OCSL 10-Q Quarterly Report March 31, 2012

OAKTREE SPECIALTY LENDING CORP

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10-Q 1 d344572d10q.htm FORM 10-Q Form 10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2012

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: 01-33901

Fifth Street Finance Corp.

(Exact name of registrant as specified in its charter)


Delaware		26-1219283
(State or jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

10 Bank Street, 12 ^th Floor, White Plains, NY		10606
(Address of principal executive office)		(Zip Code)

REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE:

(914) 286-6800

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 Select Market

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

None

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 periods as the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES þ NO ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, 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 ¨ NO ¨

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 “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):


Large accelerated filer þ	Accelerated filer ¨	Non-accelerated filer ¨	Smaller reporting company ¨
		(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act) YES ¨ NO þ

The registrant had 82,420,903 shares of common stock outstanding as of May 8, 2012.

FIFTH STREET FINANCE CORP.

FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2012

TABLE OF CONTENTS


	PART I — FINANCIAL INFORMATION

Item 1.	Consolidated Financial Statements (unaudited):

	Consolidated Statements of Assets and Liabilities as of March 31, 2012 and September 30, 2011	1

	Consolidated Statements of Operations for the three and six months ended March 31, 2012 and March 31, 2011	2

	Consolidated Statements of Changes in Net Assets for the six months ended March 31, 2012 and March 31, 2011	3

	Consolidated Statements of Cash Flows for the six months ended March 31, 2012 and March 31, 2011	4

	Consolidated Schedule of Investments as of March 31, 2012	5

	Consolidated Schedule of Investments as of September 30, 2011	13

	Notes to Consolidated Financial Statements	21

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	59

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	85

Item 4.	Controls and Procedures	86

	PART II — OTHER INFORMATION

Item 1.	Legal Proceedings	87

Item 1A.	Risk Factors	87

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	88

Item 6.	Exhibits	88

Signatures		90

PART I—FINANCIAL INFORMATION

Item 1.

Consolidated Financial Statements

Fifth Street Finance Corp.

Consolidated Statements of Assets and Liabilities

(in thousands, except per share data)

(unaudited)


	March 31, 2012			September 30, 2011
ASSETS
Investments at fair value:
Control investments (cost March 31, 2012: $15,331; cost September 30, 2011: $13,726)	$	17,198		$	14,500
Affiliate investments (cost March 31, 2012: $21,126; cost September 30, 2011: $34,182)		22,168			25,897
Non-control/Non-affiliate investments (cost March 31, 2012: $1,042,240; cost September 30, 2011: $1,108,174)		1,016,857			1,079,440

Total investments at fair value (cost March 31, 2012: $1,078,697; cost September 30, 2011: $1,156,082)		1,056,223			1,119,837
Cash and cash equivalents		115,178			67,644
Interest and fees receivable		6,825			6,752
Due from portfolio company		657			552
Deferred financing costs		14,309			14,668
Collateral posted to bank and other assets		238			264

Total assets	$	1,193,430		$	1,209,717

LIABILITIES AND NET ASSETS
Liabilities:
Accounts payable, accrued expenses and other liabilities	$	1,658		$	1,175
Base management fee payable		5,391			5,710
Incentive fee payable		5,698			4,997
Due to FSC, Inc.		1,417			1,480
Interest payable		4,309			4,669
Payments received in advance from portfolio companies		27			35
Offering costs payable		108			—
Credit facilities payable		87,500			178,024
SBA debentures payable		150,000			150,000
Convertible senior notes payable		124,000			135,000

Total liabilities		380,108			481,090

Net assets:
Common stock, $0.01 par value, 150,000 shares authorized, 82,421 and 72,376 shares issued and outstanding at March 31, 2012 and September 30, 2011		824			724
Additional paid-in-capital		929,841			829,620
Net unrealized depreciation on investments and interest rate swap		(22,095	)		(35,976	)
Net realized loss on investments and interest rate swap		(90,904	)		(63,485	)
Accumulated overdistributed net investment income		(4,344	)		(2,256	)

Total net assets (equivalent to $9.87 and $10.07 per common share at March 31, 2012 and September 30, 2011) (Note 12)		813,322			728,627

Total liabilities and net assets	$	1,193,430		$	1,209,717

See notes to Consolidated Financial Statements.

Fifth Street Finance Corp.

Consolidated Statements of Operations

(in thousands, except per share data)

(unaudited)


	Three months ended March 31, 2012			Three months ended March 31, 2011			Six months ended March 31, 2012			Six months ended March 31, 2011
Interest income:
Control investments	$	211		$	13		$	432		$	13
Affiliate investments		690			1,128			1,394			2,290
Non-control/Non-affiliate investments		28,183			21,203			57,309			37,692
Interest on cash and cash equivalents		14			4			18			14

Total interest income		29,098			22,348			59,153			40,009

PIK interest income:
Control investments		—			101			38			135
Affiliate investments		155			276			310			557
Non-control/Non-affiliate investments		2,737			3,094			5,959			5,923

Total PIK interest income		2,892			3,471			6,307			6,615

Fee income:
Control investments		—			—			—			126
Affiliate investments		146			133			254			267
Non-control/Non-affiliate investments		9,905			3,741			15,790			8,008

Total fee income		10,051			3,874			16,044			8,401

Dividend and other income:
Non-control/Non-affiliate investments		39			8			72			11

Total dividend and other income		39			8			72			11

Total investment income		42,080			29,701			81,576			55,036

Expenses:
Base management fee		5,391			4,786			11,132			8,565
Incentive fee		5,698			4,139			10,945			7,653
Professional fees		600			508			1,691			1,198
Board of Directors fees		70			36			126			85
Interest expense		5,602			2,724			11,326			4,663
Administrator expense		708			391			1,524			745
General and administrative expenses		1,256			561			2,394			1,515

Total expenses		19,325			13,145			39,138			24,424

Gain on extinguishment of convertible senior notes		36			—			1,341			—

Net investment income		22,791			16,556			43,779			30,612

Unrealized appreciation on interest rate swap		—			234			—			971
Unrealized appreciation (depreciation) on investments:
Control investments		(25	)		(757	)		1,089			7,313
Affiliate investments		10,610			(8,591	)		9,327			(10,171	)
Non-control/Non-affiliate investments		(2,538	)		8,742			3,465			18,357

Net unrealized appreciation (depreciation) on investments		8,047			(606	)		13,881			15,499

Realized loss on investments:
Control investments		—			(41	)		—			(7,806	)
Affiliate investments		(10,693	)		—			(10,620	)		—
Non-control/Non-affiliate investments		(89	)		(472	)		(16,800	)		(6,157	)

Net realized loss on investments		(10,782	)		(513	)		(27,420	)		(13,963	)

Net increase in net assets resulting from operations	$	20,056		$	15,671		$	30,240		$	33,119

Net investment income per common share — basic	$	0.29		$	0.27		$	0.58		$	0.52
Earnings per common share — basic	$	0.25		$	0.25		$	0.40		$	0.57
Weighted average common shares outstanding — basic		79,534			62,120			75,935			58,340
Net investment income per common share — diluted	$	0.28		$	0.27		$	0.54		$	0.52
Earnings per common share — diluted	$	0.24		$	0.25		$	0.38		$	0.57
Weighted average common shares outstanding — diluted		87,943			62,120			84,084			58,340

See notes to Consolidated Financial Statements.

Fifth Street Finance Corp.

Consolidated Statements of Changes in Net Assets

(in thousands, except per share data)

(unaudited)


	Six months ended March 31, 2012			Six months ended March 31, 2011
Operations:
Net investment income	$	43,779		$	30,612
Net unrealized appreciation on investments and interest rate swap		13,881			16,470
Net realized loss on investments		(27,420	)		(13,963	)

Net increase in net assets from operations		30,240			33,119
Stockholder transactions:
Distributions to stockholders		(45,867	)		(36,309	)

Net decrease in net assets from stockholder transactions		(45,867	)		(36,309	)
Capital share transactions:
Issuance of common stock, net		99,876			143,430
Issuance of common stock under dividend reinvestment plan		446			2,336

Net increase in net assets from capital share transactions		100,322			145,766

Total increase in net assets		84,695			142,576

Net assets at beginning of period		728,627			569,172

Net assets at end of period	$	813,322		$	711,748

Net asset value per common share	$	9.87		$	10.68

Common shares outstanding at end of period		82,421			66,668

See notes to Consolidated Financial Statements.

Fifth Street Finance Corp.

Consolidated Statements of Cash Flows

(in thousands)

(unaudited)


	Six months ended March 31, 2012			Six months ended March 31, 2011
Cash flows from operating activities:
Net increase in net assets resulting from operations	$	30,240		$	33,119
Adjustments to reconcile net increase in net assets resulting from operations to net cash provided (used) by operating activities:
Gain on extinguishment of convertible senior notes		(1,341	)		—
Net unrealized appreciation on investments and interest rate swap		(13,881	)		(16,470	)
Net realized losses on investments and interest rate swap		27,420			13,963
PIK interest income		(6,307	)		(6,615	)
Recognition of fee income		(16,044	)		(8,401	)
Accretion of original issue discount on investments		(914	)		(809	)
Amortization of deferred financing costs		2,051			955
Change in operating assets and liabilities:
Fee income received		12,578			14,011
Increase in interest and fees receivable		(225	)		(1,826	)
(Increase) decrease in due from portfolio company		(105	)		7
Decrease in collateral posted to bank and other assets		26			81
Increase in accounts payable, accrued expenses and other liabilities		483			101
Increase (decrease) in base management fee payable		(319	)		1,910
Increase in incentive fee payable		700			1,280
Decrease in due to FSC, Inc.		(63	)		(275	)
Increase (decrease) in interest payable		(360	)		370
Decrease in payments received in advance from portfolio companies		(8	)		(469	)
Purchases of investments and net revolver activity, net of syndications		(204,346	)		(452,661	)
Principal payments received on investments (scheduled payments)		23,309			10,186
Principal payments received on investments (payoffs)		228,604			62,204
PIK interest income received in cash		1,798			6,711
Proceeds from the sale of investments		11,549			—

Net cash provided (used) by operating activities		94,845			(342,628	)

Cash flows from financing activities:
Dividends paid in cash		(45,421	)		(33,973	)
Borrowings under SBA debentures payable		—			65,300
Borrowings under credit facilities		223,500			378,000
Repayments of borrowings under credit facilities		(314,024	)		(244,000	)
Repurchases of convertible senior notes		(9,378	)		—
Proceeds from the issuance of common stock		100,700			143,922
Deferred financing costs paid		(1,973	)		(4,338	)
Offering costs paid		(715	)		(492	)

Net cash provided (used) by financing activities		(47,311	)		304,419

Net increase (decrease) in cash and cash equivalents		47,534			(38,209	)
Cash and cash equivalents, beginning of period		67,644			76,765

Cash and cash equivalents, end of period	$	115,178		$	38,556

Supplemental Information:
Cash paid for interest	$	9,840		$	3,338
Non-cash financing activities:
Issuance of shares of common stock under dividend reinvestment plan	$	446		$	2,336

See notes to Consolidated Financial Statements.

Fifth Street Finance Corp.

Consolidated Schedule of Investments

March 31, 2012

(dollar amounts in thousands)

(unaudited)


Portfolio Company/Type of Investment(1)(2)(5)	Industry	Principal(8)		Cost		Fair Value
Control Investments(3)
Lighting By Gregory, LLC(9)(13)(14)	Housewares & specialties
First Lien Term Loan A, 9.75% PIK due 2/28/2013		$	4,586	$	3,996	$	1,610
First Lien Bridge Loan, 8% PIK due 3/31/2012(17)			113		113		—
97.38% membership interest					1,210		—

					5,319		1,610
Coll Materials Group LLC(19)	Environmental & facilities services
Second Lien Term Loan, 12% cash due 11/1/2014			6,885		6,885		6,880
50% Membership interest in CD Holdco, LLC					3,127		8,708

					10,012		15,588

Total Control Investments (2.1% of net assets)				$	15,331	$	17,198

Affiliate Investments(4)
Caregiver Services, Inc.	Healthcare services
Second Lien Term Loan A, LIBOR+6.85% (5.15% floor) cash due 2/25/2013		$	4,997	$	4,880	$	5,125
Second Lien Term Loan B, 12.5% cash 4% PIK due 2/25/2013			15,403		15,166		15,402
1,080,399 shares of Series A Preferred Stock					1,080		1,641

					21,126		22,168

Total Affiliate Investments (2.7% of net assets)				$	21,126	$	22,168

Non-Control/Non-Affiliate Investments(7)
Repechage Investments Limited(13)(14)	Restaurants
First Lien Term Loan, 12.75% cash 2.75% PIK due 10/16/2011(16)		$	3,608	$	3,412	$	1,908
7,500 shares of Series A Preferred Stock of Elephant & Castle, Inc.					750		—

					4,162		1,908
Traffic Control & Safety Corporation(9)(14)	Construction & engineering
Senior Term Loan A, LIBOR+9.0% cash due 6/29/2012			5,000		4,956		5,000
Senior Revolver, LIBOR+9.0% cash due 6/29/2012			12,486		12,409		12,514
Second Lien Term Loan, 12% cash 3% PIK due 5/28/2015(13)			21,760		20,829		10,918
Subordinated Loan, 15% PIK due 5/28/2015(13)			5,772		5,531		—
24,750 shares of Series B Preferred Stock					247		—
43,494 shares of Series D Preferred Stock					435		—
25,000 shares of Common Stock					3		—

					44,410		28,432
TBA Global, LLC	Advertising
53,994 Senior Preferred Shares					216		388
191,977 Shares A Shares					192		75

					408		463
Fitness Edge, LLC	Leisure facilities
First Lien Term Loan A, LIBOR+5.25% (4.75% floor), cash due 7/31/2012			375		375		378
First Lien Term Loan B, 12% cash 2.5% PIK due 7/31/2012			5,850		5,839		6,008
1,000 Common Units					43		179

					6,257		6,565
Capital Equipment Group, Inc.(9)	Industrial machinery
Second Lien Term Loan, 12% cash 2.75% PIK due 7/10/2013			10,383		10,271		10,444
33,463 shares of Common Stock					345		717

					10,616		11,161
Rail Acquisition Corp.(14)	Electronic manufacturing services
First Lien Term Loan, 12% PIK due 9/1/2013			19,568		15,637		3,083
First Lien Revolver, 7.85% cash due 9/1/2013			4,369		4,370		4,370

					20,007		7,453

Fifth Street Finance Corp.

Consolidated Schedule of Investments

March 31, 2012

(dollar amounts in thousands)

(unaudited)


Portfolio Company/Type of Investment(1)(2)(5)	Industry	Principal(8)		Cost		Fair Value
Western Emulsions, Inc.	Construction materials
Second Lien Term Loan, 12.5% cash 2.5% PIK due 6/30/2014			6,931		6,843		7,085

					6,843		7,085
Storyteller Theaters Corporation	Movies & entertainment
1,692 shares of Common Stock					—		62
20,000 shares of Preferred Stock					200		200

					200		262
HealthDrive Corporation	Healthcare services
First Lien Term Loan A, 10% cash due 7/17/2013			5,763		5,611		5,706
First Lien Term Loan B, 12% cash 1% PIK due 7/17/2013			10,335		10,285		10,329
First Lien Revolver, 12% cash due 7/17/2013			1,250		1,245		1,265

					17,141		17,300
idX Corporation	Distributors
Second Lien Term Loan, 12.5% cash 2% PIK due 7/1/2014			19,088		18,872		19,407

					18,872		19,407
Cenegenics, LLC	Healthcare services
414,419 Common Units(6)					598		1,342

					598		1,342
Trans-Trade, Inc.	Air freight & logistics
First Lien Term Loan A, 13% cash 2.5% PIK due 9/10/2014			12,682		12,508		12,640
First Lien Term Loan B, 12% cash due 9/10/2014			5,860		5,789		2,365

					18,297		15,005
Riverlake Equity Partners II, LP	Multi-sector holdings
1.89% limited partnership interest(15)					240		240

					240		240
Riverside Fund IV, LP	Multi-sector holdings
0.33% limited partnership interest(6)(15)					598		598

					598		598
Ambath/Rebath Holdings, Inc.	Home improvement retail
First Lien Term Loan A, LIBOR+7% (3% floor) cash due 12/30/2014			3,000		2,989		2,851
First Lien Term Loan B, 12.5% cash 2.5% PIK due 12/30/2014			23,293		23,268		20,687
First Lien Term Revolver, LIBOR+6.5% (3% floor) cash due 12/30/2014(10)			1,500		1,500		1,356

					27,757		24,894
JTC Education, Inc.	Education services
First Lien Term Loan, LIBOR+9.5% (3% floor) cash due 12/31/2014			29,404		28,839		29,295
First Lien Revolver, LIBOR+9.5% (3.25% floor) cash due 12/31/2014			2,175		1,875		2,310
17,391 Shares of Series A-1 Preferred Stock					313		313
17,391 Shares of Common Stock					187		10

					31,214		31,928
Tegra Medical, LLC(9)	Healthcare equipment
First Lien Term Loan A, LIBOR+7% (3% floor) cash due 12/31/2014			20,854		20,619		20,808
First Lien Term Loan B, 12% cash 2% PIK due 12/31/2014			22,897		22,660		22,679
First Lien Revolver, LIBOR+7% (3% floor) cash due 12/31/2014			2,500		2,457		2,473

					45,736		45,960
Psilos Group Partners IV, LP	Multi-sector holdings
2.52% limited partnership interest(12)(15)					—		—

					—		—

Fifth Street Finance Corp.

Consolidated Schedule of Investments

March 31, 2012

(dollar amounts in thousands)

(unaudited)


Portfolio Company/Type of Investment(1)(2)(5)	Industry	Principal(8)		Cost			Fair Value
Mansell Group, Inc.	Advertising
First Lien Term Loan A, LIBOR+7% (3% floor) cash due 4/30/2015			10,123		9,988			10,137
First Lien Term Loan B, LIBOR+9% (3% floor) cash 1.5% PIK due 4/30/2015			9,212		9,091			9,173
First Lien Revolver, LIBOR+6% (3% floor) cash due 4/30/2015(11)					(25	)		—

					19,054			19,310
NDSSI Holdings, LLC(9)	Electronic equipment & instruments
First Lien Term Loan A, LIBOR+9.75% (3% floor) cash 1% PIK due 12/31/2012			21,864		21,604			21,380
First Lien Term Loan B, LIBOR+9.75% (3% floor) cash 3.75% PIK due 12/31/2012			8,076		8,076			8,095
First Lien Revolver, LIBOR+7% (3% floor) cash due 12/31/2012			3,500		3,461			3,459
2,000 Series D Preferred Units					2,379			2,378

					35,520			35,312
Eagle Hospital Physicians, Inc.(9)	Healthcare services
First Lien Term Loan, LIBOR+8.75% (3% floor) cash due 8/11/2015			24,978		24,561			24,927
First Lien Revolver, LIBOR+5.75% (3% floor) cash due 8/11/2015			1,100		1,065			1,113

					25,626			26,040
Enhanced Recovery Company, LLC	Diversified support services
First Lien Term Loan A, LIBOR+7% (2% floor) cash due 8/13/2015			13,380		13,189			13,356
First Lien Term Loan B, LIBOR+10% (2% floor) cash 1% PIK due 8/13/2015			11,071		10,916			10,986
First Lien Revolver, LIBOR+7% (2% floor) cash due 8/13/2015(11)					(56	)		—

					24,049			24,342
Specialty Bakers LLC	Food distributors
First Lien Term Loan A, LIBOR+8.5% cash due 9/15/2015			4,650		4,416			4,587
First Lien Term Loan B, LIBOR+11% (2.5% floor) cash due 9/15/2015			11,000		10,804			10,837
First Lien Revolver, LIBOR+8.5% cash due 9/15/2015(11)					(71	)		—

					15,149			15,424
Welocalize, Inc.	Internet software & services
First Lien Term Loan A, LIBOR+8% (2% floor) cash due 11/19/2015			20,843		20,516			20,915
First Lien Term Loan B, LIBOR+9% (2% floor) cash 1.25% PIK due 11/19/2015			23,933		23,561			24,014
First Lien Revolver, LIBOR+7% (2% floor) cash due 11/19/2015(11)					(190	)		—
2,086,163 Common Units in RPWL Holdings, LLC					3,347			3,065

					47,234			47,994
Miche Bag, LLC	Apparel, accessories & luxury goods
First Lien Term Loan A, LIBOR+9% (3% floor) cash due 12/7/2013			11,125		10,877			11,109
First Lien Term Loan B, LIBOR+10% (3% floor) cash 3% PIK due 12/7/2015			17,693		15,544			17,357
First Lien Revolver, LIBOR+7% (3% floor) cash due 12/7/2015			1,500		1,407			1,499
10,371 Preferred Equity units in Miche Holdings, LLC					1,037			1,169
146,289 Series D Common Equity units in Miche Holdings, LLC					1,463			725

					30,328			31,859
Bunker Hill Capital II (QP), LP	Multi-sector holdings
0.50% limited partnership interest(15)					66			66

					66			66
Advanced Pain Management	Healthcare services
First Lien Term Loan, LIBOR+5% (1.75% floor) cash due 12/22/2015			7,380		7,271			7,383
First Lien Revolver, LIBOR+5% (1.75% floor) cash due 12/22/2015(11)					(4	)		—

					7,267			7,383

Fifth Street Finance Corp.

Consolidated Schedule of Investments

March 31, 2012

(dollar amounts in thousands)

(unaudited)


Portfolio Company/Type of Investment(1)(2)(5)	Industry	Principal(8)		Cost			Fair Value
DISA, Inc.	Human resources & employment services
First Lien Term Loan A, LIBOR+7.5% (0.75% floor) cash due 12/30/2015			11,865		11,671			11,970
First Lien Term Loan B, LIBOR+10% (1% floor) cash 1.5% PIK due 12/30/2015			8,459		8,332			8,634
First Lien Revolver, LIBOR+6% (1% floor) cash due 12/30/2015(11)					(61	)		—

					19,942			20,604
Saddleback Fence and Vinyl Products, Inc.	Building products
First Lien Term Loan, 8% cash due 11/30/2013			648		648			648
First Lien Revolver, 8% cash due 11/30/2013					—			—

					648			648
Best Vinyl Fence & Deck, LLC	Building products
First Lien Term Loan B, 8% PIK due 6/30/2012			4,190		4,190			2,090

					4,190			2,090
Physicians Pharmacy Alliance, Inc.	Healthcare services
First Lien Term Loan, LIBOR+9% cash 1.5% PIK due 1/4/2016			16,362		16,066			16,161
First Lien Revolver, LIBOR+6% cash due 1/4/2016(11)					(35	)		—

					16,031			16,161
Cardon Healthcare Network, LLC(9)	Diversified support services
First Lien Term Loan A, LIBOR+10% (1.75% floor) cash due 1/24/2017			10,665		10,478			10,970
First Lien Term Loan B, LIBOR+9% (1.75% floor) cash due 1/24/2017			22,283		22,055			22,316
First Lien Revolver, LIBOR+6.5% (1.75% floor) cash due 1/24/2017(11)					(44	)		—
65,903 Class A Units					250			342

					32,739			33,628
U.S. Retirement Partners, Inc.	Diversified financial services
First Lien Term Loan, LIBOR+9.5% (2% floor) cash due 1/6/2016			32,850		32,401			32,255

					32,401			32,255
Phoenix Brands Merger Sub LLC(9)	Household products
Senior Term Loan, LIBOR+5% (1.5% floor) cash due 1/31/2016			7,446		7,288			7,418
Subordinated Term Loan, 10% cash 3.875% PIK due 2/1/2017			20,789		20,373			19,900
First Lien Revolver, LIBOR+5% (1.5% floor) cash due 1/31/2016			2,143		2,014			2,204

					29,675			29,522
U.S. Collections, Inc.	Diversified support services
First Lien Term Loan, LIBOR+5.25% (1.75% floor) cash due 3/31/2016			8,543		8,411			8,510

					8,411			8,510
CCCG, LLC(9)	Oil & gas equipment & services
First Lien Term Loan, LIBOR+8% (1.75% floor) cash 1% PIK due 7/29/2015			34,747		34,004			34,377

					34,004			34,377
Maverick Healthcare Group, LLC	Healthcare equipment
First Lien Term Loan, LIBOR+9% (1.75% floor) cash due 12/31/2016			24,688		24,205			24,163

					24,205			24,163
Refac Optical Group	Specialty stores
First Lien Term Loan A, LIBOR+7.5% cash due 3/23/2016			13,930		13,628			13,934
First Lien Term Loan B, LIBOR+8.5% cash 1.75% PIK due 3/23/2016			20,242		19,796			20,333
First Lien Revolver, LIBOR+7.5% cash due 3/23/2016(11)					(117	)		—
1,000 Shares of Common Stock in Refac Holdings, Inc.					1			64
1,000 Shares of Preferred Stock in Refac Holdings, Inc.					999			999

					34,307			35,330

Fifth Street Finance Corp.

Consolidated Schedule of Investments

March 31, 2012

(dollar amounts in thousands)

(unaudited)


Portfolio Company/Type of Investment(1)(2)(5)	Industry	Principal(8)		Cost			Fair Value
Pacific Architects & Engineers, Inc.	Diversified support services
First Lien Term Loan A, LIBOR+5% (1.5% floor) cash due 4/4/2017			3,994		3,936			3,932
First Lien Term Loan B, LIBOR+6% (1.5% floor) cash due 4/4/2017			4,700		4,635			4,634

					8,571			8,566
Securus Technologies, Inc.	Integrated telecommunication services
Second Lien Term Loan, LIBOR+8.25% (1.75% floor) cash due 5/31/2018			22,500		22,086			22,339

					22,086			22,339
Gundle/SLT Environmental, Inc.	Environmental & facilities services
First Lien Term Loan, LIBOR+5.5% (1.5% floor) cash due 5/27/2016			7,940		7,854			7,990

					7,854			7,990
Titan Fitness, LLC	Leisure facilities
First Lien Term Loan A, LIBOR+8.75 (1.25% floor) cash due 6/30/2016			16,125		15,970			16,042
First Lien Term Loan B, LIBOR+10.75% (1.25% floor) cash 1.5% PIK due 6/30/2016			11,633		11,524			11,643
First Lien Term Loan C, 18% PIK due 6/30/2016			2,976		2,951			2,970
First Lien Revolver, LIBOR+8.75% (1.25% floor) cash due 6/30/2016(11)					(33	)		—

					30,412			30,655
Baird Capital Partners V, LP	Multi-sector holdings
0.4% limited partnership interest(15)					386			386

					386			386
Charter Brokerage, LLC	Oil & gas equipment services
Senior Term Loan, LIBOR+6.5% (1.5% floor) cash due 7/13/2016			16,938		16,788			16,915
Mezzanine Term Loan, 11.75% cash 2% PIK due 7/13/2017			10,143		10,059			9,927
Senior Revolver, LIBOR+6.5% (1.5% floor) cash due 7/13/2016(11)					(62	)		—

					26,785			26,842
Stackpole Powertrain International ULC(15)	Auto parts & equipment
Subordinated Term Loan, 12% cash 2% PIK due 8/1/2018			18,243		18,080			18,164
1,000 Common Units					1,000			1,063

					19,080			19,227
Discovery Practice Management, Inc.	Healthcare services
Senior Term Loan A, LIBOR+7.5% cash due 8/8/2016			6,722		6,652			6,691
Senior Term Loan B, 12% cash 3% PIK due 8/8/2016			6,344		6,281			6,269
Senior Revolver, LIBOR+7% cash due 8/8/2016(11)					(32	)		—

					12,901			12,960
CTM Group, Inc.	Leisure products
Mezzanine Term Loan A, 11% cash 2% PIK due 2/10/2017			10,637		10,534			10,562
Mezzanine Term Loan B, 18.4% PIK due 2/10/2017			3,480		3,451			3,560

					13,985			14,122
Bojangles	Restaurants
First Lien Term Loan, LIBOR+6.5% (1.5% floor) cash due 8/17/2017			5,789		5,686			5,833

					5,686			5,833
Milestone Partners IV, LP	Multi-sector holdings
3.07% limited partnership interest(15)					525			525

					525			525
Insight Pharmaceuticals, LLC	Pharmaceuticals
First Lien Term Loan, LIBOR+6% (1.5% floor) cash due 8/25/2016			9,950		9,883			10,193
Second Lien Term Loan, LIBOR+11.75% (1.5% floor) cash due 8/25/2017			17,500		17,347			17,660

					27,230			27,853

Fifth Street Finance Corp.

Consolidated Schedule of Investments

March 31, 2012

(dollar amounts in thousands)

(unaudited)


Portfolio Company/Type of Investment(1)(2)(5)	Industry	Principal(8)		Cost			Fair Value
National Spine and Pain Centers, LLC	Healthcare services
Mezzanine Term Loan, 11% cash 1.6% PIK due 9/27/2017			26,830		26,583			26,842
299,292.94 Class A Units(6)					299			222

					26,882			27,064
RCPDirect, LP.	Multi-sector holdings
0.91% limited partnership interest(15)					297			297

					297			297
The MedTech Group, Inc.	Healthcare equipment
Senior Term Loan, LIBOR+5.5% (1.5% floor) cash due 9/7/2016			12,935		12,831			12,921

					12,831			12,921
Digi-Star Acquisition Holdings, Inc.	Industrial Machinery
Mezzanine Term Loan, 12% cash 1.5% PIK due 11/18/2017			10,056		9,940			10,121
225 Class A Preferred Units					225			225
2,500 Class A Common Units					25			44

					10,190			10,390
CPASS Acquisition Company	Internet software & services
Senior Term Loan, LIBOR+9% (1.5% floor) cash 1% PIK due 11/21/2016			4,955		4,848			5,029
Senior Revolver, LIBOR+9% (1.5% floor) cash due 11/21/2016(11)					(18	)		—

					4,830			5,029
Genoa Healthcare Holdings, LLC	Pharmaceuticals
Mezzanine Term Loan, 12% cash 2% PIK due 6/1/2017			12,584		12,467			12,555
500,000 Preferred units					475			487
500,000 Class A Common Units					25			32

					12,967			13,074
SolutionSet, Inc.	Advertising
Senior Term Loan, LIBOR+6% (1% floor) cash due 12/21/2016			9,739		9,646			9,687

					9,646			9,687
Slate Pharmaceuticals Acquisition Corp.	Healthcare services
Subordinated Term Loan, 12% cash 1.5% PIK due 12/29/2017			20,077		19,889			20,107

					19,889			20,107
ACON Equity Partners III, LP	Multi-sector holdings
0.31% limited partnership interest(12)(15)					—			—

					—			—
Blue Coat Systems, Inc.	Internet software & services
First Lien Term Loan, LIBOR+6% (1.5% floor) cash due 2/15/2018			15,000		14,853			15,000
Second Lien Term Loan, LIBOR+10% (1.5% floor) cash due 8/15/2018			7,000		6,932			7,000

					21,785			22,000
CRGT, Inc. (18)	IT consulting & other services
Mezzanine Term Loan, 12.5% cash 3% PIK due 3/9/2018			25,547		25,295			25,618

					25,295			25,618
Riverside Fund V, LP	Multi-sector holdings
0.4% limited partnership interest(12)(15)					—			—

					—			—
World 50, Inc.	Research & consulting services
Senior Term Loan A, LIBOR+6.25% (1.5% floor) cash due 3/30/2017			9,000		8,858			9,000
Senior Term Loan B, 12.5% cash due 3/30/2017			5,500		5,415			5,500
Senior Revolver, LIBOR+6.25% (1.5% floor) cash due 3/30/2017(11)					(62	)		—

					14,211			14,500

Fifth Street Finance Corp.

