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: March 31, 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, and subordinated debt of private U.S. companies.

Key Financial Metrics

Note: Debt includes $340,000 under the Revolving Credit Facility and $300,000 under the Repurchase Agreement (JPM Facility).

Material Changes vs. Prior Period

• Portfolio Growth: Total investment portfolio fair value increased by approximately 22% to $2.25 billion, driven by significant capital raising and new investments totaling $561.4 million during the quarter.
• Operating Expenses: Total operating expenses rose to $35.6 million from $11.9 million. This increase is primarily due to a $14.8 million accrual for capital gains incentive fees (compared to $3.3 million in Q1 2011) and higher base management fees ($12.2 million vs. $4.8 million) reflecting the larger asset base.
• Unrealized Gains: The company recorded a net change in unrealized appreciation on investments of $61.0 million, compared to $10.4 million in the prior year period, attributed to strengthening credit markets.
• Capital Raising: The company sold 42.8 million shares for gross proceeds of $452.3 million during the quarter, significantly expanding its capital base.

Guidance, Outlook, and Risks

• Outlook: Management expects operating expenses to level off as the public offering closes (anticipated May 2012) and the asset base stabilizes. The company intends to maintain its RIC status by distributing at least 90% of investment company taxable income.
• Financing: The company amended its Revolving Credit Facility in March 2012, extending maturity to March 2013 and reducing the interest rate to LIBOR + 1.50%. It also increased the capacity of its JPM repurchase facility to $400 million.
• Risks:
  • Interest Rate Risk: Approximately 62% of the portfolio pays variable rates. Rising rates increase interest income but also increase borrowing costs on floating-rate debt.
  • Valuation Risk: Investments are primarily Level 3 assets (unobservable inputs), requiring significant management judgment and third-party valuations.
  • Leverage: The company utilizes a Total Return Swap (TRS) with Citibank (notional amount $491.6 million) and repurchase agreements, creating exposure to margin calls if underlying asset values decline.
• Unusual Items: A significant portion of the capital gains incentive fee ($14.7 million) was accrued based on unrealized gains. While recorded as an expense for GAAP purposes, this fee is not payable to the advisor until gains are realized.

Investor Verification Checklist

• Incentive Fee Accruals: Verify the impact of the $14.8 million unrealized capital gains incentive fee on reported net investment income, noting it is a non-cash expense for the period.
• Debt Covenants: Review the "Super-Collateralization Events" and asset coverage ratios in the credit facility and TRS agreements to assess leverage risk.
• Portfolio Quality: Examine the investment rating distribution (94% rated 1 or 2) and the specific valuation methodologies used for Level 3 assets.
• Distribution Sustainability: Confirm that distributions ($0.2016 per share) are fully covered by tax-basis net investment income ($35.0 million) and do not represent a return of capital.
• Offering Status: Monitor the closing of the continuous public offering and the subsequent deployment of cash reserves ($315.6 million).