Floating rate senior loans are rated below investment grade. What does that mean for investors?

Senior loans are rated below-investment grade—just like their sister market, high yield bonds. Due to higher leverage and other factors, non-investment-grade debt has a greater risk of default than the so-called high grade markets. Investors typically are Compensated for this higher risk with higher yields. These types of loans are typically made to companies with ratings below investment grade, so the level of credit risk (i.e., the degree to which changes in the issuers’ financial condition will affect bond prices) is comparatively high. It’s important to keep in mind that valuations in this market segment can change quickly. In other words, just because the bonds are “senior” doesn’t mean that they aren’t volatile.

Is the senior loan market liquid?

In aggregate, the roughly $900 billion senior loan market is quite liquid although it faced the same liquidity challenges witnessed by all debt markets during the 2007/2008 financial crisis. Within the sector itself, larger issues tend to be more liquid than smaller, and the loans of well-known companies may be a better bid than those of the more esoteric. Liquidity may also be impacted for issues that are facing credit stress which, in some cases, may provide the opportunity for bottom-up managers to purchase loans at a deep discount to their intrinsic value.

What might happen to senior loans in a recession?

Like corporate bonds, senior loans are subject to the credit risk of the indebted company and economic slowdowns may put pressure on corporate cash flows and/or profitability. Declining cash flows may reduce the ability of a company to service its debt and, incidentally, may push its market price lower. The lower credit ratings of senior loans by that senior loans are more highly leveraged than their investment-grade counterparts or may provide lower recovery rates in the event of a default. This means they may be more vulnerable in a recession, however, managers may seek to mitigate the credit risk associated with below investment-grade debt by careful credit analysis of the borrower and an assessment of the collateral attached to the loan. Although our investment process is bottom-up (focusing on the fundamental risk characteristics of a single issuer), we are influenced by developments in the broader economic and credit cycles that might impact specific industries or the senior loan market in general. The nationally recognized statistical rating organizations (NRSROs) relative to investment grade debt may indicate that senior loans are more highly leveraged than their investment-grade counterparts or may provide lower recovery rates in the event of a default. This means they may be more vulnerable in a recession, however, managers may seek to mitigate the credit risk associated with below investment-grade debt by careful credit analysis of the borrower and an assessment of the collateral attached to the loan. Although our investment process is bottom-up (focusing on the fundamental risk characteristics of a single issuer), we are influenced by developments in the broader economic and credit cycles that might impact specific industries or the senior loan market in general.

What are default rates and why are they important for senior loans?

A default occurs when a borrower fails to make timely principal or interest payments. All defaults in the asset class may be totaled up as a percent of the entire market for any given period of time; this results in a default rate. Default rates are often cited in the financial press as one measure of creditworthiness for the senior loan market broadly. Default rates can be measured on a historical basis, or default rates may be forecasted. The average default rate since 2000 is 3.6%.⁵

How did senior loans perform during the global financial crisis?

While past performance is no guarantee of future results, senior loans have delivered positive returns in 24 of the last 25 calendar years. 2008 marked the lone negative calendar year, however the negative return was fully offset by a strong recovery in 2009. In 2008, concerns about the impact of the global financial crisis caused loan prices to fall. As the risks and concerns subsided, the asset class experienced a dramatic recovery. In addition, defaults were only slightly elevated during the crisis relative to long-term averages (3.5% default rate 4 in 2008, versus 3.3% annual average over the trailing 20 years).⁶

There can be no assurance that the Fund will achieve its investment objectives.

Investment Strategies: Under normal market conditions, the Fund will invest at least 80% of its Managed Assets (as defined below) in floating rate instruments. Under current market conditions, the Fund anticipates that its portfolio of floating rate instruments will primarily consist of floating rate loans. In addition, the Fund may invest up to 20% of its Managed Assets in each of: (i) structured products (including, without limitation, the rated debt tranches of collateralized loan obligations (“CLOs”), floating rate mortgage-backed securities and credit linked notes), (ii) derivatives, including credit derivatives, (iii) warrants and equity securities that are incidental to the Fund’s purchase of floating rate instruments or in connection with a reorganization of a Borrower or issuer and (iv) fixed rate instruments (including, without limitation, high yield corporate debt securities, or bonds, or U.S. government debt securities). To the extent that a structured product or a security underlying a derivative is, or is composed of, a floating rate instrument, the Fund will include it for the purposes of the Fund’s 80% policy.

The Fund may invest in securities of any credit quality, maturity and duration. The Fund may invest in U.S. dollar and non-U.S. dollar denominated securities of issuers located anywhere in the world, and of issuers that operate in any industry. In pursuing the Fund’s investment objective, the Adviser will seek to enhance the Fund’s return by the use of leverage.

Limited Operating History. The Fund is a non-diversified, closed-end management investment company with a limited operating history. As a result, prospective investors have a limited track record or history on which to base their investment decision. The Adviser acts as an investment adviser for collateralized loan obligation vehicles, separately managed accounts, listed investment companies (including closed-end funds and an exchange traded fund) and other investment vehicles.

