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, 2012
Business Model: Externally managed, non-diversified, closed-end management investment company regulated as a Business Development Company (BDC) and taxed as a Regulated Investment Company (RIC). The company invests primarily in senior secured loans, second lien loans, subordinated debt, and equity of private U.S. companies.
Capital Status: Closed its continuous public offering in May 2012. As of August 13, 2012, 248,342,719 shares were outstanding.
Key Financial Metrics
| Metric | Six Months Ended June 30, 2012 | Six Months Ended June 30, 2011 |
|---|---|---|
| Total Assets | $3,391,342 | $2,144,225 |
| Investments at Fair Value | $2,947,983 | $1,844,358 |
| Net Investment Income | $51,415 | $20,323 |
| Net Increase in Net Assets from Operations | $127,478 | $40,142 |
| Net Asset Value (NAV) per Share | $9.61 | $9.35 |
| Total Debt (Credit Facilities + Repurchase Agreements) | $737,967 | $554,286 |
| Cash and Cash Equivalents | $231,916 | $210,714 |
Note: All figures in thousands except per share data.
Material Changes vs. Prior Period
- Portfolio Growth: Total investments increased by approximately 60% (from $1.84B to $2.95B) driven by capital raised in the continuous public offering and new investment activity ($1.56B in purchases vs. $527M in sales/repayments).
- Revenue Expansion: Net investment income more than doubled to $51.4M, primarily due to the larger asset base. However, net investment income per share decreased to $0.25 from $0.33 due to cash drag from rapid capital deployment.
- Expense Increases: Total operating expenses rose to $62.2M from $22.6M. This includes a significant increase in accrued capital gains incentive fees ($16.5M vs. $3.9M) and interest expense ($10.5M vs. $4.5M) due to increased leverage.
- Unrealized Gains: The portfolio recorded a net change in unrealized appreciation of $56.9M, compared to a depreciation of $1.6M in the prior year, driven by strengthening credit markets.
- Leverage: Borrowings increased significantly. The Broad Street credit facility was fully drawn at $380M, and the JPM repurchase facility increased to $350M.
Guidance, Outlook, and Risks
- Outlook: Management expects operating expenses to level off as a percentage of assets as the public offering closes and the asset base stabilizes. The company anticipates interest and dividend income to level off as the portfolio size stabilizes.
- Distributions: The company declared monthly cash distributions of $0.0675 per share for July and August 2012. Distributions are funded primarily by net investment income (95% in the first half of 2012).
- Key Risks:
- Interest Rate Risk: The company is exposed to rising interest rates on its variable-rate debt (LIBOR-based), which could increase interest expense. Approximately 70.5% of the portfolio pays variable rates.
- Liquidity and Covenants: The Walnut Street credit facility contains strict covenants, including maintaining an asset coverage ratio of 2:1 and a net asset value of at least $200M. Failure to meet these could trigger acceleration of debt.
- Valuation Uncertainty: A significant portion of the portfolio (Level 3 assets) relies on unobservable inputs and fair value determinations by the board, which involves subjective judgment.
- Expense Reimbursement: The company relies on an expense reimbursement agreement with Franklin Square Holdings to ensure distributions do not represent a return of capital, though there is no assurance this will continue indefinitely.
Investor Verification Checklist
- Capital Deployment Pace: Verify the rate at which the company is deploying the capital raised in the May 2012 offering to assess potential cash drag on future returns.
- Debt Maturities: Review the maturity dates of the Broad Street facility (March 2013) and JPM facility (July 2015) to understand refinancing risks.
- Incentive Fee Accruals: Confirm the portion of the $16.5M capital gains incentive fee that is based on unrealized gains, as these are not payable until gains are realized.
- Portfolio Quality: Examine the "Investment Rating" breakdown; 90% of the portfolio is rated "2" (performing), but monitor the 5% rated "3" (requiring closer monitoring) and 1% rated "4" (underperforming).
- Qualifying Assets: Verify compliance with the 70% qualifying asset test under the Investment Company Act of 1940, which stood at 78.8% as of June 30, 2012.