10-K
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d141731d10k.htm
FORM 10-K
Form 10-K
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
☒
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2020
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER: 814-00757
FS KKR Capital Corp.
(Exact name of registrant as specified in its charter)
Maryland
26-1630040
(State of Incorporation)
(I.R.S. Employer Identification Number)
201 Rouse Boulevard
Philadelphia, Pennsylvania
19112
(Address of principal executive offices)
(Zip Code)
Registrants telephone number, including area code:
(215) 495-1150
Securities
registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, par value $0.001 per share
FSK
The New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by
check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒.
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the
Act. Yes ☐ No ☒.
Indicate by check mark
whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for shorter period that the registrant was required to
submit and post such files). Yes ☒ No ☐.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K is not contained herein, and will not be contained, to the best of Registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definition of accelerated filer, large accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ☒
Accelerated filer ☐
Non-accelerated filer ☐
Smaller reporting company ☐
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the
extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant has filed a report on and attestation to its managements assessment of the effectiveness of its internal control over financial reporting under
Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act). Yes ☐ No ☒.
The aggregate market value
of common stock held by non-affiliates of the registrant (assuming solely for the purpose of this disclosure, but without conceding, all executive officers and directors of the registrant are
affiliates), as of June 30, 2020, the last business day of the registrants most recently completed second fiscal quarter, was approximately $1.7 billion.
There were 123,755,965 shares of the registrants common stock outstanding as of February 25, 2021.
Documents
Incorporated by Reference
The contents of the amendment to this Annual Report on Form 10-K, which will be filed with the
U.S. Securities and Exchange Commission within 120 days following the end of the registrants fiscal year, are incorporated by reference into Part III of this Annual Report on Form 10-K.
Table of Contents
TABLE OF CONTENTS
Page
PART I
ITEM 1.
BUSINESS
1
ITEM 1A.
RISK FACTORS
18
ITEM 1B.
UNRESOLVED STAFF COMMENTS
46
ITEM 2.
PROPERTIES
46
ITEM 3.
LEGAL PROCEEDINGS
46
ITEM 4.
MINE SAFETY DISCLOSURES
46
PART II
ITEM 5.
MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
47
ITEM 6.
SELECTED FINANCIAL DATA
50
ITEM 7.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
51
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
67
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
70
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
161
ITEM 9A.
CONTROLS AND PROCEDURES
161
ITEM 9B.
OTHER INFORMATION
162
PART III
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
163
ITEM 11.
EXECUTIVE COMPENSATION
163
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
MATTERS
163
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
163
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
163
PART IV
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
164
ITEM 16.
FORM 10-K SUMMARY
167
SIGNATURES
168
Table of Contents
PART I
Many of the amounts and percentages presented in Part I have been rounded for convenience of presentation.
Item 1.
Business.
Summary
FS KKR Capital
Corp. (NYSE: FSK), or the Company, which may also be referred to as we, us or our, was incorporated under the general corporation laws of the State of Maryland on December 21, 2007 and formally commenced
investment operations on January 2, 2009. We are an externally managed, non-diversified, closed-end management investment company that has elected to be regulated
as a business development company, or BDC, under the Investment Company Act of 1940, as amended, or the 1940 Act. As such, we are required to comply with certain regulatory requirements. In addition, we have elected to be treated for U.S. federal
income tax purposes, and intend to qualify annually, as a regulated investment company, or RIC, under Subchapter M of the Internal Revenue Code of 1986, as amended, or the Code. As of December 31, 2020, we had total assets of approximately
$7.2 billion.
We are managed by FS/KKR Advisor, LLC, or the Advisor, a registered investment adviser under the Investment
Advisers Act of 1940, as amended, or the Advisers Act, which oversees the management of our operations and is responsible for making investment decisions with respect to our portfolio. Our investment objectives are to generate current income and, to
a lesser extent, long-term capital appreciation. We seek to meet our investment objectives by:
utilizing the experience and expertise of the management team of the Advisor;
employing a defensive investment approach focused on long-term credit performance and principal protection;
focusing primarily on debt investments in a broad array of private U.S. companies, including middle-market companies, which we define as companies with
annual earnings before interest, taxes, depreciation and amortization, or EBITDA, of $25 million to $100 million at the time of investment;
investing primarily in established, stable enterprises with positive cash flows; and
maintaining rigorous portfolio monitoring in an attempt to anticipate and pre-empt negative credit events
within our portfolio, such as an event of insolvency, liquidation, dissolution, reorganization or bankruptcy of a portfolio company.
Our portfolio is comprised primarily of investments in senior secured loans and second lien secured loans of private middle market U.S. companies and, to a lesser extent, subordinated loans and certain
asset-based financing loans of private U.S. companies. Although we do not expect a significant portion of our portfolio to be comprised of subordinated loans, there is no limit on the amount of such loans in which we may invest. We may purchase
interests in loans or make other debt investments, including investments in senior secured bonds, through secondary market transactions in the
over-the-counter, or OTC, market or directly from our target companies as primary market or directly originated investments. In connection with our debt
investments, we may on occasion receive equity interests such as warrants or options as additional consideration. We may also purchase or otherwise acquire interests in the form of common or preferred equity or equity-related securities, such as
rights and warrants that may be converted into or exchanged for common stock or other equity or the cash value of common stock or other equity, including through a co-investment with a financial sponsor or
possibly the restructuring of an investment. In addition, a portion of our portfolio may be comprised of corporate bonds, structured products, other debt securities and derivatives, including total return swaps and credit default swaps. The Advisor
will seek to tailor our investment focus as market conditions evolve. Depending on market conditions, we may increase or decrease our exposure to less senior portions of the capital structures of our portfolio companies or otherwise make
opportunistic investments, such as where the market price of loans, bonds or other securities reflects a lower value than deemed warranted by the Advisors fundamental analysis. Such investment opportunities may occur due to general
dislocations in the markets, a misunderstanding by the market of a particular company or an industry being out of favor with the broader investment community and may include event driven investments, anchor orders and structured products.
The senior secured loans, second lien secured loans and senior secured bonds in which we invest generally have stated terms of
three to seven years and subordinated debt investments that we make generally have stated terms of up to ten years, but the expected average life of such securities is generally three to four years. However, we may invest in loans and securities
with any maturity or duration. Our debt investments may be rated by a nationally recognized statistical rating organization, or NRSRO, and, in such case, generally will carry a rating below investment grade (rated lower than Baa3 by
Moodys Investors Service, Inc., or Moodys, or lower than BBB- by Standard & Poors Ratings Services, or S&P). We may invest without limit in debt or other securities
of any rating, as well as debt or other securities that have not been rated by a NRSRO.
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To seek to enhance our returns, we employ leverage as market conditions permit and at
the discretion of the Advisor, but in no event will leverage employed exceed the maximum amount permitted by the 1940 Act. Prior to June 14, 2019, in accordance with the 1940 Act, we were allowed to borrow amounts such that our asset coverage,
calculated pursuant to the 1940 Act, was at least 200% after such borrowing. Effective June 15, 2019, following approval by our stockholders, our asset coverage requirement was reduced from 200% to 150%.
As a BDC, we are subject to certain regulatory restrictions in making our investments. For example, BDCs generally are not permitted to co-invest with certain affiliated entities in transactions originated by the BDC or its affiliates in the absence of an exemptive order from the U.S. Securities and Exchange Commission, or the SEC. However, BDCs are
permitted to, and may, simultaneously co-invest in transactions where price is the only negotiated term. In an order dated January 5, 2021, the SEC granted exemptive relief permitting us, subject to the
satisfaction of certain conditions, to co-invest in certain privately negotiated investment transactions, including investments originated and directly negotiated by the Advisor or KKR Credit
Advisors (US) LLC, or KKR Credit, with our co-investment affiliates. We believe this relief enhances our ability to further our investment objectives and strategy. We believe this relief may also increase
favorable investment opportunities for us in part by allowing us to participate in larger investments, together with our co-investment affiliates, than would be available to us if such relief had not
been obtained.
Corporate Capital Trust, Inc. Acquisition
On December 19, 2018, we completed our acquisition of Corporate Capital Trust, Inc., or CCT, pursuant to that certain Agreement
and Plan of Merger, or the 2018 Merger Agreement, dated as of July 22, 2018, by and among us, CCT, IC Acquisition, Inc., a former wholly-owned subsidiary of the Company, or Merger Sub, and the Advisor. Pursuant to the 2018 Merger
Agreement, CCT was first merged with and into Merger Sub, with CCT as the surviving corporation, and, immediately following such merger, CCT was then merged with and into the Company, with the Company as the surviving company, or the 2018
Merger. In accordance with the terms of the 2018 Merger Agreement, at the time of the transactions contemplated by the 2018 Merger Agreement, each outstanding share of CCT common stock was converted into the right to receive 2.3552 shares
of our common stock. As a result, we issued an aggregate of approximately 292,324,670 shares of our common stock to former CCT stockholders. Following the consummation of the 2018 Merger, we entered into a new investment advisory
agreement with the Advisor, or the investment advisory agreement. Share and exchange ratio amounts in the foregoing do not reflect the Reverse Stock Split as discussed below.
Reverse Stock Split
On June 15, 2020, the Company filed
Articles of Amendment to its Articles of Incorporation, or the Reverse Stock Split Amendment, with the State Department of Assessments and Taxation of the State of Maryland to effect a 4 to 1 reverse split of the Companys shares of common
stock, or the Reverse Stock Split. The Reverse Stock Split became effective in accordance with the terms of the Reverse Stock Split Amendment on June 15, 2020. As a result of the Reverse Stock Split, every four shares of the Companys
common stock issued and outstanding were automatically combined into one share of the Companys common stock, and the number of outstanding shares of the Companys common stock was reduced from approximately 495.0 million to
approximately 123.8 million as of June 15, 2020. The Reverse Stock Split did not modify the rights or preferences of the Companys common stock. The Company also filed a separate Articles of Amendment to its Articles of Incorporation
with the State Department of Assessments and Taxation of the State of Maryland to provide that there would be no change in the par value of $0.001 per share as a result of the Reverse Stock Split.
Pending Merger with FSKR
On November 23, 2020, the Company entered into an Agreement and Plan of Merger, or the 2020 Merger Agreement, with FS KKR Capital Corp II., a Maryland corporation, or FSKR and, together with the
Company, the Funds, Rocky Merger Sub, Inc., a Maryland corporation and wholly-owned subsidiary of FSK, or Merger Sub, and the Advisor. The 2020 Merger Agreement provides that, subject to the conditions set forth in the 2020 Merger Agreement, Merger
Sub will merge with and into FSKR, with FSKR continuing as the surviving company and as a wholly-owned subsidiary of the Company, or the First Merger, and, immediately thereafter, FSKR will merge with and into the Company, with the Company
continuing as the surviving company or, together with the First Merger, the 2021 Merger. See Note 14 to our consolidated financial statements included in this annual report on Form 10-K for additional
information.
About the Advisor
The Advisor is a Delaware limited liability company, located at 201 Rouse Boulevard, Philadelphia, PA 19112, registered as an investment adviser with the SEC under the Advisers Act. The Advisor is a
partnership between an affiliate of Franklin
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Square Holdings, L.P. (which does business as FS Investments), or FS Investments, and KKR Credit. Our chairman and chief executive officer, Michael C. Forman, serves as the Advisors
chairman and chief executive officer.
The Advisor has significant experience in private lending and private equity investing,
and has developed an expertise in using all levels of a firms capital structure to produce income-generating investments, while focusing on risk management. The Advisor also has extensive knowledge of the managerial, operational and regulatory
requirements of publicly registered alternative asset entities, such as BDCs. We believe that the active and ongoing participation by the Advisor, FS Investments, KKR Credit and their respective affiliates in the credit markets, and the depth of
experience and disciplined investment approach of the Advisor, will allow the Advisor to successfully execute our investment strategies.
Our board of directors, which is comprised of a majority of independent directors, oversees and monitors our investment performance, and beginning with the second anniversary of the effective date of the
investment advisory agreement, will review the investment advisory agreement to determine, among other things, whether the fees payable under such agreement are reasonable in light of the services provided.
About FS Investments
FS
Investments is a leading asset manager dedicated to helping individuals, financial professionals and institutions design better portfolios. The firm provides access to alternative sources of income and growth, and focuses on setting industry
standards for investor protection, education and transparency. FS Investments is headquartered in Philadelphia, PA, with offices in New York, NY, Orlando, FL and Leawood, KS. The firm had approximately $23 billion in assets under management as of
December 31, 2020.
About KKR Credit
KKR Credit is a Delaware limited liability company, located at 555 California Street, 50th Floor, San Francisco, CA 94104, registered as an investment adviser with the SEC under the Advisers Act. It
had approximately $78 billion of assets under management as of December 31, 2020 across investment funds, structured finance vehicles, specialty finance companies and separately managed accounts that invest capital in both liquid and
illiquid credit strategies on behalf of some of the largest public and private pension plans, global financial institutions, university endowments and other institutional and public market investors. Its investment professionals utilize an industry
and thematic approach to investing and benefit from access, where appropriate, to the broader resources and intellectual capital of KKR & Co. Inc., or KKR & Co.
KKR Credit is a subsidiary of KKR & Co., a leading global investment firm with approximately $252 billion in assets under
management as of December 31, 2020, that manages investments across multiple asset classes, including private equity, energy, infrastructure, real estate and credit, with strategic manager partnerships that manage hedge funds. KKR &
Co. aims to generate attractive investment returns for its fund investors by following a patient and disciplined investment approach, employing world-class people, and driving growth and value creation with KKR & Co. portfolio companies.
KKR & Co. invests its own capital alongside the capital it manages for fund investors and provides financing solutions and investment opportunities through its capital markets business.
Potential Market Opportunity
We believe significant investment opportunities will continue to present themselves in the senior secured and second lien secured loan asset class, as well as investments in debt securities of middle
market companies.
Attractive Opportunities in Senior Secured and Second Lien Secured Loans
The variable rate structure of most senior secured and second lien secured loans present significant opportunities across the asset class,
particularly within a rising interest rate environment. Additionally, the strong defensive characteristics inherent to many securities across the asset class make them compelling to many investors. Because senior secured debt has priority in payment
among an issuers security holders (i.e., holders are due to receive payment before junior creditors and equity holders), they carry the least potential risk within the issuers capital structure. Further, senior secured debt investments
are secured by the issuers assets, which may be seized in the event of a default. Senior secured loans generally also carry restrictive covenants aimed at ensuring repayment before junior creditors, including unsecured bondholders and other
security holders, preserving collateral to protect against credit deterioration.
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Opportunity in Middle Market Private Companies
In addition to investing in senior secured and second lien secured loans, we believe that the market for lending to private companies,
particularly middle market private companies within the United States, is underserved and presents a compelling investment opportunity. The following characteristics support our belief:
Large Target Market. Middle market U.S. companies have historically represented a significant portion of the growth segment of the U.S. economy.
These companies also often require substantial capital investment to grow their businesses. Historically, significant private equity capital has been available for investment in middle market companies and we expect that private equity firms will
continue to leverage their investments in middle market companies with senior secured and second lien secured loans.
Limited Investment Competition. Despite the size of the market, regulatory changes and other factors have diminished the role of traditional
financial institutions in providing financing to middle market companies in favor of lending to large corporate clients and leading syndication efforts for capital markets transactions. Further, we believe a limited number of of lenders are willing
to hold large amounts of middle market loans. As a result, we believe our ability to eliminate syndication risk by holding middle market loans is a competitive advantage.
Lending and originating new loans to middle market companies, which are often private, generally requires a greater dedication of a
lenders time and resources compared to lending to larger companies as it is often more difficult to make investments in, and acquire information, about smaller companies . Many investment firms lack the breadth and scale necessary to identify
investment opportunities, particularly directly originated investments in middle market companies, which may result in their overlooking many attractive investment opportunities. Middle market companies also may require more active monitoring and
participation on the lenders part. We believe that many large financial organizations, which often have relatively high cost structures, are not suited to deal with these factors and instead emphasize services and transactions to larger
corporate clients, resulting in a reduction in the availability of financing to middle market companies.
Attractive Market Segment. The underserved nature of such a large segment of the market can at times create significant investment
opportunities. In many environments, lending to middle market companies may offer more attractive economics than lending to larger corporations in terms of transaction pricing, up-front and ongoing fees,
prepayment penalties, stricter covenants and quality collateral. In addition, middle market companies often have simpler capital structures and carry less leverage than larger companies, thus aiding the structuring and negotiation process and
allowing us greater flexibility in structuring favorable transactions.
Potential Competitive Strengths
We believe that we offer investors the following potential competitive strengths:
Large, scalable, global platform with seasoned investment professionals
We believe that the breadth and depth of the experience of the Advisor and its affiliates, which are dedicated to sourcing, structuring,
executing, monitoring and harvesting a broad range of private investments, provide us with a significant competitive advantage in sourcing and analyzing attractive investment opportunities. Our investment platform is supported by approximately 125
dedicated investment professionals at KKR Credit located in nine global cities. We also benefit from the expertise, network and resources of KKR & Co., which has over 400 investment professionals located in twenty global cities. The
individual members of these teams have diverse investment backgrounds, with prior experience at investment banks, commercial banks, other asset managers and operating companies. We believe this diverse experience provides an in-depth understanding of the strategic, financial and operational challenges and opportunities of middle-market companies.
Utilization of long-standing relationships and international capital market capabilities to source investments
The Advisor and its affiliates have worked diligently over many years to build strategic relationships with private equity firms, banks and trading desks globally. Our and our affiliates long
history of serving as a reliable financing partner to middle-market sponsors, even during periods of significant market dislocation, has enhanced our reputation. We believe that our network of relationships will continue to produce attractive
investment opportunities.
The Advisor also leverages the intellectual capital, industry experience and global network of
KKR & Co.s Capital Markets franchise to support the origination of new private credit investment opportunities. Through KKR & Co.s Capital
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Markets franchise, the Advisor benefits from expanded sources of deal flow, real-time market intelligence on pricing trends and continuous dialogue with issuers and sponsors to provide holistic
financing solutions to current and prospective portfolio companies. In addition, KKR & Co.s Capital Markets franchise gives us the ability to access and originate larger transactions and enhances the Advisors ability to manage
risk.
Focus on larger middle market companies and customized one-stop credit
solutions
We are focused on providing customized credit solutions to private upper middle market companies, which we
generally define as companies with annual EBITDA of at least $50 million at the time of our investment. Based on its size and scale, the KKR Credit platform is able to originate, commit to and hold positions in excess of $1 billion in a
given transaction. This size allows us to serve in the lead financing role for certain larger middle market companies with more than $100 million in EBITDA. We believe our ability to underwrite an entire transaction provides financial sponsors
and companies with a greater degree of financing certainty and further enhances our competitive position. The KKR Credit platform also offers a variety of financing structures and has the flexibility to structure investments to meet the needs of
companies. Finally, we believe that the upper end of the middle market is less competitive as fewer lenders have the requisite size and scale to provide holistic solutions for these companies.
Long-term investment horizon
Our long-term investment horizon gives us great flexibility, which we believe allows us to maximize returns on our investments. Unlike most private equity and venture capital funds, as well as many
private debt funds, we are not required to return capital to our stockholders once we exit a portfolio investment. We believe that freedom from such capital return requirements, which allows us to invest using a longer-term focus, provides us with
the opportunity to increase total returns on invested capital, compared to other private company investment vehicles.
Disciplined, income-oriented investment philosophy
The Advisor employs a defensive investment approach focused on long-term credit performance and principal protection. This investment approach involves a multi-stage selection process for each investment
opportunity, as well as ongoing monitoring of each investment made, with particular emphasis on early detection of deteriorating credit conditions at portfolio companies which would result in adverse portfolio developments. This strategy is designed
to maximize current income and minimize the risk of capital loss while maintaining the potential for long-term capital appreciation.
Investment expertise across all levels of the corporate capital structure
The Advisor believes that its broad expertise and experience investing at all levels of a companys capital structure enable us to manage risk while affording us the opportunity for significant
returns on our investments. We attempt to capitalize on this expertise in an effort to produce and maintain an investment portfolio that will perform in a broad range of economic conditions.
Ability to create bespoke financing solutions through asset-based opportunities
The Advisor believes that there is an expansive and growing opportunity to create customized solutions in underserved asset classes,
including across the aircraft, consumer finance and auto and equipment finance sectors. The Advisor will seek to identify investments with strong collateral protection, a low correlation to the broader markets and equity-like upside potential.
Maintenance of portfolio diversification
In addition to focusing our investments in middle-market companies, we seek to invest across various industries. The Advisor monitors our
investment portfolio to ensure we have acceptable industry balance, using industry and market metrics as key indicators. By monitoring our investment portfolio for industry balance, we seek to reduce the effects of economic downturns associated with
any particular industry or market sector. Notwithstanding our intent to invest across a variety of industries, we may from time to time hold securities of a single portfolio company that comprise more than 5.0% of our total assets and/or more than
10.0% of the outstanding voting securities of the portfolio company. For that reason, we are classified as a non-diversified management investment company under the 1940 Act.
Investment Strategy
Our
principal focus is to invest in senior secured and second lien secured loans of private middle market U.S. companies, and to a lesser extent, subordinated loans and certain asset-based financing loans of private U.S. companies. Although we do not
expect a significant portion of our portfolio to be comprised of subordinated loans, there is no limit on the amount of such loans
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in which we may invest. We may purchase interests in loans or make other debt investments, including investments in senior secured bonds, through secondary market transactions in the OTC market
or directly from our target companies as primary market or directly originated investments. In connection with our debt investments, we may on occasion receive equity interests such as warrants or options as additional consideration. We may also
purchase or otherwise acquire interests in the form of common or preferred equity or equity-related securities, such as rights and warrants that may be converted into or exchanged for common stock or other equity or the cash value of common stock or
other equity, including through a co-investment with a financial sponsor or possibly the restructuring of an investment. In addition, a portion of our portfolio may be comprised of bonds, structured products,
other debt securities and derivatives. The Advisor will seek to tailor our investment focus as market conditions evolve. Depending on market conditions, we may increase or decrease our exposure to less senior portions of the capital structures of
our portfolio companies or otherwise make opportunistic investments, such as where the market price of loans, bonds or other securities reflects a lower value than deemed warranted by the Advisors fundamental analysis. Such investment
opportunities may occur due to general dislocations in the markets, a misunderstanding by the market of a particular company or an industry being out of favor with the broader investment community and may include event driven investments, anchor
orders and structured products.
When identifying prospective portfolio companies, we focus primarily on the attributes set
forth below, which we believe will help us generate higher total returns with an acceptable level of risk. While these criteria provide general guidelines for our investment decisions, if we believe the benefits of investing are sufficiently strong,
not all of these criteria necessarily will be met by each portfolio company in which we choose to invest. These attributes are:
Leading, defensible market positions. We seek to invest in companies that have developed strong competitive positions within their respective
markets and exhibit the potential to maintain sufficient cash flows and profitability to service our debt in a range of economic environments. We seek companies that can protect their competitive advantages through scale, scope, customer loyalty,
product pricing or product quality versus their competitors, thereby minimizing business risk and protecting profitability.
Investing in stable companies with positive cash flow. We seek to invest in established, stable companies with strong profitability and cash
flows. Such companies, we believe, are well-positioned to maintain consistent cash flow to service and repay our loans and maintain growth in their businesses or market share. We do not intend to invest to any significant degree in start-up companies, turnaround situations or companies with speculative business plans.
Proven management teams. We focus on companies that have experienced management teams with an established track record of success. We typically
prefer our portfolio companies to have proper incentives in place, which may include non-cash and performance-based compensation, to align managements goals with ours.
Private equity sponsorship. Often we seek to participate in transactions sponsored by what we believe to be sophisticated and seasoned private
equity firms. The Advisor believes that a private equity sponsors willingness to invest significant sums of equity capital into a company is an endorsement of the quality of the investment opportunity. Further, by co-investing with such experienced private equity firms which commit significant sums of equity capital ranking junior in priority of payment to our debt investments, we may benefit from the due diligence review
performed by the private equity firm, in addition to our own due diligence review. Further, strong private equity sponsors with significant investments at risk may have both the ability and incentive to contribute additional capital in difficult
economic times should operational or financial issues arise, which could provide additional protections for our investments.
Allocation among various issuers and industries. We seek to allocate our portfolio broadly among issuers and industries, thereby attempting to
reduce the risk of a downturn in any one company or industry having a disproportionate adverse impact on the value of our portfolio.
Viable exit strategy. While we attempt to invest in securities that may be sold in a privately negotiated OTC market, providing us a means by
which we may exit our positions, we expect that a large portion of our portfolio may not be sold on this secondary market. For any investments that are not able to be sold within this market, we focus primarily on investing in companies whose
business models and growth prospects offer attractive exit possibilities, including repayment of our investments, an initial public offering of equity securities, a merger, a sale or a recapitalization, in each case with the potential for capital
gains.
Joint Venture
We also co-invest with South Carolina Retirement Systems Group Trust, or SCRS, through Strategic Credit Opportunities Partners, LLC, or SCJV, a joint
venture with SCRS. SCJV invests its capital in a range of investments, including senior secured
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loans (both first lien and second lien) to middle market companies, broadly syndicated loans, equity, warrants and other investments. We and SCRS each have 50% voting control of SCJV and together
are required to agree on all investment decisions as well as certain other significant actions for SCJV. As of December 31, 2020, SCJV had total capital commitments of $1 billion, $875 million of which was from us and the remaining
$125 million of which was from SCRS. As of December 31, 2020, we had funded approximately $809.2 million of our commitment. Additionally, as of December 31, 2020, SCJV had $328.0 million of borrowing capacity. As of
December 31, 2020, our investment in SCJV was approximately $712.5 million at fair value. We do not consolidate SCJV in our consolidated financial statements.
Investment Types
We primarily focus on the following investment types:
Senior Secured Loans
Senior secured loans are situated at the top of a companys capital structure. Because these loans generally have priority in payment, they carry the least risk among all investments in a firm.
Generally, our senior secured loans are expected to have maturities of three to seven years, offer some form of amortization, and have first priority security interests in the assets of the borrower. Generally, we expect that the interest rate on
our senior secured loans typically will have variable rates over a standard benchmark, such as the prime rate or the London Interbank Offered Rate, or LIBOR.
Second Lien Secured Loans
Second lien secured loans are immediately
junior to senior secured loans and have substantially the same maturities, collateral and covenant structures as senior secured loans. Second lien secured loans, however, are granted a second priority security interest in the assets of the borrower,
which means that any realization of collateral will generally be applied to pay senior secured loans in full before second lien secured loans are paid and the value of the collateral may not be sufficient to repay in full both senior secured loans
and second lien secured loans. In return for this junior ranking, second lien secured loans generally offer higher returns compared to senior secured debt. These higher returns come in the form of higher interest and in some cases the potential for
equity participation through warrants, though to a lesser extent than with subordinated loans. Generally, we expect these loans to carry a fixed rate, or a floating current yield over a standard benchmark. In addition, we may receive additional
returns from any warrants we may receive in connection with these investments.
Senior Secured Bonds
Senior secured bonds are generally secured by collateral on a senior, pari passu or junior basis with other debt instruments in an
issuers capital structure and have similar maturities and covenant structures as senior secured loans. Generally, we expect these investments to carry a fixed rate.
Subordinated Debt
In addition to senior secured loans, second lien
secured loans and senior secured bonds, we may invest a portion of our assets in subordinated debt. Subordinated debt investments usually rank junior in priority of payment to senior debt and are often unsecured, but are situated above preferred
equity and common equity in the capital structure. In return for their junior status compared to senior debt, subordinated debt investments typically offer higher returns through both higher interest rates and possible equity ownership in the form
of warrants, enabling the lender to participate in the capital appreciation of the borrower. These warrants typically require only a nominal cost to exercise. We generally target subordinated debt with interest-only payments throughout the life of
the security, with the principal due at maturity. Typically, subordinated debt investments have maturities of five to ten years. Generally, we expect these securities to carry a fixed rate, or a floating current yield over a standard benchmark. In
addition, we may receive additional returns from any warrants we may receive in connection with these investments. In some cases, a portion of the total interest may accrue or be
paid-in-kind, or PIK.
Equity and
Equity-Related Securities
While we intend to maintain our focus on investments in debt securities, from time to time,
when we see the potential for extraordinary gain, or in connection with securing particularly favorable terms in a debt investment, we may enter into investments in preferred or common equity, typically in conjunction with a private equity sponsor
we believe to be sophisticated and seasoned. In addition, we may receive the right to make equity investments in a portfolio company whose debt securities we hold in connection with the next equity financing round for that company. This right may
provide us with the opportunity to further enhance our returns over time through equity investments in our portfolio companies. In addition, we may hold equity-
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related securities, such as rights and warrants that may be converted into or exchanged for common stock or other equity or the cash value of common stock or other equity, generally obtained in
conjunction with one of our debt investments or through a co-investment with a financial sponsor, such as an institutional investor or private equity firm. In the future, we may achieve liquidity through a
merger or acquisition of a portfolio company, a public offering of a portfolio companys stock or by exercising our right, if any, to require a portfolio company to repurchase the equity-related securities we hold.
Convertible Securities
We may invest in convertible securities, such as bonds, debentures, notes, preferred stocks or other securities that may be converted into, or exchanged for, a specified amount of common stock of the same
or different issuer within a particular period of time at a specified price or formula.
Non-U.S. Securities
We may invest in non-U.S. securities, which may include securities denominated in U.S. dollars or
in non-U.S. currencies and securities of companies in emerging markets, to the extent permitted by the 1940 Act.
Investments in Asset-Based Opportunities
We may invest in
asset-based opportunities through joint ventures, investment platforms, private investment funds or other business entities that provide one or more of the following services: origination or sourcing of potential investment opportunities,
due diligence and negotiation of potential investment opportunities and/or servicing, development and management (including turnaround) and disposition of investments. Such investments may be in or alongside existing or newly formed operators,
consultants and/or managers that pursue such opportunities and may or may not include capital and/or assets contributed by third party investors. Such investments may include opportunities to direct-finance physical assets, such as airplanes and
ships, and/or operating assets, such as financial service entities, as opposed to investment securities, or to invest in origination and/or servicing platforms directly. These asset-based opportunities are expected to offer mezzanine-like structural
downside protection as well as asset collateral, and equity-like upside that can be achieved through appreciation at the asset-level or, in the case of platforms, through growth of the enterprise value. Key
areas of focus include, without limitation, aircraft, real estate and consumer finance.
Structured Products
We may invest in structured products, which may include collateralized debt obligations, collateralized bond
obligations, collateralized loan obligations, structured notes and credit-linked notes. The issuers of such investment products may be structured as trusts or other types of pooled investment vehicles. Such products may also involve the deposit with
or purchase by an entity of the underlying investments and the issuance by that entity of one or more classes of securities backed by, or representing interests in, the underlying investments or referencing an indicator related to such investments.
Derivatives
We may also invest from time to time in derivatives, including total return swaps, interest rate swaps, credit default swaps and foreign currency forward contracts. We anticipate that any use of
derivatives would primarily be as a substitute for investing in conventional securities or to hedge potential risk that is identified by the Advisor.
Investments with Third-Parties
We
may co-invest with third parties through partnerships, joint ventures or other entities, thereby acquiring jointly-controlled
or non-controlling interests in certain investments in conjunction with participation by one or more third parties in such investment. Such joint venture partners or third party managers may include
former personnel of the Advisor or its affiliates or associated persons.
Cash and Cash Equivalents
We may maintain a certain level of cash or equivalent instruments, including money market funds, to make
follow-on investments, if necessary, in existing portfolio companies or to take advantage of new opportunities.
Comparison of Targeted Debt Investments to Corporate Bonds
Loans to
private companies are debt instruments that can be compared to corporate bonds to aid an investors understanding. As with corporate bonds, loans to private companies can range in credit quality depending on security-specific
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factors, including total leverage, amount of leverage senior to the security in question, variability in the issuers cash flows, the quality of assets securing debt and the degree to which
such assets cover the subject companys debt obligations. As is the case in the corporate bond market, we will require greater returns for securities that we perceive to carry increased risk. The companies in which we invest may be leveraged,
often as a result of leveraged buyouts or other recapitalization transactions, and, in many cases, will not be rated by national rating agencies. When our targeted debt investments do carry ratings from a NRSRO, we believe that such ratings
generally will be below investment grade (rated lower than Baa3 by Moodys or lower than BBB- by S&P). To the extent we make unrated investments, we believe that such
investments would likely receive similar ratings if they were to be examined by a NRSRO. Compared to below-investment grade corporate bonds that are typically available to the public, our targeted senior
secured and second lien secured loan investments are higher in the capital structure, have priority in receiving payment, are secured by the issuers assets, allow the lender to seize collateral if necessary, and generally exhibit higher rates
of recovery in the event of default. Corporate bonds, on the other hand, are often unsecured obligations of the issuer.
The
market for loans to private companies possesses several key differences compared to the corporate bond market. For instance, due to a possible lack of debt ratings for certain middle market firms, and also due to the reduced availability of
information for private companies, investors must conduct extensive due diligence investigations before committing to an investment. This intensive due diligence process gives the investor significant access to management, which is often not
possible in the case of corporate bondholders, who rely on underwriters, debt rating agencies and publicly available information for due diligence reviews and monitoring of corporate issuers. While holding these investments, private debt investors
often receive monthly or quarterly updates on the portfolio companys financial performance, along with possible representation on the companys board of directors, which allows the investor to take remedial action quickly if conditions
happen to deteriorate. Due to reduced liquidity, the relative scarcity of capital and extensive due diligence and expertise required on the part of the investor, we believe that private debt securities typically offer higher returns than corporate
bonds of equivalent credit quality.
Investment Process
The investment professionals employed by the Advisor or its affiliates have spent their careers developing the resources necessary to invest in private companies. Our current transaction process is
highlighted below.
