FS KKR Capital Corp (FSIC) Q1 2018 Filing Summary
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended March 31, 2018. FS Investment Corporation (FSIC) is an externally managed, non-diversified, closed-end management investment company regulated as a Business Development Company (BDC). The company's investment objective is to generate current income and, to a lesser extent, long-term capital appreciation by investing primarily in senior secured loans and second lien secured loans of private U.S. companies. As of the filing date, the company had transitioned its investment advisory relationship from FB Income Advisor, LLC (with GSO/Blackstone as sub-adviser) to FS/KKR Advisor, LLC, effective April 9, 2018.
Key Financial Metrics
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Net Investment Income | $50.5 million | $52.6 million |
| Net Increase in Net Assets from Operations | $12.9 million | $63.4 million |
| Earnings Per Share (Basic & Diluted) | $0.05 | $0.26 |
| Net Asset Value (NAV) Per Share | $9.16 | $9.30 (Dec 31, 2017) |
| Total Investments (Fair Value) | $3.80 billion | $3.93 billion (Dec 31, 2017) |
| Total Debt Outstanding | $1.72 billion | $1.72 billion (Dec 31, 2017) |
| Cash and Foreign Currency | $215.1 million | $138.7 million (Dec 31, 2017) |
| Available Borrowing Capacity | $260.4 million | $260.8 million (Dec 31, 2017) |
| Portfolio Yield (Gross, Pre-Leverage) | 10.0% | 9.6% |
Material Changes vs. Prior Period
- Operating Performance: Net increase in net assets from operations decreased significantly from $63.4 million in Q1 2017 to $12.9 million in Q1 2018. This decline was primarily driven by a shift from net unrealized appreciation of $112.4 million in Q1 2017 to net unrealized depreciation of $32.7 million in Q1 2018.
- Revenue Composition: Total investment income decreased to $101.0 million from $106.1 million. Fee income dropped sharply to $2.5 million from $19.5 million due to lower structuring and prepayment activity. This was partially offset by an increase in dividend income ($7.4 million vs. $0) and paid-in-kind (PIK) interest income ($13.4 million vs. $8.5 million).
- Expense Management: Total operating expenses remained relatively flat at $53.0 million. However, net expenses decreased to $50.5 million due to a management fee waiver of $2.6 million, which was not present in the prior year.
- Portfolio Activity: The company reduced its portfolio size, with net portfolio activity showing a decrease of $100.0 million (purchases of $116.0 million vs. sales/repayments of $215.9 million).
Guidance, Outlook, and Risks
- Management Change: A significant corporate development occurred on April 9, 2018, when GSO/Blackstone resigned as sub-adviser and FS/KKR Advisor, LLC (a joint venture of FS Investments and KKR Credit) became the new investment adviser. The new agreement features a 1.50% base management fee and a subordinated incentive fee with a 7.0% annualized hurdle rate.
- Distributions: The company declared a regular quarterly cash distribution of $0.19 per share for Q1 2018. Management intends to make a special distribution in Q4 2018 representing cumulative net investment income earned in the 12 months following October 1, 2017, in excess of $0.76 per share.
- Share Repurchases: The board authorized a $50 million share repurchase program in February 2018. During Q1, the company repurchased 137,560 shares. Subsequent to the quarter end (through May 9, 2018), an additional 3.3 million shares were repurchased for $25 million.
- Risks: The filing highlights risks related to the transition of the investment adviser, potential conflicts of interest with FS/KKR Advisor and its affiliates, and the impact of interest rate fluctuations on variable-rate debt investments and borrowing costs. The portfolio contains 69.2% variable-rate investments.
Investor Verification Checklist
- Advisory Transition Impact: Verify the specific terms of the new FS/KKR Advisor agreement and how the change in fee structure (1.50% base fee vs. previous 1.75% with waiver) affects long-term expense ratios.
- Unrealized Depreciation Drivers: Investigate the specific portfolio companies responsible for the $32.7 million in net unrealized depreciation to assess credit quality and potential future impairments.
- PIK Interest Sustainability: Review the composition of the portfolio to understand the reliance on Paid-in-Kind (PIK) interest, which comprised 13% of total investment income, and its impact on cash flow versus accrual income.
- Special Distribution Timing: Monitor the company's ability to generate sufficient net investment income to fund the anticipated special distribution in Q4 2018.
- Share Repurchase Execution: Track the remaining $25 million capacity under the repurchase program and the average price paid relative to NAV to gauge management's view on share valuation.