FSK

FS KKR Capital Corp (FS Investment Corporation) 10-K Summary

Business Context and Reporting Period

Company: FS Investment Corporation (FS KKR Capital Corp)
Reporting Period: Fiscal Year Ended December 31, 2013
Structure: Externally managed, non-diversified, closed-end management investment company regulated as a Business Development Company (BDC) and taxed as a Regulated Investment Company (RIC).
Management: Managed by FB Income Advisor, LLC (FB Advisor) with GSO/Blackstone Debt Funds Management LLC (GDFM) as sub-adviser.
Strategy: Invests primarily in senior secured and second lien secured loans of private U.S. middle-market companies to generate current income and long-term capital appreciation.
Listing Status: Shares were not listed on a national exchange as of year-end; the company applied to list on the NYSE with trading expected to commence in April 2014.

Key Financial Metrics (Year Ended Dec 31, 2013)

Material Changes vs. Prior Period

• Net Investment Income Growth: Net investment income increased 83% to $244.98 million, driven by portfolio growth and increased direct originations. However, EPS decreased to $1.04 from $1.45 due to a significant reduction in unrealized gains.
• Unrealized Gains/Losses: The company recorded a net unrealized depreciation of $25.98 million in 2013, compared to a net unrealized appreciation of $127.40 million in 2012. This shift was primarily due to the conversion of 2012 unrealized gains into realized gains in 2013.
• Portfolio Composition: The portfolio shifted toward direct originations, which comprised 51% of the portfolio by fair value in 2013 (up from 27% in 2012). The number of portfolio companies decreased to 165 from 263.
• Financing Structure: The company terminated its Total Return Swap (TRS) with Citibank in August 2012 and replaced it with a revolving credit facility (Arch Street). In 2013, the JPM Facility was amended to increase capacity to $950 million.
• Expense Ratio: The ratio of expenses to average net assets increased to 8.90% in 2013 from 7.67% in 2012, largely due to higher management fees relative to assets following the TRS termination and increased interest expense.

Guidance, Outlook, and Risks

• Liquidity Event: The company expects to list its shares on the NYSE in April 2014. Upon listing, the share repurchase program (terminated March 21, 2014) will be replaced by public market liquidity.
• Distributions: The company intends to maintain monthly cash distributions. Distributions for 2013 were fully funded by net investment income (100%).
• Key Risks:
  • Liquidity Risk: Shares are currently illiquid; no public market exists until the NYSE listing is approved.
  • Valuation Risk: A significant portion of the portfolio (Level 3 assets) is valued in good faith by the board, introducing subjectivity.
  • Interest Rate Risk: 72.2% of the portfolio pays variable rates. Rising rates increase income but also increase borrowing costs on floating-rate debt facilities.
  • Regulatory Risk: Compliance with BDC asset coverage tests (200%) and RIC distribution requirements (90% of taxable income) limits flexibility.

Investor Verification Checklist

• NYSE Listing Approval: Verify if the NYSE listing has been approved and if trading has commenced as expected in April 2014.
• Debt Covenants: Review compliance with asset coverage ratios and borrowing base tests across the Arch Street, Broad Street, JPM, and Walnut Street facilities.
• Portfolio Quality: Monitor the "Investment Rating" distribution; 8% of the portfolio was rated "3" (requiring closer monitoring) and 1% rated "4" (underperforming) as of year-end.
• Expense Reimbursement: Confirm if Franklin Square Holdings continues to reimburse expenses to ensure distributions are not funded by offering proceeds or borrowings.
• Realized vs. Unrealized Gains: Assess the sustainability of earnings given the large swing from unrealized appreciation in 2012 to depreciation in 2013.