Our Transaction Process
Sourcing
The relationships of the Advisor and its affiliates provide us with access to a robust and established pipeline of investment opportunities sourced from a variety of different investment channels,
including private equity sponsors, non-sponsored corporates, financial advisors, banks, brokers and family offices.
Evaluation
Screening. Once a potential investment has
been identified, the Advisor screens the opportunity and makes a preliminary determination concerning whether to proceed with a more comprehensive deal-level due diligence review.
Pipeline/Risk Update. Upon review of the full deal pipeline, the Advisor raises key risks and issues to determine whether or
not an investment meets our basic investment criteria and offers an acceptable probability of attractive returns with identifiable downside risk. The objective is for the Advisor to identify a suitable and attractive opportunity for a more
comprehensive due diligence review based on the facts and circumstances surrounding the investment.
Deal-level
Q&A: After an investment has been identified and preliminary due diligence has been completed, screening memos and a credit research analysis is prepared. These reports are reviewed by the Advisors investment committee, or
the Investment Committee, to discuss key diligence and structuring issues. Following the Advisors review, the Investment Committee will complete any incremental due diligence prior to formal Investment Committee approval. Though each
transaction may involve a somewhat different approach, the Advisors diligence of each opportunity could include:
a full operational analysis to identify the key risks and opportunities of the targets business, including a detailed review of historical and
projected financial results;
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a detailed analysis of industry dynamics, competitive position, regulatory, tax and legal matters;
on-site visits, if deemed necessary;
background checks to further evaluate management and other key personnel;
a review by legal and accounting professionals, environmental or other industry consultants, if necessary;
financial sponsor due diligence, including portfolio company and lender reference checks, if necessary; and
a review of managements experience and track record.
Execution
Following any incremental due diligence, the Investment
Committee is presented with a formal recommendation for approval. Once the Investment Committee has determined that the portfolio company is suitable for investment, the Advisor works with the management team of the prospective company to finalize
the structure and terms of the investment. We believe that structuring transactions appropriately is a key factor to producing strong investment results. Accordingly, we will actively consider transaction structures and seek to process and negotiate
terms that provide the best opportunities for superior risk-adjusted returns.
Post-Investment Monitoring
Portfolio Monitoring. The Advisor monitors our portfolio with a focus toward anticipating negative credit events. To maintain portfolio company performance and help to ensure a successful exit, the
Advisor works closely with, as applicable, the lead equity sponsor, loan syndicator, portfolio company management, consultants, advisers and other security holders to discuss financial position, compliance with covenants, financial requirements and
execution of the companys business plan. In addition, depending on the size, nature and performance of the transaction, we may occupy a seat or serve as an observer on a portfolio companys board of directors or similar governing body.
Typically, the Advisor receives financial reports detailing operating performance, sales volumes, cost of goods sold,
operating expenses, operating margins, cash flows, financial position and other key operating metrics on a quarterly basis from our portfolio companies. The Advisor uses this data, combined with due diligence gained through contact with the
companys customers, suppliers, competitors, market research and other methods, to conduct an ongoing, rigorous assessment of the companys operating performance and prospects.
In addition to various risk management and monitoring tools, the Advisor uses an investment rating system to characterize and monitor the
expected level of returns on each investment in our portfolio. The Advisor uses an investment rating scale of 1 to 4. See Item 7. Managements Discussion and Analysis of Financial Condition and Results of
OperationsPortfolio Asset Quality for a description of the conditions associated with each investment rating.
Valuation Process. We determine the net asset value of our investment portfolio each quarter. Securities are valued at fair value
as determined in good faith by our board of directors. In connection with that determination, the Advisor provides our board of directors with portfolio company valuations which are based on relevant inputs, including, but not limited to, indicative
dealer quotes, values of like securities, recent portfolio company financial statements and forecasts, and valuations prepared by independent third-party valuation services.
Accounting Standards Codification Topic 820, Fair Value Measurements and Disclosure , or ASC Topic 820, issued by the Financial
Accounting Standards Board, or FASB, clarifies the definition of fair value and requires companies to expand their disclosure about the use of fair value to measure assets and liabilities in interim and annual periods subsequent to initial
recognition. ASC Topic 820 defines fair value as the price that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 also establishes
a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets;
Level 2, which includes inputs such as quoted prices for similar securities in active markets and quoted prices for identical securities where there is little or no activity in the market; and Level 3, defined as unobservable inputs for
which little or no market data exists, therefore requiring an entity to develop its own assumptions.
With respect to
investments for which market quotations are not readily available, we undertake a multi-step valuation process each quarter, as described below:
our quarterly fair valuation process begins by the Advisor providing financial and operating information with respect to each portfolio company or
investment to our independent third-party valuation service providers;
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our independent third-party valuation service providers review this information, along with other public and private information, and provide the
Advisor with a valuation range for each portfolio company or investment;
the Advisor then discusses the independent third-party valuation service providers valuation ranges and provides the valuation committee of the
board of directors, or the valuation committee, with a valuation recommendation for each investment, along with supporting materials;
preliminary valuations are then discussed with the valuation committee;
our valuation committee reviews the preliminary valuations and the Advisor, together with our independent third-party valuation service providers and,
if applicable, supplements the preliminary valuations to reflect any comments provided by the valuation committee;
following the completion of its review, our valuation committee recommends that our board of directors approves the fair valuations determined by the
valuation committee; and
our board of directors discusses the valuations and determines the fair value of each such investment in our portfolio in good faith based on various
statistical and other factors, including the input and recommendation of the Advisor, the valuation committee and our independent third-party valuation service providers.
Determination of fair value involves subjective judgments and estimates. Accordingly, the notes to our consolidated financial statements
refer to the uncertainty with respect to the possible effect of such valuations and any change in such valuations on our consolidated financial statements. In making its determination of fair value, our board of directors may use any approved
independent third-party pricing or valuation services. However, our board of directors is not required to determine fair value in accordance with the valuation provided by any single source, and may use any relevant data, including information
obtained from the Advisor or any approved independent third-party valuation or pricing service that our board of directors deems to be reliable in determining fair value under the circumstances. Below is a description of factors that the Advisor,
any approved independent third-party valuation services and our board of directors may consider when determining the fair value of our investments.
Valuation of fixed income investments, such as loans and debt securities, depends upon a number of factors, including prevailing interest rates for like securities, expected volatility in future interest
rates, call features, put features and other relevant terms of the debt. For investments without readily available market prices, we may incorporate these factors into discounted cash flow models to arrive at fair value. Other factors that may be
considered include the borrowers ability to adequately service its debt, the fair market value of the borrower in relation to the face amount of its outstanding debt and the quality of collateral securing our debt investments.
For convertible debt securities, fair value generally approximates the fair value of the debt plus the fair value of an option to purchase
the underlying security (i.e., the security into which the debt may convert) at the conversion price. To value such an option, a standard option pricing model may be used.
Our equity interests in portfolio companies for which there is no liquid public market are valued at fair value. Our board of directors, in its determination of fair value, may consider various factors,
such as multiples of EBITDA, cash flows, net income, revenues or, in limited instances, book value or liquidation value. All of these factors may be subject to adjustments based upon the particular circumstances of a portfolio company or our actual
investment position. For example, adjustments to EBITDA may take into account compensation to previous owners or acquisition, recapitalization, restructuring or other related items.
The Advisor, any approved independent third-party valuation services and our board of directors may also consider private merger and
acquisition statistics, public trading multiples discounted for illiquidity and other factors, valuations implied by third-party investments in the portfolio companies or industry practices in determining fair
value. The Advisor, any approved independent third-party valuation services and our board of directors may also consider the size and scope of a portfolio company and its specific strengths and weaknesses, and
may apply discounts or premiums, where and as appropriate, due to the higher (or lower) financial risk and/or the smaller size of portfolio companies relative to comparable firms, as well as such other factors as our board of directors, in
consultation with the Advisor and any approved independent third-party valuation services, if applicable, may consider relevant in assessing fair value. Generally, the value of our equity interests in public companies for which market quotations are
readily available is based upon the most recent closing public market price. Portfolio securities that carry certain restrictions on sale are typically valued at a discount from the public market value of the security.
When we receive warrants or other equity securities at nominal or no additional cost in connection with an investment in a debt security,
the cost basis in the investment will be allocated between the debt securities and any such warrants or other equity
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securities received at the time of origination. Our board of directors subsequently values these warrants or other equity securities received at their fair value.
The fair values of our investments are determined in good faith by our board of directors. Our board of directors is responsible for the
valuation of our portfolio investments at fair value as determined in good faith pursuant to our valuation policy and consistently applied valuation process. Our board of directors has
delegated day-to-day responsibility for implementing our valuation policy to the Advisor, and has authorized the Advisor to utilize independent third-party
valuation and pricing services that have been approved by our board of directors. The valuation committee is responsible for overseeing the Advisors implementation of the valuation process.
Managerial Assistance. As a BDC, we must offer, and provide upon request, managerial assistance to certain of our portfolio
companies. This assistance could involve, among other things, monitoring the operations of our portfolio companies, participating in board and management meetings, consulting with and advising officers of portfolio companies and providing other
organizational and financial guidance. Depending on the nature of the assistance required, the Advisor will provide such managerial assistance on our behalf to portfolio companies that request this assistance. To the extent fees are paid for these
services, we, rather than the Advisor, will retain any fees paid for such assistance.
Exit
While we attempt to invest in securities that may be sold in a privately negotiated OTC market, providing us a means by which we may exit
our positions, we expect that a large portion of our portfolio may not be sold on this secondary market. For any investments that are not able to be sold within this market, we focus primarily on investing in companies whose business models and
growth prospects offer attractive exit possibilities, including repayment of our investments, an initial public offering of equity securities, a merger, a sale or a recapitalization, in each case with the potential for capital gains to the extent we
maintain an equity interest in the underlying portfolio company.
Risk Management
We seek to limit the downside potential of our investment portfolio by, among other things:
applying our investment strategy guidelines for portfolio investments;
requiring a total return on investments (including both interest and potential appreciation) that adequately compensates us for credit risk;
allocating our portfolio among various issuers and industries, size permitting, with an adequate number of companies, across different industries, with
different types of collateral; and
negotiating or seeking debt investments with covenants or features that protect us while affording portfolio companies flexibility in managing their
businesses consistent with preservation of capital, which may include affirmative and negative covenants, default penalties, lien protection, change of control provisions and board rights.
We may also enter into interest rate hedging transactions at the sole discretion of the Advisor. Such transactions will enable us to
selectively modify interest rate exposure as market conditions dictate.
Affirmative Covenants
Affirmative covenants require borrowers to take actions that are meant to ensure the solvency of the company, facilitate the lenders
monitoring of the borrower, and ensure payment of interest and loan principal due to lenders. Examples of affirmative covenants include covenants requiring the borrower to maintain adequate insurance, accounting and tax records, and to produce
frequent financial reports for the benefit of the lender.
Negative Covenants
Negative covenants impose restrictions on the borrower and are meant to protect lenders from actions that the borrower may take that could
harm the credit quality of the lenders investments. Examples of negative covenants include restrictions on the payment of dividends and restrictions on the issuance of additional debt without the lenders approval. In addition, certain
covenants restrict a borrowers activities by requiring it to meet certain earnings interest coverage ratio and leverage ratio requirements. These covenants are also referred to as financial or maintenance covenants.
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Operating and Regulatory Structure
Our investment activities are managed by the Advisor and supervised by our board of directors, a majority of whom are independent. Under
the investment advisory agreement, we have agreed to pay the Advisor an annual base management fee based on the average weekly value of our gross assets (excluding cash and cash equivalents) and an incentive fee based on our performance. See Notes 2
and 4 to our consolidated financial statements included in this annual report on Form 10-K for a description of the fees we pay to the Advisor.
From time to time, the Advisor may enter into sub-advisory relationships with registered
investment advisers that possess skills or attributes that the Advisor believes will aid it in achieving our investment objectives. The Advisor oversees our day-to-day
operations, including the provision of general ledger accounting, fund accounting, legal services, investor relations, certain government and regulatory affairs activities, and other administrative services. The Advisor also performs, or oversees
the performance of, our corporate operations and required administrative services, which includes being responsible for the financial records that we are required to maintain and preparing reports for our stockholders and reports filed with the SEC.
In addition, the Advisor assists us in calculating our net asset value, overseeing the preparation and filing of tax returns and the printing and dissemination of reports to our stockholders, and generally overseeing the payment of our expenses and
the performance of administrative and professional services rendered to us by others.
Pursuant to our administration
agreement, dated April 9, 2018, or the administration agreement, we reimburse the Advisor for expenses necessary to perform services related to our administration and operations, including the Advisors allocable portion of the
compensation and related expenses of certain personnel of FS Investments and KKR Credit providing administrative services to us on behalf of the Advisor. We reimburse the Advisor no less than quarterly for all costs and expenses incurred by the
Advisor in performing its obligations and providing personnel and facilities under the administration agreement. The Advisor allocates the cost of such services to us based on factors such as total assets, revenues, time allocations and/or other
reasonable metrics. Our board of directors reviews the methodology employed in determining how the expenses are allocated to us and the proposed allocation of administrative expenses among us and certain affiliates of the Advisor. Our board of
directors then assesses the reasonableness of such reimbursements for expenses allocated to us based on the breadth, depth and quality of such services as compared to the estimated cost to us of obtaining similar services from third-party service
providers known to be available. In addition, our board of directors considers whether any single third-party service provider would be capable of providing all such services at comparable cost and quality. Finally, our board of directors compares
the total amount paid to the Advisor for such services as a percentage of our net assets to the same ratio as reported by other comparable BDCs.
We have contracted with State Street Bank and Trust Company to provide various accounting and administrative services, including, but not limited to, preparing preliminary financial information for review
by the Advisor, preparing and monitoring expense budgets, maintaining accounting and corporate books and records, processing trade information provided by us and performing testing with respect to RIC compliance.
As a BDC, we are required to comply with certain regulatory requirements. Also, while we are permitted to finance investments using debt,
our ability to use debt will be limited in certain significant respects pursuant to the 1940 Act. Within the limits of existing regulation, we will adjust our use of debt, according to market conditions, to the level we believe will allow us to
generate maximum risk-adjusted returns. See Regulation. We have elected to be treated for U.S. federal income tax purposes, and intend to qualify annually, as a RIC under the Code.
Regulation
We have
elected to be regulated as a BDC under the 1940 Act and as a RIC under the Code. The 1940 Act contains prohibitions and restrictions relating to transactions between BDCs and their affiliates, principal underwriters and affiliates of those
affiliates or underwriters, as described below. The 1940 Act also requires that a majority of our directors be persons other than interested persons, as that term is defined in the 1940 Act. In addition, the 1940 Act provides that we may
not change the nature of our business so as to cease to be, or to withdraw our election as, a BDC unless approved by a majority of our outstanding voting securities. The 1940 Act defines a majority of the outstanding voting securities as
the lesser of (i) 67% or more of the voting securities present at a meeting if the holders of more than 50% of our outstanding voting securities are present or represented by proxy or (ii) 50% of our outstanding voting securities.
We will generally not be able to issue and sell our common stock at a price per share, after deducting underwriting
commissions and discounts, that is below our net asset value per share. We may, however, sell our common stock, or warrants, options or rights to acquire our common stock, at a price below the then-current net asset value of our common stock if our
board of directors determines that such sale is in our best interests and the best interests of our stockholders, and our stockholders
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approve such sale. At the 2020 annual stockholders meeting, our stockholders approved the sale of shares of our common stock at a price below the then-current net asset value per share, subject
to certain conditions, during the period beginning on July 15, 2020 and expiring on July 15, 2021. We currently do not intend to utilize this authority to sell shares of our common stock at a price below the then-current net asset value
per share. In addition, we may generally issue new shares of our common stock at a price below net asset value per share in rights offerings to existing stockholders, in payment of dividends and in certain other limited circumstances.
As a BDC, we are subject to certain regulatory restrictions in making our investments. For example, BDCs generally are not permitted to co-invest with certain affiliated entities in transactions originated by the BDC or its affiliates in the absence of an exemptive order from the SEC. However, BDCs are permitted to, and may, simultaneously co-invest in transactions where price is the only negotiated term. In an order dated January 5, 2021, the SEC granted exemptive relief permitting us, subject to the satisfaction of certain conditions, to co-invest in certain privately negotiated investment transactions, including investments originated and directly negotiated by the Advisor or KKR Credit, with our
co-investment affiliates. Under the terms of this relief, a required majority (as defined in Section 57(o) of the 1940 Act) of our independent directors must make certain conclusions in
connection with a co-investment transaction, including that (1) the terms of the proposed transaction, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not
involve overreaching of us or our stockholders on the part of any person concerned and (2) the transaction is consistent with the interests of our stockholders and is consistent with our investment objectives and strategy and any criteria
established by our board of directors.
Under the 1940 Act, we may only invest up to 30% of our portfolio in entities that are
not considered eligible portfolio companies under the 1940 Act, including companies located outside of the United States, entities that are operating pursuant to certain exceptions under the 1940 Act and publicly traded entities whose
public equity market capitalization exceeds the levels provided for under the 1940 Act.
We may invest up to 100% of our assets
in securities acquired directly from issuers in privately negotiated transactions. Our intention is to not write (sell) or buy put or call options to manage risks associated with the publicly traded securities of our portfolio companies. We may
enter into hedging transactions to manage the risks associated with interest rate and currency fluctuations. We may purchase or otherwise receive warrants or options to purchase the common stock of our portfolio companies in connection with
acquisition financings or other investments. In connection with such an acquisition, we may acquire rights to require the issuers of acquired securities or their affiliates to repurchase them under certain circumstances.
We also do not intend to acquire securities issued by any investment company that exceed the limits imposed by the 1940 Act. Under these
limits, we generally cannot acquire more than 3% of the voting stock of any investment company (as defined in the 1940 Act), invest more than 5% of the value of our total assets in the securities of one investment company or invest more than 10% of
the value of our total assets in the securities of investment companies in the aggregate. With regard to that portion of our portfolio invested in securities issued by investment companies, it should be noted that such investments might subject our
stockholders to additional expenses.
On June 14, 2019, our stockholders approved the application of the modified asset
coverage requirement set forth in Section 61(a)(2) of the 1940 Act, as amended by the Small Business Credit Availability Act. As a result, we are permitted, under specified conditions, to issue multiple classes of debt and one class of stock
senior to our common stock if our asset coverage, as defined in the 1940 Act, is at least equal to 150% immediately after each such issuance, such that the Companys maximum debt to equity ratio increased from a prior maximum of 1.0x
(equivalent of $1 of debt outstanding for each $1 equity) to a maximum of 2.0x (equivalent to $2 of debt outstanding for each $1 of equity). In addition, while any senior securities remain outstanding, we must make provisions to prohibit any
distribution to our stockholders or the repurchase of such securities or shares unless we meet the applicable asset coverage ratios at the time of the distribution or repurchase. We may also borrow amounts up to 5% of the value of our total assets
for temporary purposes without regard to asset coverage.
Securities Exchange Act and Sarbanes-Oxley Act Compliance
We are subject to the reporting and disclosure requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act,
including the filing of quarterly, annual and current reports, proxy statements and other required items. In addition, we are subject to the Sarbanes-Oxley Act, which imposes a wide variety of regulatory requirements on publicly-held companies and
their insiders. Many of these requirements affect us. For example:
pursuant to Rule 13a-14 promulgated under the Exchange Act, our chief executive officer and chief financial
officer are required to certify the accuracy of the financial statements contained in our periodic reports;
pursuant to Item 307 of Regulation S-K, our periodic reports are required to disclose our conclusions
about the effectiveness of our disclosure controls and procedures;
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pursuant to Rule 13a-15 promulgated under the Exchange Act, our management is required to prepare a report
regarding its assessment of our internal control over financial reporting; and
pursuant to Item 308 of Regulation S-K, our auditors must attest to, and report on, our managements
assessment of our internal control over financial reporting.
The Sarbanes-Oxley Act requires us to review
our current policies and procedures to determine whether we comply with the Sarbanes-Oxley Act and the regulations promulgated thereunder. We monitor our compliance with all regulations that are adopted under the Sarbanes-Oxley Act and take actions
necessary to ensure that we are in compliance therewith.
The New York Stock Exchange Corporate Governance Regulations
The New York Stock Exchange, or NYSE, has adopted corporate governance regulations with which listed companies must comply. We believe we
currently are in compliance with such corporate governance listing standards. We intend to monitor our compliance with all future listing standards and to take reasonably necessary actions to ensure that we stay in compliance.
Taxation as a RIC
We
have elected to be subject to tax as a RIC under Subchapter M of the Code. As a RIC, we generally will not have to pay corporate-level U.S. federal income taxes on any ordinary income or capital gains that we timely distribute each tax year as
distributions to our stockholders. To qualify for and maintain our qualification as a RIC, we must, among other things, meet certain source-of-income and asset
diversification requirements (as described below). In addition, in order to maintain RIC tax treatment, we must distribute to our stockholders, for each tax year, distributions generally of an amount at least equal to 90% of our investment
company taxable income, which is generally the sum of our net ordinary income plus the excess, if any, of realized net short-term capital gains over realized net long-term capital losses, determined without regard to any deduction for
distributions paid, or the Annual Distribution Requirement.
If we:
qualify as a RIC; and
satisfy the Annual Distribution Requirement,
then we will not be subject to U.S. federal income tax on the portion of our income or capital gains we distribute (or are deemed to distribute) as distributions to our stockholders. We will be subject to
U.S. federal income tax at the regular corporate rates on any income or capital gains not distributed (or deemed distributed) as distributions to our stockholders.
As a RIC, we will be subject to a 4% nondeductible federal excise tax on certain undistributed income unless we distribute distributions in a timely manner to our stockholders generally of an amount at
least equal to the sum of (1) 98% of our net ordinary income (taking into account certain deferrals and elections) for the calendar year, (2) 98.2% of our capital gain net income, which is the excess of capital gains in excess of capital
losses, or capital gain net income (as adjusted for certain ordinary losses), for the one-year period ending October 31 of that calendar year and (3) any net ordinary income and capital
gain net income for the preceding years that were not distributed during such years and on which we paid no U.S. federal income tax, or the Excise Tax Avoidance Requirement. Any distribution declared by us during October, November or December of any
calendar year, payable to stockholders of record on a specified date in such a month and actually paid during January of the following calendar year, will be treated as if it had been paid by us, as well as received by our U.S. stockholders, on
December 31 of the calendar year in which the distribution was declared.
We have previously incurred, and may incur in
the future, such excise tax on a portion of our income and capital gains. While we intend to distribute income and capital gains to minimize exposure to the 4% excise tax, we may not be able to, or may choose not to, distribute amounts sufficient to
avoid the imposition of the tax entirely. In that event, we generally will be liable for the excise tax only on the amount by which we do not meet the excise tax avoidance requirement.
In order to qualify as a RIC for U.S. federal income tax purposes, we must, among other things:
continue to qualify as a BDC under the 1940 Act at all times during each tax year;
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derive in each tax year at least 90% of our gross income from dividends, interest, payments with respect to certain securities, loans, gains from the
sale of stock or other securities, net income from certain qualified publicly-traded partnerships, or other income derived with respect to our business of investing in such stock or other securities, or the 90% Income Test; and
diversify our holdings so that at the end of each quarter of the tax year:
at least 50% of the value of our assets consists of cash, cash equivalents, U.S. government securities, securities of other RICs, and other securities
if such other securities of any one issuer do not represent more than 5% of the value of our assets or more than 10% of the outstanding voting securities of such issuer; and
no more than 25% of the value of our assets is invested in the securities, other than U.S. government securities or securities of other RICs, of one
issuer, of two or more issuers that are controlled, as determined under applicable Code rules, by us and that are engaged in the same or similar or related trades or businesses or of certain qualified
publicly-traded partnerships, or the Diversification Tests.
A
RIC is limited in its ability to deduct expenses in excess of its investment company taxable income. If our expenses in a given tax year exceed our investment company taxable income, we may experience a net operating loss for that tax year. However,
a RIC is not permitted to carry forward net operating losses to subsequent tax years and such net operating losses do not pass through to its stockholders. In addition, deductible expenses can be used only to offset investment company taxable
income, not net capital gain. A RIC may not use any net capital losses (that is, the excess of realized capital losses over realized capital gains) to offset its investment company taxable income, but may carry forward such net capital losses, and
use them to offset future capital gains, indefinitely. Due to these limits on deductibility of expenses and net capital losses, we may for tax purposes have aggregate taxable income for several years that we are required to distribute and that is
taxable to our stockholders even if such taxable income is greater than the net income we actually earn during those years.
For U.S. federal income tax purposes, we may be required to recognize taxable income in circumstances in which we do not receive a
corresponding payment in cash. For example, if we hold debt instruments that are treated under applicable tax rules as having original issue discount (such as debt instruments with PIK interest or, in certain cases, increasing interest rates or debt
instruments that were issued with warrants), we must include in income each tax year a portion of the original issue discount that accrues over the life of the obligation, regardless of whether cash representing such income is received by us in the
same tax year. We may also have to include in income other amounts that we have not yet received in cash, such as deferred loan origination fees that are paid after origination of the loan or are paid in
non-cash compensation such as warrants or stock. We anticipate that a portion of our income may constitute original issue discount or other income required to be included in taxable income prior to receipt of
cash. Further, we have elected to amortize market discount and include such amounts in our taxable income in the current tax year, instead of upon their disposition, as an election not to do so would limit our ability to deduct interest expense for
tax purposes.
We invest a portion of our net assets in below investment grade instruments. Investments in these types of
instruments may present special tax issues for us. U.S. federal income tax rules are not entirely clear about issues such as when we may cease to accrue interest, original issue discount or market discount, when and to what extent deductions may be
taken for bad debts or worthless instruments, how payments received on obligations in default should be allocated between principal and income and whether exchanges of debt instruments in a bankruptcy or workout context are taxable. We will address
these and other issues to the extent necessary in order to seek to ensure that we distribute sufficient income to avoid any material U.S. federal income or excise tax.
Because any original issue discount or other amounts accrued will be included in our investment company taxable income for the tax year of the accrual, we may be required to make a distribution to our
stockholders in order to satisfy the Annual Distribution Requirement, even though we will not have received any corresponding cash amount. As a result, we may have difficulty meeting the Annual Distribution Requirement necessary to maintain RIC tax
treatment under Subchapter M of the Code. We may have to sell or otherwise dispose of some of our investments at times and/or at prices we would not consider advantageous, raise additional debt or equity capital or forgo new investment opportunities
for this purpose. If we are not able to obtain cash from other sources, we may fail to qualify for RIC tax treatment and thus become subject to corporate-level income tax.
Although we do not presently expect to do so, we are authorized to borrow funds and to sell or otherwise dispose of assets in order to satisfy distribution requirements. However, under the 1940 Act, we
are not permitted to make distributions to our stockholders while our debt obligations and other senior securities are outstanding unless certain asset coverage tests are met.
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See RegulationSenior Securities. Moreover, our ability to sell or otherwise dispose of assets to meet the Annual Distribution Requirement may be limited by (1) the
illiquid nature of our portfolio and/or (2) other requirements relating to our status as a RIC, including the Diversification Tests. If we sell or otherwise dispose of assets in order to meet the Annual Distribution Requirement or the Excise
Tax Avoidance Requirement, we may make such dispositions at times that, from an investment standpoint, are not advantageous.
A
portfolio company in which we invest may face financial difficulties that require us to work-out, modify or otherwise restructure our investment in the portfolio company. Any such transaction could, depending
upon the specific terms of the transaction, result in unusable capital losses and future non-cash income. Any such transaction could also result in our receiving assets that give rise to non-qualifying income for purposes of the 90% Income Test or otherwise would not count toward satisfying the Diversification Tests.
Some of the income that we might otherwise earn, such as fees for providing managerial assistance, certain fees earned with respect to our investments, income recognized in a work-out or restructuring of a portfolio investment, or income recognized from an equity investment in an operating partnership, may not satisfy the 90% Income Test. To manage the risk that such income might
disqualify us as a RIC for failure to satisfy the 90% Income Test, one or more subsidiary entities treated as U.S. corporations for entity-level income tax purposes may be employed to earn such income and (if applicable) hold the related asset.
Such subsidiary entities will be required to pay U.S. federal income tax on their earnings, which ultimately will reduce the yield to our stockholders on such fees and income.
Competition
Our primary competitors for investments include other BDCs and
investment funds (including private equity funds, mezzanine funds and CLO funds). In addition, alternative investment vehicles, such as hedge funds, have begun to invest in areas in which they have not traditionally invested, including making
investments in middle market private U.S. companies. We also compete with traditional financial services companies such as commercial banks. We believe we will be able to compete with these entities for financing opportunities on the basis of, among
other things, the experience of the Advisor and its affiliates.
Many of our competitors are substantially larger and have
considerably greater financial, technical and marketing resources than we do. For example, some competitors may have a lower cost of capital and access to funding sources that are not available to us. In addition, some of our competitors may have
higher risk tolerances or different risk assessments than we have and may not be subject to the regulatory restrictions that the 1940 Act imposes on us as a BDC or the restrictions that the Code imposes on us as a RIC. These characteristics could
allow our competitors to consider a wider variety of investments, establish more relationships and offer better pricing and more flexible structuring than us.
Employees
We do not currently have any employees. Each of our executive
officers is a principal, officer or employee of the Advisor or its affiliates, which manages and oversees our investment operations. In the future, the Advisor may directly retain personnel based upon its needs.
Available Information
We
file with or submit to the SEC annual, quarterly and current periodic reports, proxy statements and other information meeting the informational requirements of the Exchange Act. This information is available free of charge by calling us collect at (215) 495-1150 or on our website at www.fskkradvisor.com/fsk . Information contained on our website is not incorporated into this annual report on Form
10-K and you should not consider such information to be part of this annual report on Form 10-K. Such information is also available from the EDGAR database on the
SECs web site at www.sec.gov .
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Item 1A.
Risk Factors
Investing in our securities involves a number of significant risks. In addition to the other information contained in this annual report on Form 10-K, investors
should consider carefully the following information before making an investment in our securities. If any of the following events occur, our business, financial condition and results of operations could be materially and adversely affected. In such
case, the net asset value and market price of our common stock could decline or the value of our debt or equity investments may decline, and investors may lose all or part of their investment. Please refer also to those risk factors relating to our
proposed merger with FS KKR Capital Corp. II included under the caption Risk FactorsRisks Relating to the Merger in pre-effective amendment no.1 to our registration statement on Form N-14 (333-251667) filed with the SEC on February 25, 2021, which are incorporated herein by reference.
Summary of Risk Factors
The following is a summary of the principal risk
factors associated with an investment in the Company. Further details regarding each risk included in the below summary list can be found further below.
Risks Related to Our Business and Structure
If our investment advisory agreement were to be terminated, or if the Advisor loses any members of its senior management team, our ability to achieve
our investment objectives could be significantly harmed.
The inability of the Advisor to generate investment opportunities through relationships with private equity sponsors, investment banks and commercial
banks could adversely affect our business.
We operate in a highly competitive market for investment opportunities.
Our board of directors may change our policies and strategies without prior notice or stockholder approval.
The SBCA Act allows us to incur additional leverage.
Future legislation or rules could modify how we treat and use derivatives and other financial arrangements.
Compliance with regulations applicable to us as a public company will involve significant expenditures.
Failure to maintain safeguard the security of our data could compromise our ability to conduct business.
We and our Advisor could be the target of litigation, including in connection with stockholder activism.
Risks Related to the Advisory and its Affiliates
The Advisor and its affiliates face conflicts of interest as a result of arrangements between us and the Advisor and related to obligations the Advisor
and its affiliates have to our affiliates and to other clients.
We may be obligated to pay the Advisor incentive compensation on income that we have not received.
We may face additional competition because employees of the Advisor are not prohibited from raising money for or managing another entity that makes the
same types of investments that we target.
The Advisors liability to us is limited, and we are required to indemnify it against certain liabilities, which may lead it to act in a riskier
manner on our behalf than it would when acting for its own account.
Risks Related to Business Development Companies and
RICs
Failure to maintain our status as a BDC would reduce our operating flexibility.
We will be subject to corporate-level income tax if we are unable to qualify as a RIC or to satisfy the RIC annual distribution requirements, and our
investments may be subject to corporate-level income tax.
Our ability to acquire investments may be adversely affected if we cannot obtain financing.
The requirement that we invest a sufficient portion of our assets in qualifying assets could preclude us from investing in accordance with our current
business strategy; conversely, the failure to invest a sufficient portion of our assets in qualifying assets could result in our failure to maintain our status as a BDC.
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Regulations governing our operation as a BDC and a RIC will affect our ability and means to raise additional capital or borrow for investment purposes,
which may have a negative effect on our growth.
Our ability to enter into transactions with our affiliates is restricted.
Risks Related to our Investments
Our investments in prospective portfolio companies may be risky, and we could lose all of our investment.
International investments create additional risks.
Our investments in private investment funds subject us indirectly to the underlying risks of such private investment funds and additional fees and
expenses.
We may acquire financial instruments for purposes of hedging or reducing our risks, which may be costly and ineffective and could reduce
the cash available to service debt or for distribution to stockholders.
There may be circumstances where our debt investments could be subordinated to claims of other creditors or we could be subject to lender liability
claims. If there is a default, the value of any collateral securing our debt investments may not be sufficient to repay in full both the other creditors and us.
We generally will not control our portfolio companies.
Declines in market values or fair market values of our investments could result in significant net unrealized depreciation of our portfolio, which in
turn would reduce our net asset value.
A significant portion of our investment portfolio is and will be recorded at fair value as determined in good faith by our board of directors and, as a
result, there is uncertainty as to the value of our portfolio investments.
