FS KKR Capital Corp (FS Investment Corporation) 10-Q Summary
Business Context and Reporting Period
Company: FS Investment Corporation (FSIC), a Business Development Company (BDC) and Regulated Investment Company (RIC).
Reporting Period: Three months ended March 31, 2017.
Business Overview: The Company invests primarily in senior secured loans, second lien secured loans, and subordinated debt of private U.S. middle-market companies. It also holds equity/other investments and collateralized securities. The portfolio is managed by FB Income Advisor, LLC.
Key Financial Metrics
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Net Investment Income | $52,590 | $49,938 |
| Net Increase in Net Assets from Operations | $63,393 | $(12,097) |
| Earnings Per Share (Basic & Diluted) | $0.26 | $(0.05) |
| Total Investments (Fair Value) | $3,924,168 | $3,726,816 |
| Net Asset Value (NAV) Per Share | $9.45 | $9.41 |
| Total Debt Outstanding | $1,837,985 | $1,702,789 |
| Cash and Foreign Currency | $53,684 | $71,376 |
| Asset Coverage Ratio | 2.26x | 2.35x |
Material Changes vs. Prior Period
- Profitability: The Company reported a net increase in net assets of $63.4 million ($0.26/share) compared to a net decrease of $12.1 million ($(0.05)/share) in Q1 2016. This improvement was driven by a significant net change in unrealized appreciation of $112.4 million, offsetting a net realized loss of $101.0 million.
- Revenue: Total investment income increased to $106.1 million from $103.1 million. Interest income decreased ($86.5M vs $101.2M) due to prepayments of higher-yielding assets, while fee income surged to $19.6 million from $1.6 million due to increased prepayment activity.
- Portfolio Composition: First lien senior secured loans increased to 57% of the portfolio (from 52%), while second lien loans decreased to 9% (from 16%). Subordinated debt increased to 15% (from 12%).
- Liquidity: Cash balances declined from $264.6 million to $53.0 million, primarily due to net investment purchases of $539.7 million against proceeds of $364.3 million.
- Debt: Total borrowings increased to $1.84 billion. The Company amended its ING Credit Facility, increasing commitments to $327.5 million and extending the maturity.
Guidance, Outlook, and Risks
- Distributions: The Board declared a quarterly cash distribution of $0.22275 per share, payable July 5, 2017. Distributions for Q1 2017 were funded entirely by net investment income.
- Portfolio Yield: The estimated gross portfolio yield prior to leverage was 9.3% based on amortized cost.
- Asset Quality: 83% of the portfolio is rated "2" (performing), 10% rated "1" (exceeding expectations), and 1% rated "5" (underperforming with expected loss). No investments were on non-accrual status as of March 31, 2017.
- Unfunded Commitments: The Company has $202.1 million in unfunded debt commitments and minor equity commitments, which it maintains sufficient liquidity to fund.
- Risks: Key risks include interest rate fluctuations (65.5% of portfolio is variable rate), credit risk in private middle-market companies, and the reliance on fair value estimates for Level 3 assets (99.7% of portfolio).
Investor Verification Checklist
- Realized vs. Unrealized Gains: Verify the sustainability of the $112.4 million unrealized gain, which drove the quarter's profitability, against the $101.0 million realized loss.
- Fee Income Volatility: Assess the impact of the spike in fee income ($19.6M) driven by prepayments; this is non-recurring and may not persist.
- Debt Maturity Wall: Review the maturity schedule of $1.84 billion in debt, noting significant unsecured notes maturing in 2019 and 2020.
- Asset Coverage: Confirm the asset coverage ratio of 2.26x remains compliant with the 1940 Act requirements (minimum 2.0x) given the high leverage.
- Level 3 Valuations: Scrutinize the valuation methodology for the $3.9 billion in Level 3 assets, as these rely on unobservable inputs and management estimates.