Investment and Market Risk. An investment in the Fund’s Common Shares is subject to investment risk, including the possible loss of the entire principal amount invested. An investment in the Fund’s Common Shares represents an indirect investment in the portfolio of floating rate instruments, other securities and derivative investments owned by the Fund, and the value of these investments may fluctuate, sometimes rapidly and unpredictably. At any point in time an investment in the Fund’s Common Shares may be worth less than the original amount invested, even after taking into account distributions paid by the Fund and the ability of shareholders to reinvest dividends. The Fund may also use leverage, which would magnify the Fund’s investment, market and certain other risks.

Common Shares Liquidity Risk An investment in the Fund is suitable only for long-term investors who can bear the risks associated with the limited liquidity of the Common Shares. BGFREI is a newly organized, non-diversified, closed-end management investment company that continuously offers its Common Shares and is operated as an “interval fund”. In order to provide liquidity to shareholders, the Fund, subject to applicable law, will conduct repurchase offers of the Fund’s outstanding Common Shares at NAV, subject to approval of the Board. The Fund will provide notification of each repurchase offer at least 7 calendar days before the repurchase request deadline. The Fund may impose a repurchase fee of up to 2% on Common Shares that are accepted for repurchase by the Fund and have been held by an investor for less than one year.

Repurchase Program Risk The Fund believes that these repurchase offers are generally beneficial to the Fund’s shareholders, and repurchases generally will be funded from available cash, cash from the sale of Common Shares or sales of portfolio securities. However, repurchase offers and the need to fund repurchase obligations may affect the ability of the Fund to be fully invested or force the Fund to maintain a higher percentage of its assets in liquid investments, which may harm the Fund’s investment performance. Moreover, diminution in the size of the Fund through repurchases may result in untimely sales of portfolio securities (with associated imputed transaction costs, which may be significant), and may limit the ability of the Fund to participate in new investment opportunities or to achieve its investment objective. The Fund may accumulate cash by holding back (i.e., not reinvesting) payments received in connection with the Fund’s investments and cash from the sale of Common Shares. The Fund believes that it can meet the maximum potential amount of the Fund’s repurchase obligations. If at any time cash and other liquid assets held by the Fund are not sufficient to meet the Fund’s repurchase obligations, the Fund intends, if necessary, to sell investments. In addition, if the Fund borrows to finance repurchases, interest on that borrowing will negatively affect Common Shareholders who do not tender their Common Shares by increasing the Fund’s expenses and reducing any net investment income.

If a repurchase offer is oversubscribed, the Fund may determine to increase the amount repurchased by up to 2% of the Fund’s outstanding Common Shares as of the date of the Repurchase Request Deadline. In the event the Fund determines not to repurchase more than the repurchase offer amount, or if shareholders tender more than the repurchase offer amount plus 2% of the Fund’s outstanding Common Shares as of the date of the Repurchase Request Deadline, the Fund will repurchase the Common Shares tendered on a pro rata basis, and shareholders will have to wait until the next repurchase offer to make another repurchase request. As a result, shareholders may be unable to liquidate all or a given percentage of their investment in the Fund during a particular repurchase offer. Some shareholders, in anticipation of proration, may tender more Common Shares than they wish to have repurchased in a particular month, thereby increasing the likelihood that proration will occur. A shareholder may be subject to market and other risks, and the NAV of Common Shares tendered in a repurchase offer may decline between the Repurchase Request Deadline and the date on which the NAV for tendered Common Shares is determined. In addition, the repurchase of Common Shares by the Fund will generally be a taxable event to Common Shareholders.

Loans Risk. Under normal market conditions, the Fund will invest primarily in Loans. The Loans that the Fund may invest primarily in Loans. The Loans that the Fund may invest in include Loans that are first lien, second lien, third lien or that are unsecured. In addition, the Loans the Fund will invest in will usually be rated below investment grade or may also be unrated. Loans are subject to a number of risks described elsewhere in this Prospectus, including credit risk, liquidity risk, below investment grade instruments risk and management risk.

Although certain Loans in which the Fund may invest will be secured by collateral, there can be no assurance that such collateral could be readily liquidated or that the liquidation of such collateral would satisfy the Borrower’s obligation in the event of non-payment of scheduled interest or principal. In the event of the bankruptcy or insolvency of a Borrower, the Fund could experience delays or limitations with respect to its ability to realize the benefits of the collateral securing a Loan. In the event of a decline in the value of the already pledged collateral, if the terms of a Loan do not require the Borrower to pledge additional collateral, the Fund will be exposed to the risk that the value of the collateral will not at all times equal or exceed the amount of the Borrower’s obligations under the Loans. To the extent that a Loan is collateralized by stock in the Borrower or its subsidiaries, such stock may lose some or all of its value in the event of the bankruptcy or insolvency of the Borrower. Those Loans that are under-collateralized involve a greater risk of loss.

In general, the secondary trading market for Loans is not fully-developed. No active trading market may exist for certain Loans, which may make it difficult to value them. Illiquidity and adverse market conditions may mean that the Fund may not be able to sell certain Loans 18 quickly or at a fair price. To the extent that a secondary market does exist for certain Loans, the market for them may be subject to irregular trading activity, wide bid/ask spreads and extended trade settlement periods.