We are exposed to risks associated with changes in interest rates.
A covenant breach by our portfolio companies may harm our operating results.
Our portfolio companies may be highly leveraged.
We may not realize gains from our equity investments.
An investment strategy focused primarily on privately held companies presents certain challenges, including the lack of available information about
these companies.
A lack of liquidity in certain of our investments may adversely affect our business.
We may not have the funds or ability to make additional investments in our portfolio companies.
Prepayments of our debt investments by our portfolio companies could adversely impact our results.
Our investments may include original issue discount and PIK instruments.
We may from time to time enter into derivative transactions which expose us to certain risks.
We may invest through special purpose vehicles, which may entail greater risks.
Risks Related to Debt Financing
We currently incur indebtedness to make investments, which magnifies the potential for gain or loss on amounts invested in our common stock and may
increase the risk of investing in our common stock.
The agreements governing our debt financing arrangements contain various covenants which, if not complied with, could have a material adverse effect on
our ability to meet our investment obligations.
Risks Related to an Investment in Our Common Stock
There is a risk that investors in our common stock may not receive distributions.
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Portions of the distributions that we make may represent a return of capital to stockholders.
Our shares of common stock may trade at a discount to net asset value and we may issue shares at prices below our then-current net asset value.
We may pay distributions from offering proceeds, borrowings or the sale of assets.
A stockholders interest in us will be diluted if we issue additional shares.
Certain provisions of our charter and bylaws as well as provisions of the Maryland General Corporation Law could deter takeover attempts and have an
adverse impact on the value of our common stock.
The net asset value and/or market price of our common stock may fluctuate significantly.
Holders of any preferred stock that we issue will have the right to elect members of the board of directors.
General Risk Factors
Events outside of our control, including public health crises, could negatively affect our operations.
If the current period of capital market disruption and instability continues, investors in our equity securities may not receive distributions
consistent with historical levels or at all, and the valuation of our investments and our ability to raise capital could be negatively impacted.
Global economic, political and market conditions may adversely affect our business and financial condition.
Changes to U.S. tariff and import/export regulations may negatively affect our portfolio companies.
Economic sanction laws in the U.S. and other jurisdictions may prohibit us and our affiliates from transacting with certain countries, individuals and
companies.
Future economic downturns could impair our portfolio companies and harm our operating results.
Risks Related to Our Business and Structure
Our ability to achieve our investment objectives depends on the Advisors ability to manage and support our investment process and if our agreement with the Advisor were to be terminated, or if
the Advisor loses any members of its senior management team, our ability to achieve our investment objectives could be significantly harmed.
Because we have no employees, we depend on the investment expertise, skill and network of business contacts of the Advisor. The Advisor evaluates, negotiates, structures, executes, monitors and services
our investments. Our future success depends to a significant extent on the continued service of the Advisor, as well as its senior management team. The departure of any members of the Advisors senior management team could have a material
adverse effect on our ability to achieve our investment objectives.
Our ability to achieve our investment objectives depends
on the Advisors ability to identify, analyze, invest in, finance and monitor companies that meet our investment criteria. The Advisors capabilities in structuring the investment process, providing competent, attentive and efficient
services to us, and facilitating access to financing on acceptable terms depend on the employment of investment professionals in an adequate number and of adequate sophistication to match the corresponding flow of transactions. To achieve our
investment objectives, the Advisor may need to hire, train, supervise and manage new investment professionals to participate in our investment selection and monitoring process. The Advisor may not be able to find investment professionals in a timely
manner or at all. Failure to support our investment process could have a material adverse effect on our business, financial condition and results of operations.
In addition, each of our investment advisory agreement and administration agreement with the Advisor has termination provisions that allow the parties to terminate the agreements without penalty. The
investment advisory agreement and administration agreement may each be terminated at any time, without penalty, by the Advisor, upon 60 days notice to us. If the investment advisory agreement is terminated, it may adversely affect the quality
of our investment opportunities. In addition, in the event such agreement is terminated, it may be difficult for us to replace the Advisor and the termination of such agreement may adversely impact the terms of any existing or future financing
arrangement, which could have a material adverse effect on our business and financial condition.
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The Advisor is a recently-formed investment adviser with a limited track record of acting as an
investment adviser to a BDC, and any failure by the Advisor to manage and support our investment process may hinder the achievement of our investment objectives.
The Advisor is a recently-formed investment adviser jointly operated by an affiliate of FS Investments and KKR Credit with limited prior experience acting as an investment adviser to a BDC. The 1940 Act
and the Code impose numerous constraints on the operations of BDCs that do not apply to other investment vehicles. While both affiliates of FS Investments and KKR Credit have individually acted as investment advisers to BDCs previously, the
Advisors limited experience in managing a portfolio of assets under the constraints of the 1940 Act and the Code may hinder the Advisors ability to take advantage of attractive investment opportunities and, as a result, may adversely
affect our ability to achieve our investment objectives. FS Investments and KKR Credits individual track records and achievements are not necessarily indicative of the future results they will achieve as a joint investment adviser.
Accordingly, we can offer no assurance that we will replicate the historical performance of other investment companies with which FS Investments and KKR Credit have been affiliated, and we caution that our investment returns could be lower than the
returns achieved by such other companies.
Because our business model depends to a significant extent upon relationships with private
equity sponsors, investment banks and commercial banks, the inability of the Advisor to maintain or develop these relationships, or the failure of these relationships to generate investment opportunities, could adversely affect our business.
If the Advisor fails to maintain its existing relationships with private equity sponsors, investment banks and
commercial banks on which it relies to provide us with potential investment opportunities, or develop new relationships with other sponsors or sources of investment opportunities, we may not be able to grow our investment portfolio. In addition,
individuals with whom the Advisor has relationships generally are not obligated to provide us with investment opportunities, and, therefore, there is no assurance that such relationships will generate investment opportunities for us.
We operate in a highly competitive market for investment opportunities, which could reduce returns and result in losses.
A number of entities compete with us to make the types of investments that we plan to make and we believe that recent market trends,
including sustained periods of low interest rates, have increased the number of competitors seeking to invest in loans to private, middle market companies in the United States. We compete with public and private funds, commercial and investment
banks, commercial financing companies and, to the extent they provide an alternative form of financing, private equity and hedge funds. Many of our competitors are substantially larger and have considerably greater financial, technical and marketing
resources than we do. For example, we believe some of our competitors have access to funding sources that are not available to us. In addition, some of our competitors could have higher risk tolerances or different risk assessments, which could
allow them to consider a wider variety of investments and establish more relationships than us. Furthermore, many of our competitors are not subject to the regulatory restrictions that the 1940 Act imposes on us as a business development company or
the source of income, asset diversification and distribution requirements we must satisfy to maintain our qualification as a RIC. The competitive pressures we face could have a material adverse effect on our business, financial condition, results of
operations and cash flows. As a result of this competition, we can provide no assurance that we will be able to take advantage of attractive investment opportunities that arise from time to time, and we can provide no assurance that we will be able
to identify and make investments that are consistent with our investment objective.
The amount of capital in the private debt
markets and overall competition for loans could result in short term returns for us that are lower than our long-term targets. In addition, one of the effects of the COVID-19 pandemic has been a decrease in
the number of new investment opportunities in U.S. middle market companies during 2020, and we can offer no assurance about when, or if, the number of U.S. middle market company investing opportunities will equal or exceed those available prior to
the COVID-19 pandemic. In the event these conditions continue for an extended amount of time, they could have a material adverse effect on our business, financial condition and results of operations.
Identifying, structuring and consummating investments involves competition among capital providers and market and transaction
uncertainty. The Advisor can provide no assurance that it will able to identify a sufficient number of suitable investment opportunities or to avoid prepayment of existing investments to satisfy our investment objectives, including as necessary to
effectively structure credit facilities or other forms of leverage. The loan origination market is very competitive, which can result in loan terms that are more favorable to borrowers, and conversely less favorable to lenders, such as lower
interest rates and fees, weaker borrower financial and other covenants, borrower rights to cure defaults, and other terms more favorable to borrowers than current or historical norms. Increased competition could cause us to make more loans that are cov-lite in nature and, in a distressed scenario, there can be no assurance that these loans will retain the same value as loans with a full package of covenants. As a result of these conditions, the
market for leveraged loans could become less advantageous
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than expected for us, and this could increase default rates, decrease recovery rates or otherwise harm our returns. The risk of prepayment is also higher in the current competitive environment if
borrowers are offered more favorable terms by other lenders. The financial markets have experienced substantial fluctuations in prices and liquidity for leveraged loans. Any further disruption in the credit and other financial markets could have
substantial negative effects on general economic conditions, the availability of required capital for companies and the operating performance of such companies. These conditions also could result in increased default rates and credit downgrades, and
affect the liquidity and pricing of the investments made by us. Conversely, periods of economic stability and increased competition among capital providers could increase the difficulty of locating investments that are desirable for us.
With respect to the investments we make, we do not seek to compete based primarily on the interest rates we offer, and we believe that
some of our competitors could make loans with interest rates that will be lower than the rates we offer. In the secondary market for acquiring existing loans, we compete generally on the basis of pricing terms. With respect to all investments, we
could lose some investment opportunities if we do not match our competitors pricing, terms and structure. However, if we match our competitors pricing, terms and structure, we could experience decreased net interest income, lower yields
and increased risk of credit loss. We could also compete for investment opportunities with accounts managed or sponsored by Advisor or its affiliates. Although Advisor allocates opportunities in accordance with its allocation policy, allocations to
such other accounts will reduce the amount and frequency of opportunities available to us and thus not necessarily be in the best interests of us and our securityholders. Moreover, the performance of investments will not be known at the time of
allocation.
Our board of directors may change our operating policies and strategies without prior notice or stockholder approval.
Our board of directors has the authority to modify or waive our current operating policies, investment criteria and
strategies without prior notice and without stockholder approval. Moreover, we have significant investment flexibility within our investment strategies. Therefore, we may invest our assets in ways with which investors may not agree. We also cannot
predict the effect any changes to our current operating policies, investment criteria and strategies would have on our business, net asset value, operating results and the value of our stock. However, the effects might be adverse, which could
negatively impact our ability to pay stockholders distributions and cause them to lose all or part of their investment.
Changes in laws
or regulations governing our operations or the operations of our business partners may adversely affect our business or cause us to alter our business strategy.
We, our portfolio companies and our business partners are subject to regulation at the local, state and federal level. New legislation may be enacted, amended or repealed or new interpretations, rulings
or regulations could be adopted, including those governing the types of investments we are permitted to make and the deductibility of interest expense by our portfolio companies, potentially with retroactive effect. For example, certain provisions
of the Dodd-Frank Act, which influences many aspects of the financial services industry, have been amended or repealed and the Code has been substantially amended and reformed. New or repealed legislation, interpretations, rulings or regulations
could require changes to certain business practices of us or our portfolio companies, negatively impact the operations, cash flows or financial condition of us or our portfolio companies, impose additional costs on us or our portfolio companies or
otherwise adversely affect our business or the business of our portfolio companies. In addition, any changes to the laws and regulations governing our operations, including with respect to permitted investments, may cause us to alter our investment
strategy to avail ourselves of new or different opportunities or make other changes to our business. Such changes could result in material differences to our strategies and plans as set forth in this annual report on Form 10-K and may result in our investment focus shifting from the areas of expertise of the Advisor to other types of investments in which the Advisor may have less expertise or little or no experience. Thus, any such
changes, if they occur, could have a material adverse effect on our results of operations and the value of a stockholders investment.
The SBCA Act allows us to incur additional leverage.
On March 23, 2018, the Small Business Credit Availability Act, or the SBCA Act, became law. The SBCA Act, among other things, amends Section 61(a) of the 1940 Act to add a new
Section 61(a)(2) which reduces the asset coverage requirements for senior securities applicable to BDCs from 200% to 150% provided that certain disclosure and approval requirements are met. Effective June 15, 2019, following approval by
our stockholders, our asset coverage requirement was reduced from 200% to 150%, such that the Companys maximum debt to equity ratio increased from a prior maximum of 1.0x (equivalent of $1 of debt outstanding for each $1 of equity) to a
maximum of 2.0x (equivalent to $2 of debt outstanding for each $1 of equity). As a result, we are able to incur substantial additional indebtedness, and, therefore the risk of an investment in us may increase. See Risks Related to Debt
FinancingWe currently incur indebtedness to make investments, which magnifies the potential for gain or loss on amounts invested in our common stock and may increase the risk of investing in our common stock.
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Future legislation or rules could modify how we treat derivatives and other financial
arrangements, or place conditions on our use of derivatives and other financial arrangements .
Future
legislation or rules may modify how we treat derivatives and other financial arrangements, or place conditions on our use of derivatives and other financial arrangements. For example, the SEC in October 2020 adopted Rule 18f-4, which is designed to modernize the regulation of the use of derivatives by registered investment companies and BDCs. Among other things, Rule 18f-4 limits a funds
derivatives exposure through a value-at-risk test and requires the adoption and implementation of a derivatives risk management program for certain derivatives users.
Additionally, subject to certain conditions, funds that do not invest heavily in derivatives may be deemed limited derivatives users and would not be subject to the full requirements of Rule 18f-4. In
connection with the adoption of Rule 18f-4, the SEC also eliminated the asset segregation and cover framework arising from prior SEC guidance for covering derivatives and certain financial instruments.
Compliance with Rule 18f-4 will be required in August 2022. Rule 18f-4 could limit the Companys ability to engage in certain derivatives and other transactions
and/or increase the costs of such transactions, which could adversely affect the value or performance of the Company.
As a public
company, we are subject to regulations not applicable to private companies, such as provisions of the Sarbanes-Oxley Act. Efforts to comply with such regulations will involve significant expenditures, and
non-compliance with such regulations may adversely affect us.
As a public
company, we incur legal, accounting and other expenses, including costs associated with the periodic reporting requirements applicable to a company whose securities are registered under the Exchange Act, as well as additional corporate governance
requirements, including requirements under the Sarbanes-Oxley Act, and other rules implemented by the SEC and the listing standards of the NYSE. Our management is required to report on our internal control over financial reporting pursuant to
Section 404 of the Sarbanes-Oxley Act and rules and regulations of the SEC thereunder. In particular, our management is required to review on an annual basis our internal control over financial reporting, and on a quarterly and annual basis to
evaluate and disclose changes in our internal control over financial reporting. Section 404 of the Sarbanes-Oxley Act also generally requires an attestation from our independent registered public accounting firm on the effectiveness of our
internal control over financial reporting.
We incur significant expenses in connection with our compliance with the
Sarbanes-Oxley Act and other regulations applicable to public companies, which may negatively impact our financial performance and our ability to make distributions. Compliance with such regulations also requires a significant amount of our
managements time and attention. For example, we cannot be certain as to the timing of the completion of our Sarbanes-Oxley mandated evaluations, testings and remediation actions, if any, or the impact of the same on our operations, and we may
not be able to ensure that the process is effective or that our internal control over financial reporting are or will be deemed effective in the future. In the event that we are unable to maintain an effective system of internal control and maintain
compliance with the Sarbanes-Oxley Act and related rules, we may be adversely affected.
We may experience fluctuations in our quarterly
results.
We could experience fluctuations in our quarterly operating results due to a number of factors, including our
ability or inability to make investments in companies that meet our investment criteria, the interest rate payable on the debt securities we acquire, the level of our expenses, variations in and the timing of fee income and the recognition of
realized and unrealized gains or losses, the degree to which we encounter competition in our markets and general economic conditions. As a result of these factors, results for any previous period should not be relied upon as being indicative of
performance in future periods.
If we, our affiliates and our and their respective third-party service providers are unable to maintain
the availability of electronic data systems and safeguard the security of data, our ability to conduct business may be compromised, which could impair our liquidity, disrupt our business, damage our reputation or otherwise adversely affect our
business.
Cybersecurity refers to the combination of technologies, processes, and procedures established to protect
information technology systems and data from unauthorized access, attack, or damage. We, our affiliates and our and their respective third-party service providers are subject to cybersecurity risks.
Cybersecurity risks have significantly increased in recent years and, while we have not experienced any material losses relating to cyber attacks or other information security breaches, we could suffer such losses in the future. Our, our affiliates
and our and their respective third-party service providers computer systems, software and networks may be vulnerable to unauthorized access, computer viruses or other malicious code and other events that could have a security impact. If one or
more of such events occur, this potentially could jeopardize confidential and other information, including nonpublic personal information and sensitive business data, processed and stored in, and transmitted through, computer systems and networks,
or otherwise cause interruptions or malfunctions in our operations or the operations of
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our affiliates and our and their respective third-party service providers. This could result in significant losses, reputational damage, litigation, regulatory fines or penalties, or otherwise
adversely affect our business, financial condition or results of operations. Privacy and information security laws and regulation changes, and compliance with those changes, may result in cost increases due to system changes and the development of
new administrative processes. In addition, we may be required to expend significant additional resources to modify our protective measures and to investigate and remediate vulnerabilities or other exposures arising from operational and security
risks.
We and our Advisor could be the target of litigation.
We and our Advisor could become the target of securities class action litigation or other similar claims if our common stock price
fluctuates significantly or for other reasons. The proceedings could continue without resolution for long periods of time and the outcome of any such proceedings could materially adversely affect our business, financial condition, and/or operating
results. Any litigation or other similar claims could consume substantial amounts of our managements time and attention, and that time and attention and the devotion of associated resources could, at times, be disproportionate to the amounts
at stake. Litigation and other claims are subject to inherent uncertainties, and a material adverse impact on our financial statements could occur for the period in which the effect of an unfavorable final outcome in litigation or other similar
claims becomes probable and reasonably estimable. In addition, we could incur expenses associated with defending ourselves against litigation and other similar claims, and these expenses could be material to our earnings in future periods.
Our business and operations could be negatively affected if we become subject to stockholder activism, which could cause us to incur
significant expense, hinder the execution of our investment strategy or impact our stock price.
Stockholder activism,
which could take many forms, including making public demands that we consider certain strategic alternatives for the Company, engaging in public campaigns to attempt to influence our corporate governance and/or our management, and commencing proxy
contests to attempt to elect the activists representatives or others to our board of directors, or arise in a variety of situations, has been increasing in the BDC space recently. While we are currently not subject to any stockholder activism,
due to our proposed merger with FS KKR Capital Corp II., potential volatility of our stock price and for a variety of other reasons, we may in the future become the target of stockholder activism. Stockholder activism could result in substantial
costs and divert managements and our board of directors attention and resources from our business. Additionally, such stockholder activism could give rise to perceived uncertainties as to our future and adversely affect our relationships
with service providers and our portfolio companies. Also, we may be required to incur significant legal and other expenses related to any activist stockholder matters. Further, our stock price could be subject to significant fluctuation or otherwise
be adversely affected by the events, risks and uncertainties of any stockholder activism.
Risks Related to the Advisor and its Affiliates
The Advisor and its affiliates, including our officers and some of our directors, face conflicts of interest as a result of
compensation arrangements between us and the Advisor, which could result in actions that are not in the best interests of our stockholders.
The Advisor and its affiliates receive substantial fees from us in return for their services, and these fees could influence the advice provided to us. We pay to the Advisor an incentive fee that is based
on the performance of our portfolio and an annual base management fee that is based on the average weekly value of our gross assets. Because the incentive fee is based on the performance of our portfolio, the Advisor may be incentivized to make
investments on our behalf that are riskier or more speculative than would be the case in the absence of such compensation arrangement. The way in which the incentive fee is determined may also encourage the Advisor to use leverage to increase the
return on our investments. In addition, because the base management fee is based upon the average weekly value of our gross assets, which includes any borrowings for investment purposes, the Advisor may be incentivized to recommend the use of
leverage or the issuance of additional equity to make additional investments and increase the average weekly value of our gross assets. Under certain circumstances, the use of leverage may increase the likelihood of default, which could disfavor
holders of our common stock. Our compensation arrangements could therefore result in our making riskier or more speculative investments, or relying more on leverage to make investments, than would otherwise be the case. This could result in higher
investment losses, particularly during cyclical economic downturns.
We may be obligated to pay the Advisor incentive compensation on
income that we have not received.
Any incentive fee payable by us that relates to our net investment income may be
computed and paid on income that may include interest that has been accrued but not yet received. If a portfolio company defaults on a loan that is structured to provide accrued interest, it is possible that accrued interest previously included in
the calculation of the incentive fee will become
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uncollectible. The Advisor is not under any obligation to reimburse us for any part of the incentive fee it received that was based on accrued income that we never received as a result of a
default by an entity on the obligation that resulted in the accrual of such income, and such circumstances would result in our paying an incentive fee on income we never received.
For U.S. federal income tax purposes, we are required to recognize taxable income (such as deferred interest that is accrued as original
issue discount) in some circumstances in which we do not receive a corresponding payment in cash. Under such circumstances, we may have difficulty meeting the Annual Distribution Requirement necessary to maintain RIC tax treatment under the Code.
This difficulty in making the required distribution may be amplified to the extent that we are required to pay an incentive fee with respect to such accrued income. As a result, we may have to sell some of our investments at times and/or at prices
we would not consider advantageous, raise additional debt or equity capital, or forgo new investment opportunities for this purpose. If we are not able to obtain cash from other sources, we may fail to qualify for RIC tax treatment and thus become
subject to corporate-level income tax.
There may be conflicts of interest related to obligations the Advisors senior management
and investment teams have to our affiliates and to other clients.
The members of the senior management and investment
teams of the Advisor serve or may serve as officers, directors or principals of entities that operate in the same or a related line of business as we do, or of investment vehicles managed by the same personnel. For example, the Advisor is also the
investment adviser to FS KKR Capital Corp. II, or together with the Company, the Fund Complex, and the officers, managers and other personnel of the Advisor may serve in similar or other capacities for the investment advisers to future investment
vehicles affiliated with FS Investments or KKR Credit. In serving in these multiple and other capacities, they may have obligations to other clients or investors in those entities, the fulfillment of which may not be in our best interests or in the
best interest of our stockholders. Our investment objectives may overlap with the investment objectives of such investment funds, accounts or other investment vehicles. For example, we rely on the Advisor to manage our
day-to-day activities and to implement our investment strategy. The Advisor and certain of its affiliates are presently, and plan in the future to continue to be,
involved with activities which are unrelated to us. As a result of these activities, the Advisor, its employees and certain of its affiliates will have conflicts of interest in allocating their time between us and other activities in which they are
or may become involved, including the management of other entities affiliated with FS Investments or KKR Credit. The Advisor and its employees will devote only as much of its or their time to our business as the Advisor and its employees, in their
judgment, determine is reasonably required, which may be substantially less than their full time.
The time and resources that
individuals employed by the Advisor devote to us may be diverted and we may face additional competition due to the fact that individuals employed by the Advisor are not prohibited from raising money for or managing another entity that makes the same
types of investments that we target.
Neither the Advisor, nor persons providing services to us on behalf of the
Advisor, are prohibited from raising money for and managing another investment entity that makes the same types of investments as those we target. As a result, the time and resources that these individuals may devote to us may be diverted. In
addition, we may compete with any such investment entity for the same investors and investment opportunities.
The Advisors
liability is limited under each of the investment advisory agreement and the administration agreement, and we are required to indemnify it against certain liabilities, which may lead it to act in a riskier manner on our behalf than it would when
acting for its own account.
Pursuant to each of the investment advisory agreement and the administration agreement,
the Advisor and its officers, managers, partners, members (and their members, including the owners of their members), agents, employees, controlling persons and any other person or entity affiliated with, or acting on behalf of, the Advisor will not
be liable to us for their acts under the investment advisory agreement or the administration agreement, as applicable, absent willful misfeasance, bad faith or gross negligence in the performance of their duties. We have agreed to indemnify, defend
and protect the Advisor and its officers, managers, partners, members (and their members, including the owners of their members), agents, employees, controlling persons and any other person or entity affiliated with, or acting on behalf of, the
Advisor with respect to all damages, liabilities, costs and expenses resulting from acts of the Advisor not arising out of willful misfeasance, bad faith or gross negligence in the performance of their duties under the investment advisory agreement
or the administration agreement, as applicable. These protections may lead the Advisor to act in a riskier manner when acting on our behalf than it would when acting for its own account.
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Risks Related to Business Development Companies
Failure to maintain our status as a BDC would reduce our operating flexibility.
If we do not remain a BDC, we might be regulated as a closed-end investment company under the 1940
Act, which would subject us to substantially more regulatory restrictions under the 1940 Act and correspondingly decrease our operating flexibility.
We are uncertain of our sources for funding our future capital needs and if we cannot obtain debt or equity financing on acceptable terms, or at all, our ability to acquire investments and to expand
our operations will be adversely affected.
Any working capital reserves we maintain may not be sufficient for
investment purposes, and we may require debt or equity financing to operate. We may also need to access the capital markets to refinance existing debt obligations to the extent maturing obligations are not repaid with cash flows from operations. In
order to maintain RIC tax treatment, we must distribute distributions to our stockholders each tax year on a timely basis generally of an amount at least equal to 90% of our investment company taxable income, determined without regard to any
deduction for distributions paid, and the amounts of such distributions will therefore not be available to fund investment originations or to repay maturing debt. In addition, with certain limited exceptions, we are only allowed to borrow amounts or
issue debt securities or preferred stock, which we refer to collectively as senior securities, such that our asset coverage, as calculated pursuant to the 1940 Act, equals at least 150% immediately after such borrowing, which, in certain
circumstances, may restrict our ability to borrow or issue debt securities or preferred stock. In the event that we develop a need for additional capital in the future for investments or for any other reason, and we cannot obtain debt or equity
financing on acceptable terms, or at all, our ability to acquire investments and to expand our operations will be adversely affected. As a result, we would be less able to allocate our portfolio among various issuers and industries and achieve our
investment objectives, which may negatively impact our results of operations and reduce our ability to make distributions to our stockholders.
The requirement that we invest a sufficient portion of our assets in qualifying assets could preclude us from investing in accordance with our
current business strategy; conversely, the failure to invest a sufficient portion of our assets in qualifying assets could result in our failure to maintain our status as a BDC.
As a BDC, we may not acquire any assets other than qualifying assets unless, at the time of such acquisition, at least 70% of
our total assets are qualifying assets. Therefore, we may be precluded from investing in what we believe are attractive investments if such investments are not qualifying assets. Similarly, these rules could prevent us from making additional
investments in existing portfolio companies, which could result in the dilution of our position, or could require us to dispose of investments at an inopportune time to comply with the 1940 Act. If we were forced to sell non-qualifying investments in the portfolio for compliance purposes, the proceeds from such sale could be significantly less than the current value of such investments. Conversely, if we fail to invest a sufficient
portion of our assets in qualifying assets, we could lose our status as a BDC, which would subject us to substantially more regulatory restrictions and significantly decrease our operating flexibility.
Regulations governing our operation as a BDC and a RIC will affect our ability to raise, and the way in which we raise, additional capital or borrow
for investment purposes, which may have a negative effect on our growth.
As a result of our need to satisfy the Annual
Distribution Requirement in order to maintain RIC tax treatment under Subchapter M of the Code, we may need to periodically access the capital markets to raise cash to fund new investments. We may issue senior securities, as defined in
the 1940 Act, including issuing preferred stock, borrowing money from banks or other financial institutions, or issuing debt securities only in amounts such that our asset coverage, as defined in the 1940 Act, equals at least 150% after such
incurrence or issuance. Our ability to issue certain other types of securities is also limited. Under the 1940 Act, we are also generally prohibited from issuing or selling our common stock at a price per share, after deducting underwriting
commissions, that is below our net asset value per share, without first obtaining approval for such issuance from our stockholders and our independent directors. Compliance with these limitations on our ability to raise capital may unfavorably limit
our investment opportunities. These limitations may also reduce our ability in comparison to other companies to profit from favorable spreads between the rates at which we can borrow and the rates at which we can lend.
In addition, because we incur indebtedness for investment purposes, if the value of our assets declines, we may be unable to satisfy the
asset coverage test under the 1940 Act, which would prohibit us from paying distributions and, as a result, could cause us to be subject to corporate-level tax on our income and capital gains, regardless of the amount of distributions paid. If we
cannot satisfy the asset coverage test, we may be required to sell a portion of our investments and, depending on the nature of our debt financing, repay a portion of our indebtedness at a time when such sales may be disadvantageous.
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Our ability to enter into transactions with our affiliates is restricted.
We are prohibited under the 1940 Act from participating in certain transactions with certain of our affiliates without the prior approval
of a majority of the independent members of our board of directors and, in some cases, the SEC. Any person that owns, directly or indirectly, 5% or more of our outstanding voting securities will be our affiliate for purposes of the 1940 Act, and we
will generally be prohibited from buying or selling any securities from or to such affiliate, absent the prior approval of our board of directors. The 1940 Act also prohibits certain joint transactions with certain of our affiliates,
which could include investments in the same portfolio company (whether at the same or different times), without prior approval of our board of directors and, in some cases, the SEC. In an order dated January 5, 2021, the SEC granted exemptive relief
permitting us, subject to the satisfaction of certain conditions, to co-invest in certain privately negotiated investment transactions, including investments originated and directly negotiated by the Advisor
or KKR Credit, with our co-investment affiliates. If a person acquires more than 25% of our voting securities, we will be prohibited from buying or selling any security from or to such person or certain of
that persons affiliates, or entering into prohibited joint transactions with such persons to the extent not covered by the exemptive relief, absent the prior approval of the SEC. Similar restrictions limit our ability to transact business with
our officers or directors or their respective affiliates. As a result of these restrictions, we may be prohibited from buying or selling any security from or to any portfolio company of a fund managed by the Advisor without the prior approval of the
SEC, which may limit the scope of investment opportunities that would otherwise be available to us.
Risks Related to Our Investments
Our investments in prospective portfolio companies may be risky, and we could lose all or part of our investment.
Our investments in senior secured loans, second lien secured loans, senior secured bonds, subordinated debt and equity
of private U.S. companies, including middle market companies, may be risky and there is no limit on the amount of any such investments in which we may invest.
Senior Secured Loans, Second Lien Secured Loans and Senior Secured Bonds . There is a risk that any collateral pledged by portfolio companies in which we have taken a security interest may decrease
in value over time or lose its entire value, may be difficult to sell in a timely manner, may be difficult to appraise and may fluctuate in value based upon the success of the business and market conditions, including as a result of the inability of
the portfolio company to raise additional capital. To the extent our debt investment is collateralized by the securities of a portfolio companys subsidiaries, such securities may lose some or all of their value in the event of the bankruptcy
or insolvency of the portfolio company. Also, in some circumstances, our security interest may be contractually or structurally subordinated to claims of other creditors. In addition, deterioration in a portfolio companys financial condition
and prospects, including its inability to raise additional capital, may be accompanied by deterioration in the value of the collateral for the debt. Secured debt that is under-collateralized involves a greater risk of loss. In addition, second lien
secured debt is granted a second priority security interest in collateral, which means that any realization of collateral will generally be applied to pay senior secured debt in full before second lien secured debt is paid. Consequently, the fact
that debt is secured does not guarantee that we will receive principal and interest payments according to the debts terms, or at all, or that we will be able to collect on the debt should we be forced to enforce our remedies.
Subordinated Debt. Our subordinated debt investments will generally rank junior in priority of payment to senior debt and will
generally be unsecured. This may result in a heightened level of risk and volatility or a loss of principal, which could lead to the loss of the entire investment. These investments may involve additional risks that could adversely affect our
investment returns. To the extent interest payments associated with such debt are deferred, such debt may be subject to greater fluctuations in valuations, and such debt could subject us and our stockholders to
non-cash income. Because we will not receive any principal repayments prior to the maturity of some of our subordinated debt investments, such investments will be of greater risk than amortizing loans.
Equity and Equity-Related Securities. We may make select equity investments. In addition, in connection with our debt
investments, we on occasion receive equity interests such as warrants or options as additional consideration. The equity interests we receive may not appreciate in value and, in fact, may decline in value. Accordingly, we may not be able to realize
gains from our equity interests, and any gains that we do realize on the disposition of any equity interests may not be sufficient to offset any other losses we experience.
Convertible Securities. We may invest in convertible securities, such as bonds, debentures, notes, preferred stocks or other securities that may be converted into, or exchanged for, a specified
amount of common stock of the same or different issuer within a particular period of time at a specified price or formula. A convertible security may be subject to redemption at the option of the issuer at a price established in the convertible
securitys governing instrument. If a convertible security held by us is
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called for redemption, it will be required to permit the issuer to redeem the security, convert it into the underlying common stock or sell it to a third party. Any of these actions could have an
adverse effect on our ability to achieve our investment objective.
Non-U.S.
Securities. We may invest in non-U.S. securities, which may include securities denominated in U.S. dollars or in non-U.S. currencies and securities of companies in
emerging markets, to the extent permitted by the 1940 Act. Because evidences of ownership of such securities usually are held outside the United States, we would be subject to additional risks if we invested in
non-U.S. securities, which include possible adverse political and economic developments, seizure or nationalization of foreign deposits and adoption of governmental restrictions which might adversely affect or
restrict the payment of principal and interest on the non-U.S. securities to investors located outside the country of the issuer, whether from currency blockage or otherwise. Because non-U.S. securities may be purchased with and payable in foreign currencies, the value of these assets as measured in U.S. dollars may be affected unfavorably by changes in currency rates and exchange control
regulations. In addition, investing in securities of companies in emerging markets involves many risks, including potential inflationary economic environments, regulation by foreign governments, different accounting standards, political
uncertainties and economic, social, political, financial, tax and security conditions in the applicable emerging market, any of which could negatively affect the value of companies in emerging markets or investments in their securities.