Consolidated Schedule of Investments

March 31, 2012

(dollar amounts in thousands)

(unaudited)

Portfolio Company/Type of Investment(1)(2)(5)

Industry

Principal(8)

Cost

Fair Value

Huddle House, Inc.

Restaurants

Subordinated Term Loan, 11% cash 1.6% PIK due 3/30/2018

13,850

13,714

13,851

13,714

13,851

Total Non-Control/Non-Affiliate Investments (125.0% of net assets)

1,042,240

1,016,857

Total Portfolio Investments (129.9% of net assets)

1,078,697

1,056,223

(1)	Debt investments are income producing unless otherwise noted. Equity is non-income producing unless otherwise noted.

(2)	See Note 3 to the Consolidated Financial Statements for portfolio composition by geographic region.

(3)	Control Investments are defined by the Investment Company Act of 1940 (“1940 Act”) as investments in companies in which the Company owns more than 25% of the voting securities or maintains greater than 50% of the board representation.

(4)	Affiliate Investments are defined by the 1940 Act as investments in companies in which the Company owns between 5% and 25% of the voting securities.

(5)	Equity ownership may be held in shares or units of companies related to the portfolio companies.

(6)	Income producing through payment of dividends or distributions.

(7)	Non-Control/Non-Affiliate Investments are defined by the 1940 Act as investments that are neither Control Investments nor Affiliate Investments.

(8)	Principal includes accumulated PIK interest and is net of repayments.

(9)

Interest rates have been adjusted on certain term loans and revolvers. These rate adjustments are temporary in nature due to financial or payment covenant violations in the original credit agreements, or permanent in nature per loan amendment or waiver documents. The table below summarizes these rate adjustments by portfolio company:


Portfolio Company	Effective date	Cash interest	PIK interest	Reason

Cardon Healthcare Network, LLC	January 24, 2012	+ 1.5% on Term Loan A		Per loan amendment

Traffic Control & Safety Corporation	January 1, 2012	+ 3.0% on Senior Term Loan & Senior Revolver	+ 2.0% on Subordinated Term Loan	Default interest per loan agreement
		– 4.0% on Second Lien Term Loan	+ 3.0% on Second Lien Term Loan

Tegra Medical, LLC	January 1, 2012		+ 0.5% on Term Loan B	Per loan amendment

NDSSI Holdings, Inc.	December 31, 2011		– 1.0% on Term Loan A	Per loan amendment

Phoenix Brands Merger Sub LLC	December 22, 2011	+ 0.75% on Subordinated Term Loan; + 0.50% on Senior Term Loan & Revolver		Per loan amendment

CCCG, LLC	November 15, 2011	+ 0.5% on Term Loan		Per waiver agreement

Eagle Hospital Physicians, Inc.	July 1, 2011	– 0.25% on Term Loan & Revolver		Per loan amendment

Lighting By Gregory, LLC	March 11, 2011	+ 6.0% on Bridge Loan	– 8.0% on Bridge Loan	Per loan amendment

Capital Equipment Group, Inc.	July 1, 2010	– 2.0% on Term Loan	– 0.75% on Term Loan	Per waiver agreement

Fifth Street Finance Corp.

Consolidated Schedule of Investments

March 31, 2012

(dollar amounts in thousands)

(unaudited)

(10)	Revolving credit line has been suspended and is deemed unlikely to be renewed in the future.

(11)	Cost amounts represent unearned income related to undrawn commitments.

(12)	Represents an unfunded commitment to fund limited partnership interest.

(13)	Investment was on cash non-accrual status as of March 31, 2012.

(14)	Investment was on PIK non-accrual status as of March 31, 2012.

(15)	Investment is not a qualifying asset as defined under Section 55(a) of the 1940 Act.

(16)	Repechage Investments Limited Term Loan is under negotiation and, as such, the maturity date of the loan has been temporarily suspended.

(17)	Lighting By Gregory, LLC Bridge Loan is under negotiation and, as such, the maturity date of the loan has been temporarily suspended.

(18)	In March 2012, the Company received a cash payment from CRGT, Inc. in full satisfaction of all obligations under the senior loan agreement. As part of this refinancing, the Company closed on a $25.5 million subordinated debt investment in CRGT, Inc.

(19)

In November 2011, Nicos Polymers & Grinding, Inc. was merged into Coll Materials Group, LLC. As a result of this transaction, the Company’s 50% membership interest in CD Holdco, LLC now represents a 23.25% membership interest in Coll Materials Group, LLC and the first lien revolver and term loan were consolidated into a $6.9 million second lien term loan with a scheduled maturity of three years that bears monthly cash interest at a rate of 12.0% per annum.

Fifth Street Finance Corp.

Consolidated Schedule of Investments

(dollar amounts in thousands)

September 30, 2011


Portfolio Company/Type of Investment(1)(2)(5)	Industry	Principal(8)		Cost		Fair Value
Control Investments(3)
Lighting By Gregory, LLC(9)(13)(14)	Housewares & specialties
First Lien Term Loan A, 9.75% PIK due 2/28/2013		$	4,366	$	3,996	$	2,526
First Lien Bridge Loan, 8% PIK due 3/31/2012			112		113		—
97.38% membership interest					1,210		—

					5,319		2,526
Nicos Polymers & Grinding, Inc.	Environmental & facilities services
First Lien Term Loan, 8% cash due 12/4/2017			5,347		5,280		5,189
First Lien Revolver, 8% cash due 12/4/2017			1,500		1,500		1,551
50% Membership interest in CD Holdco, LLC					1,627		5,234

					8,407		11,974

Total Control Investments (2.0% of net assets)				$	13,726	$	14,500

Affiliate Investments(4)
O’Currance, Inc.(13)(14)	Data Processing & outsourced services
First Lien Term Loan A, 12.875% cash 4% PIK due 3/21/2012		$	11,414	$	11,254	$	3,173
First Lien Term Loan B, 12.875% cash 4% PIK 3/21/2012			1,164		1,140		324
1.75% Preferred Membership interest in O’Currance Holding Co., LLC					130		—
3.3% Membership Interest in O’Currance Holding Co., LLC					250		—

					12,774		3,497
Caregiver Services, Inc.	Healthcare services
Second Lien Term Loan A, LIBOR+6.85% (5.15% floor) cash due 2/25/2013			5,712		5,527		5,843
Second Lien Term Loan B, 12.5% cash 4% PIK due 2/25/2013			15,161		14,801		15,067
1,080,399 shares of Series A Preferred Stock					1,080		1,490

					21,408		22,400

Total Affiliate Investments (3.6% of net assets)				$	34,182	$	25,897

Non-Control/Non-Affiliate Investments(7)
Repechage Investments Limited(13)(14)	Restaurants
First Lien Term Loan, 12.75% cash 2.75% PIK due 10/16/2011		$	3,558	$	3,412	$	1,829
7,500 shares of Series A Preferred Stock of Elephant & Castle, Inc.					750		—

					4,162		1,829
Traffic Control & Safety Corporation(9)	Construction & engineering
Senior Term Loan, LIBOR+9% cash due 6/29/2012			5,000		4,870		4,957
Senior Revolver, LIBOR+9% cash due 6/29/2012			11,986		11,754		11,966
Second Lien Term Loan, 12% cash 3% PIK due 5/28/2015			20,795		20,602		17,545
Subordinated Loan, 15% PIK due 5/28/2015			5,325		5,325		1,346
24,750 shares of Series B Preferred Stock					247		—
43,494 shares of Series D Preferred Stock					435		—
25,000 shares of Common Stock					3		—

					43,236		35,814
TBA Global, LLC	Advertising
53,994 Senior Preferred Shares					216		388
191,977 Shares A Shares					192		74

					408		462
Fitness Edge, LLC	Leisure facilities
First Lien Term Loan A, LIBOR+5.25% (4.75% floor) cash due 7/31/2012			750		749		757
First Lien Term Loan B, 12.5% cash 2.5% PIK due 7/31/2012			5,776		5,750		5,814
1,000 Common Units(6)					43		181

					6,542		6,752

Fifth Street Finance Corp.

Consolidated Schedule of Investments

(dollar amounts in thousands)

September 30, 2011


Portfolio Company/Type of Investment(1)(2)(5)	Industry	Principal(8)		Cost			Fair Value
Boot Barn	Apparel, accessories & luxury goods and footwear
255.78 shares of Series A&B Preferred Stock					247			71
1,354 shares of Common Stock					9			9

					256			80
Premier Trailer Leasing, Inc.(9)(13)(14)	Trucking
Second Lien Term Loan, 13.25% cash 3.25% PIK due 10/23/2012			19,070		17,064			—
285 shares of Common Stock					1			—

					17,065			—
Capital Equipment Group, Inc.(9)	Industrial machinery
Second Lien Term Loan, 12% cash 2.75% PIK due 7/10/2013			10,278		10,112			10,226
33,463 shares of Common Stock					345			634

					10,457			10,860
Rail Acquisition Corp.	Electronic manufacturing services
First Lien Term Loan, 12% PIK due 9/1/2013			18,415		15,636			4,106
First Lien Revolver, 7.85% cash due 9/1/2013			4,554		4,554			4,554

					20,190			8,660
Western Emulsions, Inc.	Construction materials
Second Lien Term Loan, 12.5% cash 2.5% PIK due 6/30/2014			6,844		6,736			6,840

					6,736			6,840
Storyteller Theaters Corporation	Movies & entertainment
1,692 shares of Common Stock					—			62
20,000 shares of Preferred Stock					200			200

					200			262
HealthDrive Corporation	Healthcare services
First Lien Term Loan A, 10% cash due 7/17/2013			6,263		6,049			6,352
First Lien Term Loan B, 12% cash 1% PIK due 7/17/2013			10,282		10,212			10,217
First Lien Revolver, 12% cash due 7/17/2013(11)					(7	)		—

					16,254			16,569
idX Corporation	Distributors
Second Lien Term Loan, 12.5% cash 2% PIK due 7/1/2014			18,895		18,631			18,938

					18,631			18,938
Cenegenics, LLC	Healthcare services
414,419 Common Units(6)					598			1,060

					598			1,060
IZI Medical Products, Inc.	Healthcare technology
First Lien Term Loan A, 12% cash due 3/31/2014			3,236		3,215			3,244
First Lien Term Loan B, 13% cash 3% PIK due 3/31/2014			17,258		16,861			17,061
First Lien Revolver, 10% cash due 3/31/2014(11)					(25	)		—
453,755 Preferred units of IZI Holdings, LLC					454			642

					20,505			20,947
Trans-Trade, Inc.	Air freight & logistics
First Lien Term Loan, 13% cash 2.5% PIK due 9/10/2014			12,523		12,287			11,763
First Lien Revolver, 12% cash due 9/10/2014			5,800		5,697			5,479

					17,984			17,242
Riverlake Equity Partners II, LP	Multi-sector holdings
1.89% limited partnership interest(16)					122			122

					122			122
Riverside Fund IV, LP	Multi-sector holdings
0.33% limited partnership interest(16)					445			445

					445			445

Fifth Street Finance Corp.

Consolidated Schedule of Investments

(dollar amounts in thousands)

September 30, 2011


Portfolio Company/Type of Investment(1)(2)(5)	Industry	Principal(8)		Cost			Fair Value
ADAPCO, Inc.	Fertilizers & agricultural chemicals
First Lien Term Loan A, 10% cash due 12/17/2014			8,000		7,871			8,010
First Lien Term Loan B, 12% cash 2% PIK due 12/17/2014			15,521		15,306			15,371
First Lien Term Revolver, 10% cash due 12/17/2014			5,750		5,623			5,809

					28,800			29,190
Ambath/Rebath Holdings, Inc.	Home improvement retail
First Lien Term Loan A, LIBOR+7% (3% floor) cash due 12/30/2014			3,500		3,500			3,497
First Lien Term Loan B, 12.5% cash 2.5% PIK due 12/30/2014			22,999		22,999			22,600
First Lien Term Revolver, LIBOR+6.5% (3% floor) cash due 12/30/2014(10)			1,500		1,500			1,479

					27,999			27,576
JTC Education, Inc.	Education services
First Lien Term Loan, LIBOR+9.5% (3% floor) cash due 12/31/2014			30,134		29,467			29,780
First Lien Revolver, LIBOR+9.5% (3.25% floor) cash due 12/31/2014(11)					(305	)		—
17,391 Shares of Series A-1 Preferred Stock					313			313
17,391 Shares of Common Stock					187			83

					29,662			30,176
Tegra Medical, LLC	Healthcare equipment
First Lien Term Loan A, LIBOR+7% (3% floor) cash due 12/31/2014			22,540		22,244			22,744
First Lien Term Loan B, 12% cash 2% PIK due 12/31/2014			22,551		22,270			22,226
First Lien Revolver, LIBOR+7% (3% floor) cash due 12/31/2014			2,500		2,449			2,501

					46,963			47,471
Psilos Group Partners IV, LP	Multi-sector holdings
2.52% limited partnership interest(12)(16)					—			—

					—			—
Mansell Group, Inc.	Advertising
First Lien Term Loan A, LIBOR+7% (3% floor) cash due 4/30/2015			10,675		10,512			10,654
First Lien Term Loan B, LIBOR+9% (3% floor) cash 1.5% PIK due 4/30/2015			9,142		9,001			9,067
First Lien Revolver, LIBOR+6% (3% floor) cash due 4/30/2015(11)					(29	)		—

					19,484			19,721
NDSSI Holdings, LLC	Electronic equipment & instruments
First Lien Term Loan, LIBOR+9.75% (3% floor) cash 1% PIK due 12/31/2012			29,788		29,370			29,278
First Lien Revolver, LIBOR+7% (3% floor) cash due 12/31/2012			3,500		3,435			3,538
2,000 Series D Preferred Units					2,047			2,047

					34,852			34,863
Eagle Hospital Physicians, Inc.(9)	Healthcare services
First Lien Term Loan, LIBOR+8.75% (3% floor) cash due 8/11/2015			25,400		24,907			25,246
First Lien Revolver, LIBOR+5.75% (3% floor) cash due 8/11/2015(11)					(42	)		—

					24,865			25,246
Enhanced Recovery Company, LLC	Diversified support services
First Lien Term Loan A, LIBOR+7% (2% floor) cash due 8/13/2015			13,961		13,713			13,945
First Lien Term Loan B, LIBOR+10% (2% floor) cash 1% PIK due 8/13/2015			11,070		10,882			11,015
First Lien Revolver, LIBOR+7% (2% floor) cash due 8/13/2015(11)					(69	)		—

					24,526			24,960
Epic Acquisition, Inc.	Healthcare services
First Lien Term Loan A, LIBOR+8% (3% floor) cash due 8/13/2015			8,329		8,189			8,343
First Lien Term Loan B, 12.25% cash 3% PIK due 8/13/2015			17,246		16,962			17,281
First Lien Revolver, LIBOR+6.5% (3% floor) cash due 8/13/2015(11)					(50	)		—

					25,101			25,624

Fifth Street Finance Corp.

Consolidated Schedule of Investments

(dollar amounts in thousands)

September 30, 2011


Portfolio Company/Type of Investment(1)(2)(5)	Industry	Principal(8)		Cost			Fair Value
Specialty Bakers LLC	Food distributors
First Lien Term Loan A, LIBOR+8.5% cash due 9/15/2015			8,325		8,148			8,220
First Lien Term Loan B, LIBOR+11% (2.5% floor) cash due 9/15/2015			11,000		10,770			10,756
First Lien Revolver, LIBOR+8.5% cash due 9/15/2015			2,000		1,916			2,029

					20,834			21,005
CRGT, Inc.	IT consulting & other services
First Lien Term Loan A, LIBOR+7.5% cash due 10/1/2015			27,913		27,495			27,659
First Lien Term Loan B, 12.5% cash 10/1/2015			22,000		21,648			21,869
First Lien Revolver, LIBOR+7.5% cash due 10/1/2015(11)					(200	)		—

					48,943			49,528
Welocalize, Inc.	Internet software & services
First Lien Term Loan A, LIBOR+8% (2% floor) cash due 11/19/2015			15,990		15,720			15,668
First Lien Term Loan B, LIBOR+9% (2% floor) cash 1.25% PIK due 11/19/2015			21,231		20,888			20,983
First Lien Revolver, LIBOR+7% (2% floor) cash due 11/19/2015			5,250		5,152			5,162
2,086,163 Common Units in RPWL Holdings, LLC					2,086			1,973

					43,846			43,786
Miche Bag, LLC	Apparel, accessories & luxury goods
First Lien Term Loan A, LIBOR+9% (3% floor) cash due 12/7/2013			13,708		13,353			13,735
First Lien Term Loan B, LIBOR+10% (3% floor) cash 3% PIK due 12/7/2015			17,425		14,983			17,115
First Lien Revolver, LIBOR+7% (3% floor) cash due 12/7/2015(11)					(105	)		—
10,371 Preferred Equity units in Miche Holdings, LLC(6)					1,037			1,169
146,289 Series D Common Equity units in Miche Holdings, LLC(6)					1,463			1,496

					30,731			33,515
Bunker Hill Capital II (QP), LP	Multi-sector holdings
0.50% limited partnership interest(16)					40			40

					40			40
Dominion Diagnostics, LLC(9)	Healthcare services
First Lien Term Loan A, LIBOR+7% (2.5% floor) cash due 12/17/2015			29,550		29,030			29,442
First Lien Term Loan B, LIBOR+10.5% (2.5% floor) cash 1% PIK due 12/17/2015			20,008		19,675			19,546
First Lien Revolver, LIBOR+6.5% (2.5% floor) cash due 12/17/2015(11)					(83	)		—

					48,622			48,988
Advanced Pain Management	Healthcare services
First Lien Term Loan, LIBOR+5% (1.75% floor) cash due 12/22/2015			8,046		7,923			8,007
First Lien Revolver, LIBOR+5% (1.75% floor) cash due 12/22/2015			133		129			135

					8,052			8,142
DISA, Inc.	Human resources & employment services
First Lien Term Loan A, LIBOR+7.5% (0.75% floor) cash due 12/30/2015			12,460		12,256			12,542
First Lien Term Loan B, LIBOR+10% (1% floor) cash 1.5% PIK due 12/30/2015			8,395		8,264			8,410
First Lien Revolver, LIBOR+6% (1% floor) cash due 12/30/2015(11)					(63	)		—

					20,457			20,952
Saddleback Fence and Vinyl Products, Inc.	Building products
First Lien Term Loan, 8% cash due 11/30/2013			773		773			773
First Lien Revolver, 8% cash due 11/30/2013					—			—

					773			773

Fifth Street Finance Corp.

Consolidated Schedule of Investments

(dollar amounts in thousands)

September 30, 2011


Portfolio Company/Type of Investment(1)(2)(5)	Industry	Principal(8)		Cost			Fair Value
Best Vinyl Fence & Deck, LLC	Building products
First Lien Term Loan A, 8% cash due 11/30/2013			2,061		1,947			2,061
First Lien Term Loan B, 8% PIK due 7/31/2011(15)			3,969		3,969			2,000
First Lien Revolver, 8% cash due 11/30/2013					—			—

					5,916			4,061
Physicians Pharmacy Alliance, Inc.	Healthcare services
First Lien Term Loan, LIBOR+9% cash 1.5% PIK due 1/4/2016			16,766		16,461			16,702
First Lien Revolver, LIBOR+6% cash due 1/4/2016(11)					(35	)		—

					16,426			16,702
Cardon Healthcare Network, LLC	Diversified support services
First Lien Term Loan, LIBOR+10% (1.75% floor) cash due 1/6/2016(9)			11,250		11,051			11,210
First Lien Revolver, LIBOR+6.5% (1.75% floor) cash due 1/6/2016(11)					(35	)		—

					11,016			11,210
U.S. Retirement Partners, Inc.	Diversified financial services
First Lien Term Loan, LIBOR+9.5% (2% floor) cash due 1/6/2016			13,600		13,311			13,329

					13,311			13,329
IOS Acquisitions, Inc.	Oil & gas equipment & services
First Lien Term Loan A, LIBOR+8% (2% floor) cash due 1/14/2016			8,700		8,576			8,656
First Lien Term Loan B, LIBOR+10% (2% floor) cash 2% PIK due 1/14/2016			10,618		10,466			10,480
First Lien Revolver, LIBOR+8% (2% floor) cash due 1/14/2016			750		714			777

					19,756			19,913
Actient Pharmaceuticals, LLC	Healthcare services
First Lien Term Loan, LIBOR+6.25% (2% floor) cash due 7/29/2015			9,180		9,018			9,169

					9,018			9,169
Phoenix Brands Merger Sub LLC	Household products
Senior Term Loan, LIBOR+5% (1.5% floor) cash due 1/31/2016			8,036		7,875			7,674
Subordinated Term Loan, 10% cash 3.875% PIK due 2/1/2017			20,390		20,035			19,071
First Lien Revolver, LIBOR+5% (1.5% floor) cash due 1/31/2016			3,429		3,303			3,198

					31,213			29,943
U.S. Collections, Inc.	Diversified support services
First Lien Term Loan, LIBOR+5.25% (1.75% floor) cash due 3/31/2016			10,847		10,649			10,828

					10,649			10,828
CCCG, LLC	Oil & gas equipment & services
First Lien Term Loan, LIBOR+8% (1.75% floor) cash 1% PIK due 7/29/2015			34,738		34,115			34,152

					34,115			34,152
Maverick Healthcare Group, LLC	Healthcare equipment
First Lien Term Loan, LIBOR+9% (1.75% floor) cash due 12/31/2016			24,813		24,292			24,440

					24,292			24,440
Refac Optical Group	Specialty stores
First Lien Term Loan A, LIBOR+7.5% cash due 3/23/2016			14,220		13,920			14,273
First Lien Term Loan B, LIBOR+8.5% cash 1.75% PIK due 3/23/2016			20,162		19,731			20,078
First Lien Revolver, LIBOR+7.5% cash due 3/23/2016(11)					(113	)		—
1,000 Shares of Common Stock in Refac Holdings, Inc.					1			—
1,000 Shares of Preferred Stock in Refac Holdings, Inc.					999			847

					34,538			35,198

Fifth Street Finance Corp.

Consolidated Schedule of Investments

(dollar amounts in thousands)

September 30, 2011


Portfolio Company/Type of Investment(1)(2)(5)	Industry	Principal(8)		Cost			Fair Value
Pacific Architects & Engineers, Inc.	Diversified support services
First Lien Term Loan A, LIBOR+5% (1.5% floor) cash due 4/4/2017			4,416		4,352			4,332
First Lien Term Loan B, LIBOR+6% (1.5% floor) cash due 4/4/2017			5,000		4,929			4,903

					9,281			9,235
Ernest Health, Inc.	Healthcare services
Second Lien Term Loan, LIBOR+8.5% (1.75% floor) cash due 5/13/2017			25,000		24,656			25,049

					24,656			25,049
Securus Technologies, Inc.	Integrated telecommunication services
Second Lien Term Loan, LIBOR+8.25% (1.75% floor) cash due 5/31/2018			26,500		25,995			26,374

					25,995			26,374
Gundle/SLT Environmental, Inc.	Environmental & facilities services
First Lien Term Loan, LIBOR+5.5% (1.5% floor) cash due 5/27/2016			7,980		7,904			7,977

					7,904			7,977
Titan Fitness, LLC	Leisure facilities
First Lien Term Loan A, LIBOR+8.75 (1.25% floor) cash due 6/30/2016			17,063		16,878			16,938
First Lien Term Loan B, LIBOR+10.75% (1.25% floor) cash 1.5% PIK due 6/30/2016			11,545		11,422			11,343
First Lien Term Loan C, 18% PIK due 6/30/2016			2,721		2,693			2,593
First Lien Revolver, LIBOR+8.75% (1.25% floor) cash due 6/30/2016			543		506			821

					31,499			31,695
Baird Capital Partners V, LP	Multi-sector holdings
0.4% limited partnership interest(16)					299			299

					299			299
Charter Brokerage, LLC	Oil & gas equipment services
Senior Term Loan, LIBOR+6.5% (1.5% floor) cash due 7/13/2016			17,411		17,242			17,411
Mezzanine Term Loan, 11.75% cash 2% PIK due 7/13/2017			10,043		9,948			10,043
Senior Revolver, LIBOR+6.5% (1.5% floor) cash due 7/13/2016			1,176		1,107			1,177

					28,297			28,631
Stackpole Powertrain International ULC(16)	Auto parts & equipment
Subordinated Term Loan, 12% cash 2% PIK due 8/1/2018			18,059		17,883			18,059
1,000 Common Units					1,000			1,000

					18,883			19,059
Discovery Practice Management, Inc.	Healthcare services
Senior Term Loan A, LIBOR+7.5% cash due 8/8/2016			7,027		6,942			7,027
Senior Term Loan B, 12% cash 3% PIK due 8/8/2016			6,248		6,174			6,248
Senior Revolver, LIBOR+7% cash due 8/8/2016(11)					(37	)		—

					13,079			13,275
CTM Group, Inc.	Leisure products
Mezzanine Term Loan A, 11% cash 2% PIK due 2/10/2017			10,530		10,417			10,530
Mezzanine Term Loan B, 18.4% PIK due 2/10/2017			3,181		3,147			3,181

					13,564			13,711
Bojangles	Restaurants
First Lien Term Loan, LIBOR+6.5% (1.5% floor) cash due 8/17/2017			10,000		9,803			10,000

					9,803			10,000
Milestone Partners IV, LP	Multi-sector holdings
3.07% limited partnership interest(12)(16)					—			—

					—			—

Fifth Street Finance Corp.

Consolidated Schedule of Investments

(dollar amounts in thousands)

September 30, 2011

Portfolio Company/Type of Investment(1)(2)(5)

Industry

Principal(8)

Cost

Fair Value

Insight Pharmaceuticals, LLC

Pharmaceuticals

First Lien Term Loan, LIBOR+6% (1.5% floor) cash due 8/25/2016

10,000

9,926

10,000

Second Lien Term Loan, LIBOR+11.75% (1.5% floor) cash due 8/25/2017

17,500

17,331

17,500

27,257

27,500

National Spine and Pain Centers, LLC

Healthcare services

Mezzanine Term Loan, 11% cash 1.6% PIK due 9/27/2017

19,002

18,816

19,002

250,000 Class A Units

250

19,066

19,252

Total Non-Control/Non-Affiliate Investments (148.1% of net assets)

1,108,174

1,079,440

Total Portfolio Investments (153.7% of net assets)

1,156,082

1,119,837

(1)	Debt investments are income producing unless otherwise noted. Equity is non-income producing unless otherwise noted.

(2)	See Note 3 to the Consolidated Financial Statements for portfolio composition by geographic region.

(3)	Control Investments are defined by the Investment Company Act of 1940 (“1940 Act”) as investments in companies in which the Company owns more than 25% of the voting securities or maintains greater than 50% of the board representation.

(4)	Affiliate Investments are defined by the 1940 Act as investments in companies in which the Company owns between 5% and 25% of the voting securities.

(5)	Equity ownership may be held in shares or units of companies related to the portfolio companies.

(6)	Income producing through payment of dividends or distributions.

(7)	Non-Control/Non-Affiliate Investments are defined by the 1940 Act as investments that are neither Control Investments nor Affiliate Investments.

(8)	Principal includes accumulated PIK interest and is net of repayments.

(9)


Portfolio Company	Effective date	Cash interest	PIK interest	Reason

Cardon Healthcare Network, LLC	July 1, 2011	– 2.5% on Term Loan		Tier pricing per credit agreement

Eagle Hospital Physicians, Inc.	July 1, 2011	– 0.25% on Term Loan & Revolver		Per loan agreement

Dominion Diagnostics, LLC	April 1, 2011	– 0.5% on Term Loan A	– 1.0% on Term Loan B	Tier pricing per credit agreement

Lighting by Gregory, LLC	March 11, 2011	– 2.0% on Bridge Loan		Per loan amendment

Capital Equipment Group, Inc.	July 1, 2010	– 2.0% on Term Loan	– 0.75% on Term Loan	Per waiver agreement

Traffic Control & Safety Corporation	June 1, 2010	– 4.0% on Second Lien Term Loan	+ 1.0% on Second Lien Term Loan	Per restructuring agreement

Premier Trailer Leasing, Inc.	August 4, 2009	+ 4.0% on Term Loan		Default interest per credit agreement

Fifth Street Finance Corp.

Consolidated Schedule of Investments

(dollar amounts in thousands)

September 30, 2011

(10)	Revolving credit line had been suspended and was deemed unlikely to be renewed in the future.

(11)	Cost amounts represent unearned income related to undrawn commitments.

(12)	Represents an unfunded commitment to fund limited partnership interest.

(13)	Investment was on cash non-accrual status as of September 30, 2011.

(14)	Investment was on PIK non-accrual status as of September 30, 2011.

(15)	Best Vinyl Fence & Deck, LLC Term Loan B was under negotiation and, as such, the maturity date of the loan had been temporarily suspended.

(16)	Investment is not a qualifying asset as defined under Section 55(a) of the 1940 Act.

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

Note 1.

Organization

Fifth Street Mezzanine Partners III, L.P. (the “Partnership”), a Delaware limited partnership, was organized on February 15, 2007 to primarily invest in debt securities of small and middle market companies. FSMPIII GP, LLC was the Partnership’s general partner (the “General Partner”). The Partnership’s investments were managed by Fifth Street Management LLC (the “Investment Adviser”). The General Partner and Investment Adviser were under common ownership.

Effective January 2, 2008, the Partnership merged with and into Fifth Street Finance Corp. (the “Company”), an externally managed, closed-end, non-diversified management investment company that has elected to be treated as a business development company under the Investment Company Act of 1940 (the “1940 Act”). Fifth Street Finance Corp. is managed by the Investment Adviser. Prior to January 2, 2008, references to the Company are to the Partnership. Since January 2, 2008, references to the “Company”, “FSC”, “we” or “our” are to Fifth Street Finance Corp., unless the context otherwise requires.

The Company also has certain wholly-owned subsidiaries, including subsidiaries that are not consolidated for income tax purposes, which hold certain portfolio investments of the Company. The subsidiaries are consolidated with the Company for accounting purposes, and the portfolio investments held by the subsidiaries are included in the Company’s Consolidated Financial Statements. All significant intercompany balances and transactions have been eliminated.

