UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2012.
COMMISSION FILE NUMBER: 814-00757
FS Investment Corporation
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
Cira Centre
2929 Arch Street, Suite 675
Philadelphia, Pennsylvania 19104
(Address of principal executive office)
(215) 495-1150
(Registrant’s telephone number, including area code)
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 x 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 whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x.
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
The issuer has 248,342,719 shares of common stock outstanding as of August 13, 2012.
TABLE OF CONTENTS
PART I—FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Unaudited Consolidated Statements of Operations for the three and six months ended June 30, 2012 and 2011
Unaudited Consolidated Statements of Changes in Net Assets for the six months ended June 30, 2012 and 2011
Unaudited Consolidated Statements of Cash Flows for the six months ended June 30, 2012 and 2011
Consolidated Schedules of Investments as of June 30, 2012 (Unaudited) andDecember 31, 2011
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 3.
ITEM 4.
PART II—OTHER INFORMATION
ITEM 1.
ITEM 1A.
ITEM 5.
ITEM 6.
Consolidated Balance Sheets
(in thousands, except share and per share amounts)
Assets
Investments, at fair value (amortized cost—$2,909,025 and $1,862,279, respectively)
Cash
Due from counterparty
Receivable for investments sold and repaid
Interest receivable
Receivable for common stock purchased
Deferred financing costs
Unrealized gain on total return swap(1)
Receivable due on total return swap(1)
Prepaid expenses and other assets
Total assets
Liabilities
Unrealized loss on total return swap(1)
Payable for investments purchased
Credit facilities payable
Repurchase agreement payable(2)
Stockholder distributions payable
Management fees payable
Accrued capital gains incentive fee(3)
Administrative services expense payable
Interest payable
Deferred income
Other accrued expenses and liabilities
Total liabilities
Stockholders’ equity
Preferred stock, $0.001 par value, 50,000,000 shares authorized, none issued and outstanding
Common stock, $0.001 par value, 450,000,000 shares authorized, 246,968,207 and 160,390,540 shares issued and outstanding, respectively
Capital in excess of par value
Accumulated undistributed net realized gains on investments and total return swap and gain/loss on foreign currency(1)
Accumulated undistributed (distributions in excess of) net investment income(4)
Net unrealized appreciation (depreciation) on investments and total return swap and gain/loss on foreign currency(1)
Total stockholders' equity
Total liabilities and stockholders’ equity
Net asset value per share of common stock at period end
See notes to unaudited consolidated financial statements.
1
Unaudited Consolidated Statements of Operations
Investment Income
Interest income
Dividend income
Total investment income
Operating expenses
Management fees
Capitals gains incentive fees(1)
Administrative services expenses
Stock transfer agent fees
Accounting and administrative fees
Interest expense
Other general and administrative expenses
Total operating expenses
Net investment income
Realized and unrealized gain/loss
Net realized gain (loss) on investments
Net realized gain (loss) on total return swap(2)
Net realized gain (loss) on foreign currency
Net change in unrealized appreciation (depreciation) on investments
Net change in unrealized appreciation (depreciation) on total return swap(2)
Net change in unrealized gain (loss) on foreign currency
Total net realized and unrealized gain/loss on investments
Net increase (decrease) in net assets resulting from operations
Per share information—basic and diluted
Weighted average shares outstanding
2
Unaudited Consolidated Statements of Changes in Net Assets
(in thousands)
Operations
Net realized gain (loss) on investments, total return swap and foreign currency(1)
Net change in unrealized appreciation (depreciation) on total return swap(1)
Stockholder distributions(2)
Distributions from net investment income
Distributions from net realized gain on investments
Net decrease in net assets resulting from stockholder distributions
Capital share transactions
Issuance of common stock
Reinvestment of stockholder distributions
Repurchases of common stock
Offering costs
Net increase in net assets resulting from capital share transactions
Total increase in net assets
Net assets at beginning of period
Net assets at end of period
3
Unaudited Consolidated Statements of Cash Flows
Cash flows from operating activities
Adjustments to reconcile net increase (decrease) in net assets resulting from operations to net cash used in operating activities:
Purchases of investments
Paid-in-kind interest
Proceeds from sales and repayments of investments
Net change in unrealized (appreciation) depreciation on investments
Net change in unrealized (appreciation) depreciation on total return swap(1)
Net change in unrealized (gain) loss on foreign currency
Net realized (gain) loss on investments
Accretion of discount
Amortization of deferred financing costs
(Increase) decrease in due from counterparty
(Increase) decrease in receivable for investments sold and repaid
(Increase) decrease in interest receivable
(Increase) decrease in receivable due on total return swap(1)
(Increase) decrease in prepaid expenses and other assets
Increase (decrease) in payable for investments purchased
Increase (decrease) in management fees payable
Increase (decrease) in accrued capital gains incentive fee
Increase (decrease) in administrative services expense payable
Increase (decrease) in interest payable
Increase (decrease) in deferred income
Increase (decrease) in other accrued expenses and liabilities
Net cash used in operating activities
Cash flows from financing activities
Payments to investment adviser for offering and organization costs(2)
Stockholder distributions
Borrowings under credit facilities(3)
Borrowings under repurchase agreement(4)
Deferred financing costs paid
Net cash provided by financing activities
Total increase in cash
Cash at beginning of period
Cash at end of period
4
Unaudited Consolidated Schedule of Investments
As of June 30, 2012
(in thousands, except share amounts)
Portfolio Company(a)
Senior Secured Loans—First Lien—59.8%
A.P. Plasman Inc., L+850, 1.5% LIBOR Floor, 12/29/16(e)(f)(h)
Academy, Ltd., L+450, 1.5% LIBOR Floor, 8/3/18(d)
Advance Pierre Foods, Inc., L+525, 1.8% LIBOR Floor, 9/30/16(d)
Airvana Network Solutions Inc., L+800, 2.0% LIBOR Floor, 3/18/15(e)
Airxcel, Inc., L+575, 1.8% LIBOR Floor, 2/23/16
AlixPartners, LLP, L+525, 1.3% LIBOR Floor, 6/29/19(d)(g)
Allen Systems Group, Inc., L+575, 1.8% LIBOR Floor, 11/21/15
Altegrity, Inc., L+600, 1.8% LIBOR Floor, 2/21/15(d)
American & Efird Global, LLC, L+900, 1.5% LIBOR Floor, 12/21/16(e)(f)
American Racing & Entertainment, LLC, Term Loan A, L+700, 6/30/14(e)
American Racing & Entertainment, LLC, Term Loan B, 9.0%, 6/30/14(e)
American Racing & Entertainment, LLC, Term Loan C, 9.0%, 6/30/14(e)
Amscan Holdings, Inc., L+525, 1.5% LIBOR Floor, 12/2/17(d)
Ardent Health Services LLC, L+500, 1.5% LIBOR Floor, 9/15/15(d)
Aspect Software, Inc., L+450, 1.8% LIBOR Floor, 5/7/16(d)
Asurion, LLC, L+950, 1.5% LIBOR Floor, 8/16/19(e)
Attachmate Corp., L+575, 1.5% LIBOR Floor, 11/22/17(d)
Audio Visual Services Group, Inc., L+225, 2/28/14
Avaya Inc., L+275, 10/24/14(d)
Avaya Inc., L+450, 10/26/17(d)
Aveta, Inc., L+650, 2.0% LIBOR Floor, 4/4/17(d)
Avis Budget Car Rental, LLC, L+500, 1.3% LIBOR Floor, 9/22/18(d)(h)
AZ Chem U.S. Inc., L+575, 1.5% LIBOR Floor, 12/22/17
Barrington Broadcasting Group LLC, L+600, 1.5% LIBOR Floor, 6/14/17
BBB Industries, LLC, L+450, 2.0% LIBOR Floor, 6/28/13
Blackboard Inc., L+600, 1.5% LIBOR Floor, 10/4/18(d)(e)(f)
Boyd Gaming Corp., L+475, 1.3% LIBOR Floor, 12/17/15(d)(h)
Brock Holdings III, Inc., L+450, 1.5% LIBOR Floor, 3/14/17(d)
Caesars Entertainment Operating Co., Inc., L+425, 1/28/18(d)(g)(h)
Camp International Holding Co., L+525, 1.3% LIBOR Floor, 5/8/19(d)
Carestream Health, Inc., L+350, 1.5% LIBOR Floor, 2/25/17
Cenveo Corp., L+475, 1.5% LIBOR Floor, 12/21/16(d)
Chrysler Group LLC, L+475, 1.3% LIBOR Floor, 5/24/17(d)(e)
Citgo Petroleum Corp., L+600, 2.0% LIBOR Floor, 6/24/15(d)(h)
Citgo Petroleum Corp., L+700, 2.0% LIBOR Floor, 6/24/17(d)(e)(h)
Clear Channel Capital I, LLC, L+365, 1/29/16(e)(g)
Consolidated Container Co. LLC, L+500, 1.3% LIBOR Floor, 7/3/19(g)
The Container Store, Inc., L+500, 1.3% LIBOR Floor, 4/6/19(d)
Data Device Corp., L+550, 1.8% LIBOR Floor, 12/23/16(e)(g)
Data Device Corp., L+600, 1.5% LIBOR Floor, 6/11/18(g)
Datatel, Inc., L+500, 1.3% LIBOR Floor, 7/19/18(d)
Deluxe Entertainment Services Group Inc., L+650, 1.5% LIBOR Floor, 7/3/17(f)
Drumm Investors LLC, L+375, 1.3% LIBOR Floor, 5/4/18
Dynegy Power, LLC, L+775, 1.5% LIBOR Floor, 8/5/16
East Cameron Partners, L.P., 18.0%, 10/11/12
Eastman Kodak Co., L+750, 1.0% LIBOR Floor, 7/20/13
Education Management Holdings LLC, L+700, 1.3% LIBOR Floor, 3/30/18(d)(h)
Electrical Components International, Inc., L+525, 1.5% LIBOR Floor, 2/4/16
Electrical Components International, Inc., L+525, 1.5% LIBOR Floor, 2/4/17
Entercom Radio, LLC, L+500, 1.3% LIBOR Floor, 11/23/18(d)(h)
Everest Acquisition LLC, L+525, 1.3% LIBOR Floor, 5/25/18(d)
5
Unaudited Consolidated Schedule of Investments (continued)
Fairway Group Acquisition Co., L+600, 1.5% LIBOR Floor, 3/3/17(d)(e)
Fibertech Networks, LLC, L+500, 1.8% LIBOR Floor, 11/30/16
First Data Corp., L+275, 9/24/14(d)
First Data Corp., L+400, 3/24/18(d)
First Reserve Crestwood Holdings LLC, L+850, 2.0% LIBOR Floor, 10/3/16(e)
Flanders Corp., L+950, 1.5% LIBOR Floor, 5/14/18(e)(f)
Fleetgistics Holdings, Inc., L+588, 2.0% LIBOR Floor, 3/23/15
Florida Gaming Centers, Inc., 15.8%, 4/25/16(e)
Frac Tech International, LLC, L+475, 1.5% LIBOR Floor, 5/6/16(d)
Freescale Semiconductor, Inc., L+425, 12/1/16(d)(h)
Greeneden U.S. Holdings II, LLC, L+525, 1.5% LIBOR Floor, 1/31/19(d)
Gymboree Corp., L+350, 1.5% LIBOR Floor, 2/23/18
Halifax Media Holdings LLC, L+1050, 0.8% LIBOR Floor, 12/31/16(e)(f)
Harland Clarke Holdings Corp., L+250, 6/30/14(d)
Hawaiian Telcom Holdco, Inc., L+575, 1.3% LIBOR Floor, 2/28/17
HCR Manor Care, Inc., L+350, 1.5% LIBOR Floor, 4/6/18(e)
Hupah Finance Inc., L+500, 1.3% LIBOR Floor, 1/21/19(d)
Immucor, Inc., L+575, 1.5% LIBOR Floor, 8/19/18(d)
INC Research, LLC, L+575, 1.3% LIBOR Floor, 7/12/18(e)
Ineos Finance Plc, L+525, 1.3% LIBOR Floor, 4/27/18(d)(g)(h)
Intelligrated, Inc., L+575, 1.8% LIBOR Floor, 2/18/17(e)
Intralinks, Inc., L+425, 1.5% LIBOR Floor, 6/15/14(e)(h)
inVentiv Health, Inc., L+525, 1.5% LIBOR Floor, 5/15/18(d)
Ipreo Holdings LLC, L+650, 1.5% LIBOR Floor, 8/7/17(e)
Jason Inc., L+625, 2.0% LIBOR Floor, 9/21/14
KIK Custom Products Inc., L+225, 5/31/14(d)(h)
Kinetic Concepts, Inc., L+575, 1.3% LIBOR Floor, 5/4/18
Klune Industries, Inc., L+700, 2.0% LIBOR Floor, 8/31/17(e)(f)
La Paloma Generating Co., LLC, L+550, 1.5% LIBOR Floor, 5/15/17(d)
Lantiq Deutschland GmbH, L+700, 2.0% LIBOR Floor, 11/16/15(e)(h)
Lawson Software, Inc., L+500, 1.3% LIBOR Floor, 3/16/18(d)
Leading Edge Aviation Services, Inc., L+850, 1.5% LIBOR Floor, 4/5/18(f)
Maritime Telecommunications Network, Inc., L+600, 1.5% LIBOR Floor, 3/4/16(e)
MDA Info Products Ltd., L+550, 1.5% LIBOR Floor, 1/4/17
Mosaic U.S. Holdings Inc., L+275, 4/3/13(e)
Natural Products Group, LLC, L+700, 3.0% LIBOR Floor, 3/5/15
NCI Building Systems, Inc., L+675, 1.3% LIBOR Floor, 5/2/18(f)(g)
NCO Group, Inc., L+675, 1.3% LIBOR Floor, 4/3/18(d)(f)
Norit Holding BV, L+525, 1.5% LIBOR Floor, 7/8/17(d)(h)
NPC International, Inc., L+525, 1.5% LIBOR Floor, 12/28/18(d)
NSH Merger Sub, Inc., L+650, 1.8% LIBOR Floor, 2/3/17(e)
OpenLink International, Inc., L+625, 1.5% LIBOR Floor, 10/25/17
Ozburn-Hessey Holding Co., LLC, L+550, 2.0% LIBOR Floor, 4/8/16
Pharmaceutical Product Development, Inc., L+500, 1.3% LIBOR Floor, 12/5/18(d)
PL Propylene LLC, L+575, 1.3% LIBOR Floor, 3/27/17(h)
Postmedia Network Inc., L+500, 1.3% LIBOR Floor, 7/13/16(d)(h)
Presidio Inc., L+550, 1.8% LIBOR Floor, 3/31/17(e)
Princeton Review, Inc., L+550, 1.5% LIBOR Floor, 12/7/14
Remy International, Inc., L+450, 1.8% LIBOR Floor, 12/17/13(d)(h)
Reynolds Group Holdings, Inc., L+525, 1.3% LIBOR Floor, 2/9/18(d)(h)
Reynolds Group Holdings, Inc., L+525, 1.3% LIBOR Floor, 8/9/18(d)(h)
Sagittarius Restaurants LLC, L+550, 2.0% LIBOR Floor, 5/18/15(e)
6
Sheridan Holdings, Inc., L+475, 1.3% LIBOR Floor, 6/29/18(g)
Sheridan Production Co., LLC, L+550, 2.0% LIBOR Floor, 4/20/17(d)
Shield Finance Co. Sarl, L+450, 1.3% LIBOR Floor, 6/13/19(h)
Sitel, LLC, L+675, 1/30/17(d)
Smile Brands Group Inc., L+525, 1.8% LIBOR Floor, 12/21/17(d)
Sorenson Communication, Inc., L+400, 2.0% LIBOR Floor, 8/16/13(d)(g)
Spansion, LLC, L+550, 2.0% LIBOR Floor, 2/9/15(d)(g)(h)
Sports Authority, Inc., L+600, 1.5% LIBOR Floor, 11/16/17(d)
Sprouts Farmers Markets, LLC, L+475, 1.3% LIBOR Floor, 4/15/17
SRA International, Inc., L+525, 1.3% LIBOR Floor, 7/20/18(d)(e)
Star West Generation LLC, L+450, 1.5% LIBOR Floor, 5/17/18(d)
Styron Sarl, L+450, 1.5% LIBOR Floor, 6/14/16(d)
Summit Entertainment, LLC, L+550, 1.3% LIBOR Floor, 9/7/16(d)
Surgery Center Holdings, Inc., L+500, 1.5% LIBOR Floor, 2/6/17
Surgical Care Affiliates, LLC, L+400, 12/30/17
Technicolor SA, L+500, 2.0% LIBOR Floor, 5/26/16(g)(h)
Technicolor SA, L+600, 2.0% LIBOR Floor, 5/26/17(g)(h)
Technicolor SA, EURIBOR+500, 2.0% LIBOR Floor, 5/26/16(g)(h)
Technicolor SA, EURIBOR+600, 2.0% LIBOR Floor, 5/26/17(g)(h)
Texas Competitive Electric Holdings Co. LLC, L+350, 10/10/14
Texas Competitive Electric Holdings Co. LLC, L+450, 10/10/17(g)
Thomson Reuters (Healthcare) Inc., L+550, 1.3% LIBOR Floor, 6/3/19(d)
TI Group Automotive Systems, LLC, L+550, 1.3% LIBOR Floor, 3/19/18(d)(h)
Titlemax, Inc., L+850, 1.5% LIBOR Floor, 6/15/15(e)
Total Safety U.S., Inc., L+625, 1.3% LIBOR Floor, 4/28/18
Toys “R” Us, Inc., L+450, 1.5% LIBOR Floor, 8/17/16(d)
Travelport LLC, L+450, 8/23/15(d)(g)
Twin-Star International, Inc., L+400, 4/24/13
Unifrax I LLC, L+550, 1.5% LIBOR Floor, 11/28/18(d)
Univar Inc., L+350, 1.5% LIBOR Floor, 4/28/17(d)
Univision Communications Inc., L+425, 9/29/14(d)
Virtual Radiologic Corp., L+550, 1.8% LIBOR Floor, 12/22/16
VPG Group Holdings LLC, L+900, 1.0% LIBOR Floor, 10/5/16(e)(f)
WASH Multifamily Laundry Systems, LLC, L+500, 3.0% LIBOR Floor, 8/4/14
Web.com Group, Inc., L+550, 1.5% LIBOR Floor, 10/27/17(d)(e)(h)
Willbros Group, Inc., L+750, 2.0% LIBOR Floor, 6/30/14(f)(h)
WireCo WorldGroup Inc., L+475, 1.3% LIBOR Floor, 2/15/17(g)
Woodstream Corp., L+350, 8/22/14
Woodstream Corp., L+375, 8/22/14
Yell Group Plc, L+300, 7/31/14(h)
Zayo Group, LLC, L+550, 1.5% LIBOR Floor, 9/15/16
Zayo Group, LLC, L+588, 1.3% LIBOR Floor, 7/2/19(g)
Total Senior Secured Loans—First Lien
Unfunded Loan Commitments
Net Senior Secured Loans—First Lien
Senior Secured Loans—Second Lien—22.9%
Advance Pierre Foods, Inc., L+950, 1.8% LIBOR Floor, 9/29/17(d)(e)
Advantage Sales & Marketing Inc., L+775, 1.5% LIBOR Floor, 6/17/18(d)
AlixPartners, LLP, L+950, 1.3% LIBOR Floor, 12/27/19(d)(g)
Alkermes, Inc., L+800, 1.5% LIBOR Floor, 9/16/18(h)
American Racing & Entertainment, LLC, 12.0%, 6/30/18
7
Asurion, LLC, L+750, 1.5% LIBOR Floor, 5/24/19(d)
Atlantic Broadband Finance, LLC, L+850, 1.3% LIBOR Floor, 10/4/19(d)
Attachmate Corp., L+950, 1.5% LIBOR Floor, 10/27/18(d)(e)(g)
Blackboard Inc., L+1000, 1.5% LIBOR Floor, 10/4/19
BNY ConvergEx Group, LLC, L+700, 1.8% LIBOR Floor, 12/17/17
Brock Holdings III, Inc., L+825, 1.8% LIBOR Floor, 3/16/18(d)
Camp International Holding Co., L+875, 1.3% LIBOR Floor, 11/8/19
Data Device Corp., L+1000, 1.5% LIBOR Floor, 6/14/19(e)(g)
DEI Sales, Inc., L+850, 1.5% LIBOR Floor, 1/15/18(e)
Equipower Resources Holdings, LLC, L+850, 1.5% LIBOR Floor, 6/21/19(g)
FR Brand Acquisition Corp., L+600, 2/7/15(d)
FR Brand Acquisition Corp., L+700, 2/7/15(d)
Fram Group Holdings Inc., L+900, 1.5% LIBOR Floor, 1/29/18(d)
Goodman Global, Inc., L+700, 2.0% LIBOR Floor, 10/27/17(d)
Hubbard Radio, LLC, L+725, 1.5% LIBOR Floor, 4/27/18
JHCI Holdings, Inc., L+550, 12/19/14
JW Aluminum Co., L+675, 12/15/13(e)
Kronos Inc., L+575, 6/11/15(d)
Mood Media Corp., L+875, 1.5% LIBOR Floor, 11/6/18(d)(e)(h)
NES Rentals Holdings, Inc., L+1150, 1.8% LIBOR Floor, 10/20/14
Paw Luxco II Sarl, EURIBOR+950, 1/29/19(h)
Pelican Products, Inc., L+1000, 1.5% LIBOR Floor, 6/15/19
Pregis Corp., L+1000, 1.5% LIBOR Floor, 3/23/18(e)
Sedgwick CMS Holdings Inc., L+750, 1.5% LIBOR Floor, 5/30/17
Sensus U.S.A. Inc., L+725, 1.3% LIBOR Floor, 5/9/18(d)
Sheridan Holdings, Inc., L+775, 1.3% LIBOR Floor, 7/1/19(g)
SMG Holdings, L+950, 1.3% LIBOR Floor, 12/3/18(e)
Southern Pacific Resource Corp., Prime +750, 1/7/16(d)(e)(h)
SRAM, LLC, L+750, 1.5% LIBOR Floor, 12/7/18
TPF Generation Holdings, LLC, L+425, 12/15/14(d)
Travelport LLC, L+600, 12/1/16
Vertafore, Inc., L+825, 1.5% LIBOR Floor, 10/19/17(d)
Web.com Group, Inc., L+950, 1.5% LIBOR Floor, 10/27/18(e)(h)
Wm. Bolthouse Farms, Inc., L+750, 2.0% LIBOR Floor, 8/11/16(d)
Total Senior Secured Loans—Second Lien
Net Senior Secured Loans—Second Lien
Senior Secured Bonds—11.7%
Advanced Lighting Technologies, Inc., 10.5%, 6/1/19(e)
Allen Systems Group, Inc., 10.5%, 11/15/16(e)
Aspect Software, Inc., 10.6%, 5/15/17(d)
Avaya Inc., 7.0%, 4/1/19(d)
Cenveo Corp., 8.9%, 2/1/18
Chester Downs & Marina, LLC, 9.3%, 1/15/20(d)
Chrysler Group LLC, 8.3%, 6/15/21
Eastman Kodak Co., 10.6%, 3/15/19(e)(j)
First Data Corp., 8.9%, 8/15/20(e)
HOA Restaurant Group, LLC, 11.3%, 4/1/17(e)
Hughes Satellite Systems Corp., 6.5%, 6/15/19(d)(h)
Ineos Finance Plc, 7.5%, 5/1/20(d)(h)
Ineos Finance Plc, 8.4%, 2/15/19(d)(h)
8
NES Rentals Holdings, Inc., 12.3%, 4/15/15(g)
Paetec Holdings Corp., 8.9%, 6/30/17(d)(h)
Palace Entertainment Holdings, LLC, 8.9%, 4/15/17(d)