Investments in Asset-Based Opportunities. We may invest in asset-based opportunities through joint ventures, investment platforms,
private investment funds or other business entities that provide one or more of the following services: origination or sourcing of potential investment opportunities, due diligence and negotiation of potential investment opportunities and/or
servicing, development and management (including turnaround) and disposition of investments. Such investments may be in or alongside existing or newly formed operators, consultants and/or managers that pursue such opportunities and may or may not
include capital and/or assets contributed by third party investors. Such investments may include opportunities to direct-finance physical assets, such as airplanes and ships, and/or operating assets, such as financial service entities, as opposed to
investment securities, or to invest in origination and/or servicing platforms directly. In valuing our investments, we rely primarily on information provided by operators, consultants and/or managers. Valuations of illiquid securities involve
various judgments and consideration of factors that may be subjective. There is a risk that inaccurate valuations could adversely affect the value of our common stock. We may not be able to promptly withdraw our investment in these asset-based
opportunities, which may result in a loss to us and adversely affect our investment returns.
Structured Products. We
may invest in structured products, which may include collateralized debt obligations, collateralized bond obligations, collateralized loan obligations, structured notes and credit-linked notes. When investing in structured products, we may invest in
any level of the subordination chain, including subordinated (lower-rated) tranches and residual interests (the lowest tranche). Structured products may be highly levered and therefore, the junior debt and equity tranches that we may invest in are
subject to a higher risk of total loss and deferral or nonpayment of interest than the more senior tranches to which they are subordinated. In addition, we will generally have the right to receive payments only from the issuer or counterparty, and
will generally not have direct rights against the underlying borrowers or entities. Furthermore, the investments we make in structured products are at times thinly traded or have only a limited trading market. As a result, investments in such
structured products may be characterized as illiquid securities.
Derivatives. We may invest from time to time in
derivatives, including total return swaps, interest rate swaps, credit default swaps and foreign currency forward contracts. Derivative investments have risks, including: the imperfect correlation between the value of such instruments and our
underlying assets, which creates the possibility that the loss on such instruments may be greater than the gain in the value of the underlying assets in our portfolio; the loss of principal; the possible default of the other party to the
transaction; and illiquidity of the derivative investments. If a counterparty becomes bankrupt or otherwise fails to perform its obligations under a derivative contract due to financial difficulties, we may experience significant delays in obtaining
any recovery under the derivative contract in a bankruptcy or other reorganization proceeding, or may not recover at all. In addition, in the event of the insolvency of a counterparty to a derivative transaction, the derivative contract would
typically be terminated at its fair market value. If we are owed this fair market value in the termination of the derivative contract and our claim is unsecured, we will be treated as a general creditor of such counterparty and will not have any
claim with respect to the underlying security. Certain of the derivative investments in which we may invest may, in certain circumstances, give rise to a form of financial leverage, which may magnify the risk of owning such instruments. The ability
to successfully use derivative investments depends on the ability of the Advisor to predict pertinent market movements, which cannot be assured. In addition, amounts paid by us as premiums and cash or other assets held in margin accounts with
respect to our derivative investments would not be available to it for other investment purposes, which may result in lost opportunities for gain.
Below Investment Grade Risk. In addition, we invest in securities that are rated below investment grade by rating agencies or that would be rated below investment grade if they were rated. Below
investment grade securities, which are often referred to
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as junk, have predominantly speculative characteristics with respect to the issuers capacity to pay interest and repay principal. They may also be difficult to value and
illiquid.
International investments create additional risks.
We expect to make investments in portfolio companies that are domiciled outside of the United States. We anticipate that up to 30% of our
investments may be in these types of assets. Our investments in foreign portfolio companies are deemed non-qualifying assets, which means, as required by the 1940 Act, they, along with other non-qualifying assets, may not constitute more than 30% of our total assets at the time of our acquisition of any asset, after giving effect to the acquisition. Notwithstanding the limitation on our ownership of
foreign portfolio companies, such investments subject us to many of the same risks as our domestic investments, as well as certain additional risks, including the following:
foreign governmental laws, rules and policies, including those restricting the ownership of assets in the foreign country or the repatriation of
profits from the foreign country to the United States;
foreign currency devaluations that reduce the value of and returns on our foreign investments;
adverse changes in the availability, cost and terms of investments due to the varying economic policies of a foreign country in which we invest;
adverse changes in tax rates, the tax treatment of transaction structures and other changes in operating expenses of a particular foreign country in
which we invest;
the assessment of foreign-country taxes (including withholding taxes, transfer taxes and value added taxes, any or all of which could be significant)
on income or gains from our investments in the foreign country;
adverse changes in foreign-country laws, including those relating to taxation, bankruptcy and ownership of assets;
changes that adversely affect the social, political and/or economic stability of a foreign country in which we invest;
high inflation in the foreign countries in which we invest, which could increase the costs to us of investing in those countries;
deflationary periods in the foreign countries in which we invest, which could reduce demand for our assets in those countries and diminish the value of
such investments and the related investment returns to us; and
legal and logistical barriers in the foreign countries in which we invest that materially and adversely limit our ability to enforce our contractual
rights with respect to those investments.
In addition, we may make investments in countries whose
governments or economies may prove unstable. Certain of the countries in which we may invest may have political, economic and legal systems that are unpredictable, unreliable or otherwise inadequate with respect to the implementation, interpretation
and enforcement of laws protecting asset ownership and economic interests. In some of the countries in which we may invest, there may be a risk of nationalization, expropriation or confiscatory taxation, which may have an adverse effect on our
portfolio companies in those countries and the rates of return that we are able to achieve on such investments. We may also lose the total value of any investment which is nationalized, expropriated or confiscated. The financial results and
investment opportunities available to us, particularly in developing countries and emerging markets, may be materially and adversely affected by any or all of these political, economic and legal risks.
Our investments in private investment funds, including hedge funds, private equity funds, limited liability companies and other business entities,
subject us indirectly to the underlying risks of such private investment funds and additional fees and expenses.
We
may invest in private investment funds, including hedge funds, private equity funds, limited liability companies and other business entities which would be required to register as investment companies but for an exemption under Sections 3(c)(1) and
3(c)(7) of the 1940 Act. Our investments in private funds are subject to substantial risks. Investments in such private investment funds expose us to the risks associated with the businesses of such funds or entities as well as such private
investment funds portfolio companies. These private investment funds may or may not be registered investment companies and, thus, may not be subject to protections afforded by the 1940 Act, covering, among other areas, liquidity requirements,
governance by an independent board, affiliated transaction restrictions, leverage limitations, public disclosure requirements and custody requirements.
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We rely primarily on information provided by managers of private investment funds in
valuing our investments in such funds. There is a risk that inaccurate valuations provided by managers of private investment funds could adversely affect the value of our common stock. In addition, there can be no assurance that a manager of a
private investment fund will provide advance notice of any material change in such private investment funds investment program or policies and thus, our investment portfolio may be subject to additional risks which may not be promptly
identified by the Advisor. Moreover, we may not be able to withdraw our investments in certain private investment funds promptly after we make a decision to do so, which may result in a loss to us and adversely affect our investment returns.
Investments in the securities of private investment funds may also involve duplication of advisory fees and certain other
expenses. By investing in private investment funds indirectly through us, you bear a pro rata portion of our advisory fees and other expenses, and also indirectly bear a pro rata portion of the advisory fees, performance-based allocations and other
expenses borne by us as an investor in the private investment funds. In addition, the purchase of the shares of some private investment funds requires the payment of sales loads and (in the case of closed-end
investment companies) sometimes substantial premiums above the value of such investment companies portfolio securities.
In addition, certain private investment funds may not provide us with the liquidity we require and would thus subject us to liquidity
risk. Further, even if an investment in a private investment fund is deemed liquid at the time of investment, the private investment fund may, in the future, alter the nature of our investments and cease to be a liquid investment fund, subjecting us
to liquidity risk.
We may acquire various structured financial instruments for purposes of hedging or reducing our risks,
which may be costly and ineffective and could reduce the cash available to service debt or for distribution to stockholders.
We may seek to hedge against interest rate and currency exchange rate fluctuations and credit risk by using structured financial instruments such as futures, options, swaps and forward contracts, subject
to the requirements of the 1940 Act. Use of structured financial instruments for hedging purposes may present significant risks, including the risk of loss of the amounts invested. Defaults by the other party to a hedging transaction can result in
losses in the hedging transaction. Hedging activities also involve the risk of an imperfect correlation between the hedging instrument and the asset being hedged, which could result in losses both on the hedging transaction and on the instrument
being hedged. Use of hedging activities may not prevent significant losses and could increase our losses. Further, hedging transactions may reduce cash available to service our debt or pay distributions to our stockholders.
Investing in middle market companies involves a number of significant risks, any one of which could have a material adverse effect on our operating
results.
Investments in middle market companies involve some of the same risks that apply generally to investments in
larger, more established companies. However, such investments have more pronounced risks in that they:
may have limited financial resources and may be unable to meet the obligations under their debt securities that we hold, which may be accompanied by a
deterioration in the value of any collateral pledged under such securities and a reduction in the likelihood of us realizing any guarantees we may have obtained in connection with our investment;
have shorter operating histories, narrower product lines and smaller market shares than larger businesses, which tends to render them more vulnerable
to competitors actions and changing market conditions, as well as general economic downturns;
are more likely to depend on the management talents and efforts of a small group of persons; therefore, the death, disability, resignation or
termination of one or more of these persons could have a material adverse impact on our portfolio company and, in turn, on us;
generally have less predictable operating results, may from time to time be parties to litigation, may be engaged in rapidly changing businesses with
products subject to a substantial risk of obsolescence, and may require substantial additional capital to support their operations, finance expansion or maintain their competitive position. In addition, our executive officers and directors and
members of the Advisor may, in the ordinary course of business, be named as defendants in litigation arising from our investments in the portfolio companies; and
may have difficulty accessing the capital markets to meet future capital needs, which may limit their ability to grow or to repay their outstanding
indebtedness upon maturity.
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Our portfolio companies may incur debt that ranks equally with, or senior to, our investments in
such companies.
Our portfolio companies may have, or may be permitted to incur, other debt that ranks equally with, or
senior to, the debt in which we invest. By their terms, such debt instruments may entitle the holders to receive payment of interest or principal on or before the dates on which we are entitled to receive payments with respect to the debt
instruments in which we invest. Also, in the event of insolvency, liquidation, dissolution, reorganization or bankruptcy of a portfolio company, holders of debt instruments ranking senior to our investment in that portfolio company would typically
be entitled to receive payment in full before we receive any proceeds. After repaying such senior creditors, such portfolio company may not have any remaining assets to use for repaying its obligation to us. In the case of debt ranking equally with
debt instruments in which we invest, we would have to share on an equal basis any distributions with other creditors holding such debt in the event of an insolvency, liquidation, dissolution, reorganization or bankruptcy of the relevant portfolio
company.
There may be circumstances where our debt investments could be subordinated to claims of other creditors or we could be subject
to lender liability claims.
If one of our portfolio companies were to go bankrupt, depending on the facts and
circumstances, including the extent to which we actually provided managerial assistance to that portfolio company, a bankruptcy court might recharacterize our debt investment and subordinate all or a portion of our claim to that of other creditors.
In situations where a bankruptcy carries a high degree of political significance, our legal rights may be subordinated to other creditors. We may also be subject to lender liability claims for actions taken by us with respect to a borrowers
business or in instances where we exercise control over the borrower or render significant managerial assistance.
Second priority liens
on collateral securing debt investments that we make to our portfolio companies may be subject to control by senior creditors with first priority liens. If there is a default, the value of the collateral may not be sufficient to repay in full both
the first priority creditors and us.
Certain debt investments that we make in portfolio companies may be secured on a
second priority basis by the same collateral securing first priority debt of such companies. The first priority liens on the collateral will secure the portfolio companys obligations under any outstanding senior debt and may secure certain
other future debt that may be permitted to be incurred by such company under the agreements governing the loans. The holders of obligations secured by the first priority liens on the collateral will generally control the liquidation of and be
entitled to receive proceeds from any realization of the collateral to repay their obligations in full before us. In addition, the value of the collateral in the event of liquidation will depend on market and economic conditions, the availability of
buyers and other factors. There can be no assurance that the proceeds, if any, from the sale or sales of all of the collateral would be sufficient to satisfy the debt obligations secured by the second priority liens after payment in full of all
obligations secured by the first priority liens on the collateral. If such proceeds are not sufficient to repay amounts outstanding under the debt obligations secured by the second priority liens, then we, to the extent not repaid from the proceeds
of the sale of the collateral, will only have an unsecured claim against such companys remaining assets, if any.
We may
also make unsecured debt investments in portfolio companies, meaning that such investments will not benefit from any interest in collateral of such companies. Liens on any such portfolio companys collateral, if any, will secure the portfolio
companys obligations under its outstanding secured debt and may secure certain future debt that is permitted to be incurred by the portfolio company under its secured debt agreements. The holders of obligations secured by such liens will
generally control the liquidation of, and be entitled to receive proceeds from, any realization of such collateral to repay their obligations in full before us. In addition, the value of such collateral in the event of liquidation will depend on
market and economic conditions, the availability of buyers and other factors. There can be no assurance that the proceeds, if any, from sales of such collateral would be sufficient to satisfy our unsecured debt obligations after payment in full of
all secured debt obligations. If such proceeds were not sufficient to repay the outstanding secured debt obligations, then our unsecured claims would rank equally with the unpaid portion of such secured creditors claims against the portfolio
companys remaining assets, if any.
The rights we may have with respect to the collateral securing the debt investments
we make in our portfolio companies with senior debt outstanding may also be limited pursuant to the terms of one or more intercreditor agreements that we enter into with the holders of senior debt. Under such an intercreditor agreement, at any time
that obligations that have the benefit of the first priority liens are outstanding, any of the following actions that may be taken in respect of the collateral will be at the direction of the holders of the obligations secured by the first priority
liens: the ability to cause the commencement of enforcement proceedings against the collateral; the ability to control the conduct of such proceedings; the approval of amendments to collateral documents; releases of liens on the collateral; and
waivers of past defaults under collateral documents. We may not have the ability to control or direct such actions, even if our rights are adversely affected.
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We generally will not control our portfolio companies.
We do not expect to control most of our portfolio companies, even though we may have board representation or board observation rights, and
our debt agreements with such portfolio companies may contain certain restrictive covenants. As a result, we are subject to the risk that a portfolio company in which we invest may make business decisions with which we disagree and the management of
such company, as representatives of the holders of their common equity, may take risks or otherwise act in ways that do not serve our interests as debt investors. Due to the lack of liquidity for our investments in
non-traded companies, we may not be able to dispose of our interests in our portfolio companies as readily as we would like or at an appropriate valuation. As a result, a portfolio company may make decisions
that could decrease the value of our portfolio holdings.
Declines in market values or fair market values of our investments could result
in significant net unrealized depreciation of our portfolio, which in turn would reduce our net asset value.
Under the
1940 Act, we are required to carry our investments at market value or, if no market value is ascertainable, at fair value as determined in good faith by or under the direction of our board of directors. While most of our investments are not publicly
traded, applicable accounting standards require us to assume as part of our valuation process that our investments are sold in a principal market to market participants (even if we plan on holding an investment through its maturity) and impairments
of the market values or fair market values of our investments, even if unrealized, must be reflected in our financial statements for the applicable period as unrealized depreciation, which could result in a significant reduction to our net asset
value for a given period.
A significant portion of our investment portfolio is and will be recorded at fair value as determined in good
faith by our board of directors and, as a result, there is and will be uncertainty as to the value of our portfolio investments.
Under the 1940 Act, we are required to carry our portfolio investments at market value or, if there is no readily available market value, at fair value, as determined by our board of directors. There is
not a public market for the securities of the privately held companies in which we invest. Most of our investments are not publicly traded or actively traded on a secondary market but are, instead, traded on a privately negotiated OTC secondary
market for institutional investors or are not traded at all. As a result, we value these securities quarterly at fair value as determined in good faith by our board of directors.
Certain factors that may be considered in determining the fair value of our investments include dealer quotes for securities traded on the
secondary market for institutional investors, the nature and realizable value of any collateral, the portfolio companys earnings and its ability to make payments on its indebtedness, the markets in which the portfolio company does business,
comparison to comparable publicly traded companies, discounted cash flows and other relevant factors. Because such valuations, and particularly valuations of private securities and private companies, are inherently uncertain, may fluctuate over
short periods of time and may be based on estimates, our determinations of fair value may differ materially from the values that would have been used if a ready market for these non-traded securities existed.
Due to this uncertainty, our fair value determinations may cause our net asset value on a given date to materially understate or overstate the value that we may ultimately realize upon the sale of one or more of our investments.
We are exposed to risks associated with changes in interest rates, including with respect to the phase out of LIBOR.
We are subject to financial market risks, including changes in interest rates. General interest rate fluctuations may have a substantial
negative impact on our investments, investment opportunities and cost of capital and, accordingly, may have a material adverse effect on our investment objectives, our rate of return on invested capital and our ability to service our debt and make
distributions to our stockholders. In addition, an increase in interest rates would make it more expensive to use debt for our financing needs, if any.
Our investment portfolio primarily consists of senior secured debt with maturities typically ranging from three to seven years. The longer the duration of these securities, generally, the more susceptible
they are to changes in market interest rates. As market interest rates increase, those securities with a lower yield-at-cost can experience a mark-to-market unrealized loss. An impairment of the fair market value of our investments, even if unrealized, must be reflected in our financial statements for the applicable
period and may therefore have a material adverse effect on our results of operations for that period.
Because we incur
indebtedness to make investments, our net investment income is dependent, in part, upon the difference between the rate at which we borrow funds or pay interest on outstanding debt securities and the rate at which we invest these funds. An increase
in interest rates would make it more expensive to use debt to finance our investments or to refinance our current financing arrangements. In addition, certain of our financing arrangements provide for adjustments in the loan interest rate along with
changes in market interest rates. Therefore, in periods of rising interest rates, our cost of funds will increase, which
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could materially reduce our net investment income. Any reduction in the level of interest rates on new investments relative to interest rates on our current investments could also adversely
impact our net investment income.
We have and may continue to structure the majority of our debt investments with floating
interest rates to position our portfolio for rate increases. However, there can be no assurance that this will successfully mitigate our exposure to interest rate risk. For example, in the event of a rising interest rate environment, payments under
floating rate debt instruments generally would rise and there may be a significant number of issuers of such floating rate debt instruments that would be unable or unwilling to pay such increased interest costs and may otherwise be unable to repay
their loans. Rising interest rates could also cause portfolio companies to shift cash from other productive uses to the payment of interest, which may have a material adverse effect on their business and operations and could, over time, lead to
increased defaults. Investments in floating rate debt instruments may also decline in value in response to rising interest rates if the interest rates of such investments do not rise as much, or as quickly, as market interest rates in general.
Similarly, during periods of rising interest rates, our fixed rate investments may decline in value because the fixed rate of interest paid thereunder may be below market interest rates.
In July 2017, the head of the United Kingdom Financial Conduct Authority announced the desire to phase out the use of LIBOR by the end of
2021. At this time, no consensus exists as to what rate or rates will become accepted alternatives to LIBOR, although the U.S. Federal Reserve, in connection with the Alternative Reference Rates Committee, a steering committee comprised of large
U.S. financial institutions, is considering replacing U.S. dollar LIBOR with the Secured Overnight Financing Rate, SOFR. Given the inherent differences between LIBOR and SOFR, or any other alternative benchmark rate that may be established, there
are many uncertainties regarding a transition from LIBOR, including, but not limited to, the need to amend all contracts with LIBOR as the referenced rate and how this will impact the cost of variable rate debt and certain derivative financial
instruments. In addition, SOFR or other replacement rates may fail to gain market acceptance. Any failure of SOFR or alternative reference rates to gain market acceptance could adversely affect the return on, value of and market for securities
linked to such rates.
The effect of the establishment of alternative reference rates or any other reforms to LIBOR or other
reference rates (including whether LIBOR will continue to be an acceptable market benchmark) cannot be predicted at this time, and the transition away from LIBOR and other current reference rates to alternative reference rates is complex and could
have a material adverse effect on our business, financial condition and results of operations. Factors such as the pace of the transition to replacement or reformed rates, the specific terms and parameters for and market acceptance of any
alternative reference rate, prices of and the liquidity of trading markets for products based on alternative reference rates, and our ability to transition and develop appropriate systems and analytics for one or more alternative reference rates
could also have a material adverse effect on our business, financial condition and results of operations. We may also need to renegotiate any credit or similar agreements extending beyond 2021 with our portfolio companies that utilize LIBOR as a
factor in determining the interest rate and certain of our existing credit facilities to replace LIBOR with the new standard that is established. If the agreements with our portfolio companies are unable to be renegotiated, our investments may bear
interest at a lower rate, which would decrease investment income and potentially the value of such investments.
In addition,
the IRS has issued proposed regulations regarding the tax consequences of the transition from interbank offered rates to new reference rates in debt instruments and non-debt contracts. Under the proposed
regulations, to avoid such alteration or modification of the terms of a debt instrument being treated as a taxable exchange, the fair market value of the modified instrument or contract must be substantially equivalent to its fair market value
before the qualifying change was made. The IRS may withdraw, amend or finalize, in whole or part, these proposed regulations and/or provide additional guidance, with potential retroactive effect.
Furthermore, because a rise in the general level of interest rates can be expected to lead to higher interest rates applicable to our debt
investments, an increase in interest rates would make it easier for us to meet or exceed the incentive fee hurdle rate in the investment advisory agreement and may result in a substantial increase of the amount of incentive fees payable to the
Advisor with respect to pre-incentive fee net investment income.
A covenant breach by our
portfolio companies may harm our operating results.
A portfolio companys failure to satisfy financial or
operating covenants imposed by us or other lenders could lead to defaults and, potentially, termination of its loans and foreclosure on its secured assets, which could trigger cross-defaults under other agreements and jeopardize a portfolio
companys ability to meet its obligations under the debt or equity securities that we hold. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms, which may include the waiver of certain financial
covenants, with a defaulting portfolio company.
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Our portfolio companies may be highly leveraged.
Some of our portfolio companies may be highly leveraged, which may have adverse consequences to these companies and to us as an investor.
These companies may be subject to restrictive financial and operating covenants and the leverage may impair these companies ability to finance their future operations and capital needs. As a result, these companies flexibility to respond
to changing business and economic conditions and to take advantage of business opportunities may be limited. Further, a leveraged companys income and net assets will tend to increase or decrease at a greater rate than if borrowed money were
not used.
We may not realize gains from our equity investments.
Certain investments that we may make may include equity related securities, such as rights and warrants that may be converted into or
exchanged for common stock or the cash value of the common stock. In addition, we may make direct equity investments in portfolio companies. The equity interests we receive may not appreciate in value and, in fact, may decline in value. Accordingly,
we may not be able to realize gains from our equity interests and any gains that we do realize on the disposition of any equity interests may not be sufficient to offset any other losses we experience. We may also be unable to realize any value if a
portfolio company does not have a liquidity event, such as a sale of the business, recapitalization or public offering, which would allow us to sell the underlying equity interests. We may be unable to exercise any put rights we acquire, which grant
us the right to sell our equity securities back to the portfolio company, for the consideration provided in our investment documents if the issuer is in financial distress.
An investment strategy focused primarily on privately held companies presents certain challenges, including the lack of available information about these companies.
Our investments are primarily in privately held companies. Investments in private companies pose significantly greater risks than
investments in public companies. First, private companies have reduced access to the capital markets, resulting in diminished capital resources and the ability to withstand financial distress. As a result, these companies, which may present greater
credit risk than public companies, may be unable to meet the obligations under their debt securities that we hold. Second, the investments themselves often may be illiquid. The securities of most of the companies in which we invest are not publicly
traded or actively traded on the secondary market and are, instead, traded on a privately negotiated OTC secondary market for institutional investors. In addition, such securities may be subject to legal and other restrictions on resale. As such, we
may have difficulty exiting an investment promptly or at a desired price prior to maturity or outside of a normal amortization schedule. In addition, in a restructuring, we may receive substantially different securities than our original investment
in a portfolio company, including securities in a different part of the capital structure. These investments may also be difficult to value because little public information generally exists about private companies, requiring an experienced due
diligence team to analyze and value the potential portfolio company. Finally, these companies often may not have third-party debt ratings or audited financial statements. We must therefore rely on the ability of the Advisor to obtain adequate
information through due diligence to evaluate the creditworthiness and potential returns from investing in these companies. These companies and their financial information will generally not be subject to the Sarbanes-Oxley Act and other rules and
regulations that govern public companies. If we are unable to uncover all material information about these companies, we may not make a fully informed investment decision, and we may lose money on our investments.
A lack of liquidity in certain of our investments may adversely affect our business.
We invest in certain companies whose securities are not publicly traded or actively traded on the secondary market and are, instead,
traded on a privately negotiated OTC secondary market for institutional investors and whose securities are subject to legal and other restrictions on resale or are otherwise less liquid than publicly traded securities. The illiquidity of certain of
our investments may make it difficult for us to sell these investments when desired. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we had previously
recorded these investments. The reduced liquidity of our investments may make it difficult for us to dispose of them at a favorable price or at all, and, as a result, we may suffer losses.
We may not have the funds or ability to make additional investments in our portfolio companies.
We may not have the funds or ability to make additional investments in our portfolio companies. After our initial investment in a portfolio company, we may be called upon from time to time to provide
additional funds to such company or have the opportunity to increase our investment through the exercise of a warrant to purchase common stock. There is no assurance that we will make, or will have sufficient funds to make, follow-on investments. Any decisions not to make a follow-on investment or any inability on our part to make such an investment may have a negative impact on a portfolio
company in need of such an investment, may result in a missed opportunity for us to increase our participation in a successful operation or may reduce the expected return on the investment.
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Prepayments of our debt investments by our portfolio companies could adversely impact our results
of operations and reduce our return on equity.
We are subject to the risk that the investments we make in our
portfolio companies may be repaid prior to maturity. When this occurs, we will generally reinvest these proceeds in temporary investments, pending their future investment in new portfolio companies. These temporary investments will typically have
substantially lower yields than the debt being prepaid and we could experience significant delays in reinvesting these amounts. Any future investment in a new portfolio company may also be at lower yields than the debt that was repaid. As a result,
our results of operations could be materially adversely affected if one or more of our portfolio companies elect to prepay amounts owed to us. Additionally, prepayments, net of prepayment fees, could negatively impact our return on equity.
Our investments may include original issue discount and PIK instruments.
To the extent that we invest in original issue discount or PIK instruments and the accretion of original issue discount or PIK interest
income constitutes a portion of our income, we will be exposed to risks associated with the requirement to include such non-cash income in taxable and accounting income prior to receipt of cash, including the
following:
The higher interest rates on PIK instruments reflect the payment deferral and increased credit risk associated with these instruments, and PIK
instruments generally represent a significantly higher credit risk than coupon loans;
Original issue discount and PIK instruments may have unreliable valuations because the accruals require judgments about collectability of the deferred
payments and the value of any associated collateral;
An election to defer PIK interest payments by adding them to the principal on such instruments increases our future investment income which increases
our gross assets and, as such, increases the Advisors future base management fees which, thus, increases the Advisors future income incentive fees at a compounding rate;
Market prices of PIK instruments and other zero coupon instruments are affected to a greater extent by interest rate changes, and may be more volatile
than instruments that pay interest periodically in cash. While PIK instruments are usually less volatile than zero coupon debt instruments, PIK instruments are generally more volatile than cash pay securities;
The deferral of PIK interest on an instrument increases the
loan-to-value ratio, which is a measure of the riskiness of a loan, with respect to such instrument;
Even if the conditions for income accrual under GAAP are satisfied, a borrower could still default when actual payment is due upon the maturity of such
loan;
For accounting purposes, cash distributions to investors representing original issue discount income are not derived from paid-in capital, although they may be paid from the offering proceeds. Thus, although a distribution of original issue discount income may come from the cash invested by investors, the 1940 Act does not require that
investors be given notice of this fact;
Tax legislation requires that income be recognized for tax purposes no later than when recognized for financial reporting purposes;
The required recognition of PIK interest for U.S. federal income tax purposes may have a negative impact on liquidity, as it represents a non-cash component of our investment company taxable income that may require cash distributions to stockholders in order to maintain our ability to be subject to tax as a RIC; and
Original issue discount may create a risk of non-refundable cash payments to the Advisor based on non-cash accruals that may never be realized.
We may from time to time enter into
total return swaps, credit default swaps or other derivative transactions which expose us to certain risks, including credit risk, market risk, liquidity risk and other risks similar to those associated with the use of leverage.
We may from time to time enter into total return swaps, credit default swaps or other derivative transactions that seek to modify or
replace the investment performance of a particular reference security or other asset. These transactions are typically individually negotiated, non-standardized agreements between two parties to exchange
payments, with payments generally
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calculated by reference to a notional amount or quantity. Swap contracts and similar derivative contracts are not traded on exchanges; rather, banks and dealers act as principals in these
markets. These investments may present risks in excess of those resulting from the referenced security or other asset. Because these transactions are not an acquisition of the referenced security or other asset itself, the investor has no right
directly to enforce compliance with the terms of the referenced security or other asset and has no voting or other consensual rights of ownership with respect to the referenced security or other asset. In the event of insolvency of a counterparty,
we will be treated as a general creditor of the counterparty and will have no claim of title with respect to the referenced security or other asset.
A total return swap is a contract in which one party agrees to make periodic payments to another party based on the change in the market value of the referenced security or other assets underlying the
total return swap during a specified period, in return for periodic payments based on a fixed or variable interest rate.
A
total return swap is subject to market risk, liquidity risk and risk of imperfect correlation between the value of the total return swap and the debt obligations underlying the total return swap. In addition, we may incur certain costs in connection
with a total return swap that could in the aggregate be significant.
A credit default swap is a contract in which one party
buys or sells protection against a credit event with respect to an issuer, such as an issuers failure to make timely payments of interest or principal on its debt obligations, bankruptcy or restructuring during a specified period. Generally,
if we sell credit protection using a credit default swap, we will receive fixed payments from the swap counterparty and if a credit event occurs with respect to the applicable issuer, we will pay the swap counterparty par for the issuers
defaulted debt securities and the swap counterparty will deliver the defaulted debt securities to us. Generally, if we buy credit protection using a credit default swap, we will make fixed payments to the counterparty and if a credit event occurs
with respect to the applicable issuer, we will deliver the issuers defaulted securities underlying the swap to the swap counterparty and the counterparty will pay us par for the defaulted securities. Alternatively, a credit default swap may be
cash settled and the buyer of protection would receive the difference between the par value and the market value of the issuers defaulted debt securities from the seller of protection.
Credit default swaps are subject to the credit risk of the underlying issuer. If we are selling credit protection, there is a risk that we
will not properly assess the risk of the underlying issuer, a credit event will occur and we will have to pay the counterparty. If we are buying credit protection, there is a risk that we will not properly assess the risk of the underlying issuer,
no credit event will occur and we will receive no benefit for the premium paid.
A derivative transaction is also subject to
the risk that a counterparty will default on its payment obligations thereunder or that we will not be able to meet our obligations to the counterparty. In some cases, we may post collateral to secure our obligations to the counterparty, and we may
be required to post additional collateral upon the occurrence of certain events such as a decrease in the value of the reference security or other asset. In some cases, the counterparty may not collateralize any of its obligations to us.
Derivative investments effectively add leverage to a portfolio by providing investment exposure to a security or market without owning or
taking physical custody of such security or investing directly in such market. In addition to the risks described above, such arrangements are subject to risks similar to those associated with the use of leverage.
We may invest through joint ventures, partnerships or other special purpose vehicles and our investments through these vehicles may entail greater
risks, and investments in which we have a non-controlling interest may involve risks specific to third-party management of those investments.
We may co-invest with third parties through partnerships, joint ventures or other entities, such
as SCJV, thereby acquiring jointly-controlled or non-controlling interests in certain investments in conjunction with participation by one or more third parties in such investment. We may have interests or
objectives that are inconsistent with those of the third-party partners or co-venturers. Although we may not have full control over these investments and therefore, may have a limited ability to protect its
position therein, we expect that we will negotiate appropriate rights to protect our interests. Nevertheless, such investments may involve risks not present in investments where a third party is not involved, including the possibility that a
third-party partner or co-venturer may have financial difficulties, resulting in a negative impact on such investment, may have economic or business interests or goals which are inconsistent with ours, or may
be in a position to take (or block) action in a manner contrary to the our investment objectives or the increased possibility of default by, diminished liquidity or insolvency of, the third party, due to a sustained or general economic downturn.
Third-party partners or co-venturers may opt to liquidate an investment at a time during which such liquidation is not optimal for us. In addition, we may in certain circumstances be liable for the actions of
its third-party partners or co-venturers. In those circumstances where such third parties involve a management group, such third parties may receive compensation
arrangements relating to such investments, including incentive compensation arrangements
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Risks Related to Debt Financing
We currently incur indebtedness to make investments, which magnifies the potential for gain or loss on amounts invested in our common stock and may increase the risk of investing in our common
stock.
The use of borrowings and other types of financing, also known as leverage, magnifies the potential for gain or
loss on amounts invested and, therefore, increases the risks associated with investing in our common stock. When we use leverage to partially finance our investments, through borrowing from banks and other lenders or issuing debt securities, we, and
therefore our stockholders, will experience increased risks of investing in our common stock. Any lenders and debt holders would have fixed dollar claims on our assets that are senior to the claims of our stockholders. If the value of our assets
increases, then leverage would cause the net asset value attributable to our common stock to increase more sharply than it would have had we not utilized leverage. Conversely, if the value of our assets decreases, leverage would cause net asset
value to decline more sharply than it otherwise would have had we not utilized leverage. Similarly, any increase in our income in excess of interest payable on our indebtedness would cause our net investment income to increase more than it would
without leverage, while any decrease in our income would cause net investment income to decline more sharply than it would have had we not utilized leverage. Such a decline could negatively affect our ability to make distributions to stockholders.
