FS KKR Capital Corp (FSIC) 10-K Summary
Business Context and Reporting Period
Company: FS Investment Corporation (FSIC), a closed-end management investment company regulated as a Business Development Company (BDC) and taxed as a Regulated Investment Company (RIC).
Reporting Period: Fiscal year ended December 31, 2017.
Strategy: The Company invests primarily in senior secured loans, second lien secured loans, and subordinated debt of private U.S. middle-market companies. It employs leverage to enhance returns, subject to a 50% asset coverage limit under the Investment Company Act of 1940.
Management Transition: A material development in 2017 was the announcement that GSO / Blackstone Debt Funds Management LLC (GDFM) would resign as investment sub-adviser effective April 9, 2018. The Company is transitioning to a new advisory structure involving FS Investments and KKR Credit, potentially through a joint adviser (FS/KKR Advisor) or co-advisory agreements, subject to stockholder approval and SEC exemptive relief.
Key Financial Metrics (Year Ended Dec 31, 2017)
| Metric | 2017 | 2016 |
|---|---|---|
| Total Assets | $4.10 billion | $4.11 billion |
| Total Net Assets | $2.28 billion | $2.30 billion |
| Investment Income | $419.3 million | $422.8 million |
| Net Investment Income | $203.8 million ($0.83/share) | $207.3 million ($0.85/share) |
| Net Realized Gain/(Loss) | ($142.5 million) | ($63.2 million) |
| Net Unrealized Appreciation/(Depreciation) | $120.8 million | $150.2 million |
| Net Increase in Net Assets from Operations | $182.0 million ($0.74/share) | $294.3 million ($1.21/share) |
| Total Debt Outstanding | $1.72 billion | $1.69 billion |
| Available Borrowing Capacity | $260.8 million | $260.8 million |
| Portfolio Yield (Gross, Pre-Leverage) | 9.6% | 9.1% |
| Distributions Declared | $0.86/share | $0.89/share |
Material Changes vs. Prior Period
- Net Income Decline: Net increase in net assets from operations decreased by approximately 38% compared to 2016, driven primarily by a significant increase in net realized losses ($142.5 million in 2017 vs. $63.2 million in 2016) and a reduction in net investment income.
- Realized Losses: The increase in realized losses was attributed to the conversion of unrealized depreciation to realized losses and the depreciation of certain equity positions.
- Portfolio Composition: Direct originations increased to 92% of the portfolio (from 88% in 2016). The portfolio yield improved to 9.6% from 9.1%.
- Stock Performance: While the total return based on Net Asset Value (NAV) was positive at 7.97%, the total return based on market value was negative at -21.39%, reflecting a widening discount to NAV.
- Advisory Structure: The Company moved from a sub-advisory relationship with GDFM (Blackstone) to a planned transition with KKR Credit and FS Investments.
Guidance, Outlook, and Risks
Management Commentary: Management maintains a defensive investment approach focused on long-term credit performance. The transition of investment advisory services is intended to create a premier alternative lending platform. The Board authorized a $50 million stock repurchase program in February 2018 to be executed when the stock trades below NAV.
Outlook: The Company intends to maintain its quarterly distribution policy, though distributions may be funded from offering proceeds or borrowings if earnings are insufficient. A special distribution is planned for Q4 2018 based on net investment income earned in the 12 months following October 1, 2017.
Risks and Contingencies:
- Advisory Transition Risk: There is no assurance that the new advisory agreements with KKR Credit/FS/KKR Advisor will receive stockholder approval or SEC exemptive relief in time to prevent a gap in advisory services.
- Liquidity and Leverage: The Company relies on debt financing; rising interest rates could increase borrowing costs. Asset coverage ratios must be maintained to pay distributions.
- Portfolio Valuation: A significant portion of the portfolio is valued in good faith by the Board due to lack of active markets, introducing valuation uncertainty.
- Market Conditions: Risks include economic recessions, volatility in energy prices (affecting energy sector holdings), and potential defaults by portfolio companies.
Key Facts for Investor Verification
- Advisory Transition Status: Verify the outcome of the stockholder vote regarding the new investment advisory agreements with KKR Credit and FS/KKR Advisor, and the receipt of necessary SEC exemptive relief.
- Discount to NAV: Monitor the market price relative to the $9.30 NAV per share, as the stock traded at a significant discount (approx. 21% based on market return) in 2017.
- Distribution Coverage: Confirm that net investment income ($0.83/share) continues to cover the declared distribution rate ($0.86/share) to ensure sustainability without return of capital.
- Debt Maturities: Review the schedule of debt maturities, with significant notes due in 2019 and 2020, to assess refinancing risks.
- Portfolio Quality: Monitor the percentage of assets on non-accrual (0.2% as of year-end) and the distribution of investment ratings (79% rated "2" or better).