On November 28, 2011, the Company transferred the listing of its common stock from the New York Stock Exchange to the NASDAQ Global Select Market, where it continues to trade under the symbol “FSC.” The following table reflects common stock offerings that have occurred from inception through March 31, 2012:


Date	Transaction	Shares		Offering price			Gross proceeds
June 17, 2008	Initial public offering		10,000,000	$	14.12		$	141.2 million
July 21, 2009	Follow-on public offering (including underwriters’ exercise of over-allotment option)		9,487,500	$	9.25		$	87.8 million
September 25, 2009	Follow-on public offering (including underwriters’ exercise of over-allotment option)		5,520,000	$	10.50		$	58.0 million
January 27, 2010	Follow-on public offering		7,000,000	$	11.20		$	78.4 million
February 25, 2010	Underwriters’ partial exercise of over-allotment option		300,500	$	11.20		$	3.4 million
June 21, 2010	Follow-on public offering (including underwriters’ exercise of over-allotment option)		9,200,000	$	11.50		$	105.8 million
December 2010	At-the-Market offering		429,110	$	11.87	(1)	$	5.1 million
February 4, 2011	Follow-on public offering (including underwriters’ exercise of over-allotment option)		11,500,000	$	12.65		$	145.5 million
June 24, 2011	Follow-on public offering (including underwriters’ partial exercise of over-allotment option)		5,558,469	$	11.72		$	65.1 million
January 26, 2012	Follow-on public offering		10,000,000	$	10.07		$	100.7 million

(1)	Average offering price

On February 3, 2010, the Company’s consolidated wholly-owned subsidiary, Fifth Street Mezzanine Partners IV, L.P., received a license, effective February 1, 2010, from the United States Small Business Administration, or SBA, to operate as a small business investment company, or SBIC, under Section 301(c) of the Small Business Investment Act of 1958. SBICs are designated to stimulate the flow of private equity capital to eligible small businesses. Under SBA regulations, SBICs may make loans to eligible small businesses and invest in the equity securities of small businesses.

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

The SBIC license allows the Company’s SBIC subsidiary to obtain leverage by issuing SBA-guaranteed debentures, subject to the satisfaction of certain customary procedures. SBA-guaranteed debentures are non-recourse, interest only debentures with interest payable semi-annually and have a ten year maturity. The principal amount of SBA-guaranteed debentures is not required to be paid prior to maturity but may be prepaid at any time without penalty. The interest rate of SBA-guaranteed debentures is fixed at the time of issuance at a market-driven spread over U.S. Treasury Notes with 10-year maturities.

SBA regulations currently limit the amount of SBA-guaranteed debentures that an SBIC may issue to $150 million when it has at least $75 million in regulatory capital. Affiliated SBICs are permitted to issue up to a combined maximum amount of $225 million in SBA-guaranteed debentures when they have at least $112.5 million in combined regulatory capital. As of March 31, 2012, the Company’s SBIC subsidiary had $75 million in regulatory capital and $150 million in SBA-guaranteed debentures outstanding, which had a fair value of $126.2 million. These debentures bear interest at a weighted average interest rate of 3.567% (excluding the SBA annual charge), as follows:


Rate Fix Date	Debenture Amount		Fixed Interest Rate			SBA Annual Charge
September 2010	$	73,000		3.215	%		0.285	%
March 2011		65,300		4.084	%		0.285	%
September 2011		11,700		2.877	%		0.285	%

For the three and six months ended March 31, 2012, the Company recorded interest expense of $1.6 million and $3.2 million, respectively, related to the SBA-guaranteed debentures.

The SBA restricts the ability of SBICs to repurchase their capital stock. SBA regulations also include restrictions on a “change of control” or transfer of an SBIC and require that SBICs invest idle funds in accordance with SBA regulations. In addition, the Company’s SBIC subsidiary may also be limited in its ability to make distributions to the Company if it does not have sufficient capital, in accordance with SBA regulations.

The Company’s SBIC subsidiary is subject to regulation and oversight by the SBA, including requirements with respect to maintaining certain minimum financial ratios and other covenants. Receipt of an SBIC license does not assure that the SBIC subsidiary will receive SBA-guaranteed debenture funding and is dependent upon the SBIC subsidiary continuing to be in compliance with SBA regulations and policies.

The SBA, as a creditor, will have a superior claim to the SBIC subsidiary’s assets over the Company’s stockholders in the event the Company liquidates the SBIC subsidiary or the SBA exercises its remedies under the SBA-guaranteed debentures issued by the SBIC subsidiary upon an event of default.

The Company has received exemptive relief from the Securities and Exchange Commission (“SEC”) to permit it to exclude the debt of the SBIC subsidiary guaranteed by the SBA from the definition of senior securities in the Company’s 200% asset coverage test under the 1940 Act. This allows the Company increased flexibility under the 200% asset coverage test by permitting it to borrow up to $150 million more than it would otherwise be able to under the 1940 Act absent the receipt of this exemptive relief.

Note 2.

Significant Accounting Policies

Basis of Presentation and Liquidity:

The Consolidated Financial Statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and Regulation S-X. In the opinion of management, all adjustments of a normal recurring nature considered necessary for the fair presentation of the Consolidated Financial Statements have been made. The financial results of the Company’s portfolio investments are not consolidated in the Company’s Consolidated Financial Statements.

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

Although the Company expects to fund the growth of its investment portfolio through the net proceeds from the recent and future equity offerings, the Company’s dividend reinvestment plan, and issuances of senior securities or future borrowings, to the extent permitted by the 1940 Act, the Company cannot assure that its plans to raise capital will be successful. In addition, the Company intends to distribute to its stockholders between 90% and 100% of its taxable income each year in order to satisfy the requirements applicable to Regulated Investment Companies (“RICs”) under Subchapter M of the Internal Revenue Code (“Code”). Consequently, the Company may not have the funds or the ability to fund new investments, to make additional investments in its portfolio companies, to fund its unfunded commitments to portfolio companies or to repay borrowings. In addition, the illiquidity of its portfolio investments may make it difficult for the Company to sell these investments when desired and, if the Company is required to sell these investments, it may realize significantly less than their recorded value.

Use of Estimates:

The preparation of financial statements in conformity with GAAP requires management to make certain estimates and assumptions affecting amounts reported in the financial statements and accompanying notes. These estimates are based on the information that is currently available to the Company and on various other assumptions that the Company believes to be reasonable under the circumstances. Actual results could differ materially from those estimates under different assumptions and conditions. The most significant estimates inherent in the preparation of the Company’s Consolidated Financial Statements are the valuation of investments and revenue recognition.

The Consolidated Financial Statements include portfolio investments at fair value of $1.06 billion and $1.12 billion at March 31, 2012 and September 30, 2011, respectively. The portfolio investments represent 129.9% and 153.7% of net assets at March 31, 2012 and September 30, 2011, respectively, and their fair values have been determined by the Company’s Board of Directors in good faith in the absence of readily available market values. Because of the inherent uncertainty of valuation, the determined values may differ significantly from the values that would have been used had a ready market existed for the investments, and the differences could be material.

The Company classifies its investments in accordance with the requirements of the 1940 Act. Under the 1940 Act, “Control Investments” are defined as investments in companies in which the Company owns more than 25% of the voting securities or has rights to maintain greater than 50% of the board representation; “Affiliate Investments” are defined as investments in companies in which the Company owns between 5% and 25% of the voting securities; and “Non-Control/Non-Affiliate Investments” are defined as investments that are neither Control Investments nor Affiliate Investments.

Fair Value Measurements:

The Financial Accounting Standards Board Accounting Standards Codification (“ASC”) Topic 820 Fair Value Measurements and Disclosures (“ASC 820”) defines fair value as the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A liability’s fair value is defined as the amount that would be paid to transfer the liability to a new obligor, not the amount that would be paid to settle the liability with the creditor. Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available or reliable, valuation techniques are applied. These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price transparency for the investments or market and the investments’ complexity.

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

Assets recorded at fair value in the Company’s Consolidated Financial Statements are categorized based upon the level of judgment associated with the inputs used to measure their fair value.

Hierarchical levels, defined by ASC 820 and directly related to the amount of subjectivity associated with the inputs to fair valuation of these assets and liabilities, are as follows:

•

Level 1 — Unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.

•

Level 2 — Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data at the measurement date for substantially the full term of the assets or liabilities.

•

Level 3 — Unobservable inputs that reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.

Under ASC 820, the Company performs detailed valuations of its debt and equity investments on an individual basis, using market, income and bond yield approaches as appropriate. In general, the Company utilizes the bond yield method in determining the fair value of its investments, as long as it is appropriate. If, in the Company’s judgment, the bond yield approach is not appropriate, it may use the market approach or income approach in determining the fair value of the Company’s investment in the portfolio company. If there is deterioration in the credit quality of the portfolio company or an investment is in workout status, the Company may use alternative methodologies, including an asset liquidation or expected recovery model.

Under the market approach, the Company estimates the enterprise value of the portfolio companies in which it invests. There is no one methodology to estimate enterprise value and, in fact, for any one portfolio company, enterprise value is best expressed as a range of fair values, from which the Company derives a single estimate of enterprise value. To estimate the enterprise value of a portfolio company, the Company analyzes various factors, including the portfolio company’s historical and projected financial results. Typically, private companies are valued based on multiples of EBITDA (earnings before interest, taxes, depreciation, and amortization), cash flows, net income, revenues, or in limited cases, book value. The Company generally requires portfolio companies to provide annual audited and quarterly and monthly unaudited financial statements, as well as annual projections for the upcoming fiscal year.

Under the income approach, the Company generally prepares and analyzes discounted cash flow models based on projections of the future free cash flows of the business.

Under the bond yield approach, the Company uses bond yield models to determine the present value of the future cash flow streams of its debt investments. The Company reviews various sources of transactional data, including private mergers and acquisitions involving debt investments with similar characteristics, and assesses the information in the valuation process.

The Company’s Board of Directors undertakes a multi-step valuation process each quarter in connection with determining the fair value of the Company’s investments:

•

The quarterly valuation process begins with each portfolio company or investment being initially valued by the Company’s finance department;

•

Preliminary valuations are then reviewed and discussed with principals of the Investment Adviser;

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

•

Separately, independent valuation firms engaged by the Board of Directors prepare preliminary valuations on a selected basis and submit the reports to the Company;

•

The finance department compares and contrasts its preliminary valuations to the preliminary valuations of the independent valuation firms;

•

The finance department prepares a valuation report for the Valuation Committee of the Board of Directors;

•

The Valuation Committee of the Board of Directors is apprised of the preliminary valuations of the independent valuation firms;

•

The Valuation Committee of the Board of Directors reviews the preliminary valuations, and the finance department responds and supplements the preliminary valuations to reflect any comments provided by the Valuation Committee;

•

The Valuation Committee of the Board of Directors makes a recommendation to the Board of Directors regarding the fair value of the investments in the Company’s portfolio; and

•

The Board of Directors discusses valuations and determines the fair value of each investment in the Company’s portfolio in good faith.

The fair value of all of the Company’s investments at March 31, 2012 and September 30, 2011 was determined by the Board of Directors. The Board of Directors is solely responsible for the valuation of the portfolio investments at fair value as determined in good faith pursuant to the Company’s valuation policy and a consistently applied valuation process.

The Board of Directors has authorized the engagement of independent valuation firms to provide valuation assistance. Upon completion of their processes each quarter, the independent valuation firms provide the Company with written reports regarding the preliminary valuations of selected portfolio securities as of the close of such quarter. The Company will continue to engage independent valuation firms to provide assistance regarding the determination of the fair value of selected portfolio securities each quarter; however, the Board of Directors is ultimately and solely responsible for determining the fair value of the Company’s investments in good faith. The Company intends to have a portion of the portfolio valued by an independent third party on a quarterly basis, with a substantial portion being valued on an annual basis.

Investment Income:

Interest income, adjusted for amortization of premium and accretion of original issue discount, is recorded on an accrual basis to the extent that such amounts are expected to be collected. The Company stops accruing interest on investments when it is determined that interest is no longer collectible. In connection with its investment, the Company sometimes receives nominal cost equity that is valued as part of the negotiation process with the particular portfolio company. When the Company receives nominal cost equity, the Company allocates its cost basis in its investment between its debt securities and its nominal cost equity at the time of origination. Any resulting discount from recording the loan is accreted into interest income over the life of the loan.

Distributions of earnings from portfolio companies are recorded as dividend income when the distribution is received.

The Company has investments in debt securities which contain payment-in-kind or “PIK” interest provisions. PIK interest is computed at the contractual rate specified in each investment agreement and added to the principal balance of the investment and recorded as income.

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

Fee income consists of the monthly collateral management fees that the Company receives in connection with its debt investments and the accreted portion of the debt origination fees. The Company capitalizes a portion of the upfront loan origination fees received in connection with investments. The unearned fee income from such fees is accreted into fee income, based on the straight line method or effective interest method as applicable, over the life of the investment.

The Company has also structured exit fees across certain of its portfolio investments to be received upon the future exit of those investments. Exit fees are fees which are payable upon the exit of a debt security. These fees are to be paid to the Company upon the sooner to occur of (i) a sale of the borrower or substantially all of the assets of the borrower, (ii) the maturity date of the loan or (iii) the date when full prepayment of the loan occurs. The receipt of such fees is contingent upon the occurrence of one of the events listed above for each of the investments. A percentage of these fees is included in net investment income over the life of the loan.

Gain on Extinguishment of Convertible Senior Notes:

The Company may repurchase its Convertible Senior Notes in accordance with the 1940 Act and the rules promulgated thereunder and may surrender these Notes to the Trustee for cancellation. If the repurchase occurs at a purchase price below par value, a gain on the extinguishment of these Notes is recorded. The amount of the gain recorded is the difference between the reacquisition price and the net carrying amount of the Notes, net of the proportionate amount of unamortized debt issuance costs.

Cash and Cash Equivalents:

Cash and cash equivalents consist of demand deposits and highly liquid investments with maturities of three months or less, when acquired. The Company places its cash and cash equivalents with financial institutions and, at times, cash held in bank accounts may exceed the Federal Deposit Insurance Corporation insured limit. Included in cash and cash equivalents is $6.1 million that is held at Wells Fargo Bank, National Association (“Wells Fargo”) in connection with the Company’s credit facility. The Company is restricted in terms of access to this cash until such time as the Company submits its required monthly reporting schedules and Wells Fargo verifies the Company’s compliance per the terms of the credit agreement.

Deferred Financing Costs:

Deferred financing costs consist of fees and expenses paid in connection with the closing or amending of credit facilities and are capitalized at the time of payment. Deferred financing costs are amortized using the straight line method over the terms of the respective credit facilities. This amortization expense is included in interest expense in the Company’s Consolidated Statement of Operations.

Collateral Posted to Bank:

Collateral posted to bank consisted of cash posted as collateral with respect to the Company’s interest rate swap, which was terminated in August 2011. The Company was restricted in terms of access to this collateral until such swap was terminated or the swap agreement expired. Cash collateral posted was held in an account at Wells Fargo.

Interest Rate Swap:

The Company does not utilize hedge accounting and marks its interest rate swaps to fair value on a quarterly basis through its Consolidated Statement of Operations. As of March 31, 2012, the Company was not party to any interest rate swap agreements.

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

Offering Costs:

Offering costs consist of fees and expenses incurred in connection with the public offer and sale of the Company’s common stock, including legal, accounting and printing fees. $0.8 million of offering costs have been charged to capital during the six months ended March 31, 2012.

Income Taxes:

As a RIC, the Company is not subject to federal income tax on the portion of its taxable income and gains distributed currently to its stockholders as a dividend. The Company intends to distribute between 90% and 100% of its taxable income and gains, within the Subchapter M rules, and thus the Company anticipates that it will not incur any federal or state income tax at the RIC level. As a RIC, the Company is also subject to a federal excise tax based on distributive requirements of its taxable income on a calendar year basis (e.g., calendar year 2012). The Company anticipates timely distribution of its taxable income within the tax rules; however, the Company incurred a de minimis federal excise tax for calendar years 2008, 2009 and 2010. The Company did not incur a federal excise tax for calendar year 2011 and does not expect to incur a federal excise tax for calendar year 2012. The Company may incur a federal excise tax in future years.

The purpose of the Company’s taxable subsidiaries is to permit the Company to hold equity investments in portfolio companies which are “pass through” entities for federal tax purposes in order to comply with the “source income” requirements contained in the RIC tax requirements. The taxable subsidiaries are not consolidated with the Company for income tax purposes and may generate income tax expense as a result of their ownership of certain portfolio investments. This income tax expense, if any, would be reflected in the Company’s Consolidated Statements of Operations. The Company uses the asset and liability method to account for its taxable subsidiaries’ income taxes. Using this method, the Company recognizes deferred tax assets and liabilities for the estimated future tax effects attributable to temporary differences between financial reporting and tax bases of assets and liabilities. In addition, the Company recognizes deferred tax benefits associated with net operating loss carry forwards that it may use to offset future tax obligations. The Company measures deferred tax assets and liabilities using the enacted tax rates expected to apply to taxable income in the years in which it expects to recover or settle those temporary differences.

ASC 740 Accounting for Uncertainty in Income Taxes (“ASC 740”) provides guidance for how uncertain tax positions should be recognized, measured, presented, and disclosed in the Company’s Consolidated Financial Statements. ASC 740 requires the evaluation of tax positions taken or expected to be taken in the course of preparing the Company’s tax returns to determine whether the tax positions are “more-likely-than-not” of being sustained by the applicable tax authority. Tax positions not deemed to meet the more-likely-than-not threshold are recorded as a tax benefit or expense in the current year. Management’s determinations regarding ASC 740 may be subject to review and adjustment at a later date based upon factors including, but not limited to, an ongoing analysis of tax laws, regulations and interpretations thereof. The Company recognizes the tax benefits of uncertain tax positions only where the position is “more likely than not” to be sustained assuming examination by tax authorities. Management has analyzed the Company’s tax positions, and has concluded that no liability for unrecognized tax benefits should be recorded related to uncertain tax positions taken on returns filed for open tax years 2008, 2009 or 2010. The Company identifies its major tax jurisdictions as U.S. Federal and New York State, and the Company is not aware of any tax positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will change materially in the next 12 months.

Recent Accounting Pronouncements

In May 2011, the FASB issued Accounting Standards Update No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-04”).

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

ASU 2011-04 amends ASC 820 and requires entities to change the wording used to describe the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. ASU 2011-04 clarifies the application of existing fair value measurement and disclosure requirements related to the application of the highest and best use and valuation premise concepts for financial and nonfinancial instruments, measuring the fair value of an instrument classified in shareholders’ equity, and disclosures about fair value measurements. ASU 2011-04 changes the measurement of the fair value of financial instruments that are managed within a portfolio and the application of premiums and discounts in a fair value measurement related to size as a characteristic of the reporting entity’s holding rather than a characteristic of the asset or liability. ASU 2011-04 requires additional disclosures about fair value measurements categorized within Level 3 of the fair value hierarchy including the valuation processes used by the reporting entity, the sensitivity of the fair value to changes in unobservable inputs, and the interrelationships between those unobservable inputs, if any. All the amendments to ASC 820 made by ASU 2011-04 are effective for interim and annual periods beginning after December 15, 2011. The adoption of this disclosure-only guidance is included in Note 3 — Portfolio Investments and did not have an impact on the Company’s consolidated financial results.

Note 3.

Portfolio Investments

At March 31, 2012, 129.9% of net assets or $1.06 billion was invested in 67 long-term portfolio investments and 14.2% of net assets or $115.2 million was invested in cash and cash equivalents. In comparison, at September 30, 2011, 153.7% of net assets or $1.12 billion was invested in 65 long-term portfolio investments and 9.3% of net assets or $67.6 million was invested in cash and cash equivalents. As of March 31, 2012, 81.3% of the Company’s portfolio at fair value consisted of debt investments that were secured by first or second priority liens on the assets of the portfolio companies. Moreover, the Company held equity investments in certain of its portfolio companies consisting of common stock, preferred stock, limited partnership interests or limited liability company interests. These instruments generally do not produce a current return but are held for potential investment appreciation and capital gain.

During the three and six months ended March 31, 2012, the Company recorded net realized losses of $10.8 million and $27.4 million, respectively. During the three and six months ended March 31, 2011, the Company recorded net realized losses on investments of $0.5 million and $14.0 million, respectively. During the three and six months ended March 31, 2012, the Company recorded net unrealized appreciation of $8.0 million and $13.9 million, respectively. During the three and six months ended March 31, 2011, the Company recorded net unrealized depreciation of $0.4 million and net unrealized appreciation of $16.5 million, respectively.

The composition of the Company’s investments as of March 31, 2012 and September 30, 2011 at cost and fair value was as follows:


	March 31, 2012				September 30, 2011
	Cost		Fair Value		Cost		Fair Value
Investments in debt securities	$	1,056,115	$	1,029,661	$	1,137,754	$	1,099,708
Investments in equity securities		22,582		26,562		18,328		20,129

Total	$	1,078,697	$	1,056,223	$	1,156,082	$	1,119,837

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

The composition of the Company’s debt investments as of March 31, 2012 and September 30, 2011 at fixed rates and floating rates was as follows:


	March 31, 2012					September 30, 2011
	Fair Value		% of Debt Portfolio			Fair Value		% of Debt Portfolio
Fixed rate debt securities	$	351,469		34.13	%	$	359,873		32.72	%
Floating rate debt securities		678,192		65.87	%		739,835		67.28	%

Total	$	1,029,661		100.00	%	$	1,099,708		100.00	%

The following table presents the financial instruments carried at fair value as of March 31, 2012, by caption on the Company’s Consolidated Statement of Assets and Liabilities for each of the three levels of hierarchy established by ASC 820.


	Level 1		Level 2		Level 3		Total
Investments in debt securities (first lien)	$	—	$	—	$	736,192	$	736,192
Investments in debt securities (second lien)		—		—		122,261		122,261
Investments in debt securities (subordinated)		—		—		171,208		171,208
Investments in equity securities (preferred)		—		—		7,801		7,801
Investments in equity securities (common)		—		—		18,761		18,761

Total investments at fair value	$	—	$	—	$	1,056,223	$	1,056,223

The following table presents the financial instruments carried at fair value as of September 30, 2011, by caption on the Company’s Consolidated Statement of Assets and Liabilities for each of the three levels of hierarchy established by ASC 820.


	Level 1		Level 2		Level 3		Total
Investments in debt securities (first lien)	$	—	$	—	$	875,092	$	875,092
Investments in debt securities (second lien)		—		—		143,383		143,383
Investments in debt securities (subordinated)		—		—		81,233		81,233
Investments in equity securities (preferred)		—		—		7,167		7,167
Investments in equity securities (common)		—		—		12,962		12,962

Total investments at fair value	$	—	$	—	$	1,119,837	$	1,119,837

When a determination is made to classify a financial instrument within Level 3 of the valuation hierarchy, the determination is based upon the fact that the unobservable factors are the most significant to the overall fair value measurement. However, Level 3 financial instruments typically include, in addition to the unobservable or Level 3 components, observable components (that is, components that are actively quoted and can be validated by external sources). Accordingly, the appreciation (depreciation) in the tables below includes changes in fair value due in part to observable factors that are part of the valuation methodology.

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

The following table provides a roll-forward in the changes in fair value from December 31, 2011 to March 31, 2012 for all investments for which the Company determines fair value using unobservable (Level 3) factors.


	First Lien Debt			Second Lien Debt			Subordinated Debt			Preferred Equity			Common Equity			Total
Fair value as of December 31, 2011	$	834,405		$	139,624		$	123,696		$	7,429		$	14,744		$	1,119,898
New investments & net revolver activity		62,064			7,000			47,016			—			3,747			119,827
Redemptions/repayments		(162,030	)		(25,745	)		—			—			—			(187,775	)
Net accrual of PIK interest income		850			347			857			172			—			2,226
Accretion of original issue discount		248			60			—			—			—			308
Net change in unearned income		2,323			378			(397	)		—			—			2,304
Net unrealized appreciation		6,917			243			36			331			520			8,047
Net change from unrealized to realized		(8,585	)		354			—			(131	)		(250	)		(8,612	)
Transfer into (out of) Level 3		—			—			—			—			—			—

Fair value as of March 31, 2012	$	736,192		$	122,261		$	171,208		$	7,801		$	18,761		$	1,056,223

Net unrealized appreciation (depreciation) relating to Level 3 assets still held at March 31, 2012 and reported within net unrealized appreciation (depreciation) on investments in the Consolidated Statement of Operations for the three months ended March 31, 2012	$	(1,668	)	$	597		$	36		$	200		$	270		$	(565	)

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

The following table provides a roll-forward in the changes in fair value from December 31, 2010 to March 31, 2011, for all investments for which the Company determines fair value using unobservable (Level 3) factors.


	First Lien Debt			Second Lien Debt			Subordinated Debt			Preferred Equity			Common Equity			Total
Fair value as of December 31, 2010	$	642,402		$	84,296		$	5,320		$	3,963		$	6,414		$	742,395
New investments & net revolver activity		196,101			—			20,000			999			905			218,005
Redemptions/repayments		(17,074	)		(1,581	)		—			—			—			(18,655	)
Net accrual of PIK interest income		1,895			(241	)		215			—			—			1,869
Accretion of original issue discount		338			82			—			—			—			420
Net change in unearned income		(2,844	)		119			(389	)		—			—			(3,114	)
Net unrealized appreciation (depreciation)		1,335			(89	)		(799	)		(149	)		(904	)		(606	)
Net change from unrealized to realized		(268	)		—			—			(254	)		(43	)		(565	)
Transfer into (out of) Level 3		—			—			—			—			—			—

Fair value as of March 31, 2011	$	821,885		$	82,586		$	24,347		$	4,559		$	6,372		$	939,749

Net unrealized appreciation (depreciation) relating to Level 3 assets still held at March, 31, 2011 and reported within net unrealized appreciation (depreciation) on investments in the Consolidated Statement of Operations for the three months ended March 31, 2011	$	1,067		$	(89	)	$	(799	)	$	(403	)	$	(947	)	$	(1,171	)

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

The following table provides a roll-forward in the changes in fair value from September 30, 2011 to March 31, 2012 for all investments for which the Company determines fair value using unobservable (Level 3) factors.


	First Lien Debt			Second Lien Debt			Subordinated Debt			Preferred Equity			Common Equity			Total
Fair value as of September 30, 2011	$	875,092		$	143,383		$	81,233		$	7,167		$	12,962		$	1,119,837
New investments & net revolver activity		102,817			7,000			89,516			700			4,313			204,346
Redemptions/repayments		(241,538	)		(23,751	)		—			(713	)		(9	)		(266,011	)
Net accrual of PIK interest income		1,545			908			1,723			333			—			4,509
Accretion of original issue discount		794			120			—			—			—			914
Net change in unearned income		3,424			1,088			(894	)		—			—			3,618
Net unrealized appreciation (depreciation)		1,850			10,223			(370	)		432			1,746			13,881
Net change from unrealized to realized		(7,792	)		(16,710	)		—			(118	)		(251	)		(24,871	)
Transfer into (out of) Level 3		—			—			—			—			—			—

Fair value as of March 31, 2012	$	736,192		$	122,261		$	171,208		$	7,801		$	18,761		$	1,056,223

Net unrealized appreciation (depreciation) relating to Level 3 assets still held at March 31, 2012 and reported within net unrealized appreciation (depreciation) on investments in the Consolidated Statement of Operations for the six months ended March 31, 2012	$	(5,942	)	$	(6,487	)	$	(370	)	$	314		$	1,495		$	(10,990	)

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

The following table provides a roll-forward in the changes in fair value from September 30, 2010 to March 31, 2011, for all investments for which the Company determines fair value using unobservable (Level 3) factors.


	First Lien Debt			Second Lien Debt			Subordinated Debt			Preferred Equity			Common Equity			Total
Fair value as of September 30, 2010	$	416,324		$	136,786		$	5,470		$	2,892		$	2,349		$	563,821
New investments & net revolver activity		425,950			—			20,000			2,036			4,728			452,714
Redemptions/repayments		(24,078	)		(51,722	)		—			—			—			(75,800	)
Net accrual of PIK interest income		3,691			(4,214	)		427			—			—			(96	)
Accretion of original issue discount		494			315			—			—			—			809
Net change in unearned income		(7,121	)		918			(389	)		—			—			(6,592	)
Net unrealized appreciation (depreciation)		17,154			283			(1,161	)		(115	)		(662	)		15,499
Net change from unrealized to realized		(10,529	)		220			—			(254	)		(43	)		(10,606	)
Transfer into (out of) Level 3		—			—			—			—			—			—

Fair value as of March 31, 2011	$	821,885		$	82,586		$	24,347		$	4,559		$	6,372		$	939,749

Net unrealized appreciation (depreciation) relating to Level 3 assets still held at March, 31, 2011 and reported within net unrealized appreciation (depreciation) on investments in the Consolidated Statement of Operations for the six months ended March 31, 2011	$	6,625		$	503		$	(1,161	)	$	(369	)	$	(705	)	$	4,893

The Company utilizes a bond yield model to estimate the fair value of its debt investments where there is not a readily available market value (Level 3) based on the present value of expected cash flows. The significant observable inputs into the model are market interest rates for debt with similar characteristics, which are adjusted for the portfolio company’s credit risk. The credit risk component of the valuation considers several factors including financial performance, business outlook, debt priority and collateral position. These factors are incorporated into the calculation of the capital structure premium, tranche specific risk premium, size premium and industry premium, which are significant unobservable inputs into the model.

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

Significant Unobservable Inputs for Level 3 Investments

The following table provides quantitative information related to the significant unobservable inputs for Level 3 investments, which are carried at fair value as of March 31, 2012:


Asset	Fair Value		Valuation Technique	Unobservable Input	Range							Weighted Average
First lien debt	$	720,120	Bond yield approach	Capital structure premium		(a	)	0.0%		-	1.0%		0.3%
				Tranche specific risk premium/(discount)		(a	)	(2.5%	)	-	12.5%		3.0%
				Size premium		(a	)	0.0%		-	2.0%		1.3%
				Industry premium/(discount)		(a	)	(1.3%	)	-	3.9%		0.3%

		16,072	Enterprise value approach	Weighted average cost of capital				21.0%		-	22.0%		21.5%
				Company specific risk premium		(a	)	4.0%		-	8.0%		6.1%
				Revenue growth rate				10.0%		-	10.0%		10.0%
				EBITDA multiple		(b	)	3.2x		-	7.5x		5.9x

Second lien & subordinated debt		282,551	Bond yield approach	Capital structure premium		(a	)	2.0%		-	2.0%		2.0%
				Tranche specific risk premium		(a	)	1.5%		-	7.8%		4.4%
				Size premium		(a	)	0.0%		-	2.0%		1.0%
				Industry premium/(discount)		(a	)	(1.3%	)	-	0.8%		(0.2%	)
		10,918	Enterprise value approach	Weighted average cost of capital				24.0%		-	24.0%		24.0%
				Company specific risk premium		(a	)	6.0%		-	6.0%		6.0%
				Revenue growth rate				10.4%		-	10.4%		10.4%
				EBITDA multiple		(b	)	7.6x		-	7.6x		7.6x

Preferred & common equity		26,562	Enterprise value approach	Weighted average cost of capital				10.0%		-	36.0%		24.8%
				Company specific risk premium		(a	)	2.0%		-	21.0%		12.1%
				Revenue growth rate				3.6%		-	26.3%		15.2%
				EBITDA multiple		(b	)	4.6x		-	10.2x		7.8x


Total	$	1,056,223

(a)	Used when market participant would take into account this premium or discount when pricing the investment.

(b)	Used when market participant would use such multiples when pricing the investment.

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

Under the bond yield approach, the significant unobservable inputs used in the fair value measurement of the Company’s investments in debt securities are capital structure premium, tranche specific risk premium/(discount), size premium, and industry premium/(discount). Significant increases or decreases in any of those inputs in isolation may result in a significantly lower or higher fair value measurement, respectively.