Reynolds Group Holdings, Inc., 7.1%, 4/15/19(d)(h)
Sorenson Communication, Inc., 10.5%, 2/1/15
Speedy Cash Intermediate Holdings Corp., 10.8%, 10/15/18(e)
Symbion, Inc., 8.0%, 6/15/16(d)(e)
Taminco Global Chemical Corp., 9.8%, 3/31/20(e)(h)
Technicolor SA, 9.4%, 4/23/16(g)(h)
Texas Competitive Electric Holdings Co. LLC, 11.5%, 10/1/20(e)
Titlemax, Inc., 13.3%, 7/15/15(e)
United Refining Co., 10.5%, 2/28/18(e)
Univision Communications Inc., 6.9%, 5/15/19
UPCB Finance VI Ltd., 6.9%, 1/15/22(d)(h)
Viasystems Group, Inc., 7.9%, 5/1/19(d)(h)
Total Senior Secured Bonds
Subordinated Debt—22.0%
Advantage Sales & Marketing Inc., 13.0%, 12/23/18
Alpha Natural Resources, Inc., 6.3%, 6/1/21(h)
Aurora Diagnostics, LLC, 10.8%, 1/15/18
BakerCorp. International Inc., 8.3%, 6/1/19(e)
Bresnan Broadband Holdings LLC, 8.0%, 12/15/18(d)(h)
Burlington Coat Factory Holdings Inc., 10.0%, 2/15/19
Calumet Lubricants Co., L.P., 9.4%, 5/1/19(h)
Calumet Lubricants Co., L.P., 9.6%, 8/1/20(h)
Cenveo Corp., 7.9%, 12/1/13
Chesapeake Energy Corp., L+700, 1.5% LIBOR Floor, 12/2/17(d)(e)(g)(h)
Cincinnati Bell Inc., 8.4%, 10/15/20(d)(h)
Commscope Inc., 8.3%, 1/15/19(d)
Comstock Resources, Inc., 9.5%, 6/15/20(d)(h)
Cumulus Media Inc., 7.8%, 5/1/19(h)
Del Monte Foods Co., 7.6%, 2/15/19(d)
Entercom Radio, LLC, 10.5%, 12/1/19(d)(h)
Everest Acquisition LLC, 9.4%, 5/1/20(d)
Flanders Corp., 10.0%, 3.8% PIK, 5/14/18
Frontier Communications Corp., 9.3%, 7/1/21(h)
Grifols, SA, 8.3%, 2/1/18(d)(h)
Gymboree Corp., 9.1%, 12/1/18
Harland Clarke Holdings Corp., 9.5%, 5/15/15
Infiltrator Systems, Inc., 12.0%, 2.0% PIK, 3/11/18
Ipreo Holdings LLC, 11.5%, 8/15/18(e)
J.Crew Group, Inc., 8.1%, 3/1/19
JBS U.S.A. LLC, 8.3%, 2/1/20(d)(h)
Kinetic Concepts, Inc., 10.5%, 11/1/18(e)
Lone Pine Resources Canada Ltd., 10.4%, 2/15/17(h)
Monitronics International, Inc., 9.1%, 4/1/20(d)(h)
NRG Energy, Inc., 8.3%, 9/1/20(d)(h)
Pharmaceutical Product Development, Inc., 9.5%, 12/1/19
Post Holdings, Inc., 7.4%, 2/15/22(d)(h)
Prestige Brands Holdings, Inc., 8.1%, 2/1/20(d)(h)
Quicksilver Resources Inc., 7.1%, 4/1/16(d)(h)
9
Resolute Energy Corp., 8.5%, 5/1/20(d)(h)
Samson Investment Co., 9.8%, 2/15/20(d)(e)
SandRidge Energy, Inc., 8.1%, 10/15/22(d)(h)
Sensata Technologies, Inc., 6.5%, 5/15/19(h)
Sequel Industrial Products Holdings, LLC, 12.5%, 2.5% PIK, 5/10/18
Symmetry Medical Inc., 12.0%, 2.0% PIK, 12/29/17(h)
ThermaSys Corp., 10.0%, 2.5% PIK, 12/31/16
Univar Inc., 12.0%, 6/30/18(e)
Total Subordinated Debt
Collateralized Securities—3.5%
Apidos CDO IV Class E, L+360, 10/27/18(h)
Ares 2007 CLO 11A Class E, L+600, 10/11/21(h)
Ares 2007 CLO 12X Class E, L+575, 11/25/20(h)
Blue Mountain CLO III Class E, L+355, 3/17/21(h)
Carlyle Azure CLO Class Income, 18.9%, 5/27/20(h)
Dryden CDO 23A Class E, L+700, 7/17/23(g)(h)
Dryden CDO 23A Class Subord., 15.6%, 7/17/23(g)(h)
Franklin CLO 6A Class E, L+425, 8/9/19(h)
Galaxy VII CLO Class Subord., 25.3%, 10/13/18(h)
Lightpoint CLO 2006 V Class D, L+365, 8/5/19(h)
Lightpoint CLO 2007 VII Class D, L+400, 5/15/21(h)
Mountain View CLO II Class Pref., 28.5%, 1/12/21(h)
Octagon CDO 2007 1A Class Income, 57.6%, 8/25/21(h)
Octagon CLO 2006 10A Class Income, 41.2%, 10/18/20(h)
Rampart CLO 2007 1A Class Subord., 36.3%, 10/25/21(h)
Stone Tower CLO VI Class Subord., 41.0%, 4/17/21(h)
Trimaran CLO IV Ltd. Class Pref., 26.2%, 12/1/17(h)
Total Collateralized Securities
Equity/Other—4.2%(i)
Aquilex Corp., Common Equity, Class A Shares(e)(j)
Aquilex Corp., Common Equity, Class B Shares(e)(j)
East Cameron Partners, L.P., Common Equity(j)
East Cameron Partners, L.P., Preferred Equity(j)
Flanders Corp., Common Equity(j)
Florida Gaming Centers, Inc., Strike: $0.01, Warrants(j)
Florida Gaming Corp., Strike: $25.00, Warrants(j)
Ipreo Holdings LLC, Common Equity(j)
JW Aluminum Co., Common Equity(j)
Klune Industries, Inc., Preferred Equity(j)
Leading Edge Aviation Services, Inc., Common Equity(j)
Leading Edge Aviation Services, Inc., Preferred Equity(j)
Milagro Holdings, LLC, Common Equity(j)
Milagro Holdings, LLC, Preferred Equity(j)
Plains Offshore Operations Inc., Preferred Equity(e)
Plains Offshore Operations Inc., Strike: $20.00, Warrants(e)(j)
Sequel Industrial Products Holdings, LLC, Common Equity(j)
Sequel Industrial Products Holdings, LLC, Preferred Equity(j)
10
Sequel Industrial Products Holdings, LLC, Strike: $100.00, Warrants(j)
ThermaSys Corp., Common Equity(j)
ThermaSys Corp., Preferred Equity(j)
VPG Group Holdings LLC, Class A-2 Units(j)
Total Equity/Other
TOTAL INVESTMENTS—124.1%
LIABILITIES IN EXCESS OF OTHER ASSETS—(24.1%)
NET ASSETS—100.0%
Total Return Swap
Citibank TRS Facility (Note 8)(h)
11
Consolidated Schedule of Investments
As of December 31, 2011
Senior Secured Loans—First Lien—68.3%
1-800 Contacts, Inc., L+395, 3.8% LIBOR Floor, 3/4/15(e)
A.P. Plasman Inc., L+850, 1.5% LIBOR Floor, 12/29/16(e)(g)
Airvana Network Solutions Inc., L+800, 2.0% LIBOR Floor, 3/18/15(e)(f)
American & Efird Global, LLC, L+900, 1.5% LIBOR Floor, 12/21/16(e)
AmWINS Group, Inc., L+250, 6/8/13(d)
Attachmate Corp., L+500, 1.5% LIBOR Floor, 4/27/17(d)
Avis Budget Car Rental, LLC, L+500, 1.3% LIBOR Floor, 9/22/18(d)(g)
AZ Chem U.S. Inc., L+575, 1.5% LIBOR Floor, 12/22/17(f)
BJ’s Wholesale Club, Inc., L+575, 1.3% LIBOR Floor, 9/29/18(d)
Blackboard Inc., L+600, 1.5% LIBOR Floor, 10/4/18(d)(e)
Boyd Gaming Corp., L+475, 1.3% LIBOR Floor, 12/17/15(d)(g)
Canwest LP, L+500, 1.3% LIBOR Floor, 7/23/16(d)(g)
CCC Information Services Inc., L+400, 1.5% LIBOR Floor, 11/11/15(d)
Cenveo Corp., L+475, 1.5% LIBOR Floor, 12/21/16(d)(g)
Ceridian Corp., L+300, 11/9/14(d)
Citgo Petroleum Corp., L+700, 2.0% LIBOR Floor, 6/24/17(d)(e)(g)
Clear Channel Capital I, LLC, L+365, 1/29/16(f)
ConvaTec Inc., L+425, 1.5% LIBOR Floor, 12/22/16(d)
Corel Corp., L+400, 5/2/12(e)(g)
Custom Building Products, Inc., L+400, 1.8% LIBOR Floor, 3/1/15(d)
Data Device Corp., L+550, 1.8% LIBOR Floor, 12/23/16(e)
Datatel, Inc., L+500, 1.3% LIBOR Floor, 7/19/18(d)(f)
Decision Resources LLC, L+550, 1.5% LIBOR Floor, 12/6/16(d)
Del Monte Foods Co., L+300, 1.5% LIBOR Floor, 3/8/18
Dynegy Power, LLC, L+775, 1.5% LIBOR Floor, 8/5/16(f)(g)
Entercom Radio, LLC, L+500, 1.3% LIBOR Floor, 11/23/18
Equipower Resources Holdings, LLC, L+425, 1.5% LIBOR Floor, 1/26/18
12
Consolidated Schedule of Investments (continued)
Freescale Semiconductor, Inc., L+425, 12/1/16(d)(g)
Goodman Global, Inc., L+400, 1.8% LIBOR Floor, 10/28/16(d)
Harbor Freight Tools USA, Inc., L+500, 1.5% LIBOR Floor, 12/22/17(d)
Harland Clarke Holdings Corp., L+250, 6/30/14(d)(f)(g)
Immucor, Inc. , L+575, 1.5% LIBOR Floor, 8/19/18(d)
Intralinks, Inc., L+425, 1.5% LIBOR Floor, 6/15/14(e)(g)
J.Crew Group, Inc., L+350, 1.3% LIBOR Floor, 3/7/18
KIK Custom Products Inc., L+225, 5/31/14(d)(g)
Kinetic Concepts, Inc., L+575, 1.3% LIBOR Floor, 5/4/18(d)
Klune Industries, Inc., L+700, 2.0% LIBOR Floor, 8/31/17(e)
La Paloma Generating Co., LLC, L+550, 1.5% LIBOR Floor, 8/25/17
Lantiq Deutschland GmbH, L+700, 2.0% LIBOR Floor, 11/16/15(d)(e)(g)
Mood Media Corp., L+550, 1.5% LIBOR Floor, 5/4/18(d)(g)
NCO Group, Inc., L+500, 2.5% LIBOR Floor, 5/15/13(d)
Norit Holding BV, L+525, 1.5% LIBOR Floor, 7/8/17(d)(g)
Ozburn-Hessey Holding Co., LLC, L+550, 2.0% LIBOR Floor, 4/8/16(d)
Playboy Enterprises, Inc., L+650, 1.8% LIBOR Floor, 3/4/17
Presidio Inc., L+550, 1.8% LIBOR Floor, 3/31/17(e)(f)
Protection One, Inc., L+425, 1.8% LIBOR Floor, 6/4/16(d)
Remy International, Inc., L+450, 1.8% LIBOR Floor, 12/17/13(d)(g)
Res-Care, Inc., L+550, 1.8% LIBOR Floor, 12/22/16(e)
Reynolds Group Holdings, Inc., L+525, 1.3% LIBOR Floor, 2/9/18(d)(g)
Reynolds Group Holdings, Inc., L+525, 1.3% LIBOR Floor, 7/31/18(d)(g)
Sealed Air Corp., L+375, 1.0% LIBOR Floor, 10/3/18(d)(g)
Shield Finance Co. Sarl, L+563, 2.0% LIBOR Floor, 6/15/16(e)(g)
Sorenson Communication, Inc., L+400, 2.0% LIBOR Floor, 8/16/13(d)
Spansion, LLC, L+550, 2.0% LIBOR Floor, 2/9/15(d)(g)
13
Summit Entertainment, LLC, L+600, 1.5% LIBOR Floor, 8/28/16(d)
Summit Materials Companies I, LLC, L+500, 1.5% LIBOR Floor, 12/31/15(d)
Surgery Center Holdings, Inc., L+500, 1.5% LIBOR Floor, 2/6/17(d)
TASC, Inc., L+325, 1.3% LIBOR Floor, 12/18/15
Telcordia Technologies Inc., L+500, 1.8% LIBOR Floor, 4/30/16(d)
Texas Competitive Electric Holdings Co. LLC, L+450, 10/10/17(d)
TNS, Inc., L+400, 2.0% LIBOR Floor, 11/18/15(d)(g)
Toys”R”Us, Inc., L+450, 1.5% LIBOR Floor, 8/17/16(d)
VPG Group Holdings LLC, L+900, 1.0% LIBOR Floor, 10/5/16(e)
W3 Co., L+625, 1.3% LIBOR Floor, 4/28/18
Web.com Group, Inc., L+550, 1.5% LIBOR Floor, 10/27/17(d)(e)(g)
Yell Group Plc, L+300, 7/31/14(g)
Senior Secured Loans—Second Lien—25.9%
Alkermes, Inc., L+800, 1.5% LIBOR Floor, 9/16/18(g)
AMN Healthcare Services, Inc., L+1000, 1.8% LIBOR Floor, 9/1/16(e)(g)
AmWINS Group, Inc., L+550, 6/8/14(e)
Aquilex Holdings LLC, L+950, 1.5% LIBOR Floor, 2/3/12
Attachmate Corp., L+800, 1.5% LIBOR Floor, 10/27/17(d)
BNY ConvergEx Group, LLC, L+700, 1.8% LIBOR Floor, 12/17/17(d)
Datatel, Inc., L+725, 1.5% LIBOR Floor, 2/18/18(d)(f)
Decision Resources LLC, L+850, 1.5% LIBOR Floor, 12/6/17(e)
Deluxe Entertainment Services Group Inc., L+900, 2.0% LIBOR Floor, 5/11/13(e)
Hubbard Radio, LLC, L+725, 1.5% LIBOR Floor, 4/27/18(d)
JHCI Holdings, Inc., L+550, 12/19/14(d)
Mood Media Corp., L+875, 1.5% LIBOR Floor, 11/6/18(e)(g)
Paw Luxco II Sarl, EURIBOR+950, 1/29/19(g)
Roundy’s Supermarkets, Inc., L+800, 2.0% LIBOR Floor, 4/16/16(d)
14
Southern Pacific Resource Corp., Prime +750, 1/7/16(d)(e)(g)
Web.com Group, Inc., L+950, 1.5% LIBOR Floor, 10/27/18(g)
Senior Secured Bonds—7.7%
Connacher Oil & Gas Ltd., 8.5%, 8/1/19(e)(g)
Eastman Kodak Co., 10.6%, 3/15/19(e)(g)
First Data Corp., 8.9%, 8/15/20(d)(e)
Hughes Satellite Systems Corp., 6.5%, 6/15/19(d)(g)
Kabel BW, 7.5%, 3/15/19(d)(g)
Nexstar Broadcasting Group, Inc., 8.9%, 4/15/17(d)(g)
Paetec Holdings Corp., 8.9%, 6/30/17(d)(g)
Roofing Supply Group LLC, 8.6%, 12/1/17(d)
Subordinated Debt—15.6%
Advantage Sales & Marketing Inc., 13.0%, 12/23/18(f)
Alpha Natural Resources, Inc., 6.3%, 6/1/21(g)
AMC Networks Inc., 7.8%, 7/15/21(g)
Aquilex Corp., 11.1%, 12/15/16(e)(h)
Bresnan Broadband Holdings LLC, 8.0%, 12/15/18(d)(g)
Calumet Lubricants Co., L.P., 9.4%, 5/1/19(g)
Cincinnati Bell Inc., 8.4%, 10/15/20(d)(g)
Cumulus Media Inc., 7.8%, 5/1/19(g)
Entercom Radio, LLC, 10.5%, 12/1/19(d)(g)
Grifols, SA, 8.3%, 2/1/18(d)(g)
Harland Clarke Holdings Corp., 9.5%, 5/15/15(g)
Hughes Satellite Systems Corp., 7.6%, 6/15/21(d)(g)
15
N.E.W. Customer Service Cos., Inc., L+750, 2.0% LIBOR Floor, 3/22/17(d)
NCO Group Inc., L+488, 11/15/13(e)
Quicksilver Resources Inc., 7.1%, 4/1/16(d)(g)
Sealed Air Corp., 8.4%, 9/15/21(d)(g)
Sensata Technologies, Inc., 6.5%, 5/15/19(g)
Symmetry Medical Inc., 12.0%, 2.0% PIK, 12/29/17(g)
WCA Waste Corp., 7.5%, 6/15/19
Collateralized Securities—4.6%
Apidos CDO IV Class E, L+360, 10/27/18(g)
Ares 2007 CLO 11A Class E, L+600, 10/11/21(g)
Ares 2007 CLO 12X Class E, L+575, 11/25/20(g)
Base CLO I Class E, EURIBOR+500, 10/17/18(g)
Blue Mountain CLO III Class E, L+355, 3/17/21(g)
Carlyle Azure CLO Class Income, 21.3%, 5/27/20(g)
Franklin CLO 6A Class E, L+425, 8/9/19(g)
Galaxy VII CLO Class Subord., 20.2%, 10/13/18(g)
Lightpoint CLO 2006 V Class D, L+365, 8/5/19(g)
Lightpoint CLO 2007 VII Class D, L+400, 5/15/21(g)
Mountain View CLO II Class Pref., 25.9%, 1/12/21(g)
Octagon CDO 2007 1A Class Income, 43.9%, 8/25/21(g)
Octagon CLO 2006 10A Class Income, 35.3%, 10/18/20(g)
Rampart CLO 2007 1A Class Subord., 21.9%, 10/25/21(g)
Stone Tower CLO VI Class Subord., 22.4%, 4/17/21(g)
Trimaran CLO IV Ltd. Class Pref., 16.6%, 12/1/17(g)
16
Equity/Other—1.0%
East Cameron Partners, L.P., Common Equity(h)
East Cameron Partners, L.P., Preferred Equity(h)
Florida Gaming Centers, Inc., Strike: $0.01, Warrants(h)
Florida Gaming Corp., Strike: $25.00, Warrants(h)
Ipreo Holdings LLC, Common Equity(h)
JW Aluminum Co., Common Equity(h)
Klune Industries, Inc., Preferred Equity(h)
Milagro Holdings, LLC, Common Equity(h)
Milagro Holdings, LLC, Preferred Equity(h)
VPG Group Holdings LLC, Class A-2 Units(h)
TOTAL INVESTMENTS—123.1%
LIABILITIES IN EXCESS OF OTHER ASSETS—(23.1%)
NET ASSETS—100%
Citibank TRS Facility (Note 8)(g)
17
Notes to Unaudited Consolidated Financial Statements
Note 1. Principal Business and Organization
FS Investment Corporation, or the Company, was incorporated under the general corporation laws of the State of Maryland on December 21, 2007 and formally commenced operations on January 2, 2009. The Company 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. The Company is an externally managed, non-diversified, closed-end management investment company that has elected to be treated for federal income tax purposes, and intends to qualify annually, as a regulated investment company, or RIC, as defined under Subchapter M of the Internal Revenue Code of 1986, as amended, or the Code. As of June 30, 2012, the Company had five wholly-owned financing subsidiaries, Broad Street Funding LLC, or Broad Street, which was established on February 2, 2010, Arch Street Funding LLC, or Arch Street, which was established on March 1, 2011, Locust Street Funding LLC, or Locust Street, which was established on July 5, 2011, Race Street Funding LLC, or Race Street, which was established on July 5, 2011, and Walnut Street Funding LLC, or Walnut Street, which was established on May 16, 2012. The consolidated financial statements include both the Company’s accounts and the accounts of its wholly-owned financing subsidiaries. All significant intercompany transactions have been eliminated in consolidation.
In May 2012, the Company closed its continuous public offering of shares of common stock to new investors. The Company sold 247,454,171 shares (as adjusted for stock distributions) of common stock for gross proceeds of $2,605,158 in its continuous public offering. Following the closing of its continuous public offering, the Company has continued to issue shares pursuant to its distribution reinvestment plan. As of August 13, 2012, the Company had sold a total of 250,237,817 shares (as adjusted for stock distributions) of common stock and raised total gross proceeds of $2,631,891, including approximately $1,000 contributed by the principals of the Company’s investment adviser in February 2008. During the six months ended June 30, 2012 and 2011, the Company sold 87,375,008 and 48,700,320 shares for gross proceeds of $926,281 and $518,405 at an average price per share of $10.60 and $10.64, respectively. The gross proceeds received during the six months ended June 30, 2012 and 2011 include reinvested stockholder distributions of $39,906 and $12,248, respectively, for which the Company issued 4,134,389 and 1,200,940 shares of common stock, respectively. During the period from July 1, 2012 to August 13, 2012, the Company received gross proceeds of $17,351 from the reinvestment of stockholders distributions, for which the Company issued 1,785,090 shares of common stock.
The proceeds from the issuance of common stock as presented on the Company’s consolidated statements of changes in net assets and consolidated statements of cash flows are presented net of selling commissions and dealer manager fees of $83,061 and $47,190 for the six months ended June 30, 2012 and 2011, respectively.
Note 2. Summary of Significant Accounting Policies
Basis of Presentation: The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP, for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. For a more complete discussion of significant accounting policies and certain other information, the Company’s interim unaudited consolidated financial statements should be read in conjunction with its audited financial statements as of and for the year ended December 31, 2011 included in the Company’s annual report on Form 10-K. Operating results for the three and six months ended June 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012. The
18
Notes to Unaudited Consolidated Financial Statements (continued)
Note 2. Summary of Significant Accounting Policies (continued)
December 31, 2011 balance sheet and schedule of investments are derived from the 2011 audited financial statements. The Company has evaluated the impact of subsequent events through the date the consolidated financial statements were issued and filed with the Securities and Exchange Commission, or the SEC.
Use of Estimates: The preparation of the financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Many of the amounts have been rounded, and all amounts are in thousands, except share and per share amounts.
Reclassifications: Certain amounts in the 2011 financial statements have been reclassified to conform to the classifications used to prepare the 2012 financial statements. These reclassifications had no material impact on the consolidated financial position, results of operations or cash flows as previously reported.
Capital Gains Incentive Fee: Pursuant to the terms of the investment advisory and administrative services agreement the Company entered into with FB Income Advisor, LLC, or FB Advisor, the incentive fee on capital gains earned on liquidated investments of the Company’s portfolio during operations prior to a liquidation of the Company is determined and payable in arrears as of the end of each calendar year (or upon termination of the investment advisory and administrative services agreement). Such fee will equal 20.0% of the Company’s incentive fee capital gains (i.e., the Company’s realized capital gains on a cumulative basis from inception, calculated as of the end of the applicable period, net of all realized capital losses and unrealized capital depreciation on a cumulative basis), less the aggregate amount of any previously paid capital gains incentive fees. On a quarterly basis, the Company accrues for the capital gains incentive fee by calculating such fee as if it were due and payable as of the end of such period.
