NEWS 12.31.14 10K/A

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K/A
AMENDMENT No. 1
 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2014
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from             to            
Commission file number 001-33211
 
NewStar Financial, Inc.
(Exact name of registrant as specified in its charter)
 
Delaware
  
54-2157878
(State or other jurisdiction of
incorporation or organization)
  
(I.R.S. Employer
Identification No.)
 
 
 
500 Boylston Street, Suite 1250, Boston, MA
  
02116
(Address of principal executive offices)
  
(Zip Code)
Registrant’s telephone number, including area code: (617) 848-2500
 
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common Stock, par value $0.01 per share
 
The NASDAQ Global Market
Securities registered pursuant to Section 12(g) of the Act:
None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  ¨    No  x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes  ¨    No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K    ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer  ¨
 
Accelerated Filer  x
 
Non-Accelerated Filer  ¨
 
Smaller reporting company  ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
As of June 30, 2014, the last business day of our most recently completed second fiscal quarter, the aggregate market value of the voting stock held by non-affiliates was $364,137,958, based on the number of shares held by non-affiliates of the registrant as of June 30, 2014, and based on the reported last sale price of common stock on June 30, 2014. This calculation does not reflect a determination that persons are affiliates for any other purposes.
As of February 27, 2015, 47,080,915 shares of common stock, par value of $0.01 per share, were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s Definitive Proxy Statement to be filed with the Securities and Exchange Commission (“SEC”) pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), relating to the Registrant’s Annual Meeting of Stockholders scheduled to be held May 20, 2015 are incorporated by reference into Part III of this Form 10-K. With the exception of the portions of the Proxy Statement specifically incorporated herein by reference, the Proxy Statement is not deemed to be filed as part of this Form 10-K.



EXPLANATORY NOTE

NewStar Financial, Inc. (which is referred to throughout this Annual Report as “NewStar”, “the Company”, “we” and “us”) filed its Annual Report on Form 10-K for the fiscal year ended December 31, 2014 (the “Original Form 10-K”), with the U.S. Securities and Exchange Commission (the “SEC”) on March 4, 2015. This Amendment No. 1 is being filed to correct an error in the content of Item 1, “Business.” The error appears in the Loan Portfolio section on Page 8 of the Original Form 10-K. In the second sentence of the section, we state that our loan portfolio totaled approximately $2.9 billion of funding commitments, representing $2.6 billion of balances outstanding and $3.0 billion of funds committed but undrawn as of December 31, 2014. However, $0.3 billion of the committed funds remain undrawn, as opposed to the previously reported $3.0 billion.

Among other immaterial amendments contained in this Amendment No. 1, we have revised the Index to the Financial Statements in Item 8, “Financial Statements and Supplementary Data” on Page 56 of the Original Form 10-K, and certain table headings to update the years from 2011, 2012, and 2013, to 2012, 2013, and 2014, respectively. This Amendment No. 1 includes revisions to Part I, Item 1, Part II, Item 8, and, for the purpose of reflecting the exhibits hereto, Part IV, Item 15. We have included the remaining unaltered portions of the Original Form 10-K in their entirety to, among other things, facilitate efficient communication to our stockholders in connection with our 2015 Annual Meeting of Stockholders.

This Amendment No. 1 does not update any disclosures to reflect developments since the filing date of the Original Form 10-K.



Table of Contents

TABLE OF CONTENTS
 
 
Page
PART I
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 1B.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
PART II
 
Item 5.
 
 
 
Item 6.
 
 
 
Item 7.
 
 
 
Item 7A.
 
 
 
Item 8.
 
 
 
Item 9.
 
 
 
Item 9A.
 
 
 
Item 9B.
 
 
PART III
 
Item 10.
 
 
 
Item 11.
 
 
 
Item 12.
 
 
 
Item 13.
 
 
 
Item 14.
 
 
PART IV
 
Item 15.
 
 
 
 

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Forward-Looking Statements
Statements in this Annual Report about our anticipated financial condition, results of operations, and growth, as well as about the future development of our products and markets and the future performance of the financial markets in general, are forward-looking statements. You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. They may include words such as “anticipate,” “estimate,” “expect,” “project,” “plan,” “intend,” “believe,” “may,” “should,” “can have,” “likely” and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events and circumstances. These forward-looking statements are based on assumptions that we have made in light of our industry experience and on our perceptions of historical trends, current conditions, expected future developments and other factors. As you read this Annual Report, you should understand that these statements are not guarantees of performance or results. They involve risks and uncertainties that are beyond our control. Important information about the bases for our assumptions and factors that may cause our actual results and other circumstances to differ materially from those described in the forward-looking statements are discussed in Item 1A. “Risk Factors” and generally throughout this Annual Report.
 
Item 1.
Business
Overview
NewStar Financial, Inc. (which is referred to throughout this Annual Report as “NewStar”, “the Company”, “we” and “us”) is an internally-managed, commercial finance company with specialized lending platforms focused on meeting the complex financing needs of companies and private investors in the middle market. The Company is also a registered investment adviser and provides asset management services to institutional investors through a series of managed credit funds that co-invest in certain types of loans originated by the Company. Through its specialized lending platforms, the Company provides a range of senior secured debt financing options to mid-sized companies to fund working capital, growth strategies, acquisitions and recapitalizations, as well as, purchases of equipment and other capital assets.
These lending activities require specialized skills and transaction experience, as well as, a significant investment in personnel and operating infrastructure. To meet these demands, our loans and leases are originated directly by teams of credit-trained bankers and experienced marketing officers organized around key industry and market segments. These teams represent specialized lending groups that are supported by centralized credit management and operating platforms. This structure enables us to leverage common standards, systems, and industry and professional expertise across multiple businesses.
We target our marketing and origination efforts at private equity firms, mid-sized companies, corporate executives, banks, real estate investors and a variety of other referral sources and financial intermediaries to develop new customer relationships and source lending opportunities. Our origination network is national in scope and we target companies with business operations across a broad range of industry sectors. We employ highly experienced bankers, marketing officers and credit professionals to identify and structure new lending opportunities and manage customer relationships. We believe that the quality of our professionals, the breadth of their relationships and referral networks, and their ability to develop creative solutions for customers position us to be a valued partner and preferred lender for mid-sized companies and private equity funds with middle market investment strategies.
Our emphasis on direct origination is an important aspect of our marketing and credit strategy. Our national network is designed around specialized origination channels intended to generate a large set of potential lending opportunities. That allows us to be highly selective in our credit process and to allocate capital to market segments that we believe represent the most attractive opportunities. Our direct origination network also generates proprietary lending opportunities with yield characteristics that we believe would not otherwise be available through intermediaries. In addition, direct origination provides us with direct access to management teams and enhances our ability to conduct detailed due diligence and credit analysis of prospective borrowers. It also allows us to negotiate transaction terms directly with borrowers and, as a result, advise our customers on financial strategies and capital structures, which we believe benefits our credit performance.
The Company typically provides financing commitments to companies in amounts that range in size from $10 million to $50 million. The size of financing commitments depends on various factors, including the type of loan, the credit characteristics of the borrower, the economic characteristics of the loan, and our role in the transaction. We also selectively arrange larger transactions that we may retain on our balance sheet or syndicate to other lenders, which may include funds that we manage for third party institutional investors. By syndicating loans to other lenders and our managed funds, we are able to provide larger financing commitments to our customers and generate fee income, while limiting our risk exposure to single borrowers. From time to time, however, our balance sheet exposure to a single borrower may exceed $35 million.
NewStar offers a set of credit products and services that have many common attributes, but which are highly specialized by lending group and market segment. Although both the Leveraged Finance and Business Credit lending groups structure loans as revolving credit facilities and term loans, the style of lending and approach to credit management is highly specialized.

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The Equipment Finance group broadens our product offering to include a range of lease financing options. The operational intensity of each product also varies by lending group.
Although NewStar operates as a single segment, the Company derives revenues from its asset management activities and four specialized lending groups that target market segments in which we believe that we have competitive advantages:
Leveraged Finance, provides senior, secured cash flow loans and, to a lesser extent, second lien and unitranche loans, which are primarily used to finance acquisitions of mid-sized companies with annual cash flow (EBITDA) typically between $10 million and $50 million by private equity investment funds managed by established professional alternative asset managers;
Business Credit, provides senior, secured asset-based loans primarily to fund working capital needs of mid-sized companies with sales revenue typically totaling between $25 million and $500 million;
Real Estate, provides first mortgage debt primarily to finance acquisitions of commercial real estate properties typically valued between $10 million and $50 million by professional commercial real estate investors;
Equipment Finance, provides leases, loans and lease lines to finance purchases of equipment and other capital expenditures typically for companies with annual sales of at least $25 million; and
Asset Management, provides opportunities for qualified institutions to invest in credit funds managed by the Company with strategies to co-invest in loans originated by its Leveraged Finance lending group.
Information regarding revenues, profits and losses and total assets of this single segment can be found in the financial statements in Item 8.
Strategic Relationship
In December of 2014, NewStar formed a strategic relationship with GSO Capital (“GSO”), the credit division of Blackstone, and Franklin Square Capital Partners (“Franklin Square”), the largest manager of business development companies, intended to expand the Company’s lending and asset management platforms. The relationship combined a series of initiatives expected to accelerate our loan growth and expand the Company’s asset management platform, with a long-term strategic investment to partially fund the related growth strategy. Under the terms of the investment, funds managed by Franklin Square and sub-advised by GSO committed to purchase $300 million of 8.25% subordinated notes due 2024 with warrants exercisable for 12 million shares of our common stock at an exercise price of $12.62 (the "warrants"). The Company issued $200 million in principal amount of the notes in December 2014. The warrants were issued in two tranches in December 2014 and January 2015. We are required to borrow the remaining $100 million of notes in increments of at least $25 million by December 2015. The Company expects to use the proceeds from the transaction to enhance its ability to originate and lead transactions across all of its specialized lending groups. As a result, we believe we will significantly increase our origination volume and facilitate the growth of our asset base. In addition, we anticipate that our relationship with GSO will result in cross-referral and co-lending opportunities, provide us with access to new channels of origination, and enable us to provide larger capital commitments and a more complete set of financing options to our clients.
Lending Groups
Our lending activities are organized into four specialized lending groups: Leveraged Finance, Business Credit, Real Estate, and Equipment Finance.
Leveraged Finance
Through our Leveraged Finance group, the Company provides senior, secured cash flow loans and, to a lesser extent, second lien and unitranche loans, to middle market companies. These companies are typically backed by established private equity groups that manage large investment funds and have proven investment track records. The proceeds of these loans are used primarily for acquisitions, recapitalizations and refinancing or other general corporate purposes. The Leveraged Finance group also provides senior secured loans to larger middle market companies with greater financing needs by participating in larger credit facilities with other lenders as a member of a syndicate.
We believe that private equity backed companies represent an attractive segment of the overall market for financing middle market companies. Commonly known as sponsored lending, this financing segment is large, often representing 30-40% of total middle market lending measured by new loan volume. Transaction activity in this financing segment is driven by an estimated 600 private equity firms in the US that specialize in investing in middle market companies. By focusing our origination activity on this universe of firms, the Company seeks to leverage its direct origination effort into significant transaction flow, as each firm typically completes several transactions per year.
We believe that NewStar is among the most active lenders focused on financing private equity backed companies in the middle market and that we have established a recognized brand in the market with a reputation as a smart, reliable lender that is

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responsive, consistent and constructive. Since inception, the Company has funded loans totaling more than $6 billion to approximately 550 companies backed by nearly 285 different financial sponsors. The Company’s national lending strategy is supported by a network of offices located across the country. We develop new customer relationships and source our loans primarily through the direct marketing and origination efforts of our bankers. The Company’s bankers call directly on prospective clients and referrals sources from this network of offices. They have established relationships with a wide range of prospective customers and referral sources, including approximately 285 private equity groups with investment strategies focused on the middle market, mid-sized companies, corporate executives, banks, other non-bank “club” lenders, and investment banks. To a lesser extent, we may also source loans and other debt products by participating in larger credit facilities syndicated by other lenders.
We generally compete for lending opportunities on the basis of our reputation and transaction experience. Through our strategic relationship, we also expect to originate financing opportunities from referrals of transactions in which we co-lend with Franklin Square or other affiliates of GSO. We believe that our strategic relationship will also help us compete more effectively for lending opportunities by enabling us to provide larger credit commitments and “one-stop” financing solutions to customers comprised of unitranche loans or a combination of senior and junior debt capital in partnership with GSO or Franklin Square.
NewStar offers a range of senior debt financing options, including revolving credit facilities, term loans and other debt products secured by a variety of business assets. Loans are typically structured to mature in five to six years and require monthly or quarterly interest payments at variable rates based on a spread to LIBOR or the prime rate, many with interest rate floors. Through our strategic relationship, we also seek to offer a more complete range of debt financing options, including second lien term loans, unitranche term loans, subordinated notes and, to a lesser extent, private equity co-investments.
We target mid-sized companies operating in a broad range of industries and market segments where we believe that we have competitive advantages and significant lending and underwriting experience, including:
healthcare;
manufacturing and industrial;
financial services;
energy/chemical services;
printing/publishing;
consumer, retail and restaurants; and
business and technology services.
Our loans and other debt products, which may be part of larger credit facilities, typically range in size from $10 million to $50 million, although we generally limit the size of the loans that we retain to $25 million. In certain cases, however, our loans and debt products may exceed $35 million. We also have the capability to arrange significantly larger transactions which we syndicate to other lenders, including funds that we manage. As a result of syndication and asset management activities, our exposure to certain loans and other debt products may exceed $35 million from time to time through “Loans held-for-sale,” which represent amounts in excess of our target hold for investment position.
The Company has well established lending guidelines and transaction parameters. We focus on transactions with established companies that have strong market positions in targeted industry sectors. Our borrowers are typically unrated, but have credit profiles that we believe are comparable to B1/B2/B3 rated companies due to their limited size and use of leverage. The Company’s preference is generally to finance acquisitions and other productive uses of capital subject to structural parameters, such as maximum leverage, that can vary significantly depending on the facts and circumstances of each situation. Substantially all the Company’s loans have significant lender protections, including financial covenants that are set at levels with cushions to projected financial performance. They also typically include restrictive covenants and mandatory prepayment provisions that limit borrowers’ ability to incur additional indebtedness and make acquisitions. Many transactions also include an excess cash flow recapture provision, which is designed to accelerate debt repayment and de-leveraging.
NewStar is also selective in targeting transaction sponsors, focusing on more established firms with between $500 million and several billion dollars of committed capital managed across multiple funds. The Company invests significant resources in developing relationships with target sponsors and understanding their respective investment strategies, performance track records, access to capital, and industry focus, as well as the backgrounds of their investment professionals. Our management believes that a significant factor in the Company’s success has been the quality of its private equity franchise and the breadth of relationships it has developed with private equity firms. In many cases, the relationships that members of our management have with investment professionals at these firms extend from early in their professional careers. We believe the value created by our private equity relationships is reflected in the transaction flow that the Company generates and in the repeat business we have experienced with targeted sponsors.

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NewStar’s origination and credit strategies are strongly influenced by industry dynamics. The Company has invested in the development of an experienced staff of portfolio managers with deep industry expertise responsible for covering nine broad industry sectors. These portfolio managers maintain extensive networks of industry contacts in their respective industries and employ a research-driven framework to develop insights into these sectors intended to guide origination strategy and credit selection.
As of December 31, 2014, our Leveraged Finance loan portfolio totaled $2.3 billion in funding commitments and $2.1 billion in balances outstanding, representing 81.4% of our loan portfolio. This represented 189 transactions with an average balance outstanding of approximately $11.3 million. During 2014, we originated $1.6 billion of new Leveraged Finance loans, of which we retained $1.0 billion and originated $583.4 million for credit funds.
Business Credit
Through its Business Credit lending group, NewStar provides working capital financing to asset-intensive companies that typically borrow against the value of their inventory and accounts receivable. These asset-based loans may also be used to support other business purposes, including acquisitions and recapitalizations, as well as growth strategies. Typical borrowers generate sales revenue between $25 million and $500 million and operate across a range of industry sectors. The Company generally provides revolving credit facilities in amounts linked to borrowers’ expected working capital needs and may also provide term loans backed by longer term assets and other excess collateral.
This type of fully-followed, asset-based lending is highly credit and operationally intensive. As part of the underwriting process and ongoing management of credit relationships, Business Credit tracks collateral values and performs regular field audits to confirm financial and borrowing base reporting. Audit results and appraisals are used to determine collateral eligibility and advance rates. Collateral values are tracked by specialized collateral analysts and daily borrowing activity is managed by collateral analysts and experienced account executives.
Nearly all of our asset-based lending relationships require dominion over borrowers’ cash. Cash dominion gives us significant control of a borrowers’ cash flow, including collections of all accounts receivable through lock-boxes controlled by the Company. This also facilitates subsequent disbursements of cash to repay advances under the credit line or for other corporate purposes including paying vendors, employees and others. We also verify receivables in certain circumstances, which involves verification specialists contacting account debtors of borrowers to confirm the existence and amount of receivables pledged as collateral.
Business Credit develops lending opportunities and sources transactions through an extensive network of long-standing relationships with corporate executives, private equity firms, intermediaries, turnaround consultants, banks and other referral sources. With our main Business Credit office in Dallas and marketing offices in Boston, Chicago, Los Angeles, Portland and San Francisco, we have a national asset-based lending origination platform capable of originating significant loan volume. The group’s centralized marketing effort combined with regional sales coverage is designed to generate a significant flow of prospects and capitalize on the most attractive lending opportunities in the market.
The Business Credit group also anticipates to benefit from the strategic relationship with Franklin Square and GSO by offering asset-based revolving credit facilities as a co-lender with them. We also expect to provide financing for companies referred to us by GSO or Blackstone that are experiencing some financial stress or completing turnarounds.
Asset-based loans originated by this group typically range in size from $5 million to $50 million. We also have the ability to arrange significantly larger transactions that we may syndicate to others.
Business Credit targets mid-sized companies in a variety of asset-intensive industries for our asset-based loans including:
business services;
auto/transportation;
marketing;
retail;
general manufacturing;
wholesale distribution; and
technology.
Our asset-based credit products include the following:
revolving lines of credit; and
senior secured term loans.
In determining our borrowers’ ability and willingness to repay loans, our Business Credit group conducts a detailed due diligence investigation to assess financial reporting accuracy and capabilities as well as to verify the values of business assets among other things. We employ third parties to conduct field exams to audit financial reporting and to appraise the value of certain types of collateral in order to estimate its liquidation value. Financing arrangements with our customers also typically

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include substantial controls over the application of borrowers’ cash and we typically retain discretion over collateral advance rates and eligibility among other key terms and conditions.
As of December 31, 2014 our Business Credit loan portfolio totaled $419.8 million in funding commitments and $286.9 million in balances outstanding, representing 10.9% of our loan portfolio. This represented 38 transactions with an average balance outstanding of approximately $7.6 million. During 2014, we originated $119.1 million of new asset-based loans.
Real Estate
Our Real Estate group provides first mortgage, transitional financing to professional real estate investors and developers to acquire and reposition commercial properties typically valued between $10 million and $50 million. We source our commercial real estate loans primarily through property investors, specialized commercial real estate brokers, regional banks and other financial intermediaries, as well as through our strategic partners.
Approximately $105.4 million of our aggregate loan portfolio is comprised of loans secured by first mortgages on commercial properties. The collateral to the commercial real estate loan portfolio consists of a range of property types located across the US in significant metropolitan statistical areas with a modest concentration in loans secured by suburban office buildings.
The Company typically finances the acquisition of properties valued between $10 and $50 million as the sole lender without recourse to the sponsor. Loans are most often structured with an initial term of three years with two one year extension options. These loans generally do not provide for scheduled amortization and the primary source of repayment is refinancing upon stabilization of the property or sale. We generally hold back a portion of loan proceeds to fund improvements, tenant build-outs, and interest reserves.
After curtailing new lending activity in this group due to the dislocation in the real estate market during the financial crisis and ensuing recession, we have restarted real estate lending activity in connection with our new strategic relationships.
We have a selective focus on property types where we have significant lending and underwriting experience, including:
office;
multi-family;
retail; and
industrial.
Our focus on property types may vary by geographic region based on both economic fundamentals and underlying local market conditions that impact the demand for real estate. Our loans typically range in size from $10 million to $35 million. Although we generally limit loan sizes to $25 million, our exposure to certain loans and other debt products may exceed $30 million from time to time.
For our commercial real estate loans, we perform due diligence and credit analyses that focus on the following key considerations:
the sponsor’s history, capital and liquidity, and portfolio of other properties;
the property’s historical and projected cash flow as a primary source of repayment;
tenant creditworthiness;
the borrower’s plan for the subject property, including refinancing options upon stabilization as a secondary source of repayment;
the property’s condition;
local real estate market conditions;
loan-to-value based on independent third-party appraisals;
the borrower’s demonstrated operating capability and creditworthiness;
licensing and environmental issues related to the property and the borrower; and
the borrower’s management.
As of December 31, 2014 our Real Estate loan portfolio totaled $108.9 million in funding commitments and $105.4 million in balances outstanding, representing 4.0% of our total loan portfolio. This represented seven lending relationships with an average balance outstanding of approximately $15.1 million. During 2014, we did not originate any new commercial real estate loans.