Leverage is generally considered a speculative investment technique.
In addition, the decision to utilize leverage will
increase our assets and, as a result, will increase the amount of base management fees payable to the Advisor. See Risks Related to the Advisor and its AffiliatesThe Advisor and its affiliates, including our officers and some of our
directors, face conflicts of interest as a result of compensation arrangements between us and the Advisor, which could result in actions that are not in the best interests of our stockholders.
Illustration. The following table illustrates the effect of leverage on returns from an investment in shares of our common stock
assuming various annual returns, net of expenses. The calculations in the table below are hypothetical and actual returns may be higher or lower than those appearing below. The calculation assumes (i) $8.8 billion in total assets, (ii) a
weighted average cost of funds of 3.71%, (iii) $5.1 billion in debt outstanding and (iv) $3.1 billion in stockholders equity. In order to compute the Corresponding return to stockholders, the Assumed Return on
Our Portfolio (net of expenses) is multiplied by the assumed total assets to obtain an assumed return to us. From this amount, the interest expense is calculated by multiplying the assumed weighted average cost of funds times the assumed debt
outstanding, and the product is subtracted from the assumed return to us in order to determine the return available to stockholders. The return available to stockholders is then divided by our stockholders equity to determine the
Corresponding return to stockholders. Actual interest payments may be different.
Assumed Return on Our Portfolio (net of expenses)
(10)%
(5)%
%
5%
10%
Corresponding return to stockholders
(34.49
)%
(20.30
)%
(6.10
)%
8.09
%
22.28
%
Similarly, assuming (i) $8.8 billion in total assets, (ii) a weighted average cost of funds of
3.71% and (iii) $5.1 billion in debt outstanding, our assets would need to yield an annual return (net of expenses) of approximately 2.15% in order to cover the annual interest payments on our outstanding debt.
The agreements governing our debt financing arrangements contain, and agreements governing future debt financing arrangements may contain, various
covenants which, if not complied with, could have a material adverse effect on our ability to meet our investment obligations and to pay distributions to our stockholders.
The agreements governing certain of our debt financing arrangements contain, and agreements governing future debt financing arrangements
may contain, certain financial and operational covenants. These covenants require us and our subsidiaries to, among other things, maintain certain financial ratios, including asset coverage and minimum stockholders equity. Compliance with
these covenants depends on many factors, some of which are beyond our and their control. In the event of deterioration in the capital markets and pricing levels subsequent to this period, net unrealized depreciation in our and our subsidiaries
portfolios may increase in the future and could result in non-compliance with certain covenants, or our taking actions which could disrupt our business and impact our ability to meet our investment objectives.
There can be no assurance that we and our subsidiaries will continue to comply with the covenants under our financing
arrangements. Failure to comply with these covenants could result in a default which, if we and our subsidiaries were unable to obtain a waiver, consent or amendment from the debt holders, could accelerate repayment under any or all of our and their
debt instruments and thereby force us to liquidate investments at a disadvantageous time and/or at a price which could result in losses, or allow our lenders to sell assets pledged as collateral under our financing arrangements in order to satisfy
amounts due thereunder. These occurrences could have a material adverse impact on our liquidity, financial condition, results of operations
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and ability to pay distributions. See Item 7. Managements Discussion and Analysis of Financial Condition and Results of OperationsFinancial Condition, Liquidity and Capital
Resources for a more detailed discussion of the terms of our debt financings.
Risks Related to an Investment in Our Common Stock
There is a risk that investors in our common stock may not receive distributions.
We cannot assure stockholders that we will achieve investment results that will allow us to make a specified level of cash distributions.
All distributions will be paid at the discretion of our board of directors and will depend on our earnings, our net investment income, our financial condition, maintenance of our RIC status, compliance with applicable BDC regulations and such other
factors as our board of directors may deem relevant from time to time. Furthermore, we are permitted to issue senior securities, including multiple classes of debt and one class of stock senior to our shares of common stock. If any such senior
securities are outstanding, we are prohibited from paying distributions to holders of shares of our common stock unless we meet the applicable asset coverage ratios at the time of distribution. As a result, we may be limited in our ability to make
distributions.
Our distribution proceeds may exceed our earnings. Therefore, portions of the distributions that we make may represent a
return of capital to stockholders, which will lower their tax basis in their shares of common stock.
The tax treatment
and characterization of our distributions may vary significantly from time to time due to the nature of our investments. The ultimate tax characterization of our distributions made during a tax year may not finally be determined until after the end
of that tax year. We may make distributions during a tax year that exceed our investment company taxable income and net capital gains for that tax year. In such a situation, the amount by which our total distributions exceed investment company
taxable income and net capital gains generally would be treated as a return of capital up to the amount of a stockholders tax basis in the shares, with any amounts exceeding such tax basis treated as a gain from the sale or exchange of such
shares. A return of capital generally is a return of a stockholders investment rather than a return of earnings or gains derived from our investment activities. Moreover, we may pay all or a substantial portion of our distributions from the
proceeds of the sale of shares of our common stock or from borrowings in anticipation of future cash flow, which could constitute a return of stockholders capital and will lower such stockholders tax basis in our shares, which may result
in increased tax liability to stockholders when they sell such shares.
Our shares of common stock may trade at a discount to net asset
value, and such discount may be significant.
Shares of closed-end investment
companies, including BDCs, may trade at a market price that is less than the net asset value that is attributable to those shares. This characteristic of closed-end investment companies is separate and
distinct from the risk that our net asset value per share may decline. It is not possible to predict whether shares of our common stock will trade at, above, or below net asset value. If our common stock is trading at a price below its net asset
value per share, we will generally not be able to issue additional shares of our common stock at their market price without first obtaining approval for such issuance from our stockholders and our independent directors. In past years, we obtained
the approval of our stockholders to issue shares of common stock at prices below the then-current net asset value of our common stock, subject to certain conditions, during the twelve-month periods beginning on the dates of such approvals. The
current authorization expires on July 15, 2021. We may again seek the approval of our stockholders to issue shares of our common stock at prices below the then-current net asset value per share for a twelve-month period following stockholder
approval. However, we may not obtain the necessary approvals to sell shares of common stock below net asset value after July 15, 2021.
We may pay distributions from offering proceeds, borrowings or the sale of assets to the extent our cash flows from operations, net investment
income or earnings are not sufficient to fund declared distributions.
We may fund distributions from the uninvested
proceeds of a securities offering and borrowings, and we have not established limits on the amount of funds we may use from such proceeds or borrowings to make any such distributions. We have paid and may continue to pay distributions from the sale
of assets to the extent distributions exceed our earnings or cash flows from operations. Distributions from offering proceeds or from borrowings could reduce the amount of capital we ultimately invest in our portfolio companies.
A stockholders interest in us will be diluted if we issue additional shares, which could reduce the overall value of an investment in us.
Our investors do not have preemptive rights to any shares we issue in the future. Our charter authorizes us to issue
750,000,000 shares of common stock. Pursuant to our charter, a majority of our entire board of directors may amend our charter
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to increase the number of authorized shares of stock without stockholder approval. After an investor purchases shares, our board of directors may elect to sell additional shares in the future,
issue equity interests in private offerings or issue share-based awards to our independent directors or employees of the Advisor. To the extent we issue additional equity interests after an investor purchases our shares, an investors
percentage ownership interest in us will be diluted. In addition, depending upon the terms and pricing of any additional offerings and the value of our investments, an investor may also experience dilution in the book value and fair value of his or
her shares.
Stockholders may experience dilution in their ownership percentage if they do not participate in our distribution
reinvestment plan.
Stockholders who do not participate in our distribution reinvestment plan may experience accretion
to the net asset value of their shares if our shares are trading at a premium to net asset value and dilution if our shares are trading at a discount to net asset value. The level of accretion or discount would depend on various factors, including
the proportion of our stockholders who participate in the plan, the level of premium or discount at which our shares are trading and the amount of the distribution payable to a stockholder.
Certain provisions of our charter and bylaws as well as provisions of the Maryland General Corporation Law could deter takeover attempts and have an adverse impact on the value of our common stock.
The Maryland General Corporation Law, or the MGCL, and our charter and bylaws contain certain provisions that may have
the effect of discouraging, delaying or making difficult a change in control of our company or the removal of our incumbent directors. Under the Business Combination Act of the MGCL, certain business combinations between us and an interested
stockholder (defined generally to include any person who beneficially owns 10% or more of the voting power of our outstanding shares) or an affiliate thereof is prohibited for five years and thereafter is subject to special stockholder voting
requirements, to the extent that such statute is not superseded by applicable requirements of the 1940 Act. However, our board of directors has adopted a resolution exempting from the Business Combination Act any business combination between us and
any person to the extent that such business combination receives the prior approval of our board of directors, including a majority of our directors who are not interested persons as defined in the 1940 Act. Under the Control Share
Acquisition Act of the MGCL, control shares acquired in a control share acquisition have no voting rights except to the extent approved by a vote of two-thirds of the votes entitled to
be cast on the matter, excluding shares owned by the acquirer, by officers or by directors who are employees of the corporation. Our bylaws contain a provision exempting from the Control Share Acquisition Act any and all acquisitions by any person
of shares of our common stock, but such provision may be repealed at any time (before or after a control share acquisition). However, we will amend our bylaws to repeal such provision (so as to be subject to the Control Share Acquisition Act) only
if our board of directors determines that it would be in our best interests and if the staff of the SEC does not object to our determination that our being subject to the Control Share Acquisition Act does not conflict with the 1940 Act. The
Business Combination Act (if our board of directors should repeal the resolution) and the Control Share Acquisition Act (if we amend our bylaws to be subject to that Act) may discourage others from trying to acquire control of us and increase the
difficulty of consummating any offer.
We have also adopted measures that may make it difficult for a third party to obtain
control of us, including provisions of our charter: (a) classifying our board of directors into three classes serving staggered three-year terms, (b) providing that a director may be removed only for cause and only by vote of at least two-thirds of the votes entitled to be cast, and (c) authorizing our board of directors to (i) classify or reclassify shares of our stock into one or more classes or series, (ii) cause the issuance of
additional shares of our stock, and (iii) amend our charter from time to time, without stockholder approval, to increase or decrease the aggregate number of shares of stock or the number of shares of stock of any class or series that we have
authority to issue. These provisions, as well as other provisions of our charter and bylaws, may discourage, delay, defer, make more difficult or prevent a transaction or a change in control that might otherwise be in the best interest of our
stockholders.
The net asset value of our common stock may fluctuate significantly.
The net asset value and liquidity, if any, of the market for shares of our common stock may be significantly affected by numerous factors,
some of which are beyond our control and may not be directly related to our operating performance. These factors include: (i) changes in regulatory policies or tax guidelines, particularly with respect to RICs or BDCs; (ii) loss of RIC or
BDC status; (iii) changes in earnings or variations in operating results; (iv) changes in the value of our portfolio of investments; (v) changes in accounting guidelines governing valuation of our investments; (vi) any shortfall
in revenue or net income or any increase in losses from levels expected by investors; (vii) departure of our investment adviser or certain of its key personnel; (viii) general economic trends and other external factors; and (ix) loss
of a major funding source.
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The market price of our common stock may fluctuate significantly.
The market price and liquidity of the market for our common stock may be significantly affected by numerous factors, some of which are
beyond our control and may not be directly related to our operating performance. These factors include:
significant volatility in the market price and trading volume of securities of publicly traded RICs, BDCs or other companies in our sector, which are
not necessarily related to the operating performance of these companies;
price and volume fluctuations in the overall stock market from time to time;
changes in law, regulatory policies or tax guidelines, or interpretations thereof, particularly with respect to RICs or BDCs;
loss of our BDC or RIC status;
changes in our earnings or variations in our operating results;
changes in the value of our portfolio of investments;
any shortfall in revenue or net income or any increase in losses from levels expected by investors or securities analysts;
departure of the Advisors key personnel;
operating performance of companies comparable to us;
short-selling pressure with respect to shares of our common stock or BDCs generally;
future sales of our securities convertible into or exchangeable or exercisable for our common stock or the conversion of such securities;
uncertainty surrounding the strength of the economy;
general economic trends and other external factors; and
loss of a major funding source.
In the past, following periods of volatility in the market price of a companys securities, securities class action litigation has often been brought against that company. If the market price of our
common stock fluctuates significantly, we may be the target of securities litigation in the future. Securities litigation could result in substantial costs and divert managements attention and resources from our business. See Risks
Related to Our Business and StructureWe and our Advisor could be the target of litigation.
If we issue preferred stock, debt
securities or convertible debt securities, the net asset value and market value of our common stock may become more volatile.
We also cannot assure you that the issuance of preferred stock, debt securities or convertible debt securities would result in a higher yield or return to the holders of our common stock. The issuance of
preferred stock, debt securities or convertible debt securities would likely cause the net asset value and market value of our common stock to become more volatile. If the dividend rate on the preferred stock, or the interest rate on the debt
securities, were to approach the net rate of return on our investment portfolio, the benefit of leverage to the holders of our common stock would be reduced. If the dividend rate on the preferred stock, or the interest rate on the debt securities,
were to exceed the net rate of return on our portfolio, the use of leverage would result in a lower rate of return to the holders of common stock than if we had not issued the preferred stock or debt securities. Any decline in the net asset value of
our investment would be borne entirely by the holders of our common stock. Therefore, if the market value of our portfolio were to decline, the leverage would result in a greater decrease in net asset value to the holders of our common stock than if
we were not leveraged through the issuance of preferred stock. This decline in net asset value would also tend to cause a greater decline in the market price for our common stock.
There is also a risk that, in the event of a sharp decline in the value of our net assets, we would be in danger of failing to maintain
required asset coverage ratios which may be required by the preferred stock, debt securities, convertible debt or units or of a downgrade in the ratings of the preferred stock, debt securities, convertible debt or units or our current investment
income might not be sufficient to meet the dividend requirements on the preferred stock or the interest payments on the debt securities. In
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order to counteract such an event, we might need to liquidate investments in order to fund redemption of some or all of the preferred stock, debt securities or convertible debt. In addition, we
would pay (and the holders of our common stock would bear) all costs and expenses relating to the issuance and ongoing maintenance of the preferred stock, debt securities, convertible debt or any combination of these securities. Holders of preferred
stock, debt securities or convertible debt may have different interests than holders of common stock and may at times have disproportionate influence over our affairs.
Holders of any preferred stock that we may issue will have the right to elect members of the board of directors and have class voting rights on certain matters.
The 1940 Act requires that holders of shares of preferred stock must be entitled as a class to elect two directors at all times and to
elect a majority of the directors if dividends on such preferred stock are in arrears by two years or more, until such arrearage is eliminated. In addition, certain matters under the 1940 Act require the separate vote of the holders of any issued
and outstanding preferred stock, including changes in fundamental investment restrictions and conversion to open-end status and, accordingly, preferred stockholders could veto any such changes. Restrictions
imposed on the declarations and payment of dividends or other distributions to the holders of our common stock and preferred stock, both by the 1940 Act and by requirements imposed by rating agencies, might impair our ability to maintain our
qualification as a RIC for U.S. federal income tax purposes.
We have obtained the approval of our stockholders to issue shares of our
common stock at prices below the then-current net asset value per share of our common stock, and any such issuance could materially dilute our stockholders interest in our common stock and reduce our net asset value per share.
We have obtained the approval of our stockholders to issue shares of our common stock at prices below the then-current
net asset value of our common stock, subject to certain conditions, during the twelve-month period concluding on July 15, 2021. Any sale or other issuance of shares of our common stock at a price below net asset value per share would result in
an immediate dilution to our common stock and a reduction of our net asset value per share. This dilution would occur as a result of a proportionately greater decrease in a stockholders interest in our earnings and assets and voting interest
in us than the increase in our assets resulting from such issuance. Such dilutive effects may be material.
Risks Related to U.S. Federal
Income Tax
We will be subject to corporate-level income tax if we are unable to qualify as a RIC under Subchapter M of the Code or
to satisfy the RIC annual distribution requirements.
Besides maintaining our election to be treated as a BDC under the
1940 Act, in order for us to qualify as a RIC under Subchapter M of the Code, we must meet the following annual distribution, income source and asset diversification requirements. See Item 1. BusinessTaxation as a RIC.
The Annual Distribution Requirement will be satisfied if we distribute to our stockholders on an annual basis at least 90% of our net ordinary income
and net short-term capital gain in excess of net long-term capital loss. if any. We will be subject to a 4% nondeductible U.S. federal excise tax, however, to the extent that we do not satisfy certain additional minimum distribution requirements on
a calendar year basis. Because we use debt financing, we are subject to certain asset coverage ratio requirements under the 1940 Act and are currently, and may in the future become, subject to certain financial covenants under loan and credit
agreements that could, under certain circumstances, restrict us from making distributions necessary to satisfy the Annual Distribution Requirement. If we are unable to obtain cash from other sources, we could fail to qualify for RIC tax treatment
and thus become subject to corporate-level U.S. federal income tax.
The 90% Income Test will be satisfied if we earn at least 90% of our gross income for each tax year from dividends, interest, gains from the sale of
securities or similar sources.
The Diversification Tests will be satisfied if we meet certain asset diversification requirements at the end of each quarter of our tax year. To
satisfy these requirements, at least 50% of the value of our assets must consist of cash, cash equivalents, U.S. government securities, securities of other RICs, and other securities if such securities of any one issuer do not represent more than 5%
of the value of our assets or more than 10% of the outstanding voting securities of such issuer; and no more than 25% of the value of our assets can be invested in the securities, other than U.S. government securities or securities of other RICs, of
one issuer, of two or more issuers that are controlled, as determined under applicable Code rules, by us and that are engaged in the same or similar or related trades or businesses or of certain qualified publicly-traded partnerships.
Failure to meet these requirements may result in our
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having to dispose of certain investments quickly in order to prevent the loss of RIC status. Because most of our investments will be in private companies, and therefore will be relatively
illiquid, any such dispositions could be made at disadvantageous prices and could result in substantial losses.
We must satisfy these tests on an ongoing basis in order to maintain RIC tax treatment, and may be required to make distributions to stockholders at times when it would be more advantageous to invest cash
in our existing or other investments, or when we do not have funds readily available for distribution. Compliance with the RIC tax requirements may hinder our ability to operate solely on the basis of maximizing profits and the value of our
stockholders investments. Also, the rules applicable to our qualification as a RIC are complex, with many areas of uncertainty. If we fail to qualify for or maintain RIC tax treatment for any reason and are subject to corporate income tax, the
resulting corporate taxes could substantially reduce our net assets, the amount of income available for distribution and the amount of our distributions. Such a failure may have a material adverse effect on us and on any investment in us. The Code
provides certain forms of relief from RIC disqualification due to failures of the 90% Income Test or any of the Diversification Tests, although there may be additional taxes due in such cases. We cannot assure you that we would qualify for any such
relief should we fail either the 90% Income Test or any of the Diversification Tests.
Some of our investments may be subject to
corporate-level income tax.
We may invest in certain debt and equity investments through taxable subsidiaries and the
taxable income of these taxable subsidiaries will be subject to federal and state corporate income taxes. We may invest in certain foreign debt and equity investments which could be subject to foreign taxes (such as income tax, withholding and value
added taxes).
We may have difficulty paying our required distributions if we recognize income before or without receiving cash
representing such income.
For U.S. federal income tax purposes, we may be required to recognize taxable income in
circumstances in which we do not receive a corresponding payment in cash. For example, our investments may include debt instruments that are treated under applicable tax rules as having original issue discount (such as debt instruments with PIK
interest or, in certain cases, increasing interest rates or debt instruments that were issued with warrants). To the extent original issue discount or PIK interest constitutes a portion of our income, we must include in taxable income each tax year
a portion of the original issue discount or PIK interest that accrues over the life of the instrument, regardless of whether cash representing such income is received by us in the same tax year. We may also have to include in income other amounts
that we have not yet received in cash, such as deferred loan origination fees that are paid after origination of the loan or are paid in non-cash compensation such as warrants or stock. We anticipate that a
portion of our income may constitute original issue discount or other income required to be included in taxable income prior to receipt of cash. Further, we may elect to amortize market discount and include such amounts in our taxable income in the
current tax year, instead of upon disposition, as not making the election would limit our ability to deduct interest expenses for tax purposes.
Because any original issue discount or other amounts accrued will be included in our investment company taxable income for the tax year of the accrual, we may be required to make a distribution to our
stockholders in order to satisfy the Annual Distribution Requirement, even though we will not have received any corresponding cash amount. As a result, we may have difficulty meeting the Annual Distribution Requirement necessary to qualify for and
maintain RIC tax treatment under Subchapter M of the Code. We may have to sell some of our investments at times and/or at prices we would not consider advantageous, raise additional debt or equity capital or forgo new investment opportunities for
this purpose. If we are not able to obtain cash from other sources, we may fail to qualify for or maintain RIC tax treatment and thus become subject to corporate-level income tax.
Furthermore, we may invest in the equity securities of non-U.S. corporations (or other non-U.S. entities classified as corporations for U.S. federal income tax purposes) that could be treated under the Code and U.S. Treasury regulations as passive foreign investment companies and/or
controlled foreign corporations. The rules relating to investment in these types of non-U.S. entities are designed to ensure that U.S. taxpayers are either, in effect, taxed currently (or on an
accelerated basis with respect to corporate level events) or taxed at increased tax rates at distribution or disposition. In certain circumstances, these rules also could require us to recognize taxable income or gains where we do not receive a
corresponding payment in cash and, unless the income and gains are related to our business of investing in stocks and securities, all or a portion of such taxable income and gains may not be considered qualifying income for purposes of the 90%
Income Test.
Our portfolio investments may present special tax issues.
Investments in below-investment grade debt instruments and certain equity securities may present special tax issues for us. U.S. federal
income tax rules are not entirely clear about issues such as when we may cease to accrue interest, original issue
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discount or market discount, when and to what extent deductions may be taken for bad debts or worthless debt in equity securities, how payments received on obligations in default should be
allocated between principal and interest income, as well as whether exchanges of debt instruments in a bankruptcy or workout context are taxable. Such matters could cause us to recognize taxable income for U.S. federal income tax purposes, even in
the absence of cash or economic gain, and require us to make taxable distributions to our stockholders to maintain our RIC status or preclude the imposition of either U.S. federal corporate income or excise taxation. Additionally, because such
taxable income may not be matched by corresponding cash received by us, we may be required to borrow money or dispose of other investments to be able to make distributions to our stockholders. These and other issues will be considered by us, to the
extent determined necessary, in order that we minimize the level of any U.S. federal income or excise tax that we would otherwise incur. See Item 1. BusinessTaxation as a RIC.
If we do not qualify as a publicly offered regulated investment company, as defined in the Code, you will be taxed as though you
received a distribution of some of our expenses.
A publicly offered regulated investment company is a RIC
whose shares are either (i) continuously offered pursuant to a public offering, (ii) regularly traded on an established securities market or (iii) held by at least 500 persons at all times during the tax year. If we do not qualify as
a publicly offered regulated investment company for any tax year, a noncorporate stockholders allocable portion of our affected expenses, including our management fees, will be treated as an additional distribution to the stockholder and will
be deductible by such stockholder only to the extent permitted under the limitations described below. For noncorporate stockholders, including individuals, trusts, and estates, significant limitations generally apply to the deductibility of certain
expenses of a non-publicly offered regulated investment company, including management fees. In particular, these expenses, referred to as miscellaneous itemized deductions, are deductible to an individual only
to the extent they exceed 2% of such a stockholders adjusted gross income for the taxable years after 2025 and are entirely not deductible against gross income before 2026, are not deductible for alternative minimum tax purposes and are
subject to the overall limitation on itemized deductions imposed by the Code. Although we believe that we are currently considered a publicly offered regulated investment company, as defined in the Code, there can be no assurance, however, that we
will be considered a publicly offered regulated investment company in the future.
Legislative or regulatory tax changes could adversely
affect investors.
At any time, the federal income tax laws governing RICs or the administrative interpretations of
those laws or regulations may be amended. Any of those new laws, regulations or interpretations may take effect retroactively and could adversely affect the taxation of us or our stockholders. Therefore, changes in tax laws, regulations or
administrative interpretations or any amendments thereto could diminish the value of an investment in our shares or the value or the resale potential of our investments.
General Risks
Events outside of our control, including public health crises, could
negatively affect our portfolio companies and our results of operations.
Periods of market volatility have occurred
and could continue to occur in response to pandemics or other events outside of our control. These types of events have adversely affected, and could continue to adversely affect operating results for us and for our portfolio companies. For example,
the COVID-19 pandemic has resulted in the following in many affected jurisdictions, including the United States: (i) restrictions on travel and the temporary closure of many corporate offices, retail
stores, and manufacturing facilities and factories, resulting in significant disruption to the business of many companies, (ii) increased defaults by borrowers, (iii) volatility in credit markets and (iv) rapidly evolving action by
government officials to address the economic and market problems. In addition to these developments having adverse consequences for us and our portfolio companies, the operations of the Advisor have been, and could continue to be, adversely
impacted, including through quarantine measures and travel restrictions imposed on its personnel or service providers based or temporarily located in affected countries, or any related health issues of such personnel or service providers.
As the potential impact of COVID-19 is difficult to predict, the extent to which COVID-19 could negatively affect our and our portfolio companies operating results or the duration of any potential business or supply-chain disruption is uncertain. Any potential impact to our results of
operations will depend to a large extent on future developments and new information that could emerge regarding the duration and severity of the COVID-19 pandemic and the actions taken by authorities and other
entities to contain the spread of COVID-19 or treat its impact, all of which are beyond our control. These potential impacts, while uncertain, could adversely affect our and our portfolio companies
operating results.
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We are currently operating in a period of capital markets disruption and economic uncertainty.
The U.S. capital markets have experienced extreme volatility and disruption following the global outbreak of COVID-19 that began in December 2019. Some economists and major investment banks have expressed concern that the continued spread of the virus globally could lead to a world-wide economic downturn. Disruptions in
the capital markets have increased the spread between the yields realized on risk-free and higher risk securities, resulting in illiquidity in parts of the capital markets. These and future market disruptions and/or illiquidity would be expected to
have an adverse effect on our business, financial condition, results of operations and cash flows. Unfavorable economic conditions also would be expected to increase our funding costs, limit our access to the capital markets or result in a decision
by lenders not to extend credit to us. These events have limited and could continue to limit our investment originations, limit our ability to grow and have a material negative impact on our operating results and the fair values of our debt and
equity investments. In addition, while recent government stimulus measures worldwide have reduced volatility in the financial markets, volatility may return as such measures are phased out, and the long-term impacts of such stimulus on fiscal policy
and inflation remain unknown.
If the current period of capital market disruption and instability continues for an extended period of
time, there is a risk that investors in our equity securities may not receive distributions consistent with historical levels or at all or that our distributions may not grow over time and a portion of our distributions may be a return of capital.
Our ability to pay distributions consistent with our historical range or to continue to pay our distribution fully in
cash rather than shares of common stock might be adversely affected by the impact of one or more of the risk factors described in this annual report on Form 10-K, including the
COVID-19 pandemic. If we are unable to satisfy the asset coverage test applicable to us under the 1940 Act as a business development company or if we violate certain covenants under our existing or future
credit facilities or other leverage, we may also be limited in our ability to make distributions. If we declare a distribution and if more stockholders opt to receive cash distributions rather than participate in our dividend reinvestment plan, we
may be forced to sell some of our investments in order to make cash distribution payments. To the extent we make distributions to stockholders that include a return of capital, such portion of the distribution essentially constitutes a return of the
stockholders investment. Although such return of capital may not be taxable, such distributions would generally decrease a stockholders basis in our common stock and may therefore increase such stockholders tax liability for
capital gains upon the future sale of such stock. A return of capital distribution may cause a stockholder to recognize a capital gain from the sale of our common stock even if the stockholder sells its shares for less than the original purchase
price.
Future disruptions or instability in capital markets could negatively impact the valuation of our investments and our ability to
raise capital.
From time to time, the global capital markets may experience periods of disruption and instability,
which could be prolonged and which could materially and adversely impact the broader financial and credit markets, have a negative impact on the valuations of our investments and reduce the availability to us of debt and equity capital. For example,
between 2008 and 2009, instability in the global capital markets resulted in disruptions in liquidity in the debt capital markets, significant write-offs in the financial services sector, the re-pricing of
credit risk in the broadly syndicated credit market and the failure of major domestic and international financial institutions. In particular, the financial services sector was negatively impacted by significant write-offs as the value of the assets
held by financial firms declined, impairing their capital positions and abilities to lend and invest. While market conditions have recovered from the events of 2008 and 2009, there have been continuing periods of volatility (e.g., the ongoing
COVID-pandemic). For example, continued uncertainty surrounding the negotiation of trade deals between Britain and the European Union following the United Kingdoms exit from the European Union and uncertainty between the United States and
other countries with respect to trade policies, treaties, and tariffs, among other factors, have caused disruption in the global markets. There can be no assurance that market conditions will not worsen in the future.
While most of our investments are not publicly traded, applicable accounting standards require us to assume as part of our valuation
process that our investments are sold in a principal market to market participants (even if we plan on holding an investment through its maturity) and impairments of the market values or fair market values of our investments, even if unrealized,
must be reflected in our financial statements for the applicable period, which could result in significant reductions to our net asset value for the period. With certain limited exceptions, we are only allowed to borrow amounts or issue debt
securities if our asset coverage, as calculated pursuant to the 1940 Act, equals at least 150% immediately after such borrowing. Equity capital may also be difficult to raise during periods of adverse or volatile market conditions because, subject
to some limited exceptions, as a BDC, we are generally not able to issue additional shares of our common stock at a price less than net asset value without first obtaining approval for such issuance from our stockholders and our independent
directors. If we are unable to raise capital or refinance existing debt on acceptable terms, then we may be limited in our ability to make new commitments or to fund existing commitments to our portfolio companies. Significant changes in the capital
markets may also affect the pace of our
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investment activity and the potential for liquidity events involving our investments. Thus, the illiquidity of our investments may make it difficult for us to sell such investments to access
capital if required, and as a result, we could realize significantly less than the value at which we have recorded our investments if we were required to sell them for liquidity purposes.
Global economic, political and market conditions, including downgrades of the U.S. credit rating, may adversely affect our business, results of operations and financial condition.
The current global financial market situation, as well as various social and political tensions in the United States
and around the world, may contribute to increased market volatility, may have long-term effects on the United States and worldwide financial markets and may cause economic uncertainties or deterioration in the U.S. and worldwide. The impact of
downgrades by rating agencies to the U.S. governments sovereign credit rating or its perceived creditworthiness as well as potential government shutdowns and uncertainty surrounding transfers of power could adversely affect the U.S. and global
financial markets and economic conditions. Since 2010, several European Union countries have faced budget issues, some of which may have negative long-term effects for the economies of those countries and other European Union countries. There is
concern about national-level support for the Euro and the accompanying coordination of fiscal and wage policy among European Economic and Monetary Union member countries. In addition, the fiscal policy of foreign nations, such as Russia and China,
may have a severe impact on the worldwide and U.S. financial markets. The decision made in the United Kingdom referendum to leave the EU (the so-called Brexit) has led to volatility in global
financial markets and may lead to weakening in consumer, corporate and financial confidence in the United Kingdom and Europe. While the United Kingdom commenced its withdrawal from the EU on January 31, 2020, the transition and its surrounding
negotiations are ongoing, which creates uncertainty, which may lead to continued volatility. Additionally, trade wars and volatility in the U.S. repo market, the U.S. high yield bond markets, the Chinese stock markets and global markets for
commodities may affect other financial markets worldwide. In addition, while recent government stimulus measures worldwide have reduced volatility in the financial markets, volatility may return as such measures are phased out, and the long-term
impacts of such stimulus on fiscal policy and inflation remain unknown. We cannot predict the effects of these or similar events in the future on the U.S. and global economies and securities markets or on our investments. We monitor developments in
economic, political and market conditions and seek to manage our investments in a manner consistent with achieving our investment objective, but there can be no assurance that we will be successful in doing so.
Changes to United States tariff and import/export regulations may have a negative effect on our portfolio companies.
There have been significant changes to United States trade policies, treaties and tariffs, and in the future there may be additional
significant changes. These and any future developments, and continued uncertainty surrounding trade policies, treaties and tariffs, may have a material adverse effect on global economic conditions and the stability of global financial markets, and
may significantly reduce global trade and, in particular, trade between the impacted nations and the United States. Any of these factors could depress economic activity and restrict our portfolio companies access to suppliers or customers and
could have material adverse effects on our business, financial condition and results of operations.
Economic sanction laws in the United
States and other jurisdictions may prohibit us and our affiliates from transacting with certain countries, individuals and companies.
Economic sanction laws in the United States and other jurisdictions may prohibit us or our affiliates from transacting with certain countries, individuals and companies. In the United States, the U.S.
Department of the Treasurys Office of Foreign Assets Control administers and enforces laws, executive orders and regulations establishing U.S. economic and trade sanctions, which prohibit, among other things, transactions with, and the
provision of services to, certain non-U.S. countries, territories, entities and individuals. These types of sanctions may significantly restrict or completely prohibit investment activities in certain
jurisdictions, and if we, our portfolio companies or other issuers in which we invest were to violate any such laws or regulations, we may face significant legal and monetary penalties.
The Foreign Corrupt Practices Act, or FCPA, and other anti-corruption laws and regulations, as well as anti-boycott regulations, may also
apply to and restrict our activities, our portfolio companies and other issuers of our investments. If an issuer or we were to violate any such laws or regulations, such issuer or we may face significant legal and monetary penalties. The U.S.
government has indicated that it is particularly focused on FCPA enforcement, which may increase the risk that an issuer or us becomes the subject of such actual or threatened enforcement. In addition, certain commentators have suggested that
private investment firms and the funds that they manage may face increased scrutiny and/or liability with respect to the activities of their underlying portfolio companies. As such, a violation of the FCPA or other applicable regulations by us or an
issuer of our portfolio investments could have a material adverse effect on us. We are committed to complying with the FCPA and other anti-corruption laws and regulations, as well as anti-boycott regulations, to which it is subject. As a result, we
may be adversely affected because of its unwillingness to enter into transactions that violate any such laws or regulations.