While the investment advisory and administrative services agreement with FB Advisor neither includes nor contemplates the inclusion of unrealized gains in the calculation of the capital gains incentive fee, pursuant to an interpretation of an American Institute for Certified Public Accountants, or AICPA, Technical Practice Aid for investment companies, commencing during the quarter ended December 31, 2010, the Company changed its methodology for accruing for this incentive fee to include unrealized gains in the calculation of the capital gains incentive fee expense and related accrued capital gains incentive fee. This accrual reflects the incentive fees that would be payable to FB Advisor if the Company’s entire portfolio was liquidated at its fair value as of the balance sheet date even though FB Advisor is not entitled to an incentive fee with respect to unrealized gains unless and until such gains are actually realized. During the three and six months ended June 30, 2012, the Company accrued capital gains incentive fees of $1,698 and $16,499, respectively, based on the performance of its portfolio, of which $1,253 and $15,972, respectively, were based on unrealized gains and $445 and $527, respectively, were based on realized gains. During the three and six months ended June 30, 2011, the Company accrued capital gains incentive fees of $640 and $3,911, respectively, based on the performance of its portfolio, of which $601 and $2,743, respectively, were based on unrealized gains and $39 and $1,168, respectively, were based on realized gains.
Note 3. Recently Issued Accounting Standards
In May 2011, the Financial Accounting Standards Board, or the FASB, issued Accounting Standards Update No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement
19
Note 3. Recently Issued Accounting Standards (continued)
and Disclosure Requirements in U.S. GAAP and IFRSs. This guidance represents the converged guidance of the FASB and the International Accounting Standards Board, or collectively, the Accounting Boards, on fair value measurement. The collective efforts of the Accounting Boards reflected in this guidance have resulted in common requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term “fair value” and enhanced disclosure requirements for investments that do not have readily determinable fair values. The Accounting Boards have concluded the common requirements will result in greater comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with GAAP and International Financial Reporting Standards. The amendments to the FASB codification in this guidance are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. The Company has implemented this guidance and it did not have a material impact on its consolidated financial statements, except for enhanced disclosures around fair value measurements.
Note 4. Related Party Transactions
The Company has entered into an investment advisory and administrative services agreement with FB Advisor. Pursuant to the investment advisory and administrative services agreement, FB Advisor is entitled to an annual base management fee of 2.0% of the average value of the Company’s gross assets and an incentive fee based on the Company’s performance.
The incentive fee consists of three parts. The first part, which is referred to as the subordinated incentive fee on income, is calculated and payable quarterly in arrears and equals 20.0% of “pre-incentive fee net investment income” for the immediately preceding quarter and is subject to a hurdle rate, expressed as a rate of return on adjusted capital, as defined in the Company’s investment advisory and administrative services agreement, equal to 2.0% per quarter, or an annualized hurdle rate of 8.0%. As a result, FB Advisor will not earn this incentive fee for any quarter until the Company’s pre-incentive fee net investment income for such quarter exceeds the hurdle rate of 2.0%. Once the Company’s pre-incentive fee net investment income in any quarter exceeds the hurdle rate, FB Advisor will be entitled to a “catch-up” fee equal to the amount of the pre-incentive fee net investment income in excess of the hurdle rate, until the Company’s pre-incentive fee net investment income for such quarter equals 2.5%, or 10.0% annually, of adjusted capital. This “catch-up” feature allows FB Advisor to recoup the fees foregone as a result of the existence of the hurdle rate. The second part of the incentive fee, which is referred to as the incentive fee on capital gains during operations, is an incentive fee on capital gains earned on liquidated investments from the Company’s portfolio during operations prior to a liquidation of the Company and is determined and payable in arrears as of the end of each calendar year (or upon termination of the investment advisory and administrative services agreement). This fee equals 20.0% of the Company’s incentive fee capital gains, which equals the Company’s realized capital gains on a cumulative basis from inception, calculated as of the end of the applicable period, computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the aggregate amount of any previously paid capital gain incentive fees. The third part of the incentive fee, which is referred to as the subordinated liquidation incentive fee, equals 20.0% of the net proceeds from a liquidation of the Company in excess of adjusted capital, as calculated immediately prior to liquidation.
The Company commenced accruing fees under the investment advisory and administrative services agreement on January 2, 2009, upon the commencement of the Company’s operations. Management fees are paid
20
Note 4. Related Party Transactions (continued)
on a quarterly basis in arrears. As of December 31, 2011, $9,572 in base management fees were payable to FB Advisor. During the six months ended June 30, 2012 and 2011, the Company accrued $27,549 and $10,784, respectively, in base management fees payable to FB Advisor, including $15,345 and $6,023, respectively, in base management fees accrued during the three months ended June 30, 2012 and 2011. The Company paid $21,736 and $8,168, respectively, of these fees during the six months ended June 30, 2012 and 2011. As of June 30, 2012, there was $15,385 in management fees payable to FB Advisor.
The Company accrues for the capital gains incentive fee, which, if earned, is paid annually. The Company accrues the incentive fee based on net realized and unrealized gains; however, under the terms of the investment advisory and administrative services agreement, the fee payable to FB Advisor is based on realized gains and no such fee is payable with respect to unrealized gains unless and until such gains are actually realized. During the three months ended June 30, 2012 and 2011, the Company accrued capital gains incentive fees of $1,698 and $640, respectively, based on the performance of its portfolio, of which $1,253 and $601, respectively, were based on unrealized gains and $445 and $39, respectively, were based on realized gains. During the six months ended June 30, 2012 and 2011, the Company accrued capital gains incentive fees of $16,499 and $3,911, respectively, based on the performance of its portfolio, of which $15,972 and $2,743, respectively, were based on unrealized gains and $527 and $1,168, respectively, were based on realized gains.
The Company reimburses FB Advisor for expenses necessary to perform services related to the Company’s administration and operations. The amount of this reimbursement is set at the lesser of (1) FB Advisor’s actual costs incurred in providing such services and (2) the amount that the Company estimates it would be required to pay alternative service providers for comparable services in the same geographic location. FB Advisor is required to allocate the cost of such services to the Company based on objective factors such as total assets, revenues, time records and other reasonable metrics. The Company’s board of directors then assesses the reasonableness of such reimbursements based on the breadth, depth and quality of such services as compared to the estimated cost to the Company of obtaining similar services from third-party providers known to be available. In addition, the Company’s board of directors considers whether any single third-party service provider would be capable of providing all such services at comparable cost and quality and, at least annually, the Company’s board of directors compares the total amount paid to FB Advisor for such services as a percentage of the Company’s net assets to the same ratio as reported by other comparable BDCs.
As of December 31, 2011, the Company had $154 of administrative services expense payable to FB Advisor. During the six months ended June 30, 2012 and 2011, the Company incurred administrative services expenses of $2,334 and $988, respectively, attributable to FB Advisor, of which $2,091 and $800, respectively, related to the allocation of costs of administrative personnel for services rendered to the Company by employees of FB Advisor and the remainder related to other reimbursable expenses. The Company paid FB Advisor $1,654 and $814, respectively, for the services rendered under this arrangement during the six months ended June 30, 2012 and 2011. As of June 30, 2012, the Company had $834 in administrative services expense payable to FB Advisor.
The dealer manager for the Company’s continuous public offering was FS2Capital Partners, LLC, or FS2, which is one of the Company’s affiliates. During the six months ended June 30, 2012 and 2011, FS2 retained $15,842 and $9,115, respectively, for selling commissions and dealer manager fees in connection with the sale of the Company’s common stock.
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Under the terms of the investment advisory and administrative services agreement, when the Company’s registration statement was declared effective by the SEC and the Company was successful in raising gross proceeds in excess of $2,500, or the minimum offering requirement, from persons who were not affiliated with the Company or FB Advisor, FB Advisor became entitled to receive 1.5% of gross proceeds raised in the Company’s continuous public offering until all offering costs and organization costs funded by FB Advisor or its affiliates (including Franklin Square Holdings, L.P., or Franklin Square Holdings, the Company’s sponsor and an affiliate of FB Advisor) had been recovered. On January 2, 2009, the Company satisfied the minimum offering requirement. The Company paid total reimbursements of $0 and $641 to FB Advisor and its affiliates during the six months ended June 30, 2012 and 2011, respectively. The reimbursements were recorded as a reduction of capital. As of June 30, 2012, no amounts were payable to FB Advisor and its affiliates under this arrangement.
FB Advisor’s senior management team is comprised of the same personnel as the senior management teams of FS Investment Advisor, LLC and FSIC II Advisor, LLC, the investment advisers to Franklin Square Holdings’ other affiliated BDCs, FS Energy and Power Fund and FS Investment Corporation II, respectively. As a result, such personnel provide investment advisory services to each of the Company, FS Energy and Power Fund and FS Investment Corporation II. While none of FB Advisor, FS Investment Advisor, LLC or FSIC II Advisor, LLC is currently making private corporate debt investments for clients other than the Company, FS Energy and Power Fund and FS Investment Corporation II, respectively, any, or all, may do so in the future. In the event that FB Advisor undertakes to provide investment advisory services to other clients in the future, it intends to allocate investment opportunities in a fair and equitable manner consistent with the Company’s investment objectives and strategies, if necessary, so that the Company will not be disadvantaged in relation to any other client of FB Advisor or its management team. In addition, even in the absence of FB Advisor retaining additional clients, it is possible that some investment opportunities may be provided to FS Energy and Power Fund or FS Investment Corporation II rather than to the Company.
Beginning on February 26, 2009, Franklin Square Holdings agreed to reimburse the Company for expenses in an amount that was sufficient to ensure that, for tax purposes, the Company’s net investment income and net capital gains were equal to or greater than the cumulative distributions paid to its stockholders in each quarter. This arrangement was designed to ensure that no portion of the Company’s distributions would represent a return of capital for its stockholders. Under this arrangement, Franklin Square Holdings had no obligation to reimburse any portion of the Company’s expenses.
Pursuant to an expense support and conditional reimbursement agreement, dated as of March 13, 2012, or the expense reimbursement agreement, Franklin Square Holdings has agreed to reimburse the Company for expenses in an amount that is sufficient to ensure that no portion of the Company’s distributions to stockholders will be paid from its offering proceeds or borrowings. However, because certain investments the Company may make, including preferred and common equity investments, may generate dividends and other distributions to the Company that are treated for tax purposes as a return of capital, a portion of the Company’s distributions to stockholders may also be deemed to constitute a return of capital for tax purposes to the extent that the Company may use such dividends or other distribution proceeds to fund its distributions to stockholders. Under those circumstances, Franklin Square Holdings will not reimburse the Company for the portion of such distributions to stockholders that represent a return of capital for tax purposes, as the purpose of the expense reimbursement arrangement is not to prevent tax-advantaged distributions to stockholders.
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Under the expense reimbursement agreement, Franklin Square Holdings will reimburse the Company for expenses in an amount equal to the difference between the Company’s cumulative distributions paid to its stockholders in each quarter, less the sum of the Company’s net investment income for tax purposes, net capital gains and dividends and other distributions paid to the Company on account of preferred and common equity investments in portfolio companies (to the extent such amounts are not included in net investment income or net capital gains for tax purposes) in each quarter.
Pursuant to the expense reimbursement agreement, the Company will have a conditional obligation to reimburse Franklin Square Holdings for any amounts funded by Franklin Square Holdings under such agreement if (and only to the extent that), during any fiscal quarter occurring within three years of the date on which Franklin Square Holdings funded such amount, the sum of the Company’s net investment income for tax purposes, net capital gains and the amount of any dividends and other distributions paid to the Company on account of preferred and common equity investments in portfolio companies (to the extent not included in net investment income or net capital gains for tax purposes) exceeds the distributions paid by the Company to stockholders. The expense reimbursement agreement does not apply to any amounts funded by Franklin Square Holdings prior to the date of such agreement.
The Company or Franklin Square Holdings may terminate the expense reimbursement agreement at any time. If the Company terminates the investment advisory and administrative services agreement with FB Advisor, the Company will be required to repay Franklin Square Holdings all reimbursements funded by Franklin Square Holdings within three years of the date of termination.
The specific amount of expenses reimbursed by Franklin Square Holdings, if any, will be determined at the end of each quarter. During the six months ended June 30, 2012 and 2011, no such reimbursements were required from Franklin Square Holdings. Franklin Square Holdings is controlled by the Company’s chairman, president and chief executive officer, Michael C. Forman, and the Company’s vice-chairman, David J. Adelman. There can be no assurance that the expense reimbursement agreement will remain in effect or that Franklin Square Holdings will reimburse any portion of the Company’s expenses in future quarters.
Note 5. Distributions
The following table reflects the cash distributions per share that the Company has declared and paid on its common stock during the six months ended June 30, 2012 and 2011:
For the Three Months Ended
Fiscal 2011
March 31, 2011
June 30, 2011
Fiscal 2012
March 31, 2012
June 30, 2012
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Note 5. Distributions (continued)
On July 10, 2012, the Company’s board of directors declared a regular monthly cash distribution of $0.0675 per share, which was paid on July 31, 2012 to stockholders of record on July 30, 2012. On August 8, 2012, the Company’s board of directors declared a regular monthly cash distribution of $0.0675 per share, which is expected to be paid on August 31, 2012 to stockholders of record on August 30, 2012. The timing and amount of any future distributions to stockholders are subject to applicable legal restrictions and the sole discretion of the Company’s board of directors.
The Company has adopted an “opt in” distribution reinvestment plan for its stockholders. As a result, if the Company makes a distribution, its stockholders will receive distributions in cash unless they specifically “opt in” to the distribution reinvestment plan so as to have their cash distributions reinvested in additional shares of the Company’s common stock.
The Company may fund its cash distributions to stockholders from any sources of funds available to it, including offering proceeds, borrowings, net investment income from operations, capital gains proceeds from the sale of assets, non-capital gains proceeds from the sale of assets, dividends or other distributions paid to it on account of preferred and common equity investments in portfolio companies and expense reimbursements from Franklin Square Holdings. The Company has not established limits on the amount of funds it may use from available sources to make distributions. The following table reflects the sources of the cash distributions that the Company has paid on its common stock during the six months ended June 30, 2012 and 2011:
Source of Distribution
Offering proceeds
Borrowings
Net investment income(1)
Capital gains proceeds from the sale of assets
Non-capital gains proceeds from the sale of assets
Distributions on account of preferred and common equity
Expense reimbursement from sponsor
Total
The Company’s net investment income on a tax basis for the six months ended June 30, 2012 and 2011 was $78,011 and $25,570, respectively. As of June 30, 2012 and December 31, 2011, the Company had $444 and $2,145, respectively, of undistributed net investment income on a tax basis.
The difference between the Company’s GAAP-basis net investment income and its tax-basis net investment income is due to the tax-basis amortization of organization costs incurred prior to the commencement of the Company’s operations, the reversal of interest income earned on a tax basis due to the required accretion of
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discount on a non-performing loan which was sold during the six months ended June 30, 2011, the reversal of the required accrual for GAAP purposes of incentive fees on unrealized gains even though no such incentive fees on unrealized gains are payable by the Company, the inclusion of realized gains on the Company’s total return swap in tax-basis net investment income and the accretion of discount on the total return swap. The following table sets forth a reconciliation between GAAP-basis net investment income and tax-basis net investment income during the six months ended June 30, 2012 and 2011:
GAAP-basis net investment income
Amortization of organization costs
Reversal of tax accretion of discount on investment due to sale
Reversal of incentive fee accrual on unrealized gains
GAAP realized gains on total return swap
Accretion of discount on total return swap
Tax-basis net investment income
The determination of the tax attributes of the Company’s distributions is made annually as of the end of the Company’s fiscal year based upon the Company’s taxable income for the full year and distributions paid for the full year. Therefore, a determination made on a quarterly basis may not be representative of the actual tax attributes of the Company’s distributions for a full year. The actual tax characteristics of distributions to stockholders are reported to stockholders annually on a Form 1099-DIV.
The following table reflects the stock distributions per share that the Company has declared on its common stock through June 30, 2012:
Date Declared
Fiscal 2009
March 31, 2009
April 30, 2009
May 29, 2009
June 30, 2009
July 30, 2009
August 31, 2009
December 31, 2009
Fiscal 2010
January 28, 2010
The purpose of these special stock distributions was to maintain a net asset value per share that was below the then-current offering price, after deducting selling commissions and dealer manager fees, as required by the 1940 Act, subject to certain limited exceptions. The Company’s board of directors determined that its portfolio performance sufficiently warranted taking these actions.
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The stock distributions increased the number of shares outstanding, thereby reducing the Company’s net asset value per share. However, because the stock distributions were issued to all stockholders as of the applicable record date in proportion to their holdings as of such date, the reduction in net asset value per share as a result of the stock distributions was offset exactly by the increase in the number of shares owned by each investor. As overall value to an investor was not reduced as a result of the special stock distributions, the Company’s board of directors determined that these issuances would not be dilutive to stockholders as of the applicable record date. As the stock distributions did not change any stockholder’s proportionate interest in the Company, they did not represent taxable distributions. Specific tax characteristics of all distributions are reported to stockholders annually on Form 1099-DIV.
As of June 30, 2012 and December 31, 2011, the components of accumulated earnings on a tax-basis were as follows:
Distributable ordinary income
Incentive fee accrual on unrealized gains
Unamortized organization costs
The aggregate cost of the Company’s investments for federal income tax purposes totaled $2,909,025 and $1,862,625 as of June 30, 2012 and December 31, 2011, respectively. The aggregate net unrealized appreciation (depreciation) on a tax basis, including the Company’s total return swap, or TRS, with Citibank, N.A., or Citibank, was $40,287 and ($20,263) as of June 30, 2012 and December 31, 2011, respectively.
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Note 6. Investment Portfolio
The following table summarizes the composition of the Company’s investment portfolio at cost and fair value as of June 30, 2012 and December 31, 2011:
Senior Secured Loans—First Lien
Senior Secured Loans—Second Lien
Senior Secured Bonds
Subordinated Debt
Collateralized Securities
Equity/Other
The Company does not “control” and is not an “affiliate” of any of its portfolio companies, each as defined in the 1940 Act. In general, under the 1940 Act, the Company would be presumed to “control” a portfolio company if it owned 25% or more of its voting securities and would be an “affiliate” of a portfolio company if it owned 5% or more of its voting securities.
The Company’s investment portfolio may contain loans that are in the form of lines of credit or revolving credit facilities, which require the Company to provide funding when requested by portfolio companies in accordance with the terms of the underlying loan agreements. As of June 30, 2012, the Company had six such investments, all of which were revolving loan agreements with an aggregate unfunded commitment of $33,218. As of December 31, 2011, the Company had four such investments, three of which were revolving loan agreements with an aggregate unfunded commitment of $20,302 and one of which was an unfunded bridge loan commitment with an aggregate unfunded commitment of $35,000. The Company maintains sufficient cash on hand to fund such unfunded loan commitments should the need arise.
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Note 6. Investment Portfolio (continued)
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 June 30, 2012 and December 31, 2011:
Industry Classification
Consumer Discretionary
Consumer Staples
Energy
Financials
Healthcare
Industrials
Information Technology
Materials
Telecommunication Services
Utilities
Note 7. Fair Value of Financial Instruments
Under existing accounting guidance, fair value is defined as the price that the Company would receive upon selling an investment or pay to transfer a liability in an orderly transaction to a market participant in the principal or most advantageous market for the investment. This accounting guidance emphasizes that valuation techniques maximize the use of observable market inputs and minimize the use of unobservable inputs. Inputs refer broadly to the assumptions that market participants would use in pricing an asset or liability, including assumptions about risk. Inputs may be observable or unobservable. Observable inputs are inputs that reflect the assumptions market participants would use in pricing an asset or liability developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the assumptions market participants would use in pricing an asset or liability developed based on the best information available in the circumstances. The Company classifies the inputs used to measure these fair values into the following hierarchy as defined by current accounting guidance:
Level 1: Inputs that are quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2: Inputs that are quoted prices for similar assets or liabilities in active markets.
Level 3: Inputs that are unobservable for an asset or liability.
A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
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Note 7. Fair Value of Financial Instruments (continued)
As of June 30, 2012 and December 31, 2011, the Company’s investments were categorized as follows in the fair value hierarchy:
Valuation Inputs
Level 1—Price quotations in active markets
Level 2—Significant other observable inputs
Level 3—Significant unobservable inputs
The Company’s investments as of June 30, 2012 consisted primarily of debt securities that are traded on a private over-the-counter market for institutional investors. Except as described below, the Company valued its investments by using independent third-party pricing services, which provided prevailing bid and ask prices that were screened for validity by the services from dealers on the date of the relevant period end. Sixteen senior secured loan investments and seven subordinated debt investments, for which broker quotes were not available, were valued by an independent valuation firm, which determined the fair value of such investments by considering, among other factors, the borrower’s ability to adequately service its debt, prevailing interest rates for like investments, call features and other relevant terms of the debt. All of the Company’s equity/other investments were valued by the same independent valuation firm, which determined the fair value of such investments by considering, among other factors, contractual rights ascribed to such investments, as well as various income scenarios and multiples of earnings before interest, taxes, depreciation and amortization, or EBITDA, cash flows, net income, revenues or, in limited instances, book value or liquidation value. One senior secured loan investment, which was purchased near June 30, 2012, was valued at cost, as the Company’s board of directors determined that the cost of such investment was the best indication of its fair value. The Company valued its TRS in accordance with the agreements between Arch Street and Citibank, which collectively establish the TRS and are collectively referred to herein as the TRS Agreement. Pursuant to the TRS Agreement, the value of the TRS is based on the increase or decrease in the value of the loans underlying the TRS, together with accrued interest income, interest expense and certain other expenses incurred under the TRS. The loans underlying the TRS are valued by Citibank. Citibank bases its valuation on the indicative bid prices provided by an independent third-party pricing service. Bid prices reflect the highest price that market participants may be willing to pay. These valuations are sent to the Company for review and testing. The Company’s valuation committee and board of directors review and approve the value of the TRS, as well as the value of the loans underlying the TRS, on a quarterly basis as part of their quarterly determination of net asset value. To the extent the Company’s valuation committee or board of directors has any questions or concerns regarding the valuation of the loans underlying the TRS, such valuation will be discussed or challenged pursuant to the terms of the TRS. For additional disclosures on the Company’s TRS, see Note 8.
The Company’s investments as of December 31, 2011 consisted primarily of debt securities that are traded on a private over-the-counter market for institutional investors. Except as described below, the Company valued its investments by using independent third-party pricing services, which provided prevailing bid and ask prices that were screened for validity by the services from dealers on the date of the relevant period end. Eleven senior secured loan investments and three subordinated debt investments, for which broker quotes were not available,
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were valued by an independent valuation firm, which determined the fair value of such investments by considering, among other factors, the borrower’s ability to adequately service its debt, prevailing interest rates for like investments, call features and other relevant terms of the debt. All of the Company’s equity/other investments were valued by the same independent valuation firm, which determined the fair value of such investments by considering various factors, such as multiples of EBITDA, cash flows, net income, revenues or, in limited instances, book value or liquidation value. Two senior secured loans and two subordinated debt investments, which were purchased near December 31, 2011, were valued at cost, as the Company’s board of directors determined that the cost of each investment was the best indication of its fair value. The Company valued its TRS in accordance with the TRS Agreement, as described above. For additional disclosures on the Company’s TRS, see Note 8.