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Equipment Finance
Our Equipment Finance group provides a range of equipment loan and lease financing options to mid-sized companies to fund various types of capital expenditures. We originate equipment loans and leases through a team of experienced marketing officers who develop new business directly with prospective lessees. We continue to expand our internal sales and marketing efforts to cross-sell leases to our existing customers and call directly on other end-users in the market, including portfolio companies owned by private equity investment firms with whom we have established relationships through our Leveraged Finance group.
We finance essential-use equipment for mid-sized businesses nationwide. Our Equipment Finance group offers a variety of leases and loan products with various end-of-term options to fund a wide range of equipment types, including manufacturing, technology, healthcare, transportation, and telecom equipment. Targeted transaction sizes range from $1.0 million to $20 million. We also offer lease lines to meet customers’ needs for planned capital expenditures. We focus on companies with annual sales of at least $25 million across a broad array of industries, including business services, healthcare, telecommunications, financial services, education, retail and manufacturing.
As of December 31, 2014, our Equipment Finance portfolio totaled $96.7 million in funding commitments and balances outstanding, representing 3.7% of our loan portfolio. This represented 50 transactions with an average balance outstanding of approximately $1.7 million. During 2014, we originated $67.1 million of new equipment finance products.
Asset Management
As a registered investment adviser since 2012, NewStar offers investment products for qualified institutions to invest in private credit funds managed by the Company.
We believe that NewStar was among the first independent commercial finance companies to develop an asset management platform to provide investment strategies targeting middle market loans. The Company launched its first fund in 2005, which was called NewStar Credit Opportunities Fund ("NCOF) to co-invest in loans originated by the Company. The fund was capitalized with $150 million of equity from third party investors. This equity commitment was then levered to support an investment portfolio of $600 million using bank credit facilities to support the initial ramp-up followed by a securitization, to provide long-term match funding for the fund’s assets. The Company launched the $300 million Arlington Fund in 2013. It was increased to $400 million in 2014, and also employed leverage through a loan securitization. The Company closed its third fund, a $400 million levered fund known as the Clarendon Fund in 2014, with an anchor equity investment from funds sponsored by Franklin Square and sub-advised by GSO. As part of our strategic relationship, we intend to offer GSO and Franklin Square opportunities to invest additional capital in future lending vehicles managed by NewStar.
The Company’s asset management activities provide opportunities for both high margin fee revenue and important strategic benefits. We earn management fees for our role as the investment manager for our funds with little incremental expense because the funds invest in the same loans that are being originated and underwritten by us for our own account. Compensation as investment manager is comprised of both base management fees and incentive fees. We also enjoy important strategic benefits from the management of credit funds because we believe that our competitive position is enhanced by providing more capital to our customers, while limiting our direct balance sheet risk.
NewStar is currently investing in the Arlington Fund and the Clarendon Fund, as we return capital to investors in our first fund, following the expiry of its investment period. The Company’s managed funds are allocated a portion of the loans we originate based on an established allocation policy that defines a set of rules for managing this activity.
As of December 31, 2014, NewStar’s managed assets totaled $950 million with $400 million managed in each of the Arlington Fund and the Clarendon Fund and $39 million remaining in the NCOF. The Company also manages assets for its own account through a total return swap that references a portfolio of approximately $110 million.
Our asset management revenue was approximately $1.0 million in 2014 and $2.5 million in 2013.
Loans and Other Debt Products
Senior secured cash flow loans
Our senior secured cash flow loans are provided by our Leveraged Finance group. We underwrite these loans based on the cash flow, profitability and enterprise value of the borrower, with the value of any tangible assets as secondary protection. These loans are generally secured by a first-priority security interest in all or substantially all of the borrowers’ assets and, in certain transactions, the pledge of their common stock.
As of December 31, 2014, senior secured cash flow loans totaled $2.2 billion in funding commitments and $2.0 billion in balances outstanding, representing 77.9% of our loan portfolio.

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Senior secured asset-based loans
Our senior secured asset-based loans are provided primarily by our Business Credit group, and to a lesser degree by our Leveraged Finance group, and are secured by a first-priority lien on tangible assets and have a first-priority in right of payment. Senior secured asset-based loans are typically advanced under revolving credit facilities against a borrowing base comprised of collateral, including eligible accounts receivable, inventories and other long-term assets.
As of December 31, 2014, senior secured asset-based loans totaled $518.7 million in funding commitments and $385.9 million in balances outstanding, representing 14.7% of our loan portfolio.
First mortgage loans
Our first mortgage loans are provided by our Real Estate group and are secured by a mortgage bearing a first lien on the real property serving as collateral. Our first mortgage loans require borrowers to demonstrate satisfactory collateral value at closing through a third party property appraisal and typically contain provisions governing the use of property operating cash flow and disbursement of loan proceeds during the term of the loan.
As of December 31, 2014, first mortgage loans totaled $108.9 million in funding commitments and $105.4 million in balances outstanding, representing 4.0% of our loan portfolio.
Other
Our other loans and debt products are categorized as $50.8 million of senior subordinated asset-based (which are equal as to collateral and subordinate as to right of payment to other senior lenders), $33.1 million of second lien (which are second liens on all or substantially all of a borrower’s assets, and in some cases, junior in right of payment to senior lenders), and $6.4 million of mezzanine/subordinated (which are subordinated as to rights to collateral and right of payment to senior lenders).
Loan Portfolio
The Company’s loan portfolio is comprised of loans, leases and other debt products. As of December 31, 2014, the loan portfolio totaled approximately $2.9 billion of funding commitments, representing $2.6 billion of balances outstanding and $0.3 billion of funds committed but undrawn as of December 31, 2014. Loans originated by our Leveraged Finance group comprised 81.4% of the portfolio, while 10.9% of the loan portfolio was originated by our Business Credit and Equipment Finance lending groups, 4.0% comprised of commercial mortgages originated by our Real Estate lending group, and the remaining 3.7% was originated by our Equipment Finance group as of December 31, 2104. Consistent with our strategy to focus on senior secured lending, first lien senior debt represented 96.6% of the portfolio.
As of December 31, 2014, we had seven loans with outstanding balances greater than $25.0 million. In most of these cases, we either sought to maximize our potential recovery of the outstanding principal by adding to our position through a workout or our hold size increased as a result of a portfolio purchase, syndication or through asset management activities. As of December 31, 2014, we had two impaired loans that had an outstanding balance greater than $30 million. As of December 31, 2014 our largest outstanding loan was 1.4% of our loan portfolio, and the top ten outstanding loans comprised 10.2% of our loan portfolio.
Loan Portfolio Overview
The following tables present information regarding the outstanding balances of our loans and other debt products:
 
December 31,
 
2014
 
2013
 
2012
 
($ in thousands)
Composition Type
 
 
 
 
 
 
 
 
 
 
 
First mortgage
$
105,394

 
4.0
%
 
$
123,029

 
5.2
%
 
$
177,462

 
9.5
%
Senior secured asset-based
385,882

 
14.7

 
239,314

 
10.1

 
201,219

 
10.7

Senior secured cash flow
2,044,126

 
77.9

 
1,948,965

 
82.4

 
1,448,182

 
77.3

Other
90,320

 
3.4

 
54,031

 
2.3

 
47,400

 
2.5

Total
$
2,625,722

 
100.0
%
 
$
2,365,339

 
100.0
%
 
$
1,874,263

 
100.0
%

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December 31,
 
2014
 
2013
 
2012
 
($ in thousands)
Composition by Lending Group
 
 
 
 
 
Leveraged Finance
$
2,136,744

 
$
2,005,325

 
$
1,499,833

Business Credit
286,918

 
182,633

 
177,587

Real Estate
105,394

 
123,029

 
177,478

Equipment Finance
96,666

 
54,352

 
19,365

Total
$
2,625,722

 
$
2,365,339

 
$
1,874,263

 
December 31, 2014
 
Percentage of
Leveraged
Finance
 
Percentage of
Loan Portfolio
Leveraged Finance by Industry
 
 
 
Industrial/other
18.2
%
 
14.8
%
Other business services
14.3

 
11.6

Manufacturing—consumer non-durable
10.4

 
8.5

Financial services
8.3

 
6.7

Healthcare
7.3

 
5.9

Manufacturing—consumer durable
6.6

 
5.4

Auto/Transportation
6.1

 
5.0

Cable/Telecom
5.1

 
4.1

Energy/Chemical Services
4.5

 
3.7

Restaurants
4.2

 
3.5

Consumer services
3.1

 
2.5

Environmental services
2.9

 
2.3

Tech services
2.7

 
2.2

Printing/Publishing
2.4

 
1.9

Marketing services
1.6

 
1.3

Entertainment/Leisure
1.0

 
0.9

Building materials
0.8

 
0.6

Retail
0.4

 
0.4

Broadcasting
0.1

 
0.1

Total
100.0
%
 
81.4
%

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December 31, 2014
 
Percentage of
Business Credit
 
Percentage of
Loan Portfolio
Business Credit by Industry
 
 
 
Other Business Services
34.9
%
 
3.8
%
Manufacturing—consumer non-durable
19.8

 
2.2

Auto/Transportation
11.8

 
1.3

Building materials
10.5

 
1.1

Industrial/other
8.6

 
0.9

Retail
6.8

 
0.8

Entertainment/Leisure
2.4

 
0.3

Manufacturing—consumer durable
2.0

 
0.2

Printing/Publishing
1.6

 
0.2

Healthcare
1.4

 
0.1

Marketing services
0.2

 

Total
100.0
%
 
10.9
%
 
December 31, 2014
 
Percentage of
Real Estate
 
Percentage of
Loan Portfolio
Real Estate by Property Type
 
 
 
Office
62.7
%
 
2.5
%
Retail
21.0

 
0.8

Multi-family
16.3

 
0.7

Total
100.0
%
 
4.0
%
 
December 31, 2014
 
Percentage of
Equipment
Finance
 
Percentage of
Loan Portfolio
Equipment Finance by Industry
 
 
 
Industrial/other
22.0
%
 
0.8
%
Other business services
19.4

 
0.7

Auto/Transportation
17.4

 
0.6

Printing/Publishing
9.6

 
0.3

Energy/Chemical Services
7.7

 
0.3

Environmental services
5.5

 
0.2

Cable/Telecom
5.1

 
0.2

Healthcare
4.6

 
0.2

Building materials
3.3

 
0.1

Financial services
1.6

 
0.1

Restaurants
1.5

 

Retail
0.9

 

Manufacturing - consumer non-durable
0.9

 

Marketing services
0.3

 

Tech services
0.2

 

Total
100.0
%
 
3.5
%



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The table below shows the final maturities of our loan portfolio as of December 31, 2014:
 
Due in One
Year or Less
 
Due in One to
Five Years
 
Due After
Five Years
 
Total
 
($ in thousands)
Senior secured cash flow
$
68,577

 
$
1,748,997

 
$
226,552

 
$
2,044,126

Senior secured asset-based
95,048

 
282,698

 
8,136

 
385,882

First mortgage
62,386

 
43,008

 

 
105,394

Other
6,000

 
26,239

 
58,081

 
90,320

Total
$
232,011

 
$
2,100,942

 
$
292,769

 
$
2,625,722

The table below shows the outstanding balances of fixed-rate and adjustable-rate loans and other debt products as of December 31, 2014:
 
Fixed-
Rate(1)
 
Adjustable-
Rate(2)(3)
 
Total
 
($ in thousands)
Senior secured cash flow
$
4,847

 
$
2,039,279

 
$
2,044,126

Senior secured asset-based
96,666

 
289,216

 
385,882

First mortgage

 
105,394

 
105,394

Other

 
90,320

 
90,320

Total
$
101,513

 
$
2,524,209

 
$
2,625,722

(1)
As of December 31, 2014, we did not have any interest-rate protection products against the $101.5 million of fixed-rate loans and other debt products outstanding.
(2)
As of December 31, 2014, we had interest rate floors on $2.1 billion of adjustable-rate loans outstanding.
(3)
As of December 31, 2014, adjustable-rate loans include $87.8 million of non-accrual loans.

NewStar is a Delaware corporation that was incorporated in 2004. Our principal executive office is located at 500 Boylston Street, Suite 1250, Boston, Massachusetts 02116, and our telephone number is (617) 848-2500. We maintain a website at www.newstarfin.com.
Recent Developments
Strategic Relationship
On November 4, 2014, we announced a strategic relationship GSO and Franklin Square and entered into an investment agreement with FS Investment Corporation, FS Investment Corporation II, and FS Investment Corporation III (collectively the “Franklin Square Funds”) pursuant to which we agreed to issue $300 million of 8.25% subordinated notes due 2024 and warrants exercisable for 12 million shares of the Company’s common stock at an exercise price of $12.62 per share (the “Warrants”).
On December 4, 2014, we issued $200 million of the subordinated notes. The Warrants were issued in two tranches on December 4, 2014 and January 23, 2015. We are required to issue the remaining $100 million of 8.25% subordinated notes due 2024 within one year of the initial purchase.
Clarendon Fund
In December 2014, we formed a new managed credit fund, NewStar Clarendon Fund CLO ("Clarendon Fund") a $400 million middle market CLO used to provide leverage for a managed credit fund anchored by an investment from funds sponsored by Franklin Square Capital Partners and sub-advised by GSO Capital, the credit division of Blackstone, to co-invest in middle market commercial loans originated by the Company. In January 2015, we completed the sale of the Clarendon Fund's CLO bonds to third party investors. As of December 31, 2014, the Clarendon Fund loan portfolio had an outstanding balance of approximately $236.7 million.



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Liquidity
On January 13, 2015, we entered into an amendment to our credit facility with Wells Fargo Bank, National Association to fund leveraged finance loans. The amendment increased the commitment amount under the credit facility from $275.0 million to $375.0 million, increased the amount by which the commitment amount may be increased to up to $425.0 million, and modified certain concentration amounts and specified threshold amounts, among other things.
Stock Repurchase Program
On December 22, 2014, the Company repurchased 1,000,000 shares of its common stock in a privately negotiated transaction with an unaffiliated third party for an aggregate purchase price of $10.2 million. This transaction was not made under the stock repurchase program announced on August 13, 2014 described below.
On August 13, 2014, our Board of Directors authorized the repurchase of up to $10.0 million of the Company’s common stock from time to time on the open market or in privately negotiated transactions. The timing and amount of any shares purchased are determined by our management based on its evaluation of market conditions and other factors. The repurchase program, which will expire on August 15, 2015 unless extended by the Board of Directors, may be suspended or discontinued at any time without notice. As of December 31, 2014, we had repurchased 382,999 shares of our common stock under this program at a weighted average price per share of $11.54.
Competition
Our markets are highly competitive and are characterized by competitive factors that vary based upon product and geographic region. We currently compete with a large number of financial services companies, including:
specialty and commercial finance companies, including business development companies;
private investment funds and hedge funds;
national and regional banks;
investment banks; and
insurance companies.
The markets in which we operate are fragmented. We compete based on the following factors, which vary by industry, asset class and property types:
the interest rates and other pricing and/or loan or other debt product terms;
the quality of our people and their relationships;
our knowledge of our customers’ industries and business needs;
the flexibility of our product offering;
the responsiveness of our process; and
our focus on customer service.
Regulation
Some aspects of our operations are subject to supervision and regulation by state and federal governmental authorities and may be subject to various laws and regulations imposing various requirements and restrictions, which, among other things:
regulate credit granting activities, including establishing licensing requirements in some jurisdictions;
establish the maximum interest rates, finance charges and other fees we may charge our customers;
govern secured transactions;
require specified information disclosures to our customers;
set collection, foreclosure, repossession and claims handling customer procedures and other trade practices;
regulate our customers’ insurance coverage;
prohibit discrimination in the extension of credit and administration of our loans; and
regulate the use and reporting of information related to a customer’s credit experience.
Many of our competitors are subject to more extensive supervision and regulation. If we were to become subject to similar supervision or regulation in the future, it could impact our ability to conduct our business.

