FS KKR Capital Corp (FS Investment Corporation) 10-K Summary
Business Context and Reporting Period
Company: FS Investment Corporation (FSIC)
Reporting Period: Fiscal year ended December 31, 2010
Structure: Externally managed, non-diversified, closed-end management investment company operating as a Business Development Company (BDC) and Regulated Investment Company (RIC).
Management: Managed by FB Income Advisor, LLC (FB Advisor) with GSO / Blackstone Debt Funds Management LLC (GDFM) as sub-adviser.
Investment Strategy: Focuses on generating current income and long-term capital appreciation through investments in senior secured loans, second lien secured loans, and mezzanine debt of private U.S. companies (small and middle-market).
Market Status: Shares are sold in a continuous public offering at $10.75 per share. There is no established public market for the shares; liquidity is provided via quarterly tender offers.
Key Financial Metrics (Year Ended Dec 31, 2010)
| Metric | 2010 Value | 2009 Value |
|---|---|---|
| Investment Income | $30,670,000 | $4,420,000 |
| Net Investment Income | $9,392,000 | $2,151,000 |
| Net Increase in Net Assets from Operations | $28,264,000 | $11,456,000 |
| Total Assets | $782,005,000 | $110,068,000 |
| Total Net Assets | $389,232,000 | $93,197,000 |
| Net Asset Value (NAV) per Share | $9.42 | $9.10 |
| Portfolio Fair Value | $733,580,000 | $100,592,000 |
| Portfolio Yield (Gross, pre-leverage) | 8.5% | 13.2% |
| Debt Outstanding (Credit Facility) | $297,201,000 | $0 |
| Cash and Equivalents | $38,790,000 | $9,035,000 |
| Distributions Paid (Total) | $21,389,000 | $3,134,000 |
| Distributions per Share | $0.8728 | $0.6717 |
Material Changes vs. Prior Period
- Portfolio Growth: The investment portfolio expanded significantly from $100.6 million in 2009 to $733.6 million in 2010, driven by $849.2 million in new investments. The number of portfolio companies increased from 50 to 144.
- Leverage Deployment: The company initiated a revolving credit facility in 2010. As of year-end, $297.2 million was outstanding, compared to no debt in 2009. This increased the expense ratio to 9.89% (from 6.53% in 2009) due to interest expense and a change in incentive fee accrual methodology.
- Accounting Change: In Q4 2010, the company changed its methodology for accruing capital gains incentive fees to include unrealized gains. This resulted in a $4.063 million accrual that is not currently payable, reducing reported GAAP net investment income compared to tax-basis income.
- Asset Quality: The weighted average credit rating of the portfolio improved from B3 (2009) to B2 (2010). 93% of the portfolio was rated "2" (performing as expected) at year-end.
Guidance, Outlook, and Risks
Outlook and Strategy: Management intends to continue deploying capital into senior secured and second lien loans of private U.S. companies. The company plans to maintain leverage up to 50% of asset value as permitted by the 1940 Act. A liquidity event (listing, merger, or liquidation) is targeted within 5-7 years after the offering stage concludes.
Recent Developments:
- New Financing: On March 18, 2011, a wholly-owned subsidiary (Arch Street Funding LLC) entered into a $200 million Total Return Swap (TRS) with Citibank to obtain economic exposure to loans without direct ownership, potentially offering lower financing costs.
- Offering Status: As of March 15, 2011, the company had raised approximately $577.4 million in gross proceeds.
Key Risks:
- Liquidity: Shares are not publicly traded; investors rely on quarterly tender offers (limited to 2.5% of shares per quarter) for liquidity.
- Valuation Uncertainty: The majority of the portfolio consists of private debt securities valued at fair value by the Board of Directors (Level 3 inputs), which involves subjective judgment.
- Regulatory Constraints: As a BDC, the company must maintain 70% of assets in "qualifying assets" and meet asset coverage tests (200%) to pay distributions or issue senior securities.
- Interest Rate Risk: While most investments are floating-rate, rising rates increase borrowing costs. The company uses a credit facility and TRS with floating rates (LIBOR + spread).
Investor Verification Checklist
- Verify Distribution Sources: Confirm that distributions are funded by net investment income and capital gains rather than offering proceeds or borrowings (which would be a return of capital).
- Review Incentive Fee Accruals: Note the $4.063 million accrual for unrealized gains in 2010; verify that this does not represent a current cash liability to the advisor.
- Assess Leverage Impact: Monitor the $297.2 million credit facility and the new $200 million TRS to ensure asset coverage ratios remain above the 200% threshold required for distributions.
- Check Portfolio Concentration: Review the top 10 portfolio companies to ensure diversification limits (no more than 25% in one issuer for RIC status) are maintained.
- Monitor Liquidity Event Timeline: Track progress toward the 5-7 year target for a liquidity event (listing or sale) given the current non-traded status.