FSK

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: June 30, 2010
Business Model: Externally managed, non-diversified closed-end investment company operating as a Business Development Company (BDC) and Regulated Investment Company (RIC). The portfolio consists primarily of senior secured loans, second lien loans, and mezzanine debt of private U.S. companies.

Key Financial Metrics

Material Changes vs. Prior Period

• Portfolio Expansion: Investments at fair value increased by 243% from $100.6 million to $344.6 million, driven by significant capital raises and new investment activity ($305.3 million invested in 71 companies).
• Leverage Initiation: The company established a $140 million revolving credit facility with Deutsche Bank in March 2010, fully drawn as of June 30, 2010. This introduced $870,000 in interest expense for the six-month period.
• Unrealized Losses: Unlike the prior year which saw unrealized appreciation, the company recorded a net unrealized depreciation of $6.09 million. Management attributes this to increased risk premiums in credit markets due to European sovereign debt concerns and global economic uncertainty in Q2 2010.
• Revenue Growth: Investment income surged to $9.19 million from $0.73 million, reflecting the larger asset base. Net investment income grew to $4.25 million.
• Expense Structure: Total operating expenses increased to $4.94 million from $0.73 million, primarily due to higher management fees ($2.29 million) and the new interest expense.

Guidance, Outlook, and Risks

• Market Outlook: Management notes that while credit spreads improved in July and August 2010, the Q2 sell-off highlighted sensitivity to sovereign debt issues and economic recovery uncertainty. The company expects general and administrative expenses to increase in absolute dollars but decline as a percentage of assets as the asset base grows.
• Distribution Policy: The company intends to distribute sufficient dividends to maintain RIC status. Distributions for the six months ended June 30, 2010, were funded 71% by net investment income and 29% by capital gains proceeds. No expense reimbursements were received from the sponsor (Franklin Square Holdings) in 2010, compared to $176,000 in 2009.
• Capital Resources: The company continues a continuous public offering. As of August 13, 2010, gross proceeds raised totaled approximately $245.9 million. The credit facility was subsequently amended in July 2010 to increase capacity to $240 million and lower borrowing costs.
• Risks: Key risks include interest rate fluctuations (most portfolio investments are variable rate, but the credit facility is floating), credit spreads widening, and the impact of the Dodd-Frank Act on the financial services industry. The company has no off-balance sheet arrangements.

Investor Verification Checklist

• Debt Covenants: Verify compliance with the "Super-Collateralization Events" and borrowing base requirements of the Deutsche Bank credit facility, particularly given the unrealized depreciation in the portfolio.
• Valuation Methodology: Confirm the reliability of Level 3 fair value inputs used for the $344.6 million portfolio, as these rely on unobservable inputs and dealer quotes rather than active market prices.
• Distribution Sustainability: Monitor the ratio of distributions to net investment income to ensure distributions remain fully covered by earnings and do not become a return of capital.
• Expense Ratios: Track the ratio of total operating expenses to average net assets (3.34% for the six months ended June 30, 2010) to ensure it declines as the asset base scales.
• Portfolio Concentration: Review industry exposure, noting that Information Technology (23.4%) and Industrials (19.9%) represent the largest sectors.