The Company periodically benchmarks the bid and ask prices received from the third-party pricing services against the actual prices at which the Company purchases and sells its investments. Based on the results of the benchmark analysis and the experience of the Company’s management in purchasing and selling these investments, the Company believes that these prices are reliable indicators of fair value. However, because of the private nature of this marketplace (meaning actual transactions are not publicly reported), the Company believes that these valuation inputs are classified as Level 3 within the fair value hierarchy. The Company may also use other methods to determine fair value for securities for which it cannot obtain prevailing bid and ask prices through third-party pricing services or independent dealers, including the use of an independent valuation firm. The Company periodically benchmarks the valuations provided by the independent valuation firm against the actual prices at which it purchases and sells its investments. The Company’s valuation committee and board of directors reviewed and approved the valuation determinations made with respect to these investments in a manner consistent with the Company’s valuation process.
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The following is a reconciliation for the six months ended June 30, 2012 and 2011 of investments for which significant unobservable inputs (Level 3) were used in determining fair value:
Fair value at beginning of period
Accretion of discount (amortization of premium)
Net realized gain (loss)
Net change in unrealized appreciation (depreciation)
Purchases
Sales and redemptions
Net transfers in or out of Level 3
Fair value at end of period
The amount of total gains or losses for the period included in changes in net assets attributable to the change in unrealized gains or losses relating to investments still held at the reporting date
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The valuation techniques and significant unobservable inputs used in recurring Level 3 fair value measurements of assets as of June 30, 2012 were as follows:
Type of Investment
Valuation Technique(2)
Unobservable Input
Range
Senior Secured Loans—First Lien:
Senior Secured Loans—Second Lien:
Subordinated Debt:
Equity/Other:
Note 8. Total Return Swap
On March 18, 2011, Arch Street entered into the TRS for a portfolio of senior secured floating rate loans with Citibank. On June 9, 2011, Arch Street entered into an amendment to the TRS to increase the maximum market value of the portfolio of loans which may be subject to the TRS from $200,000 to $300,000; on February 16, 2012, Arch Street entered into a second amendment to the TRS to increase this amount from $300,000 to $515,000; and on June 12, 2012, Arch Street entered into a third amendment to the TRS to increase this amount from $515,000 to $615,000.
A TRS 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 assets underlying the TRS, which may include a specified security, basket of securities or securities indices during the specified period, in return for periodic payments based on a fixed or variable interest rate. A TRS effectively adds 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. Because of the unique structure of a TRS, a TRS often offers lower financing costs than are offered through more traditional borrowing arrangements.
The TRS with Citibank enables the Company, through its ownership of Arch Street, to obtain the economic benefit of owning the loans subject to the TRS, without actually owning them, in return for an interest-type payment to Citibank. As such, the TRS is analogous to Arch Street borrowing funds to acquire loans and incurring interest expense to a lender.
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Note 8. Total Return Swap (continued)
The obligations of Arch Street under the TRS are non-recourse to the Company and the Company’s exposure under the TRS is limited to the value of the Company’s investment in Arch Street, which generally will equal the value of cash collateral provided by Arch Street under the TRS. Pursuant to the terms of the TRS, Arch Street may select a portfolio of loans with a maximum aggregate market value (determined at the time each such loan becomes subject to the TRS) of $615,000. Arch Street is required to initially cash collateralize a specified percentage of each loan (generally between 20% and 25% of the market value of such loan) included under the TRS in accordance with margin requirements described in the TRS Agreement. Under the terms of the TRS, Arch Street has agreed not to draw upon, or post as collateral, such cash collateral in respect of other financings or operating requirements prior to the termination of the TRS. Neither the cash collateral required to be posted with Citibank nor any other assets of Arch Street are available to pay the debts of the Company.
Pursuant to the terms of an investment management agreement that the Company has entered into with Arch Street, the Company acts as the manager of the rights and obligations of Arch Street under the TRS, including selecting the specific loans to be included in the portfolio of loans subject to the TRS. Accordingly, the loans selected by Arch Street for purposes of the TRS are selected by the Company in accordance with its investment objectives and strategy to generate current income and, to a lesser extent, long-term capital appreciation. In addition, pursuant to the terms of the TRS, Arch Street may select any loan or obligation available in the market to be included in the portfolio of loans that meets the obligation criteria set forth in the TRS Agreement.
Each individual loan, and the portfolio of loans taken as a whole, must meet criteria described in the TRS Agreement, including a requirement that each of the loans underlying the TRS be rated by Moody’s Investors Service, Inc., or Moody’s, and Standard & Poor’s Corporation, or S&P, and quoted by a nationally-recognized pricing service. Under the terms of the TRS, Citibank, as calculation agent, determines whether there has been a failure to satisfy the portfolio criteria in the TRS. If such failure continues for 30 days following the delivery of notice thereof, then Citibank has the right, but not the obligation, to terminate the TRS. Arch Street receives from Citibank all interest and fees payable in respect of the loans included in the portfolio. Arch Street pays to Citibank interest at a rate equal to the one-month London Interbank Offered Rate, or LIBOR, + 1.27% per annum on the full notional amount of the loans subject to the TRS. In addition, upon the termination or repayment of any loan subject to the TRS, Arch Street will either receive from Citibank the appreciation in the value of such loan, or pay to Citibank any depreciation in the value of such loan.
Under the terms of the TRS, Arch Street may be required to post additional cash collateral, on a dollar-for-dollar basis, in the event of depreciation in the value of the underlying loans after such value decreases below a specified amount. The amount of collateral required to be posted by Arch Street is determined primarily on the basis of the aggregate value of the underlying loans. The limit on the additional collateral that Arch Street may be required to post pursuant to the TRS is equal to the difference between the full notional amount of the loans underlying the TRS and the amount of cash collateral already posted by Arch Street.
The Company has no contractual obligation to post any such additional collateral or to make any interest payments to Citibank. The Company may, but is not obligated to, increase its equity investment in Arch Street for the purpose of funding any additional collateral or payment obligations for which Arch Street may become obligated during the term of the TRS. If the Company does not make any such additional investment in Arch Street and Arch Street fails to meet its obligations under the TRS, then Citibank will have the right to terminate the TRS and seize the cash collateral posted by Arch Street under the TRS.
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Citibank may terminate the TRS on or after March 18, 2013, the second anniversary of the effectiveness of the TRS. Arch Street may terminate the TRS at any time upon providing no more than 30 days, and no less than 10 days, prior notice to Citibank. Any termination prior to the second anniversary of the effectiveness of the TRS will result in payment of an early termination fee to Citibank based on the maximum notional amount of the TRS. Under the terms of the TRS, the early termination fee will equal the present value of a stream of monthly payments which would be owed by Arch Street to Citibank for the period from the termination date through and including March 18, 2013. Such monthly payments will equal the product of (x) $463,500, multiplied by (y) 1.27% per annum. If the TRS had been terminated as of June 30, 2012, Arch Street would have been required to pay an early termination fee of approximately $3,967. Arch Street is required to pay a minimum usage fee in connection with the TRS (other than with respect to the additional $100,000 in loans that may become subject to the TRS in connection with the amendment entered into in June 2012). Arch Street also pays Citibank customary fees in connection with the establishment and maintenance of the TRS.
The value of the TRS is based primarily on the valuation of the underlying portfolio of loans subject to the TRS. Pursuant to the terms of the TRS, on each business day, Citibank values each underlying loan in good faith on a mark-to-market basis by determining how much Citibank would receive on such date if it sold the loan in the open market. Citibank reports the mark-to-market values of the underlying loans to Arch Street.
As of June 30, 2012 and December 31, 2011, the fair value of the TRS was $2,453 and ($1,996), respectively. The fair value of the TRS is reflected as an unrealized gain or loss on total return swap on the consolidated balance sheets. The change in value of the TRS is reflected in the consolidated statements of operations as net change in unrealized appreciation (depreciation) on total return swap.
As of June 30, 2012, Arch Street had selected 125 underlying loans with a total notional amount of $546,189 and posted $126,633 in cash collateral held by Citibank (of which only $119,232 was required to be posted), which is reflected in due from counterparty on the consolidated balance sheets. As of December 31, 2011, Arch Street had selected 70 underlying loans with a total notional amount of $298,498 and posted $69,684 in cash collateral held by Citibank (of which only $61,460 was required to be posted), which is reflected in due from counterparty on the consolidated balance sheets.
For purposes of the asset coverage ratio test applicable to the Company as a BDC, the Company has agreed with the staff of the SEC to treat the outstanding notional amount of the TRS, less the initial amount of any cash collateral required to be posted by Arch Street under the TRS, as a senior security for the life of that instrument. The Company may, however, accord different treatment to the TRS in the future in accordance with any applicable new rules or interpretations adopted by the staff of the SEC.
Further, for purposes of Section 55(a) under the 1940 Act, the Company has agreed with the staff of the SEC to treat each loan underlying the TRS as a qualifying asset if the obligor on such loan is an eligible portfolio company and as a non-qualifying asset if the obligor is not an eligible portfolio company. The Company may, however, accord different treatment to the TRS in the future in accordance with any applicable new rules or interpretations adopted by the staff of the SEC.
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The following is a summary of the underlying loans subject to the TRS as of June 30, 2012:
Underlying Loan(1)
Academy, Ltd., L+450, 1.5% LIBOR Floor, 8/3/18
AccentCare, Inc., L+300, 1.0% LIBOR Floor, 2/14/17
Advantage Sales & Marketing Inc., L+375, 1.5% LIBOR Floor, 12/17/17
AlixPartners, LLP, L+525, 1.3% LIBOR Floor, 6/29/19
Alliant Holdings LLC, L+500, 1.8% LIBOR Floor, 8/21/14
Allied Security Holdings LLC, L+425, 1.3% LIBOR Floor, 2/3/17
Altegrity, Inc., L+600, 1.8% LIBOR Floor, 2/21/15
Applied Systems, Inc., L+400, 1.3% LIBOR Floor, 12/8/16
Ardent Medical Services, Inc., L+500, 1.5% LIBOR Floor, 9/15/15
Aspect Software, Inc., L+450, 1.8% LIBOR Floor, 5/7/16
Asurion, LLC, L+400, 1.5% LIBOR Floor, 5/24/18
Avis Budget Car Rental, LLC, L+500, 1.3% LIBOR Floor, 9/22/18(2)
Axcan Intermediate Holdings Inc., L+400, 1.5% LIBOR Floor, 2/11/17
Barbri, Inc., L+450, 1.5% LIBOR Floor, 6/17/17
Bass Pro Group, LLC, L+400, 1.3% LIBOR Floor, 6/13/17
Bausch & Lomb Inc., L+425, 1.0% LIBOR Floor, 5/18/19
BJ’s Wholesale Club, Inc., L+400, 1.3% LIBOR Floor, 9/30/18
Blackboard Inc., L+600, 1.5% LIBOR Floor, 10/4/18
Burlington Coat Factory Holdings Inc., L+475, 1.5% LIBOR Floor, 2/23/17
Bushnell Inc., L+375, 8/24/15
Caesars Entertainment Operating Co., Inc., L+425, 1/28/18(2)
Camp International Holding Co., L+525, 1.3% LIBOR Floor, 5/8/19
CCC Information Services Group Inc., L+400, 1.5% LIBOR Floor, 11/11/15
CCM Merger, Inc., L+475, 1.3% LIBOR Floor, 3/1/17
Cequel Communications LLC, L+300, 1.0% LIBOR Floor, 2/14/19
Chrysler Group LLC, L+475, 1.3% LIBOR Floor, 5/24/17
CompuCom Systems, Inc., L+350, 8/23/14
Consolidated Container Co. LLC, L+500, 1.3% LIBOR Floor, 7/3/19
The Container Store, Inc., L+500, 1.3% LIBOR Floor, 4/6/19
Corel Corp., L+700, 5/2/14(2)
CPG International I Inc., L+450, 1.5% LIBOR Floor, 2/18/17
Datatel, Inc., L+500, 1.3% LIBOR Floor, 7/19/18
DigitalGlobe Inc., L+450, 1.3% LIBOR Floor, 10/12/18(2)
Emergency Medical Services Corp., L+375, 1.5% LIBOR Floor, 5/25/18
Energy Transfer Equity L.P., L+300, 0.8% LIBOR Floor, 3/23/17(2)
Entercom Radio, LLC, L+500, 1.3% LIBOR Floor, 11/23/18(2)
Equipower Resources Holdings, LLC, L+500, 1.5% LIBOR Floor, 12/21/18
Fairmount Minerals, Ltd., L+400, 1.3% LIBOR Floor, 3/15/17
Flexera Software Inc., L+625, 1.3% LIBOR Floor, 9/30/17
Frac Tech International, LLC, L+475, 1.5% LIBOR Floor, 5/6/16
Freedom Group, Inc., L+425, 1.3% LIBOR Floor, 4/19/19
FREIF North American Power I LLC, L+450, 1.5% LIBOR Floor, 3/29/19
Generac Power Systems, Inc., L+500, 1.3% LIBOR Floor, 2/9/19(2)
Getty Images, Inc., L+375, 1.5% LIBOR Floor, 11/7/16
Goodman Global, Inc., L+400, 1.8% LIBOR Floor, 10/28/16
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Greeneden U.S. Holdings II, LLC, L+525, 1.5% LIBOR Floor, 1/31/19
Hamilton Lane Advisors LLC, L+500, 1.5% LIBOR Floor, 2/28/18
Harbor Freight Tools USA, Inc., L+425, 1.3% LIBOR Floor, 12/22/17
HarbourVest Partners L.P., L+475, 1.5% LIBOR Floor, 12/17/16
The Hillman Group, Inc., L+350, 1.5% LIBOR Floor, 5/28/16
Hubbard Radio, LLC, L+375, 1.5% LIBOR Floor, 4/28/17
Hunter Fan Co., L+250, 4/16/14
Hupah Finance Inc., L+500, 1.3% LIBOR Floor, 1/21/19
Hyland Software, Inc., L+475, 1.5% LIBOR Floor, 12/17/16
IASIS Healthcare LLC, L+375, 1.3% LIBOR Floor, 5/3/18
Immucor, Inc., L+575, 1.5% LIBOR Floor, 8/19/18
INC Research, LLC, L+575, 1.3% LIBOR Floor, 7/12/18
Ineos Finance Plc, L+525, 1.3% LIBOR Floor, 4/27/18(2)
Infogroup Inc., L+425, 1.5% LIBOR Floor, 5/26/18
Intelsat Jackson Holdings SA, L+375, 1.5% LIBOR Floor, 4/2/18(2)
inVentiv Health, Inc., L+500, 1.5% LIBOR Floor, 8/4/16
inVentiv Health, Inc., L+525, 1.5% LIBOR Floor, 5/15/18
JHCI Holdings, Inc., L+250, 6/19/14
Kinetek Industries, Inc., L+550, 11/14/14
Kronos Worldwide Inc., L+500, 1.3% LIBOR Floor, 12/28/17
Lawson Software, Inc., L+500, 1.3% LIBOR Floor, 3/16/18
Lord & Taylor, LLC, L+450, 1.3% LIBOR Floor, 1/11/19
MedAssets, Inc., L+375, 1.5% LIBOR Floor, 11/16/16(2)
Microsemi Corp., L+450, 1.3% LIBOR Floor, 2/2/18(2)
Monitronics International, Inc., L+425, 1.3% LIBOR Floor, 3/23/18(2)
Mood Media Corp., L+550, 1.5% LIBOR Floor, 5/6/18(2)
Mosaic U.S. Holdings Inc., L+275, 4/3/13
NCI Building Systems, Inc., L+675, 1.3% LIBOR Floor, 5/2/18
Norit Holding BV, L+525, 1.5% LIBOR Floor, 7/8/17(2)
NuSil Technology LLC, L+400, 1.3% LIBOR Floor, 4/7/17
Nuveen Investments, Inc., L+550, 5/13/17
NXP BV, L+425, 1.3% LIBOR Floor, 3/19/19(2)
NXP BV, L+425, 1.3% LIBOR Floor, 3/4/17(2)
On Assignment, Inc., L+375, 1.3% LIBOR Floor, 5/15/19(2)
Orbitz Worldwide, Inc., L+300, 7/25/14(2)
Pelican Products, Inc., L+350, 1.5% LIBOR Floor, 3/7/17
Pelican Products, Inc., L+550, 1.5% LIBOR Floor, 6/6/18
Pharmaceutical Product Development, Inc., L+500, 1.3% LIBOR Floor, 12/5/18
Presidio IS Corp., L+550, 1.8% LIBOR Floor, 3/31/17
Protection One, Inc., L+450, 1.3% LIBOR Floor, 3/21/19
PRV Aerospace, LLC, L+525, 1.3% LIBOR Floor, 5/10/18
RadNet Management, Inc., L+375, 2.0% LIBOR Floor, 4/6/16
RBS Holdings Co. LLC, L+500, 1.5% LIBOR Floor, 3/23/17
RBS Worldpay, Inc., L+450, 1.8% LIBOR Floor, 10/15/17
RedPrairie Corp., L+400, 2.0% LIBOR Floor, 3/24/16
Reynolds Group Holdings, Inc., L+525, 1.3% LIBOR Floor, 2/9/18(2)
Reynolds Group Holdings, Inc., L+525, 1.3% LIBOR Floor, 8/9/18(2)
Rocket Software Inc., L+550, 1.5% LIBOR Floor, 2/8/18
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Roofing Supply Group LLC, L+525, 1.3% LIBOR Floor, 5/31/19
Roundy’s Supermarkets, Inc., L+450, 1.3% LIBOR Floor, 2/13/19(2)
Sagittarius Restaurants LLC, L+550, 2.0% LIBOR Floor, 5/18/15
Savers, Inc., L+300, 1.3% LIBOR Floor, 3/4/17
Scitor Corp., L+350, 1.5% LIBOR Floor, 2/15/17
Scotsman Industries, Inc., L+425, 1.5% LIBOR Floor, 4/30/16
Smile Brands Group Inc., L+525, 1.8% LIBOR Floor, 12/21/17
Spectrum Brands, Inc., L+400, 1.0% LIBOR Floor, 6/16/16(2)
SRA International, Inc., L+525, 1.3% LIBOR Floor, 7/20/18
Star West Generation LLC, L+450, 1.5% LIBOR Floor, 5/17/18
SymphonyIRI Group, Inc., L+375, 1.3% LIBOR Floor, 12/1/17
Taminco Global Chemical Corp., L+500, 1.3% LIBOR Floor, 2/15/19(2)
TASC, Inc., L+325, 1.3% LIBOR Floor, 5/4/17
Telesat Canada, Inc., L+325, 1.0% LIBOR Floor, 3/28/19(2)
Thomson Reuters (Healthcare) Inc., L+550, 1.3% LIBOR Floor, 6/3/19
TI Group Automotive Systems, LLC, L+550, 1.3% LIBOR Floor, 3/19/18(2)
Totes Isotoner Corp., L+575, 1.5% LIBOR Floor, 1/8/18
TravelCLICK, Inc., L+450, 1.5% LIBOR Floor, 3/16/16
U.S. Security Associates Holdings, Inc., L+475, 1.3% LIBOR Floor, 7/28/17
United Surgical Partners International, Inc., L+475, 1.3% LIBOR Floor, 4/3/19
Vision Solutions, Inc., L+450, 1.5% LIBOR Floor, 7/23/16
Wall Street Systems Holdings, Inc., L+400, 1.5% LIBOR Floor, 6/20/17
WireCo WorldGroup Inc., L+475, 1.3% LIBOR Floor, 2/15/17
The Yankee Candle Co., Inc., L+400, 1.3% LIBOR Floor, 4/2/19
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The following is a summary of the underlying loans subject to the TRS as of December 31, 2011:
Atlantic Broadband Finance, LLC, L+300, 1.0% LIBOR Floor, 11/29/15
B&G Foods Corp., L+350, 1.0% LIBOR Floor, 11/18/18(2)
Beacon Merger Sub. Inc., L+575, 1.3% LIBOR Floor, 9/30/18
Bentley Systems Inc., L+425, 1.5% LIBOR Floor, 11/24/16
Colfax Corp., L+350, 1.0% LIBOR Floor, 1/30/19(2)
Gemini Holdings Inc., L+450, 1.5% LIBOR Floor, 6/16/17
Gibson Energy ULC, L+450, 1.3% LIBOR Floor, 6/6/18(2)
Grifols, SA, L+425, 1.8% LIBOR Floor, 6/4/16(2)
Hyland Software, Inc., L+425, 1.5% LIBOR Floor, 12/17/16
Infogroup, Inc., L+425, 1.5% LIBOR Floor, 5/25/17
inVentiv Health, Inc., L+525, 1.5% LIBOR Floor, 8/4/18
Kar Holdings, Inc., L+375, 1.3% LIBOR Floor, 5/19/17
Kronos, Inc., L+500, 1.3% LIBOR Floor, 12/28/17
NBTY, Inc., L+325, 1.0% LIBOR Floor, 10/1/17
NuSil Technology LLC, L+400, 1.3% LIBOR Floor, 5/31/17
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Protection One, Inc., L+425, 1.8% LIBOR Floor, 6/4/16
Ranpak Corp., L+350, 1.3% LIBOR Floor, 4/15/17
RBS Holdings Co. LLC, L+500, 1.5% LIBOR Floor, 3/23/17(2)
Reynolds Group Holdings, Inc., L+460, 1.2% LIBOR Floor, 7/31/18(2)
Sensus USA Inc., L+350, 1.3% LIBOR Floor, 5/5/17
Six Flags Theme Parks, Inc., L+325, 1.0% LIBOR Floor, 12/16/18(2)
SymphonyIRI Group Inc., L+375, 1.3% LIBOR Floor, 12/1/17
Terex Corp., L+400, 1.5% LIBOR Floor, 7/26/17(2)
Totes Isotoner Corp., L+575, 1.5% LIBOR Floor, 7/7/17
TravelCLICK Holdings, Inc., L+450, 1.5% LIBOR Floor, 2/11/17
Unifrax Corp., L+550, 1.5% LIBOR Floor, 11/18/18
U.S. Security Associates Holdings, Inc., L+475, 1.5% LIBOR Floor, 7/26/17
Verint Systems Inc., L+325, 1.3% LIBOR Floor, 10/15/17(2)
Vision Solutions, Inc., L+450, 1.5% LIBOR Floor, 9/20/16
Wall Street Systems Inc., L+400, 1.5% LIBOR Floor, 6/20/17
Waste Industries USA, Inc., L+350, 1.3% LIBOR Floor, 3/17/17
TOTAL
Total TRS Fair Value:
Note 9. Share Repurchase Program
The Company intends to conduct quarterly tender offers pursuant to its share repurchase program. The Company’s board of directors will consider the following factors, among others, in making its determination regarding whether to cause the Company to offer to repurchase shares and under what terms:
the effect of such repurchases on the Company’s qualification as a RIC (including the consequences of any necessary asset sales);
the liquidity of its assets (including fees and costs associated with disposing of assets);
the Company’s investment plans and working capital requirements;
the relative economies of scale with respect to the Company’s size;
the Company’s history in repurchasing shares or portions thereof; and
the condition of the securities markets.