Under the enterprise value approach, the significant unobservable inputs used in the fair value measurement of the Company’s investments in debt or equity securities are the weighted average cost of capital, company specific risk premium, revenue growth rate and EBITDA multiple. Significant increases or decreases in a portfolio company’s weighted average cost of capital or company specific risk premium in isolation may result in a significantly lower or higher fair value measurement, respectively. Significant increases or decreases in the revenue growth rate or EBITDA multiple in isolation may result in a significantly higher or lower fair value measurement, respectively.

Financial Instruments Disclosed, But Not Carried, At Fair Value

The following table presents the carrying value and fair value of the Company’s financial liabilities disclosed, but not carried, at fair value as of March 31, 2012 and the level of each financial liability within the fair value hierarchy:


	Carrying Value		Fair Value		Level 1		Level 2		Level 3
Credit facilities payable	$	87,500	$	87,500	$	—	$	—	$	87,500
SBA debentures payable		150,000		126,200		—		—		126,200
Convertible senior notes payable		124,000		118,000		—		—		118,000

Total	$	361,500	$	331,700	$	—	$	—	$	331,700

The carrying values of credit facilities payable approximates their fair values and are included in Level 3 of the hierarchy.

The Company utilizes the bond yield approach to estimate the fair value of its SBA debentures payable, which are included in Level 3 of the hierarchy. Under the bond yield approach, the Company uses bond yield models to determine the present value of the future cash flows streams for the debentures. The Company reviews various sources of data involving investments with similar characteristics and assesses the information in the valuation process.

The Company uses recent market transactions to estimate the fair value of the convertible senior notes payable, which are included in Level 3 of the hierarchy.

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

The Company’s off-balance sheet arrangements consisted of $94.4 million and $108.8 million of unfunded commitments to provide debt financing to its portfolio companies or to fund limited partnership interests as of March 31, 2012 and September 30, 2011, respectively. Such commitments are subject to the portfolio companies’ satisfaction of certain financial and nonfinancial covenants and involve, to varying degrees, elements of credit risk in excess of the amount recognized in the Statement of Assets and Liabilities and are not reflected on the Company’s Consolidated Statements of Assets and Liabilities.

A summary of the composition of the unfunded commitments (consisting of revolvers, term loans and limited partnership interests) as of March 31, 2012 and September 30, 2011 is shown in the table below:


	March 31, 2012		September 30, 2011
JTC Education, Inc.	$	11,825	$	14,000
Welocalize, Inc.		10,000		750
Charter Brokerage, LLC		7,353		6,176
Rail Acquisition Corp.		5,630		5,446
Refac Optical Group		5,500		5,500
Phoenix Brands Merger Sub LLC		4,286		3,000
Enhanced Recovery Company, LLC		4,000		4,000
DISA, Inc.		4,000		4,000
Specialty Bakers, LLC		4,000		2,000
World 50, Inc.		4,000		—
Miche Bag, LLC		3,500		5,000
Titan Fitness, LLC		3,500		2,957
Discovery Practice Management, Inc.		3,000		3,000
Cardon Healthcare Network, LLC		3,000		2,000
Traffic Control & Safety Corporation		2,514		3,014
Riverside Fund V, LP (limited partnership interest)		2,000		—
Mansell Group, Inc.		2,000		2,000
Physicians Pharmacy Alliance, Inc.		2,000		2,000
Tegra Medical, LLC		1,500		1,500
Milestone Partners IV, LP (limited partnership interest)		1,475		2,000
Eagle Hospital Physicians, Inc.		1,400		2,500
Psilos Group Partners IV, LP (limited partnership interest)		1,000		1,000
CPASS Acquisition Company		1,000		—
ACON Equity Partners III, LP (limited partnership interest)		1,000		—
Bunker Hill Capital II (QP), LP (limited partnership interest)		934		960
Riverlake Equity Partners II, LP (limited partnership interest)		760		878
HealthDrive Corporation		750		2,000
RCPDirect, LP (limited partnership interest)		703		—
Baird Capital Partners V, LP (limited partnership interest)		614		701
Riverside Fund IV, LP (limited partnership interest)		402		555
Saddleback Fence and Vinyl Products, Inc.		401		400
Advanced Pain Management		400		267
CRGT, Inc.		—		12,500
Dominion Diagnostics, LLC		—		5,000
ADAPCO, Inc.		—		4,250
Epic Acquisition, Inc.		—		3,000
IZI Medical Products, Inc.		—		2,500
Flatout, Inc.		—		1,500
IOS Acquisitions, Inc.		—		1,250
Best Vinyl Fence & Deck, LLC		—		1,000
Trans-Trade, Inc.		—		200

Total	$	94,447	$	108,804

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

Summaries of the composition of the Company’s investment portfolio at cost and fair value as a percentage of total investments are shown in the following tables:


	March 31, 2012				September 30, 2011
Cost:
First lien debt	$	750,089	69.54	%	$	890,729	77.05	%
Second lien debt		130,110	12.06	%		161,455	13.97	%
Subordinated debt		175,916	16.31	%		85,570	7.40	%
Purchased equity		14,998	1.39	%		11,263	0.97	%
Equity grants		5,474	0.51	%		6,158	0.53	%
Limited partnership interests		2,110	0.19	%		907	0.08	%

Total	$	1,078,697	100.00	%	$	1,156,082	100.00	%


	March 31, 2012				September 30, 2011
Fair value:
First lien debt	$	736,192	69.70	%	$	875,092	78.14	%
Second lien debt		122,261	11.58	%		143,383	12.80	%
Subordinated debt		171,208	16.21	%		81,233	7.25	%
Purchased equity		18,736	1.77	%		12,548	1.12	%
Equity grants		5,716	0.54	%		6,675	0.60	%
Limited partnership interests		2,110	0.20	%		906	0.09	%

Total	$	1,056,223	100.00	%	$	1,119,837	100.00	%

The Company invests in portfolio companies located in North America. The following tables show the portfolio composition by geographic region at cost and fair value as a percentage of total investments. The geographic composition is determined by the location of the corporate headquarters of the portfolio company, which may not be indicative of the primary source of the portfolio company’s business.



	March 31, 2012				September 30, 2011
Cost:
Northeast U.S.	$	361,126	33.48	%	$	389,185	33.66	%
Southwest U.S.		219,619	20.36	%		273,513	23.66	%
Southeast U.S.		217,979	20.21	%		244,988	21.19	%
West U.S.		173,642	16.10	%		142,745	12.35	%
Midwest U.S.		87,251	8.09	%		86,768	7.51	%
Canada		19,080	1.76	%		18,883	1.63	%

Total	$	1,078,697	100.00	%	$	1,156,082	100.00	%


	March 31, 2012				September 30, 2011
Fair value:
Northeast U.S.	$	364,477	34.51	%	$	389,898	34.82	%
Southeast U.S.		221,318	20.95	%		248,588	22.20	%
Southwest U.S.		203,631	19.28	%		246,358	22.00	%
West U.S.		158,109	14.97	%		127,522	11.39	%
Midwest U.S.		89,462	8.47	%		88,412	7.90	%
Canada		19,226	1.82	%		19,059	1.69	%

Total	$	1,056,223	100.00	%	$	1,119,837	100.00	%

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

The composition of the Company’s portfolio by industry at cost and fair value as of March 31, 2012 and September 30, 2011 were as follows:


	March 31, 2012				September 30, 2011
Cost:
Healthcare services	$	147,462	13.67	%	$	227,145	19.65	%
Healthcare equipment		82,773	7.67	%		71,254	6.16	%
Internet software & services		73,850	6.85	%		43,846	3.79	%
Diversified support services		73,770	6.84	%		55,472	4.80	%
Oil & gas equipment services		60,788	5.64	%		82,168	7.11	%
Construction and engineering		44,410	4.12	%		43,236	3.74	%
Pharmaceuticals		40,197	3.73	%		27,257	2.36	%
Leisure facilities		36,668	3.40	%		38,041	3.29	%
Electronic equipment & instruments		35,521	3.29	%		34,852	3.01	%
Specialty stores		34,307	3.18	%		34,538	2.99	%
Diversified financial services		32,401	3.00	%		13,311	1.15	%
Education services		31,214	2.89	%		29,662	2.57	%
Apparel, accessories & luxury goods		30,328	2.81	%		30,986	2.68	%
Household products		29,675	2.75	%		31,213	2.70	%
Advertising		29,108	2.70	%		19,892	1.72	%
Home improvement retail		27,757	2.57	%		27,999	2.42	%
IT consulting & other services		25,295	2.34	%		48,943	4.23	%
Restaurants		23,562	2.18	%		13,966	1.21	%
Integrated telecommunication services		22,086	2.05	%		25,995	2.25	%
Industrial machinery		20,805	1.93	%		10,457	0.90	%
Electronic manufacturing services		20,006	1.85	%		20,190	1.75	%
Human resources & employment services		19,941	1.85	%		20,457	1.77	%
Auto parts & equipment		19,080	1.77	%		18,883	1.63	%
Distributors		18,872	1.75	%		18,631	1.61	%
Air freight & logistics		18,298	1.70	%		17,984	1.56	%
Environmental & facilities services		17,866	1.66	%		16,311	1.41	%
Food distributors		15,149	1.40	%		20,834	1.80	%
Research & consulting services		14,211	1.32	%		—	0.00	%
Leisure products		13,986	1.30	%		13,564	1.17	%
Construction materials		6,843	0.63	%		6,736	0.58	%
Housewares & specialties		5,319	0.49	%		5,319	0.46	%
Building products		4,838	0.45	%		6,689	0.58	%
Multi-sector holdings		2,111	0.20	%		907	0.09	%
Movies & entertainment		200	0.02	%		199	0.02	%
Fertilizers & agricultural chemicals		—	0.00	%		28,800	2.49	%
Healthcare technology		—	0.00	%		20,505	1.77	%
Trucking		—	0.00	%		17,065	1.48	%
Data processing & outsourced services		—	0.00	%		12,775	1.10	%

Total	$	1,078,697	100.00	%	$	1,156,082	100.00	%

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)


	March 31, 2012				September 30, 2011
Fair Value:
Healthcare services	$	150,526	14.25	%	$	231,478	20.67	%
Healthcare equipment		83,045	7.86	%		71,911	6.42	%
Diversified support services		75,047	7.11	%		56,232	5.02	%
Internet software & services		75,023	7.10	%		43,786	3.91	%
Oil & gas equipment services		61,220	5.80	%		82,696	7.38	%
Pharmaceuticals		40,926	3.87	%		27,500	2.46	%
Leisure facilities		37,219	3.52	%		38,447	3.43	%
Specialty stores		35,330	3.34	%		35,198	3.14	%
Electronic equipment & instruments		35,314	3.34	%		34,863	3.11	%
Diversified financial services		32,255	3.05	%		13,329	1.19	%
Education services		31,928	3.02	%		30,176	2.69	%
Apparel, accessories & luxury goods		31,859	3.02	%		33,595	3.00	%
Household products		29,523	2.80	%		29,943	2.67	%
Advertising		29,459	2.79	%		20,183	1.80	%
Construction and engineering		28,433	2.69	%		35,814	3.20	%
IT consulting & other services		25,618	2.43	%		49,528	4.42	%
Home improvement retail		24,894	2.36	%		27,576	2.46	%
Environmental & facilities services		23,578	2.23	%		19,952	1.78	%
Integrated telecommunication services		22,339	2.12	%		26,374	2.36	%
Restaurants		21,591	2.04	%		11,829	1.06	%
Industrial machinery		21,551	2.04	%		10,860	0.97	%
Human resources & employment services		20,604	1.95	%		20,952	1.87	%
Distributors		19,407	1.84	%		18,938	1.69	%
Auto parts & equipment		19,227	1.82	%		19,059	1.70	%
Food distributors		15,423	1.46	%		21,006	1.88	%
Air freight & logistics		15,004	1.42	%		17,243	1.54	%
Research & consulting services		14,500	1.37	%		—	0.00	%
Leisure products		14,122	1.34	%		13,711	1.22	%
Electronic manufacturing services		7,453	0.71	%		8,660	0.77	%
Construction materials		7,085	0.67	%		6,840	0.61	%
Building products		2,737	0.26	%		4,833	0.43	%
Multi-sector holdings		2,111	0.21	%		907	0.11	%
Housewares & specialties		1,610	0.15	%		2,526	0.23	%
Movies & entertainment		262	0.02	%		258	0.02	%
Data processing & outsourced services		—	0.00	%		3,497	0.31	%
Fertilizers & agricultural chemicals		—	0.00	%		29,190	2.61	%
Healthcare technology		—	0.00	%		20,947	1.87	%

Total	$	1,056,223	100.00	%	$	1,119,837	100.00	%

The Company’s investments are generally in small and mid-sized companies in a variety of industries. At March 31, 2012 and September 30, 2011, the Company had no single investment that represented greater than 10% of the total investment portfolio at fair value. Income, consisting of interest, dividends, fees, other investment income, and realization of gains or losses, can fluctuate upon repayment or sale of an investment and in any given year can be highly concentrated among several investments. For the three and six months ended March 31, 2012 and March 31, 2011, no individual investment produced income that exceeded 10% of investment income.

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

Note 4.

Fee Income

The Company receives a variety of fees in the ordinary course of business. Certain fees, such as origination fees, are capitalized and amortized in accordance with ASC 310-20 Nonrefundable Fees and Other Costs . In accordance with ASC 820, the net unearned fee income balance is netted against the cost of the respective investments. Other fees, such as servicing and collateral management fees, are classified as fee income and recognized as they are earned on a monthly basis.

Accumulated unearned fee income activity for the six months ended March 31, 2012 and March 31, 2011 was as follows:


	Six months ended March 31, 2012			Six months ended March 31, 2011
Beginning unearned fee income balance	$	18,333		$	11,901
Net fees received		12,265			10,589
Unearned fee income recognized		(15,883	)		(3,997	)

Ending unearned fee income balance	$	14,715		$	18,493

As of March 31, 2012, the Company had structured $6.4 million in aggregate exit fees across 9 portfolio investments upon the future exit of those investments. Exit fees are fees which are payable upon the exit of a debt investment. These fees are to be paid to the Company upon the sooner to occur of (i) a sale of the borrower or substantially all of the assets of the borrower, (ii) the maturity date of the loan or (iii) the date when full prepayment of the loan occurs. The receipt of such fees is contingent upon the occurrence of one of the events listed above for each of the investments. A percentage of these fees is included in net investment income over the life of the loan.

Note 5.

Share Data

Effective January 2, 2008, the Partnership merged with and into the Company. At the time of the merger, all outstanding partnership interests in the Partnership were exchanged for 12,480,972 shares of common stock of the Company. An additional 26 fractional shares were payable to the stockholders in cash.

On June 17, 2008, the Company completed an initial public offering of 10,000,000 shares of its common stock at the offering price of $14.12 per share. The net proceeds totaled $129.5 million after deducting investment banking commissions of $9.9 million and offering costs of $1.8 million.

On July 21, 2009, the Company completed a follow-on public offering of 9,487,500 shares of its common stock, which included the underwriters’ exercise of their over-allotment option, at the offering price of $9.25 per share. The net proceeds totaled $82.7 million after deducting investment banking commissions of $4.4 million and offering costs of $0.7 million.

On September 25, 2009, the Company completed a follow-on public offering of 5,520,000 shares of its common stock, which included the underwriters’ exercise of their over-allotment option, at the offering price of $10.50 per share. The net proceeds totaled $54.9 million after deducting investment banking commissions of $2.8 million and offering costs of $0.3 million.

On January 27, 2010, the Company completed a follow-on public offering of 7,000,000 shares of its common stock at the offering price of $11.20 per share, with 300,500 additional shares being sold as part of the underwriters’ partial exercise of their over-allotment option on February 25, 2010. The net proceeds totaled $77.5 million after deducting investment banking commissions of $3.7 million and offering costs of $0.5 million.

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

On April 20, 2010, at the Company’s 2010 Annual Meeting, the Company’s stockholders approved, among other things, amendments to the Company’s restated certificate of incorporation to increase the number of authorized shares of common stock from 49,800,000 shares to 150,000,000 shares and to remove the Company’s authority to issue shares of Series A Preferred Stock.

On June 21, 2010, the Company completed a follow-on public offering of 9,200,000 shares of its common stock, which included the underwriters’ exercise of their over-allotment option, at the offering price of $11.50 per share. The net proceeds totaled $100.5 million after deducting investment banking commissions of $4.8 million and offering costs of $0.5 million.

On December 7, 2010, the Company entered into an at-the-market equity offering sales agreement relating to shares of its common stock. Throughout the month of December 2010, the Company sold 429,110 shares of its common stock at an average offering price of $11.87 per share. The net proceeds totaled $5.0 million after deducting fees and commissions of $0.1 million. The Company terminated the at-the-market equity offering sales agreement effective January 20, 2011 and did not sell any shares of the Company’s common stock pursuant thereto subsequent to December 31, 2010.

On February 4, 2011, the Company completed a follow-on public offering of 11,500,000 shares of its common stock, which included the underwriters’ exercise of their over-allotment option, at the offering price of $12.65 per share. The net proceeds totaled $138.6 million after deducting investment banking commissions of $6.5 million and offering costs of $0.3 million.

On June 24, 2011, the Company completed a follow-on public offering of 5,558,469 shares of its common stock, which included the underwriters’ partial exercise of their over-allotment option, at the offering price of $11.72 per share. The net proceeds totaled $62.7 million after deducting investment banking commissions of $2.3 million and offering costs of $0.2 million.

On January 26, 2012, the Company completed a follow-on public offering of 10,000,000 shares of its common stock at the offering price of $10.07 per share. The net proceeds totaled $99.9 million after deducting offering costs of $0.8 million.

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

The following table sets forth the computation of basic and diluted earnings per share, pursuant to ASC 260-10 Earnings per Share , for the three and six months ended March 31, 2012 and March 31, 2011:


	Three months ended March 31, 2012		Three months ended March 31, 2011		Six months ended March 31, 2012		Six months ended March 31, 2011
(Amounts in thousands, except per share amounts)
Earnings per common share — basic:
Net increase in net assets resulting from operations	$	20,056	$	15,671	$	30,240	$	33,119
Weighted average common shares outstanding — basic		79,534		62,120		75,935		58,340
Earnings per common share — basic	$	0.25	$	0.25	$	0.40	$	0.57
Earnings per common share — diluted:
Net increase in net assets resulting from operations, before adjustments	$	20,056	$	15,671	$	30,240	$	30,119
Adjustments for interest on convertible senior notes, base management fees, incentive fees and gain on extinguishment of convertible senior notes		1,450		—		1,908		—

Net increase in net assets resulting from operations, as adjusted		21,506	$	15,671		32,148	$	30,119
Weighted average common shares outstanding — basic		79,534		62,120		75,935		58,340
Adjustments for dilutive effect of convertible notes		8,409		—		8,149		—

Weighted average common shares outstanding — diluted		87,943		62,120		84,084		58,340
Earnings per common share — diluted	$	0.24	$	0.25	$	0.38	$	0.57

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

The following table reflects the dividend distributions per share that the Board of Directors of the Company has declared and the Company has paid, including shares issued under the dividend reinvestment plan (“DRIP”), on its common stock from inception to March 31, 2012:

Date Declared

Record
Date

Payment
Date

Amount
per Share

Cash
Distribution

DRIP Shares
Issued

DRIP Shares
Value

5/1/2008

5/19/2008

6/3/2008

0.30

1.9 million

133,317

1.9 million

8/6/2008

9/10/2008

9/26/2008

0.31

5.1 million

196,786

(1)

1.9 million

12/9/2008

12/19/2008

12/29/2008

0.32

6.4 million

105,326

0.8 million

12/9/2008

12/30/2008

1/29/2009

0.33

6.6 million

139,995

0.8 million

12/18/2008

12/30/2008

1/29/2009

0.05

1.0 million

21,211

0.1 million

4/14/2009

5/26/2009

6/25/2009

0.25

5.6 million

11,776

0.1 million

8/3/2009

9/8/2009

9/25/2009

0.25

7.5 million

56,890

0.6 million

11/12/2009

12/10/2009

12/29/2009

0.27

9.7 million

44,420

0.5 million

1/12/2010

3/3/2010

3/30/2010

0.30

12.9 million

58,689

0.7 million

5/3/2010

5/20/2010

6/30/2010

0.32

14.0 million

42,269

0.5 million

8/2/2010

9/1/2010

9/29/2010

0.10

5.2 million

25,425

0.3 million

8/2/2010

10/6/2010

10/27/2010

0.10

5.2 million

24,850

0.3 million

8/2/2010

11/3/2010

11/24/2010

0.11

5.7 million

26,569

0.3 million

8/2/2010

12/1/2010

12/29/2010

0.11

5.7 million

28,238

0.3 million

11/30/2010

1/4/2011

1/31/2011

0.1066

5.4 million

36,038

0.5 million

11/30/2010

2/1/2011

2/28/2011

0.1066

5.5 million

29,072

0.4 million

11/30/2010

3/1/2011

3/31/2011

0.1066

6.5 million

43,766

0.6 million

1/30/2011

4/1/2011

4/29/2011

0.1066

6.5 million

45,193

0.6 million

1/30/2011

5/2/2011

5/31/2011

0.1066

6.5 million

48,870

0.6 million

1/30/2011

6/1/2011

6/30/2011

0.1066

6.5 million

55,367

0.6 million

5/2/2011

7/1/2011

7/29/2011

0.1066

7.1 million

58,829

(1)

0.6 million

5/2/2011

8/1/2011

8/31/2011

0.1066

7.1 million

64,431

(1)

0.6 million

5/2/2011

9/1/2011

9/30/2011

0.1066

7.2 million

52,487

(1)

0.5 million

8/1/2011

10/14/2011

10/31/2011

0.1066

7.3 million

40,388

(1)

0.4 million

8/1/2011

11/15/2011

11/30/2011

0.1066

7.3 million

43,034

(1)

0.4 million

8/1/2011

12/13/2011

12/23/2011

0.1066

7.3 million

43,531

(1)

0.4 million

11/10/2011

1/13/2012

1/31/2012

0.0958

6.6 million

29,902

(1)

0.3 million

11/10/2011

2/15/2012

2/29/2012

0.0958

7.4 million

45,071

0.4 million

11/10/2011

3/15/2012

3/30/2012

0.0958

7.5 million

41,807

(1)

0.4 million

(1)	Shares were purchased on the open market and distributed.

In October 2008, the Company’s Board of Directors authorized a stock repurchase program to acquire up to $8 million of the Company’s outstanding common stock. Stock repurchases under this program were made through the open market at times and in such amounts as Company management deemed appropriate. The stock repurchase program expired December 2009. In October 2008, the Company repurchased 78,000 shares of common stock on the open market as part of its share repurchase program.

In October 2010, the Company’s Board of Directors authorized a stock repurchase program to acquire up to $20 million of the Company’s outstanding common stock. Stock repurchases under this program were to be made through the open market at times and in such amounts as the Company’s management deemed appropriate, provided it was below the most recently published net asset value per share. The stock repurchase program expired December 31, 2011, with the Company not repurchasing any shares of its common stock pursuant to the repurchase program.

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

Note 6.

Lines of Credit

On November 16, 2009, Fifth Street Funding, LLC, a consolidated wholly-owned bankruptcy remote, special purpose subsidiary (“Funding”), and the Company entered into a Loan and Servicing Agreement (“Wells Agreement”), with respect to a three-year credit facility (“Wells Fargo facility”) with Wells Fargo, as successor to Wachovia Bank, National Association, Wells Fargo Securities, LLC, as administrative agent, each of the additional institutional and conduit lenders party thereto from time to time, and each of the lender agents party thereto from time to time, in the amount of $50 million, with an accordion feature which allowed for potential future expansion of the facility up to $100 million. The facility bore interest at LIBOR plus 4.0% per annum and had a maturity date of November 16, 2012.

On May 26, 2010, the Company amended the Wells Fargo facility to expand the borrowing capacity under that facility. Pursuant to the amendment, the Company received an additional $50 million commitment, thereby increasing the size of the facility from $50 million to $100 million, with an accordion feature that allows for potential future expansion of that facility from a total of $100 million up to a total of $150 million. In addition, the interest rate of the Wells Fargo facility was reduced from LIBOR plus 4% per annum to LIBOR plus 3.5% per annum, with no LIBOR floor, and the maturity date of the facility was extended from November 16, 2012 to May 26, 2013.

On November 5, 2010, the Company amended the Wells Fargo facility to, among other things, provide for the issuance from time to time of letters of credit for the benefit of the Company’s portfolio companies. The letters of credit are subject to certain restrictions, including a borrowing base limitation and an aggregate sublimit of $15.0 million. On February 28, 2011, the Company amended the Wells Fargo facility to, among other things, (i) reduce the interest rate to LIBOR plus 3.0% per annum, with no LIBOR floor, (ii) extend the period during which the Company may make new borrowings under the facility to February 25, 2013, and (iii) extend the maturity date of the facility to February 25, 2014. The facility may be extended for up to two additional years upon the mutual consent of Wells Fargo and each of the lender parties thereto. On November 30, 2011, the Company amended the Wells Fargo facility to, among other things, reduce the interest rate to LIBOR plus 2.75% per annum, with no LIBOR floor. On April 23, 2012, the Company amended the Wells Fargo facility to, among other things, expand the borrowing capacity under the facility. Pursuant to the amendment, the Company received an additional $50 million commitment, thereby increasing the size of the facility to $150 million, with an accordion feature which allows for future expansion of the facility up to a total of $250 million. In addition, the period during which the Company may make and reinvest borrowings under the facility was extended to April 23, 2014 and the maturity date of the facility was extended to April 25, 2016.

In connection with the Wells Fargo facility, the Company concurrently entered into (i) a Purchase and Sale Agreement with Funding, pursuant to which the Company will sell to Funding certain loan assets it has originated or acquired, or will originate or acquire and (ii) a Pledge Agreement with Wells Fargo, pursuant to which the Company pledged all of its equity interests in Funding as security for the payment of Funding’s obligations under the Wells Agreement and other documents entered into in connection with the Wells Fargo facility. Funding was formed for the sole purpose of entering into the Wells Fargo facility and has no other operations.

The Wells Agreement and related agreements governing the Wells Fargo facility required both Funding and the Company to, among other things (i) make representations and warranties regarding the collateral as well as each of their businesses, (ii) agree to certain indemnification obligations and (iii) comply with various covenants, servicing procedures, limitations on acquiring and disposing of assets, reporting requirements and other customary requirements for similar credit facilities. The Wells Fargo facility agreements also include usual and customary default provisions such as the failure to make timely payments under the facility, a change in control of Funding, and the failure by Funding or the Company to materially perform under the Wells Agreement and related agreements governing the facility, which, if not complied with, could accelerate repayment under the facility, thereby materially and adversely affecting the Company’s liquidity, financial condition and results of operations. The Company is currently in compliance with all financial covenants under the Wells Fargo facility.

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

The Wells Fargo facility is secured by all of the assets of Funding, and all of the Company’s equity interest in Funding. The Company uses the Wells Fargo facility to fund a portion of its loan origination activities and for general corporate purposes. Each loan origination under the facility is subject to the satisfaction of certain conditions. The Company cannot be assured that Funding will be able to borrow funds under the Wells Fargo facility at any particular time or at all. As of March 31, 2012, the Company had $7.0 million of borrowings outstanding under the Wells Fargo facility that had a fair value of $7.0 million. The Company’s borrowings under the Wells Fargo facility bore interest at a weighted average interest rate of 3.130% during the six months ended March 31, 2012. For the three and six months ended March 31, 2012, the Company recorded interest expense of $0.6 million and $1.3 million, respectively, related to the Wells Fargo facility.

On May 27, 2010, the Company entered into a three-year secured syndicated revolving credit facility (“ING facility”) pursuant to a Senior Secured Revolving Credit Agreement (“ING Credit Agreement”) with certain lenders party thereto from time to time and ING Capital LLC, as administrative agent. The ING facility allowed for the Company to borrow money at a rate of either (i) LIBOR plus 3.5% per annum or (ii) 2.5% per annum plus an alternate base rate based on the greatest of the Prime Rate, Federal Funds Rate plus 0.5% per annum or LIBOR plus 1% per annum, and had a maturity date of May 27, 2013. The ING facility also allows the Company to request letters of credit from ING Capital LLC, as the issuing bank. The initial commitment under the ING facility was $90 million, and the ING facility included an accordion feature that allowed for potential future expansion of the facility up to a total of $150 million. The ING facility is secured by substantially all of the Company’s assets, as well as the assets of the Company’s wholly-owned subsidiary, FSFC Holdings, Inc., and its indirect wholly-owned subsidiary, Fifth Street Fund of Funds LLC, subject to certain exclusions for, among other things, equity interests in the Company’s SBIC subsidiary, and equity interests in Funding and Funding II (which is defined and discussed below) as further set forth in a Guarantee, Pledge and Security Agreement (“ING Security Agreement”) entered into in connection with the ING Credit Agreement, among FSFC Holdings, Inc., ING Capital LLC, as collateral agent, and the Company. Fifth Street Fund of Funds LLC and FSFC Holdings, Inc. were formed to hold certain of the Company’s portfolio companies for tax purposes and have no other operations. None of the Company’s SBIC subsidiary, Funding or Funding II is party to the ING facility and their respective assets have not been pledged in connection therewith. The ING facility provides that the Company may use the proceeds and letters of credit under the facility for general corporate purposes, including acquiring and funding leveraged loans, mezzanine loans, high-yield securities, convertible securities, preferred stock, common stock and other investments.

On February 22, 2011, the Company amended the ING facility to, among other things, expand the borrowing capacity to $215 million. In addition, the ING facility’s accordion feature was increased to allow for potential future expansion up to a total of $300 million and the maturity date was extended to February 22, 2014. On July 8, 2011, the Company amended the ING facility to, among other things, expand the borrowing capacity to $230 million and increase the accordion feature to allow for potential future expansion up to a total of $350 million. In addition, the ING facility’s interest rate was reduced to LIBOR plus 3.0% per annum, with no LIBOR floor, when the facility is drawn more than 35%. Otherwise, the interest rate will be LIBOR plus 3.25% per annum, with no LIBOR floor.

On February 29, 2012, the Company amended the ING facility to, among other things, (i) extend the period during which the Company may make and repay borrowings under the ING facility to February 27, 2015, (ii) extend the maturity date to February 29, 2016 and (iii) increase the accordion feature to allow for potential future expansion up to a total of $450 million.

Pursuant to the ING Security Agreement, FSFC Holdings, Inc. and Fifth Street Fund of Funds LLC guaranteed the obligations under the ING Security Agreement, including the Company’s obligations to the lenders and the administrative agent under the ING Credit Agreement. Additionally, the Company pledged its entire equity interest in FSFC Holdings, Inc. and FSFC Holdings, Inc. pledged its entire equity interest in Fifth Street Fund of Funds LLC to the collateral agent pursuant to the terms of the ING Security Agreement.

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

The ING Credit Agreement and related agreements governing the ING facility required FSFC Holdings, Inc., Fifth Street Fund of Funds LLC and the Company to, among other things (i) make representations and warranties regarding the collateral as well as each of the Company’s businesses, (ii) agree to certain indemnification obligations and (iii) agree to comply with various affirmative and negative covenants and other customary requirements for similar credit facilities. The ING facility documents also include usual and customary default provisions such as the failure to make timely payments under the facility, the occurrence of a change in control, and the failure by the Company to materially perform under the ING Credit Agreement and related agreements governing the facility, which, if not complied with, could accelerate repayment under the facility, thereby materially and adversely affecting the Company’s liquidity, financial condition and results of operations. The Company is currently in compliance with all financial covenants under the ING facility.

