FS KKR Capital Corp (FS Investment Corporation) 10-K Summary
Business Context and Reporting Period
Company: FS Investment Corporation (FSIC), a non-diversified, closed-end management investment company organized as a Business Development Company (BDC) and a Regulated Investment Company (RIC).
Reporting Period: Fiscal year ended December 31, 2011.
Strategy: The Company invests primarily in senior secured loans, second lien secured loans, and subordinated debt of private U.S. companies, with a focus on small and middle-market firms. It is externally managed by FB Income Advisor, LLC (FB Advisor) with GSO / Blackstone Debt Funds Management LLC (GDFM) as sub-adviser. The Company is in an ongoing public offering and is not listed on a public exchange, providing limited liquidity via quarterly tender offers.
Key Financial Metrics (Year Ended Dec 31, 2011)
| Metric | 2011 Value | 2010 Value |
|---|---|---|
| Investment Income | $115,484 | $30,670 |
| Net Investment Income | $71,364 | $9,392 |
| Net Increase in Net Assets from Operations | $53,470 | $28,264 |
| Total Assets | $2,144,225 | $782,005 |
| Total Net Assets | $1,498,892 | $389,232 |
| Portfolio Fair Value | $1,844,358 | $733,580 |
| Portfolio Yield (Gross, Pre-Leverage) | 10.4% | 8.5% |
| Number of Portfolio Companies | 183 | 144 |
| Debt Outstanding (Credit Facility + JPM Facility) | $554,286 | $297,201 |
| Cash and Cash Equivalents | $210,714 | $38,790 |
| Distributions Paid (Total) | $86,657 | $21,389 |
Material Changes vs. Prior Period
- Portfolio Growth: The investment portfolio more than doubled in fair value, growing from $733.6 million in 2010 to $1.84 billion in 2011, driven by significant capital raises ($1.27 billion in gross proceeds in 2011) and new investments totaling $1.98 billion.
- Income Expansion: Net investment income increased significantly to $71.4 million from $9.4 million, reflecting the larger asset base and an increase in gross portfolio yield from 8.5% to 10.4%.
- Unrealized Losses: Unlike 2010, which saw unrealized appreciation, 2011 recorded a net change in unrealized depreciation on investments of $(35.99 million). This was primarily attributed to a widening of credit spreads in the third quarter of 2011 due to European sovereign debt uncertainty.
- Leverage Increase: Total borrowings increased to $554.3 million (comprising a $340 million credit facility and $214.3 million under a JPM repurchase facility) compared to $297.2 million in 2010.
- Expense Reversal: The Company reversed $4.06 million in capital gains incentive fees accrued in 2010 due to unrealized losses in the portfolio, which positively impacted net investment income for 2011.
Guidance, Outlook, and Risks
- Liquidity Event: The Company intends to seek a liquidity event (listing, merger, or liquidation) within three years of completing its offering stage. As of the filing date, the offering was expected to complete in the second quarter of 2012.
- Share Repurchases: The Company conducts quarterly tender offers to provide limited liquidity. In 2011, it repurchased 458,229 shares at an average price of $9.64. Repurchases are limited to 10% of the weighted average shares outstanding in the prior year.
- Regulatory Constraints: As a BDC, the Company is subject to asset coverage requirements (200% coverage for senior securities) and restrictions on co-investing with affiliates unless exemptive relief is obtained from the SEC (which is currently being sought).
- Key Risks:
- Interest Rate Risk: The Company uses floating-rate debt (LIBOR-based) to finance fixed and floating-rate assets. Rising rates increase borrowing costs.
- Valuation Uncertainty: A significant portion of the portfolio (Level 3 assets) is valued in good faith by the Board due to the lack of active markets, introducing subjectivity.
- Liquidity Risk: Shares are not publicly traded; investors rely on quarterly tender offers or a future liquidity event to exit.
- Concentration Risk: The portfolio is concentrated in private U.S. companies, which may have reduced access to capital and higher default risks during economic downturns.
Investor Verification Checklist
- Portfolio Quality: Verify the distribution of the 1-5 investment rating scale (96% of the portfolio was rated "2" or better as of Dec 31, 2011) and monitor for any migration to lower ratings.
- Leverage Ratios: Confirm the Company maintains the required 200% asset coverage ratio under the 1940 Act, especially given the increase in debt to $554 million.
- Offering Status: Monitor the completion of the public offering and the subsequent timeline for the intended liquidity event.
- Expense Reimbursement: Review the status of the expense reimbursement agreement with Franklin Square Holdings, which ensures distributions are not paid from offering proceeds or borrowings.
- Unrealized Depreciation: Assess the impact of the $(35.99 million) unrealized loss on future net asset value and the potential for realized losses if assets must be sold to meet distribution requirements.