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Note 9. Share Repurchase Program (continued)
The Company currently intends to limit the number of shares to be repurchased during any calendar year to the number of shares it can repurchase with the proceeds it receives from the sale of shares under its distribution reinvestment plan. At the discretion of the Company’s board of directors, the Company may also use cash on hand, cash available from borrowings and cash from liquidation of securities investments as of the end of the applicable period to repurchase shares. In addition, the Company will limit the number of shares to be repurchased in any calendar year to 10% of the weighted average number of shares outstanding in the prior calendar year, or 2.5% in each quarter, though the actual number of shares that the Company offers to repurchase may be less in light of the limitations noted above. The Company will offer to repurchase such shares on each date of repurchase at a price equal to 90% of the share price in effect on each date of repurchase, which will be determined in the same manner that the Company determined the offering price per share for purposes of its continuous public offering. The Company’s board of directors may amend, suspend or terminate the repurchase program at any time upon 30 days’ notice. The first such tender offer commenced in March 2010, and the repurchase occurred in connection with the Company’s April 1, 2010 closing. During the six months ended June 30, 2012, the Company repurchased 797,341 shares at $9.63 per share for aggregate consideration totaling $7,679. On July 2, 2012, the Company repurchased 410,578 shares at $9.72 per share for aggregate consideration totaling $3,991.
Note 10. Broad Street Credit Facility
On January 28, 2011, Broad Street, Deutsche Bank AG, New York Branch, or Deutsche Bank, and the other lenders party thereto entered into an amended and restated multi-lender, syndicated revolving credit facility, or the Broad Street credit facility, which amended and restated the revolving credit facility that Broad Street originally entered into with Deutsche Bank on March 10, 2010 and the amendments thereto. On March 23, 2012, Broad Street entered into an amendment to the Broad Street credit facility to extend the maturity date of the facility to March 23, 2013, increase the amount of the Tranche C Commitment (described below) from $100,000 to $140,000 and reduce the interest rate for all borrowings under the facility to a rate of LIBOR + 1.50% per annum. Deutsche Bank is a lender and serves as administrative agent under the Broad Street credit facility.
The Broad Street credit facility provides for borrowings in an aggregate amount up to $380,000. Pursuant to the terms of the facility, borrowings thereunder may be designated as Tranche A borrowings in an amount up to $240,000 (referred to herein as the Tranche A Commitment) or as Tranche C borrowings in an amount up to $140,000 (referred to herein as the Tranche C Commitment). The facility also provides for Tranche B borrowings in an amount up to $100,000 (referred to herein as the Tranche B Commitment), but there are currently no Tranche B Commitments outstanding. All Tranche A Commitments and Tranche C Commitments bear interest at the rate of LIBOR + 1.50% per annum and will mature and be due and payable on March 23, 2013.
Under the Broad Street credit facility, the Company has transferred from time to time debt securities to Broad Street as a contribution to capital and retains a residual interest in the contributed debt securities through the Company’s ownership of Broad Street. The Company may contribute additional debt securities to Broad Street from time to time and Broad Street may purchase additional debt securities from various sources. Broad Street has appointed the Company to manage its portfolio of debt securities pursuant to the terms of an investment management agreement. Broad Street’s obligations to the lenders under the facility are secured by a first priority security interest in substantially all of the assets of Broad Street, including its portfolio of debt securities. The obligations of Broad Street under the facility are non-recourse to the Company and the Company’s exposure under the facility is limited to the value of the Company’s investment in Broad Street.
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Note 10. Broad Street Credit Facility (continued)
As of June 30, 2012 and December 31, 2011, $380,000 and $340,000, respectively, was outstanding under the Broad Street credit facility. The carrying amount of the amount outstanding under the facility approximates its fair value. The Company incurred costs of $2,504 in connection with obtaining and amending the facility, which the Company has recorded as deferred financing costs on its consolidated balance sheets and amortizes to interest expense over the life of the facility. As of June 30, 2012, $690 of such deferred financing costs had yet to be amortized to interest expense.
The effective interest rate under the Broad Street credit facility was 1.91% per annum as of June 30, 2012. Interest is paid quarterly in arrears and commenced August 20, 2010. The Company recorded interest expense of $2,006 and $2,267 for the three months ended June 30, 2012 and 2011, respectively, of which $237 and $223, respectively, related to the amortization of deferred financing costs and $18 and $0, respectively, related to commitment fees on the unused portion of the credit facility. The Company recorded interest expense of $4,430 and $4,460 for the six months ended June 30, 2012 and 2011, respectively, of which $431 and $428, respectively, related to the amortization of deferred financing costs and $18 and $0, respectively, related to commitment fees on the unused portion of the credit facility. The Company paid $4,270 and $4,248 in interest expense for the six months ended June 30, 2012 and 2011, respectively. The average borrowings under the facility for the six months ended June 30, 2012 and 2011 were $357,166 and $337,434, respectively, with a weighted average interest rate of 2.26% and 2.35%, respectively.
Borrowings under the Broad Street credit facility are subject to compliance with a borrowing base, pursuant to which the amount of funds advanced to Broad Street varies depending upon the types of assets in Broad Street’s portfolio. The occurrence of certain events described as “Super-Collateralization Events” in the credit agreement that governs the facility, or a decline in the Company’s net asset value below a specified threshold, results in a lowering of the amount of funds that will be advanced against such assets. Super-Collateralization Events include, without limitation, (i) certain key employees ceasing to be directors, principals, officers or investment managers of GSO / Blackstone Debt Funds Management LLC, or GDFM, the sub-adviser to the Company; (ii) the bankruptcy or insolvency of GDFM or FB Advisor; (iii) GDFM ceasing to act as the Company’s sub-adviser or FB Advisor ceasing to act as the Company’s investment adviser; (iv) the Company ceasing to act as Broad Street’s investment manager, becoming bankrupt or insolvent, defaulting on certain material agreements or failing to maintain a net asset value at least equal to $50,000; and (v) the Company, GDFM or FB Advisor committing fraud or other illicit acts in its or their investment advisory capacities.
In connection with the facility, Broad Street has made certain representations and warranties and is required to comply with various covenants, reporting requirements and other customary requirements for similar facilities. In addition to customary events of default included in financing transactions, the facility contains the following events of default: (a) the failure to make principal payments when due or interest payments within three business days of when due; (b) borrowings under the facility exceeding the applicable advance rates; (c) the purchase by Broad Street of certain ineligible assets; (d) the insolvency or bankruptcy of Broad Street or the Company; (e) the Company ceases to act as investment manager of Broad Street’s assets; (f) the decline of the Company’s net asset value below $50,000; and (g) fraud or other illicit acts by the Company, FB Advisor or GDFM in its or their investment advisory capacities. During the continuation of an event of default, Broad Street must pay interest at a default rate.
Broad Street has agreed to pay Deutsche Bank $950 upon the termination date of the Broad Street credit facility, provided that such termination fee will not be payable if Broad Street refinances the facility with Deutsche Bank or enters into an alternate financing arrangement with or through Deutsche Bank.
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Borrowings of Broad Street will be considered borrowings of the Company for purposes of complying with the asset coverage requirements under the 1940 Act applicable to BDCs.
Note 11. Broad Street Funding LLC
The financial statements of Broad Street are maintained separately from those of the Company. The assets of Broad Street are pledged as collateral supporting the amounts outstanding under the Broad Street credit facility and, as such, are not available to pay the debts of the Company. The following are the balance sheets of Broad Street as of June 30, 2012 and December 31, 2011:
Investments, at fair value (amortized cost—$716,028 and $652,920, respectively)
Credit facility payable
Due to FS Investment Corporation
Accrued expenses
Member’s equity
Total liabilities and member's equity
Note 12. Repurchase Transaction
On July 21, 2011, the Company entered into a conventional debt financing arrangement with JPMorgan Chase Bank, N.A., London Branch, or JPM, through two wholly-owned subsidiaries, pursuant to which up to $300,000 was made available to the Company to fund investments in new securities and for other general corporate purposes. On February 15, 2012, the Company amended the JPM financing arrangement to increase the amount of the debt financing available under the arrangement from $300,000 to $400,000. Pricing under the facility is based on three-month LIBOR plus a spread of 3.25% per annum for the relevant period. The Company elected to structure the financing in the manner described more fully below in order to, among other things, obtain such financing at a lower cost than would be available through alternate arrangements.
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Note 12. Repurchase Transaction (continued)
Pursuant to the financing transaction, loans in the Company’s portfolio having an aggregate market value of up to $800,000 may be sold by the Company from time to time to Locust Street, a special-purpose, bankruptcy-remote subsidiary of the Company, pursuant to an asset transfer agreement the Company entered into with Locust Street, or the Asset Transfer Agreement. Under the Asset Transfer Agreement, as of June 30, 2012, the Company had sold loans to Locust Street for a purchase price of approximately $365,396, all of which consisted of equity interests in Locust Street that Locust Street issued to the Company. The Company owns all of the equity in Locust Street.
Loans purchased by Locust Street will secure the obligations of Locust Street under Class A Floating Rate Notes, or the Class A Notes, to be issued by Locust Street from time to time to Race Street, another special-purpose, bankruptcy-remote subsidiary of the Company, pursuant to an indenture that Locust Street entered into with Citibank, as trustee, or the Indenture. The Class A Notes may be issued in an aggregate principal amount of up to $560,000 and mature on July 15, 2021. Race Street will purchase the issued Class A Notes from time to time at a purchase price equal to their par value and intends to purchase up to $560,000 in aggregate principal amount of such Class A Notes. The Company owns all of the equity in Race Street.
Race Street, in turn, has entered into repurchase transactions with JPM pursuant to the terms of a master repurchase agreement and the related annex and amended and restated confirmation to such agreement, or collectively, the JPM Facility. Pursuant to the JPM Facility, JPM has agreed to purchase from time to time Class A Notes held by Race Street for an aggregate purchase price equal to approximately 71% of the principal amount of Class A Notes purchased. Subject to certain conditions, the maximum principal amount of Class A Notes that may be purchased under the JPM Facility is $560,000. Accordingly, the maximum amount payable at any time to Race Street under the JPM Facility will not exceed $400,000. Under the JPM Facility, Race Street will, on a quarterly basis, repurchase the Class A Notes sold to JPM under the JPM Facility and subsequently resell such Class A Notes to JPM. The final repurchase transaction must occur no later than July 15, 2015. The repurchase price paid by Race Street to JPM for each repurchase of the Class A Notes will be equal to the purchase price paid by JPM for such Class A Notes, plus interest thereon accrued at the applicable pricing rate under the JPM Facility, as described below.
If at any time during the term of the JPM Facility the market value of the underlying loans held by Locust Street securing the Class A Notes declines by an amount greater than 27% of their initial aggregate purchase price, or the Margin Threshold, Race Street will be required to post cash collateral with JPM in an amount at least equal to the amount by which the market value of such loans at such time is less than the Margin Threshold. In such event, in order to satisfy these margin-posting requirements, Race Street intends to borrow funds from the Company pursuant to a revolving credit agreement the Company entered into, as lender, with Race Street, as borrower, on July 21, 2011, or the Revolving Credit Agreement. The Company may, in its sole discretion, make such loans from time to time to Race Street pursuant to the terms of the Revolving Credit Agreement. Borrowings under the Revolving Credit Agreement accrue interest at a rate equal to one-month LIBOR plus a spread of 0.75% per annum.
Interest on the Class A Notes accrues at three-month LIBOR plus a spread of 4.00% per annum. Principal on the Class A Notes will be due and payable on the stated maturity date of July 15, 2021. Pursuant to the Indenture, Locust Street has made certain representations and warranties and is required to comply with various covenants, reporting requirements and other customary requirements for similar transactions. In addition to
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customary events of default included in similar transactions, the Indenture contains the following events of default: (a) the failure to make principal payments on the Class A Notes at their stated maturity or redemption date, or to make interest payments on the Class A Notes within five business days of when due; (b) the failure of the aggregate outstanding principal balance (subject to certain reductions) of the loans securing the Class A Notes to be at least 130% of the outstanding principal amount of the Class A Notes; and (c) GDFM ceasing to be the sub-advisor to FB Advisor.
In connection with the Class A Notes and the Indenture, Locust Street also entered into (i) a collateral management agreement with the Company, as collateral manager, dated as of July 21, 2011, pursuant to which the Company will manage the assets of Locust Street, and (ii) a collateral administration agreement with Virtus Group, LP, or Virtus, as collateral administrator, dated as of July 21, 2011, pursuant to which Virtus will perform certain administrative services with respect to the assets of Locust Street.
Pricing under the JPM Facility is based on three-month LIBOR plus a spread of 3.25% per annum for the relevant period. Commencing January 2013, Race Street is permitted to reduce (based on certain thresholds) the aggregate principal amount of Class A Notes subject to the JPM Facility. Such reductions will be subject to breakage fees calculated as the present value of 1.25% per annum over the remaining term of the JPM Facility applied to the amount of such reduction.
As of June 30, 2012 and December 31, 2011, Class A Notes in the aggregate principal amount of $490,000 and $300,000, respectively, had been purchased by Race Street from Locust Street and subsequently sold to JPM under the JPM Facility for aggregate proceeds of $350,000 and $214,286, respectively. As of June 30, 2012 and December 31, 2011, the fair value of investments held by Locust Street was $805,156 and $576,830, respectively, which included investments purchased by Locust Street with proceeds from the issuance of Class A Notes. On July 16, 2012, an additional Class A Note in the principal amount of $70,000 was purchased by Race Street from Locust Street and subsequently sold to JPM for proceeds of $50,000. The Company funded each purchase of Class A Notes by Race Street through a capital contribution to Race Street. As of June 30, 2012 and December 31, 2011, Race Street’s liability under the JPM Facility was $350,000 and $214,286, respectively, plus $2,747 and $1,294, respectively, of accrued interest expense. The Class A Notes issued by Locust Street and purchased by Race Street eliminate in consolidation on the Company’s financial statements.
The Company incurred costs of $425 in connection with obtaining the JPM Facility, which the Company has recorded as deferred financing costs on its consolidated balance sheets and amortizes to interest expense over the life of the JPM Facility. As of June 30, 2012, $327 of such deferred financing costs had yet to be amortized to interest expense.
The effective interest rate on the borrowings under the JPM Facility was 3.72% per annum as of June 30, 2012. The Company recorded interest expense of $3,250 and $6,007, respectively, for the three and six months ended June 30, 2012, of which $26 and $53, respectively, related to the amortization of deferred financing costs. The Company paid $2,862 and $4,501, respectively, in interest expense during the three and six months ended June 30, 2012. The average borrowings under the JPM Facility for the three and six months ended June 30, 2012 were $341,667 and $313,069, respectively, with a weighted average interest rate of 3.77% and 3.76%, respectively.
Amounts outstanding under the JPM Facility will be considered borrowings by the Company for purposes of complying with the asset coverage requirements under the 1940 Act applicable to BDCs.
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Note 13. Walnut Street Credit Facility
On May 17, 2012, Walnut Street, Wells Fargo Securities, LLC, and Wells Fargo Bank, National Association, or collectively with Wells Fargo Securities, LLC, Wells Fargo, entered into a revolving credit facility, or the Walnut Street credit facility. Wells Fargo Securities, LLC serves as the administrative agent and Wells Fargo Bank, National Association is the sole lender, collateral agent, account bank and collateral custodian under the facility. The Walnut Street credit facility provides for borrowings in an aggregate principal amount up to $250,000 on a committed basis.
Under the Walnut Street credit facility, the Company contributes cash or debt securities to Walnut Street from time to time and retains a residual interest in any assets contributed through its ownership of Walnut Street or receives fair market value for any debt securities sold to Walnut Street. Walnut Street may purchase additional debt securities from various sources. Walnut Street has appointed the Company to manage its portfolio of debt securities pursuant to the terms of a collateral management agreement. Walnut Street’s obligations to Wells Fargo under the Walnut Street credit facility are secured by a first priority security interest in substantially all of the assets of Walnut Street, including its portfolio of debt securities. The obligations of Walnut Street under the Walnut Street credit facility are non-recourse to the Company.
Pricing under the Walnut Street credit facility is based on LIBOR for an interest period equal to the weighted average LIBOR interest period of eligible debt securities owned by Walnut Street, plus a spread ranging between 1.50% and 2.75% per annum, depending on the composition of the portfolio of debt securities for the relevant period. Beginning on September 17, 2012, Walnut Street will be subject to a non-usage fee to the extent the aggregate principal amount available under the Walnut Street credit facility has not been borrowed. Any amounts borrowed under the Walnut Street credit facility will mature, and all accrued and unpaid interest thereunder will be due and payable, on May 17, 2017.
As of June 30, 2012, $7,967 was outstanding under the Walnut Street credit facility. The carrying amount outstanding under the facility approximates its fair value. The Company incurred costs of $3,576 in connection with obtaining the Walnut Street credit facility, which the Company has recorded as deferred financing costs on its consolidated balance sheets and amortizes to interest expense over the life of the facility. As of June 30, 2012, $3,488 of such deferred financing costs had yet to be amortized to interest expense.
The effective interest rate on the borrowings under the Walnut Street credit facility was 2.71% per annum as of June 30, 2012. Interest is payable quarterly in arrears and will commence October 15, 2012. The Company recorded interest expense of $90 for the six months ended June 30, 2012, of which $88 related to the amortization of deferred financing costs. The Company paid $0 in interest expense during the six months ended June 30, 2012. The average borrowings under the Walnut Street credit facility for the six months ended June 30, 2012 was $88, with a weighted average interest rate of 2.71%.
Borrowings under the Walnut Street credit facility are subject to compliance with a borrowing base, pursuant to which the amount of funds advanced to Walnut Street varies depending upon the types of debt securities in Walnut Street’s portfolio.
The occurrence of certain events described as “Collateral Control Events,” or collateral control events, in the credit agreement which governs the Walnut Street credit facility triggers (i) a requirement that Walnut Street obtain the consent of Wells Fargo prior to entering into any transaction with respect to portfolio assets and (ii) the right of Wells Fargo to direct Walnut Street to enter into transactions with respect to any portfolio assets,
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(in thousands, except share information)
Note 13. Walnut Street Credit Facility (continued)
in each case in Wells Fargo’s sole discretion. Collateral control events include non-performance of any obligation under the transaction documents by Walnut Street, the Company, FB Advisor or GDFM, and other events with respect to such entities that are adverse to Wells Fargo and the secured parties under the Walnut Street credit facility.
In connection with the Walnut Street credit facility, Walnut Street has made certain representations and warranties and is required to comply with various covenants, reporting requirements and other customary requirements for similar facilities. In addition to customary events of default included in financing transactions, the Walnut Street credit facility contains the following events of default: (a) the failure to make principal payments when due or interest payments within three business days of when due; (b) a borrowing base deficiency that is not cured in accordance with the terms of the facility; (c) the insolvency or bankruptcy of Walnut Street or the Company; (d) the resignation or removal of the Company as collateral manager; (e) the failure of the Company to maintain an asset coverage ratio of greater than or equal to 2:1; (f) the failure of the Company to have a net asset value of at least $200,000; and (g) the failure of Walnut Street to qualify as a bankruptcy-remote entity. Upon the occurrence and during the continuation of an event of default, Wells Fargo may declare the outstanding advances and all other obligations under the Walnut Street credit facility immediately due and payable. During the continuation of an event of default, Walnut Street must pay interest at a default rate.
Borrowings of Walnut Street will be considered borrowings of the Company for purposes of complying with the asset coverage requirements under the 1940 Act applicable to BDCs.
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Note 14. Financial Highlights
The following is a schedule of financial highlights of the Company for the six months ended June 30, 2012 and the year ended December 31, 2011:
Per Share Data:(1)
Net asset value, beginning of period
Results of operations(2)
Net realized and unrealized appreciation (depreciation) on investments and total return swap and gain/loss on foreign currency
Stockholder distributions(3)
Issuance of common stock(4)
Repurchases of common stock(5)
Offering costs(2)
Net increase (decrease) in net assets resulting from capital share transactions
Net asset value, end of period
Shares outstanding, end of period
Total return(6)
Ratio/Supplemental Data:
Net assets, end of period
Ratio of net investment income to average net assets(7)
Ratio of accrued incentive fees to average net assets(7)
Ratio of interest expense to average net assets(7)
Ratio of operating expenses to average net assets(7)
Portfolio turnover(7)
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Note 14. Financial Highlights (continued)
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The information contained in this section should be read in conjunction with our unaudited consolidated financial statements and related notes thereto appearing elsewhere in this quarterly report on Form 10-Q. In this report, “we,” “us” and “our” refer to FS Investment Corporation.
Forward-Looking Statements
Some of the statements in this quarterly report on Form 10-Q constitute forward-looking statements because they relate to future events or our future performance or financial condition. The forward-looking statements contained in this quarterly report on Form 10-Q may include statements as to:
our future operating results;
our business prospects and the prospects of our portfolio companies;
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;
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 FB Advisor, FS Investment Advisor, LLC, FSIC II Advisor, LLC, FS Energy and Power Fund, FS Investment Corporation II, GDFM or any of their affiliates;
the dependence of our future success on the general economy and its effect on the industries in which we invest;
our use of financial leverage;
the ability of FB Advisor to locate suitable investments for us and to monitor and administer our investments;
the ability of FB 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 Wall Street Reform and Consumer Protection Act and the rules and regulations issued thereunder;
the effect of changes to tax legislation and our tax position; and
the tax status of the enterprises in which we invest.
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 quarterly report on Form 10-Q involve risks and uncertainties. Our actual results could differ materially from those implied or expressed in the forward-looking statements for any reason. 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 or natural disasters; and
future changes in laws or regulations and conditions in our operating areas.
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We have based the forward-looking statements included in this quarterly report on Form 10-Q on information available to us on the date of this quarterly report on Form 10-Q, and we assume no obligation to update any such forward-looking statements. 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 quarterly report on Form 10-Q 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 Securities Exchange Act of 1934, as amended, or the Exchange Act.
Overview
We were incorporated under the general corporation laws of the State of Maryland on December 21, 2007, and commenced operations on January 2, 2009 upon raising gross proceeds in excess of $2,500 from sales of shares of our common stock in our continuous public offering to persons who were not affiliated with us or FB Advisor. 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 federal income tax purposes, and intends to qualify annually, as a RIC under the Code. In May 2012, we closed our continuous public offering of shares of common stock to new investors.
Our investment objectives are to generate current income and, to a lesser extent, long-term capital appreciation. Our portfolio is comprised primarily of investments in senior secured loans, second lien secured loans and, to a lesser extent, subordinated loans of private U.S. companies. We may purchase interests in loans through secondary market transactions in the “over-the-counter” market for institutional loans or directly from our target companies. 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 minority interests in the form of common or preferred equity in our target companies, either in conjunction with one of our debt investments or through a co-investment with a financial sponsor. In addition, a portion of our portfolio may be comprised of corporate bonds and other debt securities.
The senior secured and second lien secured loans in which we invest generally have stated terms of three to seven years and our subordinated debt investments generally have stated terms of up to ten years, but the expected average life of such securities is generally between three and seven years. However, there is no limit on the maturity or duration of any security in our portfolio. The loans in which we invest are often rated by a nationally-recognized statistical ratings organization and generally will carry a rating below investment grade (rated lower than “Baa3” by Moody’s or lower than “BBB-” by S&P). However, we also invest in non-rated debt securities.
Our investment activities are managed by FB Advisor and supervised by our board of directors, a majority of whom are independent. Under our investment advisory and administrative services agreement, we have agreed to pay FB Advisor an annual base management fee based on our gross assets as well as incentive fees based on our performance. See “—Contractual Obligations” for a description of the fees to which FB Advisor is entitled.
FB Advisor has engaged GDFM to act as our investment sub-adviser. GDFM assists FB Advisor in identifying investment opportunities and makes investment recommendations for approval by FB Advisor according to asset allocation and other guidelines set by FB Advisor. GDFM, a registered investment adviser under the Investment Advisers Act of 1940, as amended, is a subsidiary of GSO Capital Partners LP, or GSO. GSO, the credit platform of The Blackstone Group L.P., a leading global alternative asset manager and provider of financial advisory services, is one of the world’s largest credit platforms in the alternative asset business with approximately $50.5 billion in assets under management as of June 30, 2012.