Each loan or letter of credit originated under the ING facility is subject to the satisfaction of certain conditions. The Company cannot be assured that it will be able to borrow funds under the ING facility at any particular time or at all.

As of March 31, 2012, the Company had $80.5 million of borrowings outstanding under the ING facility that had a fair value of $80.5 million. The Company’s borrowings under the ING facility bore interest at a weighted average interest rate of 3.403% during the six months ended March 31, 2012. For the three and six months ended March 31, 2012, the Company recorded interest expense of $1.4 million and $2.8 million, respectively, related to the ING facility.

On September 16, 2011, Fifth Street Funding II, LLC, a consolidated wholly-owned bankruptcy remote, special purpose subsidiary (“Funding II”), entered into a Loan and Servicing Agreement (“Sumitomo Agreement”) with respect to a seven-year credit facility (“Sumitomo facility”) with Sumitomo Mitsui Banking Corporation (“SMBC”), an affiliate of Sumitomo Mitsui Financial Group, Inc., as administrative agent, and each of the lenders from time to time party thereto, in the amount of $200 million. The Sumitomo facility bears interest at a rate of LIBOR plus 2.25% per annum with no LIBOR floor, permits the Company to make new borrowings until September 16, 2014, matures on September 16, 2018 and includes an option for a one-year extension.

In connection with the Sumitomo facility, the Company concurrently entered into a Purchase and Sale Agreement with Funding II, pursuant to which it will sell to Funding II certain loan assets the Company has originated or acquired, or will originate or acquire.

The Sumitomo Agreement and related agreements governing the Sumitomo facility required both Funding II and the Company to, among other things (i) make representations and warranties regarding the collateral as well as each of its businesses, (ii) agree to certain indemnification obligations and (iii) comply with various covenants, servicing procedures, limitations on acquiring and disposing of assets, reporting requirements and other customary requirements for similar credit facilities. The Sumitomo facility agreements also include usual and customary default provisions such as the failure to make timely payments under the facility, a change in control of Funding II, and the failure by Funding II or the Company to materially perform under the Sumitomo Agreement and related agreements governing the Sumitomo facility, which, if not complied with, could accelerate repayment under the facility, thereby materially and adversely affecting the Company’s liquidity, financial condition and results of operations. Funding II was formed for the sole purpose of entering into the Sumitomo facility and has no other operations.

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

The Sumitomo facility is secured by all of the assets of Funding II. Each loan origination under the facility is subject to the satisfaction of certain conditions. There is no assurance that Funding II will be able to borrow funds under the Sumitomo facility at any particular time or at all. As of March 31, 2012, the Company had no borrowings outstanding under the Sumitomo facility. The Company’s borrowings under the Sumitomo facility bore interest at a weighted average interest rate of 2.773% during the six months ended March 31, 2012. For the three and six months ended March 31, 2012, the Company recorded interest expense of $0.2 million and $0.4 million, respectively, related to the Sumitomo facility.

As of March 31, 2012, except for assets that were funded through the Company’s SBIC subsidiary, substantially all of the Company’s assets were pledged as collateral under the Wells Fargo facility, the ING facility or the Sumitomo facility. With respect to the assets funded through the Company’s SBIC subsidiary, the SBA, as a creditor, will have a superior claim to the SBIC subsidiary’s assets over the Company’s stockholders.

Interest expense for the three and six months ended March 31, 2012 was $5.6 million and $11.3 million, respectively. Interest expense for the three and six months ended March 31, 2011 was $2.7 million and $4.7 million, respectively.

Note 7.

Interest and Dividend Income

Interest income is recorded on an accrual basis to the extent that such amounts are expected to be collected. In accordance with the Company’s policy, accrued interest is evaluated periodically for collectability. The Company stops accruing interest on investments when it is determined that interest is no longer collectible. Distributions from portfolio companies are recorded as dividend income when the distribution is received.

The Company holds debt in its portfolio that contains PIK interest provisions. The PIK interest, which represents contractually deferred interest added to the loan balance that is generally due at the end of the loan term, is generally recorded on the accrual basis to the extent such amounts are expected to be collected. The Company generally ceases accruing PIK interest if there is insufficient value to support the accrual or if the Company does not expect the portfolio company to be able to pay all principal and interest due. The Company’s decision to cease accruing PIK interest involves subjective judgments and determinations based on available information about a particular portfolio company, including whether the portfolio company is current with respect to its payment of principal and interest on its loans and debt securities; monthly and quarterly financial statements and financial projections for the portfolio company; the Company’s assessment of the portfolio company’s business development success, including product development, profitability and the portfolio company’s overall adherence to its business plan; information obtained by the Company in connection with periodic formal update interviews with the portfolio company’s management and, if appropriate, the private equity sponsor; and information about the general economic and market conditions in which the portfolio company operates. Based on this and other information, the Company determines whether to cease accruing PIK interest on a loan or debt security. The Company’s determination to cease accruing PIK interest on a loan or debt security is generally made well before the Company’s full write-down of such loan or debt security.

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

Accumulated PIK interest activity for the six months ended March 31, 2012 and March 31, 2011 was as follows:


	Six months ended March 31, 2012			Six months ended March 31, 2011
PIK balance at beginning of period	$	22,672		$	19,301
Gross PIK interest accrued		8,351			7,002
PIK income reserves		(2,044	)		(387	)
PIK interest received in cash		(1,798	)		(6,711	)
Loan exits and other PIK adjustments		—			(316	)

PIK balance at end of period	$	27,181		$	18,889

As of March 31, 2012, the Company had stopped accruing cash and/or PIK interest and original issue discount (“OID”) on four investments, including three that had not paid all of their scheduled cash interest payments for the period ended March 31, 2012. As of March 31, 2011, the Company had stopped accruing cash interest, PIK interest and OID on three investments that had not paid all of their scheduled cash interest payments for the period ended March 31, 2011.

Cash non-accrual status is inclusive of PIK and other noncash income, where applicable. The percentages of the Company’s portfolio investments at cost and fair value by accrual status as of March 31, 2012, September 30, 2011 and March 31, 2011 were as follows:


	March 31, 2012										September 30, 2011										March 31, 2011
	Cost		% of Portfolio			Fair Value		% of Portfolio			Cost		% of Portfolio			Fair Value		% of Portfolio			Cost		% of Portfolio			Fair Value		% of Portfolio
Accrual	$	1,027,219		95.23	%	$	1,038,705		98.34	%	$	1,116,762		96.60	%	$	1,111,986		99.30	%	$	916,768		96.18	%	$	931,796		99.15	%
PIK non-accrual		15,637		1.45	%		3,082		0.29	%		—		0.00	%		—		0.00	%		—		0.00	%		—		0.00	%
Cash non-accrual		35,841		3.32	%		14,436		1.37	%		39,320		3.40	%		7,851		0.70	%		36,425		3.82	%		7,953		0.85	%

Total	$	1,078,697		100.00	%	$	1,056,223		100.00	%	$	1,156,082		100.00	%	$	1,119,837		100.00	%	$	953,193		100.00	%	$	939,749		100.00	%

The non-accrual status of the Company’s portfolio investments as of March 31, 2012, September 30, 2011 and March 31, 2011 was as follows:

March 31, 2012

September 30, 2011

March 31, 2011

Lighting by Gregory, LLC

Cash non-accrual

MK Network, LLC(1)

—

Cash non-accrual

O’Currance, Inc.(1)

—

Cash non-accrual

—

Premier Trailer Leasing, Inc.(1)

—

Cash non-accrual

Repechage Investments Limited

Cash non-accrual

—

Rail Acquisition Corp.

PIK non-accrual

—

Traffic Control & Safety Corp. — Second Lien and Subordinated Debt

Cash non-accrual

—

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

(1)	The Company no longer holds this investment. See Note 9 for a discussion of the Company’s recent realization events.

Income non-accrual amounts related to the above investments for the three and six months ended March 31, 2012 and March 31, 2011 were as follows:


	Three months ended March 31, 2012		Three months ended March 31, 2011		Six months ended March 31, 2012		Six months ended March 31, 2011
Cash interest income	$	967	$	1,460	$	2,157	$	3,566
PIK interest income		1,217		146		2,044		387
OID income		6		30		96		60

Total	$	2,190	$	1,636	$	4,297	$	4,013

Note 8.

Taxable/Distributable Income and Dividend Distributions

Taxable income differs from net increase (decrease) in net assets resulting from operations primarily due to: (1) unrealized appreciation (depreciation) on investments, as investment gains and losses are not included in taxable income until they are realized; (2) origination fees received in connection with investments in portfolio companies, which are amortized into interest income over the life of the investment for book purposes, are treated as taxable income upon receipt; (3) organizational and deferred offering costs; (4) recognition of interest income on certain loans; and (5) income or loss recognition on exited investments.

At September 30, 2011, the Company has net loss carryforwards of $11.8 million to offset net capital gains, to the extent provided by federal tax law. Of the capital loss carryforwards, $1.5 million will expire on September 30, 2017 and $10.3 million will expire on September 30, 2019. During the year ended September 30, 2011, the Company realized capital losses from the sale of investments after October 31, 2010 and prior to year end (“post-October capital losses”) of $29.9 million, which for tax purposes are treated as arising on the first day of the following year.

Listed below is a reconciliation of “net increase in net assets resulting from operations” to taxable income for the three and six months ended March 31, 2012.


	Three months ended March 31, 2012			Six months ended March 31, 2012
Net increase in net assets resulting from operations	$	20,056		$	30,240
Net change in unrealized appreciation		(8,047	)		(13,881	)
Book/tax difference due to deferred loan origination fees, net		(5,729	)		(7,812	)
Book/tax difference due to organizational and deferred offering costs		(22	)		(43	)
Book/tax difference due to interest income on certain loans		1,662			2,232
Book/tax difference due to capital losses not recognized		10,782			27,420
Other book-tax differences		(39	)		(73	)

Taxable/Distributable Income(1)	$	18,663		$	38,083

(1)	The Company’s taxable income for 2012 is an estimate and will not be finally determined until the Company files its tax return for the fiscal year ended September 30, 2012. Therefore, the final taxable income may be different than the estimate.

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

On December 22, 2010, the Regulated Investment Company Modernization Act of 2010 (the “Act”) was enacted, which changed various technical rules governing the tax treatment of RICs. The changes are generally effective for taxable years beginning after the date of enactment. Under the Act, the Company will be permitted to carryforward net capital losses incurred in taxable years beginning after the date of enactment for an unlimited period. However, any losses incurred during those future taxable years will be required to be utilized prior to the losses incurred in pre-enactment taxable years, which carry an expiration date. As a result of this ordering rule, pre-enactment net loss carryforwards may be more likely to expire unused.

Distributions to stockholders are recorded on the record date. The Company is required to distribute annually to its stockholders at least 90% of its net taxable income and net realized short-term capital gains in excess of net realized long-term capital losses for each taxable year in order to be eligible for the tax benefits allowed to a RIC under Subchapter M of the Code. The Company anticipates paying out as a dividend all or substantially all of those amounts. The amount to be paid out as a dividend is determined by the Board of Directors and is based on management’s estimate of the Company’s annual taxable income. For tax purposes, distributions may include returns of capital. The Company maintains an “opt out” dividend reinvestment plan for its stockholders.

The Company’s Board of Directors has declared the following distributions from inception to March 31, 2012:

Dividend Type

Date Declared

Record Date

Payment Date

Amount Per Share

Quarterly

5/1/2008

5/19/2008

6/3/2008

0.30

Quarterly

8/6/2008

9/10/2008

9/26/2008

0.31

Quarterly

12/9/2008

12/19/2008

12/29/2008

0.32

Quarterly

12/9/2008

12/30/2008

1/29/2009

0.33

Special

12/18/2008

12/30/2008

1/29/2009

0.05

Quarterly

4/14/2009

5/26/2009

6/25/2009

0.25

Quarterly

8/3/2009

9/8/2009

9/25/2009

0.25

Quarterly

11/12/2009

12/10/2009

12/29/0209

0.27

Quarterly

1/12/2010

3/3/2010

3/30/2010

0.30

Quarterly

5/3/2010

5/20/2010

6/30/2010

0.32

Quarterly

8/2/2010

9/1/2010

9/29/2010

0.10

Monthly

8/2/2010

10/6/2010

10/27/2010

0.10

Monthly

8/2/2010

11/3/2010

11/24/2010

0.11

Monthly

8/2/2010

12/1/2010

12/29/2010

0.11

Monthly

11/30/2010

1/4/2011

1/31/2011

0.1066

Monthly

11/30/2010

2/1/2011

2/28/2011

0.1066

Monthly

11/30/2010

3/1/2011

3/31/2011

0.1066

Monthly

1/30/2011

4/1/2011

4/29/2011

0.1066

Monthly

1/30/2011

5/2/2011

5/31/2011

0.1066

Monthly

1/30/2011

6/1/2011

6/30/2011

0.1066

Monthly

5/2/2011

7/1/2011

7/29/2011

0.1066

Monthly

5/2/2011

8/1/2011

8/31/2011

0.1066

Monthly

5/2/2011

9/1/2011

9/30/2011

0.1066

Monthly

8/1/2011

10/14/2011

10/31/2011

0.1066

Monthly

8/1/2011

11/15/2011

11/30/2011

0.1066

Monthly

8/1/2011

12/13/2011

12/23/2011

0.1066

Monthly

11/10/2011

1/13/2012

1/31/2012

0.0958

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

Dividend Type

Date Declared

Record
Date

Payment Date

Amount Per Share

Monthly

11/10/2011

2/15/2012

2/29/2012

0.0958

Monthly

11/10/2011

3/15/2012

3/30/2012

0.0958

Monthly

2/7/2012

4/13/2012

4/30/2012

0.0958

Monthly

2/7/2012

5/15/2012

5/31/2012

0.0958

Monthly

2/7/2012

6/15/2012

6/29/2012

0.0958

For income tax purposes, the Company estimates that its distributions for the calendar year 2012 will be composed primarily of ordinary income, and will be reflected as such on the Form 1099-DIV for the calendar year 2012. The Company anticipates declaring further distributions to its stockholders to meet the RIC distribution requirements.

As a RIC, the Company is also subject to a federal excise tax based on distributive requirements of its taxable income on a calendar year basis. Because the Company did not satisfy these distribution requirements for calendar years 2008, 2009 and 2010, the Company incurred a de minimis federal excise tax for those calendar years. The Company did not incur a federal excise tax for calender year 2011 and does not expect to incur a federal excise tax for calendar year 2012.

Note 9.

Realized Gains or Losses and Net Unrealized Appreciation or Depreciation on Investments and Interest Rate Swap

Realized gains or losses are measured by the difference between the net proceeds from the sale or redemption and the cost basis of the investment or interest rate swap without regard to unrealized appreciation or depreciation previously recognized, and includes investments written-off during the period, net of recoveries. Realized losses may also be recorded in connection with the Company’s determination that certain investments are considered worthless securities and/or meet the conditions for loss recognition per the applicable tax rules.

Net unrealized appreciation or depreciation on investments and interest rate swap reflects the net change in the valuation of the portfolio pursuant to the Company’s valuation guidelines and the reclassification of any prior period unrealized appreciation or depreciation.

During the six months ended March 31, 2012, the Company recorded investment realization events, including the following:

•

In November 2011, the Company recorded a realized loss in the amount of $18.1 million as a result of a Delaware bankruptcy court judge ruling which confirmed a Chapter 11 plan of reorganization that provided no recovery on the Company’s investment in Premier Trailer Leasing, Inc.;

•

In November 2011, the Company received a cash payment of $20.2 million from IZI Medical Products, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited above par (including associated fees) and the Company received an additional $1.3 million proceeds from its equity investment, realizing a gain of $0.8 million;

•

In December 2011, the Company received a cash payment of $23.0 million from ADAPCO, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited above par (including associated fees) and no realized gain or loss was recorded on this transaction;

•

In December 2011, the Company received a cash payment of $2.0 million from Best Vinyl Fence & Deck, LLC in full satisfaction of all obligations related to the Term Loan A under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

•

In December 2011, the Company received a cash payment of $9.2 million from Actient Pharmaceuticals LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;

•

In December 2011, the Company sold $4.0 million of its $10.0 million debt investment in Bojangles and no realized gain or loss was recorded on this transaction;

•

In December 2011, the Company sold $2.0 million of its $11.5 million debt investment in US Collections, Inc. and no realized gain or loss was recorded on this transaction;

•

In January 2012, the Company received a cash payment of $18.5 million from IOS Acquisitions, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited above par (including associated fees) and no realized gain or loss was recorded on this transaction;

•

In February 2012, the Company received a cash payment of $2.1 million from O’Currance, Inc. The debt investment was exited below par and the Company recorded a realized loss in the amount of $10.7 million on this transaction;

•

In February 2012, the Company received a cash payment of $25.0 million from Ernest Health, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited above par (including associated fees) and no realized gain or loss was recorded on this transaction;

•

In March 2012, the Company received a cash payment of $47.7 million from CRGT, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited above par (including associated fees) and no realized gain or loss was recorded on this transaction;

•

In March 2012, the Company received a cash payment of $24.5 million from Epic Acquisition, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited above par (including associated fees) and no realized gain or loss was recorded on this transaction;

•

In March 2012, the Company received a cash payment of $48.8 million from Dominion Diagnostics, LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited above par (including associated fees) and no realized gain or loss was recorded on this transaction; and

•

In March 2012, the Company received a cash payment of $5.0 million from Genoa Healthcare Holdings, LLC in full satisfaction of all obligations under the senior loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction.

During the six months ended March 31, 2011, the Company recorded investment realization events, including the following:

•

In October 2010, the Company received a cash payment of $8.7 million from Goldco, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;

•

In November 2010, the Company received a cash payment of $11.0 million from TBA Global, LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;

•

In November 2010, the Company restructured its investment in Vanguard Vinyl, Inc. The restructuring resulted in a material modification of the terms of the loan agreement. As such, the Company recorded a realized loss in the amount of $1.7 million in accordance with ASC 470-50;

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

•

In December 2010, the Company restructured its investment in Nicos Polymers & Grinding, Inc. The restructuring resulted in a material modification of the terms of the loan agreement. As such, the Company recorded a realized loss in the amount of $3.9 million in accordance with ASC 470-50;

•

In December 2010, the Company received a cash payment of $25.3 million from Boot Barn in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;

•

In December 2010, the Company received a cash payment of $11.7 million from Western Emulsions, Inc. in partial satisfaction of the obligations under the loan agreement. No realized gain or loss was recorded on this transaction;

•

In December 2010, the Company restructured its investment in Lighting by Gregory, LLC. The restructuring resulted in a material modification of the terms of the loan agreement. As such, the Company recorded a realized loss in the amount of $7.8 million in accordance with ASC 470-50; and

•

In March 2011, the Company received a cash payment of $5.0 million from AmBath/ReBath Holdings, Inc. as part of a restructuring of the loan agreement. The restructuring resulted in a material modification of the terms of the loan agreement. As such, the Company recorded a realized loss in the amount of $0.3 million in accordance with ASC 470-50.

During the six months ended March 31, 2012, the Company recorded net unrealized appreciation of $13.9 million. This consisted of $1.8 million of net unrealized appreciation on equity investments and $27.7 million of net reclassifications from unrealized depreciation to realized losses on our investments, offset by $15.6 million of net unrealized depreciation on debt investments. During the six months ended March 31, 2011, the Company recorded net unrealized appreciation of $16.5 million. This consisted of $10.9 million of net reclassifications from unrealized depreciation to realized losses on our investments, $5.7 million of net unrealized appreciation on debt investments and $1.0 million of net unrealized appreciation on the interest rate swap, offset by $1.1 million of net unrealized depreciation on equity investments.

Note 10.

Concentration of Credit Risks

The Company places its cash in financial institutions and at times such balances may be in excess of the FDIC insured limit. The Company limits its exposure to credit loss by depositing its cash with high credit quality financial institutions and monitoring their financial stability.

Note 11.

Related Party Transactions

The Company has entered into an investment advisory agreement with the Investment Adviser. Under the investment advisory agreement, the Company pays the Investment Adviser a fee for its services consisting of two components — a base management fee and an incentive fee.

Base management Fee

The base management fee is calculated at an annual rate of 2% of the Company’s gross assets, which includes any borrowings for investment purposes. The base management fee is payable quarterly in arrears, and will be calculated based on the value of the Company’s gross assets at the end of each fiscal quarter, and appropriately adjusted on a pro rata basis for any equity capital raises or repurchases during such quarter. The base management fee for any partial month or quarter will be appropriately prorated.

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

For the three and six months ended March 31, 2012, base management fees were $5.4 million and $11.1 million, respectively. For the three and six months ended March 31, 2011, base management fees were $4.8 million and $8.6 million, respectively. At March 31, 2012, the Company had a liability on its Consolidated Statement of Assets and Liabilities in the amount of $5.4 million reflecting the unpaid portion of the base management fee payable to the Investment Adviser.

Incentive Fee

The incentive fee portion of the investment advisory agreement has two parts. The first part is calculated and payable quarterly in arrears based on the Company’s “Pre-Incentive Fee Net Investment Income” for the immediately preceding fiscal quarter. For this purpose, “Pre-Incentive Fee Net Investment Income” means interest income, dividend income and any other income (including (i) any other fees (other than fees for providing managerial assistance), such as commitment, origination, structuring, diligence and consulting fees or other fees that the Company receives from portfolio companies or (ii) other income that must be distributed to its stockholders, including, for example, any gain recorded in connection with the extinguishment of its debt) accrued during the fiscal quarter, minus the Company’s operating expenses for the quarter (including the base management fee, expenses payable under the Company’s administration agreement with FSC, Inc., and any interest expense and dividends paid on any issued and outstanding indebtedness or preferred stock, but excluding the incentive fee). Pre-Incentive Fee Net Investment Income includes, in the case of investments with a deferred interest feature (such as original issue discount, debt instruments with PIK interest and zero coupon securities), accrued income that the Company has not yet received in cash. Pre-Incentive Fee Net Investment Income does not include any realized capital gains, realized capital losses or unrealized capital appreciation or depreciation. Pre-Incentive Fee Net Investment Income, expressed as a rate of return on the value of the Company’s net assets at the end of the immediately preceding fiscal quarter, will be compared to a “hurdle rate” of 2% per quarter (8% annualized), subject to a “catch-up” provision measured as of the end of each fiscal quarter. The Company’s net investment income used to calculate this part of the incentive fee is also included in the amount of its gross assets used to calculate the 2% base management fee. The operation of the incentive fee with respect to the Company’s Pre-Incentive Fee Net Investment Income for each quarter is as follows:

•

No incentive fee is payable to the Investment Adviser in any fiscal quarter in which the Company’s Pre-Incentive Fee Net Investment Income does not exceed the hurdle rate of 2% (the “preferred return” or “hurdle”);

•

100% of the Company’s Pre-Incentive Fee Net Investment Income with respect to that portion of such Pre-Incentive Fee Net Investment Income, if any, that exceeds the hurdle rate but is less than or equal to 2.5% in any fiscal quarter (10% annualized) is payable to the Investment Adviser. The Company refers to this portion of its Pre-Incentive Fee Net Investment Income (which exceeds the hurdle rate but is less than or equal to 2.5%) as the “catch-up.” The “catch-up” provision is intended to provide the Investment Adviser with an incentive fee of 20% on all of the Company’s Pre-Incentive Fee Net Investment Income as if a hurdle rate did not apply when the Company’s Pre-Incentive Fee Net Investment Income exceeds 2.5% in any fiscal quarter; and

•

20% of the amount of the Company’s Pre-Incentive Fee Net Investment Income, if any, that exceeds 2.5% in any fiscal quarter (10% annualized) is payable to the Investment Adviser once the hurdle is reached and the catch-up is achieved (20% of all Pre-Incentive Fee Net Investment Income thereafter is allocated to the Investment Adviser).

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

The second part of the incentive fee is determined and payable in arrears as of the end of each fiscal year (or upon termination of the investment advisory agreement, as of the termination date), commencing on September 30, 2008, and equals 20% of the Company’s realized capital gains, if any, on a cumulative basis from inception through the end of each fiscal year, computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the aggregate amount of any previously paid capital gain incentive fees.

GAAP requires the Company to accrue for the theoretical capital gains incentive fee that would be payable after giving effect to the net realized and unrealized capital appreciation and depreciation. It should be noted that a fee so calculated and accrued would not necessarily be payable under the investment advisory agreement, and may never be paid based upon the computation of capital gains incentive fees in subsequent periods. Amounts ultimately paid under the investment advisory agreement will be consistent with the formula reflected in the investment advisory agreement.

The Company does not currently accrue for capital gains incentive fees due to the accumulated realized and unrealized losses in the portfolio.

For the three and six months ended March 31, 2012, incentive fees were $5.7 million and $10.9 million, respectively. For the three and six months ended March 31, 2011, incentive fees were $4.1 million and $7.7 million, respectively. At March 31, 2012, the Company had a liability on its Consolidated Statement of Assets and Liabilities in the amount of $5.7 million reflecting the unpaid portion of the incentive fee payable to the Investment Adviser.

Indemnification

The investment advisory agreement provides that, absent willful misfeasance, bad faith or gross negligence in the performance of their respective duties or by reason of the reckless disregard of their respective duties and obligations, the Company’s Investment Adviser and its officers, managers, agents, employees, controlling persons, members (or their owners) and any other person or entity affiliated with it, are entitled to indemnification from the Company for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of the Investment Adviser’s services under the investment advisory agreement or otherwise as the Company’s Investment Adviser.

Administration Agreement

The Company has also entered into an administration agreement with FSC, Inc. under which FSC, Inc. provides administrative services for the Company, including office facilities and equipment, and clerical, bookkeeping and recordkeeping services at such facilities. Under the administration agreement, FSC, Inc. also performs or oversees the performance of the Company’s required administrative services, which includes being responsible for the financial records which the Company is required to maintain and preparing reports to the Company’s stockholders and reports filed with the SEC. In addition, FSC, Inc. assists the Company in determining and publishing the Company’s net asset value, overseeing the preparation and filing of the Company’s tax returns and the printing and dissemination of reports to the Company’s stockholders, and generally overseeing the payment of the Company’s expenses and the performance of administrative and professional services rendered to the Company by others. For providing these services, facilities and personnel, the Company reimburses FSC, Inc. the allocable portion of overhead and other expenses incurred by FSC, Inc. in performing its obligations under the administration agreement, including rent and the Company’s allocable portion of the costs of compensation and related expenses of the Company’s chief financial officer and chief compliance officer and their staffs. Such reimbursement is at cost with no profit to, or markup by, FSC, Inc.

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

FSC, Inc. has voluntarily determined to forgo receiving reimbursement for the services performed for the Company by its chief compliance officer. However, although FSC, Inc. currently intends to forgo its right to receive such reimbursement, it is under no obligation to do so and may cease to do so at any time in the future. FSC, Inc. may also provide, on the Company’s behalf, managerial assistance to the Company’s portfolio companies. The administration agreement may be terminated by either party without penalty upon 60 days’ written notice to the other party.

For the three and six months ended March 31, 2012, the Company incurred administration expenses of $1.1 million, including $0.3 million of general and administrative expenses, and $2.2 million, including $0.6 million of general and administrative expenses, that are due to FSC, Inc., respectively. At March 31, 2012, $1.4 million (inclusive of these administration expenses) was included in Due to FSC, Inc. in the Consolidated Statement of Assets and Liabilities.

Note 12.

Financial Highlights


(Amounts in thousands, except per share data) Per share data:	Three months ended March 31, 2012			Three months ended March 31, 2011			Six months ended March 31, 2012			Six months ended March 31, 2011
Net asset value at beginning of period	$	9.89		$	10.44		$	10.07		$	10.43
Net investment income		0.29			0.27			0.58			0.52
Net unrealized appreciation (depreciation) on investments and interest rate swap		0.10			(0.01	)		0.18			0.28
Net realized loss on investments and interest rate swap		(0.14	)		(0.01	)		(0.36	)		(0.24	)
Dividends paid		(0.29	)		(0.30	)		(0.61	)		(0.62	)
Issuance of common stock		0.02			0.29			0.01			0.31

Net asset value at end of period	$	9.87		$	10.68		$	9.87		$	10.68
Per share market value at beginning of period	$	9.57		$	12.14		$	9.32		$	11.14
Per share market value at end of period	$	9.76		$	13.35		$	9.76		$	13.35
Total return(1)		5.01	%		12.61	%		11.39	%		26.04	%
Common shares outstanding at beginning of period		72,376			55,059			72,376			54,550
Common shares outstanding at end of period		82,421			66,668			82,421			66,668
Net assets at beginning of period	$	715,665		$	574,920		$	728,627		$	569,172
Net assets at end of period	$	813,322		$	711,748		$	813,322		$	711,748
Average net assets(2)	$	789,909		$	662,783		$	757,445		$	616,969
Ratio of net investment income to average net assets(3)		11.57	%		10.13	%		11.53	%		9.95	%
Ratio of total expenses to average net assets(3)		9.81	%		8.04	%		10.31	%		7.94	%
Ratio of portfolio turnover to average investments at fair value		15.82	%		0.00	%		21.36	%		1.88	%
Weighted average outstanding debt(4)	$	417,952		$	224,511		$	428,104		$	162,925
Average debt per share	$	5.26		$	3.61		$	5.64		$	2.79

(1)

Total return equals the increase or decrease of ending market value over beginning market value, plus distributions, divided by the beginning market value, assuming dividend reinvestment prices obtained under the Company’s dividend reinvestment plan. Total return is not annualized during interim periods.

(2)	Calculated based upon the weighted average net assets for the period.

(3)	Interim periods are annualized.

(4)	Calculated based upon the weighted average of loans payable for the period.

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

Note 13.

Interest Rate Swap

In August 2010, the Company entered into a three-year interest rate swap agreement to mitigate its exposure to adverse fluctuations in interest rates for a total notional amount of $100.0 million. Under the interest rate swap agreement, the Company paid a fixed interest rate of 0.99% and received a floating rate based on the prevailing one-month LIBOR.

Swaps contain varying degrees of off-balance sheet risk which could result from changes in the market values of underlying assets, indices or interest rates and similar items. As a result, the amounts recognized in the Consolidated Statement of Assets and Liabilities at any given date may not reflect the total amount of potential losses that the Company could ultimately incur.

In August 2011, the Company terminated the interest rate swap agreement and realized a loss of $1.3 million, which included a reclassification of $0.8 million of prior unrealized depreciation.

Note 14.

Convertible Senior Notes

On April 12, 2011, the Company issued $152 million of unsecured convertible senior notes (“Convertible Notes”), including $2 million issued to Leonard M. Tannenbaum, the Company’s Chief Executive Officer. The Convertible Notes were issued pursuant to an Indenture, dated April 12, 2011 (the “Indenture”), between the Company and Deutsche Bank Trust Company Americas, as trustee (the “Trustee”).

