuance and distribution of the securities being registered hereby:
Securities and Exchange Commission fees
|
|
$
|
16,365
|
|
Financial
Industry Regulatory Authority, Inc. filing fee (FINRA)
|
|
$
|
*
|
|
Accounting
fees and expenses
|
|
$
|
*
|
|
Legal
fees and expenses
|
|
$
|
*
|
|
Printing
expenses
|
|
$
|
*
|
|
Miscellaneous
|
|
$
|
*
|
|
Total
|
|
$
|
16,365
|
|
* Fees depend on number of issuances and amount
of securities and cannot be estimated at this time.
Item 28. Persons Controlled by or
Under Common Control with Registrant
None.
Item 29. Number of Holders of Securities
As of April 27, 2021, the number of record
holders of each class of securities of the Registrant was:
Title of Class
|
|
|
Number of Record Holders
|
|
Common
Stock ($0.001 par value)
|
|
|
4
|
|
Item 30. Indemnification
Subject to the Investment Company Act, or any
valid rule, regulation or order of the SEC thereunder, our certificate of incorporation and bylaws provide that we will indemnify any
person who was or is a party or is threatened to be made a party to any threatened action, suit or proceeding whether civil, criminal,
administrative or investigative, by reason of the fact that he is or was our director or officer, or is or was serving at our request
as a director, officer, partner or trustee of another corporation, real estate investment trust, partnership, joint venture, trust, employee
benefit plan or other enterprise to the maximum extent permitted by the Delaware General Corporation Law. The Investment Company Act
provides that a company may not indemnify any director or officer against liability to it or its security holders to which he or she
might otherwise be subject by reason of his or her willful misfeasance, bad faith, gross negligence or reckless disregard of the duties
involved in the conduct of his or her office unless a determination is made by final decision of a court, by vote of a majority of a
quorum of directors who are disinterested, non-party directors or by independent legal counsel that the liability for which indemnification
is sought did not arise out of the foregoing conduct. In addition to any indemnification to which our directors and officers are entitled
pursuant to our amended and restated certificate of incorporation and amended and restated bylaws and the Delaware General Corporation
Law, our amended and restated certificate of incorporation and amended and restated bylaws permit us to indemnify our other employees
and agents to the fullest extent permitted by the Delaware General Corporation Law, whether such employees or agents are serving us or,
at our request, any other entity. As permitted by the Delaware General Corporation Law, our amended and restated certificate of incorporation
and our amended and restated bylaws, we have purchased and maintain insurance on behalf of each of our directors and officers.
The management agreement provides that our
Adviser will not be liable to us in any way for any default, failure or defect in any of the securities comprising our portfolio if it
has satisfied the duties and the standard of care, diligence and skill set forth in the management agreement. The management agreement
further states that we will indemnify the Adviser for any losses, damages, claims, costs, charges, expenses or liabilities except to
the extent such amounts result from our Adviser’s willful misconduct, bad faith or gross negligence or as otherwise prohibited
by applicable law. As a result, our Adviser may not be liable to us for breaches of its duty of care, diligence or skill. In addition,
under the license agreement, we have agreed to indemnify StoneCastle Partners for any unauthorized use of the “StoneCastle”
name and marks by us.
Item 31. Business and Other Connections
of Investment Adviser
The information in the Statement of Additional
Information under the caption “Management—Directors and Officers” and the information in the prospectus under the caption
“Management—Management Agreement” is hereby incorporated by reference.
Item 32. Location of Accounts and
Records
The Registrant’s accounts, books, and
other documents are maintained at the offices of the Registrant, at the offices of the Registrant’s investment adviser, StoneCastle-ArrowMark
Asset Management, LLC, 100 Fillmore Street, Suite 325, Denver, Colorado 80206, at the offices of the custodian, The Bank of New York
Mellon, 2 Hanson Place, Brooklyn, New York 11217, at the offices of the transfer agent, Computershare Trust Company, N.A., 250 Royall
Street, Canton, Massachusetts 02021, or at the offices of the administrator, BNY Mellon Investment Servicing (US) Inc., 4400 Computer
Drive, Westborough, Massachusetts 01581.
Item 33. Management Services
None.
Item 34. Undertakings
The Registrant hereby undertakes:
(1) Not
applicable.
(2) Not
applicable.