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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 on investments, net realized gain on total return swap, net unrealized appreciation and depreciation on investments, net unrealized appreciation and depreciation on total return swap and net unrealized gain and loss on foreign currency. Net investment income is the difference between our income from interest, dividends, fees and other investment income and our operating expenses. Net realized gain on investments is the difference between the proceeds received from dispositions of portfolio investments and their stated cost. Net realized gain on total return swap is the net monthly settlement payments received on the TRS. Net unrealized appreciation and depreciation on investments is the net change in the fair value of our investment portfolio. Net unrealized appreciation and depreciation on total return swap is the net change in fair value of the TRS. Net unrealized gain and loss on foreign currency is the net change in the value of receivables or accruals due to the impact of foreign currency fluctuations.
We may also generate revenues in the form of dividends and other distributions on the equity or other securities we hold. In addition, we may generate revenues in the form of commitment, closing, origination, structuring or diligence fees, monitoring fees, fees for providing managerial assistance, consulting fees and performance-based fees. Any such fees generated in connection with our investments will be recognized as earned.
Expenses
Our primary operating expenses include the payment of advisory fees and other expenses under the investment advisory and administrative services agreement, interest expense from financing facilities and other expenses necessary for our operations. Our investment advisory fee compensates FB Advisor for its work in identifying, evaluating, negotiating, executing, monitoring and servicing our investments. FB Advisor is responsible for compensating our investment sub-adviser.
We reimburse FB Advisor for expenses necessary to perform services related to our administration and operations. The amount of this reimbursement is set at the lesser of (1) FB Advisor’s actual costs incurred in provided such services and (2) the amount that we estimate we would be required to pay alternative service providers for comparable services in the same geographic location. FB Advisor is required to allocate the cost of such services to us based on objective factors such as total assets, revenues, time records and other reasonable metrics. Our board of directors then assesses the reasonableness of such reimbursements 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 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 and, at least annually, our board of directors compares the total amount paid to FB Advisor for such services as a percentage of our net assets to the same ratio as reported by other comparable BDCs.
We do not reimburse FB Advisor for any services for which it receives a separate fee, or for rent, depreciation, utilities, capital equipment or other administrative items allocated to a controlling person of FB Advisor. 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 common stock, subject to limitations included in the investment advisory and administrative services 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;
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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;
fees and expenses associated with marketing efforts;
federal and state registration fees;
federal, state and local taxes;
fees and expenses of directors not also serving in an executive officer capacity for us or FB Advisor;
costs of proxy statements, stockholders’ reports and notices;
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 independent audits and outside legal costs, including compliance with the Sarbanes-Oxley Act of 2002;
costs associated with our reporting and compliance obligations under the 1940 Act and applicable federal and state securities laws;
brokerage commissions for the purchase and sale of our investments;
costs associated with our chief compliance officer; and
all other expenses incurred by FB Advisor, GDFM or us in connection with administering our business, including expenses incurred by FB Advisor or GDFM in performing administrative services for us and administrative personnel paid by FB Advisor, to the extent they are not controlling persons of FB Advisor or any of its affiliates, subject to the limitations included in the investment advisory and administrative services agreement.
Beginning on February 26, 2009, Franklin Square Holdings agreed to reimburse us for expenses in an amount that was sufficient to ensure that, for tax purposes, our net investment income and net capital gains were equal to or greater than the cumulative distributions paid to our stockholders in each quarter. This arrangement was designed to ensure that no portion of our distributions would represent a return of capital for our stockholders. Under this arrangement, Franklin Square Holdings had no obligation to reimburse any portion of our expenses.
Pursuant to the expense reimbursement agreement entered into on March 13, 2012, Franklin Square Holdings has agreed to reimburse us for expenses in an amount that is sufficient to ensure that no portion of our distributions to stockholders will be paid from our offering proceeds or borrowings. However, because certain investments we may make, including preferred and common equity investments, may generate dividends and other distributions to us that are treated for tax purposes as a return of capital, a portion of our distributions to stockholders may also be deemed to constitute a return of capital for tax purposes to the extent that we may use such dividends or other distribution proceeds to fund our distributions to stockholders. Under those circumstances, Franklin Square Holdings will not reimburse us for the portion of such distributions to stockholders that represent a return of capital for tax purposes, as the purpose of the expense reimbursement arrangement is not to prevent tax-advantaged distributions to stockholders.
Under the expense reimbursement agreement, Franklin Square Holdings will reimburse us for expenses in an amount equal to the difference between our cumulative distributions paid to our stockholders in each quarter,
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less the sum of our net investment income for tax purposes, net capital gains and dividends and other distributions paid to us on account of preferred and common equity investments in portfolio companies (to the extent such amounts are not included in net investment income or net capital gains for tax purposes) in each quarter.
Pursuant to the expense reimbursement agreement, we will have a conditional obligation to reimburse Franklin Square Holdings for any amounts funded by Franklin Square Holdings under such agreement if (and only to the extent that), during any fiscal quarter occurring within three years of the date on which Franklin Square Holdings funded such amount, the sum of our net investment income for tax purposes, net capital gains and the amount of any dividends and other distributions paid to us on account of preferred and common equity investments in portfolio companies (to the extent not included in net investment income or net capital gains for tax purposes) exceeds the distributions paid by us to stockholders. The expense reimbursement agreement does not apply to any amounts funded by Franklin Square Holdings prior to the date of such agreement.
We or Franklin Square Holdings may terminate the expense reimbursement agreement at any time. If we terminate the investment advisory and administrative services agreement with FB Advisor, we will be required to repay Franklin Square Holdings all reimbursements funded by Franklin Square Holdings within three years of the date of termination.
The specific amount of expenses reimbursed by Franklin Square Holdings, if any, will be determined at the end of each quarter. Franklin Square Holdings is controlled by our chairman, president and chief executive officer, Michael C. Forman, and our vice-chairman, David J. Adelman. There can be no assurance that the expense reimbursement agreement will remain in effect or that Franklin Square Holdings will reimburse any portion of our expenses in future quarters.
Portfolio Investment Activity For The Six Months Ended June 30, 2012 and For The Year Ended December 31, 2011
During the six months ended June 30, 2012, we made investments in portfolio companies totaling $1,561,355. During the same period, we sold investments totaling $257,956 and received principal repayments of $269,132.
As of June 30, 2012, our investment portfolio, with a total fair value of $2,947,983, consisted of interests in 218 portfolio companies (48% in first lien senior secured loans, 18% in second lien senior secured loans, 9% in senior secured bonds, 18% in subordinated debt, 3% in collateralized securities and 4% in equity/other). The portfolio companies that comprised our portfolio as of such date had an average annual EBITDA of approximately $391.4 million. As of June 30, 2012, the investments in our portfolio were purchased at a weighted average price of 95.1% of par or stated value, as applicable, the weighted average credit rating of the investments in our portfolio that were rated (constituting approximately 64.4% of our portfolio based on the fair value of our investments) was B2 based upon the Moody’s scale and our estimated gross annual portfolio yield, prior to leverage, was 10.6% based upon the purchase price of our investments.
As of December 31, 2011, our investment portfolio, with a total fair value of $1,844,358, consisted of interests in 183 portfolio companies (55% in first lien senior secured loans, 21% in second lien senior secured loans, 6% in senior secured bonds, 13% in subordinated debt, 4% in collateralized securities and 1% in equity/other). The portfolio companies that comprised our portfolio as of such date had an average annual EBITDA of approximately $390.0 million. As of December 31, 2011, the investments in our portfolio were purchased at a weighted average price of 94.1% of par or stated value, as applicable, the weighted average credit rating of the investments in our portfolio that were rated (constituting approximately 70.9% of our portfolio based on the fair value of our investments) was B2 based upon the Moody’s scale and our estimated gross annual portfolio yield, prior to leverage, was 10.4% based upon the purchase price of our investments.
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The following table summarizes the composition of our investment portfolio at cost and fair value as of June 30, 2012 and December 31, 2011:
We do not “control” and are not an “affiliate” of any of our portfolio companies, each as defined in the 1940 Act. In general, under the 1940 Act, we would be presumed to “control” a portfolio company if we owned 25% or more of its voting securities and would be an “affiliate” of a portfolio company if we owned 5% or more of its voting securities.
Our investment portfolio may contain loans that are in the form of lines of credit or revolving credit facilities, which require us to provide funding when requested by portfolio companies in accordance with the terms of the underlying loan agreements. As of June 30, 2012, we had six such investments, all of which were revolving loan agreements with an aggregate unfunded commitment of $33,218. As of December 31, 2011, we had four such investments, three of which were revolving loan agreements with an aggregate unfunded commitment of $20,302 and one of which was an unfunded bridge loan commitment with an aggregate unfunded commitment of $35,000. We maintain sufficient cash on hand to fund such unfunded loan commitments should the need arise.
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Portfolio Asset Quality
In addition to various risk management and monitoring tools, FB Advisor uses an investment rating system to characterize and monitor the expected level of returns on each investment in our portfolio. FB Advisor uses an investment rating scale of 1 to 5. The following is a description of the conditions associated with each investment rating:
Summary Description
The following table shows the distribution of our investments on the 1 to 5 investment rating scale at fair value as of June 30, 2012 and December 31, 2011:
Investment Rating
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 three months ended June 30, 2012 and June 30, 2011
We generated investment income of $63,054 and $24,990 for the three months ended June 30, 2012 and 2011, respectively, in the form of interest earned on senior secured loans, senior secured bonds, subordinated debt, collateralized loan obligations and collateralized debt obligations in our portfolio and dividends and other distributions earned on equity/other securities. Such revenues represent $58,249 and $22,553 of cash income earned as well as $4,805 and $2,437 in non-cash portions relating to accretion of discount and PIK interest for the three months ended June 30, 2012 and 2011, 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 increase in investment income is due primarily to the growth of our portfolio over the last year. The level of income we receive is directly related to the balance of income-producing investments multiplied by the weighted average yield of our investments. We expect the dollar amount of interest and any dividend income that we earn to level off as the size of our investment portfolio stabilizes as a result of the closing of our public offering in May 2012.
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Our total operating expenses were $26,531 and $10,683 for the three months ended June 30, 2012 and 2011, respectively. Our operating expenses include base management fees attributed to FB Advisor of $15,345 and $6,023 for the three months ended June 30, 2012 and 2011, respectively. Our operating expenses also include administrative services expenses attributed to FB Advisor of $1,431 and $404 for the three months ended June 30, 2012 and 2011, respectively.
FB Advisor is eligible to receive incentive fees based on performance. We accrued capital gains incentive fees of $1,698 and $640 for the three months ended June 30, 2012 and 2011, respectively, of which $1,253 and $601, respectively, were based on unrealized gains and $445 and $39, respectively, were based on realized gains. No such fees are actually payable by us with respect to unrealized gains unless and until those gains are actually realized. See “—Critical Accounting Policies—Capital Gains Incentive Fee.”
We recorded interest expense of $5,346 and $2,267 for the three months ended June 30, 2012 and 2011, respectively, in connection with the Broad Street credit facility, the JPM Facility and the Walnut Street credit facility. Fees incurred with our fund administrator, which provides various accounting and administrative services to us, totaled $425 and $172 for the three months ended June 30, 2012 and 2011, respectively. We incurred fees and expenses with our stock transfer agent of $881 and $395 for the three months ended June 30, 2012 and 2011, respectively.
Our other general and administrative expenses totaled $1,405 and $782 for the three months ended June 30, 2012 and 2011, respectively, and consisted of the following:
Expenses associated with our independent audit and related fees
Compensation of our chief compliance officer
Legal fees
Printing fees
Directors’ fees
Other
During the three months ended June 30, 2012 and 2011, the ratio of our operating expenses to our average net assets was 1.20% and 1.50%, respectively. We generally expect our operating expenses to decline as a percentage of our total assets during periods of asset growth and increase as a percentage of our total assets during periods of asset declines. Our ratio of operating expenses to our average net assets during the three months ended June 30, 2012 and 2011 includes $5,346 and $2,267, respectively, related to interest expense and $1,698 and $640, respectively, related to accruals for incentive fees. Without such expenses, our ratio of operating expenses to average net assets would have been 0.88% and 1.09%, respectively. Incentive fees and interest expense, among other things, may increase or decrease our operating expenses in relation to our expense ratios relative to comparative periods depending on portfolio performance and changes in benchmark interest rates such as LIBOR, among other factors. The lower ratio of operating expenses to average net assets during the three months ended June 30, 2012 compared to the three months ended June 30, 2011 can primarily be attributed to the spreading of our operating expenses over a larger asset base.
As the size of our asset base and number of investors grew over the past year, our general and administrative expenses increased accordingly. Printing fees increased as the number of filings increased and the volume of each printing increased in conjunction with an increase in the number of stockholders prior to the closing of our public offering. In addition, the fees payable to our directors who do not also serve in an executive officer capacity for us or FB Advisor are determined by reference to a sliding scale based on our net asset value.
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Over the next several quarters, we expect our operating expenses related to our ongoing operations to level off as the size of our asset base stabilizes as a result of the closing of our public offering in May 2012.
During the three months ended June 30, 2012 and 2011, no expense reimbursements were required from Franklin Square Holdings pursuant to the expense reimbursement agreement.
Net Investment Income
Our net investment income totaled $36,523 ($0.16 per share) and $14,307 ($0.19 per share) for the three months ended June 30, 2012 and 2011, respectively. The decrease in net investment income on a per share basis can be attributed to, among other things, the accelerated rate of capital raising during the three months ended June 30, 2012 prior to the closing of our public offering and the resulting cash drag due to the pace of deployment of such capital.
Net Realized Gains or Losses
We sold investments and received principal repayments of $178,252 and $129,252, respectively, during the three months ended June 30, 2012, from which we realized net gains of $7,696. We also realized a net gain on our TRS of $4,793 and a net loss of ($4) from foreign currency transactions during the three months ended June 30, 2012. We sold investments and received principal repayments of $131,209 and $79,312, respectively, during the three months ended June 30, 2011, from which we realized net gains of $14,370.
Net Change in Unrealized Appreciation (Depreciation) on Investments and Total Return Swap and Unrealized Gain (Loss) on Foreign Currency
For the three months ended June 30, 2012, the net change in unrealized appreciation (depreciation) on investments totaled ($4,138), the net change in unrealized appreciation (depreciation) on the TRS was ($63) and the net change in unrealized gain (loss) on foreign currency totaled $261. For the three months ended June 30, 2011, the net change in unrealized appreciation (depreciation) on investments totaled ($11,957), the net change in unrealized appreciation (depreciation) on the TRS was $1,079, and the net change in unrealized gain (loss) on foreign currency totaled $21. The nominal amount of net change in unrealized appreciation (depreciation) on our investments during the three months ended June 30, 2012 was primarily a result of general stability in credit spreads over such period. The net change in unrealized appreciation (depreciation) on our investments during the three months ended June 30, 2011 was primarily driven by sales of investments that resulted in the conversion of unrealized gains on such investments to realized gains, thereby reducing unrealized appreciation.
Net Increase (Decrease) in Net Assets Resulting from Operations
For the three months ended June 30, 2012, the net increase (decrease) in net assets resulting from operations was $45,068 ($0.20 per share) compared to a net increase (decrease) in net assets resulting from operations of $17,820 ($0.24 per share) during the three months ended June 30, 2011.
Comparison of the six months ended June 30, 2012 and June 30, 2011
We generated investment income of $113,589 and $42,914 for the six months ended June 30, 2012 and 2011, respectively, in the form of interest earned on senior secured loans, senior secured bonds, subordinated debt, collateralized loan obligations and collateralized debt obligations in our portfolio and dividends and other distributions earned on equity/other securities. Such revenues represent $105,704 and $39,061 of cash income earned as well as $7,885 and $3,853 in non-cash portions relating to accretion of discount and PIK interest for the six months ended June 30, 2012 and 2011, respectively. Cash flows related to such non-cash revenues may not
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occur for a number of reporting periods or years after such revenues are recognized. The increase in investment income is due primarily to the growth of our portfolio over the last year. The level of income we receive is directly related to the balance of income-producing investments multiplied by the weighted average yield of our investments. We expect the dollar amount of interest and any dividend income that we earn to level off as the size of our investment portfolio stabilizes as a result of the closing of our public offering in May 2012.
Our total operating expenses were $62,174 and $22,591 for the six months ended June 30, 2012 and 2011, respectively. Our operating expenses include base management fees attributed to FB Advisor of $27,549 and $10,784 for the six months ended June 30, 2012 and 2011, respectively. Our operating expenses also include administrative services expenses attributed to FB Advisor of $2,334 and $988 for the six months ended June 30, 2012 and 2011, respectively.
FB Advisor is eligible to receive incentive fees based on performance. We accrued capital gains incentive fees of $16,499 and $3,911 for the six months ended June 30, 2012 and 2011, respectively, of which $15,972 and $2,743, respectively, were based on unrealized gains and $527 and $1,168, respectively, were based on realized gains. No such fees are actually payable by us with respect to unrealized gains unless and until those gains are actually realized. See “—Critical Accounting Policies—Capital Gains Incentive Fee.”
We recorded interest expense of $10,527 and $4,460 for the six months ended June 30, 2012 and 2011, respectively, in connection with the Broad Street credit facility, the JPM Facility and the Walnut Street credit facility. Fees incurred with our fund administrator, which provides various accounting and administrative services to us, totaled $846 and $394 for the six months ended June 30, 2012 and 2011, respectively. We incurred fees and expenses with our stock transfer agent of $1,821 and $690 for the six months ended June 30, 2012 and 2011, respectively.
Our other general and administrative expenses totaled $2,598 and $1,364 for the six months ended June 30, 2012 and 2011, respectively, and consisted of the following:
Compensation of our chief financial officer and our chief compliance officer(1)
During the six months ended June 30, 2012 and 2011, the ratio of our operating expenses to our average net assets was 3.17% and 3.79%, respectively. We generally expect our operating expenses to decline as a percentage of our total assets during periods of asset growth and increase as a percentage of our total assets during periods of asset declines. Our ratio of operating expenses to our average net assets during the six months
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ended June 30, 2012 and 2011 includes $10,527 and $4,460, respectively, related to interest expense and $16,499 and $3,911, respectively, related to accruals for incentive fees. Without such expenses, our ratio of operating expenses to average net assets would have been 1.79% and 2.38%, respectively. Incentive fees and interest expense, among other things, may increase or decrease our operating expenses in relation to our expense ratios relative to comparative periods depending on portfolio performance and changes in benchmark interest rates such as LIBOR, among other factors. The lower ratio of operating expenses to average net assets during the six months ended June 30, 2012 compared to the six months ended June 30, 2011 can primarily be attributed to the spreading of our operating expenses over a larger asset base.
During the six months ended June 30, 2012 and 2011, no expense reimbursements were required from Franklin Square Holdings pursuant to the expense reimbursement agreement.
Our net investment income totaled $51,415 ($0.25 per share) and $20,323 ($0.33 per share) for the six months ended June 30, 2012 and 2011, respectively. The decrease in net investment income on a per share basis can be attributed to, among other things, the accelerated rate of capital raising during the six months ended June 30, 2012 prior to the closing of our public offering and the resulting cash drag due to the pace of deployment of such capital.
We sold investments and received principal repayments of $257,956 and $269,132, respectively, during the six months ended June 30, 2012, from which we realized net gains of $4,594. We also realized a net gain on our TRS of $9,867 and a net gain of $13 from foreign currency transactions during the six months ended June 30, 2012. We sold investments and received principal repayments of $384,112 and $225,093, respectively, during the six months ended June 30, 2011, from which we realized net gains of $20,023.
For the six months ended June 30, 2012, the net change in unrealized appreciation (depreciation) on investments totaled $56,879, the net change in unrealized appreciation (depreciation) on the TRS was $4,449 and the net change in unrealized gain (loss) on foreign currency totaled $261. For the six months ended June 30, 2011, the net change in unrealized appreciation (depreciation) on investments totaled ($1,564), the net change in unrealized appreciation (depreciation) on the TRS was $1,287, and the net change in unrealized gain (loss) on foreign currency totaled $73. The net change in unrealized appreciation (depreciation) on our investments during the six months ended June 30, 2012 was primarily driven by a general strengthening of the credit markets during the first quarter of 2012. The net change in unrealized appreciation (depreciation) on our investments during the six months ended June 30, 2011 was primarily driven by sales of investments that resulted in the conversion of unrealized gains on such investments to realized gains, thereby reducing unrealized appreciation.
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For the six months ended June 30, 2012, the net increase (decrease) in net assets resulting from operations was $127,478 ($0.62 per share) compared to a net increase (decrease) in net assets resulting from operations of $40,142 ($0.65 per share) during the six months ended June 30, 2011.
Financial Condition, Liquidity and Capital Resources
In May 2012, we closed our continuous public offering of shares of common stock to new investors. We sold 247,454,171 shares (as adjusted for stock distributions) of common stock for gross proceeds of $2,605,158 in our continuous public offering. Following the closing of our continuous public offering, we have continued to issue shares pursuant to our distribution reinvestment plan. As of August 13, 2012, we had sold a total of 250,237,817 shares (as adjusted for stock distributions) of common stock for total gross proceeds of $2,631,891, including approximately $1,000 contributed by the principals of our investment adviser in February 2008. During the six months ended June 30, 2012, we sold 87,375,008 shares of our common stock for gross proceeds of $926,281. The gross proceeds received during the six months ended June 30, 2012 include reinvested stockholder distributions of $39,906, for which we issued 4,134,389 shares of common stock. During the six months ended June 30, 2012, we also incurred offering costs of $3,234 in connection with the sale of our common stock, which consisted primarily of legal, due diligence and printing fees. The offering costs were offset against capital in excess of par value in our consolidated financial statements. The sales commissions and dealer manager fees related to the sale of our common stock were $83,061 for the six months ended June 30, 2012. These sales commissions and fees include $15,842 retained by the dealer manager, FS2, which is one of our affiliates.
We 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. In May 2012, we closed our continuous public offering of shares of our common stock and, following the closing, sell shares only pursuant to our distribution reinvestment plan.
Prior to investing in securities of portfolio companies, we invest the net proceeds from the sale of shares of our common stock and from sales and paydowns of existing investments primarily in cash, cash equivalents, 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.
As of June 30, 2012, we had $231,916 in cash held in custodial accounts and $126,633 in cash held as collateral by Citibank under the terms of the TRS.
To provide our stockholders with limited liquidity, we conduct quarterly tender offers pursuant to our share repurchase program. The following table reflects certain information regarding the quarterly tender offers that we have conducted since December 31, 2010:
December 31, 2010
September 30, 2011
December 31, 2011
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Broad Street Credit Facility
On January 28, 2011, Broad Street, Deutsche Bank, and the other lenders party thereto entered into the Broad Street credit facility, which amended and restated the revolving credit facility that Broad Street originally entered into with Deutsche Bank on March 10, 2010 and the amendments thereto. On March 23, 2012, Broad Street entered into an amendment to the Broad Street credit facility to extend the maturity date of the facility to March 23, 2013, increase the amount of the Tranche C Commitment (described below) from $100,000 to $140,000 and reduce the interest rate for all borrowings under the facility to a rate of LIBOR + 1.50% per annum. Deutsche Bank is a lender and serves as administrative agent under the Broad Street credit facility.