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Future economic recessions or downturns could impair our portfolio companies and harm our
operating results.
Many of our portfolio companies may be susceptible to economic slowdowns or recessions and may be
unable to repay our debt investments during these periods. Therefore, our non-performing assets are likely to increase, and the value of our portfolio is likely to decrease during these periods. Adverse
economic conditions may also decrease the value of any collateral securing our debt investments. A prolonged recession may further decrease the value of such collateral and result in losses of value in our portfolio and a decrease in our revenues,
net income and net asset value. Unfavorable economic conditions also could increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us on terms we deem acceptable. These events
could prevent us from increasing investments and harm our operating results. Economic downturns or recessions may also result in a portfolio companys failure to satisfy financial or operating covenants imposed by us or other lenders, which
could lead to defaults and, potentially, acceleration of the time when the loans are due and foreclosure on its assets representing collateral for its obligations, which could trigger cross defaults under other agreements and jeopardize our
portfolio companys ability to meet its obligations under the debt that we hold and the value of any equity securities we own. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms with a
defaulting portfolio company.
A prolonged continuation of depressed oil and natural gas prices could negatively impact the energy and
power industry and energy-related investments within our investment portfolio.
Prices for oil and natural gas, which
historically have been volatile and may continue to be volatile, may be subject to large fluctuations in response to relatively minor changes in the supply of and demand for oil and natural gas. A prolonged continuation of depressed oil and natural
gas prices would adversely affect the credit quality and performance of certain of our debt and equity investments in energy and power and related companies. A decrease in credit quality and performance would, in turn, negatively affect the fair
value of these investments, which would consequently negatively affect our net asset value. Should a prolonged period of depressed oil and natural gas prices occur, the ability of certain of our portfolio companies in the energy and power and
related industries to satisfy financial or operating covenants imposed by us or other lenders may be adversely affected, which could, in turn, negatively impact their financial condition and their ability to satisfy their debt service and other
obligations. Likewise, should a prolonged period of depressed oil and natural gas prices occur, it is possible that the cash flow and profit generating capacity of these portfolio companies could also be adversely affected thereby negatively
impacting their ability to pay us dividends or distributions on our investments.
Item 1B.
Unresolved Staff Comments.
None.
Item 2.
Properties.
We do not own any real estate or other physical properties materially important to our operation. Our headquarters are located at 201 Rouse Boulevard, Philadelphia, Pennsylvania, 19112. We believe that
our office facilities are suitable and adequate for our business as it is presently conducted.
Item 3.
Legal Proceedings.
We are not currently subject to any material legal proceedings, nor, to our knowledge, is any material legal proceeding threatened against us. From time to time, we may be party to certain legal
proceedings in the ordinary course of business, including proceedings relating to the enforcement of our rights under contracts with our portfolio companies. While the outcome of any legal proceedings cannot be predicted with certainty, we do not
expect that these proceedings will have a material adverse effect upon our financial condition or results of operations.
Item 4.
Mine Safety Disclosures.
Not applicable.
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PART II
Many of the amounts and percentages presented in Part II have been rounded for convenience of presentation, and all dollar amounts, excluding share and per share amounts, are presented in millions unless
otherwise noted.
Item 5.
Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
Our common stock has been listed on the NYSE since April 16, 2014. Our common stock traded under the ticker symbol FSIC until December 19, 2018 and has traded under the ticker symbol
FSK since December 20, 2018. Prior to April 16, 2014, there was no public market for our common stock. Our shares of common stock have historically traded at prices both above and below our net asset value per share. It is not
possible to predict whether shares of our common stock will trade at, above or below our net asset value in the future. See Risk FactorsRisks Related to an Investment in Our Common StockOur shares of common stock may trade at a
discount to net asset value.
As of February 22, 2021, we had 3,610 record holders of our common stock which does not
include beneficial owners of shares of common stock held in street name by brokers and other institutions on behalf of stockholders.
Distributions
Subject to
applicable legal restrictions and the sole discretion of our board of directors, we intend to declare and pay regular cash distributions on a quarterly basis. From time to time, we may also pay special interim distributions in the form of cash or
shares of our common stock at the discretion of our board of directors. The timing and amount of any future distributions to stockholders are subject to applicable legal restrictions and the sole discretion of our board of directors.
The following table reflects the cash distributions per share that we have declared on our common stock during the years ended
December 31, 2020, 2019 and 2018:
Distribution
For the Year Ended December 31,
Per
Share (1)
Amount
2018 (2)
$
3.40000
$
205
2019
$
3.04000
$
393
2020
$
2.56000
$
318
(1)
The amount of each per share distribution has been retroactively adjusted to reflect the Reverse Stock Split as discussed in Note 3 to our
consolidated financial statements.
(2)
Includes a $0.36 per share special cash distribution that was paid on December 3, 2018.
See Item 7. Managements Discussion and Analysis of Financial Condition and Results of OperationsRIC Status and
Distributions and Note 5 to our consolidated financial statements contained in this annual report on Form 10-K for additional information regarding our distributions and our distribution reinvestment
plan.
Stock Repurchase Programs
February 2018 Share Repurchase Program
In February 2018, our board of
directors authorized a stock repurchase program. Under the program, we were permitted to repurchase up to $50 in the aggregate of our outstanding common stock in the open market at prices below the then current net asset value per share. During the
year ended December 31, 2018, we repurchased 1,642,837 shares of common stock pursuant to the share repurchase program at an average price per share (inclusive of commissions paid) of $30.44 (totaling $50). The program has terminated since the
aggregate repurchase amount that was approved by our board of directors has been expended.
December 2018 Share Repurchase Program
In December 2018, our board of directors authorized a stock repurchase program. Under the program, we are permitted to
repurchase up to $200 in the aggregate of our outstanding common stock in the open market at prices below the then current net asset value per share.
During the year ended December 31, 2020, the Company repurchased 2,823,750 shares of common stock pursuant to the share repurchase program at an average price per share (inclusive of commissions
paid) of $16.71 (totaling $47). During the year ended
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December 31, 2019, the Company repurchased 6,287,919 shares of common stock pursuant to the share repurchase program at an average price per share (inclusive of commissions paid) of $24.30
(totaling $153). The program has concluded since the aggregate repurchase amount that was approved by the Companys board of directors has been expended.
The number of shares repurchased and the average price per share amounts have been retroactively adjusted to reflect the Reverse Stock Split as discussed below.
As previously disclosed, certain affiliates of the owners of the Advisor committed $100 to a $350 investment vehicle that may invest from
time to time in shares of the Company. In June 2020, that investment vehicle entered into a written trading plan with a third party broker in accordance with Rule 10b5-1 and Rule
10b-18 promulgated under the Exchange Act, or the Affiliated Purchaser Program, to facilitate the purchase of shares of our common stock pursuant to the terms and conditions of such plan. The Affiliated
Purchaser Program provides for the purchase of up to $100 worth of shares of our common stock, subject to the limitations provided therein.
During the year ended December 31, 2020, the Affiliated Purchaser Program purchased 3,921,610 shares of common stock at an average price per share (inclusive of commissions paid) of $15.51 (totaling
$61).
The table below provides information concerning purchases of our shares of common stock by or on behalf of the Company
or any affiliated purchaser, as defined by Rule 10b-18(a)(3) promulgated under the Exchange Act during the quarterly period ended December 31, 2020. Dollar amounts in the table below and the
related notes are presented in millions, except for share and per share amounts. Share and per share amounts in the table below have been retroactively adjusted to reflect the Reverse Stock Split.
Period
Total Number
of Shares
Purchased
Average Price
Paid per
Share (1)
Total Number of
Shares Purchased as
Part of Publicly
Announced
Plans or
Programs (2)
Maximum Number
(or Approximate
Dollar Value) of
Shares that May
Yet
Be Purchased Under
the Plans or
Programs
October 1, 2020 through October 31, 2020
632,082
15.61
632,082
199
November 1, 2020 through November 30, 2020
423,393
16.01
423,393
193
December 1, 2020 through December 31, 2020
181,610
18.58
181,610
181
1,237,085
16.18
1,237,085
(1)
Amount includes commissions paid.
(2)
Includes amounts pursuant to the Affiliated Purchaser Program.
Stock Performance Graph
This performance graph shall not be deemed
soliciting material or to be filed with the SEC for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any
filing of FS KKR Capital Corp. under the Securities Act.
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The following graph shows a comparison from April 16, 2014
(the date our shares of common stock commenced trading on the NYSE) through December 31, 2020 of the cumulative total return for our common stock, the S&P 500 Index, the Russell 2000 Financial Services Index and the Wells Fargo ® BDC Index. The graph assumes that $100 was invested at the market close on April 16, 2014 in our common stock,
the S&P 500 Index, the Russell 2000 Financial Services Index and the Wells Fargo ® BDC Index, is based on
historical stock prices and assumes all dividends or distributions are reinvested on the respective dividend or distribution payment dates without commissions. The stock price performance reflected by the following graph is not necessarily
indicative of future stock price performance.
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Item 6.
Selected Financial Data.
The following selected consolidated financial data for the years ended December 31, 2020, 2019, 2018, 2017 and 2016 is derived from our consolidated financial statements. Our consolidated financial
statements for the years ended December 31, 2020 and 2019 were audited by Deloitte & Touche LLP, our independent registered public accounting firm, while our consolidated financial statements for the years ended December 31, 2018,
2017, and 2016 were audited by RSM US LLP, our former independent registered public accounting firm. The data should be read in conjunction with our consolidated financial statements and related notes thereto and Item 7. Managements
Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this annual report on Form 10-K.
Year Ended December 31,
2020
2019
2018
2017
2016
Statements of operations data:
Investment income
$
639
$
779
$
394
$
419
$
423
Operating expenses
Total expenses and excise taxes
308
369
192
218
216
Less: Management fee waiver
(3
)
(3
)
Net expenses and excise taxes
308
369
189
215
216
Net investment income (loss)
331
410
205
204
207
Total net realized and unrealized gain (loss)
(736
)
(164
)
364
(22
)
87
Net increase (decrease) in net assets resulting from operations
$
(405
)
$
246
$
569
$
182
$
294
Per share data: (1)
Net investment income (loss)basic and diluted
$
2.66
$
3.16
$
3.28
$
3.32
$
3.40
Net increase (decrease) in net assets resulting from operationsbasic and diluted
$
(3.26
)
$
1.90
$
9.05
$
2.96
$
4.84
Distributions declared (2)
$
2.56
$
3.04
$
3.40
$
3.44
$
3.56
Balance sheet data:
Total assets
$
7,237
$
8,216
$
7,705
$
4,104
$
4,110
Credit facilities, notes, secured borrowing and repurchase agreement payable
$
3,997
$
4,173
$
3,391
$
1,712
$
1,694
Total net assets
$
3,096
$
3,866
$
4,166
$
2,285
$
2,297
Other data:
Total return based on net asset value (3)
(9.69
)%
7.14
%
(6.56
)%
7.97
%
13.19
%
Total return based on market value (4)
(19.73
)%
33.80
%
(20.15
)%
(21.39
)%
25.91
%
Number of portfolio company investments at period end
164
210
204
100
102
Total portfolio investments for the period (5)
$
2,336
$
2,907
$
5,189
$
1,284
$
1,158
Proceeds from sales and prepayments of investments
$
2,301
$
2,854
$
1,187
$
1,135
$
1,588
(1)
The per share data was derived by using the weighted average shares outstanding during the applicable period. The share information utilized
to determine per share data has been retroactively adjusted to reflect the Reverse Stock Split.
(2)
The per share data for distributions reflect the actual amount of distributions paid per share during the applicable period.
(3)
The total return based on net asset value for each year presented was calculated by taking the net asset value per share as of the end of the
applicable year, adding the cash distributions per share that were declared during the applicable calendar year and dividing the total by the net asset value per share at the beginning of the applicable year. Total return based on net asset value
does not consider the effect of any sales commissions or charges that may be incurred in connection with the sale of shares of our common stock. The historical calculation of total return based on net asset value in the table should not be
considered a representation of our future total return based on net asset value, which may be greater or less than the return shown in the table due to a number of factors, including our ability or inability to make investments in companies that
meet our investment criteria, the interest rates payable on the debt securities we acquire, the level of our expenses, variations in and the timing of the recognition of realized and unrealized gains or losses, the degree to which we encounter
competition in our markets and general economic conditions. As a result of these factors, results for any previous period should not be
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relied upon as being indicative of performance in future periods. The total return calculations set forth above represent the total return on our investment portfolio during the applicable period
and do not represent an actual return to stockholders.
(4)
The total return based on market value for each period presented was calculated based on the change in market price during the applicable
period, including the impact of distributions reinvested in accordance with the Companys distribution reinvestment plan. Total return based on market value does not consider the effect of any sales commissions or charges that may be incurred
in connection with the sale of shares of our common stock. The historical calculation of total return based on market value in the table should not be considered a representation of our future total return based on market value, which may be greater
or less than the return shown in the table due to a number of factors, including our ability or inability to make investments in companies that meet its investment criteria, the interest rates payable on the debt securities we acquire, the level of
our expenses, variations in and the timing of the recognition of realized and unrealized gains or losses, the degree to which we encounter competition in our markets, general economic conditions and fluctuations in per share market value. As a
result of these factors, results for any previous period should not be relied upon as being indicative of performance in future periods.
(5)
Total portfolio investments for the year ended December 31, 2018 include investments acquired at fair value of $4,168 in connection with
the 2018 Merger.
Item 7.
Managements Discussion and Analysis of Financial Condition and Results of Operations.
The information contained in this section should be read in conjunction with our consolidated financial statements and related notes
thereto appearing elsewhere in this annual report on Form 10-K.
Forward-Looking Statements
Some of the statements in this annual report on Form 10-K constitute
forward-looking statements because they relate to future events or our future performance or financial condition. The forward-looking statements contained in this annual report on Form 10-K may include
statements as to:
our future operating results;
our business prospects and the prospects of the companies in which we may invest, including our and their ability to achieve our respective objectives
as a result of the current COVID-19 pandemic;
the impact of the investments that we expect to make;
the ability of our portfolio companies to achieve their objectives;
our current and expected financings and investments;
receiving and maintaining corporate credit ratings and changes in the general interest rate environment;
the adequacy of our cash resources, financing sources and working capital;
the timing and amount of cash flows, distributions and dividends, if any, from our portfolio companies;
our contractual arrangements and relationships with third parties;
actual and potential conflicts of interest with the other funds in the Fund Complex, their respective current or future investment advisers or any of
their affiliates;
the dependence of our future success on the general economy and its effect on the industries in which we may invest;
general economic and political trends and other external factors, including the current COVID-19 pandemic and
related disruptions caused thereby;
our use of financial leverage;
the ability of the Advisor to locate suitable investments for us and to monitor and administer our investments;
the ability of the Advisor or its affiliates to attract and retain highly talented professionals;
our ability to maintain our qualification as a RIC and as a BDC;
the impact on our business of the Dodd-Frank Act, and the rules and regulations issued thereunder;
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the effect of changes to tax legislation on us and the portfolio companies in which we may invest and our and their tax position;
the tax status of the enterprises in which we may invest; and
the 2021 Merger, the likelihood the 2021 Merger is completed and the anticipated timing of their completion.
In addition, words such as anticipate, believe, expect and intend indicate a
forward-looking statement, although not all forward-looking statements include these words. The forward-looking statements contained in this annual report on Form 10-K involve risks and uncertainties. Our
actual results could differ materially from those implied or expressed in the forward-looking statements for any reason, including those factors set forth in Item 1A. Risk Factors. Factors that could cause actual results to differ
materially include:
changes in the economy;
risks associated with possible disruption in our operations or the economy generally due to terrorism, natural disasters or
pandemics;
future changes in laws or regulations and conditions in our operating areas; and
the price at which shares of our common stock may trade on the NYSE.
We have based the forward-looking statements included in this annual report on Form 10-K on
information available to us on the date of this annual report on Form 10-K. Except as required by the federal securities laws, we undertake no obligation to revise or update any forward-looking statements,
whether as a result of new information, future events or otherwise. Stockholders are advised to consult any additional disclosures that we may make directly to stockholders or through reports that we may file in the future with the SEC, including
annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K. The forward-looking
statements and projections contained in this annual report on Form 10-K are excluded from the safe harbor protection provided by Section 27A of the Securities Act of 1933, as amended, or the Securities
Act, and Section 21E of the Exchange Act.
Overview
We were incorporated under the general corporation laws of the State of Maryland on December 21, 2007 and formally commenced investment operations on January 2, 2009. We are an externally
managed, non-diversified, closed-end management investment company that has elected to be regulated as a BDC under the 1940 Act and has elected to be treated for U.S.
federal income tax purposes, and intends to qualify annually, as a RIC under Subchapter M of the Code.
We are externally
managed by the Advisor pursuant to the investment advisory agreement and supervised by our board of directors, a majority of whom are independent. On April 9, 2018, GSO / Blackstone Debt Funds Management LLC, or GDFM, resigned as our investment
sub-adviser and terminated its investment sub-advisory agreement effective April 9, 2018. In connection with GDFMs resignation as our investment sub-adviser on April 9, 2018, we entered into an investment advisory agreement, dated as of April 9, 2018, with the Advisor, or the prior investment advisory agreement, which replaced an investment
advisory agreement with our former investment adviser, FB Income Advisor, LLC, or FB Income Advisor. Following the consummation of the 2018 Merger, we entered into the investment advisory agreement with the Advisor, which replaced the prior
investment advisory agreement.
Our investment objectives are to generate current income and, to a lesser extent, long-term
capital appreciation. We seek to meet our investment objectives by:
utilizing the experience and expertise of the management team of the Advisor;
employing a defensive investment approach focused on long-term credit performance and principal protection;
focusing primarily on debt investments in a broad array of private U.S. companies, including middle-market companies, which we define as companies with
annual EBITDA of $25 million to $100 million at the time of investment;
investing primarily in established, stable enterprises with positive cash flows; and
maintaining rigorous portfolio monitoring in an attempt to anticipate and pre-empt negative credit events
within our portfolio, such as an event of insolvency, liquidation, dissolution, reorganization or bankruptcy of a portfolio company.
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We pursue our investment objective by investing primarily in the debt of middle market
U.S. companies with a focus on originated transactions sourced through the network of the Advisor and its affiliates. We define direct originations as any investment where the Companys investment adviser,
sub-advsier or their affiliates had negotiated the terms of the transaction beyond just the price, which, for example, may include negotiating financial covenants, maturity dates or interest rate terms. These
directly originated transactions include participation in other originated transactions where there may be third parties involved, or a bank acting as an intermediary, for a closely held club, or similar transactions. These direct originations
include investments originated by FB Income Advisor, GDFM or their affiliates.
Our portfolio is comprised primarily of
investments in senior secured loans and second lien secured loans of private middle market U.S. companies and, to a lesser extent, subordinated loans and certain asset-based financing loans of private U.S. companies. Although we do not expect a
significant portion of our portfolio to be comprised of subordinated loans, there is no limit on the amount of such loans in which we may invest. We may purchase interests in loans or make other debt investments, including investments in senior
secured bonds, through secondary market transactions in the OTC market or directly from our target companies as primary market or directly originated investments. In connection with our debt investments, we may on occasion receive equity interests
such as warrants or options as additional consideration. We may also purchase or otherwise acquire interests in the form of common or preferred equity or equity-related securities, such as rights and warrants that may be converted into or exchanged
for common stock or other equity or the cash value of common stock or other equity, including through a co-investment with a financial sponsor or possibly the restructuring of an investment. In addition, a
portion of our portfolio may be comprised of corporate bonds, structured products, other debt securities and derivatives, including total return swaps and credit default swaps. The Advisor will seek to tailor our investment focus as market
conditions evolve. Depending on market conditions, we may increase or decrease our exposure to less senior portions of the capital structures of our portfolio companies or otherwise make opportunistic investments, such as where the market price of
loans, bonds or other securities reflects a lower value than deemed warranted by the Advisors fundamental analysis. Such investment opportunities may occur due to general dislocations in the markets, a misunderstanding by the market of a
particular company or an industry being out of favor with the broader investment community and may include event driven investments, anchor orders and structured products.
The senior secured loans, second lien secured loans and senior secured bonds in which we invest generally have stated terms of three to seven years and subordinated debt investments that we make generally
have stated terms of up to ten years, but the expected average life of such securities is generally three to four years. However, we may invest in loans and securities with any maturity or duration. Our debt investments may be rated by a NRSRO and,
in such case, generally will carry a rating below investment grade (rated lower than Baa3 by Moodys or lower than BBB- by S&P). We may invest without limit in debt or other
securities of any rating, as well as debt or other securities that have not been rated by a NRSRO.
Corporate Capital Trust, Inc.
Acquisition
On December 19, 2018, we completed the 2018 Merger. Pursuant to the 2018 Merger Agreement, CCT was first
merged with and into Merger Sub, with CCT as the surviving corporation, and, immediately following such merger, CCT was then merged with and into the Company, with the Company as the surviving company. In accordance with the terms of the 2018 Merger
Agreement, at the time of the transactions contemplated by the 2018 Merger Agreement, each outstanding share of CCT common stock was converted into the right to receive 2.3552 shares of our common stock. As a result, we issued an aggregate of
approximately 292,324,670 shares of our common stock to former CCT stockholders. Following the consummation of the 2018 Merger, we entered into the investment advisory agreement, which replaced the prior investment advisory agreement. Share and
exchange ratio amounts in the foregoing do not reflect the Reverse Stock Split.
Pending Merger with FSKR
On November 23, 2020, we entered into an Agreement and Plan of Merger, or the 2020 Merger Agreement with FS KKR Capital Corp II., a
Maryland corporation, or FSKR, and together with FSK, the Funds, Rocky Merger Sub, Inc., a Maryland corporation and wholly-owned subsidiary of FSK, or Merger Sub and the Advisor.
The 2020 Merger Agreement provides that, subject to the conditions set forth in the 2020 Merger Agreement, Merger Sub will merge with and
into FSKR, with FSKR continuing as the surviving company and as a wholly-owned subsidiary of FSK, or the First Merger, and, immediately thereafter, FSKR will merge with and into the Company, with the Company continuing as the surviving company, or
together with the First Merger, the 2021 Merger. The board of directors of each Fund has approved the 2021 Merger, with the participation throughout by, and the unanimous support of, its respective independent directors. The parties to the 2020
Merger Agreement intend the 2021 Merger to be treated as a reorganization within the meaning of Section 368(a) of the Internal Revenue Code of 1986, as amended.
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In the 2021 Merger, each share of FSKRs common stock issued and outstanding
immediately prior to the effective time of the First Merger will be converted into a number of shares of the Companys common stock equal to an exchange ratio to be determined in connection with the closing of the 2021 Merger, or the Exchange
Ratio. The Exchange Ratio will equal the net asset value per share of FSKRs common stock, respectively (determined no earlier than 48 hours (excluding Sundays and holidays) prior to the closing date of the 2021 Merger), divided by the net
asset value per share of the Companys common stock (determined, in each case, no earlier than 48 hours (excluding Sundays and holidays) prior to the closing date of the 2021 Merger). Holders of the FSKRs common stock may receive
fractional shares or cash in lieu of fractional shares, at the election of the Company.
The 2020 Merger Agreement contains
representations, warranties and covenants, including, among others, covenants relating to the operation of each of the Funds and the Advisors businesses during the period prior to the closing of the 2021 Merger. The Funds have agreed to
convene and hold meetings of their respective stockholders for the purpose of obtaining the required approvals of the Funds stockholders, respectively, and have agreed to recommend that their stockholders approve their respective proposals.
The 2020 Merger Agreement provides that the board of directors of each Fund may not solicit proposals relating to alternative
transactions, or, subject to certain exceptions, enter into discussions or negotiations or provide information in connection with any proposal for an alternative transaction. However, each of the Funds may, subject to certain conditions, change its
recommendation to their respective stockholders, terminate the 2020 Merger Agreement and enter into an agreement with respect to a superior alternative proposal if the board of directors of such Fund determines in its reasonable good faith judgment,
after consultation with its outside legal counsel, that the failure to take such action would be reasonably likely to breach its standard of conduct under applicable law (taking into account any changes to the 2020 Merger Agreement proposed by the
other Fund).
Consummation of the 2021 Merger, which is currently anticipated to occur during the second or third quarter of
2021, is subject to certain closing conditions, including (1) requisite approvals of the Funds stockholders, (2) the absence of certain legal impediments to the consummation of the 2021 Merger, (3) effectiveness of the
registration statement on Form N-14, which includes a joint proxy statement of the Funds and a prospectus of the Company, or the Proxy Statement, (4) subject to certain exceptions, the accuracy of the
representations and warranties and compliance with the covenants of each party to the 2020 Merger Agreement and (5) required regulatory approvals (including expiration of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act
of 1976, as amended).
The 2020 Merger Agreement also contains certain termination rights in favor of each Fund including if
the 2021 Merger is not completed on or before November 23, 2021 or if the requisite approvals of the applicable Funds stockholders are not obtained. The 2020 Merger Agreement also provides that, upon the termination of the 2020 Merger
Agreement under certain circumstances, a third party may be required to pay FSKR a termination fee of approximately $90.8, or a third party may be required to pay FSK a termination fee of approximately $126.2.
In connection with the 2021 Merger, the Company is seeking stockholder approval to amend the Companys investment advisory agreement
to (a) reduce FSKs income incentive fee rate from 20% to 17.5% and (b) remove the total return lookback provision applicable to the subordinated incentive fee on income. The Advisor has also agreed to waive income incentive fees in
the amount of $15 per quarter for the first six full fiscal quarters of operations following the 2021 Merger for a total waiver of $90.
Revenues
The principal
measure of our financial performance is net increase in net assets resulting from operations, which includes net investment income, net realized gain or loss on investments, net realized gain or loss on foreign currency, net unrealized appreciation
or depreciation on investments and net unrealized gain or loss on foreign currency. Net investment income is the difference between our income from interest, dividends, fees and other investment income and our operating and other expenses. Net
realized gain or loss on investments is the difference between the proceeds received from dispositions of portfolio investments and their amortized cost, including the respective realized gain or loss on foreign currency for those foreign
denominated investment transactions. Net realized gain or loss on foreign currency is the portion of realized gain or loss attributable to foreign currency fluctuations. Net unrealized appreciation or depreciation on investments is the net change in
the fair value of our investment portfolio, including the respective unrealized gain or loss on foreign currency for those foreign denominated investments. Net unrealized gain or loss on foreign currency is the net change in the value of receivables
or accruals due to the impact of foreign currency fluctuations.
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We principally generate revenues in the form of interest income on the debt investments
we hold. In addition, we generate revenues in the form of non-recurring commitment, closing, origination, structuring or diligence fees, monitoring fees, fees for providing managerial assistance, consulting
fees, prepayment fees and performance-based fees. We may also generate revenues in the form of dividends and other distributions on the equity or other securities we hold.
Expenses
Our primary operating expenses include the payment of management
and incentive fees and other expenses under the investment advisory agreement and the administration agreement, interest expense from financing arrangements and other indebtedness, and other expenses necessary for our operations. The management and
incentive fees compensate the Advisor for its work in identifying, evaluating, negotiating, executing, monitoring and servicing our investments.
The Advisor oversees our day-to-day operations, including the provision of general ledger accounting, fund accounting, legal
services, investor relations, certain government and regulatory affairs activities, and other administrative services. The Advisor also performs, or oversees the performance of, our corporate operations and required administrative services, which
includes being responsible for the financial records that we are required to maintain and preparing reports for our stockholders and reports filed with the SEC. In addition, the Advisor assists us in calculating our net asset value, overseeing the
preparation and filing of tax returns and the printing and dissemination of reports to our stockholders, and generally overseeing the payment of our expenses and the performance of administrative and professional services rendered to us by others.
Pursuant to the administration agreement, we reimburse the Advisor for expenses necessary to perform services related to our
administration and operations, including the Advisors allocable portion of the compensation and related expenses of certain personnel of FS Investments and KKR Credit providing administrative services to us on behalf of the Advisor. We
reimburse the Advisor no less than quarterly for all costs and expenses incurred by the Advisor in performing its obligations and providing personnel and facilities under the administration agreement. The Advisor allocates the cost of such services
to us based on factors such as total assets, revenues, time allocations and/or other reasonable metrics. Our board of directors reviews the methodology employed in determining how the expenses are allocated to us and the proposed allocation of
administrative expenses among us and certain affiliates of the Advisor. Our board of directors then assesses the reasonableness of such reimbursements for expenses allocated to us based on the breadth, depth and quality of such services as compared
to the estimated cost to us of obtaining similar services from third-party service providers known to be available. In addition, our board of directors considers whether any single third-party service provider would be capable of providing all such
services at comparable cost and quality. Finally, our board of directors compares the total amount paid to the Advisor for such services as a percentage of our net assets to the same ratio as reported by other comparable BDCs.
We bear all other expenses of our operations and transactions, including (without limitation) fees and expenses relating to:
corporate and organization expenses relating to offerings of our securities, subject to limitations included in the investment advisory agreement;
the cost of calculating our net asset value, including the cost of any third-party pricing or valuation services;
the cost of effecting sales and repurchases of shares of our common stock and other securities;
investment advisory fees;
fees payable to third parties relating to, or associated with, making investments and valuing investments, including fees and expenses associated with
performing due diligence reviews of prospective investments;
interest payments on our debt or related obligations;
transfer agent and custodial fees;
research and market data (including news and quotation equipment and services, and any computer hardware and connectivity hardware (e.g., telephone and
fiber optic lines) incorporated into the cost of obtaining such research and market data);
fees and expenses associated with marketing efforts;
federal and state registration fees;
federal, state and local taxes;
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Table of Contents
fees and expenses of directors not also serving in an executive officer capacity for us or the Advisor;
costs of proxy statements, stockholders reports, notices and other filings;
fidelity bond, directors and officers/errors and omissions liability insurance and other insurance premiums;
direct costs such as printing, mailing, long distance telephone and staff;
fees and expenses associated with accounting, corporate governance, government and regulatory affairs activities, independent audits and outside legal
costs;
costs associated with our reporting and compliance obligations under the 1940 Act and applicable federal and state securities laws, including
compliance with the Sarbanes-Oxley Act;
brokerage commissions for our investments; and
all other expenses incurred by the Advisor or us in connection with administering our business, including expenses incurred by the Advisor in
performing administrative services for us and administrative personnel paid by the Advisor, to the extent they are not controlling persons of the Advisor or any of its affiliates, subject to the limitations included in the investment advisory
agreement and the administration agreement.
In addition, we have contracted with State Street Bank and Trust
Company to provide various accounting and administrative services, including, but not limited to, preparing preliminary financial information for review by the Advisor, preparing and monitoring expense budgets, maintaining accounting and corporate
books and records, processing trade information provided by us and performing testing with respect to RIC compliance.
COVID-19 Developments
The rapid spread of the
COVID-19 pandemic, and associated impacts on the U.S. and global economies, has negatively impacted, and is likely to continue to negatively impact, the business operations of some of our portfolio companies.
We cannot at this time fully predict the continued impact of COVID-19 on our business or the business of our portfolio companies, its duration or magnitude or the extent to which it will negatively impact our
portfolio companies operating results or our own results of operations or financial condition. We expect that certain of our portfolio companies will continue to experience economic distress for the foreseeable future and may significantly
limit business operations if subjected to prolonged economic distress. These developments could result in a decrease in the value of our investments.
COVID-19 has already had adverse effects on our investment income and we expect that such adverse effects will continue for some time. These adverse effects may
require us to restructure certain of our investments, which could result in further reductions to our investment income or in impairments on our investments. In addition, disruptions in the capital markets have resulted in illiquidity in certain
market areas. These market disruptions and illiquidity are likely to have an adverse effect on our business, financial condition, results of operations and cash flows. Unfavorable economic conditions caused by
COVID-19 can also be expected to increase our funding costs and limit our access to the capital markets. These events have limited our investment originations, which is likely to continue for the immediate
future, and have also had a material negative impact on our operating results.
We will continue to carefully monitor the
impact of the COVID-19 pandemic on our business and the business of our portfolio companies. Because the full effects of the COVID-19 pandemic are not capable of being
known at this time, we cannot estimate the impacts of COVID-19 on our future financial condition, results of operations or cash flows. We do, however, expect that it will continue to have a negative impact on
our business and the financial condition of certain of our portfolio companies.