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During 2012, we registered as an investment adviser under the Investment Adviser Act of 1940 (the “Advisers Act”) as a result of SEC rules promulgated under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The Advisers Act imposes numerous obligations on such registered investment advisers including fiduciary duties, disclosure obligations and record-keeping, operational and marketing requirements. Registered investment advisers are required by the SEC to adopt and implement written policies and procedures designed to prevent violations of the Advisers Act and to designate a chief compliance officer responsible for administering these policies and procedures. The SEC is authorized to institute proceedings and impose sanctions for violations for the Advisers Act, which may include fines, censure or the suspension or termination of an investment adviser’s registration.
Employees
As of December 31, 2014, we employed 98 people compared to 101 people at December 31, 2013. At December 31, 2014, our origination group had 34 employees, including 27 bankers who were either managing directors, directors or vice presidents, and seven associates and analysts. Our credit organization had 23 employees, including eight managing directors. Additionally, we employed 41 people who were involved in operational or administrative roles. We believe our relations with our employees are good. We had 99 employees as of February 27, 2015.
Available Information
NewStar files Annual, Quarterly and Current Reports, proxy statements and other information with the Securities and Exchange Commission (SEC). These documents are available free of charge at www.newstarfin.com shortly after such material is electronically filed with or furnished to the SEC. In addition, NewStar’s codes of business conduct and ethics as well as the various charters governing the actions of certain of NewStar’s Committees of its Board of Directors, including its Audit Committee, Risk Policy Committee, Compensation Committee and its Nominating and Corporate Governance Committee, are available at www.newstarfin.com. References to our website are not intended to incorporate information on our website into this Annual Report by reference.
The public may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers, including NewStar, that file electronically with the SEC, which is available at www.SEC.gov.
We will provide to any shareholder, upon request and without charge, copies of these documents (excluding any applicable exhibits unless specifically requested). Written requests should be directed to: Investor Relations, NewStar Financial, Inc., 500 Boylston St., Suite 1250, Boston, Massachusetts 02116.
Item 1A.
Risk Factors
The following are important risks and uncertainties we have identified that could materially affect our future results. You should consider them carefully when evaluating forward-looking statements contained in this Annual Report and otherwise made by us or on our behalf because these contingencies could cause actual results and circumstances to differ materially from those projected in forward-looking statements. The Company’s actual future results and trends may differ materially depending on a variety of factors including, but not limited to, the risks and uncertainties discussed below. If any of those contingencies actually occurs, our business, financial condition and results of operations could be negatively impacted and the trading price of our common stock could decline.
Risks Related to Our Loan Portfolio and Lending Activities
We may not recover all amounts contractually owed to us by our borrowers resulting in charge-offs, impairments and non-accruals, which may exceed our allowance for credit losses and could negatively impact our financial results and our ability to secure additional funding.
We charged off $25.4 million of loans during 2014, and expect to have additional credit losses in the future through the normal course of our lending operations. If we were to experience a material increase in credit losses exceeding our allowance for loan losses in the future, our assets, net income and operating results would be adversely impacted, which could also lead to challenges in securing additional financing.
As of December 31, 2014, we had delinquent loans of $43.6 million and had loans with an aggregate outstanding balance of $217.2 million classified as impaired. Of these impaired loans, loans with an aggregate outstanding balance of $87.8 million at December 31, 2014 were also on non-accrual status.

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Like other commercial lenders, we experience delinquencies, impairments and non-accruals, which may indicate that our risk of credit loss for a particular loan has materially increased. When a loan is over 90 days past due or if management believes it is probable that we will be unable to collect principal and interest contractually owed to us, it is our policy to place the loan on non-accrual status and classify it as impaired. In certain circumstances, a loan can be classified as impaired, but continue to be performing as a result of a troubled debt restructuring.
As of December 31, 2014, we had an allowance for credit losses of $43.7 million, including specific reserves of $20.7 million. Management periodically reviews the appropriateness of our allowance for credit losses. However, the relatively limited history of our loans and leases makes it difficult to judge the expected credit performance of our loans and leases, as it may not be predictive of future losses. Our estimates and judgments with respect to the appropriateness of our allowance for credit losses may not be accurate, and the assumptions we use to make such estimates and judgments may not be accurate. Moreover, the estimates and judgments we make regarding workout loans are more sensitive to our assumptions regarding the appropriateness of our allowance for credit losses. Our allowance may not be adequate to cover credit or other losses related to our loans and leases as a result of unanticipated adverse changes in the economy or events adversely affecting specific customers, industries or markets. If we were to experience material credit losses related to our loans, such losses could adversely impact our ability to fund future loans and our business and, to the extent losses exceed our allowance for credit losses, our results of operations and financial condition would be adversely affected.
We may have hold positions that exceed our targets which may result in more volatility in the performance of our loan portfolio.
Our loans and other debt products, which may be part of larger credit facilities, typically range in size from $10 million to $50 million, although we generally limit the size of the loans that we retain to $25 million. In certain cases, however, our loans and debt products may exceed $35 million. We also have the capability to arrange significantly larger transactions that we syndicate to other lenders, including funds that we manage. As a result of syndication and asset management activities, our exposure to certain loans and other debt products may exceed $35 million from time to time through “Loans held-for-sale,” which represent amounts in excess of our target hold for investment position. As of December 31, 2014, we had seven loans that had an outstanding balance greater than $25 million. In each of these cases, we either sought to maximize our potential recovery of the outstanding principal by adding to our position through a workout or our hold size increased as a result of a portfolio purchase, syndication or through asset management activities. As of December 31, 2014, we had two impaired loans that had outstanding balances greater than $30 million. If a borrower in one of these larger hold positions were to experience difficulty in adhering to the repayment terms of its loan with us, the negative impact to our results of operations and financial condition could be greater than a loan within our general size limits.
Disruptions in global financial markets have and may continue to increase the number of charge-offs, impairments and non-accruals in our loan portfolio, which may exceed our allowance for credit losses and could negatively impact our financial results.
Our business, financial condition and results of operations may be adversely affected by the economic and business conditions in the markets in which we operate. Delinquencies, non-accruals and credit losses generally increase during economic slowdowns or recessions. Our Leveraged Finance, Business Credit and Equipment Finance groups primarily consist of loans and leases to small and medium-sized businesses that may be particularly susceptible to economic slowdowns or recessions and may be unable to make scheduled payments of interest or principal on their borrowings during these periods. In our Real Estate group, the recent economic slowdown and recession has led to increases in payment defaults on the underlying commercial real estate. Therefore, to the extent that economic and business conditions are unfavorable, our non-performing assets are likely to remain elevated and the value of our loan portfolio is likely to decrease. Adverse economic conditions also may decrease the estimated value of the collateral, particularly real estate, securing some of our loans or other debt products. As a result, we may have certain commercial real estate loans that we have not classified as impaired with outstanding balances greater than the estimated value of the underlying collateral. Further or prolonged economic slowdowns or recessions could lead to financial losses in our loan portfolio and a decrease in our net interest income, net income and book value.
We make loans primarily to privately-owned, small and medium-sized companies that may carry more inherent risk and present an increased potential for loss than loans to larger companies.
Our loan portfolio consists primarily of loans to small and medium-sized, privately-owned companies, most of which do not publicly report their financial condition. Compared to larger, publicly-traded firms, loans to these types of companies may carry more inherent risk. The companies that we lend to generally have more limited access to capital and higher funding costs, may be in a weaker financial position, may need more capital to expand or compete, and may be unable to obtain financing from public capital markets or from traditional sources, such as commercial banks. Accordingly, loans and leases made to these types of customers involve higher risks than loans and leases made to companies that have larger businesses, greater financial

14


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resources or are otherwise able to access traditional credit sources. Numerous factors may make these types of companies more vulnerable to variations in results of operations, changes impacting their industry and changes in general market conditions. Companies in this market segment also face intense competition, including from companies with greater financial, technical, managerial and marketing resources. Any of these factors could impair a customer’s cash flow or result in other adverse events, such as bankruptcy, which could limit a customer’s ability to make scheduled payments on our loans and leases, and may lead to losses in our loan portfolio and a decrease in our net interest income, net income and book value.
Additionally, because most of our customers do not publicly report their financial condition, we are more susceptible to a customer’s fraud, which could cause us to suffer losses on our loan portfolio. The failure of a customer to accurately report its financial position, compliance with loan covenants or eligibility for additional borrowings could result in our providing loans, leases or other debt products that do not meet our underwriting criteria, defaults in loan and lease payments, the loss of some or all of the principal of a particular loan or loans, including, in the case of revolving loans, amounts we may not have advanced had we possessed complete and accurate information.
Our concentration of loans and other debt products within a particular industry or region could impair our financial condition or results of operations if that industry or region were to experience adverse changes to economic or business conditions.
We specialize in certain broad industry segments, such as business services, industrial, manufacturing and healthcare in which our bankers have experience and strong networks of proprietary deal sources and our credit personnel have significant underwriting expertise. As a result, our portfolio currently has and may develop other concentrations of risk exposure related to those industry segments. If industry segments in which we have a concentration of investments experience adverse economic or business conditions, our delinquencies, default rate and loan charge-offs in those segments may increase, which may negatively impact our financial condition and results of operations.
Our balloon and bullet transactions may involve a greater degree of risk than other types of loans.
As of December 31, 2014, balloon and bullet transactions represented 92% of the outstanding balance of our loan portfolio. Balloon and bullet loans involve a greater degree of risk than other types of transactions because they are structured to allow for either small (balloon) or no (bullet) principal payments over the term of the loan, requiring the borrower to make a large final payment upon the maturity of the loan. The ability of our customers to make this final payment upon the maturity of the loan typically depends upon their ability either to refinance the loan prior to maturity or to generate sufficient cash flow to repay the loan at maturity. The ability of a customer to accomplish any of these goals will be affected by many factors, including the availability of financing at acceptable rates to the customer, the financial condition of the customer, the marketability of the related collateral, the operating history of the related business, tax laws and the prevailing general economic conditions. Consequently, the customer may not have the ability to repay the loan at maturity, and we could lose all or most of the principal of our loan. Given their relative size and limited resources and access to capital, our small and mid-sized customers may have difficulty in repaying or financing their balloon and bullet loans on a timely basis or at all.
Our cash flow transactions are not fully covered by the value of tangible assets or collateral of the customer and, consequently, if any of these transactions become non-performing, we could suffer a loss of some or all of our value in the assets.
Cash flow lending involves lending money to a customer based primarily on the expected cash flow, profitability and enterprise value of a customer, with the value of any tangible assets as secondary protection. In some cases, these loans may have more leverage than traditional bank debt. As of December 31, 2014, cash flow transactions comprised $2.0 billion, or 78%, of the outstanding balance of our loan portfolio. In the case of our senior cash flow loans, we generally take a lien on substantially all of a customer’s assets, but the value of those assets is typically substantially less than the amount of money we advance to the customer under a cash flow transaction. In addition, some of our cash flow loans may be viewed as stretch loans, meaning they may be at leverage multiples that exceed traditional accepted bank lending standards for senior cash flow loans. Thus, if a cash flow transaction becomes non-performing, our primary recourse to recover some or all of the principal of our loan or other debt product would be to force the sale of all or part of the company as a going concern. Additionally, we may obtain equity ownership in a borrower as a means to recover some or all of the principal of our loan. The risks inherent in cash flow lending include, among other things:
reduced use of or demand for the customer’s products or services and, thus, reduced cash flow of the customer to service the loan and other debt product as well as reduced value of the customer as a going concern;
inability of the customer to manage working capital, which could result in lower cash flow;
inaccurate or fraudulent reporting of our customer’s positions or financial statements;

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economic downturns, political events, regulatory changes, litigation or acts of terrorism that affect the customer’s business, financial condition and prospects; and
our customer’s poor management of their business.
Additionally, many of our customers use the proceeds of our cash flow transactions to make acquisitions. Poorly executed or poorly conceived acquisitions can tax management, systems and the operations of the existing business, causing a decline in both the customer’s cash flow and the value of its business as a going concern. In addition, many acquisitions involve new management teams taking over control of a business. These new management teams may fail to execute at the same level as the former management team, which could reduce the cash flow of the customer available to service the loan or other debt product, as well as reduce the value of the customer as a going concern.
If interest rates rise, demand for our loans or other debt products may decrease and some of our existing customers may be unable to service interest on their loans or other debt products.
Most of our loans and other debt products bear interest at floating interest rates subject to floors. To the extent interest rates increase, monthly interest obligations owed by our customers to us will also increase. Demand for our loans or other debt products may decrease as interest rates rise or if interest rates are expected to rise in the future. In addition, if prevailing interest rates increase, some of our customers may not be able to make the increased interest payments or refinance their balloon and bullet transaction, resulting in payment defaults and loan impairments. Conversely if interest rates decline, our customers may refinance the loans they have with us at lower interest rates, or with others, leading to lower revenues.
Errors by, or dishonesty of, our employees in making credit decisions or in our loan and other debt product servicing activities could result in credit losses and harm our reputation.
We rely heavily on the performance and integrity of our employees in making our initial credit decisions with respect to our loans and other debt products and in servicing our loans and other debt products after they have closed. Because there is generally little or no publicly available information about our customers, we cannot independently confirm or verify the information our employees provide us for use in making our credit and funding decisions. Errors by our employees in assembling, analyzing or recording information concerning our customers could cause us to originate loans or fund subsequent advances that we would not otherwise originate or fund, which could result in loan losses. Losses could also arise if any of our employees were dishonest, particularly if they colluded with a customer to misrepresent the creditworthiness of a prospective customer or to provide inaccurate reports regarding the customer’s compliance with the covenants in its loan or other debt products agreement. If, based on an employee’s dishonesty, we made a loan or other debt product to a customer that was not creditworthy or failed to exercise our rights under a loan or other debt product agreement against a customer that was not in compliance with covenants in the agreement, we could lose some or all of the principal of the loan or other debt product. Fraud or dishonesty on the part of our employees could also damage our reputation which could harm our competitive position and adversely affect our business.
We are not the sole lender or agent for most of our leveraged finance loans or other debt products. Consequently, we do not have absolute control over how these loans or other debt products are administered or have control over those loans. When we are not the sole lender or agent, we may be required to seek approvals from other lenders before we take actions to enforce our rights.
Our recent loan originations are comprised of a larger percentage of broadly syndicated deals. As such, a majority of our leveraged finance loan portfolio consists of loans and other debt products in which we are neither the sole lender, the agent for the lending group that receives payments under the loan or other debt product nor the agent that controls the underlying collateral. These loans may not include the same covenants that we generally require of our borrowers. For these loans and other debt products, we may not have direct access to the customer and, as a result, may not receive the same financial or operational information as we receive for loans or other debt products for which we are the agent. This may make it more difficult for us to track or rate these loans or other debt products. Additionally, we may be prohibited or otherwise restricted from taking actions to enforce the loan or other debt product or to foreclose upon the collateral securing the loan or other debt product without the agreement of other lenders holding a specified minimum aggregate percentage, generally a majority or two-thirds of the outstanding principal balance. It is possible that an agent for one of these loans or other debt products may choose not to take the same actions to enforce the loan or other debt product or to foreclose upon the collateral securing the loan that we would have taken had we been the agent for the loan or other debt product.
Our commitments to lend additional sums to customers may exceed our resources available to fund these commitments, adversely affecting our financial condition and results of operations.
Our contractual commitments to lend additional sums to our customers may exceed our resources available to fund these commitments. Some of our funding sources are only available to fund a portion of a loan and other funding sources may not be

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immediately available. Our customers’ ability to borrow these funds may be restricted until they are able to demonstrate, among other things, that they have sufficient collateral to secure the requested additional borrowings or that the borrowing conforms to specific uses or meets certain conditions. We may have miscalculated the likelihood that our customers will request additional borrowings in excess of our readily available funds. If our calculations prove incorrect, we will not have the funds to make these loan advances without obtaining additional financing. Our failure to satisfy our full contractual funding commitment to one or more of our customers could create breach of contract or other liabilities for us and damage our reputation in the marketplace, which could then adversely affect our financial condition and results of operations.
Because there is no active trading market for most of the loans and other debt products in our loan portfolio, we might not be able to sell them at a favorable price or at all. The lack of active secondary markets for some of our investments may also create uncertainty as to the value of these investments.
We may seek to dispose of one or more of our loans and other debt products to obtain liquidity or to reduce or limit potential losses with respect to non-performing assets. There is no established trading market for most of our loans and other debt products. In addition, the fair value of other debt products that have lower levels of liquidity or are not publicly-traded may not be readily determinable and may fluctuate significantly on a monthly, quarterly and annual basis. Because these valuations are inherently uncertain, may fluctuate over short periods of time and may be based on estimates, our determinations of the fair value of our other debt products may differ materially from the values that we ultimately attain for these debt products or would be able to attain if we have to sell our other debt products. The value of our common stock could be adversely affected if our determinations regarding the fair value of these investments are materially higher than the values that we ultimately realize upon their disposal. In addition, given the limited trading market for our loans and other debt products and the uncertainty as to their fair value at any point in time, if we seek to sell a loan or other debt product to obtain liquidity or reduce or limit losses, we may not be able to do so at a favorable price or at all.
We selectively underwrite transactions that we may be unable to syndicate or sell to our credit funds.
On a selective basis, we commit to underwrite transactions that are significantly larger than our internal hold targets and we then seek to syndicate amounts in excess of our target to other lenders or plan to season the loan on our balance sheet to satisfy tax requirements and then sell the excess amounts to our credit funds. If we are unable to syndicate or sell these commitments, we may have to sell the additional exposure to third parties on unfavorable terms, which could adversely affect our financial condition or results of operations. In addition, if we must hold a larger portion of a transaction than we would like, we may not be able to complete other transactions and our loan portfolio may become more concentrated, which could affect our business, financial condition and results of operations.
We provide second lien, subordinated / mezzanine loans, other debt products and equity-linked products that may rank junior to rights of other lenders, representing a higher risk of loss than our other loans and debt products in which we have a first priority position.
To a lesser extent, we provide second lien, subordinated / mezzanine loans, other debt products and equity-linked products, which are typically junior in right of payment to obligations to customers’ senior secured lenders and contain either junior or no collateral rights. As a result of their junior nature, we may be limited in our ability to enforce our rights to collect principal and interest on these loans and other debt products or to recover any of their outstanding balance through a foreclosure of collateral. For example, typically we are not contractually entitled to receive payments of principal on a junior loan or other debt product until the senior loan or other debt product is paid in full, and we may only receive interest payments on a second lien or subordinated / mezzanine asset if the customer is not in default under its senior secured loan. In many instances, we are also prohibited from foreclosing on collateral securing a second lien, subordinated / mezzanine loan or other debt product until the senior loan is paid in full. Moreover, any amounts that we might realize as a result of our collection efforts or in connection with a bankruptcy or insolvency proceeding involving a customer under a second lien, subordinated / mezzanine loan or other debt product must generally be turned over to the senior secured lender until the senior secured lender has realized the full value of its own claims. These restrictions may materially and adversely affect our ability to recover the principal of any non-performing senior subordinate, second lien, subordinated / mezzanine loans and other debt product. In addition, on occasion we provide senior loans or other debt products that are contractually subordinated to one or more senior secured loans for the customer. In those cases we may have a first lien security interest, but one or more creditors have payment priority over us. As of December 31, 2014, our second lien and, subordinated/mezzanine loans totaled $90.3 million.
Risks Related to Our Funding and Leverage
Our ability to grow our business depends on our ability to obtain external financing. If our lenders terminate any of our credit facilities or if we default on our credit facilities, we may not be able to continue to fund our business.

