FS KKR Capital Corp (FS Investment Corporation) 10-Q Summary
Business Context and Reporting Period
Company: FS Investment Corporation (FS KKR Capital Corp)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2014
Business Model: Externally managed, non-diversified, closed-end management investment company regulated as a Business Development Company (BDC). The company invests primarily in senior secured loans, second lien secured loans, and subordinated debt of private U.S. middle-market companies.
Key Event: Shares commenced trading on the New York Stock Exchange (NYSE) under the ticker "FSIC" on April 16, 2014, following the termination of the distribution reinvestment plan and share repurchase program.
Key Financial Metrics
| Metric | Q1 2014 | Q1 2013 |
|---|---|---|
| Total Assets | $4,503,667 | $4,444,577 |
| Investments at Fair Value | $4,077,627 | $4,137,581 |
| Total Liabilities | $1,818,498 | $1,803,585 |
| Stockholders' Equity | $2,685,169 | $2,640,992 |
| Net Asset Value (NAV) per Share | $10.28 | $10.18 |
| Net Investment Income | $55,877 | $50,729 |
| Net Increase in Net Assets from Operations | $80,060 | $82,476 |
| Earnings Per Share (Basic & Diluted) | $0.32 | $0.33 |
| Cash and Cash Equivalents | $297,685 | $227,328 |
| Total Debt Outstanding | $1,688,482 | $1,673,682 |
| Portfolio Yield (Gross, Pre-Leverage) | 10.2% | 10.1% |
Material Changes vs. Prior Period
- Investment Income: Increased to $114.8 million from $110.0 million, driven by a transition to higher-yielding non-broadly syndicated assets and an increase in directly originated transactions.
- Net Investment Income: Rose to $55.9 million ($0.22/share) from $50.7 million ($0.20/share).
- Operating Expenses: Decreased slightly to $58.9 million from $59.3 million, primarily due to reductions in administrative services and stock transfer agent fees.
- Realized Gains: Net realized gain on investments was $13.8 million, compared to $14.2 million in the prior year.
- Unrealized Appreciation: Net change in unrealized appreciation on investments was $10.3 million, down from $17.5 million in Q1 2013, attributed to strong performance in senior secured bonds and subordinated debt.
- Portfolio Composition: The portfolio consists of 148 companies (down from 165). Direct originations now represent 57% of the portfolio (up from 51%), while broadly syndicated/other assets decreased to 17% (down from 21%).
Guidance, Outlook, and Risks
- Distribution Policy: The Board increased the regular monthly cash distribution from $0.0720 to $0.07425 per share (an annualized rate of 8.68%). Two special cash distributions of $0.10 per share are intended for August and November 2014.
- Fee Structure Changes: The Board approved a proposal to reduce the annualized hurdle rate for the subordinated income incentive fee from 8.0% to 7.5% and the base management fee from 2.0% to 1.75%. Pending shareholder approval, the advisor has waived fees effective April 1, 2014, to reflect the 1.75% rate.
- Liquidity and Financing: The company entered into a new $300 million senior secured revolving credit facility with ING Capital on April 3, 2014. A tender offer to purchase up to $250 million of common stock commenced on April 16, 2014.
- Asset Quality: 80% of the portfolio is rated "2" (performing as expected). Only 1% is rated "4" (underperforming) and 0% is rated "5" (expected loss of principal).
- Risks: The company is subject to interest rate risk (71.3% of the portfolio is variable rate) and credit risk associated with private middle-market companies. Valuation of Level 3 assets (99.9% of the portfolio) relies on unobservable inputs and management judgment.
Investor Verification Checklist
- Shareholder Vote: Verify the outcome of the special meeting scheduled for June 23, 2014, regarding the reduction of the management fee and hurdle rate.
- Tender Offer Results: Monitor the final price and volume of shares repurchased in the $250 million tender offer initiated in April 2014.
- Distribution Sources: Confirm the tax characterization of distributions (ordinary income vs. return of capital) in the annual Form 1099-DIV, as distributions may exceed earnings in certain periods.
- Expense Reimbursement: Review the status of the expense reimbursement agreement with Franklin Square Holdings, which ensures distributions are not paid from offering proceeds or borrowings.
- Portfolio Concentration: Assess the impact of the top 10 portfolio companies, which represent a significant portion of the fair value, on overall asset quality.