The Convertible Notes mature on April 1, 2016 (the “Maturity Date”), unless previously converted or repurchased in accordance with their terms. The Convertible Notes bear interest at a rate of 5.375% per year payable semiannually in arrears on April 1 and October 1 of each year, commencing on October 1, 2011. The Convertible Notes are the Company’s senior unsecured obligations and rank senior in right of payment to the Company’s existing and future indebtedness that is expressly subordinated in right of payment to the Convertible Notes; equal in right of payment to the Company’s existing and future unsecured indebtedness that is not so subordinated; effectively junior in right of payment to any of the Company’s secured indebtedness (including existing unsecured indebtedness that the Company later secures) to the extent of the value of the assets securing such indebtedness; and structurally junior to all existing and future indebtedness (including trade payables) incurred by the Company’s subsidiaries or financing vehicles.

Prior to the close of business on the business day immediately preceding January 1, 2016, holders may convert their Convertible Notes only under certain circumstances set forth in the Indenture, such as during specified periods when the Company’s shares of common stock trade at more than 110% of the then applicable conversion price or the Convertible Notes trade at less than 98% of their conversion value. On or after January 1, 2016 until the close of business on the business day immediately preceding the Maturity Date, holders may convert their Convertible Notes at any time. Upon conversion, the Company will deliver shares of its common stock. The conversion rate was initially, and currently is, 67.7415 shares of common stock per $1,000 principal amount of Convertible Notes (equivalent to a conversion price of approximately $14.76 per share of common stock). The conversion rate is subject to customary anti-dilution adjustments, including for any cash dividends or distributions paid on shares of the Company’s common stock in excess of a monthly dividend of $0.1066 per share, but will not be adjusted for any accrued and unpaid interest. In addition, if certain corporate events occur prior to the Maturity Date, the conversion rate will be increased for converting holders. Based on the current conversion rate, the maximum number of shares of common stock that would be issued upon conversion of the $124.0 million convertible debt outstanding at March 31, 2012 is 8,399,946. If the Company delivers shares of common stock upon a conversion at the time that net asset value per share exceeds the conversion price in effect at such time, the Company’s

FIFTH STREET FINANCE CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(in thousands, except share and per share amounts, percentages and as otherwise indicated)

stockholders may incur dilution. In addition, the Company’s stockholders will experience dilution in their ownership percentage of common stock upon the issuance of common stock in connection with the conversion of the Company’s convertible senior notes and any dividends paid on common stock will also be paid on shares issued in connection with such conversion after such issuance. The shares of common stock issued upon a conversion are not subject to registration rights.

The Company may not redeem the Convertible Notes prior to maturity. No sinking fund is provided for the Convertible Notes. In addition, if certain corporate events occur in respect of the Company, holders of the Convertible Notes may require the Company to repurchase for cash all or part of their Convertible Notes at a repurchase price equal to 100% of the principal amount of the Convertible Notes to be repurchased, plus accrued and unpaid interest through, but excluding, the required repurchase date.

The Indenture contains certain covenants, including covenants requiring the Company to provide financial information to the holders of the Convertible Notes, and the Trustee if the Company ceases to be subject to the reporting requirements of the Securities Exchange Act of 1934. These covenants are subject to limitations and exceptions that are described in the Indenture.

Interest expense for the three and six months ended March 31, 2012 was $1.8 million and $3.7 million, respectively, related to the Convertible Notes.

The Company may repurchase the Convertible Notes in accordance with the 1940 Act and the rules promulgated thereunder. Any Convertible Notes repurchased by the Company may, at the Company’s option, be surrendered to the Trustee for cancellation, but may not be reissued or resold by the Company. Any Convertible Notes surrendered for cancellation will be promptly cancelled and no longer outstanding under the Indenture. During the six months ended March 31, 2012, the Company repurchased $11.0 million principal of the Convertible Notes in the open market for an aggregate purchase price of $9.4 million and surrendered them to the Trustee for cancellation. The Company recorded a gain on the extinguishment of these Convertible Notes in the amount of the difference between the reacquisition price and the net carrying amount, net of the proportionate amount of unamortized debt issuance costs. The net gain recorded was $1.3 million.

As of March 31, 2012, there were $124.0 million Convertible Notes outstanding, which had a fair value of $118.0 million.

Note 15.

Subsequent Events

The Company’s management evaluated subsequent events through the date of issuance of these Consolidated Financial Statements. There have been no subsequent events that occurred during such period that would require disclosure in, or would be required to be recognized in, the Consolidated Financial Statements as of and for the six months ended March 31, 2012.

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in connection with our Consolidated Financial Statements and the notes thereto included elsewhere in this quarterly report on Form 10-Q.

Some of the statements in this quarterly report on Form 10-Q constitute forward-looking statements because they relate to future events or our future performance or financial condition. The forward-looking statements contained in this quarterly report on Form 10-Q may include statements as to:

•

our future operating results and dividend projections;

•

our business prospects and the prospects of our portfolio companies;

•

the impact of the investments that we expect to make;

•

the ability of our portfolio companies to achieve their objectives;

•

our expected financings and investments;

•

the adequacy of our cash resources and working capital; and

•

the timing of cash flows, if any, from the operations of our portfolio companies.

In addition, words such as “anticipate,” “believe,” “expect,” “project” and “intend” indicate forward-looking statements, although not all forward-looking statements include these words. The forward-looking statements contained in this quarterly report on Form 10-Q involve risks and uncertainties. Our actual results could differ materially from those implied or expressed in the forward-looking statements for any reason, including the factors set forth in “Risk Factors” in our annual report on Form 10-K for the year ended September 30, 2011 and elsewhere in this quarterly report on Form 10-Q for the quarter ended March 31, 2012. Other factors that could cause actual results to differ materially include:

•

changes in the economy and the financial markets;

•

risks associated with possible disruption in our operations or the economy generally due to terrorism or natural disasters;

•

future changes in laws or regulations (including the interpretation of these laws and regulations by regulatory authorities) and conditions in our operating areas, particularly with respect to business development companies, small business investment companies, or SBICs, and regulated investment companies, or RICs; and

•

other considerations that may be disclosed from time to time in our publicly disseminated documents and filings.

We have based the forward-looking statements included in this quarterly report on Form 10-Q on information available to us on the date of this quarterly report, and we assume no obligation to update any such forward-looking statements. Although we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, you are advised to consult any additional disclosures that we may make directly to you or through reports that we in the future may file with the Securities and Exchange Commission, or the SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.

Except as otherwise specified, references to the “Company,” “we,” “us,” and “our,” refer to Fifth Street Finance Corp.

All amounts are in thousands, except share and per share amounts, percentages and as otherwise indicated.

Overview

We are a specialty finance company that lends to and invests in small and mid-sized companies primarily in connection with investments by private equity sponsors. Our investment objective is to maximize our portfolio’s total return by generating current income from our debt investments and capital appreciation from our equity investments.

We were formed as a Delaware limited partnership (Fifth Street Mezzanine Partners III, L.P.) on February 15, 2007. Effective as of January 2, 2008, Fifth Street Mezzanine Partners III, L.P. merged with and into Fifth Street Finance Corp. At the time of the merger, all outstanding partnership interests in Fifth Street Mezzanine Partners III, L.P. were exchanged for 12,480,972 shares of common stock in Fifth Street Finance Corp.

On June 17, 2008, we completed an initial public offering of 10,000,000 shares of our common stock at the offering price of $14.12 per share. Our stock was listed on the New York Stock Exchange until November 28, 2011 when the Company transferred the listing to the NASDAQ Global Select Market, where it continues to trade under the symbol “FSC”.

Current Market Conditions

Since mid-2007, the global financial markets have experienced stress, volatility, illiquidity and disruption. This turmoil appears to have peaked in the fall of 2008, resulting in several major financial institutions becoming insolvent, being acquired, or receiving government assistance. While the turmoil in the financial markets appears to have abated somewhat, the global economy continues to experience economic uncertainty. Economic uncertainty impacts our business in many ways, including changing spreads, structures and purchase multiples as well as the overall supply of investment capital.

Despite the economic uncertainty, our deal pipeline remains robust, with high quality transactions backed by private equity sponsors in small to mid-sized companies. As always, we remain cautious in selecting new investment opportunities, and will only deploy capital in deals which are consistent with our disciplined philosophy of pursuing superior risk-adjusted returns.

As evidenced by our recent investment activities, we expect to grow the business in part by increasing the average investment size when and where appropriate. Although we believe that we currently have sufficient capital available to fund investments, a prolonged period of market disruptions may cause us to reduce the volume of loans we originate and/or fund, which could have an adverse effect on our business, financial condition and results of operations. In this regard, because our common stock has at times traded at a price below our then current net asset value per share and we are limited in our ability to sell our common stock at a price below net asset value per share, we may be limited in our ability to raise equity capital.

Critical Accounting Policies

Basis of Presentation

The preparation of financial statements in accordance with GAAP requires management to make certain estimates and assumptions affecting amounts reported in the Consolidated Financial Statements. We have identified investment valuation and revenue recognition as our most critical accounting estimates. We continuously evaluate our estimates, including those related to the matters described below. These estimates are based on the information that is currently available to us and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ materially from those estimates under different assumptions or conditions. A discussion of our critical accounting policies follows.

Investment Valuation

We are required to report our investments that are not publicly traded or for which current market values are not readily available at fair value. The fair value is deemed to be the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

Under the market approach, we estimate the enterprise value of the portfolio companies in which we invest. There is no one methodology to estimate enterprise value and, in fact, for any one portfolio company, enterprise value is best expressed as a range of fair values from which we derive a single estimate of enterprise value. To estimate the enterprise value of a portfolio company, we analyze various factors, including the portfolio company’s historical and projected financial results. Typically, private companies are valued based on multiples of EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization), cash flows, net income, revenues, or in limited cases, book value. We generally require portfolio companies to provide annual audited and quarterly and monthly unaudited financial statements, as well as annual projections for the upcoming fiscal year.

Under the income approach, we generally prepare and analyze discounted cash flow models based on our projections of the future free cash flows of the business.

Under the bond yield approach, we use bond yield models to determine the present value of the future cash flow streams of our debt investments. We review various sources of transactional data, including private mergers and acquisitions involving debt investments with similar characteristics, and assess the information in the valuation process.

Our Board of Directors undertakes a multi-step valuation process each quarter in connection with determining the fair value of our investments:

•

Our quarterly valuation process begins with each portfolio company or investment being initially valued by our finance department;

•

Preliminary valuations are then reviewed and discussed with the principals of our investment adviser;

•

Separately, independent valuation firms engaged by our Board of Directors prepare preliminary valuations on a selected basis and submit reports to us;

•

Our finance department compares and contrasts its preliminary valuations to the preliminary valuations of the independent valuation firms;

•

Our finance department prepares a valuation report for the Valuation Committee of our Board of Directors;

•

The Valuation Committee of our Board of Directors is apprised of the preliminary valuations of the independent valuation firms;

•

The Valuation Committee of our Board of Directors reviews the preliminary valuations, and our finance department responds and supplements the preliminary valuations to reflect any comments provided by the Valuation Committee;

•

The Valuation Committee of our Board of Directors makes a recommendation to the Board of Directors; and

•

Our Board of Directors discusses valuations and determines the fair value of each investment in our portfolio in good faith.

The fair value of all of our investments at March 31, 2012, and September 30, 2011, was determined by our Board of Directors. Our Board of Directors is solely responsible for the valuation of our portfolio investments at fair value as determined in good faith pursuant to our valuation policy and our consistently applied valuation process.

Our Board of Directors has authorized the engagement of independent valuation firms to provide us with valuation assistance. Upon completion of their processes each quarter, the independent valuation firms provide us with written reports regarding the preliminary valuations of selected portfolio securities as of the close of such quarter. We will continue to engage independent valuation firms to provide us with assistance regarding our determination of the fair value of selected portfolio securities each quarter; however, our Board of Directors is ultimately and solely responsible for determining the fair value of our investments in good faith. We intend to have a portion of the portfolio valued by an independent third party on a quarterly basis, with a substantial portion being valued on an annual basis.

The portions of our portfolio valued, as a percentage of the portfolio at fair value, by independent valuation firms by period were as follows:


For the quarter ending December 31, 2007	91.9	%
For the quarter ending March 31, 2008	92.1	%
For the quarter ending June 30, 2008	91.7	%
For the quarter ending September 30, 2008	92.8	%
For the quarter ending December 31, 2008	100.0	%
For the quarter ending March 31, 2009	88.7	%(1)
For the quarter ending June 30, 2009	92.1	%
For the quarter ending September 30, 2009	28.1	%
For the quarter ending December 31, 2009	17.2	%(2)
For the quarter ending March 31, 2010	26.9	%
For the quarter ending June 30, 2010	53.1	%
For the quarter ending September 30, 2010	61.8	%
For the quarter ending December 31, 2010	73.9	%
For the quarter ending March 31, 2011	82.0	%
For the quarter ending June 30, 2011	82.9	%
For the quarter ending September 30, 2011	91.2	%
For the quarter ending December 31, 2011	89.1	%
For the quarter ending March 31, 2012	87.3	%

(1)	96.0% excluding our investment in IZI Medical Products, Inc., which closed on December 31, 2009, and therefore was not part of the independent valuation process

(2)	24.8% excluding four investments that closed in December 2009 and therefore were not part of the independent valuation process

As of March 31, 2012 and September 30, 2011, approximately 88.5% and 92.6%, respectively, of our total assets represented investments in portfolio companies valued at fair value.

Revenue Recognition

Interest and Dividend Income

Interest income, adjusted for amortization of premium and accretion of original issue discount, is recorded on the accrual basis to the extent that such amounts are expected to be collected. We stop accruing interest on investments when it is determined that interest is no longer collectible. Distributions from portfolio companies are recorded as dividend income when the distribution is received.

Fee Income

We receive a variety of fees in the ordinary course of business. Certain fees, such as some origination fees, are capitalized and amortized in accordance with ASC 310-20 Nonrefundable Fees and Other Costs . In accordance with ASC 820, the net unearned fee income balance is netted against the cost and fair value of the

respective investments. Other fees, such as servicing fees, are classified as fee income and recognized as they are earned on a monthly basis.

We have also structured exit fees across certain of our portfolio investments to be received upon the future exit of those investments. Exit fees are payable upon the exit of a debt security. These fees are to be paid to us upon the sooner to occur of (i) a sale of the borrower or substantially all of the assets of the borrower, (ii) the maturity date of the loan or (iii) the date when full prepayment of the loan occurs. The receipt of such fees is contingent upon the occurrence of one of the events listed above for each of the investments. A percentage of these fees is included in net investment income over the life of the loan. As of March 31, 2012, we had structured $6.4 million in aggregate exit fees across 9 portfolio investments upon the future exit of those investments.

Payment-in-Kind (PIK) Interest

Our loans typically contain contractual PIK interest provisions. The PIK interest, which represents contractually deferred interest added to the loan balance that is generally due at the end of the loan term, is generally recorded on the accrual basis to the extent such amounts are expected to be collected. We generally cease accruing PIK interest if there is insufficient value to support the accrual or if we do not expect the portfolio company to be able to pay all principal and interest due. Our decision to cease accruing PIK interest involves subjective judgments and determinations based on available information about a particular portfolio company, including whether the portfolio company is current with respect to its payment of principal and interest on its loans and debt securities; monthly and quarterly financial statements and financial projections for the portfolio company; our assessment of the portfolio company’s business development success, including product development, profitability and the portfolio company’s overall adherence to its business plan; information obtained by us in connection with periodic formal update interviews with the portfolio company’s management and, if appropriate, the private equity sponsor; and information about the general economic and market conditions in which the portfolio company operates. Based on this and other information, we determine whether to cease accruing PIK interest on a loan or debt security. Our determination to cease accruing PIK interest on a loan or debt security is generally made well before our full write-down of such loan or debt security. In addition, if it is subsequently determined that we will not be able to collect any previously accrued PIK interest, the fair value of our loans or debt securities would decline by the amount of such previously accrued, but uncollectible, PIK interest.

For a discussion of risks we are subject to as a result of our use of PIK interest in connection with our investments, see “Risk Factors — Risks Relating to Our Business and Structure — We may have difficulty paying our required distributions if we recognize income before or without receiving cash representing such income,” “— We may in the future choose to pay dividends in our own stock, in which case you may be required to pay tax in excess of the cash you receive” and “— Our incentive fee may induce our investment adviser to make speculative investments” in our annual report on Form 10-K for the year ended September 30, 2011. In addition, if it is subsequently determined that we will not be able to collect any previously accrued PIK interest, the fair value of our loans or debt securities would decline by the amount of such previously accrued, but uncollectible, PIK interest. The accrual of PIK interest on our debt investments increases the recorded cost basis of these investments in our consolidated financial statements and, as a result, increases the cost basis of these investments for purposes of computing the capital gains incentive fee payable by us to our investment adviser.

To maintain our status as a RIC, PIK income must be paid out to our stockholders in the form of dividends even though we have not yet collected the cash and may never collect the cash relating to the PIK interest. Accumulated PIK interest was $27.2 million and represented 2.6% of the fair value of our portfolio of investments as of March 31, 2012 and $22.7 million or 2.0% as of September 30, 2011. The net increase in loan balances as a result of contracted PIK arrangements are separately identified in our Consolidated Statements of Cash Flows.

Portfolio Composition

Our investments principally consist of loans, purchased equity investments and equity grants in privately-held companies. Our loans are typically secured by either a first or second lien on the assets of the portfolio company and generally have terms of up to six years (but an expected average life of between three and four years). We are currently focusing our origination efforts on a prudent mix of first lien, second lien and subordinated loans which we believe will provide superior risk-adjusted returns while maintaining adequate credit protection.

A summary of the composition of our investment portfolio at cost and fair value as a percentage of total investments is shown in the following tables:


	March 31, 2012			September 30, 2011
Cost:
First lien debt		69.54	%		77.05	%
Second lien debt		12.06	%		13.97	%
Subordinated debt		16.31	%		7.40	%
Purchased equity		1.39	%		0.97	%
Equity grants		0.51	%		0.53	%
Limited partnership interests		0.19	%		0.08	%

Total		100.00	%		100.00	%


	March 31, 2012			September 30, 2011
Fair value:
First lien debt		69.70	%		78.14	%
Second lien debt		11.58	%		12.80	%
Subordinated debt		16.21	%		7.25	%
Purchased equity		1.77	%		1.12	%
Equity grants		0.54	%		0.60	%
Limited partnership interests		0.20	%		0.09	%

Total		100.00	%		100.00	%

The industry composition of our portfolio at cost and fair value as a percentage of total investments were as follows:


	March 31, 2012			September 30, 2011
Cost:
Healthcare services		13.67	%		19.65	%
Healthcare equipment		7.67	%		6.16	%
Internet software & services		6.85	%		3.79	%
Diversified support services		6.84	%		4.80	%
Oil & gas equipment & services		5.64	%		7.11	%
Construction & engineering		4.12	%		3.74	%
Pharmaceuticals		3.73	%		2.36	%
Leisure facilities		3.40	%		3.29	%
Electronic equipment & instruments		3.29	%		3.01	%
Specialty stores		3.18	%		2.99	%
Diversified financial services		3.00	%		1.15	%
Education services		2.89	%		2.57	%
Apparel, accessories & luxury goods		2.81	%		2.68	%
Household products		2.75	%		2.70	%
Advertising		2.70	%		1.72	%
Home improvement retail		2.57	%		2.42	%
IT consulting & other services		2.34	%		4.23	%


	March 31, 2012			September 30, 2011
Restaurants		2.18	%		1.21	%
Integrated telecommunication services		2.05	%		2.25	%
Industrial machinery		1.93	%		0.90	%
Electronic manufacturing services		1.85	%		1.75	%
Human resources & employment services		1.85	%		1.77	%
Auto parts & equipment		1.77	%		1.63	%
Distributors		1.75	%		1.61	%
Air freight & logistics		1.70	%		1.56	%
Environmental & facilities services		1.66	%		1.41	%
Food distributors		1.40	%		1.80	%
Research & consulting services		1.32	%		0.00	%
Leisure products		1.30	%		1.17	%
Construction materials		0.63	%		0.58	%
Housewares & specialties		0.49	%		0.46	%
Building products		0.45	%		0.58	%
Multi-sector holdings		0.20	%		0.09	%
Movies & entertainment		0.02	%		0.02	%
Fertilizers & agricultural chemicals		0.00	%		2.49	%
Healthcare technology		0.00	%		1.77	%
Trucking		0.00	%		1.48	%
Data processing & outsourced services		0.00	%		1.10	%

Total		100.00	%		100.00	%

Fair Value:
Healthcare services		14.25	%		20.67	%
Healthcare equipment		7.86	%		6.42	%
Diversified support services		7.11	%		5.02	%
Internet software & services		7.10	%		3.91	%
Oil & gas equipment & services		5.80	%		7.38	%
Pharmaceuticals		3.87	%		2.46	%
Leisure facilities		3.52	%		3.43	%
Specialty stores		3.34	%		3.14	%
Electronic equipment & instruments		3.34	%		3.11	%
Diversified financial services		3.05	%		1.19	%
Education services		3.02	%		2.69	%
Apparel, accessories & luxury goods		3.02	%		3.00	%
Household products		2.80	%		2.67	%
Advertising		2.79	%		1.80	%
Construction & engineering		2.69	%		3.20	%
IT consulting & other services		2.43	%		4.42	%
Home improvement retail		2.36	%		2.46	%
Environmental & facilities services		2.23	%		1.78	%
Integrated telecommunication services		2.12	%		2.36	%
Restaurants		2.04	%		1.06	%
Industrial machinery		2.04	%		0.97	%
Human resources & employment services		1.95	%		1.87	%
Distributors		1.84	%		1.69	%
Auto parts & equipment		1.82	%		1.70	%
Food distributors		1.46	%		1.88	%
Air freight & logistics		1.42	%		1.54	%
Research & consulting services		1.37	%		0.00	%
Leisure products		1.34	%		1.22	%
Electronic manufacturing services		0.71	%		0.77	%
Construction materials		0.67	%		0.61	%
Building products		0.26	%		0.43	%


	March 31, 2012			September 30, 2011
Multi-sector holdings		0.21	%		0.11	%
Housewares & specialties		0.15	%		0.23	%
Movies & entertainment		0.02	%		0.02	%
Data processing & outsourced services		0.00	%		0.31	%
Fertilizers & agricultural chemicals		0.00	%		2.61	%
Healthcare technology		0.00	%		1.87	%

Total		100.00	%		100.00	%

Portfolio Asset Quality

We employ a grading system to assess and monitor the credit risk of our investment portfolio. We rate all investments on a scale from 1 to 5. The system is intended to reflect the performance of the borrower’s business, the collateral coverage of the loan, and other factors considered relevant to making a credit judgment. We have determined that there should be an individual rating assigned to each tranche of securities in the same portfolio company where appropriate. This may arise when the perceived risk of loss on the investment varies significantly between tranches due to their respective seniority in the capital structure.

•

Investment Rating 1 is used for investments that are performing above expectations and/or a capital gain is expected.

•

Investment Rating 2 is used for investments that are performing substantially within our expectations, and whose risks remain neutral or favorable compared to the potential risk at the time of the original investment. All new investments are initially rated 2.

•

Investment Rating 3 is used for investments that are performing below our expectations and that require closer monitoring, but where we expect no loss of investment return (interest and/or dividends) or principal. Companies with a rating of 3 may be out of compliance with financial covenants.

•

Investment Rating 4 is used for investments that are performing below our expectations and for which risk has increased materially since the original investment. We expect some loss of investment return, but no loss of principal.

•

Investment Rating 5 is used for investments that are performing substantially below our expectations and whose risks have increased substantially since the original investment. Investments with a rating of 5 are those for which some loss of principal is expected.

The following table shows the distribution of our investments on the 1 to 5 investment rating scale at fair value, as of March 31, 2012 and September 30, 2011:


	March 31, 2012						September 30, 2011
	Fair Value		Percentage of Total Portfolio			Leverage Ratio	Fair Value		Percentage of Total Portfolio			Leverage Ratio
1	$	82,607		7.82	%	2.73	$	81,335		7.26	%	3.16
2		950,996		90.04	%	3.91		1,021,990		91.26	%	3.87
3		5,102		0.48	%	NM(1)		8,660		0.77	%	NM(1)
4		10,918		1.03	%	NM(1)		—		0.00	%	—
5		6,600		0.63	%	NM(1)		7,852		0.71	%	NM(1)

Total	$	1,056,223		100.00	%	3.82	$	1,119,837		100.00	%	3.82

(1)	Due to operating performance this ratio is not measurable and, as a result, is excluded from the total portfolio calculation.

We may from time to time modify the payment terms of our investments, either in response to current economic conditions and their impact on certain of our portfolio companies or in accordance with tier pricing provisions in certain loan agreements. As of March 31, 2012, we had modified the payment terms of our investments in 9 portfolio companies. Such modified terms may include increased PIK interest provisions and reduced cash interest rates. These modifications, and any future modifications to our loan agreements, may limit the amount of interest income that we recognize from the modified investments, which may, in turn, limit our ability to make distributions to our stockholders.

Loans and Debt Securities on Non-Accrual Status

As of March 31, 2012, we had stopped accruing cash and/or PIK interest and original issue discount (“OID”) on four investments, three of which had not paid all of their scheduled cash interest payments for the period ended March 31, 2012. As of March 31, 2011, we had stopped accruing cash interest, PIK interest and OID on three investments that had not paid all of their scheduled cash interest payments for the period ended March 31, 2011.

Cash non-accrual status is inclusive of PIK and other noncash income, where applicable. The percentage of our portfolio investments at cost and fair value by accrual status as of March 31, 2012, September 30, 2011 and March 31, 2011 was as follows:


	March 31, 2012										September 30, 2011										March 31, 2011
	Cost		% of Portfolio			Fair Value		% of Portfolio			Cost		% of Portfolio			Fair Value		% of Portfolio			Cost		% of Portfolio			Fair Value		% of Portfolio
Accrual	$	1,027,219		95.23	%	$	1,038,705		98.34	%	$	1,116,762		96.60	%	$	1,111,986		99.30	%	$	916,768		96.18	%	$	931,796		99.15	%
PIK non-accrual		15,637		1.45	%		3,082		0.29	%		—		0.00	%		—		0.00	%		—		0.00	%		—		0.00	%
Cash non-accrual		35,841		3.32	%		14,436		1.37	%		39,320		3.40	%		7,851		0.70	%		36,425		3.82	%		7,953		0.85	%

Total	$	1,078,697		100.00	%	$	1,056,223		100.00	%	$	1,156,082		100.00	%	$	1,119,837		100.00	%	$	953,193		100.00	%	$	939,749		100.00	%

The non-accrual status of our portfolio investments as of March 31, 2012, September 30, 2011 and March 31, 2011 was as follows:

March 31, 2012

September 30, 2011

March 31, 2011

Lighting by Gregory, LLC

Cash non-accrual

MK Network, LLC(1)

—

Cash non-accrual

O’Currance, Inc.(1)

—

Cash non-accrual

—

Premier Trailer Leasing, Inc.(1)

—

Cash non-accrual

Repechage Investments Limited

Cash non-accrual

—

Rail Acquisition Corp.

PIK non-accrual

—

Traffic Control & Safety Corp. — Second Lien & Subordinated Term Loans

Cash non-accrual

—

(1)	We no longer hold this investment. See “— Discussion and Analysis of Results and Operations — Comparison of the three and six months ended March 31, 2012 and March 31, 2011 — Realized Gain (Loss) on Investments and Interest Rate Swaps” for a discussion of our recent realization events.

Income non-accrual amounts related to the above investments for the three and six months ended March 31, 2012 and March 31, 2011 were as follows:


	Three months ended March 31, 2012		Three months ended March 31, 2011		Six months ended March 31, 2012		Six months ended March 31, 2011
Cash interest income	$	967	$	1,460	$	2,157	$	3,566
PIK interest income		1,217		146		2,044		387
OID income		6		30		96		60

Total	$	2,190	$	1,636	$	4,297	$	4,013

Discussion and Analysis of Results and Operations

Results of Operations

The principal measure of our financial performance is the net increase (decrease) in net assets resulting from operations, which includes net investment income (loss), net realized gain (loss) and net unrealized appreciation (depreciation). Net investment income is the difference between our income from interest, dividends, fees, and other investment income and total expenses. Net realized gain (loss) on investments is the difference between the proceeds received from dispositions of portfolio investments and their stated costs. Net unrealized appreciation (depreciation) is the net change in the fair value of our investment portfolio and interest rate swap.

Comparison of the three and six months ended March 31, 2012 and March 31, 2011

Total Investment Income

Total investment income includes interest and dividend income on our investments, fee income and other investment income. Fee income consists principally of loan and arrangement fees, administrative fees, unused fees, amendment fees, equity structuring fees, exit fees, prepayment fees and waiver fees. Other investment income consists primarily of dividend income received from certain of our equity investments.

Total investment income for the three months ended March 31, 2012 and March 31, 2011 was $42.1 million and $29.7 million, respectively. For the three months ended March 31, 2012, this amount primarily consisted of $32.0 million of interest income from portfolio investments (which included $2.9 million of PIK interest) and $10.1 million of fee income. For the three months ended March 31, 2011, this amount primarily consisted of $25.8 million of interest income from portfolio investments (which included $3.5 million of PIK interest) and $3.9 million of fee income.

Total investment income for the six months ended March 31, 2012 and March 31, 2011 was $81.6 million and $55.0 million, respectively. For the six months ended March 31, 2012, this amount primarily consisted of $65.5 million of interest income from portfolio investments (which included $6.3 million of PIK interest) and $16.0 million of fee income. For the six months ended March 31, 2011, this amount primarily consisted of $46.6 million of interest income from portfolio investments (which included $6.6 million of PIK interest) and $8.4 million of fee income.

The increase in our total investment income for the three and six months ended March 31, 2012 as compared to the three and six months ended March 31, 2011 was primarily attributable to a higher average level of outstanding debt investments, which was principally due to a net increase of seven debt investments in our portfolio and fee income related to debt payoffs, partially offset by amortization payments received and a decrease in the weighted average yield on our debt investments from 12.84% to 12.37% during the year-over-year period.

Expenses

Expenses for the three months ended March 31, 2012 and March 31, 2011 were $19.3 million and $13.1 million, respectively. Expenses increased for the three months ended March 31, 2012 as compared to the three months ended March 31, 2011 by $6.2 million. This was due primarily to increases in:

•

Base management fee, which was attributable to a 12.4% increase in the fair value of the investment portfolio due to an increase in net investment fundings in the year-over-year period;

•

Incentive fee, which was attributable to a 37.7% increase in pre-incentive fee net investment income for the year-over-year period; and

•

Interest expense, which was attributable to an 86.2% increase in weighted average debt outstanding for the year-over-year period.

Expenses for the six months ended March 31, 2012 and March 31, 2011 were $39.1 million and $24.4 million, respectively. Expenses increased for the six months ended March 31, 2012 as compared to the six months ended March 31, 2011 by $14.7 million. This was due primarily to increases in:

•

Base management fee, which was attributable to the increase in the fair value of the investment portfolio discussed above;

•

Incentive fee, which was attributable to a 43.0% increase in pre-incentive fee net investment income for the year-over-year period; and

•

Interest expense, which was attributable to an 162.8% increase in weighted average debt outstanding for the year-over-year period. The significant increase in debt outstanding for the three and six months ended March 31, 2012 as compared to the three and six months ended March 31, 2011 is attributable to our ability to obtain attractively priced debt to finance our investment operations.