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We require a substantial amount of cash to provide new loans and other debt products and to fund our obligations to existing customers. In the past, we have obtained the cash required for our operations through the issuance of equity interests and by borrowing money through credit facilities, term debt securitizations and repurchase agreements. We may not be able to continue to access these or other sources of funds.
During 2014, we completed a $289.5 million term debt securitization, issued $200 million of subordinated notes with a commitment to issue an additional $100 million, increased the size of asset-based loan credit facility from $75 million to $110 million, and increased the size of the term loan under our corporate credit facility from $200 million to $238.5 million. Additionally, we called a term debt securitization and redeemed the notes at par.
Substantially all of our non-securitized loans and other debt products are held in these facilities. Our credit facilities contain customary representations and warranties, covenants, conditions, events of default and termination events that if breached, not satisfied or triggered, could result in termination of the facility. These events of default and termination events include, but are not limited to, failure to service debt obligations, failure to meet liquidity covenants and tangible net worth covenants, and failure to remain within prescribed facility portfolio delinquency and charge-off levels. Further, all cash flow generated by our loans and other debt products subject to a particular facility would go to pay down our borrowings thereunder rather than to us if we are in default. Additionally, if the facility were terminated due to our breach, noncompliance or default, our lenders could liquidate or sell all or a portion of our loans and other debt products held in that facility. Also, if we trigger a default or there is a termination event under one facility and that default or termination results in a payment default or in the acceleration of that facility’s debt, it may trigger a default or termination event under our other facilities that have cross-acceleration or payment cross-default provisions. Consequently, if one or more of these facilities were to terminate prior to its expected maturity date, our liquidity position would be materially adversely affected, and we may not be able to satisfy our undrawn commitment balances, originate new loans or other debt products or continue to fund our operations. Even if we are able to refinance our debt, we may not be able to do so on favorable terms. If we are not able to obtain additional funding on favorable terms or at all, our ability to grow our business will be impaired.
Our deferred financing fees amortize over the contractual life of credit facilities and over the weighted average expected life of our term debt securitizations.
We have recorded deferred financing fees associated with most of our financing facilities. These deferred financing fees amortize over the contractual life of our credit facilities and over the weighted average expected life of our term debt securitizations. If a credit facility were to terminate before its contractual maturity date or if a term debt securitization were to terminate before its weighted average expected life, we would be required to accelerate amortization of the remaining balance of the deferred financing fees which could have a negative impact our results of operations and financial condition.
Our lenders and noteholders could terminate us as servicer of our loans, which would adversely affect our ability to manage our loan portfolio and reduce our net interest income.
Upon the occurrence of specified servicer termination events, our lenders under our credit facilities and the holders of the notes issued in our term debt securitizations may elect to terminate us as servicer of the loans and other debt products under the applicable facility and appoint a successor servicer. These servicer termination events include, but are not limited to, maintenance of certain financial covenants and the loss of certain key members of our senior management, including our Chief Executive Officer and Chief Investment Officer. We do not maintain key man life insurance on any of our senior management nor have we taken any other precautions to offset the financial loss we could incur as a result of any of their departures, however, we do have employment contracts with our senior management. Certain of our credit facilities include cure rights which would enable us to correct the event of default and maintain our status as servicer.
If we are terminated as servicer, we will no longer receive our servicing fee, but we will continue to receive the excess interest rate spread as long as the term debt securitization does not need to trap the excess spread as a result of defaulted loan collateral. In addition, because any successor servicer may not be able to service our loan portfolio according to our standards, any transfer of servicing to a successor servicer could result in reduced or delayed collections, delays in processing payments and information regarding the loans and other debt products and a failure to meet all of the servicing procedures required by the applicable servicing agreement. Consequently, the performance of our loans and other debt products could be adversely affected and our income generated from those loans and other debt products significantly reduced.
Our liquidity position could be adversely affected if we were unable to complete additional term debt securitizations in the future, or if the reinvestment periods in our term debt securitizations terminate early, which could create a material adverse affect on our financial condition and results of operations.
We have completed seven term debt securitizations to fund our loans and other debt products, all of which we accounted for on our balance sheet, through which we issued $2.3 billion of rated notes. Four of these balance sheet term debt

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securitization were outstanding as of December 31, 2014. Our term debt securitizations consist of asset securitization transactions in which we transfer loans and other debt products to a trust that aggregates our loans and, in turn, sells notes, collateralized by the trust’s assets, to institutional investors. The notes issued by the trusts have been rated by nationally recognized statistical rating organizations. At December 31, 2014, the ratings range from AAA to CCC+ by Standard & Poor’s, Inc. and Fitch Ratings, Inc. and Aaa to Ba2 by Moody’s Investors Service, Inc., depending on the class of notes.
We intend to complete additional term debt securitizations in the future. Several factors will affect demand for, and our ability to complete additional term debt securitizations, including:
disruptions in the capital markets generally, and the asset-backed securities market in particular;
disruptions in the credit quality and performance of our loan portfolio, particularly that portion which has been previously securitized and serves as collateral for existing term debt securitizations;
regulatory considerations;
changes in rating agency methodology;
our ability to service our loan portfolio and that ability continuing to be perceived as adequate to make the issued securities attractive to investors; and
any material downgrading or withdrawal of ratings given to securities previously issued in our term debt securitizations.
If we are unable to complete additional term debt securitizations, our ability to obtain the capital needed for us to continue to operate and grow our business would be adversely affected. In addition, our credit facilities are only intended to provide short-term financing for our transactions. If we are unable to finance our transactions over the longer term through our term debt securitizations, our credit facilities may not be renewed. Moreover, our credit facilities typically carry a higher interest rate than our term debt securitizations. Accordingly, our inability to complete additional term debt securitizations in the future could have a material adverse effect on our financial conditions and result of operations. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Market Conditions.”
If a specified default event occurred in a term debt securitization, the reinvestment period would be terminated. This could have an adverse effect on our ability to fund new assets.
The cash flows we receive from the interests we retain in our term debt securitizations could be delayed or reduced due to the requirements of the term debt securitization.
We have retained 100% of the junior-most interests issued in our balance sheet term debt securitizations, totaling $236.9 million in principal amount, issued in each of our four outstanding balance sheet term debt securitizations as of December 31, 2014. Also, as of December 31, 2014, we have repurchased $6.2 million of outstanding notes of our balance sheet term debt securitizations that were outstanding as of December 31, 2014. The notes issued in the term debt securitizations that we did not retain are senior to the junior-most interests we did retain. Our receipt of future cash flows on the junior-most interests is governed by provisions that control the distribution of cash flows from the loans and other debt products included in our term debt securitizations. On a quarterly basis, interest cash flows from the loans and other debt products must first be used to pay the interest on the senior notes and expenses of the term debt securitization. Any funds remaining after the payment of these amounts are distributed to us.
Several factors may influence the timing and amount of the cash flows we receive from loans and other debt products included in our term debt securitizations, including:
if any loan or other debt product included in a term debt securitization becomes (a) delinquent for a specified period of time as outlined in the indenture, (b) is classified as a non-performing asset, or (c) is charged off, all funds, after paying expenses and interest to the senior notes, go to a reserve account which then pays down an amount of senior notes equal to the amount of the delinquent loan or other debt product or if an overcollateralization test is present, is diverted, and used to de-lever the securitization to bring the ratio back into compliance . Except for specified senior management fees, we will not receive any distributions from funds during this period; and
if other specified events occur to the trusts, for example an event of default, our cash flows would be used to reduce the outstanding balance of the senior notes and would not be available to us until the full principal balance of the senior notes had been repaid.
We have obtained a significant portion of our debt financing through a limited number of financial institutions. This concentration of funding sources exposes us to funding risks.

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We have obtained our credit facility financing from a limited number of financial institutions. Our reliance on the underwriters of our debt financing and their affiliates for a significant amount of our funding exposes us to funding risks. If these participating lenders decided to terminate our credit facilities, we would need to establish new lending relationships to satisfy our funding needs.
Risks Related to Our Operations and Financial Results
Our quarterly net interest income and results of operations are difficult to forecast and may fluctuate substantially.
Our quarterly net interest income and results of operations are difficult to forecast. We have and may continue to experience substantial fluctuations in net interest income and results of operations from quarter to quarter. You should not rely on our results of operations in any prior reporting period to be indicative of our performance in future reporting periods. Many different factors could cause our results of operations to vary from quarter to quarter, including:
the success of our origination activities;
pre-payments on our loan portfolio;
credit losses on recent transaction and legacy workouts
default rates;
our ability to enter into financing arrangements;
competition;
seasonal fluctuations in our business, including the timing of transactions;
costs of compliance with regulatory requirements;
private equity activity;
the timing and affect of any future acquisitions;
personnel changes;
changes in accounting rules;
changes in allowance for credit losses methodology;
changes in prevailing interest rates;
general changes to the U.S. and global economies; and
political conditions or events.
We base our current and future operating expense levels and our investment plans on estimates of future net interest income, transaction activity and rate of growth. We expect that our expenses will increase in the future, and we may not be able to adjust our spending quickly enough if our net interest income falls short of our expectations. Any shortfalls in our net interest income or in our expected growth rates could result in decreases in our stock price.
Our business is highly dependent on key personnel.
Our future success depends to a significant extent on the continued services of our Chief Executive Officer and our Chief Investment Officer as well as other key personnel. Our employment agreements with each of these officers will terminate in October 2015. Although we intend to enter into new employment agreements with these officers, if we were to lose the services of any of these executives for any reason, including voluntary resignation or retirement, we may not be able to replace them with someone of equal skill or ability and our business may be adversely affected. Moreover, we may not function well without the continued services of these executives.
We may not be able to attract and retain the highly skilled employees we need to support our business.
Our ability to originate and underwrite loans and other debt products is dependent on the experience and expertise of our employees. In order to grow our business, we must attract and retain qualified personnel, especially origination and credit personnel with relationships with referral sources and an understanding of small and middle-market businesses and the industries in which our borrowers operate. Many of the financial institutions with which we compete for experienced personnel may be able to offer more attractive terms of employment. If any of our key origination personnel leave, our new loan and other debt product volume from their business contacts may decline or cease, regardless of the terms of our loan and other debt product offerings or our level of service. In addition, we invest significant time and expense in training our employees, which increases their value to competitors who may seek to recruit them and increases the costs of replacing them. As competition for qualified employees grows, our cost of labor could increase, which could adversely impact our results of operations.

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Maintenance of our Investment Company Act exemption imposes limits on our operations.
We intend to conduct our operations so that we are not required to register as an investment company under the Investment Company Act of 1940, as amended, which we refer to as the Investment Company Act. Section 3(a)(1)(C) of the Investment Company Act defines as an investment company any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40.0% of the value of the issuer’s total assets (exclusive of government securities and cash items) on an unconsolidated basis. Excluded from the term “investment securities” are, among other things, securities issued by majority-owned subsidiaries that are not themselves investment companies and are not relying on the exception from the definition of investment company in Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act.
We expect that many of our majority-owned subsidiaries, including those which we have created (or may in the future create) in connection with our term debt securitizations, will rely on exceptions and exemptions from the Investment Company Act available to certain structured finance companies and that our interests in those subsidiaries will not constitute “investment securities” for purposes of the Investment Company Act. Because these exceptions and exemptions may, among other things, limit the types of assets these subsidiaries may purchase or counterparties with which we may deal, we must monitor each subsidiary’s compliance with its applicable exception or exemption.
We must also monitor our loan portfolio to ensure that the value of the investment securities we hold does not exceed 40.0% of our total assets (exclusive of government securities and cash items) on an unconsolidated basis. If the combined value of the investment securities issued by our subsidiaries that are investment companies or that must rely on the exceptions provided by Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act rather than another exception or exemption, together with any other investment securities we may own, exceeds 40.0% of our total assets on an unconsolidated basis, we may be deemed to be an investment company. Because we believe that the interests we hold in our subsidiaries generally will not be investment securities, we do not expect to own nor do we propose to acquire investment securities in excess of 40.0% of the value of our total assets on an unconsolidated basis. However, the SEC is considering proposing amendments to Rule 3a-7 under the Investment Company Act and issued an advance notice of proposed rulemaking in August 2011 (Release No. IC-29779) to solicit public comment on the treatment of asset-backed issuers under the Investment Company Act. Under consideration are changes that could amend or eliminate the provision upon which we currently rely to ensure that our interests in certain of our subsidiaries do not constitute investment securities for purposes of the Investment Company Act. If adopted, such changes could, among other things, require us to register as an investment company or take other actions to permit us to continue to be excluded from the definition of investment company. These actions could involve substantial changes to our operations and organizational structure.
We monitor for compliance with the Investment Company Act on an ongoing basis and may be compelled to take or refrain from taking actions, to acquire additional income or loss generating assets or to forgo opportunities that might otherwise be beneficial or advisable, including, but not limited to selling assets that are considered to be investment securities or foregoing sale of assets which are not investment securities, in order to ensure that we (or a subsidiary) may continue to rely on the applicable exceptions or exemptions. These limitations on our freedom of action could have a material adverse effect on our financial condition and results of operations.
If we fail to maintain an exemption, exception or other exclusion from registration as an investment company, we could, among other things, be required to substantially change the manner in which we conduct our operations either to avoid being required to register as an investment company or to register as an investment company. If we were required to register as an investment company under the Investment Company Act, we would become subject to substantial regulation with respect to, among other things, our capital structure (including our ability to use leverage), management, operations, transactions with affiliated persons (as defined in the Investment Company Act), portfolio composition, including restrictions with respect to diversification and industry concentration, and our financial condition and results of operations may be adversely affected. If we did not register despite being required to do so, criminal and civil actions could be brought against us, our contracts would be unenforceable unless a court was to require enforcement, and a court could appoint a receiver to take control of us and liquidate our business.
Risks Related to Our Operating and Trading History
We have incurred losses in the past and may not achieve profitability in future periods.
For the years ended December 31, 2014, 2013 and 2012, we recorded net income of $10.6 million, $24.6 million, and $24.0 million, respectively. We may not be profitable in future periods for a variety of reasons. If we are unable to achieve, maintain and increase our profitability in the future, the market value of our common stock could further decline.

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We are in a highly competitive business and may not be able to compete effectively, which could impact our profitability.
The commercial lending industry is highly competitive and includes a number of competitors who provide similar types of loans to our target customers. Our principal competitors include a variety of:
specialty and commercial finance companies, including business development companies and real estate investment trusts;
private investment funds and hedge funds;
national and regional banks;
investment banks; and
insurance companies.
Some of our competitors offer a broader range of financial, lending and banking services than we do and can leverage their existing customer relationships to offer and sell services that compete directly with our products and services. In addition, some of our competitors have greater financial, technical, marketing, origination and other resources than we do. They may also have greater access to capital than we do and at a lower cost than is available to us. For example, if national and regional banks or other large competitors seek to expand within or enter our target markets, they may provide loans at lower interest rates to gain market share, which could force us to lower our rates and result in decreased returns. As a result of competition, we may not be able to attract new customers, retain existing customers or sustain the rate of growth that we have experienced to date, and our ability to expand our loan portfolio and grow future revenue may decline. If our existing customers choose to use competing sources of credit to refinance their debt, our loan portfolio could be adversely affected.
We are subject to regulation, which limits our activities and exposes us to additional fines and penalties, and any changes in such regulations could affect our business and our profitability.
We are subject to federal, state and local laws and regulations that govern non-depository commercial lenders and businesses generally. In response to SEC rules promulgated under the Dodd-Frank Act, we have registered with the SEC as an investment adviser and conformed our activities to regulation under the Investment Advisers Act of 1940. Each of the regulatory bodies with jurisdiction over us has regulatory powers dealing with many aspects of financial services, including the authority to grant, and, in specific circumstances to cancel, permissions to carry on particular businesses. Our failure to comply with applicable laws or regulations could result in fines, censure, suspensions of personnel or other sanctions, including revocation of any registration that we may be required to hold. Even if a sanction imposed against us or our personnel is small in monetary amount, the adverse publicity arising from the imposition of sanctions against us by regulators could harm our reputation and impair our ability to retain clients and develop new client relationships, which may reduce our revenues.
Furthermore, the regulatory environment in which we operate is subject to further modifications and regulation. Any changes in such laws or regulations could affect our business and profitability. In addition, if we expand our business into areas or jurisdictions that are subject to, or have adopted, more stringent laws and regulations than those that are currently applicable to us and our business, we may have to incur significant additional expense or restrict our operations in order to comply, which could adversely impact our business, results of operations or prospects.
Our common stock may continue to have a volatile public trading price.
Historically, the market price of our common stock has been highly volatile, and the market for our common stock has experienced significant price and volume fluctuations, some of which are unrelated to our company’s operating performance. Since our common stock began trading publicly on December 14, 2006, the trading price of our stock has fluctuated from a high of $20.85 to a low of $0.61. It is likely that the market price of our common stock will continue to fluctuate in the future. Factors which may have a significant adverse effect on our common stock’s market price include:
the rate of charge-offs, impairments and non-accruals in our loan portfolio;
fluctuations in interest rates and the actual or perceived impact of these rates on our current customers and future prospects;
changes to the regulatory environment in which we operate;
our ability to raise additional capital and the terms on which we can secure such capital;
general market and economic conditions; and
quarterly fluctuations in our revenues and other financial results.

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The reported average daily trading volume of our common stock for the twelve-month period ending December 31, 2014 was approximately 52,849 shares, however our trading volume has exceeded 1,000,000 shares on several occasions since our initial public offering. Such a low average trading volume may impact our shareholders’ ability to buy and sell shares of our common stock.

Item 1B.
Unresolved Staff Comments
None.

Item 2.
Properties
Our headquarters is located at 500 Boylston Street, Suite 1250, Boston, Massachusetts 02116, where we lease 18,628 square feet of office space under a lease that is scheduled to terminate on February 28, 2020. We also maintain leased offices in Darien, Connecticut, Atlanta, Georgia, Chicago, Illinois, Dallas, Texas, Los Angeles, California, New York, New York, Portland, Oregon, and San Francisco, California. We believe our office facilities are suitable and adequate for us to conduct our business.

Item 3.
Legal Proceedings
The Company from time to time is involved in litigation in the ordinary course of business. We are not currently subject to any material pending legal proceedings.

Item 4.
Mine Safety Disclosures
Not applicable.

