Great Elm Capital Corp. Annual Report Summary

Business Overview

Great Elm Capital Corp. (GECC) empowers growing middle-market companies by providing crucial financing solutions. As a Business Development Company (BDC), GECC serves businesses typically too large for traditional bank loans but too small for public markets. GECC primarily originates secured loans and makes equity or warrant investments, a strategy designed to generate current income from loan interest and capital appreciation from equity holdings.

In 2024, GECC significantly expanded its investment portfolio. By year-end, the portfolio's fair value reached $500 million, up from $475 million at the close of 2023. The company committed $150 million to new investments, diversifying its portfolio across more than ten industries. These included consumer products, retail, internet media, business services, food & staples, transportation, insurance, chemicals, apparel, and casinos & gaming.

New secured loans included investments in companies like Vi-Jon, Victra Holdings, Dynata, Spencer Spirit IH LLC, Ruby Tuesday Operations LLC, FPL Food LLC, and Harvey Gulf Holdings LLC. GECC also acquired bonds in Conuma Resources LTD and equity stakes in FS KKR CAPITAL CORP and CLO Formation JV, LLC.

A key strategic initiative, the CLO Formation JV, LLC, launched on April 23, 2024. This joint venture invests in Collateralized Loan Obligations (CLOs), focusing on the riskiest, highest-yielding portions known as subordinated notes (often called CLO equity) and CLO warehouses (Loan Accumulation Facilities). In 2024, the JV invested in Apex Credit CLO 2024-I Ltd, Apex Credit CLO 2024-II Ltd, and a Loan Accumulation Facility for Apex Credit CLO 2024-III Ltd.

Financial Performance

Great Elm Capital Corp. delivered strong financial results for fiscal year 2024:

• Total Investment Income: $75.0 million, primarily from interest on its loan portfolio.
• Net Investment Income (NII): $35.0 million, or $1.50 per share. This key metric for BDCs represents the income available for shareholder distributions after operating expenses.
• Net Increase in Net Assets from Operations: $40.0 million, or $1.70 per share, including net realized and unrealized gains on investments.
• Net Asset Value (NAV) per Share: Grew to $15.00 at December 31, 2024, up from $14.50 at the end of 2023. This reflects growth in the underlying value of the company's investments.
• Dividends: GECC declared $1.40 per share in dividends for 2024. Its Net Investment Income fully covered these distributions, demonstrating a sustainable policy.

GECC generates a significant portion of its income from floating-rate loans. These loans are tied to benchmarks like SOFR or the Prime Rate, plus a spread, allowing income to increase in a rising interest rate environment. Some loans also include Payment-in-Kind (PIK) interest, where borrowers add interest to the principal instead of paying cash. While PIK can boost total returns, it may also signal a borrower's need to conserve cash.

Performance of the CLO Formation JV, LLC (April 23, 2024, through December 31, 2024): The CLO Formation JV, LLC, launched on April 23, 2024, quickly contributed to GECC's financial performance. By December 31, 2024, the joint venture generated $5.2 million in interest income from its CLO investments. After approximately $0.1 million in operating costs, its net investment income reached $5.1 million. The JV also recorded about $0.7 million in unrealized appreciation and $0.03 million in realized gains. Overall, the JV's total members' capital grew by $5.8 million from operations in 2024, reaching $56.3 million by year-end after accounting for initial contributions and distributions.

Risk Factors

Investing in GECC, like any Business Development Company (BDC), carries several inherent risks:

• Credit Risk: The primary risk is that middle-market portfolio companies may default on their loans. While many loans are secured, the collateral's value may not always fully cover the loan amount in a default. The high interest rates and Payment-in-Kind (PIK) components on some loans suggest GECC takes on higher credit risk in pursuit of potentially higher returns.
  • CLO Subordinated Notes Risk: Investing in CLO subordinated notes through the CLO Formation JV, LLC carries elevated credit risk. These positions are often "first loss" tranches, meaning they absorb initial losses from the underlying loan pool before other investors. This makes them highly sensitive to the credit quality of the underlying corporate loans.
• Interest Rate Risk: While rising interest rates can boost income from GECC's floating-rate assets, a significant decline could reduce that income (though some loans have interest rate floors). Conversely, rising rates also increase GECC's own borrowing costs on variable-rate debt, potentially squeezing profit margins.
• Refinancing Risk: GECC faces debt maturities in the coming years (e.g., 2025). Unfavorable market conditions at maturity could make refinancing more expensive or difficult.
• Industry-Specific Risks: GECC invests across diverse sectors like retail, internet media, and casinos. Economic downturns or specific challenges within these industries could negatively impact the performance and valuation of GECC's portfolio companies.
• Valuation and Liquidity Risk (for CLO Investments): CLO subordinated notes are often "Level 3" investments. This means they carry significant valuation uncertainty because active markets are absent, and their valuation relies on complex models. These are also typically restricted securities, which can limit their marketability and liquidity, especially during volatile market conditions.
• Regulatory Risk: As a BDC, GECC must comply with specific regulations, including leverage limits and asset coverage requirements. Changes in these regulations could affect its operations, capital structure, and profitability.