(3) The
registrant hereby undertakes:
|
(a)
|
to file, during any period in which offers
or sales are being made, a post-effective amendment to the registration statement:
|
(1) to
include any prospectus required by Section 10(a)(3) of the Securities Act.
|
(2)
|
to reflect in the prospectus any facts or
events after the effective date of the registration statement (or the most recent post-effective
amendment thereof) which, individually or in the aggregate, represent a fundamental change
in the information set forth in the registration statement. Notwithstanding the foregoing,
any increase or decrease in volume of securities offered (if the total dollar value of securities
offered would not exceed that which was registered) and any deviation from the low or high
end of the estimated maximum offering range may be reflected in the form of prospectus filed
with the SEC pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price
represent no more than 20% change in the maximum aggregate offering price set forth in the
“Calculation of Registration Fee” table in the effective registration statement.
|
|
(3)
|
to include any material information with
respect to the plan of distribution not previously disclosed in the registration statement
or any material change to such information in the registration statement.
|
Provided, however, that paragraphs
4(a)(1), (2), and (3) of this section do not apply if the information required to be included in a post-effective amendment by those
paragraphs is contained in reports filed with or furnished to the SEC by the Registrant pursuant to Section 13 or Section 15(d) of the
Exchange Act of 1934 that are incorporated by reference into the registration statement, or is contained in a form of prospectus filed
pursuant to Rule 424(b) that is part of the registration statement.
|
(b)
|
that, for the purpose of determining any
liability under the Securities Act, each such post-effective amendment shall be deemed to
be a new registration statement relating to the securities offered herein, and the offering
of those securities at that time shall be deemed to be the initial bona fide offering thereof;
and
|
|
(c)
|
to remove from registration by means of
a post-effective amendment any of the securities being registered which remain unsold at
the termination of the offering; and
|
|
(d)
|
that, for the purpose of determining liability
under the Securities Act to any purchaser:
|
(1) if
the Registrant is relying on Rule 430B:
|
(A)
|
Each prospectus filed by the Registrant
pursuant to Rule 424(b)(3) shall be deemed to be part of the registration statement as of
the date the filed prospectus was deemed part of and included in the registration statement;
and
|
|
(B)
|
Each prospectus required to be filed pursuant
to Rule 424(b)(2), (b)(5), or (b)(7) as part of a registration statement in reliance on Rule
430B relating to an offering made pursuant to Rule 415(a)(1)(i), (x), or (xi) for the purpose
of providing the information required by Section 10(a) of the Securities Act shall be deemed
to be part of and included in the registration statement as of the earlier of the date such
form of prospectus is first used after effectiveness or the date of the first contract of
sale of securities in the offering described in the prospectus. As provided in Rule 430B,
for liability purposes of the issuer and any person that is at that date an underwriter,
such date shall be deemed to be a new effective date of the registration statement relating
to the securities in the registration statement to which that prospectus relates, and the
offering of such securities at that time shall be deemed to be the initial bona fide offering
thereof. Provided, however, that no statement made in a registration statement
or prospectus that is part of the registration statement or made in a document incorporated
or deemed incorporated by reference into the registration statement or prospectus that is
part of the registration statement will, as to a purchaser with a time of contract of sale
prior to such effective date, supersede or modify any statement that was made in the registration
statement or prospectus that was part of the registration statement or made in any such document
immediately prior to such effective date; or
|
|
(2)
|
if the Registrant is subject to Rule 430C:
each prospectus filed pursuant to Rule 424(b) under the Securities Act as
part of a registration statement relating to an offering, other than registration statements
relying on Rule 430B or other than prospectuses filed in reliance on Rule 430A, shall be
deemed to be part of and included in the registration statement as of the date it is first
used after effectiveness; Provided, however, that no statement made in a registration statement
or prospectus that is part of the registration statement or made in a document incorporated
or deemed incorporated by reference into the registration statement or prospectus that is
part of the registration statement will, as to a purchaser with a time of contract of sale
prior to such first use, supersede or modify any statement that was made in the registration
statement or prospectus that was part of the registration statement or made in any such document
immediately prior to such date of first use;
|
|
(e)
|
that, for the purpose of determining liability
of the Registrant under the Securities Act to any purchaser in the initial distribution
of securities: The undersigned Registrant undertakes that in a primary offering of securities
of the undersigned Registrant pursuant to this registration statement, regardless of the
underwriting method used to sell the securities to the purchaser, if the securities are offered
or sold to such purchaser by means of any of the following communications, the undersigned
Registrant will be a seller to the purchaser and will be considered to offer or sell such
securities to the purchaser:
|
|
(1)
|
any preliminary prospectus or prospectus
of the undersigned Registrant relating to the offering required to be filed pursuant to Rule 424 under
the Securities Act;
|
|
(2)
|
any free writing prospectus relating to
the offering prepared by or on behalf of the undersigned Registrant or used or referred to
by the undersigned Registrant;
|
|
(3)
|
the portion of any other free writing prospectus
or advertisement pursuant to Rule 482 under the Securities Act relating
to the offering containing material information about the undersigned Registrant or its securities
provided by or on behalf of the undersigned Registrant; and
|
|
(4)
|
any other communication
that is an offer in the offering made by the undersigned Registrant to the purchaser
|
(5)
|
The undersigned Registrant hereby undertakes that, for purposes of determining
any liability under the Securities Act, each filing of the Registrant’s annual report pursuant
to Section 13(a) or Section 15(d) of the Securities Exchange Act that is incorporated by reference into
the registration statement shall be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be deemed to be the initial
bona fide offering thereof.