PART II
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
As of February 27, 2015, there were approximately 92 stockholders of record. The number of stockholders does not include individuals or entities who beneficially own shares but whose shares are held of record by a broker or clearing agency, but does include each such broker or clearing agency as one stockholder. American Stock Transfer & Trust Company serves as transfer agent for our shares of common stock.
Our common stock has traded on the NASDAQ Global Market under the symbol “NEWS” since December 14, 2006. The quarterly range of the high and low sales price for our common stock during 2014 and 2013 is presented below:
 
2014
 
2013
 
High
 
Low
 
High
 
Low
Quarter ended:
 
 
 
 
 
 
 
December 31
$
13.98

 
$
9.73

 
$
19.02

 
$
14.18

September 30
14.35

 
10.25

 
19.83

 
12.82

June 30
14.35

 
10.20

 
13.60

 
11.37

March 31
17.95

 
13.78

 
14.81

 
12.95

On February 27, 2015, the last reported closing price of our common stock on the NASDAQ Global Market was $9.98 per share.
The following graph shows a comparison from December 31, 2009 through December 31, 2014 of cumulative total return for our common stock, the S&P 500 Index and the S&P Financials Index. The graph assumes a $100 investment at the closing price on December 31, 2009. Such returns are based on historical results and are not intended to suggest future performance. The following information in this Item 5 of this Annual Report on Form 10-K is not deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C under the Securities Exchange Act of 1934 or to the liabilities of Section 18 of the Securities Exchange Act of 1934, and will not be deemed to be incorporated by reference into any filing under

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the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent we specifically incorporate it by reference into such a filing.
We have never declared or paid cash dividends on our common stock. We have no current plans to pay cash dividends on our common stock. We intend to retain available funds and any future earnings to reduce debt and fund the development and growth of our business.
Issuer Purchases of Equity Securities
The following table sets forth the repurchases of our Common Stock that we made for the three-month period ending on December 31, 2014:
Period
Total
Number  of
Shares
Purchased (1)(2)(3)
 
Average
Price Paid
Per Share (1)(2)(3)
 
Total Number  of
Shares
Purchased
as Part of
Publicly
Announced
Plans or
Programs
 
Approximate
Dollar Value  of
Shares that May
Yet Be
Purchased
Under the Plans
or Programs
October 1-31, 2014
82,372

 
$
11.99

 
82,110

 
$
7,258,590

November 1-30, 2014
46,939

 
11.95

 
46,939

 
6,697,620

December 1-31, 2014
1,098,296

 
10.34

 
98,296

 
5,580,417

Total: Three months ended December 31, 2014
1,227,607

 
10.51

 
227,345

 
5,580,417

(1)
The Company repurchased 227,345 shares during the period pursuant to the share repurchase program that we announced on August 13, 2014 (the “August Repurchase Program”). Certain of these shares were repurchased on the open market pursuant to a trading plan under Rule 10b5-1 of the Exchange Act.
(2)
Includes an aggregate of 262 shares of Common Stock acquired from individuals in order to satisfy tax withholding requirements in connection with the vesting of restricted stock awards under equity compensation plans during the fourth quarter.
(3)
The Company repurchased 1,000,000 shares on December 18, 2014 in a privately negotiated transaction with an unaffiliated third party
(4)
The August Repurchase Program provides for the repurchase of up to $10.0 million of the Company’s common stock from time to time on the open market or in privately negotiated transactions.


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Item 6.
Selected Financial Data
Selected consolidated financial and other data for the periods and at the dates indicated and should be read in conjunction with the consolidated audited financial statements, related notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations included herein.
 
Year Ended December 31,
 
2014
 
2013
 
2012
 
2011
 
2010
 
($ in thousands, except for share and per share data)
Statement of Operations Data:
 
 
 
 
 
 
 
 
 
Interest income
$
136,171

 
$
127,684

 
$
123,945

 
$
115,680

 
$
112,826

Interest expense
57,775

 
42,971

 
35,591

 
34,953

 
40,558

Net interest income
78,396

 
84,713

 
88,354

 
80,727

 
72,268

Provision for credit losses
27,108

 
9,738

 
12,651

 
17,312

 
32,997

Net interest income (loss) after provision for credit losses
51,288

 
74,975

 
75,703

 
63,415

 
39,271

Fee income
2,467

 
3,670

 
4,619

 
3,070

 
2,409

Asset management income
1,054

 
2,482

 
2,984

 
2,635

 
2,872

Gain (loss) on derivatives
(39
)
 
(143
)
 
(315
)
 
242

 
28

Gain (loss) on sale of loans and debt securities
(230
)
 
72

 
335

 
128

 
(116
)
Gain on acquisition

 

 

 

 
5,649

Other income (loss)
7,964

 
7,431

 
3,948

 
(2,008
)
 
7,854

Total non-interest income
11,216

 
13,512

 
11,571

 
4,067

 
18,696

Compensation and benefits
30,383

 
32,672

 
31,139

 
30,144

 
26,418

General and administrative expenses
15,133

 
16,726

 
15,158

 
13,787

 
14,195

Total operating expenses
45,516

 
49,398

 
46,297

 
43,931

 
40,613

Operating income before income taxes
16,988

 
39,089

 
40,977

 
23,551

 
17,354

Results of Consolidated VIE
 
 
 
 
 
 
 
 
 
Interest income
5,268

 
5,321

 

 

 

Interest expense—credit facilities
2,865

 
1,879

 

 

 

Interest expense—Fund membership interest
1,292

 
1,353

 

 

 

Other income
229

 
51

 

 

 

Operating expenses
249

 
78

 

 

 

Net results from consolidated VIE
1,091

 
2,062

 

 

 

Income before income taxes
18,079

 
41,151

 
40,977

 
23,551

 
17,354

Income tax expense
7,485

 
16,556

 
17,000

 
9,403

 
6,935

Net income before noncontrolling interest
10,594

 
24,595

 
23,977

 
14,148

 
10,419

Net income attributable to noncontrolling interest

 

 

 

 
(187
)
Net income attributable to NewStar Financial, Inc. common stockholders
$
10,594

 
$
24,595

 
$
23,977

 
$
14,148

 
$
10,232

Income (loss) per share:
 
 
 
 
 
 
 
 
 
Basic
$
0.22

 
$
0.51

 
$
0.51

 
$
0.29

 
$
0.21

Diluted
0.21

 
0.46

 
0.45

 
0.27

 
0.19

Weighted average shares outstanding:
 
 
 
 
 
 
 
 
 
Basic
48,266,731

 
48,157,319

 
47,370,095

 
48,106,032

 
49,449,314

Diluted
51,575,491

 
52,941,981

 
52,733,552

 
52,925,924

 
52,548,104

Outstanding shares of common stock
46,620,474

 
48,658,606

 
49,311,008

 
49,345,676

 
50,562,826


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Table of Contents

 
December 31,
 
2014
 
2013
 
2012
Balance Sheet Data:
 
 
 
 
 
Cash and cash equivalents
$
33,033

 
$
43,401

 
$
27,212

Restricted cash
95,411

 
167,920

 
208,667

Cash collateral on deposit with custodian
38,975

 

 

Investments in debt securities, available-for-sale
46,881

 
22,198

 
21,127

Loans, held-for-sale
200,569

 
14,831

 
51,602

Loans, net
2,305,896

 
2,095,250

 
1,720,789

Other assets
90,244

 
86,862

 
127,673

Subtotal
2,811,009

 
2,430,462

 
2,157,070

Assets of Consolidated VIE
 
 
 
 
 
Restricted cash

 
1,950

 

Loans, net

 
171,427

 

Other assets

 
3,022

 

Total assets of Consolidated VIE

 
176,399

 

Total assets
$
2,811,009

 
$
2,606,861

 
$
2,157,070

Credit facilities
$
487,768

 
$
332,158

 
$
229,941

Term debt securitizations
1,193,187

 
1,212,374

 
1,121,764

Corporate debt
238,500

 
200,000

 
100,000

Subordinated notes
156,831

 

 

Repurchase agreements
57,227

 
67,954

 
30,583

Other liabilities
36,499

 
26,544

 
79,965

Subtotal
2,170,012

 
1,839,030

 
1,562,253

Liabilities of Consolidated VIE
 
 
 
 
 
Credit facilities

 
120,344

 

Subordinated debt

 
30,000

 

Other liabilities

 
1,277

 

Total liabilities of Consolidated VIE

 
151,621

 

Total liabilities
2,170,012

 
1,990,651

 
1,562,253

NewStar Financial, Inc. stockholders’ equity
640,997

 
615,552

 
594,817

Retained earnings of Consolidated VIE

 
658

 

Total stockholders’ equity
640,997

 
616,210

 
594,817

Supplemental Data:
 
 
 
 
 
Investments in debt securities, gross
$
53,098

 
$
25,298

 
$
25,298

Loans held-for-sale, gross
202,369

 
14,897

 
52,120

Loans held-for-investment, gross
2,370,255

 
2,325,144

 
1,796,845

Loans and investments in debt securities, gross
2,625,722

 
2,365,339

 
1,874,263

Unused lines of credit
317,583

 
326,231

 
245,483

Standby letters of credit
7,911

 
6,880

 
4,497

Total funding commitments
$
2,951,216

 
$
2,698,450

 
$
2,124,243

 
 
 
 
 
 
Loans held-for-sale, gross
$
202,369

 
$
14,897

 
$
52,120

Loans held-for-investment, gross
2,370,255

 
2,325,144

 
1,796,845

Total loans, gross
2,572,624

 
2,340,041

 
1,848,965

Deferred fees, net
(23,176
)
 
(17,130
)
 
(26,938
)
Allowance for loan losses—general
(22,258
)
 
(18,099
)
 
(19,423
)
Allowance for loan losses—specific
(20,725
)
 
(23,304
)
 
(30,213
)
Total loans, net
$
2,506,465

 
$
2,281,508

 
$
1,772,391


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Table of Contents

 
December 31,
 
2014
 
2013
 
2012
Managed Portfolio
 
 
 
 
 
NewStar Financial, Inc.
$
2,625,722

 
$
2,192,694

 
$
1,874,263

Arlington Program
383,834

 

 

Arlington Fund (1)

 
172,645

 

Clarendon Fund
236,703

 

 

NewStar TRS Fund
85,024

 

 

NCOF
36,272

 
93,263

 
559,328

Total Managed Portfolio
$
3,367,555

 
$
2,458,602

 
$
2,433,591

 
 
 
 
 
 
Managed Assets
 
 
 
 
 
NewStar Financial, Inc.
$
2,811,009

 
$
2,430,462

 
$
2,157,070

Arlington Program
400,000

 

 

Arlington Fund (1)

 
172,645

 

Clarendon Fund
400,000

 

 

NewStar TRS Fund
110,575

 

 

NCOF
39,047

 
168,225

 
620,292

Total Managed Assets
$
3,760,631

 
$
2,771,332

 
$
2,777,362

 
 
 
 
 
 
Average Balances (2):
 
 
 
 
 
Loans and other debt products, gross
$
2,320,186

 
$
1,988,416

 
$
1,893,571

Interest earning assets (3)
2,508,729

 
2,223,908

 
2,036,526

Total assets
2,543,967

 
2,275,309

 
2,051,565

Interest bearing liabilities
1,983,516

 
1,627,816

 
1,414,967

Equity
617,044

 
604,742

 
579,083

 
Year Ended December 31,
 
2014
 
2013
 
2012
Performance Ratios (4):
 
 
 
 
 
Return on average assets
0.42
%
 
1.08
%
 
1.17
%
Return on average equity
1.72

 
4.07

 
4.14

Net interest margin, before provision
3.17

 
3.90

 
4.34

Loan portfolio yield
6.09

 
6.68

 
6.54

Efficiency ratio
50.32

 
49.30

 
46.46

Credit Quality and Leverage Ratios (5):
 
 
 
 
 
Delinquent loan rate (at period end)
1.84
%
 
0.22
%
 
3.59
%
Delinquent loan rate for accruing loans 60 days or more past due (at period end)
%
 
%
 
1.17
%
Non-accrual loan rate (at period end)
3.70
%
 
3.04
%
 
4.05
%
Non-performing asset rate (at period end)
3.84
%
 
3.60
%
 
4.77
%
Net charge off rate (end of period loans)
1.07
%
 
0.77
%
 
1.49
%
Net charge off rate (average period loans)
1.10
%
 
0.91
%
 
1.43
%
Allowance for credit losses ratio (at period end)
1.84
%
 
1.80
%
 
2.78
%
Debt to equity (at period end)
3.32x

 
3.18x

 
2.49x

Equity to assets (at period end)
22.80
%
 
23.64
%
 
27.58
%
 
(1)
Consolidated as a Variable Interest Entity
(2)
Averages are based upon the average daily balance during the period.
(3)
Includes loan portfolio, cash, cash equivalents and restricted cash.
(4)
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a discussion of the calculation of performance ratios.
(5)
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for additional information related to our credit quality and leverage ratios.

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Table of Contents

Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion contains forward-looking statements. Important factors that may cause actual results and circumstances to differ materially from those described in such statements is contained below and in Item 1A. “Risk Factors” of this report.
Overview
NewStar Financial, Inc. is an internally-managed, commercial finance company with specialized lending platforms focused on meeting the complex financing needs of companies and private investors in the middle market. The Company is also a registered investment adviser and provides asset management services to institutional investors through a series of managed credit funds that co-invest in certain types of loans originated by the Company. Through its specialized lending platforms, the Company provides a range of senior secured debt financing options to mid-sized companies to fund working capital, growth strategies, acquisitions and recapitalizations, as well as, purchases of equipment and other capital assets.
These lending activities require specialized skills and transaction experience, as well as, a significant investment in personnel and operating infrastructure. To meet these demands, our loans and leases are originated directly by teams of credit-trained bankers and experienced marketing officers organized around key industry and market segments. These teams represent specialized lending groups that are supported by centralized credit management and operating platforms. This structure enables us to leverage common standards, systems, and industry and professional expertise across multiple businesses.
We target our marketing and origination efforts at private equity firms, mid-sized companies, corporate executives, banks, real estate investors and a variety of other referral sources and financial intermediaries to develop new customer relationships and source lending opportunities. Our origination network is national in scope and we target companies with business operations across a broad range of industry sectors. We employ highly experienced bankers, marketing officers and credit professionals to identify and structure new lending opportunities and manage customer relationships. We believe that the quality of our professionals, the breadth of their relationships and referral networks, and their ability to develop creative solutions for customers position us to be a valued partner and preferred lender for mid-sized companies and private equity funds with middle market investment strategies.
Our emphasis on direct origination is an important aspect of our marketing and credit strategy. Our national network is designed around specialized origination channels intended to generate a large set of potential lending opportunities. That allows us to be highly selective in our credit process and to allocate capital to market segments that we believe represent the most attractive opportunities. Our direct origination network also generates proprietary lending opportunities with yield characteristics that we believe would not otherwise be available through intermediaries. In addition, direct origination provides us with direct access to management teams and enhances our ability to conduct detailed due diligence and credit analysis of prospective borrowers. It also allows us to negotiate transaction terms directly with borrowers and, as a result, advise our customers’ financial strategies and capital structures, which we believe benefits our credit performance.
The Company typically provides financing commitments to companies in amounts that range in size from $10 million to $50 million. The size of financing commitments depends on various factors, including the type of loan, the credit characteristics of the borrower, the economic characteristics of the loan, and our role in the transaction. We also selectively arrange larger transactions that we may retain on our balance sheet or syndicate to other lenders, which may include funds that we manage for third party institutional investors. By syndicating loans to other lenders and our managed funds, we are able to provide larger financing commitments to our customers and generate fee income, while limiting our risk exposure to single borrowers. From time to time, however, our balance sheet exposure to a single borrower may exceed $35 million.
NewStar offers a set of credit products and services that have many common attributes, but which are highly specialized by lending group and market segment. Although both the Leveraged Finance and Business Credit lending groups structure loans as revolving credit facilities and term loans, the style of lending and approach to credit management is highly specialized. The Equipment Finance group broadens our product offering to include a range of lease financing options. The operational intensity of each product also varies by lending group.
Although NewStar operates as a single segment, the Company derives revenues from our asset management activities and four specialized lending groups that target market segments in which we believe that we have competitive advantages:
Leveraged Finance, provides senior, secured cash flow loans and, to a lesser extent, second lien and unitranche loans, which are primarily used to finance acquisitions of mid-sized companies with annual cash flow (EBITDA) typically between $10 million and $50 million by private equity investment funds managed by established professional alternative asset managers;
Business Credit, provides senior, secured asset-based loans primarily to fund working capital needs of mid-sized companies with sales revenue typically totaling between $25 million and $500 million;

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Real Estate, provides first mortgage debt primarily to finance acquisitions of commercial real estate properties typically valued between $10 million and $50 million by professional commercial real estate investors;
Equipment Finance, provides leases, loans and lease lines to finance purchases of equipment and other capital expenditures typically for companies with annual sales of at least $25 million; and
Asset Management, provides opportunities for qualified institutions to invest in credit funds managed by the Company with strategies to co-invest in loans originated by its Leveraged Finance lending group.
Market Conditions
As a specialized commercial finance company, we compete in various segments of the loan market to extend credit to mid-sized companies through our national specialized lending platforms. We rely primarily on large banks for warehouse lines of credit to partially fund new loan origination and the capital markets for longer term funding through the issuance of asset-backed notes that are used to refinance bank lines and provide funding with matched duration for our leveraged loan portfolio.
Market conditions in most segments of the loan market that we target improved in the fourth quarter compared to the prior quarter. According to Thomson Reuters, overall middle market loan demand in the fourth quarter increased as compared to the third quarter and as compared to the same period last year, with volume of $53 billion. The markets remained highly competitive and liquid as the supply of new capital continued to outpace demand for new financing for growth or acquisitions. The volume represented by new middle market transactions, as opposed to refinancings, increased in the fourth quarter to $24 billion; refinancing volume was $29 billion. As a percentage of total volume, new transactions remained steady at 46% versus the prior quarter but increased from 43% at the end of 2013.
The pricing environment in the broader loan market weakened through the first half of 2014 due primarily to modest M&A activity as lenders competed for a limited universe of deals, but yields rebounded in the second half of the year, increasing in both the third and fourth quarters. Despite the downward trend in the first half of the year, we believe that conditions in the middle market remained somewhat insulated from the impact of excessive liquidity evident in the broader loan markets as yields remained relatively stable through the first half of 2014 and have trended upward in the second half. Loan yields in both the large corporate market and middle market have increased in the fourth quarter. Large corporate loan yields were up to 5.9% from 5.4% in the third quarter and 4.8% in the same quarter last year. Middle market loan yields were up to 6.6% from 6.0% in the third quarter and from 5.9% in the same quarter last year. With most of the new money flowing into the loan market from CLO issuance and retail loan funds targeted for broadly syndicated loans, we believe that market conditions will continue to be more challenging for large corporate lenders and that the middle market will continue to compare favorably.
Our different lending platforms provide us with certain flexibility to allocate capital and redirect our origination focus to market segments with the most favorable conditions in terms of demand and relative value. As the pricing environment for larger, more liquid loans has remained relatively weak in the fourth quarter and loan demand among private equity firms in the lower middle market remained somewhat firmer, we continued to emphasize direct lending to smaller companies during the quarter. We believe that the yields on our new loan origination will continue to reflect a combination of these broad market trends and shifts in the mix of loans we originate.
Conditions in our core funding markets have remained steady in the fourth quarter as many fixed income investors continued to target structured investment alternatives such as CLOs to meet their return objectives. The market had been unsettled through much of the year, however, as regulatory headwinds dampened demand for CLOs among banks. The broader fixed income markets remained active in the quarter as the market seems to have adjusted to changes in the Federal Reserve’s monetary policies. As a result, we believe that investors will be more cautious about holding fixed rate debt, leading to less capital flowing into the high yield market in favor of high yielding investments with shorter duration, including floating rate bank loans and CLO bonds.
Despite a slower start to the year as compared to 2013, new U.S. CLO issuance in 2014 was over $123 billion, representing a 50% increase over 2013. Total U.S. CLO issuance in 2012 and 2011 was $55 billion and $12 billion, respectively. After trending slightly downward through the first half of 2014, CLO credit spreads have trended slightly upward through the second half of the year, however, reflecting the impact of a steepening yield curve and regulatory concerns, including FDIC surcharge for deposit insurance and risk retention rules in addition to the Volcker Rule. As a result, we believe marginal funding costs will be somewhat range bound at current levels until investors reset rate expectations and resolve regulatory issues. Despite this trend in the pricing environment, we believe that market conditions remain supportive for us to issue new CLOs. We also believe the availability and cost of warehouse financing among banks has continued to improve as more banks have begun to provide this type of financing and existing providers have increased their lending activity. As a result, we believe that the terms and conditions for financings available to established firms like NewStar have improved.
Loan demand in the middle market is strongly influenced by the level of refinancing, acquisition activity and private investment, which is driven largely by changes in the perceived risk environment, prevailing borrowing rates and private

