Business Context and Reporting Period
Company: FS Investment Corporation (FS KKR Capital Corp)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2011
Business Overview: The Company is an externally managed, non-diversified, closed-end management investment company regulated as a Business Development Company (BDC) and taxed as a Regulated Investment Company (RIC). Its primary objective is to generate current income and, to a lesser extent, long-term capital appreciation through investments in senior secured loans, second lien loans, and subordinated debt of private U.S. companies.
Key Financial Metrics
| Metric | Q1 2011 | Q1 2010 |
|---|---|---|
| Investment Income | $17,924 | $3,134 |
| Total Expenses | $11,908 | $2,019 |
| Net Investment Income | $6,016 | $1,115 |
| Net Realized Gain on Investments | $5,653 | $1,989 |
| Net Change in Unrealized Appreciation | $10,393 | $1,776 |
| Net Increase in Net Assets from Operations | $22,322 | $4,869 |
| Net Asset Value (NAV) per Share | $9.68 | $9.42 |
| Total Assets | $1,122,149 | $782,005 |
| Total Liabilities | $541,426 | $392,773 |
| Cash and Cash Equivalents | $87,448 | $38,790 |
| Credit Facility Outstanding | $337,606 | $297,201 |
Note: All figures in thousands except per share data.
Material Changes vs. Prior Period
- Portfolio Growth: Total investments at fair value increased from $733.6 million to $900.5 million, driven by significant capital raising and deployment. The portfolio consists of 143 companies as of March 31, 2011.
- Revenue Surge: Investment income increased by 472% year-over-year, primarily due to the substantial growth in the size of the investment portfolio.
- Expense Increase: Total operating expenses rose to $11.9 million from $2.0 million. This increase is attributed to higher management fees, interest expense on the expanded credit facility, and a change in accounting methodology for capital gains incentive fees to include unrealized gains.
- Leverage: Borrowings under the revolving credit facility increased to $337.6 million. The Company also entered into a new Total Return Swap (TRS) facility with a notional amount of $88.4 million.
- Capital Raising: The Company sold 18.8 million shares for gross proceeds of $199.3 million during the quarter, compared to 4.3 million shares for $44.5 million in the prior year period.
Guidance, Outlook, and Risks
- Distributions: The Board declared regular semi-monthly cash distributions of $0.032156 per share and special one-time distributions totaling $0.07 per share in April 2011. The regular semi-monthly distribution rate was increased to $0.033594 per share effective May 2011. Distributions were funded 80% by net investment income and 20% by capital gains proceeds.
- Outlook: Management expects general and administrative expenses to increase in absolute dollars due to asset base growth but decline as a percentage of assets. The Company intends to maintain its RIC status by distributing at least 90% of investment company taxable income.
- Accounting Policy Change: The Company changed its methodology for accruing capital gains incentive fees to include unrealized gains. While this increases reported expenses, no fee is payable on unrealized gains until they are realized.
- Risks:
- Interest Rate Risk: The Company is exposed to rising interest rates which increase borrowing costs on its floating-rate credit facility and TRS, though this is partially offset by higher yields on variable-rate portfolio investments.
- Valuation Risk: 100% of the investment portfolio is classified as Level 3 (unobservable inputs), relying on dealer quotes and third-party pricing services for fair value determination.
- Liquidity: The Company relies on a continuous public offering and its credit facility for liquidity. The credit facility is subject to borrowing base limitations and "Super-Collateralization Events."
Investor Verification Checklist
- Incentive Fee Accruals: Verify the impact of the $2.1 million accrual for capital gains incentive fees on unrealized gains, which reduces GAAP net investment income but is not a cash outflow until gains are realized.
- Leverage Ratios: Confirm the Company's compliance with the 1940 Act asset coverage requirements given the $337.6 million credit facility and $88.4 million TRS exposure.
- Portfolio Quality: Review the investment rating distribution; 97% of the portfolio is rated "2" (performing), with only 1% rated "1" and 2% rated "3".
- Distribution Sustainability: Assess the source of distributions, noting that 80% was funded by net investment income, with the remainder from capital gains.
- Unfunded Commitments: Note the $12.5 million unfunded commitment on revolving credit facilities within the portfolio.