Portfolio Investment Activity for the Years Ended
December 31, 2020 and 2019
Total Portfolio Activity
The following tables present certain selected information regarding our portfolio investment activity for the years ended December 31, 2020 and 2019:
For the Year Ended
Net Investment Activity
December 31,
2020
December 31,
2019
Purchases (1)
$
2,336
$
2,907
Sales and Repayments
(2,301
)
(2,854
)
Net Portfolio Activity
$
35
$
53
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For the Year Ended
December 31, 2020
December 31, 2019
New Investment Activity by Asset Class
Purchases
Percentage
Purchases
Percentage
Senior Secured LoansFirst Lien
$
1,464
62.7
%
$
1,872
64.4
%
Senior Secured LoansSecond Lien
99
4.2
%
326
11.2
%
Other Senior Secured Debt
3
0.1
%
34
1.2
%
Subordinated Debt
25
1.1
%
75
2.6
%
Asset Based Finance
426
18.2
%
361
12.4
%
Strategic Credit Opportunities Partners, LLC
319
13.7
%
197
6.8
%
Equity/Other
42
1.4
%
Total
$
2,336
100.0
%
$
2,907
100.0
%
The following table summarizes the composition of our investment portfolio at cost and fair value as of
December 31, 2020 and 2019:
December 31, 2020
December 31, 2019
Amortized
Cost (1)
Fair
Value
Percentage
of Portfolio
Amortized
Cost (1)
Fair
Value
Percentage
of Portfolio
Senior Secured LoansFirst Lien
$
3,597
$
3,449
50.9
%
$
3,868
$
3,724
50.6
%
Senior Secured LoansSecond Lien
1,035
880
13.0
%
1,273
1,196
16.3
%
Other Senior Secured Debt
127
86
1.3
%
299
239
3.2
%
Subordinated Debt
243
171
2.5
%
479
409
5.6
%
Asset Based Finance
1,025
951
14.0
%
761
737
10.0
%
Strategic Credit Opportunities Partners, LLC
810
713
10.5
%
491
479
6.5
%
Equity/Other
616
530
7.8
%
638
573
7.8
%
Total
$
7,453
$
6,780
100.0
%
$
7,809
$
7,357
100.0
%
(1)
Amortized costs represent the original cost adjusted for the amortization of premiums and/or accretion of discounts, as applicable, on
investments.
The following table presents certain selected information regarding the composition of our
investment portfolio as of December 31, 2020 and 2019:
December 31, 2020
December 31, 2019
Number of Portfolio Companies
164
210
% Variable Rate Debt Investments (based on fair value) (1)(2)
63.5
%
64.8
%
% Fixed Rate Debt Investments (based on fair value) (1)(2)
9.0
%
14.6
%
% Other Income Producing Investments (based on fair value) (3)
16.9
%
11.2
%
% Non-Income Producing Investments (based on fair value) (2)
8.1
%
6.6
%
% of Investments on Non-Accrual (based on fair value)
2.5
%
2.8
%
Weighted Average Annual Yield on Accruing Debt Investments (2)(4)
8.8
%
9.7
%
Weighted Average Annual Yield on All Debt Investments (5)
7.9
%
8.8
%
(1)
Debt Investments means investments that pay or are expected to pay a stated interest rate, stated dividend rate or other similar
stated return.
(2)
Does not include investments on non-accrual status.
(3)
Other Income Producing Investments means investments that pay or are expected to pay interest, dividends or other income to the
Company on an ongoing basis but do not have a stated interest rate, stated dividend rate or other similar stated return.
(4)
The Weighted Average Annual Yield on Accruing Debt Investments is computed as (i) the sum of (a) the stated annual interest rate,
dividend rate or other similar stated return of each accruing Debt Investment, multiplied by its par amount, adjusted to U.S. dollars and for any partial income accrual when necessary, as of the end of the applicable reporting period, plus
(b) the annual amortization of the purchase or original issue discount or premium of each accruing Debt Investment; divided by (ii) the total amortized cost of Debt Investments included in the calculated group as of the end of the
applicable reporting period.
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(5)
The Weighted Average Annual Yield on All Debt Investments is computed as (i) the sum of (a) the stated annual interest rate,
dividend rate or other similar stated return of each Debt Investment, multiplied by its par amount, adjusted to U.S. dollars and for any partial income accrual when necessary, as of the end of the applicable reporting period, plus (b) the
annual amortization of the purchase or original issue discount or premium of each Debt Investment; divided by (ii) the total amortized cost of Debt Investments included in the calculated group as of the end of the applicable reporting period.
For the year ended December 31, 2020, our total return based on net asset value was (9.69)% and our
total return based on market value was (19.73)%. For the year ended December 31, 2019, our total return based on net asset value was 7.14% and our total return based on market value was 33.80%. See footnotes 7 and 8 to the table included in
Note 12 to our audited consolidated financial statements included herein for information regarding the calculation of our total return based on net asset value and total return based on market value, respectively.
Direct Originations
We
define Direct Originations as any investment where the Advisor or its affiliates negotiates the terms of the transaction beyond just the price, which, for example, may include negotiating financial covenants, maturity dates or interest rate terms.
These Direct Originations include participation in other originated transactions where there may be third parties involved, or a bank acting as an intermediary, for a closely held club, or similar transactions. The following table presents certain
selected information regarding our Direct Originations as of December 31, 2020 and 2019:
Characteristics of All Direct Originations held in Portfolio
December 31, 2020
December 31, 2019
Number of Portfolio Companies
135
133
% of Investments on Non-Accrual
2.6
%
3.1
%
Total Cost of Direct Originations
$
7,048.4
$
6,923.9
Total Fair Value of Direct Originations
$
6,447.3
$
6,491.5
% of Total Investments, at Fair Value
95.1
%
88.2
%
Weighted Average Annual Yield on Accruing Debt Investments (1)
8.7
%
9.7
%
Weighted Average Annual Yield on All Debt Investments (2)
7.8
%
8.8
%
(1)
The Weighted Average Annual Yield on Accruing Debt Investments is computed as (i) the sum of (a) the stated annual interest rate,
dividend rate or other similar stated return of each accruing Debt Investment, multiplied by its par amount, adjusted to U.S. dollars and for any partial income accrual when necessary, as of the end of the applicable reporting period, plus
(b) the annual amortization of the purchase or original issue discount or premium of each accruing Debt Investment; divided by (ii) the total amortized cost of Debt Investments included in the calculated group as of the end of the
applicable reporting period. Does not include Debt Investments on non-accrual status.
(2)
The Weighted Average Annual Yield on All Debt Investments is computed as (i) the sum of (a) the stated annual interest rate,
dividend rate or other similar stated return of each Debt Investment, multiplied by its par amount, adjusted to U.S. dollars and for any partial income accrual when necessary, as of the end of the applicable reporting period, plus (b) the
annual amortization of the purchase or original issue discount or premium of each Debt Investment; divided by (ii) the total amortized cost of Debt Investments included in the calculated group as of the end of the applicable reporting period.
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Table of Contents
Portfolio Composition by Industry Classification
The table below describes investments by industry classification and enumerates the percentage, by fair value, of the total portfolio
assets in such industries as of December 31, 2020 and 2019:
December 31, 2020
December 31, 2019
Industry Classification
Fair
Value
Percentage of
Portfolio
Fair
Value
Percentage of
Portfolio
Automobiles & Components
$
104
1.5
%
$
247
3.4
%
Banks
14
0.2
%
15
0.2
%
Capital Goods
799
11.8
%
1,085
14.8
%
Commercial & Professional Services
564
8.3
%
557
7.6
%
Consumer Durables & Apparel
385
5.7
%
363
4.9
%
Consumer Services
145
2.1
%
294
4.0
%
Diversified Financials
467
6.9
%
575
7.8
%
Energy
107
1.6
%
208
2.8
%
Food & Staples Retailing
221
3.3
%
209
2.8
%
Food, Beverage & Tobacco
106
1.6
%
119
1.6
%
Health Care Equipment & Services
604
8.9
%
601
8.2
%
Household & Personal Products
190
2.8
%
120
1.6
%
Insurance
208
3.1
%
217
3.0
%
Materials
147
2.2
%
260
3.5
%
Media & Entertainment
36
0.5
%
94
1.3
%
Pharmaceuticals, Biotechnology & Life Sciences
34
0.5
%
30
0.4
%
Real Estate
555
8.2
%
236
3.2
%
Retailing
344
5.1
%
457
6.2
%
Semiconductors & Semiconductor Equipment
19
0.3
%
Software & Services
770
11.3
%
805
10.9
%
Strategic Credit Opportunities Partners, LLC
713
10.5
%
479
6.5
%
Technology Hardware & Equipment
15
0.2
%
94
1.3
%
Telecommunication Services
71
1.0
%
71
1.0
%
Transportation
181
2.7
%
202
2.7
%
Total
$
6,780
100.0
%
$
7,357
100.0
%
Portfolio Asset Quality
In addition to various risk management and monitoring tools, the Advisor uses an investment rating system to characterize and monitor the expected level of returns on each investment in our portfolio. The
Advisor uses an investment rating scale of 1 to 4. The following is a description of the conditions associated with each investment rating:
Investment
Rating
Summary Description
1
Performing Investmentgenerally executing in accordance with plan and there are no concerns about the portfolio companys performance or ability to meet covenant
requirements.
2
Performing investmentno concern about repayment of both interest and our cost basis but companys recent performance or trends in the industry require closer
monitoring.
3
Underperforming investmentsome loss of interest or dividend possible, but still expecting a positive return on investment.
4
Underperforming investmentconcerns about the recoverability of principal or interest.
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The following table shows the distribution of our investments on the 1 to 4 investment
rating scale at fair value as of December 31, 2020 and 2019:
December 31, 2020
December 31,
2019 (1)
Investment Rating
Fair
Value
Percentage of
Portfolio
Fair
Value
Percentage of
Portfolio
1
$
4,538
67
%
$
4,588
62
%
2
1,537
23
%
2,056
28
%
3
349
5
%
451
6
%
4
356
5
%
262
4
%
Total
$
6,780
100
%
$
7,357
100
%
(1)
Historically, the Adviser has rated its investment in SCJV as a 2 on the investment rating scale. As of December 31, 2020, the Advisor
evaluates its investment in SCJV by rating each individual loan in SCJVs portfolio on a look-through basis. The Advisor has re-evaluated its portfolio as of December 31, 2019 and has updated the
investment rating scale in the table above in order to be in accordance with the current methodology.
The
amount of the portfolio in each grading category may vary substantially from period to period resulting primarily from changes in the composition of the portfolio as a result of new investment, repayment and exit activities. In addition, changes in
the grade of investments may be made to reflect our expectation of performance and changes in investment values.
Results of Operations
Comparison of the Years Ended December 31, 2020, 2019 and 2018
Revenues
Our investment income for the years ended December 31, 2020,
2019 and 2018 was as follows:
Year Ended December 31,
2020
2019
2018
Amount
Percentage of
Total Income
Amount
Percentage of
Total Income
Amount
Percentage of
Total Income
Interest income
$
444
69.5
%
$
610
78.3
%
$
317
80.4
%
Paid-in-kind interest income
66
10.3
%
60
7.7
%
55
14.0
%
Fee income
33
5.2
%
42
5.4
%
13
3.3
%
Dividend income
96
15.0
%
67
8.6
%
9
2.3
Total investment income (1)
$
639
100.0
%
$
779
100.0
%
$
394
100.0
%
(1)
Such revenues represent $563, $705 and $332 of cash income earned as well as $76, $74 and $62 in
non-cash portions relating to accretion of discount and PIK interest for the years ended December 31, 2020, 2019 and 2018, respectively. Cash flows related to such
non-cash revenues may not occur for a number of reporting periods or years after such revenues are recognized.
The level of interest income we receive is generally related to the balance of income-producing investments, multiplied by the weighted average yield of our investments. Fee income is transaction based,
and typically consists of prepayment fees and structuring fees. As such, fee income is generally dependent on new Direct Origination investments and the occurrence of events at existing portfolio companies resulting in such fees.
The decrease in interest income during the year ended December 31, 2020 compared to the year ended December 31, 2019 can
primarily be attributed to the repayment of higher yielding assets replaced by lower yielding assets, the impact of the decline in LIBOR on our floating rate investments and the increase in our investment in Strategic Credit Opportunities Partners,
LLC during the year ended December 31, 2020. A portion of each of these factors was impacted by the current COVID-19 pandemic.
The increase in dividend income during the year ended December 31, 2020 compared to the year ended December 31, 2019 can be primarily attributed to the increase in dividends paid in respect to
our investment in Strategic Credit Opportunities Partners, LLC during the year ended December 31, 2020, compared to the year ended December 31, 2019.
The increase in investment income during the year ended December 31, 2019 compared to the year ended December 31, 2018 can be primarily attributed to the increase in investments as a result of
the 2018 Merger.
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Expenses
Our operating expenses, together with excise taxes, for the years ended December 31, 2020, 2019 and 2018 were as follows:
Year Ended December 31,
2020
2019
2018
Management fees
$
106
$
115
$
63
Subordinated income incentive fees
57
26
Administrative services expenses
7
9
4
Accounting and administrative fees
2
2
1
Interest expense
170
170
84
Other expenses (1)
13
9
7
Total operating expenses
$
298
$
362
$
185
Management fee waiver
(3
)
Net operating expenses before taxes
298
362
182
Excise taxes
10
7
7
Total net expenses, including excise taxes
$
308
$
369
$
189
(1)
Other expenses during the years ended December 31, 2020 and 2018 include $1 and $1, respectively, of breakage fees associated with the
paydown of certain debt facilities during the period.
The following table reflects selected expense ratios
as a percent of average net assets for the years ended December 31, 2020, 2019 and 2018:
Year Ended December 31,
2020
2019
2018
Ratio of operating expenses and excise taxes to average net assets
9.71
%
9.09
%
8.57
%
Ratio of management fee waiver to average net assets
(0.13
)%
Ratio of net operating expenses to average net assets
9.71
%
9.09
%
8.44
%
Ratio of incentive fees, interest expense and excise taxes to average net assets (1)
5.67
%
5.77
%
5.23
%
Ratio of net operating expenses, excluding certain expenses, to average net assets
4.04
%
3.32
%
3.21
%
(1)
Ratio data may be rounded in order to recompute the ending ratio of net operating expenses, excluding certain expenses, to average net assets.
The increase in expense ratios during the year ended December 31, 2020 compared to the year ended
December 31, 2019 can be primarily attributed to mark to market declines across the portfolio resulting in a lower asset base partially offset by the decrease in expenses during the year ended December 31, 2020.
The increase in expenses during the year ended December 31, 2019 compared to the year ended December 31, 2018 can primarily be
attributed to the increased management fee as a result of the higher asset base from the 2018 Merger and increased interest expense resulting from the higher debt outstanding due to the 2018 Merger.
Incentive fees and interest expense, among other things, may increase or decrease our expense ratios relative to comparative periods
depending on portfolio performance and changes in amounts outstanding under our financing arrangements and benchmark interest rates such as LIBOR, among other factors.
Net Investment Income
Our net investment income totaled $331 ($2.66 per
share), $410 ($3.16 per share) and $205 ($3.28 per share) for the years ended December 31, 2020, 2019 and 2018, respectively.
The decrease in net investment income during the year ended December 31, 2020 compared to the year ended December 31, 2019 can primarily be attributed to lower investment income during the year
ended December 31, 2020 as discussed above, partially offset by lower expenses. The increase in net investment income for the year December 31, 2019 compared to December 31, 2018 can be attributed to higher income as discussed
above.
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Net Realized Gains or Losses
Our net realized gains (losses) on investments, financial instruments, secured borrowing and foreign currency for the years ended
December 31, 2020, 2019 and 2018 were as follows:
Year Ended December 31,
2020
2019
2018
Net realized gain (loss) on investments (1)
$
(490
)
$
(81
)
$
(125
)
Net realized gain (loss) on swap contracts
(11
)
0
Net realized gain (loss) on foreign currency forward contracts
12
Net realized gain (loss) on secured borrowing
Net realized gain (loss) on foreign currency
(6
)
2
6
Total net realized gain (loss)
$
(496
)
$
(78
)
$
(119
)
(1)
We sold investments and received principal repayments, respectively, of $1,232 and $1,069 during the year ended December 31, 2020, $1,252
and $1,602 during the year ended December, 31, 2019 and $553 and $634 during the year ended December 31, 2018.
Net
Change in Unrealized Appreciation (Depreciation)
Our net change in unrealized appreciation (depreciation) on investments,
financial instruments, secured borrowing and unrealized gain (loss) on foreign currency for the years ended December 31, 2020, 2019 and 2018 were as follows:
Year Ended December 31,
2020
2019
2018
Net change in unrealized appreciation (depreciation) on investments
$
(221
)
$
(83
)
$
(218
)
Net change in unrealized appreciation (depreciation) on swap contracts
16
(16
)
Net change in unrealized appreciation (depreciation) on foreign currency forward contracts
(3
)
(2
)
3
Net change in unrealized gain (loss) on foreign currency
(16
)
(17
)
(3
)
Change in unrealized appreciation from merger accounting
717
Total net change in unrealized appreciation (depreciation)
$
(240
)
$
(86
)
$
483
During the year ended December 31, 2020, the net change in unrealized appreciation (depreciation) on
our investments was driven primarily by mark to market declines across the portfolio resulting from uncertainty related to the current COVID-19 pandemic. During the year ended December 31, 2019, the net
change in unrealized appreciation (depreciation) on our investments was primarily driven by mark to market declines in certain debt investments. During the year ended December 31, 2018, the net change in unrealized appreciation (depreciation)
on our investments was primarily due to the decrease in valuation of certain of our equity/other investments, as well as the recognition of fair value of investments after the allocation of purchase price discount was applied to the fair value of
CCTs investments in connection with the 2018 Merger.
Net Increase (Decrease) in Net Assets Resulting from Operations
For the years ended December 31, 2020, 2019 and 2018, the net increase (decrease) in net assets resulting from
operations was $(405) ($(3.26) per share), $246 ($1.90 per share) and $569 ($9.05 per share), respectively.
This Results
of Operations section should be read in conjunction with COVID-19 Developments above.
Financial Condition, Liquidity and Capital Resources
Overview
As of December 31, 2020, we had $191 in cash and foreign
currency, which we or our wholly-owned financing subsidiaries held in custodial accounts, and $1,040 in borrowings available under our financing arrangements, subject to borrowing base and other limitations. As of December 31, 2020, we
also had broadly syndicated investments and opportunistic investments that could be sold to create additional liquidity. As of December 31, 2020, we had unfunded debt investments with aggregate unfunded commitments of $228.4, unfunded
equity/other commitments of $142.9 and unfunded commitments of $65.8 of Strategic Credit Opportunities Partners, LLC. We maintain sufficient cash on hand, available borrowings and liquid securities to fund such unfunded commitments should the need
arise.
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We currently generate cash primarily from cash flows from fees, interest and dividends
earned from our investments, as well as principal repayments and proceeds from sales of our investments. To seek to enhance our returns, we also employ leverage as market conditions permit and at the discretion of the Advisor, but in no event will
leverage employed exceed the maximum amount permitted by the 1940 Act. Prior to June 14, 2019, in accordance with the 1940 Act, we were allowed to borrow amounts such that our asset coverage, calculated pursuant to the 1940 Act, was at least
200% after such borrowing. Effective June 15, 2019, our asset coverage requirement applicable to senior securities was reduced from 200% to 150%. As of December 31, 2020, the aggregate amount outstanding of the senior securities
issued by us was $4.0 billion. As of December 31, 2020, our asset coverage was 177%. See Financing Arrangements.
Prior to investing in securities of portfolio companies, we invest the cash received from fees, interest and dividends earned from our investments and principal repayments and proceeds from sales of our
investments primarily in cash, cash equivalents, including money market funds, U.S. government securities, repurchase agreements and high-quality debt instruments maturing in one year or less from the time of investment, consistent with our BDC
election and our election to be taxed as a RIC.
This Financial Condition, Liquidity and Capital Resources section
should be read in conjunction with COVID-19 Developments above.
Financing Arrangements
The following table presents summary information with respect to our outstanding financing arrangements as of
December 31, 2020:
As of December 31, 2020
Arrangement
Type of Arrangement
Rate
Amount
Outstanding
Amount
Available
Maturity Date
CCT Tokyo Funding Credit Facility (2)
Revolving Credit Facility
L+1.75% - 2.00% (1)(3)
$
260
$
40
December 2, 2023
Senior Secured Revolving Credit Facility (2)
Revolving Credit Facility
L+1.75%
-2.00% (1)(4)
615
(5)
1,000
December 23, 2025
4.750% Notes due 2022 (6)
Unsecured Notes
4.75%
450
May 15, 2022
5.000% Notes due 2022 (6)
Unsecured Notes
5.00%
245
June 28, 2022
4.625% Notes due 2024 (6)
Unsecured Notes
4.63%
400
July 15, 2024
4.125% Notes due 2025 (6)
Unsecured Notes
4.13%
470
February 1, 2025
8.625% Notes due 2025 (6)
Unsecured Notes
8.63%
250
May 15, 2025
3.400% Notes due 2026 (6)
Unsecured Notes
3.40%
1000
January 15, 2026
2019-1 Notes (2)(7)
Collateralized Loan Obligation
L+1.85%
-3.01% (1)
352
January 15, 2031
Total
$
4,042
$
1,040
(1)
LIBOR is subject to a 0% floor.
(2)
The carrying amount outstanding under the facility approximates its fair value.
(3)
The spread over LIBOR is determined by reference to the amount outstanding under the facility.
(4)
The spread over LIBOR is determined by reference to the ratio of the value of the borrowing base to the aggregate amount of certain
outstanding indebtedness of the Company.
(5)
Amount includes borrowing in Euros, Canadian dollars, pounds sterling and Australian dollars. Euro balance outstanding of 164 has been
converted to U.S. dollars at an exchange rate of 1.00 to $1.22 as of December 31, 2020 to reflect total amount outstanding in U.S. dollars. Canadian dollar balance outstanding of CAD $63 has been converted to U.S dollars at an exchange
rate of CAD $1.00 to $0.78 as of December 31, 2020 to reflect total amount outstanding in U.S. dollars. Pounds sterling balance outstanding of £111 has been converted to U.S. dollars at an exchange rate of £1.00 to $1.37 as of
December 31, 2020 to reflect total amount outstanding in U.S. dollars. Australian dollar balance outstanding of A$6 has been converted to U.S dollars at an exchange rate of A$1.00 to $0.77 as of December 31, 2020 to reflect total amount
outstanding in U.S. dollars.
(6)
As of December 31, 2020, the fair value of the 4.750% notes, the 5.000% notes, the 4.625% notes, the 4.125% notes, the 8.625% notes and
the 3.400% notes was approximately $468, $245, $422, $490, $285 and $994 respectively. These valuations are considered Level 2 valuations within the fair value hierarchy.
(7)
As of December 31, 2020, there were $281.4 of Class A-1R notes outstanding at L+1.85%, $20.5 of Class A-2R notes outstanding at
L+2.25%, $32.4 of Class B-1R notes outstanding at L+2.60% and $17.4 of Class B-2R notes outstanding at 3.011%.
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See Note 9 to our consolidated financial statements included herein for additional
information regarding our financing arrangements.
RIC Status and Distributions
We have elected to be subject to tax as a RIC under Subchapter M of the Code. In order to qualify for RIC tax treatment, we must, among
other things, make distributions of an amount at least equal to 90% of our investment company taxable income, determined without regard to any deduction for distributions paid, each tax year. As long as the distributions are declared by the later of
the fifteenth day of the ninth month following the close of a tax year or the due date of the tax return for such tax year, including extensions, distributions paid up to twelve months after the current tax year can be carried back to the prior tax
year for determining the distributions paid in such tax year. We intend to make sufficient distributions to our stockholders to qualify for and maintain our RIC tax status each tax year. We are also subject to a 4% nondeductible federal excise tax
on certain undistributed income unless we make distributions in a timely manner to our stockholders generally of an amount at least equal to the sum of (1) 98% of our net ordinary income (taking into account certain deferrals and elections) for the
calendar year, (2) 98.2% of our capital gain net income, which is the excess of capital gains in excess of capital losses, or capital gain net income (adjusted for certain ordinary losses), for the
one-year period ending October 31 of that calendar year and (3) any net ordinary income and capital gain net income for the preceding years that were not distributed during such years and on which we
paid no U.S. federal income tax. Any distribution declared by us during October, November or December of any calendar year, payable to stockholders of record on a specified date in such a month and actually paid during January of the following
calendar year, will be treated as if it had been paid by us, as well as received by our stockholders, on December 31 of the calendar year in which the distribution was declared. We can offer no assurance that we will achieve results that will
permit us to pay any cash distributions. If we issue senior securities, we will be prohibited from making distributions if doing so causes us to fail to maintain the asset coverage ratios stipulated by the 1940 Act or if distributions are limited by
the terms of any of our borrowings.
Subject to applicable legal restrictions and the sole discretion of our board of
directors, we intend to authorize, declare and pay regular cash distributions on a quarterly basis. We will calculate each stockholders specific distribution amount for the period using record and declaration dates and each stockholders
distributions will begin to accrue on the date that shares of our common stock are issued to such stockholder. From time to time, we may also pay special interim distributions in the form of cash or shares of our common stock at the discretion of
our board of directors.
During certain periods, our distributions may exceed our earnings. As a result, it is possible that a
portion of the distributions we make may represent a return of capital. A return of capital generally is a return of a stockholders investment rather than a return of earnings or gains derived from our investment activities. Each year a
statement on Form 1099-DIV identifying the sources of the distributions will be mailed to our stockholders. No portion of the distributions paid during the tax years ended December 31, 2020, 2019 or 2018
represented a return of capital.
We intend to continue to make our regular distributions in the form of cash, out of assets
legally available for distribution, except for those stockholders who receive their distributions in the form of shares of our common stock under our distribution reinvestment plan. Any distributions reinvested under the plan will nevertheless
remain taxable to a U.S. stockholder.
The following table reflects the cash distributions per share that we have declared on
our common stock during the years ended December 31, 2020, 2019 and 2018:
Distribution
For the Year Ended December 31,
Per
Share (1)
Amount
2018 (2)
$
3.40000
$
205
2019
$
3.04000
$
393
2020
$
2.56000
$
318
(1)
The amount of each per share distribution has been retroactively adjusted to reflect the Reverse Stock Split as discussed in Note 3 to our
unaudited consolidated financial statements included herein.
(2)
Includes a $0.36 per share special cash distribution that was paid on December 3, 2018.
See Note 5 to our consolidated financial statements contained in this annual report on Form 10-K
for additional information regarding our distributions, including a reconciliation of our GAAP-basis net investment income to our tax-basis net investment income for the years ended December 31, 2020,
2019 and 2018.
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Critical Accounting Policies
Our financial statements are prepared in conformity with GAAP, which requires us to make estimates and assumptions that affect the
reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Management has utilized available information, including our past history, industry
standards and the current economic environment, among other factors, in forming the estimates and judgments, giving due consideration to materiality. Actual results may differ from these estimates. In addition, other companies may utilize different
estimates, which may impact the comparability of our results of operations to those of companies in similar businesses. Understanding our accounting policies and the extent to which we use management judgment and estimates in applying these policies
is integral to understanding our financial statements. We describe our most significant accounting policies in Note 2. Summary of Significant Accounting Policies in our consolidated financial statements. Critical accounting policies are
those that require the application of managements most difficult, subjective or complex judgments, often because of the need to make estimates about the effect of matters that are inherently uncertain and that may change in subsequent periods.
We evaluate our critical accounting estimates and judgments required by our policies on an ongoing basis and update them as necessary based on changing conditions. We have identified one of our accounting policies, valuation of portfolio
investments, specifically the valuation of Level 3 investments, as critical because it involves significant judgments and assumptions about highly complex and inherently uncertain matters, and the use of reasonably different estimates and
assumptions could have a material impact on our reported results of operations or financial condition. As we execute our operating plans, we will describe additional critical accounting policies in the notes to our future financial statements in
addition to those discussed below.
Valuation of Portfolio Investments
We determine the net asset value of our investment portfolio each quarter. Securities are valued at fair value as determined in good faith
by our board of directors. In connection with that determination, the Advisor provides our board of directors with portfolio company valuations which are based on relevant inputs, including, but not limited to, indicative dealer quotes, values of
like securities, recent portfolio company financial statements and forecasts, and valuations prepared by independent third-party valuation services.
ASC Topic 820 issued by the FASB clarifies the definition of fair value and requires companies to expand their disclosure about the use of fair value to measure assets and liabilities in interim and
annual periods subsequent to initial recognition. ASC Topic 820 defines fair value as the price that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement
date. ASC Topic 820 also establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2,
which includes inputs such as quoted prices for similar securities in active markets and quoted prices for identical securities where there is little or no activity in the market; and Level 3, defined as unobservable inputs for which little or
no market data exists, therefore requiring an entity to develop its own assumptions.
With respect to investments for which
market quotations are not readily available, we undertake a multi-step valuation process each quarter, as described below:
our quarterly fair valuation process begins by the Advisor providing financial and operating information with respect to each portfolio company or
investment to our independent third-party valuation service providers;
our independent third-party valuation service providers review this information, along with other public and private information, and provide the
Advisor with a valuation range for each portfolio company or investment;
the Advisor then discusses the independent third-party valuation service providers valuation ranges and provides the valuation committee of the
board of directors, or the valuation committee, with a valuation recommendation for each investment, along with supporting materials;
preliminary valuations are then discussed with the valuation committee;
our valuation committee reviews the preliminary valuations and the Advisor, together with our independent third-party valuation service providers and,
if applicable, supplements the preliminary valuations to reflect any comments provided by the valuation committee;
following the completion of its review, our valuation committee recommends that our board of directors approves the fair valuations determined by the
valuation committee; and
our board of directors discusses the valuations and determines the fair value of each such investment in our portfolio in good faith based on various
statistical and other factors, including the input and recommendation of the Advisor, the valuation committee and our independent third-party valuation service providers.
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Determination of fair value involves subjective judgments and estimates. Accordingly,
the notes to our consolidated financial statements refer to the uncertainty with respect to the possible effect of such valuations and any change in such valuations on our consolidated financial statements. In making its determination of fair value,
our board of directors may use any approved independent third-party pricing or valuation services. However, our board of directors is not required to determine fair value in accordance with the valuation provided by any single source, and may use
any relevant data, including information obtained from the Advisor or any approved independent third-party valuation or pricing service that our board of directors deems to be reliable in determining fair value under the circumstances. Below is a
description of factors that the Advisor, any approved independent third-party valuation services and our board of directors may consider when determining the fair value of our investments.
Valuation of fixed income investments, such as loans and debt securities, depends upon a number of factors, including prevailing interest
rates for like securities, expected volatility in future interest rates, call features, put features and other relevant terms of the debt. For investments without readily available market prices, we may incorporate these factors into discounted cash
flow models to arrive at fair value. Other factors that may be considered include the borrowers ability to adequately service its debt, the fair market value of the borrower in relation to the face amount of its outstanding debt and the
quality of collateral securing our debt investments.
For convertible debt securities, fair value generally approximates the
fair value of the debt plus the fair value of an option to purchase the underlying security (i.e., the security into which the debt may convert) at the conversion price. To value such an option, a standard option pricing model may be used.
Our equity interests in portfolio companies for which there is no liquid public market are valued at fair value. Our board of
directors, in its determination of fair value, may consider various factors, such as multiples of EBITDA, cash flows, net income, revenues or, in limited instances, book value or liquidation value. All of these factors may be subject to adjustments
based upon the particular circumstances of a portfolio company or our actual investment position. For example, adjustments to EBITDA may take into account compensation to previous owners or acquisition, recapitalization, restructuring or other
related items.
The Advisor, any approved independent third-party valuation services and our board of directors may also
consider private merger and acquisition statistics, public trading multiples discounted for illiquidity and other factors, valuations implied by third-party investments in the portfolio companies or industry
practices in determining fair value. The Advisor, any approved independent third-party valuation services and our board of directors may also consider the size and scope of a portfolio company and its specific strengths and weaknesses, and may apply
discounts or premiums, where and as appropriate, due to the higher (or lower) financial risk and/or the smaller size of portfolio companies relative to comparable firms, as well as such other factors as our board of directors, in consultation with
the Advisor and any approved independent third-party valuation services, if applicable, may consider relevant in assessing fair value. Generally, the value of our equity interests in public companies for which market quotations are readily available
is based upon the most recent closing public market price. Portfolio securities that carry certain restrictions on sale are typically valued at a discount from the public market value of the security.
When we receive warrants or other equity securities at nominal or no additional cost in connection with an investment in a debt security,
the cost basis in the investment will be allocated between the debt securities and any such warrants or other equity securities received at the time of origination. Our board of directors subsequently values these warrants or other equity securities
received at their fair value.
The fair values of our investments are determined in good faith by our board of directors. Our
board of directors is responsible for the valuation of our portfolio investments at fair value as determined in good faith pursuant to our valuation policy and consistently applied valuation process. Our board of directors has delegated day-to-day responsibility for implementing our valuation policy to the Advisor, and has authorized the Advisor to utilize independent third-party valuation and pricing
services that have been approved by our board of directors. The valuation committee is responsible for overseeing the Advisors implementation of the valuation process.
See Note 8 to our consolidated financial statements included herein for additional information regarding the fair value of our financial instruments.
Contractual Obligations
We have entered into agreements with the Advisor to provide us with investment advisory and administrative services. Payments for
investment advisory services under the investment advisory agreement are equal to (a) an annual base management fee based on the average weekly value of our gross assets (excluding cash and cash equivalents) and (b) an incentive fee based
on our performance. The Advisor is reimbursed for administrative expenses incurred on our behalf. See Note 4 to our consolidated financial statements included herein for a discussion of these agreements and for the amount of fees and expenses
accrued under these agreements during the years ended December 31, 2020, 2019 and 2018.
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A summary of our significant contractual payment obligations for the repayment of
outstanding indebtedness at December 31, 2020 is as follows:
Payments Due By Period
Maturity Date (1)
Total
Less than
1 year
1-3
years
3-5
years
More than
5 years
CCT Tokyo Funding Credit Facility (2)
December 2, 2023
$260
$
260
Senior Secured Revolving Credit Facility (3)
December 23, 2025
$615
$615
4.750% Notes due 2022
May 15, 2022
$450
$
450
5.000% Notes due 2022
June 28, 2022
$245
$
245
4.625% Notes due 2024
July 15, 2024
$400
$400
4.125% Notes due 2025
February 1, 2025
$470
$470
8.625% Notes due 2025
May 15, 2025
$250
$250
3.400% Notes due 2026
January 15, 2026
$1,000
$1,000
2019-1 Notes
January 15, 2031
$352
$352
(1)
Amounts outstanding under the financing arrangements will mature, and all accrued and unpaid interest thereunder will be due and payable, on
the maturity date.