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investment activity. These factors were generally favorable in the fourth quarter as we originated $775 million of new loans at attractive yields. After declining through the first half of 2014 in a muted M&A volume environment, yields have rebounded. Although pricing remained thinner and leverage continued to trend higher in the broad loan market, conditions in our primary target markets remained somewhat more favorable with pricing widening and leverage stabilizing at levels that compare favorably to the broader loan market, in which larger corporations typically borrow from syndicates of banks and loans are issued, priced and traded in a bond-style market that is more highly correlated with the high yield debt market.
We believe that demand for new middle market loans and credit products will remain relatively consistent with current levels in the near term and exhibit usual seasonality. Over the long-term, we believe that demand will improve because private equity firms have substantial un-invested capital, which we believe that they will deploy through investment strategies that emphasize investments in mid-sized companies. As a result of these factors, we anticipate that demand for loans and leases offered by the Company and conditions in our lending markets will remain favorable into 2015 and continue to provide opportunities for us to increase our origination volume.
Recent Developments
Strategic Relationship
On November 4, 2014, we announced a strategic relationship GSO and Franklin Square and entered into an investment agreement with FS Investment Corporation, FS Investment Corporation II, and FS Investment Corporation III (collectively the “Franklin Square Funds”) pursuant to which we agreed to issue $300 million of 8.25% subordinated notes due 2024 and warrants exercisable for 12 million shares of the Company’s common stock at an exercise price of $12.62 per share (the “Warrants”).
On December 4, 2014, we issued $200 million of the subordinated notes. The Warrants were issued in two tranches on December 4, 2014 and January 23, 2015. We are required to issue the remaining $100 million of 8.25% subordinated notes due 2024 within one year of the initial purchase.
Clarendon Fund
In December 2014, we formed a new managed credit fund, NewStar Clarendon Fund CLO ("Clarendon Fund") a $400 million middle market CLO used to provide leverage for a managed credit fund anchored by an investment from funds sponsored by Franklin Square Capital Partners and sub-advised by GSO Capital, the credit division of Blackstone to co-invest in middle market commercial loans originated by the Company. In January 2015, we completed the sale of the Clarendon Fund's CLO bonds to third party investors. As of December 31, 2014, the Clarendon Fund loan portfolio had an outstanding balance of approximately $236.7 million.
Liquidity
On January 13, 2015, we entered into an amendment to our credit facility with Wells Fargo Bank, National Association to fund leveraged finance loans. The amendment, among other things, increased the commitment amount from $275.0 million to $375.0 million, increased the maximum amount that the credit facility may be increased to $425.0 million, subject to lender approval, and modified certain concentration amounts and specified threshold amounts.
On December 8, 2014, we entered into an amendment to our credit facility with Wells Fargo Bank, National Association to fund asset-based loan origination. The amendment, among other things, increased the commitment amount from $100.0 million to $110.0 million, extended the maturity date to December 7, 2017, and increased the maximum amount that the credit facility may be increased to $300.0 million, subject to lender approval.
On December 4, 2014, NewStar TRS I LLC, a newly-formed subsidiary of the Company, entered into a total return swap (the "TRS") of senior secured floating rate loans with Citibank, N.A. The TRS was subsequently amended on December 15, 2014 increasing the maximum notional amount to $125.0 million from $75.0 million.
Stock Repurchase Program
On December 22, 2014, we repurchased 1,000,000 shares of our common stock in a privately negotiated transaction with an unaffiliated third party for an aggregate purchase price of $10.2 million. This transaction was not made under the stock repurchase program announced on August 13, 2014 described below.
On August 13, 2014, our Board of Directors authorized the repurchase of up to $10.0 million of the Company’s common stock from time to time on the open market or in privately negotiated transactions. The timing and amount of any shares purchased are determined by our management based on its evaluation of market conditions and other factors. The repurchase program, which will expire on August 15, 2015 unless extended by the Board of Directors, may be suspended or discontinued at any time without notice. As of December 31, 2014, we had repurchased 382,999 shares of our common stock under this program at a weighted average price per share of $11.54.


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RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2014, 2013 AND 2012
NewStar’s basic and diluted income per share for 2014 was $0.22 and $0.21, respectively, on net income of $10.6 million compared to basic and diluted income per share for 2013 of $0.51 and $0.46, respectively, on net income of $24.6 million, and basic and diluted income per share for 2012 of $0.51 and $0.45, respectively, on net income of $24.0 million. Our managed portfolio was $3.4 billion at December 31, 2014 compared to $2.5 billion at December 31, 2013 and $2.4 billion at December 31, 2012. Our managed assets totaled $3.8 billion at December 31, 2014 compared to $2.9 billion at December 31, 2013, and at December 31, 2012.
Loan portfolio yield
Loan portfolio yield, which is interest income on our loans and leases divided by the average balances outstanding of our loans and leases, was 6.09% for 2014, 6.68% for 2013 and 6.54% for 2012. The decrease in loan portfolio yield was primarily driven by a decrease in our average yield on interest earning assets from new loan and lease origination and re-pricings subsequent to December 31, 2013, and the average yield on loans which were repaid subsequent to December 31, 2013 was higher than the average yield on loans in our total loan portfolio. The increase in loan portfolio yield from 2012 to 2013 was primarily driven by the recognition of deferred paid-in-kind interest on certain impaired loans, and the average yield on loans which were repaid subsequent to December 31, 2012 was lower than the average yield on loans in our average total loan portfolio for 2013. Additionally, subsequent to December 31, 2012, the outstanding balance of lower yielding commercial real estate loans decreased $54.4 million.
Net interest margin
Net interest margin, which is net interest income divided by average interest earning assets, was 3.17% for 2014, 3.90% for 2013 and 4.34% for 2012. The primary factors impacting net interest margin for 2014 were the acceleration of amortization of $1.1 million of deferred financing fees related to the Arlington Fund’s payoff of its credit facility with a portion of the proceeds from the Arlington Program’s term debt securitization, the subordinated notes interest expense, the composition of interest earning assets, non-accrual loans, changes in three-month LIBOR, credit spreads and cost of borrowings. The primary factors impacting net interest margin for 2013 were the composition of interest earning assets, the recognition of deferred paid-in-kind interest on certain impaired loans, non-accrual loans, changes in three-month LIBOR, credit spreads and cost of borrowings. The primary factors impacting net interest margin for 2012 were accelerated loan deferred fee recognition due to a prepayment of loans, non-accrual loans, changes in three-month LIBOR, credit spreads and cost of borrowings.
Efficiency ratio
Our efficiency ratio, which is total operating expenses divided by net interest income before provision for credit losses plus total non-interest income, was 50.32% for 2014, 49.30% for 2013 and 46.46% for 2012. The increase in our efficiency ratio for 2014 as compared to 2013 is primarily due to increased interest expense driven by an increase in our interest bearing liabilities, and the accelerated amortization of deferred financing fees totaling $1.1 million related to the repayment of the Arlington Fund’s credit facility, partially offset by a decrease in operating expenses. The increase in our efficiency ratio for 2013 as compared to 2012 was primarily due to an increase in operating expenses.
Allowance for credit losses ratio
Allowance for credit losses ratio, which is allowance for credit losses divided by outstanding gross loans and leases excluding loans held-for-sale, was 1.84% at December 31, 2014, 1.80% as of December 31, 2013 and 2.78% as of December 31, 2012. The increase in the allowance for credit losses ratio from 2013 to 2014 is primarily due to the increase in general provision resulting from the increase in outstanding loans due to new loan origination during the year, an increase in specific provision and the deconsolidation of the assets of the Arlington Fund on June 26, 2014, which did not carry a related allowance. The decrease in the allowance for credit losses ratio from 2012 to 2013 is primarily due to a decrease in the balance of the specific allowance for credit losses, the NCOF portfolio purchase, which was acquired on December 17, 2013 at fair value and no allowance was required at year end, the consolidation of the Arlington Fund as a VIE, for which no allowance was needed at year end, positive credit migration, improving economic conditions, and charge offs of impaired loans. During 2014, we recorded $22.1 million of net specific provision for credit losses on impaired loans and had net charge offs totaling $25.3 million. At December 31, 2014, the specific allowance for credit losses was $20.7 million, and the general allowance for credit losses was $23.0 million. At December 31, 2013, the specific allowance for credit losses was $23.3 million, and the general allowance for credit losses was $18.6 million. We continually evaluate our allowance for credit losses methodology. If we determine that a change in our allowance for credit losses methodology is advisable, as a result of the rapidly changing economic environment or otherwise, the revised allowance methodology may result in higher or lower levels of allowance. Moreover, actual losses under our current or any revised methodology may differ materially from our estimate.

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Delinquent loan rate
Delinquent loan rate, which is total delinquent loans that are 60 days or more past due, divided by outstanding gross loans and leases, was 1.84% as of December 31, 2014 as compared to 0.22% as of December 31, 2013. We had delinquent loans with an outstanding balance of $43.6 million and $5.1 million as of December 31, 2014 and 2013, respectively. We expect the delinquent loan rate to correlate to current economic conditions. During times of economic expansion we expect the rate to decline, and during times of economic contraction, we expect the rate to increase.
Delinquent loan rate for accruing loans 60 days or more past due
Delinquent loan rate for accruing loans 60 days or more past due, which is total delinquent accruing loans net of charge offs that are 60 days or more past due and less than 90 days past due, divided by outstanding gross loans and leases. We did not have any delinquent accruing loans as of December 31, 2014 or 2013. We expect the delinquent accruing loan rate to correlate to current economic conditions. During times of economic expansion we expect the rate to decline, and during times of economic contraction, we expect the rate to increase.
Non-accrual loan rate
Non-accrual loan rate is defined as total balances outstanding of loans on non-accrual status divided by the total outstanding balance of our loans and leases held for investment. Loans are put on non-accrual status if they are 90 days or more past due or if management believes it is probable that the Company will be unable to collect contractual principal and interest in the normal course of business. The non-accrual loan rate was 3.70% as of December 31, 2014 and 3.04% as of December 31, 2013. As of December 31, 2014 and 2013, the aggregate outstanding balance of non-accrual loans was $87.8 million and $70.7 million, respectively and total outstanding loans and leases held for investment was $2.4 billion and $2.3 billion, respectively. We expect the non-accrual loan rate to correlate to economic conditions. During times of economic expansion we expect the rate to decline, and during times of economic contraction, we expect the rate to increase, although actual results may vary.
Non-performing asset rate
Non-performing asset rate is defined as the sum of total balances outstanding of loans on non-accrual status and other real estate owned, divided by the sum of the total outstanding balance of our loans and leases held for investment and other real estate owned. The non-performing asset rate was 3.84% as of December 31, 2014 and 3.60% as of December 31, 2013. As of December 31, 2014 and 2013, the sum of the aggregate outstanding balance of non-performing assets was $91.0 million and $84.2 million, respectively. We expect the non-performing asset rate to correlate to economic conditions. During times of economic expansion we expect the rate to decline, and during times of economic contraction, we expect the rate to increase, although actual results may vary.
Net charge off rate (end of period loans and leases)
Net charge off rate as a percentage of end of period loan and lease portfolio is defined as annualized charge-offs net of recoveries divided by the total outstanding balance of our loans and leases held for investment. A charge-off occurs when management believes that all or part of the principal of a particular loan is no longer recoverable and will not be repaid. Typically a charge off occurs in a period after a loan has been identified as impaired and a specific allowance has been established. For 2014, 2013 and 2012, the net charge off rate was 1.07%, 0.77% and 1.49%, respectively. We expect the net charge-off rate (end of period loans and leases) to correlate to economic conditions. During times of economic expansion we expect the rate to decline, and during times of economic contraction, we expect the rate to increase, although actual results may vary.
Net charge off rate (average period loans and leases)
Net charge off rate as a percentage of average period loan and lease portfolio is defined as annualized charge-offs net of recoveries divided by the average total outstanding balance of our loans and leases held for investment for the period. For 2014, 2013 and 2012, the net charge off rate was 1.10%, 0.91% and 1.43%, respectively. We expect the net charge-off rate (average period loans and leases) to correlate to economic conditions. During times of economic expansion we expect the rate to decline, and during times of economic contraction, we expect the rate to increase, although actual results may vary.
Return on average assets
Return on average assets, which is net income divided by average total assets was 0.42% for 2014, 1.08% for 2013, and 1.17% for 2012.
Return on average equity

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Return on average equity, which is net income divided by average equity, was 1.72% for 2014, 4.07% for 2013, and 4.14% for 2012.
Review of Consolidated Results
A summary of NewStar’s consolidated financial results for the years ended December 31, 2014, 2013 and 2012 follows:
 
Year Ended December 31,
 
2014
 
2013
 
2012
 
($ in thousands)
Net interest income:
 
 
 
 
 
Interest income
$
136,171

 
$
127,684

 
$
123,945

Interest expense
57,775

 
42,971

 
35,591

Net interest income
78,396

 
84,713

 
88,354

Provision for credit losses
27,108

 
9,738

 
12,651

Net interest income after provision for credit losses
51,288

 
74,975

 
75,703

Non-interest income:
 
 
 
 
 
Fee income
2,467

 
3,670

 
4,619

Asset management income
1,054

 
2,482

 
2,984

Gain (loss) on derivatives
(39
)
 
(143
)
 
(315
)
Gain on sale of loans
(230
)
 
72

 
335

Other income (loss)
7,964

 
7,431

 
3,948

Total non-interest income
11,216

 
13,512

 
11,571

Operating expenses:
 
 
 
 
 
Compensation and benefits
30,383

 
32,672

 
31,139

General and administrative expenses
15,133

 
16,726

 
15,158

Total operating expenses
45,516

 
49,398

 
46,297

Operating income before income taxes
16,988

 
39,089

 
40,977

Results of Consolidated Variable Interest Entity:
 
 
 
 
 
Interest income
5,268

 
5,321

 

Interest expense—credit facilities
2,865

 
1,879

 

Interest expense—Fund membership interest
1,292

 
1,353

 

Other income
229

 
51

 

Operating expenses
249

 
78

 

Net results from Consolidated Variable Interest Entity
1,091

 
2,062

 

Income before income taxes
18,079

 
41,151

 
40,977

Income tax expense
7,485

 
16,556

 
17,000

Net income
$
10,594

 
$
24,595

 
$
23,977

Comparison of the Years Ended December 31, 2014 and 2013
Interest income. Interest income increased $8.4 million, to $141.4 million for 2014 from $133.0 million for 2013. The increase was primarily due to an increase in average balance of our interest earning assets to $2.5 billion from $2.2 billion, partially offset by a decrease in the yield on average interest earning assets to 5.64% from 5.98% primarily due to a decrease in contractual interest rates from new loan origination and re-pricing subsequent to December 31, 2013.
Interest expense. Interest expense increased $15.7 million, to $61.9 million for 2014 from $46.2 million for 2013. The increase is primarily due to the accelerated amortization of deferred financing fees totaling $1.1 million related to the repayment of Arlington Fund’s credit facility, an increase in the average balance of our interest bearing liabilities to $2.0 billion from $1.6 billion, and an increase in the average cost of funds to 3.12% from 2.84%.
Net interest margin. Net interest margin decreased to 3.17% for 2014 from 3.90% for 2013. The decrease in net interest margin was primarily due to an increase in our average cost of interest bearing liabilities, an increase in average cost of funds,

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the accelerated amortization of deferred financing fees totaling $1.1 million related to the repayment of Arlington Fund’s credit facility, a decrease in our average yield on interest earning assets due to the recognition of deferred paid-in-kind interest on certain impaired loans during 2013 and the acceleration of amortization of deferred fees from loans that were paid off during 2013. The net interest spread, the difference between gross yield on our interest earning assets and the total cost of our interest bearing liabilities, decreased to 2.52% from 3.14%.
The following table summarizes the yield and cost of interest earning assets and interest bearing liabilities for 2014 and 2013:
 
Year Ended December 31, 2014
 
Year Ended December 31, 2013
 
($ in thousands)
 
Average
Balance
 
Interest
Income/
Expense
 
Average
Yield/
Cost
 
Average
Balance
 
Interest
Income/
Expense
 
Average
Yield/
Cost
Total interest earning assets
$
2,508,729

 
$
141,439

 
5.64
%
 
$
2,223,908

 
$
133,005

 
5.98
%
Total interest bearing liabilities
1,983,516

 
61,932

 
3.12

 
1,627,816

 
46,203

 
2.84

Net interest spread
 
 
$
79,507

 
2.52
%
 
 
 
$
86,802

 
3.14
%
Net interest margin
 
 
 
 
3.17
%
 
 
 
 
 
3.90
%
Provision for credit losses. The provision for credit losses increased to $27.1 million for 2014 from $9.7 million for 2013. The increase in the provision was primarily due to an increase of $11.0 million of net specific provisions, as well as an increase of $6.4 million of general provisions recorded during 2014 as compared to 2013. During 2014, we recorded net specific provisions for impaired loans of $22.1 million compared to $11.2 million recorded during 2013. The increase in the net specific component of the provision for credit losses was primarily due to further negative credit migration related to six previously identified impaired loans and two loans identified as impaired during 2014. During 2014, we recorded general provisions of $5.0 million compared to a release of general provisions of $1.4 million recorded during 2013. Our general allowance for credit losses covers probable losses in our loan and lease portfolio with respect to loans and leases that are not impaired and for which no specific impairment has been identified. A specific provision for credit losses is recorded with respect to loans for which it is probable that we will be unable to collect all amounts due in accordance with the contractual terms of the loan agreement for which there is impairment recognized. The Company employs a variety of internally developed and third-party modeling and estimation tools for measuring credit risk, which are used in developing an allowance for loan and lease losses on outstanding loans and leases. The Company’s allowance framework addresses economic conditions, capital market liquidity and industry circumstances from both a top-down and bottom-up perspective. The Company considers and evaluates a number of factors, including but not limited to, changes in economic conditions, credit availability, industry, loss emergence period, and multiple obligor concentrations in assessing both probabilities of default and loss severities as part of the general component of the allowance for loan and lease losses.
On at least a quarterly basis, loans and leases are internally risk-rated based on individual credit criteria, including loan and lease type, loan and lease structures (including balloon and bullet structures common in the Company’s Leveraged Finance and Real Estate loans), borrower industry, payment capacity, location and quality of collateral if any (including the Company’s Real Estate loans). Borrowers provide the Company with financial information on either a monthly or quarterly basis. Ratings, corresponding assumed default rates and assumed loss severities are dynamically updated to reflect any changes in borrower condition or profile.
For Leveraged Finance loans and Equipment Finance products, the data set used to construct probabilities of default in its allowance for loan losses model, Moody’s CRD Private Firm Database, primarily contains middle market loans that share attributes similar to the Company’s loans. The Company also considers the quality of the loan or lease terms and lender protections in determining a loan loss in the event of default.
For Business Credit loans, the Company utilizes a proprietary model to risk rate the loans on a monthly basis. This model captures the impact of changes in industry and economic conditions as well as changes in the quality of the borrower’s collateral and financial performance to assign a final risk rating. The Company has also evaluated historical loss trends by risk rating from a comprehensive industry database covering more than twenty-five years of experience of the majority of the asset based lenders operating in the United States. Based upon the monthly risk rating from the model, the reserve is adjusted to reflect the historical average for expected loss from the industry database.
For Real Estate loans, the Company employs two mechanisms to capture the impact of industry and economic conditions. First, a loan’s risk rating, and thereby its assumed default likelihood, can be adjusted to account for overall commercial real estate market conditions. Second, to the extent that economic or industry trends adversely affect a substandard rated borrower’s loan-to-value ratio enough to impact its repayment ability, the Company applies a stress multiplier to the loan’s probability of