Gain on Extinguishment of Convertible Senior Notes

During the three and six months ended March 31, 2012, we repurchased $0.5 million and $11.0 million, respectively, of our Convertible Notes in the open market and surrendered them to the Trustee for cancellation. The aggregate purchase price of these Convertible Notes was $9.4 million. As such we recorded a gain in the amount of the difference between the reacquisition price and the net carrying amount of these Convertible Notes, net of the proportionate amount of unamortized debt issuance costs. The net gain on extinguishment of debt we recorded was $1.3 million for the six months ended March 31, 2012. Because this net gain was included in the amount that must be distributed to our stockholders in order for us to maintain our RIC status and is classified as a component of net investment income in our Consolidated Statements of Operations, such net gain was included in “Pre-Incentive Fee Net Investment Income” for purposes of the payment of the income incentive fee to the Investment Adviser under our investment advisory agreement.

Net Investment Income

As a result of the $12.4 million increase in total investment income as compared to the $6.2 million increase in total expenses, net investment income for the three months ended March 31, 2012 reflected a $6.2 million, or 37.7%, increase compared to the three months ended March 31, 2011.

As a result of the $26.6 million increase in total investment income and the $1.3 million gain on extinguishment of debt, as compared to the $14.7 million increase in total expenses, net investment income for the six months ended March 31, 2012 reflected a $13.2 million, or 43.0%, increase compared to the six months ended March 31, 2011.

Realized Gain (Loss) on Investments and Interest Rate Swap

Realized gain (loss) is the difference between the proceeds received from dispositions of portfolio investments and interest rate swaps and their stated costs. Realized losses may also be recorded in connection with our determination that certain investments are considered worthless securities and/or meet the conditions for loss recognition per the applicable tax rules.

During the six months ended March 31, 2012, we recorded investment realization events, including the following:

•

In November 2011, we recorded a realized loss in the amount of $18.1 million as a result of a Delaware bankruptcy court judge ruling which confirmed a Chapter 11 plan of reorganization that provided no recovery on our investment in Premier Trailer Leasing, Inc.;

•

In November 2011, we received a cash payment of $20.2 million from IZI Medical Products, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited above par (including associated fees) and we received an additional $1.3 million proceeds from our equity investment, realizing a gain of $0.8 million;

•

In December 2011, we received a cash payment of $23.0 million from ADAPCO, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited above par (including associated fees) and no realized gain or loss was recorded on this transaction;

•

In December 2011, we received a cash payment of $2.0 million from Best Vinyl Fence & Deck, LLC in full satisfaction of all obligations related to the Term Loan A under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;

•

In December 2011, we received a cash payment of $9.2 million from Actient Pharmaceuticals LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;

•

In December 2011, we sold $4.0 million of our $10.0 million debt investment in Bojangles and no realized gain or loss was recorded on this transaction;

•

In December 2011, we sold $2.0 million of our $11.5 million debt investment in US Collections, Inc. and no realized gain or loss was recorded on this transaction;

•

In January 2012, we received a cash payment of $18.5 million from IOS Acquisitions, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited above par (including associated fees) and no realized gain or loss was recorded on this transaction;

•

In February 2012, we received a cash payment of $2.1 million from O’Currance, Inc. The debt investment was exited below par and we recorded a realized loss in the amount of $10.7 million on this transaction;

•

In February 2012, we received a cash payment of $25.0 million from Ernest Health, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited above par (including associated fees) and no realized gain or loss was recorded on this transaction;

•

In March 2012, we received a cash payment of $47.7 million from CRGT, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited above par (including associated fees) and no realized gain or loss was recorded on this transaction;

•

In March 2012, we received a cash payment of $24.5 million from Epic Acquisition, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited above par (including associated fees) and no realized gain or loss was recorded on this transaction;

•

In March 2012, we received a cash payment of $48.8 million from Dominion Diagnostics, LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited above par (including associated fees) and no realized gain or loss was recorded on this transaction; and

•

In March 2012, we received a cash payment of $5.0 million from Genoa Healthcare Holdings, LLC in full satisfaction of all obligations under the senior loan agreement. The debt investment was exited at par (including associated fees) and no realized gain or loss was recorded on this transaction.

During the six months ended March 31, 2011, we recorded investment realization events, including the following:

•

In October 2010, we received a cash payment of $8.7 million from Goldco, Inc. in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;

•

In November 2010, we received a cash payment of $11.0 million from TBA Global, LLC in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;

•

In November 2010, we restructured our investment in Vanguard Vinyl, Inc. The restructuring resulted in a material modification of the terms of the loan agreement. As such, we recorded a realized loss in the amount of $1.7 million in accordance with ASC 470-50;

•

In December 2010, we restructured our investment in Nicos Polymers & Grinding, Inc. The restructuring resulted in a material modification of the terms of the loan agreement. As such, we recorded a realized loss in the amount of $3.9 million in accordance with ASC 470-50;

•

In December 2010, we received a cash payment of $25.3 million from Boot Barn in full satisfaction of all obligations under the loan agreement. The debt investment was exited at par and no realized gain or loss was recorded on this transaction;

•

In December 2010, we received a cash payment of $11.7 million from Western Emulsions, Inc. in partial satisfaction of the obligations under the loan agreement. No realized gain or loss was recorded on this transaction;

•

In December 2010, we restructured our investment in Lighting by Gregory, LLC. The restructuring resulted in a material modification of the terms of the loan agreement. As such, we recorded a realized loss in the amount of $7.8 million in accordance with ASC 470-50; and

•

In March 2011, we received a cash payment of $5.0 million from AmBath/ReBath Holdings, Inc. as part of a restructuring of the loan agreement. The restructuring resulted in a material modification of the terms of the loan agreement. As such, we recorded a realized loss in the amount of $0.3 million in accordance with ASC 470-50.

Net Unrealized Appreciation or Depreciation on Investments and Interest Rate Swap

Net unrealized appreciation or depreciation is the net change in the fair value of our investments and interest rate swap during the reporting period, including the reversal of previously recorded unrealized appreciation or depreciation when gains or losses are realized.

During the three months ended March 31, 2012, we recorded net unrealized appreciation of $8.0 million. This consisted of $10.6 million of net reclassifications from unrealized depreciation to realized losses on our investments and $0.4 million of net unrealized appreciation on equity investments, offset by $3.0 million of net unrealized depreciation on debt investments. During the three months ended March 31, 2011, we recorded net unrealized depreciation of $0.4 million. This consisted of $1.4 million of net unrealized depreciation of equity investments, offset by $0.2 million of net unrealized appreciation on debt investments, $0.6 million of net reclassifications from unrealized depreciation to realized losses and $0.2 million of net unrealized appreciation on our interest rate swap.

During the six months ended March 31, 2012, we recorded net unrealized appreciation of $13.9 million. This consisted of $27.7 million of net reclassifications from unrealized depreciation to realized losses on our investments and $1.8 million of net unrealized appreciation on equity investments, offset by $15.6 million of net unrealized depreciation on debt investments. During the six months ended March 31, 2011, we recorded net unrealized appreciation of $16.5 million. This consisted of $10.9 million of net reclassifications from unrealized depreciation to realized losses on our investments, $5.7 million of net unrealized appreciation on debt investments and $1.0 million of net unrealized appreciation on our interest rate swap, offset by $1.1 million of net unrealized depreciation on equity investments.

Financial Condition, Liquidity and Capital Resources

Cash Flows

We have a number of alternatives available to fund the growth of our investment portfolio and our operations, including, but not limited to, raising equity, increasing debt and funding from operational cash flow. Additionally, we may reduce investment size by syndicating a portion of any given transaction. We intend to fund our future distribution obligations through operating cash flow or with funds obtained through future equity and debt offerings or credit facilities, as we deem appropriate.

For the six months ended March 31, 2012, we experienced a net increase in cash and cash equivalents of $47.5 million. During that period, we had $94.8 million of cash provided by operating activities, primarily from $265.3 million of principal payments, PIK payments and sale proceeds received and $43.8 million of net investment income, offset by the funding of $204.3 million of investments and net revolvers. During the same period cash used by financing activities was $47.3 million, primarily consisting of $90.5 million of net repayments under our credit facilities, $45.4 million of cash dividends paid, $9.4 million of net repurchases of our convertible senior notes and $2.0 million of deferred financing costs paid, partially offset by $100.7 million of proceeds from the issuance of our common stock.

For the six months ended March 31, 2011, we experienced a net decrease in cash and cash equivalents of $38.2 million. During that period, we used $342.6 million of cash in operating activities, primarily for the funding of $452.7 million of investments and net revolvers, partially offset by $79.1 million of principal payments and PIK payments received and $30.6 million of net investment income. During the same period, cash provided by financing activities was $304.4 million, primarily consisting of $134.0 million of net borrowings under our credit facilities, $65.3 million of SBA borrowings and $143.9 million of proceeds from the issuance of our common stock, partially offset by $34.0 million of cash dividends paid and $4.3 million of deferred financing costs paid.

As of March 31, 2012, we had $115.2 million in cash and cash equivalents, portfolio investments (at fair value) of $1.06 billion, $6.8 million of interest and fees receivable, $150.0 million of SBA debentures payable, $87.5 million of borrowings outstanding under our credit facilities, $124.0 million of convertible senior notes payable and unfunded commitments of $94.4 million.

As of September 30, 2011, we had $67.6 million in cash and cash equivalents, portfolio investments (at fair value) of $1.12 billion, $6.8 million of interest and fees receivable, $150.0 million of SBA debentures payable, $178.0 million of borrowings outstanding under our credit facilities, $135.0 million of convertible senior notes payable and unfunded commitments of $108.8 million.

Other Sources of Liquidity

We intend to continue to generate cash primarily from cash flows from operations, including interest earned, future borrowings and future offerings of securities. In the future, we may also securitize a portion of our investments in first and second lien senior loans or unsecured debt or other assets. To securitize loans, we would likely create a wholly-owned subsidiary and contribute a pool of loans to the subsidiary. We would then sell interests in the subsidiary on a non-recourse basis to purchasers and we would retain all or a portion of the equity in the subsidiary. Our primary use of funds is investments in our targeted asset classes and cash distributions to holders of our common stock.

Although we expect to fund the growth of our investment portfolio through the net proceeds from future equity offerings, including our dividend reinvestment plan, and issuances of senior securities or future borrowings, to the extent permitted by the 1940 Act, our plans to raise capital may not be successful. In this regard, because our common stock has at times traded at a price below our then-current net asset value per share and we are limited in our ability to sell our common stock at a price below net asset value per share, we may be limited in our ability to raise equity capital.

In addition, we intend to distribute between 90% and 100% of our taxable income to our stockholders in order to satisfy the requirements applicable to RICs under Subchapter M of the Code. See “Regulated Investment Company Status and Distributions” below. Consequently, we may not have the funds or the ability to fund new investments, to make additional investments in our portfolio companies, to fund our unfunded commitments to portfolio companies or to repay borrowings. In addition, the illiquidity of our portfolio investments may make it difficult for us to sell these investments when desired and, if we are required to sell these investments, we may realize significantly less than their recorded value.

Also, as a business development company, we generally are required to meet a coverage ratio of total assets, less liabilities and indebtedness not represented by senior securities, to total senior securities, which include all of our borrowings and any outstanding preferred stock, of at least 200%. This requirement limits the amount that we may borrow. As of March 31, 2012, we were in compliance with this requirement. The amount of leverage that we employ will depend on our assessment of market conditions and other factors at the time of any proposed borrowing, such as the maturity, covenant package and rate structure of the proposed borrowings, our ability to raise funds through the issuance of shares of our common stock and the risks of such borrowings within the context of our investment outlook. Ultimately, we only intend to use leverage if the expected returns from borrowing to make investments will exceed the cost of such borrowing. To fund growth in our investment portfolio in the future, we anticipate needing to raise additional capital from various sources, including the equity markets and the securitization or other debt-related markets, which may or may not be available on favorable terms, if at all.

Finally, through a wholly-owned subsidiary, we sought and obtained a license from the SBA to operate an SBIC. In this regard, on February 3, 2010, our wholly-owned subsidiary, Fifth Street Mezzanine Partners IV, L.P., received a license, effective February 1, 2010, from the SBA to operate as an SBIC under Section 301(c) of the Small Business Investment Act of 1958. SBICs are designated to stimulate the flow of private equity capital to eligible small businesses. Under SBA regulations, SBICs may make loans to eligible small businesses and invest in the equity securities of small businesses.

The SBIC license allows our SBIC subsidiary to obtain leverage by issuing SBA-guaranteed debentures, subject to the issuance of a capital commitment by the SBA and other customary procedures. SBA-guaranteed debentures are non-recourse, interest only debentures with interest payable semi-annually and have a ten year maturity. The principal amount of SBA-guaranteed debentures is not required to be paid prior to maturity but may be prepaid at any time without penalty. The interest rate of SBA-guaranteed debentures is fixed at the time of issuance at a market-driven spread over U.S. Treasury Notes with 10-year maturities.

SBA regulations currently limit the amount that our SBIC subsidiary may borrow to a maximum of $150 million when it has at least $75 million in regulatory capital, receives a capital commitment from the SBA and has been through an examination by the SBA subsequent to licensing. As of March 31, 2012, our SBIC subsidiary had $75 million in regulatory capital. The SBA has issued a capital commitment to our SBIC subsidiary in the amount of $150 million, and $150.0 million of SBA debentures were outstanding as of March 31, 2012 that had a fair value of $126.2 million. These debentures bear interest at a weighted average interest rate of 3.567% (excluding the SBA annual charge), as follows:


Rate Fix Date	Debenture Amount		Fixed Interest Rate			SBA Annual Charge
September 2010	$	73,000		3.215	%		0.285	%
March 2011		65,300		4.084	%		0.285	%
September 2011		11,700		2.877	%		0.285	%

We have received exemptive relief from the Securities and Exchange Commission (“SEC”) to permit us to exclude the debt of the SBIC subsidiary guaranteed by the SBA from the definition of senior securities in the 200% asset coverage test under the 1940 Act. This allows us increased flexibility under the 200% asset coverage test by permitting us to borrow up to $150 million more than we would otherwise be able to absent the receipt of this exemptive relief.

We have also submitted an application to the SBA for a second SBIC license. On May 27, 2011, we received a letter from the Investment Division of the SBA that invited us to continue moving forward with this application. If approved, this license would provide us with the capability to issue an additional $75 million of SBA-guaranteed debentures beyond the $150 million of SBA-guaranteed debentures we, through our wholly-owned subsidiary, currently have the ability to issue. However, there are no assurances that we will be successful in obtaining a second SBIC license from the SBA. If we are able to successfully obtain such an additional SBIC license, we would have similar relief from the 200% asset coverage ratio limitation as described above with respect to the SBIC debt securities issued by such SBIC subsidiary.

Significant capital transactions that occurred since October 1, 2010

The following table reflects the dividend distributions per share that our Board of Directors has declared and we have paid, including shares issued under our DRIP, on our common stock since October 1, 2010:

Date Declared

Record Date

Payment Date

Amount per
Share

Cash
Distribution

DRIP Shares
Issued

DRIP Shares
Value

November 30, 2010

January 4, 2011

January 31, 2011

0.1066

5.4 million

36,038

0.5 million

November 30, 2010

February 1, 2011

February 28, 2011

0.1066

5.4 million

29,072

0.4 million

November 30, 2010

March 1, 2011

March 31, 2011

0.1066

6.5 million

43,766

0.6 million

January 30, 2011

April 1, 2011

April 29, 2011

0.1066

6.5 million

45,193

0.6 million

January 30, 2011

May 2, 2011

May 31, 2011

0.1066

6.5 million

48,870

0.6 million

January 30, 2011

June 1, 2011

June 30, 2011

0.1066

6.5 million

55,367

0.6 million

May 2, 2011

July 1, 2011

July 29, 2011

0.1066

7.1 million

58,829

0.6 million

May 2, 2011

August 1, 2011

August 31, 2011

0.1066

7.1 million

64,431

0.6 million

May 2, 2011

September 1, 2011

September 30, 2011

0.1066

7.2 million

52,487

0.5 million

August 1, 2011

October 14, 2011

October 31, 2011

0.1066

7.3 million

40,388

(1)

0.4 million

August 1, 2011

November 15, 2011

November 30, 2011

0.1066

7.3 million

43,034

(1)

0.4 million

August 1, 2011

December 13, 2011

December 23, 2011

0.1066

7.3 million

43,531

(1)

0.4 million

November 10, 2011

January 13, 2012

January 31, 2012

0.0958

6.6 million

29,902

(1)

0.3 million

November 10, 2011

February 15, 2012

February 29, 2012

0.0958

7.4 million

45,071

0.4 million

November 10, 2011

March 15, 2012

March 30, 2012

0.0958

7.5 million

42,071

(1)

0.4 million

February 7, 2012

April 13, 2012

April 30, 2012

0.0958

7.3 million

43,531

(1)

0.4 million

(1)	Shares were purchased on the open market and distributed.

The following table reflects share transactions that occurred from October 1, 2010 through March 31, 2012:

Date

Transaction

Shares

Share Price

Gross Proceeds

December 2010

At-the-market offering

429,110

11.87

(3)

5.1 million

February 4, 2011

Public offering(1)

11,500,000

12.65

145.5 million

June 24, 2011

Public offering(2)

5,558,469

11.72

65.1 million

January 26, 2012

Public offering

10,000,000

10.07

100.7 million

(1)	Includes the underwriters’ full exercise of their over-allotment option

(2)	Includes the underwriters’ partial exercise of their over-allotment option

(3)	Average offering price

Borrowings

On November 16, 2009, we and Fifth Street Funding, LLC, a consolidated wholly-owned bankruptcy remote special purpose subsidiary (“Funding”), entered into a Loan and Servicing Agreement (“Wells Agreement”) with respect to a three-year credit facility (“Wells Fargo facility”) with Wells Fargo Bank, National Association (“Wells Fargo”), as successor to Wachovia Bank, National Association (“Wachovia”), Wells Fargo Securities, LLC, as administrative agent, each of the additional institutional and conduit lenders party thereto from time to time, and each of the lender agents party thereto from time to time, in the amount of $50 million,

with an accordion feature which allowed for potential future expansion of the facility up to $100 million. The facility bore interest at LIBOR plus 4.0% per annum and had a maturity date of November 16, 2012.

On May 26, 2010, we amended the Wells Fargo facility to expand the borrowing capacity under that facility. Pursuant to the amendment, we received an additional $50 million commitment, thereby increasing the size of the facility from $50 million to $100 million, with an accordion feature that allows for potential future expansion of that facility from a total of $100 million up to a total of $150 million. In addition, the interest rate of the Wells Fargo facility was reduced from LIBOR plus 4% per annum to LIBOR plus 3.5% per annum, with no LIBOR floor, and the maturity date of the facility was extended from November 16, 2012 to May 26, 2013.

On November 5, 2010, we amended the Wells Fargo facility to, among other things, provide for the issuance from time to time of letters of credit for the benefit of our portfolio companies. The letters of credit are subject to certain restrictions, including a borrowing base limitation and an aggregate sublimit of $15.0 million. On February 28, 2011, we amended the Wells Fargo facility to, among other things, (i) reduce the interest rate to LIBOR plus 3.0% per annum, with no LIBOR floor, (ii) extend the period during which we may make new borrowings under the facility to February 25, 2013, and (iii) extend the maturity date of the facility to February 25, 2014. The facility may be extended for up to two additional years upon the mutual consent of Wells Fargo and each of the lender parties thereto. On November 30, 2011, we amended the Wells Fargo facility to, among other things, reduce the interest rate to LIBOR plus 2.75% per annum, with no LIBOR floor. On April 23, 2012, we amended the Wells Fargo facility to, among other things, expand the borrowing capacity under the facility. Pursuant to the amendment, we received an additional $50 million commitment, thereby increasing the size of the facility to $150 million, with an accordion feature which allows for future expansion of the facility up to a total of $250 million. In addition, the period during which we may make and reinvest borrowings under the facility was extended to April 23, 2014 and the maturity date of the facility was extended to April 25, 2016.

In connection with the Wells Fargo facility, we concurrently entered into (i) a Purchase and Sale Agreement with Funding, pursuant to which we will sell to Funding certain loan assets we have originated or acquired, or will originate or acquire and (ii) a Pledge Agreement with Wells Fargo, pursuant to which we pledged all of our equity interests in Funding as security for the payment of Funding’s obligations under the Wells Agreement and other documents entered into in connection with the Wells Fargo facility. Funding was formed for the sole purpose of entering into the Wells Fargo facility and has no other operations.

The Wells Agreement and related agreements governing the Wells Fargo facility required both Funding and us to, among other things (i) make representations and warranties regarding the collateral as well as each of our businesses, (ii) agree to certain indemnification obligations and (iii) comply with various covenants, servicing procedures, limitations on acquiring and disposing of assets, reporting requirements and other customary requirements for similar credit facilities. The Wells Fargo facility agreements also include usual and customary default provisions such as the failure to make timely payments under the facility, a change in control of Funding, and the failure by Funding or us to materially perform under the Wells Agreement and related agreements governing the facility, which, if not complied with, could accelerate repayment under the facility, thereby materially and adversely affecting our liquidity, financial condition and results of operations.

The Wells Fargo facility is secured by all of the assets of Funding, and all of our equity interest in Funding. We use the Wells Fargo facility to fund a portion of our loan origination activities and for general corporate purposes. Each loan origination under the facility is subject to the satisfaction of certain conditions. We cannot be assured that Funding will be able to borrow funds under the Wells Fargo facility at any particular time or at all. As of March 31, 2012, we had $7.0 million of borrowings outstanding under the Wells Fargo facility that had a fair value of $7.0 million. Our borrowings under the Wells Fargo facility bore interest at a weighted average interest rate of 3.130% during the six months ended March 31, 2012. For the three and six months ended March 31, 2012, we recorded interest expense of $0.6 million and $1.3 million, respectively, related to the Wells Fargo facility.

On May 27, 2010, we entered into a three-year secured syndicated revolving credit facility (“ING facility”) pursuant to a Senior Secured Revolving Credit Agreement (“ING Credit Agreement”) with certain lenders party thereto from time to time and ING Capital LLC, as administrative agent. The ING facility allowed for us to

borrow money at a rate of either (i) LIBOR plus 3.5% per annum or (ii) 2.5% per annum plus an alternate base rate based on the greatest of the Prime Rate, Federal Funds Rate plus 0.5% per annum or LIBOR plus 1% per annum, and had a maturity date of May 27, 2013. The ING facility also allowed us to request letters of credit from ING Capital LLC, as the issuing bank. The initial commitment under the ING facility was $90 million, and the ING facility included an accordion feature that allows for potential future expansion of the facility up to a total of $150 million. The ING facility is secured by substantially all of our assets, as well as the assets of our wholly-owned subsidiary, FSFC Holdings, Inc., and our indirect wholly-owned subsidiary, Fifth Street Fund of Funds LLC, subject to certain exclusions for, among other things, equity interests in our SBIC subsidiary and equity interests in Funding and Fifth Street Funding II, LLC as further set forth in a Guarantee, Pledge and Security Agreement (“ING Security Agreement”) entered into in connection with the ING Credit Agreement, among FSFC Holdings, Inc., ING Capital LLC, as collateral agent, and us. Fifth Street Fund of Funds LLC and FSFC Holdings, Inc. were formed to hold certain of our portfolio companies for tax purposes and have no other operations. None of our SBIC subsidiary, Funding or Fifth Street Funding II, LLC is party to the ING facility and their respective assets have not been pledged in connection therewith. The ING facility provides that we may use the proceeds and letters of credit under the facility for general corporate purposes, including acquiring and funding leveraged loans, mezzanine loans, high-yield securities, convertible securities, preferred stock, common stock and other investments.

On February 22, 2011, we amended the ING facility to, among other things, expand the borrowing capacity to $215 million. In addition, the ING facility’s accordion feature was increased to allow for potential future expansion up to a total of $300 million and the maturity date was extended to February 22, 2014. On July 8, 2011, we amended the ING facility to, among other things, expand the borrowing capacity to $230 million and increase the accordion feature to allow for potential future expansion up to a total of $350 million. In addition, the ING facility’s interest rate was reduced to LIBOR plus 3.0% per annum, with no LIBOR floor, when the facility is drawn more than 35%. Otherwise, the interest rate will be LIBOR plus 3.25% per annum, with no LIBOR floor.

On February 29, 2012, we amended the ING facility to, among other things, (i) extend the period during which we may make and repay borrowings under the ING facility to February 27, 2015, (ii) extend the maturity date to February 29, 2016 and (iii) increase the accordion feature to allow for potential future expansion up to a total of $450 million.

Pursuant to the ING Security Agreement, FSFC Holdings, Inc. and Fifth Street Fund of Funds LLC guaranteed the obligations under the ING Security Agreement, including our obligations to the lenders and the administrative agent under the ING Credit Agreement. Additionally, we pledged our entire equity interest in FSFC Holdings, Inc. and FSFC Holdings, Inc. pledged its entire equity interest in Fifth Street Fund of Funds LLC to the collateral agent pursuant to the terms of the ING Security Agreement.

The ING Credit Agreement and related agreements governing the ING facility required FSFC Holdings, Inc., Fifth Street Fund of Funds LLC and us to, among other things (i) make representations and warranties regarding the collateral as well as each of our businesses, (ii) agree to certain indemnification obligations and (iii) agree to comply with various affirmative and negative covenants and other customary requirements for similar credit facilities. The ING facility documents also include usual and customary default provisions such as the failure to make timely payments under the facility, the occurrence of a change in control, and the failure by us to materially perform under the ING Credit Agreement and related agreements governing the facility, which, if not complied with, could accelerate repayment under the facility, thereby materially and adversely affecting our liquidity, financial condition and results of operations.

Each loan or letter of credit originated under the ING facility is subject to the satisfaction of certain conditions. We cannot be assured that we will be able to borrow funds under the ING facility at any particular time or at all.

As of March 31, 2012, we had $80.5 million of borrowings outstanding under the ING facility that had a fair value of $80.5 million. Our borrowings under the ING facility bore interest at a weighted average interest rate of

3.403% during the six months ended March 31, 2012. For the three and six months ended March 31, 2012, we recorded interest expense of $1.4 million and $2.8 million, respectively, related to the ING facility.

On September 16, 2011, Fifth Street Funding II, LLC, a consolidated wholly-owned bankruptcy remote, special purpose subsidiary (“Funding II”), entered into a Loan and Servicing Agreement (“Sumitomo Agreement”) with respect to a seven-year credit facility (“Sumitomo facility”) with Sumitomo Mitsui Banking Corporation (“SMBC”), an affiliate of Sumitomo Mitsui Financial Group, Inc., as administrative agent, and each of the lenders from time to time party thereto, in the amount of $200 million. The Sumitomo facility bears interest at a rate of LIBOR plus 2.25% per annum with no LIBOR floor, permits us to make new norrowings until September 16, 2014, matures on September 16, 2018 and includes an option for a one-year extension.

In connection with the Sumitomo facility, we concurrently entered into a Purchase and Sale Agreement with Funding II, pursuant to which we will sell to Funding II certain loan assets we have originated or acquired, or will originate or acquire.

The Sumitomo Agreement and related agreements governing the Sumitomo facility required both Funding II and us to, among other things (i) make representations and warranties regarding the collateral as well as each of our businesses, (ii) agree to certain indemnification obligations and (iii) comply with various covenants, servicing procedures, limitations on acquiring and disposing of assets, reporting requirements and other customary requirements for similar credit facilities. The Sumitomo facility agreements also include usual and customary default provisions such as the failure to make timely payments under the facility, a change in control of Funding II, and the failure by Funding II or us to materially perform under the Sumitomo Agreement and related agreements governing the Sumitomo facility, which, if not complied with, could accelerate repayment under the facility, thereby materially and adversely affecting our liquidity, financial condition and results of operations. Funding II was formed for the sole purpose of entering into the Sumitomo facility and has no other operations.

The Sumitomo facility is secured by all of the assets of Funding II. Each loan origination under the facility is subject to the satisfaction of certain conditions. We cannot be assured that Funding II will be able to borrow funds under the Sumitomo facility at any particular time or at all. As of March 31, 2012, we had no borrowings outstanding under the Sumitomo facility. Our borrowings under the Sumitomo facility bore interest at a weighted average interest rate of 2.773% during the six months ended March 31, 2012. For the three and six months ended March 31, 2012, we recorded interest expense of $0.2 million and $0.4 million, respectively, related to the Sumitomo facility.

As of March 31, 2012, except for assets that were funded through our SBIC subsidiary, substantially all of our assets were pledged as collateral under the Wells Fargo facility, ING facility or the Sumitomo facility. With respect to the assets funded through our SBIC subsidiary, the SBA, as a creditor, will have a superior claim to the SBIC subsidiary’s assets over our stockholders.

The following table describes significant financial covenants with which we must comply under each of our credit facilities on a quarterly basis. The Sumitomo facility does not require us to comply with significant financial covenants.


Facility	Financial Covenant	Description	Target Value	Reported Value(1)
Wells Fargo facility	Minimum shareholders’ equity (inclusive of affiliates)	Net assets shall not be less than $510 million plus 50% of the aggregate net proceeds of all sales of equity interests after February 25, 2011	$541 million	$716 million
	Minimum shareholders’ equity (exclusive of affiliates)	Net assets exclusive of affiliates other than Funding shall not be less than $250 million	$250 million	$557 million
	Asset coverage ratio	Asset coverage ratio shall not be less than 2.00:1	2.00:1	3.14:1
ING facility	Minimum shareholders’ equity	Net assets shall not be less than the greater of (a) 55% of total assets; and (b) $510 million plus 50% of the aggregate net proceeds of all sales of equity interests after February 22, 2011	$670 million	$716 million
	Asset coverage ratio	Asset coverage ratio shall not be less than 2.25:1	2.25:1	3.14:1
	Interest coverage ratio	Interest coverage ratio shall not be less than 2.50:1	2.50:1	6.81:1
	Eligible portfolio investments test	Aggregate value of (a) Cash and cash equivalents and (b) Portfolio investments rated 1, 2 or 3 shall not be less than $175 million	$175 million	$687 million

(1)

As contractually required, we report financial covenants based on the last filed quarterly or annual report, in this case our Form 10-Q for the quarter ended December 31, 2011. We were also in compliance with all financial covenants under these credit facilities based on the financial information contained in this Form 10-Q for the quarter ended March 31, 2012.

We and our SBIC subsidiary are also subject to certain regulatory requirements relating to our borrowings. For a discussion of such requirements, see “Item 1. Business — Regulation — Business Development Company Regulations” and “— Small Business Investment Company Regulations” in our Annual Report on Form 10-K for the year ended September 30, 2011.