Below Investment Grade, or High Yield, Instruments Risk. The Fund anticipates that it may invest substantially all of its assets in instruments that are rated below investment grade. Below investment grade instruments are commonly referred to as “junk” or high-yield instruments and are regarded as predominantly speculative with respect to the issuer’s capacity to pay interest and repay principal. Lower grade instruments may be particularly susceptible to economic downturns, which could adversely affect the ability of the issuers of such instruments to repay principal and pay interest thereon, increase the incidence of default for such instruments and severely disrupt the market value of such instruments.

Leverage Risk. Under current market conditions, the Fund generally intends to utilize leverage in an amount up to 33 1/3% of the Fund’s Managed Assets principally through Borrowings. In the future, the Fund may elect to utilize leverage in an amount up to 50% of the Fund’s total assets through the issuance of Preferred Shares. Leverage may result in greater volatility of the net asset value and distributions on the Common Shares because changes in the value of the Fund’s portfolio investments, including investments purchased with the proceeds from Borrowings or the issuance of Preferred Shares, if any, are borne entirely by Common Shareholders. Common Share income may fall if the interest rate on Borrowings or the dividend rate on Preferred Shares rises, and may fluctuate as the interest rate on Borrowings or the dividend rate on Preferred Shares varies. In addition, the Fund’s use of leverage will result in increased operating costs. Thus, to the extent that the then-current cost of any leverage, together with other related expenses, approaches the net return on the Fund’s investment portfolio, the benefit of leverage to Common Shareholders will be reduced, and if the then-current cost of any leverage together with related expenses were to exceed the net return on the Fund’s portfolio, the Fund’s leveraged capital structure would result in a lower rate of return to Common Shareholders than if the Fund were not so leveraged. In addition, the costs associated with the Fund’s incursion and maintenance of leverage could increase over time. There can be no assurance that the Fund’s leveraging strategy will be successful.

Any decline in the net asset value of the Fund will be borne entirely by Common Shareholders. Therefore, if the market value of the Fund’s portfolio declines, the Fund’s use of leverage will result in a greater decrease in net asset value to Common Shareholders than if the Fund were not leveraged.

The Fund may also be subject to the following categories of risk: Derivatives Risk, Segregation and Coverage Risk, Counterparty Risk, Derivatives Legislation and Regulatory Risk, Commodities Regulation, Potential Conflicts of Interest Risk, Limitations on Transactions with Affiliates Risk, Dependence on Key Personnel Risk, Prepayment Risk, Inflation/Deflation Risk, Non-U.S. Instruments Risk, Foreign Currency Risk, UK Exist from the European Union, Repurchase Agreements Risk, Reverse Repurchase Agreements Risk, Investments in Equity Securities or Warrants Incidental to Investments in Floating Rate Instrument, Possible U.S. Federal Income Tax Reform, Cyber-Security Risk and Identity Theft Risks, Portfolio Turnover Risk, Non-Diversification Risk and Anti-Takeover Provisions.

Prospective investors should note that certain senior members of the Manager’s team have been working together since 1998 while at other institutions, starting at the IndoSuez Capital Division of Crédit Agricole. These team members moved to Royal Bank of Canada in 2001, joined GSO in 2005, and joined Blackstone in 2008 in connection with Blackstone’s acquisition of GSO. Certain historical information contained in this material includes references to vehicles and managed accounts managed by members of the Manager’s team while at other institutions indicated above. In March 2008, together with the acquisition of GSO and certain of its affiliates by Blackstone, the legacy collateralized loan obligation business of GSO Debt Funds Management LLC (now known as GSO / Blackstone Debt Funds Management LLC) was combined with the legacy collateralized loan obligation business of Blackstone Debt Advisors L.P. Past performance is not an indication of future investment returns, and there can be no assurance that such returns will be achieved.

Please see the Prospectus of the Fund for a full description of the risk factors listed above.

INDEX DEFINITIONS

Floating Rate Loans are represented by the S&P/LSTA Leveraged Loan index, which is a market-value weighted index covering more than 1,100 loan facilities and reflects the performance of the U.S.-denominated institutional leveraged loans. Corp High Yield is represented by the Bloomberg Barclays US Corporate High Yield index, which measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, are excluded. Emerging Market Debt is represented by the JPM EMBI Plus TR index, a market capitalization-weighted index based on bonds in emerging markets in external currency denomination across 21 countries. Municipals are represented by the Bloomberg Barclays U.S. Municipal Index, a USD-denominated index that tracks the long-term tax exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds and pre-refunded bonds. Treasuries are represented by the Bloomberg Barclays US Treasury Index, which measures US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury (excluding T-Bills). Mortgages are represented by the Bloomberg Barclays US MBS Index, which tracks agency mortgage backed pass-through securities (both fixed-rate and hybrid ARM) guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). Inv Grade Corporates are represented by the Bloomberg Barclays US Corporate Investment Grade index, which measures the investment grade, fixed-rate, taxable corporate bond market.