(2)
At December 31, 2020, $40 remained unused under the financing arrangement.
(3)
At December 31, 2020, $1,000 remained unused under the Senior Secured Revolving Credit Facility. Amount includes borrowing in Euros,
Canadian dollars, pounds sterling and Australian dollars. Euro balance outstanding of 164 has been converted to U.S. dollars at an exchange rate of 1.00 to $1.22 as of December 31, 2020 to reflect total amount outstanding in U.S.
dollars. Canadian dollar balance outstanding of CAD $63 has been converted to U.S dollars at an exchange rate of CAD $1.00 to $0.78 as of December 31, 2020 to reflect total amount outstanding in U.S. dollars. Pounds sterling balance outstanding
of £111 has been converted to U.S dollars at an exchange rate of £1.00 to $1.37 as of December 31, 2020 to reflect total amount outstanding in U.S. dollars. Australian dollar balance outstanding of A$6 has been converted to U.S
dollars at an exchange rate of A$1.00 to $0.77 as of December 31, 2020 to reflect total amount outstanding in U.S. dollars.
Off-Balance Sheet Arrangements
We
currently have no off-balance sheet arrangements, including any risk management of commodity pricing or other hedging practices.
Recently Issued Accounting Standards
In August 2018, the Financial
Accounting Standards Board, or FASB, issued Accounting Standards Update 2018-13, Fair Value Measurement (Topic 820) Disclosure FrameworkChanges to the Disclosure Requirements for Fair Value
Measurement , or ASU 2018-13. ASU 2018-13 introduces new fair value disclosure requirements and eliminates and modifies certain existing fair value disclosure
requirements. ASU 2018-13 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The Company implemented ASU
2018-13 during the year ended December 31, 2020, and it did not have a significant impact on the Companys disclosure over fair value.
In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic
848) , which provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendments apply only to contracts,
hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. ASU 2020-04 is effective for all entities as of
March 12, 2020 through December 31, 2022. The expedients and exceptions provided by the amendments do not apply to contract modifications and hedging relationships entered into or evaluated after December 31, 2022, except for hedging
transactions as of December 31, 2022, that an entity has elected certain optional expedients for and that are retained through the end of the hedging relationship. The Company is currently evaluating the impact of adopting ASU 2020-04 on its consolidated financial statements.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk.
Interest Rate Risk
We are subject to financial market risks, including
changes in interest rates. As of December 31, 2020, 63.5% of our portfolio investments (based on fair value) were debt investments paying variable interest rates and 9.0% were debt investments paying fixed interest rates while 16.9%
were other income producing investments, 8.1% consisted of non-income producing
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investments, and the remaining 2.5% consisted of investments on non-accrual status. A rise in the general level of interest rates can be expected to lead
to higher interest rates applicable to any variable rate investments we hold and to declines in the value of any fixed rate investments we hold. However, many of our variable rate investments provide for an interest rate floor, which may prevent our
interest income from increasing until benchmark interest rates increase beyond a threshold amount. To the extent that a substantial portion of our investments may be in variable rate investments, an increase in interest rates beyond this threshold
would make it easier for us to meet or exceed the hurdle rate applicable to the subordinated incentive fee on income, and may result in a substantial increase in our net investment income and to the amount of incentive fees payable to the Advisor
with respect to our increased pre-incentive fee net investment income. In 2020, the U.S. Federal Reserve and other central banks reduced certain interest rates in response to the
COVID-19 pandemic and market conditions. A prolonged reduction in interest rates may reduce our net investment income.
Pursuant to the terms of the CCT Tokyo Funding Credit Facility, Senior Secured Revolving Credit Facility and the 2019-1 Notes, we borrow at a floating rate
based on a benchmark interest rate. Under the indentures governing the 4.750% notes, the 5.000% notes, the 4.625% notes, the 4.125% notes, the 8.625% notes and the 3.400% notes we pay interest to the holders of such notes at a fixed rate. To the
extent that any present or future credit facilities or other financing arrangements that we or any of our subsidiaries enter into are based on a floating interest rate, we will be subject to risks relating to changes in market interest rates. In
periods of rising interest rates when we or our subsidiaries have such debt outstanding, or financing arrangements in effect, our interest expense would increase, which could reduce our net investment income, especially to the extent we hold fixed
rate investments.
The following table shows the effect over a twelve month period of changes in interest rates on our interest
income, interest expense and net interest income, assuming no changes in the composition of our investment portfolio, including the accrual status of our investments, and our financing arrangements in effect as of December 31, 2020 (dollar
amounts are presented in millions):
Basis Point Change in Interest Rates
Increase
(Decrease)
in Interest
Income (1)
Increase
(Decrease)
in Interest
Expense
Increase
(Decrease) in
Net Interest
Income
Percentage
Change in Net
Interest Income
Down 24 basis points
$
(1
)
$
(3
)
$
2
0.6
%
No change
Up 100 basis points
15
13
2
0.8
%
Up 300 basis points
103
36
67
21.6
%
Up 500 basis points
193
62
131
42.6
%
(1)
Assumes no defaults or prepayments by portfolio companies over the next twelve months.
We expect that our long-term investments will be financed primarily with equity and debt. If deemed prudent, we may use interest rate risk
management techniques in an effort to minimize our exposure to interest rate fluctuations. These techniques may include various interest rate hedging activities to the extent permitted by the 1940 Act. Adverse developments resulting from changes in
interest rates or hedging transactions could have a material adverse effect on our business, financial condition and results of operations. During the years ended December 31, 2020, 2019 and 2018 we did not engage in interest rate hedging
activities.
Foreign Currency Risk
From time to time, we may make investments that are denominated in a foreign currency that are subject to the effects of exchange rate movements between the foreign currency of each such investment and
the U.S. dollar, which may affect future fair values and cash flows, as well as amounts translated into U.S. dollars for inclusion in our consolidated financial statements.
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The table below presents the effect that a 10% immediate, unfavorable change in the
foreign currency exchange rates (i.e. strengthening of the U.S. dollar) would have on the fair value of our investments denominated in foreign currencies as of December 31, 2020, by foreign currency, all other valuation assumptions remaining
constant. In addition, the table below presents the par value of our investments denominated in foreign currencies and the notional amount of foreign currency forward contracts in local currency in place as of December 31, 2020 to hedge against
foreign currency risks.
Investments Denominated in Foreign Currencies
As of December 31,
2020
Hedges
As of December 31, 2020
Cost in Local
Currency
Cost
in US$
Fair Value
Reduction in Fair
Value as of
December 31, 2020
if 10%
Adverse
Change in
Exchange Rate (1)
Net Foreign
Currency Hedge
Amount in
Local Currency
Net Foreign
Currency Hedge
Amount in U.S.
Dollars
Australian Dollars
A$
10.4
$
8.0
$
7.8
$
0.8
A$
3.0
$
2.3
British Pounds Sterling
£
114.3
156.2
164.3
16.4
£
18.6
18.6
Canadian Dollars
C$
58.8
46.1
49.2
4.9
Euros
342.0
418.2
278.4
27.8
12.5
15.2
Norwegian Krone
NOK
304.5
35.5
38.3
3.8
NOK
48.2
5.6
Swedish Krona
SEK
124.0
15.1
SEK
121.4
14.8
Total
$
679.1
$
538.0
$
53.7
$
56.5
(1)
Excludes effect, if any, of any foreign currency hedges.
As illustrated in the table above, we use derivative instruments from time to time, including foreign currency forward contracts and cross
currency swaps, to manage the impact of fluctuations in foreign currency exchange rates. In addition, we have the ability to borrow in foreign currencies under our Senior Secured Revolving Credit Facility, which provides a natural hedge with regard
to changes in exchange rates between the foreign currencies and U.S. dollar and reduces our exposure to foreign exchange rate differences. We are typically a net receiver of these foreign currencies as related for our international investment
positions, and, as a result, our investments denominated in foreign currencies, to the extent not hedged, benefit from a weaker U.S. dollar and are adversely affected by a stronger U.S. dollar.
As of December 31, 2020, the net contractual amount of our foreign currency forward contracts totaled $56.5, all of which related to
hedging of our foreign currency denominated debt investments. As of December 31, 2020, we had outstanding borrowings denominated in foreign currencies of 164, CAD $63, £111 and A$6 under our Senior Secured Revolving Credit Facility.
In addition, we may have risk regarding portfolio valuation. See Item 2. Managements Discussion and Analysis of
Financial Condition and Results of OperationsCritical Accounting PoliciesValuation of Portfolio Investments.
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Item 8.
Financial Statements and Supplementary Data.
Index to Financial Statements
Page
Managements Report on Internal Control over Financial Reporting
71
Reports of Independent Registered Public Accounting Firms
72
Consolidated Balance Sheets as of December 31, 2020 and 2019
76
Consolidated Statements of Operations for the years ended December 31, 2020, 2019 and
2018
77
Consolidated Statements of Changes in Net Assets for the years ended December
31, 2020, 2019 and 2018
79
Consolidated Statements of Cash Flows for the years ended December 31, 2020, 2019 and
2018
80
Consolidated Schedules of Investments as of December 31, 2020 and 2019
81
Notes to Consolidated Financial Statements
112
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MANAGEMENTS REPORT ON INTERNAL CONTROL OVER
FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate internal control over
financial reporting. In connection with the preparation of our annual financial statements, management has conducted an assessment of the effectiveness of our internal control over financial reporting based on the framework set forth in Internal
ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013 (COSO). Managements assessment included an evaluation of the design of our internal control over financial
reporting and testing of the operational effectiveness of those controls. Based on this evaluation, we have concluded that, as of December 31, 2020, our internal control over financial reporting was effective to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Our internal control over financial reporting as of
December 31, 2020 has been audited by our independent registered public accounting firm.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and the Board of Directors of FS KKR Capital Corp.
Opinion on Internal Control over Financial Reporting
We have audited the
internal control over financial reporting of FS KKR Capital Corp. and subsidiaries (the Company) as of December 31, 2020, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee
of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in
Internal Control Integrated Framework (2013) issued by COSO.
We have also audited, in accordance with the
standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2020, of the Company and our report dated March 1, 2021, expressed an unqualified
opinion on those financial statements.
Basis for Opinion
The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting,
included in the accompanying Managements Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We are a public
accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the
PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing
the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies
and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded
as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and
directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ Deloitte & Touche LLP
San Francisco, California
March 1, 2021
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and the Board of Directors of FS KKR Capital Corp.
Opinion on the Financial Statements and Financial Highlights
We have
audited the accompanying consolidated balance sheets of FS KKR Capital Corp. and subsidiaries (the Company), including the consolidated schedules of investments, as of December 31, 2020 and 2019, the related consolidated statements of
operations, changes in net assets, and cash flows for the years then ended, the financial highlights for the years then ended, and the related notes (collectively referred to as the financial statements). In our opinion, the financial
statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations, changes in net assets, cash flows, and financial highlights for the years then ended, in
conformity with accounting principles generally accepted in the United States of America.
The consolidated financial
statements of the Company for the year ended December 31, 2018, before the effects of the adjustments to retrospectively apply the change in accounting related to the reverse stock split discussed in Note 1 to the financial statements, were audited
by other auditors whose report, dated February 27, 2019, expressed an unqualified opinion on those statements. We have also audited the adjustments to the 2018 consolidated financial statements to retrospectively apply the change in accounting for
the reverse stock split in 2020, as discussed in Note 1 to the financial statements. Our procedures included (1) comparing the amounts shown in the per share disclosures for 2018 to the Companys underlying accounting analysis, (2) comparing
the previously reported shares outstanding and the related balance sheet and income statement amounts per the Companys accounting analysis to the previously issued consolidated financial statements, and (3) recalculating the reduction of
shares to give effect to the reverse stock split and testing the mathematical accuracy of the underlying analysis. In our opinion, such retrospective adjustments are appropriate and have been properly applied. However, we were not engaged to audit,
review, or apply any procedures to the 2018 consolidated financial statements of the Company other than with respect to the retrospective adjustments, and accordingly, we do not express an opinion or any other form of assurance on the 2018
consolidated financial statements taken as a whole.
We have also audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States) (PCAOB), the Companys internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control Integrated Framework (2013) issued by
the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 1, 2021 expressed an unqualified opinion on the Companys internal control over financial reporting.
Basis for Opinion
These
financial statements and financial highlights are the responsibility of the Companys management. Our responsibility is to express an opinion on the Companys financial statements and financial highlights based on our audits. We are a
public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission
and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of
material misstatement of the financial statements and financial highlights, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and
disclosures in the financial statements and financial highlights.
Our audits also included evaluating the accounting
principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and financial highlights. Our procedures included confirmation of investments owned as of December 31, 2020 and
2019, by correspondence with the custodian, loan agents, and borrowers; when replies were not received, we performed other auditing procedures. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was
communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The
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communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below,
providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Fair Value Level 3
Investments Refer to Notes 2, 6, and 8 to the financial statements
Critical Audit Matter Description
The Company held investments classified as Level 3 investments under accounting principles generally accepted in the United States of
America. These investments included illiquid corporate bonds and loans, unlisted equity securities, and derivatives that lack observable market prices. The valuation techniques used in estimating the fair value of these investments vary based on the
specific characteristics of the investments and certain significant inputs used were unobservable. The fair value of the Companys Level 3 investments was $5.8 billion as of December 31, 2020.
We identified the valuation of Level 3 investments as a critical audit matter because of the judgments necessary for management to select
valuation techniques and to use significant unobservable inputs to estimate the fair value. This required a high degree of auditor judgment and extensive audit effort, including the need to involve fair value specialists who possess significant
valuation experience, to evaluate the appropriateness of the valuation techniques and the significant unobservable inputs, when performing audit procedures to audit managements estimate of fair value of Level 3 investments.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to valuation techniques and unobservable observable inputs used by management to estimate the fair value of Level 3 investments included the following, among others:
We tested the effectiveness of controls over managements valuation of Level 3 investments, including those related to valuation techniques and
significant unobservable inputs.
We evaluated the appropriateness of the valuation techniques used for Level 3 investments and tested the related significant unobservable inputs by
comparing these inputs to external sources. We evaluated the reasonableness of any significant changes in valuation techniques or significant unobservable inputs, including the considerations of the impact of COVID 19. For a selected sample of Level
3 investments, we performed these procedures with the assistance of our fair value specialists.
In instances where the selection of valuation techniques or significant unobservable inputs were more subjective, with the assistance of our fair value
specialists, we developed an independent estimate of the fair value and compared our estimates to managements estimates.
We evaluated managements ability to reasonably estimate fair value by comparing managements historical estimates to subsequent
transactions, taking into account changes in market or investment specific conditions, where applicable.
/s/ Deloitte
& Touche LLP
San Francisco, California
March 1, 2021
We have served as the Companys auditor since 2019.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
FS KKR Capital Corp.
Opinion on the Financial Statements
We have audited the accompanying consolidated statements of operations, changes in net assets and cash flows of FS KKR Capital Corp. (the
Company) for the year ended December 31, 2018, and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, except for the effects of the adjustments, if any, as might have been determined
to be necessary had we been engaged to audit the Companys restatement of share and per-share information, as described below, the financial statements present fairly, in all material respects, the results of the Companys operations and
its cash flows for the year ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America.
Reverse Stock Split
We were not engaged to audit the restatement of the
Companys disclosures about share and per-share information for the year ended December 31, 2018, as discussed in Note 3 to the financial statements.
Basis for Opinion
These financial statements are the responsibility of the
Companys management. Our responsibility is to express an opinion on the Companys financial statements based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the
Company in accordance with U.S. federal securities laws and applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
Except as discussed above, we conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement, whether due to error or fraud. Our audit included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing
procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audit also included evaluating the accounting principles used and
significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audit provides a reasonable basis for our opinion.
/s/ RSM US LLP
We have served as the auditor of one or more FS Investments investment companies
since 2007.
Blue Bell, Pennsylvania
February 27, 2019
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Part IFINANCIAL INFORMATION
FS KKR Capital Corp.
Consolidated Balance Sheets
(in millions, except share and per share
amounts)
December 31,
2020
2019
Assets
Investments, at fair value
Non-controlled/unaffiliated investments (amortized cost$5,314 and $6,006,
respectively)
$
4,986
$
5,661
Non-controlled/affiliated investments (amortized cost$629 and $686,
respectively)
534
717
Controlled/affiliated investments (amortized cost$1,510 and $1,117, respectively)
1,260
979
Total investments, at fair value (amortized cost$7,453 and $7,809, respectively)
6,780
7,357
Cash
182
93
Foreign currency, at fair value (cost$8 and $13, respectively)
9
13
Receivable for investments sold and repaid
173
657
Income receivable
72
82
Unrealized appreciation on foreign currency forward contracts
1
1
Deferred financing costs
15
10
Deferred merger costs
1
Prepaid expenses and other assets
4
3
Total assets
$
7,237
$
8,216
Liabilities
Payable for investments purchased
$
$
15
Debt (net of deferred financing costs of $23 and $9, respectively) (1)
3,997
4,173
Unrealized depreciation on foreign currency forward contracts
3
0
Stockholder distributions payable
74
96
Management and investment adviser fees payable
25
30
Subordinated income incentive fees payable (2)
Administrative services expense payable
2
3
Interest payable
25
23
Other accrued expenses and liabilities
15
10
Total liabilities
4,141
4,350
Commitments and contingencies (3)
Stockholders equity
Preferred stock, $0.001 par value, 50,000,000 shares authorized, none issued and outstanding
Common stock, $0.001 par value, 750,000,000 shares authorized, 123,755,965 and 126,581,766 shares issued and outstanding,
respectively (4)
0
1
Capital in excess of par value
3,866
4,041
Retained earnings (accumulated deficit) (5)
(770
)
(176
)
Total stockholders equity
3,096
3,866
Total liabilities and stockholders equity
$
7,237
$
8,216
Net asset value per share of common stock at year end (4)
$
25.02
$
30.54
(1)
See Note 9 for a discussion of the Companys financing arrangements.
(2)
See Note 2 for a discussion of the methodology employed by the Company in calculating the subordinated income incentive fees.
(3)
See Note 10 for a discussion of the Companys commitments and contingencies.
(4)
As discussed in Notes 1 and 3, the Company completed a Reverse Stock Split, effective as of June 15, 2020. The outstanding shares and net
asset value per common share reflect the Reverse Stock Split on a retroactive basis.
(5)
See Note 5 for a discussion of the sources of distributions paid by the Company.
See notes to consolidated financial statements.
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Table of Contents
FS KKR Capital Corp.
Consolidated Statements of Operations
(in millions, except share and per share amounts)
Year Ended December 31,
2020
2019
2018
Investment income
From non-controlled/unaffiliated investments:
Interest income
$
427
$
571
$
305
Paid-in-kind interest income
43
40
34
Fee income
33
42
13
Dividend income
16
10
8
From non-controlled/affiliated investments:
Interest income
10
28
3
Paid-in-kind interest income
19
16
2
Fee income
0
Dividend income
0
From controlled/affiliated investments:
Interest income
7
11
9
Paid-in-kind interest income
4
4
19
Dividend income
80
57
1
Total investment income
639
779
394
Operating expenses
Management fees (1)
106
115
63
Subordinated income incentive fees (2)
57
26
Administrative services expenses
7
9
4
Accounting and administrative fees
2
2
1
Interest expense (3)
170
170
84
Other general and administrative expenses
13
9
7
Total operating expenses
298
362
185
Management fee waiver (1)
(3
)
Net expenses
298
362
182
Net investment income before taxes
341
417
212
Excise taxes
10
7
7
Net investment income
331
410
205
See notes to consolidated financial statements.
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FS KKR Capital Corp.
Consolidated Statements of Operations
(in millions, except share and per share amounts)
Year Ended December 31,
2020
2019
2018
Realized and unrealized gain/loss
Net realized gain (loss) on investments:
Non-controlled/unaffiliated investments
$
(323
)
$
(114
)
$
(116
)
Non-controlled/affiliated investments
(132
)
32
(9
)
Controlled/affiliated investments
(35
)
1
Net realized gain (loss) on swap contracts
(11
)
Net realized gain (loss) on foreign currency forward contracts
0
12
Net realized gain (loss) on foreign currency
(6
)
2
6
Net change in unrealized appreciation (depreciation) on investments:
Non-controlled/unaffiliated investments
17
(105
)
(48
)
Non-controlled/affiliated investments
(126
)
55
(57
)
Controlled/affiliated investments
(112
)
(33
)
(113
)
Net change in unrealized appreciation (depreciation) on swap contracts
16
(16
)
Net change in unrealized appreciation (depreciation) on foreign currency forward contracts
(3
)
(2
)
3
Net change in unrealized gain (loss) on foreign currency
(16
)
(17
)
(3
)
Change in unrealized appreciation from merger accounting (4)
717
Total net realized and unrealized gain (loss)
(736
)
(164
)
364
Net increase (decrease) in net assets resulting from operations
$
(405
)
$
246
$
569
Per share informationbasic and diluted
Net increase (decrease) in net assets resulting from operations (Earnings per Share) (6)
$
(3.26
)
$
1.90
$
9.05
(5)
Weighted average shares outstanding (6)
124,290,607
129,736,685
62,844,356
(1)
See Note 4 for a discussion of the waiver by FB Income Advisor, LLC, the Companys former investment adviser, of certain management fees
to which it was otherwise entitled during the applicable period.
(2)
See Note 2 for a discussion of the methodology employed by the Company in calculating the capital gains incentive fees and subordinated income
incentive fees.
(3)
See Note 9 for a discussion of the Companys financing arrangements.
(4)
See Note 13 for a discussion of the 2018 Merger.
(5)
Includes $717 change in unrealized appreciation from merger accounting. Without such amount, net increase (decrease) in net assets resulting
from operations would have been $(2.36).
(6)
As discussed in Notes 1 and 3, the Company completed a Reverse Stock Split, effective as of June 15, 2020. The weighted average shares
used in the per share computation of the net increase (decrease) in net assets resulting from operations reflect the Reverse Stock Split on a retroactive basis.
See notes to consolidated financial statements.
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Table of Contents
FS KKR Capital Corp.
Consolidated Statements of Changes in Net Assets
(in millions)
Year Ended December 31,
2020
2019
2018
Operations
Net investment income
$
331
$
410
$
205
Net realized gain (loss) on investments, swap contracts, secured borrowing and foreign currency
(496
)
(78
)
(119
)
Net change in unrealized appreciation (depreciation) on investments, swap contracts, foreign currency forward contracts and
secured borrowing (1)
(224
)
(69
)
(231
)
Net change in unrealized gain (loss) on foreign currency
(16
)
(17
)
(3
)
Change in unrealized appreciation from merger accounting
717
Net increase (decrease) in net assets resulting from operations
(405
)
246
569
Stockholder distributions (2)
Distributions to stockholders
(318
)
(393
)
(205
)
Net decrease in net assets resulting from stockholder distributions
(318
)
(393
)
(205
)
Capital share transactions (3)
Issuance of common stock
1,567
Reinvestment of stockholder distributions
Repurchases of common stock
(47
)
(153
)
(50
)
Net increase (decrease) in net assets resulting from capital share transactions
(47
)
(153
)
1,517
Total increase (decrease) in net assets
(770
)
(300
)
1,881
Net assets at beginning of year
3,866
4,166
2,285
Net assets at end of year
$
3,096
$
3,866
$
4,166
(1)
See Note 7 for a discussion of the Companys financial instruments.
(2)
See Note 5 for a discussion of the sources of distributions paid by the Company.
(3)
See Note 3 for a discussion of the Companys capital share transactions.
See notes to consolidated financial statements.
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Table of Contents
FS KKR Capital Corp.
Consolidated Statements of Cash Flows
(in millions)
Year Ended December 31,
2020
2019
2018
Cash flows from operating activities
Net increase (decrease) in net assets resulting from operations
$
(405
)
$
246
$
569
Adjustments to reconcile net increase (decrease) in net assets resulting from operations to net cash provided by (used in)
operating activities:
Purchases of investments (1)
(2,336
)
(2,907
)
(761
)
Paid-in-kind interest
(84
)
(60
)
(55
)
Proceeds from sales and repayments of investments
2,301
2,854
1,187
Net realized (gain) loss on investments
490
81
125
Net change in unrealized (appreciation) depreciation on investments (1)
221
83
218
Net change in unrealized (appreciation) depreciation on swap contracts
(16
)
16
Net change in unrealized (appreciation) depreciation on foreign currency forward contracts
3
2
(3
)
Change in unrealized appreciation from merger accounting
(717
)
Accretion of discount
(15
)
(21
)
(7
)
Amortization of deferred financing costs and discount
12
6
6
Unrealized (gain)/loss on borrowings in foreign currency
10
19
(3
)
(Increase) decrease in receivable for investments sold and repaid
484
(513
)
(141
)
(Increase) decrease in income receivable
10
(22
)
(29
)
(Increase) decrease in deferred merger costs
(1
)
(Increase) decrease in prepaid expenses and other assets
(1
)
(2
)
1
Increase (decrease) in payable for investments purchased
(15
)
9
4
Increase (decrease) in management fees payable
(5
)
10
5
Increase (decrease) in subordinated income incentive fees payable
(14
)
1
Increase (decrease) in administrative services expense payable
(1
)
2
1
Increase (decrease) in interest payable
2
(5
)
5
Increase (decrease) in other accrued expenses and liabilities
5
(8
)
11
Other liabilities acquired from merger net of other assets
(146
)
Merger costs capitalized into purchase price
(7
)
Net cash provided by (used in) operating activities
675
(256
)
280
Cash flows from financing activities
Cash purchased in merger
197
Reinvestment of stockholder distributions
Repurchases of common stock
(47
)
(153
)
(50
)
Stockholder distributions
(340
)
(342
)
(207
)
Borrowings under credit facilities (2)
3,379
3,749
482
Borrowings under unsecured notes (2)
1,045
Repayments of credit facilities (2)
(3,542
)
(3,210
)
(732
)
Repayments under unsecured notes (2)
(805
)
Deferred financing costs and discount paid
(40
)
(26
)
(5
)
Net cash provided by (used in) financing activities
(590
)
258
(315
)
Total increase (decrease) in cash
85
2
(35
)
Cash and foreign currency at beginning of year
106
104
139
Cash and foreign currency at end of year
$
191
$
106
$
104
Supplemental disclosure
Non-cash purchases of investments
$
(238
)
$
(138
)
$
Non-cash sales of investments
$
238
$
138
$
Local and excise taxes paid
$
7
$
9
$
6
(1)
For the year ended December 31, 2018, excludes $4,428 of cost of investments acquired from the 2018 Merger.
(2)
For the year ended December 31, 2018, excludes $1,928 of debt assumed from the 2018 Merger. See Note 9 for a discussion of the
Companys financing arrangements. During the years ended December 31, 2020, 2019 and 2018, the Company paid $156, $171 and $82, respectively, in interest expense on the credit facilities and unsecured notes.
Supplemental disclosure of non-cash operating and financing activities:
In connection with the 2018 Merger, the Company issued common stock of $1,574 and acquired investments at fair value of $4,168 ($4,428 at cost) and other
assets of $64 and assumed debt of $1,928 and other liabilities of $210 during the year ended December 31, 2018.
See
notes to consolidated financial statements.
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Table of Contents
FS KKR Capital Corp.
Consolidated Schedule of Investments
As of December 31, 2020
(in millions, except share amounts)
Portfolio Company (a)
Footnotes
Industry
Rate (b)
Floor
Maturity
Principal
Amount (c)
Amortized
Cost
Fair
Value (d)
Senior Secured LoansFirst Lien111.4%
5 Arch Income Fund 2 LLC
(l)(n)(q)(w)
Diversified Financials
9.0%
11/18/23
$
28.8
$
28.8
$
25.5
5 Arch Income Fund 2 LLC
(l)(n)(q)(v)(w)
Diversified Financials
9.0%
11/18/23
4.5
4.5
4.0
A10 Capital LLC
(g)(h)
Diversified Financials
L+650
1.0
%
5/1/23
12.8
12.7
12.6
A10 Capital LLC
(v)
Diversified Financials
L+650
1.0
%
5/1/23
14.1
14.1
14.0
Abaco Systems, Inc
(g)(h)(i)
Capital Goods
L+600
1.0
%
12/7/21
60.6
60.0
60.6
ABB CONCISE Optical Group LLC
(g)(x)
Retailing
L+500
1.0
%
6/15/23
0.7
0.7
0.7
Accuride Corp
(g)(h)(i)(x)
Capital Goods
L+525
1.0
%
11/17/23
17.7
17.6
16.1
Acproducts Inc
(g)(h)(x)
Consumer Durables & Apparel
L+650
1.0
%
8/18/25
41.8
39.7
43.1
Advanced Lighting Technologies Inc
(g)(n)(w)(z)
Materials
L+750
1.0
%
10/4/22
19.8
16.4
12.0
All Systems Holding LLC
(f)(g)(h)
Commercial & Professional Services
L+625
1.0
%
10/31/23
112.2
112.3
112.6
All Systems Holding LLC
(v)
Commercial & Professional Services
L+625
1.0
%
10/31/23
7.2
7.2
7.2
American Tire Distributors Inc
(g)(x)
Automobiles & Components
L+750, 0.0% PIK (1.5% Max PIK)
1.0
%
9/2/24
23.0
21.7
22.0
Amtek Global Technology Pte Ltd
(j)(l)(z)
Automobiles & Components
E+500
0.0
%
4/4/24
54.4
66.3
59.7
Apex Group Limited
(g)(l)
Diversified Financials
L+700
1.3
%
6/15/23
$
0.6
0.6
0.6
Apex Group Limited
(l)(v)
Diversified Financials
L+700
1.3
%
6/15/23
1.3
1.2
1.3
Apex Group Limited
(g)(h)(l)
Diversified Financials
L+700
1.3
%
6/16/25
18.6
18.3
18.7
Apex Group Limited
(g)(l)
Diversified Financials
L+700
1.5
%
6/16/25
£
31.3
39.7
43.2
Ardonagh Group Ltd
(g)(l)
Insurance
L+750, 0.0% PIK (2.3% Max PIK)
0.8
%
7/14/26
0.1
0.2
0.2
Ardonagh Group Ltd
(l)(v)
Insurance
L+750, 0.0% PIK (2.3% Max PIK)
0.8
%
7/14/26
0.7
0.8
0.9
Aspect Software Inc
(g)
Software & Services
8.0% PIK (8.0% Max PIK)
1/15/21
$
0.0
0.0
0.0
Aspect Software Inc
(v)
Software & Services
L+500
1.0
%
7/15/23
0.7
0.7
0.7
Berner Food & Beverage LLC
(g)(h)(i)
Food & Staples Retailing
L+875
1.0
%
3/16/22
87.6
87.3
91.6
Borden (New Dairy Opco)
(g)(y)
Food, Beverage & Tobacco
L+250
1.0
%
7/20/25
7.6
7.6
7.6
Borden (New Dairy Opco)
(g)(y)
Food, Beverage & Tobacco
L+700, 0.0% PIK (1.0% Max PIK)
1.0
%
7/20/25
16.8
16.8
16.8
Borden Dairy Co
(g)(n)(w)(y)
Food, Beverage & Tobacco
L+825
1.0
%
7/6/23
26.0
24.1
Charles Taylor PLC
(g)(l)
Diversified Financials
L+575
0.0
%
1/24/27
£
33.6
42.9
43.3
CSafe Global
(g)
Capital Goods
L+625
1.0
%
12/23/27
$
0.1
0.1
0.1
CSafe Global
(v)
Capital Goods
L+625
1.0
%
12/23/27
1.5
1.5
1.5
CSafe Global
(g)(h)
Capital Goods
L+625
1.0
%
12/23/27
16.0
15.9
15.9
CSM Bakery Products
(g)(x)
Food, Beverage & Tobacco
L+625
1.0
%
1/4/22
1.1
1.1
1.1
CTI Foods Holding Co LLC
(g)
Food, Beverage & Tobacco
L+577, 3.0% PIK (3.0% Max PIK)
1.0
%
5/3/24
3.0
3.0
2.5
Distribution International Inc
(g)(h)(x)
Retailing
L+575
1.0
%
12/15/23
27.6
25.2
25.3
Eagle Family Foods Inc
(v)
Food, Beverage & Tobacco
L+650
1.0
%
6/14/23
7.1
7.1
7.1
Eagle Family Foods Inc
(g)(h)(i)
Food, Beverage & Tobacco
L+650
1.0%
6/14/24
45.6
45.3
45.6
Empire Today LLC
(g)(h)
Retailing
L+650
1.0%
11/17/22
75.6
75.6
76.4
Entertainment Benefits Group LLC
(g)
Media & Entertainment
L+575, 2.5% PIK (2.5% Max PIK)
1.0%
9/30/24
4.3
4.3
3.6
Entertainment Benefits Group LLC
(v)
Media & Entertainment
L+575, 2.5% PIK (2.5% Max PIK)
1.0%
9/30/24
0.5
0.5
0.4
Entertainment Benefits Group LLC
(g)(h)
Media & Entertainment
L+575, 2.5% PIK (2.5% Max PIK)
1.0%
9/30/25
30.1
29.8
25.3
FloWorks International LLC
(g)(h)
Capital Goods
L+600
1.0%
10/14/26
17.2
17.0
17.0
FloWorks International LLC
(g)
Capital Goods
L+600
1.0%
10/14/26
6.4
6.4
6.4
FloWorks International LLC
(v)
Capital Goods
L+600
1.0%
10/14/26
6.4
6.4
6.4
Frontline Technologies Group LLC
(g)
Software & Services
L+525
1.0%
9/18/23
22.3
22.3
22.3
See
notes to consolidated financial statements.
81
Table of Contents
FS KKR Capital Cor
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.