Under the Broad Street credit facility, we have transferred from time to time debt securities to Broad Street as a contribution to capital and retain a residual interest in the contributed debt securities through our ownership of Broad Street. We may contribute additional debt securities to Broad Street from time to time and Broad Street may purchase additional debt securities from various sources. Broad Street has appointed us to manage its portfolio of debt securities pursuant to the terms of an investment management agreement. Broad Street’s obligations to the lenders under the facility are secured by a first priority security interest in substantially all of the assets of Broad Street, including its portfolio of debt securities. The obligations of Broad Street under the facility are non-recourse to us and our exposure under the facility is limited to the value of our investment in Broad Street.
As of June 30, 2012 and December 31, 2011, $380,000 and $340,000, respectively, was outstanding under the Broad Street credit facility. The carrying amount of the amount outstanding under the facility approximates its fair value. We incurred costs of $2,504 in connection with obtaining and amending the facility, which we have recorded as deferred financing costs on our consolidated balance sheets and amortize to interest expense over the life of the facility. As of June 30, 2012, $690 of such deferred financing costs had yet to be amortized to interest expense.
The effective interest rate under the Broad Street credit facility was 1.91% per annum as of June 30, 2012. Interest is paid quarterly in arrears and commenced August 20, 2010. We recorded interest expense of $2,006 and $2,267 for the three months ended June 30, 2012 and 2011, respectively, of which $237 and $223, respectively, related to the amortization of deferred financing costs and $18 and $0, respectively, related to commitment fees on the unused portion of the credit facility. We recorded interest expense of $4,430 and $4,460 for the six months ended June 30, 2012 and 2011, respectively, of which $431 and $428, respectively, related to the amortization of deferred financing costs and $18 and $0, respectively, related to commitment fees on the unused portion of the credit facility. We paid $4,270 and $4,248 in interest expense for the six months ended June 30, 2012 and 2011, respectively. The average borrowings under the facility for the six months ended June 30, 2012 and 2011 were $357,166 and $337,434, respectively, with a weighted average interest rate of 2.26% and 2.35%, respectively.
Borrowings under the Broad Street credit facility are subject to compliance with a borrowing base, pursuant to which the amount of funds advanced to Broad Street varies depending upon the types of assets in Broad Street’s portfolio. The occurrence of certain events described as “Super-Collateralization Events” in the credit agreement that governs the facility, or a decline in our net asset value below a specified threshold, results in a lowering of the amount of funds that will be advanced against such assets. Super-Collateralization Events include, without limitation, (i) certain key employees ceasing to be directors, principals, officers or investment
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managers of GDFM; (ii) the bankruptcy or insolvency of GDFM or FB Advisor; (iii) GDFM ceasing to act as our sub-adviser or FB Advisor ceasing to act as our investment adviser; (iv) our ceasing to act as Broad Street’s investment manager, becoming bankrupt or insolvent, defaulting on certain material agreements or failing to maintain a net asset value at least equal to $50,000; and (v) us, GDFM or FB Advisor committing fraud or other illicit acts in our or their investment advisory capacities.
In connection with the facility, Broad Street has made certain representations and warranties and is required to comply with various covenants, reporting requirements and other customary requirements for similar facilities. In addition to customary events of default included in financing transactions, the facility contains the following events of default: (a) the failure to make principal payments when due or interest payments within three business days of when due; (b) borrowings under the facility exceeding the applicable advance rates; (c) the purchase by Broad Street of certain ineligible assets; (d) the insolvency or bankruptcy of Broad Street or us; (e) we cease to act as investment manager of Broad Street’s assets; (f) the decline of our net asset value below $50,000; and (g) fraud or other illicit acts by us, FB Advisor or GDFM in our or their investment advisory capacities. During the continuation of an event of default, Broad Street must pay interest at a default rate.
Borrowings of Broad Street will be considered borrowings by us for purposes of complying with the asset coverage requirements under the 1940 Act applicable to BDCs.
The TRS with Citibank enables us, through our ownership of Arch Street, to obtain the economic benefit of owning the loans subject to the TRS, without actually owning them, in return for an interest-type payment to Citibank. As such, the TRS is analogous to Arch Street borrowing funds to acquire loans and incurring interest expense to a lender.
The obligations of Arch Street under the TRS are non-recourse to us and our exposure under the TRS is limited to the value of our investment in Arch Street, which generally will equal the value of cash collateral provided by Arch Street under the TRS. Pursuant to the terms of the TRS, Arch Street may select a portfolio of loans with a maximum aggregate market value (determined at the time each such loan becomes subject to the TRS) of $615,000. Arch Street is required to initially cash collateralize a specified percentage of each loan (generally between 20% and 25% of the market value of such loan) included under the TRS in accordance with margin requirements described in the TRS Agreement. Under the terms of the TRS, Arch Street has agreed not to draw upon, or post as collateral, such cash collateral in respect of other financings or operating requirements prior to the termination of the TRS. Neither the cash collateral required to be posted with Citibank nor any other assets of Arch Street are available to pay our debts.
Pursuant to the terms of an investment management agreement that we have entered into with Arch Street, we act as the manager of the rights and obligations of Arch Street under the TRS, including selecting the specific loans to be included in the portfolio of loans subject to the TRS. Accordingly, the loans selected by Arch Street for purposes of the TRS are selected by us in accordance with our investment objectives and strategy to generate
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current income and, to a lesser extent, long-term capital appreciation. In addition, pursuant to the terms of the TRS, Arch Street may select any loan or obligation available in the market to be included in the portfolio of loans that meets the obligation criteria set forth in the TRS Agreement.
Each individual loan, and the portfolio of loans taken as a whole, must meet criteria described in the TRS Agreement, including a requirement that each of the loans underlying the TRS be rated by Moody’s and S&P and quoted by a nationally-recognized pricing service. Under the terms of the TRS, Citibank, as calculation agent, determines whether there has been a failure to satisfy the portfolio criteria in the TRS. If such failure continues for 30 days following the delivery of notice thereof, then Citibank has the right, but not the obligation, to terminate the TRS. Arch Street receives from Citibank all interest and fees payable in respect of the loans included in the portfolio. Arch Street pays to Citibank interest at a rate equal to the one-month LIBOR + 1.27% per annum on the full notional amount of the loans subject to the TRS. In addition, upon the termination or repayment of any loan subject to the TRS, Arch Street will either receive from Citibank the appreciation in the value of such loan or pay to Citibank any depreciation in the value of such loan.
We have no contractual obligation to post any such additional collateral or to make any interest payments to Citibank. We may, but are not obligated to, increase our equity investment in Arch Street for the purpose of funding any additional collateral or payment obligations for which Arch Street may become obligated during the term of the TRS. If we do not make any such additional investment in Arch Street and Arch Street fails to meet its obligations under the TRS, then Citibank will have the right to terminate the TRS and seize the cash collateral posted by Arch Street under the TRS.
As of June 30, 2012 and December 31, 2011, the fair value of the TRS was $2,453 and ($1,996), respectively. The fair value of the TRS is reflected as an unrealized gain or loss on total return swap on our consolidated balance sheets. The change in value of the TRS is reflected in our consolidated statements of operations as net change in unrealized appreciation (depreciation) on total return swap.
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As of June 30, 2012, Arch Street had selected 125 underlying loans with a total notional amount of $546,189 and posted $126,633 in cash collateral held by Citibank (of which only $119,232 was required to be posted), which is reflected in due from counterparty on our consolidated balance sheets. As of December 31, 2011, Arch Street had selected 70 underlying loans with a total notional amount of $298,498 and posted $69,684 in cash collateral held by Citibank (of which only $61,460 was required to be posted), which is reflected in due from counterparty on our consolidated balance sheets.
For purposes of the asset coverage ratio test applicable to us as a BDC, we have agreed with the staff of the SEC to treat the outstanding notional amount of the TRS, less the initial amount of any cash collateral required to be posted by Arch Street under the TRS, as a senior security for the life of that instrument. We may, however, accord different treatment to the TRS in the future in accordance with any applicable new rules or interpretations adopted by the staff of the SEC.
Further, for purposes of Section 55(a) under the 1940 Act, we have agreed with the staff of the SEC to treat each loan underlying the TRS as a qualifying asset if the obligor on such loan is an eligible portfolio company and as a non-qualifying asset if the obligor is not an eligible portfolio company. We may, however, accord different treatment to the TRS in the future in accordance with any applicable new rules or interpretations adopted by the staff of the SEC.
JPM Financing
On July 21, 2011, we entered into a conventional debt financing arrangement with JPM, through two wholly-owned subsidiaries, pursuant to which up to $300,000 was made available to us to fund investments in new securities and for other general corporate purposes. On February 15, 2012, we amended the JPM financing arrangement to increase the amount of the debt financing available under the arrangement from $300,000 to $400,000. Pricing under the facility is based on three-month LIBOR plus a spread of 3.25% per annum for the relevant period. We elected to structure the financing in the manner described more fully below in order to, among other things, obtain such financing at a lower cost than would be available through alternate arrangements.
Pursuant to the financing transaction, loans in our portfolio having an aggregate market value of up to $800,000 may be sold by us from time to time to Locust Street, a special-purpose, bankruptcy-remote subsidiary of ours, pursuant to the Asset Transfer Agreement. Under the Asset Transfer Agreement, as of June 30, 2012, we had sold loans to Locust Street for a purchase price of approximately $365,396, all of which consisted of equity interests in Locust Street that Locust Street issued to us. We own all of the equity in Locust Street.
Loans purchased by Locust Street will secure the obligations of Locust Street under the Class A Notes to be issued by Locust Street from time to time to Race Street, another special-purpose, bankruptcy-remote subsidiary of ours, pursuant to the Indenture. The Class A Notes may be issued in an aggregate principal amount of up to $560,000 and mature on July 15, 2021. Race Street will purchase the issued Class A Notes from time to time at a purchase price equal to their par value and intends to purchase up to $560,000 in aggregate principal amount of such Class A Notes. We own all of the equity in Race Street.
Race Street, in turn, has entered into repurchase transactions with JPM pursuant to the terms of the JPM Facility. Pursuant to the JPM Facility, JPM has agreed to purchase from time to time Class A Notes held by Race Street for an aggregate purchase price equal to approximately 71% of the principal amount of Class A Notes purchased. Subject to certain conditions, the maximum principal amount of Class A Notes that may be purchased under the JPM Facility is $560,000. Accordingly, the maximum amount payable at any time to Race Street under the JPM Facility will not exceed $400,000. Under the JPM Facility, Race Street will, on a quarterly basis, repurchase the Class A Notes sold to JPM under the JPM Facility and subsequently resell such Class A Notes to JPM. The final repurchase transaction must occur no later than July 15, 2015. The repurchase price paid by Race
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Street to JPM for each repurchase of the Class A Notes will be equal to the purchase price paid by JPM for such Class A Notes, plus interest thereon accrued at the applicable pricing rate under the JPM Facility, as described below.
If at any time during the term of the JPM Facility the market value of the underlying loans held by Locust Street securing the Class A Notes declines by an amount greater than the Margin Threshold, Race Street will be required to post cash collateral with JPM in an amount at least equal to the amount by which the market value of such loans at such time is less than the Margin Threshold. In such event, in order to satisfy these margin-posting requirements, Race Street intends to borrow funds from us pursuant to the Revolving Credit Agreement. We may, in our sole discretion, make such loans from time to time to Race Street pursuant to the terms of the Revolving Credit Agreement. Borrowings under the Revolving Credit Agreement accrue interest at a rate equal to one-month LIBOR plus a spread of 0.75% per annum.
Interest on the Class A Notes accrues at three-month LIBOR plus a spread of 4.00% per annum. Principal on the Class A Notes will be due and payable on the stated maturity date of July 15, 2021. Pursuant to the Indenture, Locust Street has made certain representations and warranties and is required to comply with various covenants, reporting requirements and other customary requirements for similar transactions. In addition to customary events of default included in similar transactions, the Indenture contains the following events of default: (a) the failure to make principal payments on the Class A Notes at their stated maturity or redemption date, or to make interest payments on the Class A Notes within five business days of when due; (b) the failure of the aggregate outstanding principal balance (subject to certain reductions) of the loans securing the Class A Notes to be at least 130% of the outstanding principal amount of the Class A Notes; and (c) GDFM ceasing to be the sub-advisor to FB Advisor.
In connection with the Class A Notes and the Indenture, Locust Street also entered into (i) a collateral management agreement with us, as collateral manager, dated as of July 21, 2011, pursuant to which we will manage the assets of Locust Street, and (ii) a collateral administration agreement with Virtus, as collateral administrator, dated as of July 21, 2011, pursuant to which Virtus will perform certain administrative services with respect to the assets of Locust Street.
As of June 30, 2012 and December 31, 2011, Class A Notes in the aggregate principal amount of $490,000 and $300,000, respectively, had been purchased by Race Street from Locust Street and subsequently sold to JPM under the JPM Facility for aggregate proceeds of $350,000 and $214,286, respectively. As of June 30, 2012 and December 31, 2011, the fair value of investments held by Locust Street was $805,156 and $576,830, respectively, which included investments purchased by Locust Street with proceeds from the issuance of Class A Notes. On July 16, 2012, an additional Class A Note in the principal amount of $70,000 was purchased by Race Street from Locust Street and subsequently sold to JPM for proceeds of $50,000. We funded each purchase of Class A Notes by Race Street through a capital contribution to Race Street. As of June 30, 2012 and December 31, 2011, Race Street’s liability under the JPM Facility was $350,000 and $214,286, respectively, plus $2,747 and $1,294, respectively, of accrued interest expense. The Class A Notes issued by Locust Street and purchased by Race Street eliminate in consolidation on our financial statements.
We incurred costs of $425 in connection with obtaining the JPM Facility, which we have recorded as deferred financing costs on our consolidated balance sheets and amortize to interest expense over the life of the JPM Facility. As of June 30, 2012, $327 of such deferred financing costs had yet to be amortized to interest expense.
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The effective interest rate on the borrowings under the JPM Facility was 3.72% per annum as of June 30, 2012. We recorded interest expense of $3,250 and $6,007, respectively, for the three and six months ended June 30, 2012, of which $26 and $53, respectively, related to the amortization of deferred financing costs. We paid $2,862 and $4,501, respectively, in interest expense during the three and six months ended June 30, 2012. The average borrowings under the JPM Facility for the three and six months ended June 30, 2012 were $341,667 and $313,069, respectively, with a weighted average interest rate of 3.77% and 3.76%, respectively.
Amounts outstanding under the JPM Facility will be considered borrowings by us for purposes of complying with the asset coverage requirements under the 1940 Act applicable to BDCs.
Walnut Street Credit Facility
On May 17, 2012, Walnut Street and Wells Fargo entered into the Walnut Street credit facility. Wells Fargo Securities, LLC serves as the administrative agent and Wells Fargo Bank, National Association is the sole lender, collateral agent, account bank and collateral custodian under the facility. The Walnut Street credit facility provides for borrowings in an aggregate principal amount up to $250,000 on a committed basis.
Under the Walnut Street credit facility, we contribute cash or debt securities to Walnut Street from time to time and retain a residual interest in any assets contributed through our ownership of Walnut Street or receive fair market value for any debt securities sold to Walnut Street. Walnut Street may purchase additional debt securities from various sources. Walnut Street has appointed us to manage its portfolio of debt securities pursuant to the terms of a collateral management agreement. Walnut Street’s obligations to Wells Fargo under the Walnut Street credit facility are secured by a first priority security interest in substantially all of the assets of Walnut Street, including its portfolio of debt securities. The obligations of Walnut Street under the Walnut Street credit facility are non-recourse to us.
As of June 30, 2012, $7,967 was outstanding under the Walnut Street credit facility. The carrying amount outstanding under the facility approximates its fair value. We incurred costs of $3,576 in connection with obtaining the Walnut Street credit facility, which we have recorded as deferred financing costs on our consolidated balance sheets and amortize to interest expense over the life of the facility. As of June 30, 2012, $3,488 of such deferred financing costs had yet to be amortized to interest expense.
The effective interest rate on the borrowings under the Walnut Street credit facility was 2.71% per annum as of June 30, 2012. Interest is payable quarterly in arrears and will commence October 15, 2012. We recorded interest expense of $90 for the six months ended June 30, 2012, of which $88 related to the amortization of deferred financing costs. We paid $0 in interest expense during the six months ended June 30, 2012. The average borrowings under the Walnut Street credit facility for the six months ended June 30, 2012 was $88, with a weighted average interest rate of 2.71%.
The occurrence of certain collateral control events triggers (i) a requirement that Walnut Street obtain the consent of Wells Fargo prior to entering into any transaction with respect to portfolio assets and (ii) the right of
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Wells Fargo to direct Walnut Street to enter into transactions with respect to any portfolio assets, in each case in Wells Fargo’s sole discretion. Collateral control events include non-performance of any obligation under the transaction documents by Walnut Street, us, FB Advisor or GDFM, and other events with respect to such entities that are adverse to Wells Fargo and the secured parties under the Walnut Street credit facility.
In connection with the Walnut Street credit facility, Walnut Street has made certain representations and warranties and is required to comply with various covenants, reporting requirements and other customary requirements for similar facilities. In addition to customary events of default included in financing transactions, the Walnut Street credit facility contains the following events of default: (a) the failure to make principal payments when due or interest payments within three business days of when due; (b) a borrowing base deficiency that is not cured in accordance with the terms of the facility; (c) the insolvency or bankruptcy of Walnut Street or us; (d) our resignation or removal as collateral manager; (e) our failure to maintain an asset coverage ratio of greater than or equal to 2:1; (f) our failure to have a net asset value of at least $200,000; and (g) the failure of Walnut Street to qualify as a bankruptcy-remote entity. Upon the occurrence and during the continuation of an event of default, Wells Fargo may declare the outstanding advances and all other obligations under the Walnut Street credit facility immediately due and payable. During the continuation of an event of default, Walnut Street must pay interest at a default rate.
Borrowings of Walnut Street will be considered borrowings by us for purposes of complying with the asset coverage requirements under the 1940 Act applicable to BDCs.
RIC Status and Distributions
We have elected to be treated for federal income tax purposes, and intend to qualify annually, as a RIC under Subchapter M of the Code. In order to qualify as a RIC, we must, among other things, distribute at least 90% of our “investment company taxable income,” as defined by the Code, each year. As long as the distributions are declared by the due date of the tax return, including extensions, distributions paid up to one year 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 status each year. We are also subject to nondeductible federal excise taxes if we do not distribute at least 98% of net ordinary income, 98.2% of any capital gain net income, if any, and any recognized and undistributed income from prior years on which we paid no federal income taxes.
Following commencement of our operations, we declared our first distribution on January 29, 2009. Subject to our board of directors’ discretion and applicable legal restrictions, we intend to authorize and declare ordinary cash distributions on a monthly basis and pay such distributions on either a monthly or quarterly basis. While we historically paid distributions on a quarterly basis, commencing in the fourth quarter of 2010, we began to pay distributions on a monthly rather than quarterly basis. We will calculate each stockholder’s specific distribution amount for the period using record and declaration dates and each stockholder’s 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 for tax purposes. A return of capital generally is a return of an investor’s investment rather than a return of earnings or gains derived from our investment activities and will be made after deducting fees and expenses, including any fees payable to FB Advisor. Each year a statement on Form 1099-DIV identifying the source of the distributions will be mailed to our stockholders. No portion of the distributions paid during the six months ended June 30, 2012 or 2011 represented a return of capital for tax purposes.
We intend to continue to make our ordinary distributions in the form of cash out of assets legally available for distribution, unless stockholders elect to receive their distributions in additional 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.
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The following table reflects the cash distributions per share that we have declared and paid on our common stock during the six months ended June 30, 2012 and 2011:
On July 10, 2012, our board of directors declared a regular monthly cash distribution of $0.0675 per share, which was paid on July 31, 2012 to stockholders of record on July 30, 2012. On August 8, 2012, our board of directors declared a regular monthly cash distribution of $0.0675 per share, which is expected to be paid on August 31, 2012 to stockholders of record on August 30, 2012. 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.
We have adopted an “opt in” distribution reinvestment plan for our stockholders. As a result, if we make a distribution, our stockholders will receive distributions in cash unless they specifically “opt in” to the distribution reinvestment plan so as to have their cash distributions reinvested in additional shares of our common stock.
We may fund our cash distributions to stockholders from any sources of funds available to us, including offering proceeds, borrowings, net investment income from operations, capital gains proceeds from the sale of assets, non-capital gains proceeds from the sale of assets, dividends or other distributions paid to us on account of preferred and common equity investments in portfolio companies and expense reimbursements from Franklin Square Holdings. We have not established limits on the amount of funds we may use from available sources to make distributions. The following table reflects the sources of the cash distributions that we have paid on our common stock during the six months ended June 30, 2012 and 2011:
Our net investment income on a tax basis for the six months ended June 30, 2012 and 2011 was $78,011 and $25,570, respectively. As of June 30, 2012 and December 31, 2011, we had $444 and $2,145, respectively, of undistributed net investment income on a tax basis.
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The difference between our GAAP-basis net investment income and our tax-basis net investment income is due to the tax-basis amortization of organization costs incurred prior to the commencement of our operations, the reversal of interest income earned on a tax basis due to the required accretion of discount on a non-performing loan which was sold during the six months ended June 30, 2011, the reversal of the required accrual for GAAP purposes of incentive fees on unrealized gains even though no such incentive fees on unrealized gains are payable by us, the inclusion of realized gains on the TRS in tax-basis net investment income and the accretion of discount on the TRS. The following table sets forth a reconciliation between GAAP-basis net investment income and tax-basis net investment income during the six months ended June 30, 2012 and 2011:
The determination of the tax attributes of our distributions is made annually as of the end of our fiscal year based upon our taxable income for the full year and distributions paid for the full year. Therefore, a determination made on a quarterly basis may not be representative of the actual tax attributes of our distributions for a full year. The actual tax characteristics of distributions to stockholders are reported to stockholders annually on a Form 1099-DIV.
The following table reflects the stock distributions per share that we have declared on our common stock through June 30, 2012:
The purpose of these special stock distributions was to maintain a net asset value per share that was below the then-current offering price, after deducting selling commissions and dealer manager fees, as required by the 1940 Act, subject to certain limited exceptions. Our board of directors determined that our portfolio performance sufficiently warranted taking these actions.
The stock distributions increased the number of shares outstanding, thereby reducing our net asset value per share. However, because the stock distributions were issued to all stockholders as of the applicable record date in proportion to their holdings as of such date, the reduction in net asset value per share as a result of the stock
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distributions was offset exactly by the increase in the number of shares owned by each investor. As overall value to an investor was not reduced as a result of the special stock distributions, our board of directors determined that these issuances would not be dilutive to stockholders as of the applicable record date. As the stock distributions did not change any stockholder’s proportionate interest in us, they did not represent taxable distributions. Specific tax characteristics of all distributions are reported to stockholders annually on Form 1099-DIV.
As of June 30, 2012 and December 31, 2011, the components of accumulated earnings on a tax basis were as follows:
The aggregate cost of our investments for federal income tax purposes totaled $2,909,025 and $1,862,625 as of June 30, 2012 and December 31, 2011, respectively. The aggregate net unrealized appreciation (depreciation) on a tax basis, including the TRS, was $40,287 and ($20,263) as of June 30, 2012 and December 31, 2011, respectively.
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. Critical accounting policies are those that require the application of management’s 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. In preparing the financial statements, management has made 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. In preparing the financial statements, management has utilized available information, including our past history, industry standards and the current economic environment, among other factors, in forming its 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. 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 that are publicly-traded are valued at the reported closing price on the valuation date. Securities that are not publicly-traded are valued at fair value as determined in good faith by our board of directors. In connection with that determination, FB Advisor prepares portfolio company valuations using 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 third-party valuation services.