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default. The multiplier is designed to account for default characteristics that are difficult to quantify when market conditions cause commercial real estate prices to decline.
For consolidated variable interest entities to which the Company is providing transitional capital, we utilize a qualitative analysis which considers the business plans related to the entity, including expected hold periods, the terms of the agreements related to the entity, the Company’s historical credit experience, the credit migration of the entity’s loans in determining expected loss, as well as conditions in the capital markets. The Company provided capital on a transitional basis to the Arlington Fund. At December 31, 2013, the expected and actual loss on the Arlington Fund was zero and no allowance was recorded. We deconsolidated the Arlington Fund on June 26, 2014. We did not recognize any losses on loans on the date of deconsolidation.
The Company periodically reviews its allowance for credit loss methodology to assess any necessary adjustments based upon changing economic and capital market conditions. If the Company determines that changes in its allowance for credit losses methodology are advisable, as a result of changes in the economic environment or otherwise, the revised allowance methodology may result in higher or lower levels of allowance. There have been no material modifications to the allowance for credit losses methodology during 2014. Given uncertain market conditions, actual losses under the Company’s current or any revised allowance methodology may differ materially from the Company’s estimate.
Additionally, when determining the amount of the general allowance, the Company supplements the base amount with an environmental reserve amount which is governed by a score card system comprised of ten individually weighted risk factors. The risk factors are designed based on those outlined in the Comptrollers of the Currency’s Allowance for Loan and Lease Losses Handbook. The Company also performs a ratio analysis of comparable money center banks, regional banks and finance companies. While the Company does not rely on this peer group comparison to set the level of allowance for credit losses, it does assist management in identifying market trends and serves as an overall reasonableness check on the allowance for credit losses computation.
A loan is considered impaired when it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impairment of a loan is based upon (i) the present value of expected future cash flows discounted at the loan’s effective interest rate, (ii) the loan’s observable market price, or (iii) the fair value of the collateral if the loan is collateral dependent, depending on the circumstances and our collection strategy. Impaired loans are identified based on the loan-by-loan risk rating process described above. Impaired loans include all non-accrual loans, loans with partial charge-offs and loans which are Troubled Debt Restructurings. It is the Company’s policy during the reporting period to record a specific provision for credit losses to cover the identified impairment on a loan.
 
 Impaired loans at December 31, 2014 were in Leveraged Finance and Real Estate over a range of industries impacted by the then current economic environment including the following: Media and Communications, Industrial, Commercial Real Estate, Other Business Services, Consumer/Retail, and Building Materials. For impaired Leveraged Finance loans, the Company measured impairment based on expected cash flows utilizing relevant information provided by the borrower and consideration of other market conditions or specific factors impacting recoverability. Such amounts are discounted based on original loan terms. For impaired Real Estate loans, the Company determined that the loans were collateral dependent and measured impairment based on the fair value of the related collateral utilizing recent appraisals from third-party appraisers, as well as internal estimates of market value. As of December 31, 2014, we had impaired loans with an aggregate outstanding balance of $217.2 million. Impaired loans with an aggregate outstanding balance of $175.6 million have been restructured and classified as troubled debt restructurings. At December 31, 2014, the Company had a $20.7 million specific allowance for impaired loans with an aggregate outstanding balance of $103.2 million. As of December 31, 2014, we had one restructured impaired loan that had an outstanding balance greater than $20 million and one restructured impaired loan that had an outstanding balance greater than $30 million. In each of these cases, we added to our position to maximize our potential recovery of the outstanding principal.
Non-interest income. Non-interest income decreased $2.2 million, to $11.4 million for 2014 from $13.6 million for 2013. For 2014, non-interest income was primarily comprised of $6.7 million of gains recognized from the sale of equity interests in certain impaired borrowers, $2.5 million of fee income, $2.1 million of income from other real estate owned properties, $1.8 million of unused fees, $1.1 million of asset management fees, $0.8 million of equity method of accounting losses, $0.6 million of net losses on the value of equity interests in certain impaired borrowers, a $0.9 million unrealized loss on a total return swap, and a $0.8 million loss on the creation of a new credit fund. For 2013, non-interest income was primarily comprised of $3.7 million of fee income, $2.5 million of asset management fees, $2.5 million of income from other real estate owned properties, $1.8 million of unused fees, $0.7 million of one-time proceeds from a revenue sharing agreement with one of our borrowers, a $0.6 million gain on the value of equity interests in an impaired borrower, $1.3 million gain on the sale of an equity interest in an impaired borrower, and $1.0 million of equity method of accounting losses.
As a result of certain of our troubled debt restructurings, we have received equity interests in several of our impaired borrowers. The equity interests in certain impaired borrowers is initially recorded at fair value when the debt is restructured and

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is subsequently analyzed at the end of each quarter. In situations where we are deemed to be under the equity method of accounting, we record our ownership share of the borrowers’ results of operations in non-interest income. Additionally, our corresponding share of our borrowers’ results of operations may directly impact the remaining net book value of these respective loans. These equity interests may give rise to potential capital gains or losses, for tax purposes. This could impact future period tax rates depending on our ability to recognize capital losses to the extent of any capital gains.
Operating expenses. Operating expenses decreased $3.7 million, to $45.8 million for 2014 from $49.5 million for 2013. Employee compensation and benefits decreased $2.3 million primarily due to a decrease in equity compensation expense resulting from the vesting of equity awards subsequent to December 31, 2013. General and administrative expenses decreased $1.6 million.
Results of Consolidated Variable Interest Entity. In April 2013, we announced that we had formed a new managed credit fund, the Arlington Fund, in partnership with an institutional investor to co-invest in middle market commercial loans originated by NewStar. As the managing member of Arlington Fund, we retained full discretion over Arlington Fund’s investment decisions, subject to usual and customary limitations, and earned management fees as compensation for our services. From inception, the Company was deemed to be the primary beneficiary of Arlington Fund and, therefore, consolidated the financial results of Arlington Fund with the Company’s results of operations and statements of financial position since April 2013.
Upon completion of the Arlington Program’s term debt securitization on June 26, 2014, our membership interests in Arlington Fund were redeemed and new membership interests in the Arlington Program were issued to its equity investors. As a result of the repayment of our advances as the Class B lender under the warehouse facility and the redemption of our membership interests in the Arlington Fund, we have no ownership or financial interests in the Arlington Fund or its successors except to the extent that we receive management fees as collateral manager of the Arlington Program. Additionally, the Arlington Program employs an independent investment professional who is responsible for investment decision making on behalf of the program. As a result, we deconsolidated the Arlington Fund from our statements of financial position beginning on June 26, 2014 and will not consolidate the Arlington Program’s operating results or statements of financial position as of that date.
Although we consolidated all of the assets and liabilities of Arlington Fund during the period from April 4, 2013 through June 26, 2014, our maximum exposure to loss was limited to our investments in membership interests in Arlington Fund, our Class B Note receivable, and the management fee receivable from Arlington Fund. These items defined our economic relationship with Arlington Fund but were eliminated upon consolidation. We managed the assets of Arlington Fund solely for the benefit of its lenders and investors. If we were to have liquidated, the assets of Arlington Fund would not have been available to our general creditors. Conversely, the investors in the debt of Arlington Fund had no recourse to our general assets. Therefore, we did not consider this debt our obligation.
Income taxes. For 2014 and 2013, we provided for income taxes based on an effective tax rate of 41% and 40%, respectively. The effective tax rates differed from the federal statutory rate of 35% due largely to state tax expense in both years.  
As of December 31, 2014 and 2013, we had net deferred tax assets of $28.1 million and $30.2 million, respectively. In assessing if we will be able to realize our deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. We considered all available evidence, both positive and negative, in determining the realizability of deferred tax assets at December 31, 2014. We considered carryback availability, the scheduled reversals of deferred tax liabilities, projected future taxable income during the reversal periods, and tax planning strategies in making this assessment. We also considered our recent history of taxable income, trends in our earnings and tax rate, positive financial ratios, and the impact of the downturn in the current economic environment (including the impact of credit on allowance and provision for loan losses; and the impact on funding levels) on the Company. Based upon our assessment, we believe that a valuation allowance was not necessary as of December 31, 2014. As of December 31, 2014, our deferred tax asset was primarily comprised of $23.9 million related to our allowance for credit losses and $10.0 million related to equity compensation, which was partially offset by deferred tax liabilities related the Equipment finance portfolio.
Comparison of the Years Ended December 31, 2013 and 2012
Interest income. Interest income increased $9.1 million, to $133.0 million for 2013 from $123.9 million for 2012. The increase was primarily due to an increase in average balance of our interest earning assets to $2.2 billion from $2.0 billion, the recognition of $2.0 million of deferred paid-in-kind interest on certain impaired loans, the acceleration of amortization of deferred fees from loans that paid off during 2013, and the consolidation of interest income from Arlington Fund, partially offset by a decrease in the yield on average interest earning assets to 5.98% from 6.09% primarily due to a decrease in contractual interest rates from new loan origination and re-pricing subsequent to December 31, 2012.

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Interest expense. Interest expense increased to $46.2 million for 2013 from $35.6 million for 2012. The increase is primarily due to an increase in the average balance of our interest bearing liabilities and an increase in the average cost of funds, the additional $100.0 million of debt under our amended corporate credit facility, and the consolidation of interest expense from Arlington Fund.
Net interest margin. Net interest margin decreased to 3.90% for 2013 from 4.34% for 2012. The decrease in net interest margin was primarily due to an increase in our average interest bearing liabilities, an increase in average cost of funds, and a decrease in the yield on average interest earning assets, partially offset by the recognition of deferred paid-in-kind interest on certain impaired loans, and the acceleration of amortization deferred fees from loans that paid off during 2013. The net interest spread, which represents the difference between gross yield on our interest earning assets and the total cost of our interest bearing liabilities, decreased to 3.14% from 3.57%.
The following table summarizes the yield and cost of interest earning assets and interest bearing liabilities for 2013 and 2012:
 
Year Ended December 31, 2013
 
Year Ended December 31, 2012
 
($ in thousands)
 
Average
Balance
 
Interest
Income/
Expense
 
Average
Yield/
Cost
 
Average
Balance
 
Interest
Income/
Expense
 
Average
Yield/
Cost
Total interest earning assets
$
2,223,908

 
$
133,005

 
5.98
%
 
$
2,036,526

 
$
123,945

 
6.09
%
Total interest bearing liabilities
1,627,816

 
46,203

 
2.84

 
1,414,967

 
35,591

 
2.52

Net interest spread
 
 
$
86,802

 
3.14
%
 
 
 
$
88,354

 
3.57
%
Net interest margin
 
 
 
 
3.90
%
 
 
 
 
 
4.34
%
Provision for credit losses. The provision for credit losses decreased to $9.7 million for 2013 from $12.7 million for 2012. The decrease in the provision was primarily due to a decrease of $5.5 million of net specific provisions recorded during 2013 as compared to 2012. During 2013, we recorded net specific provisions for impaired loans of $11.2 million compared to $16.7 million recorded during 2012. The decrease in the net specific component of the provision for credit losses was primarily due to the resolution of certain impaired loans which were subsequently charged off and positive credit migration. Our general allowance for credit losses covers probable losses in our loan and lease portfolio with respect to loans and leases that are not impaired and for which no specific impairment has been identified. A specific provision for credit losses is recorded with respect to loans for which it is probable that we will be unable to collect all amounts due in accordance with the contractual terms of the loan agreement for which there is impairment recognized. The Company employs a variety of internally developed and third-party modeling and estimation tools for measuring credit risk, which are used in developing an allowance for loan and lease losses on outstanding loans and leases. The Company’s allowance framework addresses economic conditions, capital market liquidity and industry circumstances from both a top-down and bottom-up perspective. The Company considers and evaluates changes in economic conditions, credit availability, industry and multiple obligor concentrations in assessing both probabilities of default and loss severities as part of the general component of the allowance for loan and lease losses.
Impaired loans at December 31, 2013 were in Leveraged Finance, Real Estate, and Business Credit over a range of industries impacted by the then current economic environment including the following: Media and Communications, Industrial, Commercial Real Estate, Other Business Services, Consumer/Retail, and Building Materials. For impaired Leveraged Finance loans, the Company measured impairment based on expected cash flows utilizing relevant information provided by the borrower and consideration of other market conditions or specific factors impacting recoverability. Such amounts are discounted based on original loan terms. For impaired Real Estate loans, the Company determined that the loans were collateral dependent and measured impairment based on the fair value of the related collateral utilizing recent appraisals from third-party appraisers, as well as internal estimates of market value. As of December 31, 2013, we had impaired loans with an aggregate outstanding balance of $271.0 million. Impaired loans with an aggregate outstanding balance of $240.3 million have been restructured and classified as troubled debt restructurings. At December 31, 2013, the Company had a $23.3 million specific allowance for impaired loans with an aggregate outstanding balance of $154.7 million. As of December 31, 2013, we had three restructured impaired loans which had an outstanding balance greater than $20 million. In each of these cases, we added to our position to maximize our potential recovery of the outstanding principal.
Non-interest income. Non-interest income increased $2.0 million, to $13.6 million for 2013 from $11.6 million for 2012. The increase is primarily due to $2.3 million net gains on equity method of accounting interests, and $2.5 million of income from our other real estate owned properties, partially offset by a $1.9 million loss on the value of equity interests in certain impaired borrowers. Beginning in 2013, the income and expenses from our other real estate owned properties were presented on a gross basis in our consolidated statement of operations.

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As a result of certain of our troubled debt restructurings, we have received an equity interest in several of our impaired borrowers. The equity interest in certain impaired borrowers is initially recorded at fair value when the debt is restructured and is subsequently analyzed at the end of each quarter. In situations where we are deemed to be under the equity method of accounting, we record our ownership share of the borrowers’ results of operations in non-interest income. Additionally, our corresponding share of our borrowers’ results of operations may directly impact the remaining net book value of these respective loans. These equity interests may give rise to potential capital gains or losses, for tax purposes. This could impact future period tax rates depending on our ability to recognize capital losses to the extent of any capital gains.
Operating expenses. Operating expenses increased $3.2 million, to $49.5 million for 2013 from $46.3 million for 2012. Employee compensation and benefits increased $1.5 million primarily due to an increase in headcount and higher incentive compensation accruals, which were partially offset by lower equity compensation expense. General and administrative expenses increased $1.6 million due primarily to $4.0 million of operating expenses from our other real estate owned properties and an increase of $0.4 million in occupancy expense, partially offset by a decrease of $3.1 million in loan workout costs. Beginning in 2013, the income and expenses from our other real estate owned properties were presented on a gross basis in our consolidated statement of operations.
Income taxes. For 2013 and 2012, we provided for income taxes based on an effective tax rate of 40% and 41%, respectively. The effective tax rates differed from the federal statutory rate of 35% due largely to state tax expense in both years. Our tax rate for 2013, reflects the consolidation of the results of our variable interest entities.

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Our primary sources of liquidity consist of cash flow from operations, credit facilities, term debt securitizations and proceeds from equity and debt offerings.
We believe that these sources will be sufficient to fund our current operations, lending activities and other short-term liquidity needs. Subject to market conditions, we continue to explore opportunities for the Company to increase its leverage, including through the issuance of high yield debt securities, convertible debt securities, share repurchases, secured or unsecured senior debt or revolving credit facilities, to support loan portfolio growth and/or strategic acquisitions, which may be material to us. In addition to opportunistic funding related to potential growth initiatives, our future liquidity needs will be determined primarily based on prevailing market and economic conditions, the credit performance of our loan portfolio and loan origination volume. We may need to raise additional capital in the future based on various factors including, but not limited to: faster than expected increases in the level of non-accrual loans; lower than anticipated recoveries or cash flow from operations; and unexpected limitations on our ability to fund certain loans with credit facilities. We may not be able to raise debt or equity capital on acceptable terms or at all. The incurrence of additional debt will increase our leverage and interest expense, and the issuance of any equity or securities exercisable, convertible or exchangeable into Company common stock may be dilutive for existing shareholders.
During the fourth quarter of 2014, the U.S. economy continued to show improvement and growth as the quarter saw favorable trends in personal consumption, auto sales, durable goods and consumer confidence despite continued geopolitical uncertainty and the increasing likelihood of rising interest rates. We expect the broader favorable trends and modest growth in the U.S. to continue and monetary policy to remain conducive to growth in the near term. We expect the broader favorable trends and slow growth in the U.S. to continue and monetary policy to remain conducive to growth in the near term. Despite tapering, we expect Treasury and investment grade bond rates remain relatively low and investors to continue to focus on allocating capital to riskier, higher yielding, fixed and floating rate asset classes in order to generate additional yield from their investments. The larger, more liquid segments of the securitization markets also continued to display strong volume and pricing. With the strengthening of the high yield loan markets as well as the broader securitization market, conditions in the securitization market for loans (the CLO market) remain attractive for issuers such as NewStar, despite some lingering uncertainty surrounding regulatory changes. We believe that the CLO market, which the Company partially relies upon for funding, has stabilized to a point that it will provide a reliable source of capital for companies like NewStar. In addition to these signs of stabilizing market conditions, we believe the Company has substantially greater financial flexibility and increased financing options due to the improvement in our financial performance.
We believe that our ability to access the capital markets, secure new credit facilities, and renew and/or amend our existing credit facilities continues to demonstrate an overall improvement in the market conditions for funding and indicates progress in our ability to obtain financings on improved terms in the future.  Despite these signs of improving market conditions and relative stability in recent years, we cannot assure these conditions will continue, and it is possible that the financial markets could experience stress, volatility, and/or illiquidity.  If they do, we could face materially higher financing costs and reductions in leverage, which would affect our operating strategy and could materially and adversely affect our financial condition.