The following table reflects material credit facility and SBA debenture transactions that have occurred since October 1, 2009. Amounts available and drawn are as of March 31, 2012:

Facility

Date

Transaction

Total
Facility
Amount

Upfront
fee Paid

Total
Facility
Availability

Amount
Drawn

Remaining
Availability

Interest Rate

Wells Fargo facility

11/16/2009

Entered into credit facility

50 million

0.8 million

LIBOR + 4.00%

5/26/2010

Expanded credit facility

100 million

0.9 million

LIBOR + 3.50%

2/28/2011

Amended credit facility

100 million

0.4 million

LIBOR + 3.00%

11/30/2011

Amended credit facility

100 million

—

LIBOR + 2.75%

4/23/2012

Amended credit facility

150 million

1.2 million

41 million

(1)

7 million

34 million

LIBOR + 2.75%

ING facility

5/27/ 2010

Entered into credit facility

90 million

0.8 million

LIBOR + 3.50%

2/22/ 2011

Expanded credit facility

215 million

1.6 million

LIBOR + 3.50%

7/8/ 2011

Expanded credit facility

230 million

0.4 million

LIBOR + 3.00%/3.25%(2)

2/29/2012

Amended credit facility

230 million

1.5 million

230 million

81 million

149 million

LIBOR + 3.00%/3.25%(2)

SBA

2/16/ 2010

Received capital commitment

75 million

0.8 million

9/21/ 2010

Received capital commitment

150 million

0.8 million

150 million

—

3.567%(3)

Sumitomo facility

9/16/2011

Entered into credit facility

200 million

2.5 million

52 million

(1)

—

52 million

LIBOR + 2.25%

(1)	Availability to increase upon our decision to further collateralize the facility.

(2)	LIBOR plus 3.0% when the facility is drawn more than 35%. Otherwise, LIBOR plus 3.25%.

(3)	Weighted average interest rate of 3.567% (excludes the SBA annual charge of 0.285%).

On April 12, 2011, we issued $152 million unsecured convertible senior notes (“Convertible Notes”), including $2 million issued to Leonard M. Tannenbaum, our Chief Executive Officer. The Convertible Notes were issued pursuant to an Indenture, dated April 12, 2011 (the “Indenture”), between us and Deutsche Bank Trust Company Americas, as trustee (the “Trustee”).

The Convertible Notes mature on April 1, 2016 (the “Maturity Date”), unless previously converted or repurchased in accordance with their terms. The Convertible Notes bear interest at a rate of 5.375% per year payable semiannually in arrears on April 1 and October 1 of each year, commencing on October 1, 2011. The Convertible Notes are our senior unsecured obligations and rank senior in right of payment to our existing and future indebtedness that is expressly subordinated in right of payment to the Convertible Notes; equal in right of payment to our existing and future unsecured indebtedness that is not so subordinated; effectively junior in right of payment to any of our secured indebtedness (including existing unsecured indebtedness that we later secure) to the extent of the value of the assets securing such indebtedness; and structurally junior to all existing and future indebtedness (including trade payables) incurred by our subsidiaries or financing vehicles.

Prior to the close of business on the business day immediately preceding January 1, 2016, holders may convert their Convertible Notes only under certain circumstances set forth in the Indenture, such as during specified periods when our shares of common stock trade at more than 110% of the then applicable conversion price or the Convertible Notes trade at less than 98% of their conversion value. On or after January 1, 2016 until the close of business on the business day immediately preceding the Maturity Date, holders may convert their Convertible Notes at any time. Upon conversion, we will deliver shares of our common stock. The conversion rate was initially, and currently is, 67.7415 shares of common stock per $1,000 principal amount of Convertible Notes (equivalent to a conversion price of approximately $14.76 per share of common stock). The conversion rate is subject to customary anti-dilution adjustments, including for any cash dividends or distributions paid on shares of our common stock in excess of a monthly dividend of $0.1066 per share, but will not be adjusted for any accrued and unpaid interest. In addition, if certain corporate events occur prior to the Maturity Date, the conversion rate will be increased for converting holders. Based on the current conversion rate, the maximum number of shares of common stock that would be issued upon conversion of the $124.0 million convertible debt outstanding at March 31, 2012 is 8,399,946. If we deliver shares of common stock upon a conversion at the time our net asset value per share exceeds the conversion price in effect at such time, our stockholders may incur dilution. In addition, our stockholders will experience dilution in their ownership percentage of our common stock upon our issuance of common stock in connection with the conversion of our convertible senior notes and any dividends paid on our common stock will also be paid on shares issued in connection with such conversion after such issuance. The shares of common stock issued upon a conversion are not subject to registration rights.

We may not redeem the Convertible Notes prior to maturity. No sinking fund is provided for the Convertible Notes. In addition, if certain corporate events occur in respect to us, holders of the Convertible Notes may require us to repurchase for cash all or part of their Convertible Notes at a repurchase price equal to 100% of the principal amount of the Convertible Notes to be repurchased, plus accrued and unpaid interest through, but excluding, the required repurchase date.

The Indenture contains certain covenants, including covenants requiring us to provide financial information to the holders of the Convertible Notes and the Trustee if we cease to be subject to the reporting requirements of the Securities Exchange Act of 1934. These covenants are subject to limitations and exceptions that are described in the Indenture.

For the three and six months ended March 31, 2012, we recorded interest expense of $1.8 million and $3.7 million, respectively, related to the Convertible Notes.

We may repurchase the Convertible Notes in accordance with the 1940 Act and the rules promulgated thereunder. Any Convertible Notes repurchased by us may, at our option, be surrendered to the Trustee for cancellation, but may not be reissued or resold by us. Any Convertible Notes surrendered for cancellation will be promptly cancelled and no longer outstanding under the Indenture. During the three and six months ended March 31, 2012, we repurchased $0.5 million and $11.0 million principal, respectively, of the Convertible Notes in the open market for an aggregate purchase price of $9.4 million and surrendered them to the Trustee for cancellation.

As of March 31, 2012, there were $124.0 million Convertible Notes outstanding, which had a fair value of $118.0 million.

Off-Balance Sheet Arrangements

We may be a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of our portfolio companies. As of March 31, 2012, our only off-balance sheet arrangements consisted of $94.4 million of unfunded commitments, which was comprised of $85.5 million to provide debt financing to certain of our portfolio companies and $8.9 million related to unfunded limited partnership interests. As of September 30, 2011, our only off-balance sheet arrangements consisted of $108.8 million, which was comprised of $102.7 million to provide debt financing to certain of our portfolio companies and $6.1 million related to unfunded limited partnership interests. Such commitments are subject to our portfolio companies’ satisfaction of certain financial and nonfinancial covenants and involve, to varying degrees, elements of credit risk in excess of the amount recognized in the Statement of Assets and Liabilities and are not reflected on our Consolidated Statement of Assets and Liabilities.

A summary of the composition of unfunded commitments (consisting of revolvers, term loans and limited partnership interests) as of March 31, 2012 and September 30, 2011 is shown in the table below:


	March 31, 2012		September 30, 2011
JTC Education, Inc	$	11,825	$	14,000
Welocalize, Inc.		10,000		750
Charter Brokerage, LLC		7,353		6,176
Rail Acquisition Corp.		5,630		5,446
Refac Optical Group		5,500		5,500
Phoenix Brands Merger Sub LLC		4,286		3,000
Enhanced Recovery Company, LLC		4,000		4,000
DISA, Inc.		4,000		4,000
Specialty Bakers, LLC		4,000		2,000
World 50, Inc.		4,000		—
Miche Bag, LLC		3,500		5,000
Titan Fitness, LLC		3,500		2,957
Discovery Practice Management, Inc.		3,000		3,000
Cardon Healthcare Network, LLC		3,000		2,000
Traffic Control & Safety Corp.		2,514		3,014
Riverside Fund V, LP (limited partnership interest)		2,000		—
Mansell Group, Inc.		2,000		2,000
Physicians Pharmacy Alliance, Inc.		2,000		2,000
Tegra Medical, LLC		1,500		1,500
Milestone Partners IV, LP (limited partnership interest)		1,475		2,000
Eagle Hospital Physicians, Inc.		1,400		2,500
Psilos Group Partners IV, LP (limited partnership interest)		1,000		1,000
CPASS Acquisition Company		1,000		—
ACON Equity Partners III, LP (limited partnership interest)		1,000		—
Bunker Hill Capital II (QP), LP (limited partnership interest)		934		960
Riverlake Equity Partners II, LP (limited partnership interest)		760		878
HealthDrive Corporation		750		2,000
RCPDirect, LP (limited partnership interest)		703		—
Baird Capital Partners V, LP (limited partnership interest)		614		701
Riverside Fund IV, LP (limited partnership interest)		402		555
Saddleback Fence and Vinyl Products, Inc.		401		400
Advanced Pain Management		400		267
CRGT, Inc.		—		12,500
Dominion Diagnostics, LLC		—		5,000
ADAPCO, Inc.		—		4,250
Epic Acquisition, Inc.		—		3,000
IZI Medical Products, Inc.		—		2,500
Flatout, Inc.		—		1,500
IOS Acquisitions, Inc.		—		1,250
Best Vinyl Fence & Deck, LLC		—		1,000
Trans-Trade, Inc.		—		200

Total	$	94,447	$	108,804

Contractual Obligations

The following table reflects information pertaining to debt outstanding under the SBA debentures payable, the Wells Fargo facility, the ING facility, the Sumitomo facility and our Convertible Notes:


	Debt Outstanding as of September 30, 2011		Debt Outstanding as of March 31, 2012		Weighted average debt outstanding for the six months ended March 31, 2012		Maximum debt outstanding for the six months ended March 31, 2012
SBA debentures payable	$	150,000	$	150,000	$	150,000	$	150,000
Wells Fargo facility		39,524		7,000		38,074	$	48,269
ING facility		133,500		80,500		103,287	$	145,000
Sumitomo facility		5,000		—		11,399	$	29,000
Convertible Notes		135,000		124,000		125,344	$	135,000

Total debt	$	463,024	$	361,500	$	428,104	$	490,769

The following table reflects our contractual obligations arising from the SBA debentures payable, the Wells Fargo facility, the ING facility, the Sumitomo facility, and our Convertible Notes:


	Payments due by period as of March 31, 2012
	Total		< 1 year		1-3 years		3-5 years		> 5 years
SBA debentures payable	$	150,000	$	—	$	—	$	—	$	150,000
Interest due on SBA debentures		50,953		5,778		11,556		11,572		22,047
Wells Fargo facility		7,000		—		7,000		—		—
Interest due on Wells Fargo facility		399		209		190		—		—
ING facility		80,500		—		—		80,500		—
Interest due on ING facility		10,243		2,616		5,233		2,394		—
Sumitomo facility		—		—		—		—		—
Interest due on Sumitomo facility		—		—		—		—		—
Convertible senior notes payable		124,000		—		—		124,000		—
Interest due on convertible senior notes		26,697		6,665		13,330		6,702		—

Total	$	449,792	$	15,268	$	37,309	$	225,168	$	172,047

Regulated Investment Company Status and Distributions

We elected, effective as of January 2, 2008, to be treated as a RIC under Subchapter M of the Code. As long as we qualify as a RIC, we will not be taxed on our investment company taxable income or realized net capital gains, to the extent that such taxable income or gains are distributed, or deemed to be distributed, to stockholders on a timely basis.

Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses, and generally excludes net unrealized appreciation or depreciation until realized. Dividends declared and paid by us in a year may differ from taxable income for that year as such dividends may include the distribution of current year taxable income or the distribution of prior year taxable income carried forward into and distributed in the current year. Distributions also may include returns of capital.

To maintain RIC tax treatment, we must, among other things, distribute, with respect to each taxable year, at least 90% of our investment company net taxable income (i.e., our net ordinary income and our realized net short-term capital gains in excess of realized net long-term capital losses, if any). As a RIC, we are also subject to a federal excise tax, based on distributive requirements of our taxable income on a calendar year basis (e.g., calendar year 2012). We anticipate timely distribution of our taxable income within the tax rules; however, we

incurred a de minimis U.S. federal excise tax for calendar years 2008, 2009 and 2010. We did not incur a federal excise tax for calendar year 2011 and do not expect to incur a federal excise tax for calendar year 2012. We intend to distribute to our stockholders between 90% and 100% of our annual taxable income (which includes our taxable interest and fee income). However, we are partially dependent on our SBIC subsidiary for cash distributions to enable us to meet the RIC distribution requirements. Our SBIC subsidiary may be limited by the Small Business Investment Act of 1958, and SBA regulations governing SBICs, from making certain distributions to us that may be necessary to enable us to maintain our status as a RIC. We may have to request a waiver of the SBA’s restrictions for our SBIC subsidiary to make certain distributions to maintain our RIC status. We cannot assure you that the SBA will grant such waiver. Also, the covenants under the Wells Fargo facility could, under certain circumstances, restrict Fifth Street Funding, LLC from making distributions to us and, as a result, hinder our ability to satisfy the distribution requirement. Similarly, the covenants contained in the ING facility may prohibit us from making distributions to our stockholders, and, as a result, could hinder our ability to satisfy the distribution requirement. In addition, we may retain for investment some or all of our net taxable capital gains (i.e., realized net long-term capital gains in excess of realized net short-term capital losses) and treat such amounts as deemed distributions to our stockholders. If we do this, our stockholders will be treated as if they received actual distributions of the capital gains we retained and then reinvested the net after-tax proceeds in our common stock. Our stockholders also may be eligible to claim tax credits (or, in certain circumstances, tax refunds) equal to their allocable share of the tax we paid on the capital gains deemed distributed to them. To the extent our taxable earnings for a fiscal taxable year fall below the total amount of our dividends for that fiscal year, a portion of those dividend distributions may be deemed a return of capital to our stockholders.

We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of these distributions from time to time. In addition, we may be limited in our ability to make distributions due to the asset coverage test for borrowings applicable to us as a business development company under the 1940 Act and due to provisions in our credit facilities. If we do not distribute a certain percentage of our taxable income annually, we will suffer adverse tax consequences, including possible loss of our status as a RIC. We cannot assure stockholders that they will receive any distributions or distributions at a particular level.

In accordance with certain applicable Treasury regulations and private letter rulings issued by the Internal Revenue Service, a RIC may treat a distribution of its own stock as fulfilling its RIC distribution requirements if each stockholder may elect to receive his or her entire distribution in either cash or stock of the RIC, subject to a limitation that the aggregate amount of cash to be distributed to all stockholders must be at least 20% of the aggregate declared distribution. If too many stockholders elect to receive cash, each stockholder electing to receive cash must receive a pro rata amount of cash (with the balance of the distribution paid in stock). In no event will any stockholder, electing to receive cash, receive less than 20% of his or her entire distribution in cash. If these and certain other requirements are met, for U.S federal income tax purposes, the amount of the dividend paid in stock will be equal to the amount of cash that could have been received instead of stock. We have no current intention of paying dividends in shares of our stock in accordance with these Treasury regulations or private letter rulings.

Related Party Transactions

We have entered into an investment advisory agreement with Fifth Street Management LLC, our investment adviser. Fifth Street Management is controlled by Leonard M. Tannenbaum, its managing member and the chairman of our Board of Directors and our chief executive officer. Pursuant to the investment advisory agreement, fees payable to our investment adviser will be equal to (a) a base management fee of 2.0% of the value of our gross assets, which includes any borrowings for investment purposes and excludes cash and cash equivalents, and (b) an incentive fee based on our performance. The incentive fee consists of two parts. The first part is calculated and payable quarterly in arrears and equals 20% of our “Pre-Incentive Fee Net Investment Income” for the immediately preceding quarter, subject to a preferred return, or “hurdle,” and a “catch up” feature. The second part is determined and payable in arrears as of the end of each fiscal year (or upon termination of the investment advisory agreement) and equals 20% of our “Incentive Fee Capital Gains,” which equals our realized capital gains on a cumulative basis from inception through the end of the year, if any, computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the aggregate amount of any previously paid capital gain incentive fee.

The investment advisory agreement may be terminated by either party without penalty upon no fewer than 60 days’ written notice to the other. During the three and six months ended March 31, 2012, we have incurred expenses that are due to our investment adviser of $11.1 million and $22.1 million, respectively, under the investment advisory agreement.

Pursuant to the administration agreement with FSC, Inc., which is controlled by Mr. Tannenbaum, FSC, Inc. will furnish us with the facilities and administrative services necessary to conduct our day-to-day operations, including equipment, clerical, bookkeeping and recordkeeping services at such facilities. In addition, FSC, Inc. will assist us in connection with the determination and publishing of our net asset value, the preparation and filing of tax returns and the printing and dissemination of reports to our stockholders. We will reimburse FSC, Inc. the allocable portion of overhead and other expenses incurred by it in performing its obligations under the administration agreement, including a portion of the rent and the compensation of our chief financial officer and chief compliance officer and their respective staffs. Such reimbursement is at cost with no profit to, or markup by, FSC, Inc. FSC, Inc. has voluntarily determined to forgo receiving reimbursement for the services performed for us by our chief compliance officer. Although FSC, Inc. currently intends to forgo its right to receive such reimbursement, it is under no obligation to do so and may cease to do so at any time in the future. The administration agreement may be terminated by either party without penalty upon no fewer than 60 days’ written notice to the other. During the three and six months ended March 31, 2012, we have incurred expenses that are due to FSC, Inc. of $1.0 million and $2.2 million, respectively, under the administration agreement.

We have also entered into a license agreement with Fifth Street Capital LLC pursuant to which Fifth Street Capital LLC has agreed to grant us a non-exclusive, royalty-free license to use the name “Fifth Street.” Under this agreement, we will have a right to use the “Fifth Street” name, for so long as Fifth Street Management LLC or one of its affiliates remains our investment adviser. Other than with respect to this limited license, we will have no legal right to the “Fifth Street” name. Fifth Street Capital LLC is controlled by Mr. Tannenbaum, its managing member.

Recent Developments

In April 2012, we repurchased $9.0 million principal of our Convertible Notes in the open market for an aggregate purchase price of $8.6 million.

In April 2012, we received an investment grade (BBB-) counterparty credit rating from the global rating agency Standard & Poor’s.

On April 20, 2012, Traffic Control & Safety Corporation filed for Chapter 11 bankruptcy protection in the state of Delaware.

On April 23, 2012, we amended the terms of the Wells Fargo facility to, among other things, expand the borrowing capacity under the facility. Pursuant to the amendment, we received an additional $50 million commitment, thereby increasing the size of the facility to $150 million, with an accordion feature which allows for future expansion of the facility up to a total of $250 million. In addition, the period during which we may make and reinvest borrowings under the facility was extended to April 23, 2014 and the maturity date of the facility was extended to April 25, 2016.

On May 7, 2012, our Board of Directors declared the following dividends:

•

$0.0958 per share, payable on July 31, 2012 to stockholders of record on July 13, 2012;

•

$0.0958 per share, payable on August 31, 2012 to stockholders of record on August 15, 2012; and

•

$0.0958 per share, payable on September 28, 2012 to stockholders of record on September 14, 2012.

Recently Issued Accounting Standards

See Note 2 to the Consolidated Financial Statements for a description of recent accounting pronouncements, including the expected dates of adoption and the anticipated impact on the Consolidated Financial Statements.

Item 3.

Quantitative and Qualitative Disclosure about Market Risk

We are subject to financial market risks, including changes in interest rates. Changes in interest rates may affect both our cost of funding and our interest income from portfolio investments, cash and cash equivalents and idle funds investments. Our risk management systems and procedures are designed to identify and analyze our risk, to set appropriate policies and limits and to continually monitor these risks and limits by means of reliable administrative and information systems and other policies and programs. Our investment income will be affected by changes in various interest rates, including LIBOR and prime rates, to the extent our debt investments include floating interest rates. In addition, our investments are carried at fair value as determined in good faith by our Board of Directors in accordance with the 1940 Act (See “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies — Investment Valuation”). Our valuation methodology utilizes discount rates in part in valuing our investments, and changes in those discount rates may have an impact on the valuation of our investments.

As of March 31, 2012, 65.9% of our debt investment portfolio (at fair value) and 63.2% of our debt investment portfolio (at cost) bore interest at floating rates. The composition of our floating rate debt investments by cash interest rate floor (excluding PIK) as of March 31, 2012 and September 30, 2011 was as follows:


	March 31, 2012					September 30, 2011
	Fair Value		% of Floating Rate Portfolio			Fair Value		% of Floating Rate Portfolio
Under 1%	$	91,190		13.45	%	$	125,453		16.96	%
1% to under 2%		301,794		44.50	%		261,878		35.40	%
2% to under 3%		112,363		16.57	%		168,928		22.83	%
3% to under 4%		167,342		24.67	%		176,976		23.92	%
4% to under 5%		378		0.06	%		757		0.10	%
5% and over		5,125		0.75	%		5,843		0.79	%

Total	$	678,192		100.00	%	$	739,835		100.00	%

Based on our Consolidated Statement of Assets and Liabilities as of March 31, 2012, the following table shows the approximate annualized increase (decrease) in components of net assets resulting from operations of hypothetical base rate changes in interest rates, assuming no changes in our investment and capital structure.


Basis point increase(1)	Interest income		Interest expense			Net increase
100	$	1,000	$	(1,000	)	$	—
200		4,000		(2,000	)		2,000
300		9,000		(3,000	)		6,000
400		16,000		(4,000	)		12,000
500		23,000		(4,000	)		19,000

(1)	A decline in interest rates would not have a material impact on our Consolidated Financial Statements.

We regularly measure exposure to interest rate risk. We assess interest rate risk and manage our interest rate exposure on an ongoing basis by comparing our interest rate sensitive assets to our interest rate sensitive liabilities. Based on this review, we determine whether or not any hedging transactions are necessary to mitigate exposure to changes in interest rates. The following table shows a comparison of the interest rate base for our interest-bearing cash and outstanding investments, at principal, and our outstanding borrowings as of March 31, 2012 and September 30, 2011:


	March 31, 2012				September 30, 2011
	Interest Bearing Cash and Investments		Borrowings		Interest Bearing Cash and Investments		Borrowings
Money market rate	$	115,178	$	—	$	67,644	$	—
Prime rate		706		—		38,890		53,000
LIBOR
30 day		51,658		87,500		51,368		125,024
90 day		627,996		—		654,932		—
Fixed rate		398,292		274,000		418,981		285,000

Total	$	1,193,830	$	361,500	$	1,231,815	$	463,024

On August 16, 2010, we entered into an interest rate swap agreement that was scheduled to expire on August 15, 2013, for a total notional amount of $100 million, for the purposes of hedging the interest rate risk related to the Wells facility and the ING facility. Under the interest rate swap agreement, we paid a fixed interest rate of 0.99% and received a floating rate based on the prevailing one-month LIBOR. In August 2011, we terminated our interest rate swap agreement and realized a loss of $1.3 million, which included a reclassification of $0.8 million of prior unrealized depreciation. As of March 31, 2012, we were no longer party to any interest rate swap agreements.

Item 4.

Controls and Procedures

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15 of the Securities Exchange Act of 1934). Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective in timely identifying, recording, processing, summarizing, and reporting any material information relating to us that is required to be disclosed in the reports we file or submit under the Securities Exchange Act of 1934.

There have been no changes in our internal control over financial reporting that occurred during the three months ended March 31, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

Item 1.

Legal Proceedings.

We may, from time to time, be involved in litigation arising out of our operations in the normal course of business or otherwise. Currently, we are party to pending litigation but we believe that these legal claims are frivolous and without merit, and we intend to vigorously defend ourselves against them.

Item 1A.

Risk Factors .

Except as described below, there have been no material changes during the six months ended March 31, 2012 to the risk factors discussed in Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended September 30, 2011.

Risks Related to Our Investments

Our investments in the healthcare sector face considerable uncertainties including substantial regulatory challenges.

Our investments in portfolio companies that operate in the healthcare sector represent approximately 30% of our total portfolio. Our investments in the healthcare sector are subject to substantial risks. The laws and rules governing the business of healthcare companies and interpretations of those laws and rules are subject to frequent change. Broad latitude is given to the agencies administering those regulations. Existing or future laws and rules could force our portfolio companies engaged in healthcare to change how they do business, restrict revenue, increase costs, change reserve levels and change business practices.

Healthcare companies often must obtain and maintain regulatory approvals to market many of their products, change prices for certain regulated products and to consummate some of their acquisitions and divestitures. Delays in obtaining or failure to obtain or maintain these approvals could reduce revenue or increase costs. Policy changes on the local, state and federal level, such as the expansion of the government’s role in the healthcare arena and alternative assessments and tax increases specific to the healthcare industry or healthcare products as part of federal health care reform initiatives, could fundamentally change the dynamics of the healthcare industry.

Risks Relating to Our Common Stock

Stockholders may incur dilution if we issue securities to subscribe to, convert to or purchase shares of our common stock.

The 1940 Act prohibits us from selling shares of our common stock at a price below the current net asset value per share of such stock with certain exceptions. One such exception is prior stockholder approval of issuances of securities to subscribe to, convert to or purchase shares of our common stock even if the subscription, conversion or purchase price per share of our common stock is below the net asset value per share of our common stock at the time of any such subscription, conversion or purchase. At our 2011 annual meeting of stockhold ers, our stockholders approved a proposal to authorize us to issue securities to subscribe to, convert to, or purchase shares of our common stock in one or more offerings, including under such circumstance. Such authorization has no expiration. Any decision to sell securities to subscribe to, convert to, or purchase shares of our common stock will be subject to the determination by our board of directors that such issuance is in our and our stockholders’ best interests. If we issue securities to subscribe to, convert to or purchase shares of common stock, the exercise or conversion of such securities would increase the number of outstanding shares of our common stock. Any such exercise would be dilutive on the voting power of existing stockholders, and could be dilutive with regard to dividends and our net asset value, and other economic aspects of the common stock.

Because the number of shares of common stock that could be so issued and the timing of any issuance is not currently known, the actual dilutive effect cannot be predicted; however, the table below illustrates the impact on the net asset value per common share of a business development company that would be experienced upon the exercise of a warrant to acquire shares of common stock of the business development company.

Example of Impact of Exercise of Warrant to Acquire Common Stock on Net Asset Value Per Share

The example assumes that the business development company has 1,000,000 shares of common stock outstanding, $15,000,000 in total assets and $5,000,000 in total liabilities at the time of the exercise of the warrant. As a result, the net asset value and net asset value per common share of the business development company are $10,000,000 and $10.00, respectively.

Further, the example assumes that the warrant permits the holder thereof to acquire 250,000 common shares under the following three different scenarios: (i) with an exercise price equal to a 10% premium to the business development company’s net asset value per share at the time of exercise, or $11.00 per share, (ii) with an exercise price equal to the business development company’s net asset value per share at the time of exercise, or $10.00 per share, and (iii) with an exercise price equal to a 10% discount to the business development company’s net asset value per share at the time of exercise, or $9.00 per share.


Warrant Exercise Price	Net Asset Value Per Share Prior To Exercise		Net Asset Value Per Share After Exercise
10% premium to net asset value per common share	$	10.00	$	10.20
NAV per common share	$	10.00	$	10.00
10% discount to net asset value per common share	$	10.00	$	9.80

Although we have chosen to demonstrate the impact on the net asset value per common share of a business development company that would be experienced by existing stockholders of the business development company upon the exercise of a warrant to acquire shares of common stock of the business development company, the results noted above would be similar in connection with the exercise or conversion of other securities exercisable or convertible into shares of the business development company’s common stock. In addition, the example does not take into account the impact of other securities that may be issued in connection with the issuance of exercisable or convertible securities ( e.g. , the issuance of shares of common stock in conjunction with the issuance of warrants to acquire shares of common stock).

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds.

While we did not engage in any sales of unregistered securities during the three months ended March 31, 2012, we issued a total of 45,071 shares of common stock under our dividend reinvestment plan (“DRIP”). This issuance was not subject to the registration requirements of the Securities Act of 1933, as amended. The aggregate value of the shares of our common stock issued under our DRIP was approximately $0.4 million.

Item 6.

Exhibits.


Exhibit Number		Description of Exhibit

10.1		Amendment No. 3 to Amended and Restated Senior Secured Revolving Credit Agreement among the Fifth Street Finance Corp., FSFC Holdings, Inc., Fifth Street Fund of Funds LLC, ING Capital LLC, and the lenders party thereto, dated as of February 29, 2012. (Incorporated by reference to Exhibit 10.1 filed with Fifth Street Finance Corp.’s Form 8-K (File No. 001-33901) filed on March 2, 2012).

10.2*		Amendment No. 1 and Waiver to the Loan and Servicing Agreement among Fifth Street Finance Corp., Fifth Street Funding II, LLC and Sumitomo Mitsui Banking Corporation, dated as of March 16, 2012.

10.3		Amendment No. 4 to the Amended and Restated Loan and Servicing Agreement among Fifth Street Finance Corp., Fifth Street Funding, LLC, Wells Fargo Securities, LLC and Wells Fargo Bank, N.A., dated as of April 23, 2012. (Incorporated by reference to Exhibit 10.1 filed with Fifth Street Finance Corp.’s Form 8-K (File No. 001-33901) filed on April 25, 2012).


Exhibit Number		Description of Exhibit

31.1*		Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.

31.2*		Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.

32.1*		Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).

32.2*		Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).

*	Submitted herewith.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


		Fifth Street Finance Corp.

Date: May 8, 2012		/s/ Leonard M. Tannenbaum
		Leonard M. Tannenbaum
		Chairman and Chief Executive Officer

Date: May 8, 2012		/s/ Alexander C. Frank
		Alexander C. Frank
		Chief Financial Officer

EXHIBIT INDEX


Exhibit Number		Description of Exhibit

10.1		Amendment No. 3 to Amended and Restated Senior Secured Revolving Credit Agreement among the Fifth Street Finance Corp., FSFC Holdings, Inc., Fifth Street Fund of Funds LLC, ING Capital LLC, and the lenders party thereto, dated as of February 29, 2012. (Incorporated by reference to Exhibit 10.1 filed with Fifth Street Finance Corp.’s Form 8-K (File No. 001-33901) filed on March 2, 2012).

10.2*		Amendment No. 1 and Waiver to the Loan and Servicing Agreement among Fifth Street Finance Corp., Fifth Street Funding II, LLC and Sumitomo Mitsui Banking Corporation, dated as of March 16, 2012.

10.3		Amendment No. 4 to the Amended and Restated Loan and Servicing Agreement among Fifth Street Finance Corp., Fifth Street Funding, LLC, Wells Fargo Securities, LLC and Wells Fargo Bank, N.A., dated as of April 23, 2012. (Incorporated by reference to Exhibit 10.1 filed with Fifth Street Finance Corp.’s Form 8-K (File No. 001-33901) filed on April 25, 2012).

31.1*		Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.

31.2*		Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.

32.1*		Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).

32.2*		Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).

*	Submitted herewith.

TABLE OF CONTENTS

Part I Financial Information Item 1. Consolidated Financial Statements Note 1. Organization Note 2. Significant Accounting Policies Note 3. Portfolio Investments Note 4. Fee Income Note 5. Share Data Note 6. Lines Of Credit Note 7. Interest and Dividend Income Note 8. Taxable/distributable Income and Dividend Distributions Note 9. Realized Gains Or Losses and Net Unrealized Appreciation Or Depreciation on Investments and Interest Rate Swap Note 10. Concentration Of Credit Risks Note 11. Related Party Transactions Note 12. Financial Highlights Note 13. Interest Rate Swap Note 14. Convertible Senior Notes Note 15. Subsequent Events Item 2. Management S Discussion and Analysis Of Financial Condition and Results Of Operations Item 3. Quantitative and Qualitative Disclosure About Market Risk Item 4. Controls and Procedures Part II Other Information Item 1. Legal Proceedings Item 1A. Risk Factors Item 2. Unregistered Sales Of Equity Securities and Use Of Proceeds Item 6. Exhibits

OCSL 10-Q Quarter ended March 31, 2012