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Accounting Standards Codification Topic 820, Fair Value Measurements and Disclosure, or 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 valuation process begins with each portfolio company or investment being initially valued by FB Advisor’s management team, with such valuation potentially taking into account information received from our sub-adviser or an independent valuation firm, if applicable;
preliminary valuation conclusions are then documented and discussed with our valuation committee;
our valuation committee reviews the preliminary valuation and FB Advisor’s management team, together with our independent valuation firm, if applicable, responds and supplements the preliminary valuation to reflect any comments provided by the valuation committee; and
our board of directors discusses valuations and determines the fair value of each investment in our portfolio in good faith based on various statistical and other factors, including the input and recommendation of FB Advisor, the valuation committee and any third-party valuation firm, if applicable.
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. Below is a description of factors that our board of directors may consider when valuing our equity and debt 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 our board of directors may consider include the borrower’s ability to adequately service its debt, the fair market value of the portfolio company 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 (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 analysis 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.
Our board of directors may also look to private merger and acquisition statistics, public trading multiples discounted for illiquidity and other factors, valuations implied by third-party investments in the portfolio
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companies or industry practices in determining fair value. Our board of directors may also consider the size and scope of a portfolio company and its specific strengths and weaknesses, as well as any other factors it deems relevant in assessing the 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, our board of directors allocates the cost basis in the investment 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 fair value.
The fair values of our investments are determined in good faith by our board of directors. Our board of directors is solely 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 investments as of June 30, 2012 consisted primarily of debt securities that are traded on a private over-the-counter market for institutional investors. Except as described below, we valued our investments by using independent third-party pricing services, which provided prevailing bid and ask prices that were screened for validity by the services from dealers on the date of the relevant period end. Sixteen senior secured loan investments and seven subordinated debt investments, for which broker quotes were not available, were valued by an independent valuation firm, which determined the fair value of such investments by considering, among other factors, the borrower’s ability to adequately service its debt, prevailing interest rates for like investments, call features and other relevant terms of the debt. All of our equity/other investments were valued by the same independent valuation firm, which determined the fair value of such investments by considering, among other factors, contractual rights ascribed to such investments, as well as various income scenarios and multiples of EBITDA, cash flows, net income, revenues or, in limited instances, book value or liquidation value. One senior secured loan investment, which was purchased near June 30, 2012, was valued at cost, as our board of directors determined that the cost of such investment was the best indication of its fair value. We valued the TRS in accordance with the TRS Agreement. Pursuant to the TRS Agreement, the value of the TRS is based on the increase or decrease in the value of the loans underlying the TRS, together with accrued interest income, interest expense and certain other expenses incurred under the TRS. The loans underlying the TRS are valued by Citibank. Citibank bases its valuation on the indicative bid prices provided by an independent third-party pricing service. Bid prices reflect the highest price that market participants may be willing to pay. These valuations are sent to us for review and testing. Our valuation committee and board of directors review and approve the value of the TRS, as well as the value of the loans underlying the TRS, on a quarterly basis as part of their quarterly determination of net asset value. To the extent our valuation committee or board of directors has any questions or concerns regarding the valuation of the loans underlying the TRS, such valuation will be discussed or challenged pursuant to the terms of the TRS. For additional disclosures on the TRS, see “—Financial Condition, Liquidity and Capital Resources—Total Return Swap.”
Our investments as of December 31, 2011 consisted primarily of debt securities that are traded on a private over-the-counter market for institutional investors. Except as described below, we valued our investments by using independent third-party pricing services, which provided prevailing bid and ask prices that were screened for validity by the services from dealers on the date of the relevant period end. Eleven senior secured loan investments and three subordinated debt investments, for which broker quotes were not available, were valued by an independent valuation firm, which determined the fair value of such investments by considering, among other factors, the borrower’s ability to adequately service its debt, prevailing interest rates for like investments, call features and other relevant terms of the debt. All of our equity/other investments were valued by the same independent valuation firm, which determined the fair value of such investments by considering various factors, such as multiples of EBITDA, cash flows, net income, revenues or, in limited instances, book value or liquidation value. Two senior secured loans and two subordinated debt investments, which were purchased near
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December 31, 2011, were valued at cost, as our board of directors determined that the cost of each investment was the best indication of its fair value. We valued the TRS in accordance with the TRS Agreement, as described above. For additional disclosures on the TRS, see “—Financial Condition, Liquidity and Capital Resources—Total Return Swap.”
We periodically benchmark the bid and ask prices we receive from the third-party pricing services against the actual prices at which we purchase and sell our investments. Based on the results of the benchmark analysis and the experience of our management in purchasing and selling these investments, we believe that these prices are reliable indicators of fair value. However, because of the private nature of this marketplace (meaning actual transactions are not publicly reported), we believe that these valuation inputs are classified as Level 3 within the fair value hierarchy. We may also use other methods to determine fair value for securities for which we cannot obtain prevailing bid and ask prices through third-party pricing services or independent dealers, including the use of an independent valuation firm. We periodically benchmark the valuations provided by the independent valuation firm against the actual prices at which we purchase and sell our investments. Our valuation committee and board of directors reviewed and approved the valuation determinations made with respect to these investments in a manner consistent with our valuation process.
Revenue Recognition
Security transactions are accounted for on the trade date. We record interest income on an accrual basis to the extent that we expect to collect such amounts. We record dividend income on the ex-dividend date. We do not accrue as a receivable interest or dividends on loans and securities if we have reason to doubt our ability to collect such income. Loan origination fees, original issue discount and market discount are capitalized and we amortize such amounts as interest income over the respective term of the loan. Upon prepayment of a loan or security, any unamortized loan origination fees are recorded as interest income. We record prepayment premiums on loans and securities as interest income when we receive such amounts.
Net Realized Gains or Losses, Net Change in Unrealized Appreciation or Depreciation and Net Change in Unrealized Gains or Losses on Foreign Currency
Gains or losses on the sale of investments are calculated by using the specific identification method. We measure realized gains or losses by the difference between the net proceeds from the repayment or sale and the amortized cost basis of the investment, without regard to unrealized appreciation or depreciation previously recognized, but considering unamortized upfront fees. Net change in unrealized appreciation or depreciation reflects the change in portfolio investment values during the reporting period, including any reversal of previously recorded unrealized gains or losses when gains or losses are realized. Net change in unrealized gains or losses on foreign currency reflects the change in the value of receivables or accruals during the reporting period due to the impact of foreign currency fluctuations.
Capital Gains Incentive Fee
Pursuant to the terms of the investment advisory and administrative services agreement we entered into with FB Advisor, the incentive fee on capital gains earned on liquidated investments of our portfolio during operations prior to our liquidation is determined and payable in arrears as of the end of each calendar year (or upon termination of the investment advisory and administrative services agreement). Such fee will equal 20.0% of our incentive fee capital gains (i.e., our realized capital gains on a cumulative basis from inception, calculated as of the end of the applicable period, net of all realized capital losses and unrealized capital depreciation on a cumulative basis), less the aggregate amount of any previously paid capital gains incentive fees. On a quarterly basis, we accrue for the capital gains incentive fee by calculating such fee as if it were due and payable as of the end of such period.
While the investment advisory and administrative services agreement with FB Advisor neither includes nor contemplates the inclusion of unrealized gains in the calculation of the capital gains incentive fee, pursuant to an
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interpretation of an AICPA Technical Practice Aid for investment companies, commencing during the quarter ended December 31, 2010, we changed our methodology for accruing for this incentive fee to include unrealized gains in the calculation of the capital gains incentive fee expense and related accrued capital gains incentive fee. This accrual reflects the incentive fees that would be payable to FB Advisor if our entire portfolio was liquidated at its fair value as of the balance sheet date even though FB Advisor is not entitled to an incentive fee with respect to unrealized gains unless and until such gains are actually realized. During the three and six months ended June 30, 2012, we accrued capital gains incentive fees of $1,698 and $16,499, respectively, based on the performance of our portfolio, of which $1,253 and $15,972, respectively, were based on unrealized gains and $445 and $527, respectively, were based on realized gains. During the three and six months ended June 30, 2011, we accrued capital gains incentive fees of $640 and $3,911, respectively, based on the performance of our portfolio, of which $601 and $2,743, respectively, were based on unrealized gains and $39 and $1,168, respectively, were based on realized gains.
Uncertainty in Income Taxes
We evaluate our tax positions to determine if the tax positions taken meet the minimum recognition threshold in connection with accounting for uncertainties in income tax positions taken or expected to be taken for the purposes of measuring and recognizing tax liabilities in the financial statements. Recognition of a tax benefit or liability with respect to an uncertain tax position is required only when the position is “more likely than not” to be sustained assuming examination by taxing authorities. We recognize interest and penalties, if any, related to unrecognized tax liabilities as income tax expense in our consolidated statements of operations. During the six months ended June 30, 2012 and 2011, we did not incur any interest or penalties.
Contractual Obligations
We have entered into an agreement with FB Advisor to provide us with investment advisory and administrative services. Payments for investment advisory services under the investment advisory and administrative services agreement are equal to (a) an annual base management fee of 2.0% of the average value of our gross assets and (b) an incentive fee based on our performance. FB Advisor, and to the extent it is required to provide such services, our sub-adviser, are reimbursed for administrative expenses incurred on our behalf. For the three months ended June 30, 2012 and 2011, we incurred $15,345 and $6,023, respectively, in base management fees and $1,431 and $404, respectively, in administrative services expenses under the investment advisory and administrative services agreement. For the six months ended June 30, 2012 and 2011, we incurred $27,549 and $10,784, respectively, in base management fees and $2,334 and $988, respectively, in administrative services expenses under the investment advisory and administrative services agreement. In addition, FB Advisor is eligible to receive incentive fees based on performance. During the three months ended June 30, 2012 and 2011, we accrued capital gains incentive fees of $1,698 and $640, respectively, based on the performance of our portfolio, of which $1,253 and $601, respectively, were based on unrealized gains and $445 and $39, respectively, were based on realized gains. During the six months ended June 30, 2012 and 2011, we accrued capital gains incentive fees of $16,499 and $3,911, respectively, based on the performance of our portfolio, of which $15,972 and $2,743, respectively, were based on unrealized gains and $527 and $1,168, respectively, were based on realized gains. See “—Critical Accounting Policies—Capital Gains Incentive Fee.”
As of June 30, 2012, $380,000 was outstanding under the Broad Street credit facility. All such amounts will mature, and all accrued and unpaid interest thereunder will be due and payable, on March 23, 2013. As of June 30, 2012, Race Street had sold $490,000 in aggregate principal amount of Class A Notes to JPM under the JPM Facility for aggregate proceeds of $350,000. Race Street will, on a quarterly basis, repurchase the Class A Notes sold to JPM under the JPM Facility and subsequently resell such Class A Notes to JPM. The final repurchase transaction must occur no later than July 15, 2015. As of June 30, 2012, $7,967 was outstanding under the Walnut Street credit facility. All such amounts will mature, and all accrued and unpaid interest thereunder will be due and payable, on May 17, 2017.
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A summary of our significant contractual payment obligations for the repayment of outstanding borrowings under the Broad Street credit facility, the JPM Facility, and the Walnut Street credit facility at June 30, 2012 is as follows:
Borrowings of Broad Street(1)
Borrowings of Race Street(2)
Borrowings of Walnut Street(3)
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 May 2011, the FASB issued Accounting Standards Update No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This guidance represents the converged guidance of the Accounting Boards on fair value measurement. The collective efforts of the Accounting Boards reflected in this guidance have resulted in common requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term “fair value” and enhanced disclosure requirements for investments that do not have readily determinable fair values. The Accounting Boards have concluded the common requirements will result in greater comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with GAAP and International Financial Reporting Standards. The amendments to the FASB codification in this guidance are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. We have implemented this guidance and it did not have a material impact on our consolidated financial statements, except for enhanced disclosures around fair value measurements.
Related Party Transactions
We have entered into an investment advisory and administrative services agreement with FB Advisor. Pursuant to the investment advisory and administrative services agreement, FB Advisor is entitled to an annual base management fee of 2.0% of the average value of our gross assets and an incentive fee of 20.0% of net investment income, subject to an annualized 8.0% hurdle, and 20.0% of net realized capital gains, if applicable.
We commenced accruing fees under the investment advisory and administrative services agreement on January 2, 2009, upon the commencement of our operations. Management fees are paid on a quarterly basis in arrears. As of December 31, 2011, $9,572 in base management fees were payable to FB Advisor. During the six months ended June 30, 2012 and 2011, we accrued $27,549 and $10,784, respectively, in base management fees payable to FB Advisor, including $15,345 and $6,023, respectively, in base management fees accrued during the three months ended June 30, 2012 and 2011. We paid $21,736 and $8,168, respectively, of these fees during the six months ended June 30, 2012 and 2011. As of June 30, 2012, there was $15,385 in management fees payable to FB Advisor.
We accrue for the capital gains incentive fee, which, if earned, is paid annually. We accrue the incentive fee based on net realized and unrealized gains; however, under the terms of the investment advisory and administrative services agreement, the fee payable to FB Advisor is based on realized gains and no such fee is
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payable with respect to unrealized gains unless and until such gains are actually realized. During the three months ended June 30, 2012 and 2011, we accrued capital gains incentive fees of $1,698 and $640, respectively, based on the performance of our portfolio, of which $1,253 and $601, respectively, were based on unrealized gains and $445 and $39, respectively, were based on realized gains. During the six months ended June 30, 2012 and 2011, we accrued capital gains incentive fees of $16,499 and $3,911, respectively, based on the performance of our portfolio, of which $15,972 and $2,743, respectively, were based on unrealized gains and $527 and $1,168, respectively, were based on realized gains.
We reimburse FB Advisor for expenses necessary to perform services related to our administration and operations. The amount of this reimbursement is set at the lesser of (1) FB Advisor’s actual costs incurred in providing such services and (2) the amount that we estimate we would be required to pay alternative service providers for comparable services in the same geographic location. FB Advisor is required to allocate the cost of such services to us based on objective factors such as total assets, revenues, time records and other reasonable metrics. Our board of directors then assesses the reasonableness of such reimbursements based on the breadth, depth and quality of such services compared to the estimated costs to us of obtaining similar services from third-party 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 and, at least annually, our board of directors compares the total amount paid to FB Advisor for such services as a percentage of our net assets to the same ratio as reported by other comparable BDCs.
As of December 31, 2011, we had $154 of administrative services expense payable to FB Advisor. During the six months ended June 30, 2012 and 2011, we incurred administrative services expenses of $2,334 and $988, respectively, attributable to FB Advisor, of which $2,091 and $800, respectively, related to the allocation of costs of administrative personnel for services rendered to us by employees of FB Advisor and the remainder related to other reimbursable expenses. We paid FB Advisor $1,654 and $814, respectively, for the services rendered under this arrangement during the six months ended June 30, 2012 and 2011. As of June 30, 2012, we had $834 in administrative services expense payable to FB Advisor.
The dealer manager for our public offering was FS2, which is one of our affiliates. During the six months ended June 30, 2012 and 2011, FS2 retained $15,842 and $9,115, respectively, for selling commissions and dealer manager fees in connection with the sale of our common stock.
Under the terms of the investment advisory and administrative services agreement, when our registration statement was declared effective by the SEC and we were successful in satisfying the minimum offering requirement, FB Advisor became entitled to receive 1.5% of gross proceeds raised in our continuous public offering until all offering costs and organization costs funded by FB Advisor or its affiliates (including Franklin Square Holdings) had been recovered. On January 2, 2009, we satisfied the minimum offering requirement. We paid total reimbursements of $0 and $641 to FB Advisor and its affiliates during the six months ended June 30, 2012 and 2011, respectively. The reimbursements were recorded as a reduction of capital. As of June 30, 2012, no amounts were payable to FB Advisor and its affiliates under this arrangement.
FB Advisor’s senior management team is comprised of the same personnel as the senior management teams of FS Investment Advisor, LLC and FSIC II Advisor, LLC, the investment advisers to Franklin Square Holdings’ other affiliated BDCs, FS Energy and Power Fund and FS Investment Corporation II, respectively. As a result, such personnel provide investment advisory services to us and each of FS Energy and Power Fund and FS Investment Corporation II. While none of FB Advisor, FS Investment Advisor, LLC or FSIC II Advisor, LLC is currently making private corporate debt investments for clients other than us, FS Energy and Power Fund and FS Investment Corporation II, respectively, any, or all, may do so in the future. In the event that FB Advisor undertakes to provide investment advisory services to other clients in the future, it intends to allocate investment opportunities in a fair and equitable manner consistent with our investment objectives and strategies, if necessary, so that we will not be disadvantaged in relation to any other client of FB Advisor or its management
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team. In addition, even in the absence of FB Advisor retaining additional clients, it is possible that some investment opportunities may be provided to FS Energy and Power Fund or FS Investment Corporation II rather than to us.
Under the expense reimbursement agreement, Franklin Square Holdings will reimburse us for expenses in an amount equal to the difference between our cumulative distributions paid to our stockholders in each quarter, less the sum of our net investment income for tax purposes, net capital gains and dividends and other distributions paid to us on account of preferred and common equity investments in portfolio companies (to the extent such amounts are not included in net investment income or net capital gains for tax purposes) in each quarter.
The specific amount of expenses reimbursed by Franklin Square Holdings, if any, will be determined at the end of each quarter. During the six months ended June 30, 2012 and 2011, no such reimbursements were required from Franklin Square Holdings. Franklin Square Holdings is controlled by our chairman, president and chief executive officer, Michael C. Forman, and our vice-chairman, David J. Adelman. There can be no assurance that the expense reimbursement agreement will remain in effect or that Franklin Square Holdings will reimburse any portion of our expenses in future quarters.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
We are subject to financial market risks, including changes in interest rates. As of June 30, 2012, approximately 27.5% of our portfolio investments (based on fair value) paid fixed interest rates, approximately 2.0% were non-income producing and the remainder paid variable interest rates. A rise in the general level of
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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. To the extent that a majority of our investments may be in variable rate investments, an increase in interest rates would make it easier for us to meet or exceed the hurdle rate for the subordinated incentive fee on income payable to FB Advisor, and may result in a substantial increase in our net investment income and to the amount of incentive fees payable to FB Advisor with respect to our increased pre-incentive fee net investment income.
Pursuant to the terms of the Broad Street credit facility and the Walnut Street credit facility, Broad Street and Walnut Street, respectively, borrow at a floating rate based on LIBOR. Under the terms of the TRS between Arch Street and Citibank, Arch Street pays fees to Citibank at a floating rate based on LIBOR in exchange for the right to receive the economic benefit of a pool of loans having a maximum notional amount of $615,000. Pursuant to the terms of the financing arrangement with JPM, borrowings under the Revolving Credit Agreement, pricing of repurchase transactions under the JPM Facility and interest on the Class A Notes are all subject to a floating rate based on LIBOR. We expect that any future credit facilities, total return swap agreements or other financing arrangements that we or any of our subsidiaries may enter into will also be based on a floating interest rate. As a result, we are subject to risks relating to changes in market interest rates. In periods of rising interest rates when we or our subsidiaries have debt outstanding or swap agreements 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 our investment portfolio and borrowing arrangements in effect as of June 30, 2012:
LIBOR Basis Point Change
Down 50 basis points
Current LIBOR
Up 100 basis points
Up 300 basis points
Up 500 basis points
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 six months ended June 30, 2012 and 2011, we did not engage in interest rate hedging activities.
In addition, we may have risk regarding portfolio valuation. See “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies—Valuation of Portfolio Investments.”
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Item 4. Controls and Procedures.
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
As required by Rule 13a-15(b) of the Exchange Act, we carried out an evaluation, under the supervision and with the participation of our management, including the chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2012. Based on the foregoing, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective to provide reasonable assurance that we would meet our disclosure obligations.
There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) of the Exchange Act) that occurred during the three months ended June 30, 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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Item 1. 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 1A. Risk Factors.
Investing in our common stock involves a number of significant risks. In addition to the other information contained in this quarterly report on Form 10-Q and the risk factors set forth in our annual report on Form 10-K for the year ended December 31, 2011, you should consider carefully the following information before making an investment in our common stock.
The agreements governing Walnut Street’s revolving credit facility contain various covenants which, if not complied with, could accelerate repayment under the facility, thereby materially and adversely affecting our liquidity, financial condition, results of operations and our ability to pay distributions to our stockholders.
Our wholly-owned subsidiary, Walnut Street, has entered into the Walnut Street credit facility with Wells Fargo. The agreements governing the facility contain default provisions such as: (a) the failure to make principal payments when due or interest payments within three business days of when due; (b) a borrowing base deficiency that is not cured in accordance with the terms of the facility; (c) the insolvency or bankruptcy of Walnut Street or us; (d) our resignation or removal as collateral manager; (e) our failure to maintain an asset coverage ratio of greater than or equal to 2:1; (f) our failure to have a net asset value of at least $200 million; and (g) the failure of Walnut Street to qualify as a bankruptcy-remote entity. Upon the occurrence and during the continuation of an event of default, Wells Fargo may declare the outstanding advances and all other obligations under the Walnut Street credit facility immediately due and payable. During the continuation of an event of default, Walnut Street must pay interest at a default rate. This could disrupt our business, reduce our revenues and, by delaying any dividends allowed to us under the facility until the lender has been paid in full, reduce our liquidity and cash flow and impair our ability to grow our business, make distribution payments to our stockholders and maintain our status as a RIC.
The agreements governing the Walnut Street credit facility also require Walnut Street to comply with certain operational covenants. These covenants require Walnut Street to, among other things, maintain a specified borrowing base pursuant to which the amount of funds advanced to Walnut Street varies depending upon the types of loans in Walnut Street’s portfolio. In addition, the occurrence of any collateral control event triggers (i) a requirement that Walnut Street obtain the consent of Wells Fargo prior to entering into any transaction with respect to portfolio assets and (ii) the right of Wells Fargo to direct Walnut Street to enter into transactions with respect to any portfolio assets, in each case in Wells Fargo’s sole discretion. Collateral control events include non-performance of any obligation under the transaction documents by Walnut Street, us, FB Advisor or GDFM, and other events with respect to such entities that are adverse to Wells Fargo and the secured parties under the Walnut Street credit facility.
The failure to meet collateral requirements under the Walnut Street credit facility or the occurrence of any other event of default which results in the acceleration of amounts due under the facility may force Walnut Street or us to liquidate positions at a time and/or at a price which is disadvantageous to us and could result in losses. In addition, upon the occurrence of an event of default under the facility, Wells Fargo would have the right to the assets pledged as collateral supporting the amounts outstanding under the credit facility and could sell such assets in order to satisfy amounts due under the facility.
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Each borrowing under the Walnut Street credit facility is subject to the satisfaction of certain conditions. We cannot assure stockholders that Walnut Street will be able to borrow funds under the facility at any particular time or at all. See “Part I—Item 2A. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition, Liquidity and Capital Resources” for a more detailed discussion of the terms of the Walnut Street credit facility.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
The table below provides information concerning our repurchases of shares of our common stock during the quarter ended June 30, 2012 pursuant to our share repurchase program.
Period
April 1 to April 30, 2012
May 1 to May 31, 2012
June 1 to June 30, 2012
See Note 9 to our unaudited consolidated financial statements contained in this quarterly report on Form 10-Q for a more detailed discussion of the terms of our share repurchase program.
Item 3. Defaults upon Senior Securities.
Not applicable.
Item 4. Mine Safety Disclosures.
Item 5. Other Information.
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Item 6. Exhibits.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized on August 14, 2012.
/s/ Michael C. Forman
Michael C. Forman
Chief Executive Officer
(Principal Executive Officer)
/s/ William Goebel
William Goebel
Chief Financial Officer
(Principal Financial and Accounting Officer)
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