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Strategic Relationship
On November 4, 2014, we announced a strategic relationship GSO and Franklin Square and entered into an investment agreement with FS Investment Corporation, FS Investment Corporation II, and FS Investment Corporation III (collectively the “Franklin Square Funds”) pursuant to which we agreed to issue $300 million of 8.25% subordinated notes due 2024 and warrants exercisable for 12 million shares of the Company’s common stock at an exercise price of $12.62 per share (the “Warrants”).
On December 4, 2014, we issued $200 million of the subordinated notes. The Warrants were issued in two tranches on December 4, 2014 and January 23, 2015. We are required to issue the remaining $100 million of 8.25% subordinated notes due 2024 within one year of the initial purchase.
Cash and Cash Equivalents
As of December 31, 2014 and 2013, we had $33.0 million and $43.4 million, respectively, in cash and cash equivalents. We may invest a portion of cash on hand in short-term liquid investments. From time to time, we may use a portion of our unrestricted cash to pay down our credit facilities creating undrawn capacity which may be redrawn to meet liquidity needs in the future or to equity fund loans.
Restricted Cash
Separately, we had $95.4 million and $167.9 million of restricted cash as of December 31, 2014 and 2013, respectively, and the Arlington Fund had $2.0 million of restricted cash as of December 31, 2013. The restricted cash represents the balance of the principal and interest collections accounts and pre-funding amounts in our credit facilities, our term debt securitizations and customer holdbacks and escrows. The use of the principal collection accounts’ cash is limited to funding the growth of our loan and portfolio within the facilities or paying down related credit facilities or term debt securitizations. As of December 31, 2014, we could use $32.8 million of restricted cash to fund new or existing loans. The interest collection account cash is limited to the payment of interest, servicing fees and other expenses of our credit facilities and term debt securitizations and, if either a ratings downgrade or failure to receive ratings confirmation occurs on the rated notes in a term debt securitization at the end of the funding period or if coverage ratios are not met, paying down principal with respect thereto. Cash to fund the growth of our loan portfolio and to pay interest on our term debt securitizations represented a large portion of our restricted cash balance at December 31, 2014.
Asset Quality and Allowance for Loan and Lease Losses
If a loan is 90 days or more past due, or if management believes it is probable we will be unable to collect contractual principal and interest in the normal course of business, it is our policy to place the loan on non-accrual status. If a loan financed by a term debt securitization is placed on non-accrual status, the loan may remain in the term debt securitization and excess interest spread cash distributions to us will cease until cash accumulated in the term debt securitization equals the outstanding balance of the non-accrual loan, or if an overcollateralization test is present, excess interest spread cash is diverted, and used to de-lever the securitization to bring the ratio back into compliance. When a loan is on non-accrual status, accrued interest previously recognized as interest income subsequent to the last cash receipt in the current year will be reversed, and the recognition of interest income on that loan will stop until factors indicating doubtful collection no longer exist and the loan has been brought current. We may make exceptions to this policy if the loan is well secured and is in the process of collection. As of December 31, 2014 we had impaired loans with an aggregate outstanding balance of $217.2 million. Impaired loans with an aggregate outstanding balance of $175.6 million have been restructured and classified as troubled debt restructurings. Impaired loans with an aggregate outstanding balance of $87.8 million were on non-accrual status. During 2014, $25.3 million of impaired loans were charged-off. Impaired loans of $43.6 million were greater than 60 days past due and classified as delinquent. During 2014, we recorded $22.1 million of net specific provisions for impaired loans. Included in our specific allowance for impaired loans was $8.7 million related to delinquent loans.
We closely monitor the credit quality of our loans and leases which are partly reflected in our credit metrics such as loan delinquencies, non-accruals, and charge-offs. Changes to these credit metrics are largely due to changes in economic conditions and seasoning of the loan and lease portfolio.
We have provided an allowance for loan and lease losses to provide for probable losses inherent in our loan and lease portfolio. Our allowance for loan and lease losses as of December 31, 2014 and 2013 was $43.0 million and $41.4 million, respectively, or 1.81% and 1.78% of loans and leases, gross, respectively. As of December 31, 2014, we also had a $0.7 million allowance for unfunded commitments, resulting in an allowance for credit losses of 1.84%.
The allowance for credit losses is based on a review of the appropriateness of the allowance for credit losses and its two components on a quarterly basis. The estimate of each component is based on observable information and on market and third-party data believed to be reflective of the underlying credit losses being estimated.

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It is the Company’s policy that during the reporting period to record a specific provision for credit losses for all loans which we have identified impairments. Subsequently, we may charge-off the portion of the loan for which a specific provision was recorded. All of these loans are classified as impaired (if they have not been so classified already as a result of a troubled debt restructuring) and are disclosed in the Allowance for Credit Losses footnote to the financial statements.
Activity in the allowance for loan and lease losses for the years ended December 31, 2014, 2013 and 2012 was as follows:
 
Year Ended December 31,
2014
 
2013
 
2012
($ in thousands)
Balance as of beginning of period
$
41,403

 
$
49,636

 
$
63,700

General provision for loan and lease losses
4,779

 
(1,544
)
 
(3,918
)
Specific provision for loan losses
22,070

 
11,159

 
16,653

Net charge offs
(25,269
)
 
(17,848
)
 
(26,799
)
Balance as of end of period
42,983

 
41,403

 
49,636

Allowance for losses on unfunded loan commitments
710

 
451

 
328

Allowance for credit losses
$
43,693

 
$
41,854

 
$
49,964

During 2014 we recorded a total provision for credit losses of $27.1 million. The Company increased its allowance for credit losses four basis points to 1.84% of gross loans at December 31, 2014 from 1.80% at December 31, 2013.
Borrowings and Liquidity
As of December 31, 2014 and 2013, we had outstanding borrowings totaling $2.2 billion and $2.0 billion, respectively. Borrowings under our various credit facilities and term debt securitizations are used to partially fund our positions in our loan portfolio.
As of December 31, 2014, our funding sources, maximum debt amounts, amounts outstanding and unused debt capacity, subject to certain covenants and conditions, are summarized below:
Funding Source
Maximum Debt
Amount
 
Amounts
Outstanding
 
Unused Debt
Capacity
 
Maturity
($ in thousands)
Credit facilities
$
585,000

 
$
487,768

 
$
97,232

 
2015 – 2019
Term debt securitizations(1)
1,208,187

 
1,193,187

 
15,000

 
2017 – 2023
Corporate debt
238,500

 
238,500

 

 
2016-2018
Subordinated notes
300,000

 
200,000

 
100,000

 
2024
Repurchase agreements
57,227

 
57,227

 

 
2017
Total
$
2,388,914

 
$
2,176,682

 
$
212,232

 
 
(1)
Maturities for term debt are based on contractual maturity dates. Actual maturities may occur earlier.
We must comply with various covenants. The breach of certain of these covenants could result in a termination event and the exercise of remedies if not cured. At December 31, 2014, we were in compliance with all such covenants. These covenants are customary and vary depending on the type of facility. These covenants include, but are not limited to, failure to service debt obligations, failure to meet liquidity covenants and tangible net worth covenants, and failure to remain within prescribed facility portfolio delinquency, charge-off levels, and overcollateralization tests. In addition, we are required to make termination or make‑whole payments in the event that certain of our existing credit facilities are prepaid. These termination or make-whole payments, if triggered, could be material to us individually or in the aggregate, and in the case of certain facilities, could be caused by factors outside of our control, including as a result of loan prepayment by the borrowers under the loan facilities that collateralize these credit facilities.
Credit Facilities
As of December 31, 2014 we had four credit facilities through certain of our wholly-owned subsidiaries: (i) a $275 million credit facility with Wells Fargo Bank, National Association (“Wells Fargo”) to fund leveraged finance loans, (ii) a $125

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million credit facility with DZ Bank AG Deutsche Zentral-Genossenschaftbank Frankfurt (“DZ Bank”) to fund asset-based loans, (iii) a $110 million credit facility with Wells Fargo to fund asset-based loans, and (iv) a $75 million credit facility with Wells Fargo to fund equipment leases and loans. Prior to the completion of its term debt securitization, the Arlington Fund had one credit facility, consisting of a $147.0 million of Class A Notes (as defined below) with Wells Fargo and $28.0 million of Class B Notes (as defined below) with the Company. The liability under the Class B Notes was eliminated in consolidation in accordance with GAAP.
We have a $275.0 million credit facility with Wells Fargo to fund leveraged finance loans. On January 13, 2015, we entered into an amendment to this credit facility which, among other things, increased the commitment amount to $375.0 million, with the ability to further increase the commitment amount to $425.0 million, subject to lender approval and other customary conditions, and modified certain concentration amounts and specified threshold amounts. The credit facility had an outstanding balance of $261.7 million and unamortized deferred financing fees of $2.9 million as of December 31, 2014. Interest on this facility accrued at a variable rate per annum. The facility provides for a revolving reinvestment period which ends on November 5, 2015 with a two-year amortization period.
We have a $125.0 million credit facility with DZ Bank that had an outstanding balance of $114.8 million and unamortized deferred financing fees of $0.2 million as of December 31, 2014. Interest on this facility accrues at a variable rate per annum. As part of the agreement, there is a minimum interest charge of $1.6 million per annum. If the facility is not utilized to cover this minimum requirement, then a make-whole fee is assessed to satisfy the minimum requirement. We are permitted to use the proceeds of borrowings under the credit facility to fund advances under asset-based loan commitments. The commitment amount under the credit facility provides for reinvestment until it matures on June 30, 2015 with no amortization period.
We have a $110.0 million credit facility with Wells Fargo to fund asset-based loan origination. The credit facility had an outstanding balance of $94.4 million and unamortized deferred financing fees of $0.8 million as of December 31, 2014. On December 8, 2014, we entered into an amendment which increased the commitment amount under this credit facility to $110.0 million from $100.0 million. The credit facility may be increased to an amount up to $300.0 million subject to lender approval and other customary conditions. Interest on this facility accrues at a variable rate per annum. The credit facility provides for reinvestment until it matures on December 7, 2017 with no amortization period.
We have a note purchase agreement with Wells Fargo under the terms of which Wells Fargo agreed to provide a $75.0 million credit facility to fund equipment leases and loans. The credit facility had an outstanding balance of $17.0 million and unamortized deferred financing fees of $1.1 million as of December 31, 2014. Interest on this facility accrues at a variable rate per annum. The credit facility matures on November 16, 2016.
On April 4, 2013, Arlington Fund entered into an agreement establishing $147.0 million of Class A Notes and $28.0 million of Class B Notes to partially fund eligible leveraged loans. Wells Fargo funded the Class A Notes as the initial Class A lender and we funded the Class B Notes as the initial Class B lender. On June 26, 2014, the Class A Notes and the Class B notes were redeemed in connection with the completion of the Arlington Program term debt securitization.
Corporate Credit Facility
On January 5, 2010, we entered into a note agreement with Fortress Credit Corp., which was subsequently amended on August 31, 2010, January 27, 2012, November 5, 2012, and December 4, 2012. The agreement was amended and restated on May 13, 2013 and further amended on June 3, 2013. On March 6, 2014, as permitted under the corporate credit facility with Fortress Credit Corp., we requested and received an increase of $28.5 million to the Initial Funding under this credit facility. On May 15, 2014, as permitted under the corporate credit facility with Fortress Credit Corp., we requested and received a new $10.0 million term loan (the “Term C Loan”). The credit facility, as amended, consists of a $238.5 million term note with Fortress Credit Corp. as agent, which consists of the existing outstanding balance of $100.0 million (the “Existing Funding”), an initial funding of $98.5 million (the “Initial Funding”), and three subsequent borrowings, of $5.0 million (the “Delay Draw Term A”), $25.0 million (the “Delay Draw Term B”) and the $10.0 million Term C Loan. The Existing Funding, the Initial Funding, the Delay Draw Term A, and the Term C Loan mature on May 11, 2018. The Delay Draw Term B matures on June 3, 2016. The Initial Funding, the Existing Funding and the Delay Draw Term A accrue interest at the London Interbank Offered Rate (LIBOR) plus 4.50% with an interest rate floor of 1.00%. The Delay Draw Term B accrues interest at LIBOR plus 3.375% with an interest rate floor of 1.00%. The Term C Loan accrues interest at LIBOR plus 4.25% with an interest rate floor of 1.00%.
We are permitted to use the proceeds of borrowings under the credit facility for general corporate purposes including, but not limited to, funding loans, working capital, paying down outstanding debt, acquisitions and repurchasing capital stock and dividend payments up to $37.5 million, The $37.5 million may be adjusted upward by the amount of fiscal year-end net income excluding depreciation and amortization expense.

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The term note may be prepaid at any time without a prepayment penalty including in the event of a change of control. As of December 31, 2014, the term note had an outstanding principal balance of $238.5 million and unamortized deferred financing fees of $4.1 million.
Subordinated notes
On December 4, 2014, we completed the initial closing of an investment of long-term capital from funds sponsored by Franklin Square Capital Partners ("Franklin Square") and sub-advised by GSO Capital Partners. The Franklin Square funds purchased $200.0 million of 10-year subordinated notes (the "Subordinated Notes") that rank junior to our existing and future senior debt. The Subordinated Notes were recorded at par less the initial relative fair value of the warrants issued in connection with the investment which was $43.2 million. The debt discount will accrete to par over time and will be recorded as non-cash interest expense. The Subordinated Notes bear interest at 8.25% and include a Payment-in-Kind ("PIK Toggle) feature that allows us, at our option, to elect to have interest accrued at a rate of 8.75% added to the principal of the Subordinated Notes instead of paying it in cash. The Subordinated Notes have a ten year term and will mature on December 4, 2024. They are callable during the first three years with payment of a make-whole premium. The prepayment premium decreases to 103% and 101% after the third and fourth anniversaries of the closing, respectively. They are callable at par after December 4, 2019. The Subordinated Notes require a mandatory payment at the end of each accrual period, beginning on December 5, 2019. We are required to make a cash payment of principal plus accrued interest in an amount required to prevent the Subordinated Notes from being treated as an "Applicable High Yield Discount Obligation" within the meaning of Section 163(i)(1) of the Internal Revenue Code of 1986, as amended. Events of default under the Subordinated Notes include failure to pay interest or principal when due subject to applicable grace periods, material uncured breaches of the terms of the Subordinated Notes, and bankruptcy/insolvency events.
Subordinated debt - Fund membership interest
Prior to the completion of the Arlington Program’s term debt securitization on June 26, 2014, we had purchased membership interests totaling $5.0 million in the Arlington Fund and a third-party investor had purchased membership interests totaling $30.0 million. The Company was the primary beneficiary of the Arlington Fund, and as a result of consolidating the Arlington Fund as a variable interest entity, or VIE, the membership interests representing equity ownership of Arlington Fund were characterized as debt in our consolidated statement of financial position. We applied an imputed interest rate to that debt and recorded the resulting interest expense in its consolidated statement of operations. In the consolidation, we eliminated the economic results of our related portion of the membership interests and the applied interest expense from our results of operations and statements of financial position. A portion of the proceeds from the Arlington Program’s term debt securitization were used to redeem the membership interests in the Arlington Fund. As a result, we deconsolidated the Arlington Fund from our statements of financial position beginning on June 26, 2014. We are not the primary beneficiary of the Arlington Program and will not consolidate the Arlington Program’s operating results or statements of financial position as of that date.
Term Debt Securitizations  
In June 2007 we completed a term debt securitization transaction. In conjunction with this transaction we established a separate single-purpose bankruptcy-remote subsidiary, NewStar Commercial Loan Trust 2007-1 (the “2007-1 CLO Trust”) and sold and contributed $600 million in loans and investments (including unfunded commitments), or portions thereof, to the 2007-1 CLO Trust. We remain the servicer of the loans. Simultaneously with the initial sale and contribution, the 2007-1 CLO Trust issued $546.0 million of notes to institutional investors. We retained $54.0 million, comprising 100% of the 2007-1 CLO Trust’s trust certificates. At December 31, 2014, the $316.8 million of outstanding drawn notes were collateralized by the specific loans and investments, principal collection account cash and principal payment receivables totaling $377.0 million. At December 31, 2014, deferred financing fees were $0.5 million. The 2007-1 CLO Trust permitted reinvestment of collateral principal repayments for a six-year period which ended in May 2013. During 2012, we purchased $0.2 million of the 2007-1 CLO Trust’s Class C notes. During 2010, we purchased $5.0 million of the 2007-1 CLO Trust’s Class D notes. During 2009, we purchased $1.0 million of the 2007-1 CLO Trust’s Class D notes.
During 2009, Moody’s downgraded all of the notes of the 2007-1 CLO Trust. As a result of the downgrade, amortization of the 2007-1 CLO Trust changed from pro rata to sequential, resulting in scheduled principal payments thereafter made in order of the notes seniority until all available funds are exhausted for each payment. During 2010, Standard and Poor’s downgraded the Class A-1 notes, the Class A-2 notes, the Class C notes and the Class D notes of the 2007-1 CLO Trust. The downgrade did not have any material consequence as the amortization of the 2007-1 CLO Trust changed from pro rata to sequential after the Moody’s downgrade in 2009. During the second quarter of 2011, Moody’s upgraded the Class C notes, the Class D notes, and the Class E notes. During 2011, Standard and Poor’s upgraded the Class D notes. During the fourth quarter of 2011, Moody’s upgraded all of the notes of the 2007-1 CLO Trust. During the third quarter of 2012, Fitch affirmed its ratings of all of the notes of the 2007-1 CLO Trust. During the second quarter of 2013, Moody’s upgraded the Class B notes, the Class C notes, the Class D notes, and the Class E notes and affirmed its ratings of the Class A-1 notes and the Class A-2 notes of the

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2007-1 CLO Trust. During the third quarter of 2013, Fitch affirmed its ratings on all of the notes of the 2007-1 CLO Trust. During the first quarter of 2014, Standard and Poor’s upgraded its ratings on all notes of the 2007-1 CLO Trust. During the second quarter of 2014, Moody’s affirmed the ratings of the Class B notes, the Class C notes, and the Class D notes of the 2007-1 CLO Trust.
We receive a loan collateral management fee and excess interest spread. We also receive payments with respect to the classes of notes we own in accordance with the transaction documents. We expect to receive a principal distribution as owner of the trust certificates when the term debt is retired. If loan collateral in the 2007-1 CLO Trust is in default under the terms of the indenture, the excess interest spread from the 2007-1 CLO Trust could not be distributed until the undistributed cash plus recoveries equals the outstanding balance of the defaulted loan or if we elected to remove the defaulted collateral.
The following table sets forth selected information with respect to the 2007-1 CLO Trust:
 
Notes
originally
issued
 
Outstanding
balance
December 31,
2014
 
Borrowing
spread to
LIBOR
 
Ratings
(S&P/Moody’s/
Fitch)(1)
 
($ in thousands)
 
 
 
 
2007-1 CLO Trust
 
 
 
 
 
 
 
Class A-1
$
336,500

 
$
162,405

 
0.24
%
 
AAA/Aaa/AAA
Class A-2
100,000

 
51,089

 
0.26

 
AAA/Aaa/AAA
Class B
24,000

 
24,000

 
0.55

 
AA+/Aa1/AA
Class C
58,500

 
58,293

 
1.30

 
A-/A2/A