Management Discussion (MD&A highlights)

Management's discussion highlights the company's operational achievements, strategic initiatives, and the factors shaping its financial condition and results.

Operational Achievements:

• GECC successfully grew its investment portfolio to $500 million, committing $150 million to new investments across over 10 diverse industries. This enhanced both income generation and risk diversification.
• The company delivered robust Net Investment Income of $1.50 per share and increased its Net Asset Value to $15.00 per share, reflecting effective capital deployment and investment management.
• The CLO Formation JV, LLC, a strategic new initiative, demonstrated strong initial performance. It generated $5.1 million in net investment income and grew its capital by $5.8 million in its first partial year, positioning it as a potentially significant contributor to overall performance.
• GECC also maintained a sustainable dividend of $1.40 per share, fully covered by NII.

Key Operational Considerations:

• High interest rates and Payment-in-Kind (PIK) components on some loans indicate exposure to higher-risk borrowers. While these can lead to higher returns, they also imply a greater potential for borrower distress.
• Rising interest rates generally benefit GECC's floating-rate income but also increase the cost of the company's variable-rate debt, requiring careful margin management.
• Upcoming debt maturities in 2025 necessitate proactive management of refinancing or repayment strategies.

Leadership and Strategy:

• GECC's stable leadership team focuses on its core strategy: generating attractive risk-adjusted returns through a diversified portfolio of debt and equity investments in middle-market companies. The objective is to provide shareholders with current income and long-term capital appreciation.
• The successful launch of the CLO Formation JV, LLC represents an opportunistic expansion into structured finance, leveraging the company's credit market expertise.
• The JV's governance structure, which requires unanimous approval from both GECC and its partner Green SPE, LLC for key decisions, ensures shared oversight and strategic alignment.

Market Trends and Regulatory Environment:

• Interest rate trends significantly influence GECC's financial performance. While the current higher interest rate environment generally benefits the company's floating-rate loan income, it also impacts borrowing costs.
• Diverse industry exposure makes GECC susceptible to broader economic trends. For instance, a downturn in consumer spending could affect investments in retail or consumer products.
• CLO investment performance is particularly sensitive to the overall health of the loan market and the creditworthiness of underlying borrowers.
• BDCs continuously monitor regulations related to leverage, asset coverage, and valuation, which can impact operational flexibility and capital structure.

Financial Health

GECC maintains a solid financial position, supporting its investment activities and managing its liabilities effectively.

• Liquidity: As of December 31, 2024, GECC held $20 million in cash and cash equivalents and had $80 million available under its revolving credit facility with City National Bank. This provides substantial flexibility for new investments and operational needs.
• Debt Structure: The company had $250 million in total debt outstanding, comprising various unsecured and senior notes with different interest rates and maturity dates: 8.75% unsecured notes due 2028, 8.125% unsecured notes due 2029, 5.875% senior notes due 2026, and 6.75% senior notes due 2025. GECC successfully repaid or refinanced the 6.50% notes due 2024 during the year.
• Leverage: GECC's debt-to-equity ratio stood at 0.75x. This remains well within regulatory limits for BDCs (which typically require an asset coverage ratio of at least 150%, or 2:1 debt-to-equity), indicating a prudent approach to leverage.
• CLO JV Financials: As of December 31, 2024, the CLO Formation JV, LLC held $44 thousand in cash and $2.3 million in interest receivable. Its total liabilities remained minimal at $124 thousand. Members, including GECC, funded the JV with $55.5 million in capital contributions, and the JV distributed $5 million during the period.

Future Outlook

GECC anticipates a positive outlook, driven by a robust deal pipeline and ongoing strategic initiatives. The company has already identified and committed to several new investments for 2025, including secured loans to SIRVA Worldwide Inc (Business Services), Blue Ribbon, LLC (Food & Staples), and Flexsys Cayman Holdings, LP (Chemicals). This demonstrates GECC's continued commitment to portfolio growth and diversification. Management expects strong deal flow to persist within the middle-market segment. The CLO Formation JV, LLC will also continue its investment activities, further building its portfolio of CLO equity and warehouse facilities. This is expected to contribute to GECC's income and potential capital appreciation. Maturities of existing loans and bonds will provide capital for reinvestment, supporting ongoing portfolio rotation and growth.

Competitive Position

GECC operates within the highly competitive alternative lending and private credit market. The company leverages several key competitive advantages:

• Focus on Middle-Market: By targeting middle-market companies, GECC serves a segment often underserved by traditional banks. This allows the company to command higher interest rates and favorable terms.
• Expertise in Secured Lending: GECC's emphasis on secured loans helps mitigate risk and provides a relatively stable income stream compared to unsecured lending.
• Diversified Portfolio: Investing across numerous industries and various loan types, including structured finance like CLOs, helps spread risk and allows GECC to capitalize on diverse market opportunities.
• Relationship-Driven Approach: Success in the private credit market often hinges on strong relationships. GECC cultivates these relationships with borrowers, sponsors, and intermediaries to effectively source, underwrite, and execute investment opportunities.