|
(6)
|
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of the Registrant pursuant
to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the
SEC such indemnification is against public policy as expressed in the Securities Act and is,
therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other
than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling
person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by
such director, officer or controlling person in connection with the securities being registered, the
Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such indemnification by it is against
public policy as expressed in the Securities Act and will be governed by the final adjudication
of such issue.
|
(7)
|
The Registrant hereby undertakes to send by first class mail or other
means designed to ensure equally prompt delivery, within two business days of receipt of a written or
oral request, any prospectus or Statement of Additional Information.
|
SIGNATURES
Pursuant to the requirements of the Securities
Act of 1933 and Investment Company Act of 1940, the Registrant has duly caused this Pre-Effective Amendment No. 2 to the Registration
Statement on Form N-2 to be signed on its behalf by the undersigned, thereunto duly authorized, in this City of Denver and State
of Colorado on the 26th day of May, 2021.
|
|
StoneCastle
Financial Corp.
|
|
|
|
|
By:
|
/s/
Sanjai Bhonsle
|
|
|
Sanjai Bhonsle
Chief Executive Officer
|
Pursuant to the requirements of the Securities
Act of 1933, this Pre-Effective Amendment No. 2 to the Registration Statement has been signed by the following persons in the capacities
and on the date indicated.
Name
|
|
Title
|
|
Date
|
/s/ Sanjai Bhonsle
|
|
Chief Executive Officer and Director
|
|
May
26, 2021
|
Sanjai
Bhonsle
|
|
(Principal
Executive Officer)
|
|
|
|
|
|
|
|
/s/
Patrick J. Farrell
|
|
Chief
Financial Officer
|
|
May 26, 2021
|
Patrick
J. Farrell
|
|
(Principal
Financial and Accounting Officer)
|
|
|
|
|
|
|
|
*
/s/ Guy M. Arnold
|
|
Director
|
|
May 26, 2021
|
Guy
M. Arnold
|
|
|
|
|
|
|
|
|
|
*
/s/ John Scott Emrich
|
|
Director
|
|
May 26, 2021
|
John
Scott Emrich
|
|
|
|
|
|
|
|
|
|
*
/s/ Alan J. Ginsberg
|
|
Director
|
|
May 26, 2021
|
Alan
J. Ginsberg
|
|
|
|
|
|
|
|
|
|
*
/s/ Emil W. Henry, Jr.
|
|
Director
|
|
May 26, 2021
|
Emil
W. Henry, Jr.
|
|
|
|
|
|
|
|
|
|
*
/s/ Michael Stolper
|
|
Director
|
|
May 26, 2021
|
Michael
Stolper
|
|
|
|
|
|
|
|
|
|
*
/s/ Michael P. Van Praag
|
|
Director
|
|
May 26, 2021
|
Michael
Van Praag
|
|
|
|
|
|
|
|
|
|
*
/s/ Karen L. Reidy
|
|
Director
|
|
May 26, 2021
|
Karen
L. Reidy
|
|
|
|
|
|
|
* By:
|
/s/
Sanjai Bhonsle
|
|
|
Sanjai Bhonsle
|
|
|
Attorney-In-Fact
pursuant to a power of attorney signed by each individual on December 14, 2020.
|
|
|
|
|
|
|
|
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