Portfolio markdowns, run-offs push down FSIC’s Q1 EPS

FS Investment Corporation (FSIC) covered its dividend in the first quarter, although realised and unrealised credit losses of $0.16 a share hampered its earnings per share.

FSIC management explained on its first-quarter earnings call that the muted Q1 earnings were a product of portfolio markdowns, portfolio run-off and executive focus on protecting incumbent positions.

Approximately 89 percent of these portfolio markdowns came from unrealized losses, primarily among three equity positions: JW Aluminum, PSAV and Advanced Lighting. There was also one first lien debt investment marked down, a position in Safariland, for which management expects a full recovery.

Portfolio run-off also detracted from earnings. Sales and redemptions outpaced originations and portfolio purchases by nearly $100 million. Portfolio exits fell from $364 million of last year to $216 million in Q1 of this year, a 41 percent drop.

Nearly three-quarters of the sales and redemptions for the first three months of the year can be traced back to two portfolio companies, which together represented 3.91 percent of FSIC’s book, according to the Thomson Reuters BDC Collateral database.

Stadium Management redeemed $56 million in second lien paper as part of its buyout with Onex Corporation. Waste Pro USA refinanced away $94 million in first lien debt as part of a broader $500 million bond offering.

On the other side of the equation, originations declined 79 percent against its year-ago comparable, falling from $539.7 million to $116 million.

In addition to the competitive landscape becoming even stiffer, the friction costs associated with switching strategic partners may explain the drop in quarterly production. With nearly $180 million in the pipeline for just the month of April, management believes its partnership with KKR will help turn the tide.

Management said the firm has a “robust” second-quarter pipeline and will look to opportunistically complete the remaining $24 million of its $50 million share repurchase program. FSIC repurchased $1 million of shares in the first quarter and $25 million in April and May.

FSIC’s net investment income fell in line analyst estimates. The firm reported $0.21-a-share NII for the quarter, more than meeting its $0.19-a-share dividend.

Over three-quarters of FSIC’s first-quarter originations came from deals with existing portfolio companies.

“We expect that to continue,” FSIC president Brian Gerson said.

Management emphasised the provision in the recent divorce with GSO that bars Blackstone’s credit arm from refinancing companies out of FSIC’s portfolio.

“A key component of our transaction with GSO on their exit was the anti-poaching protection to make sure that we could maintain the portfolio,” CEO Michael Forman said on the call.

Given the departure of GSO and despite the provision protecting FSIC’s incumbency, some companies may leave the portfolio through refinancing with a third party, Wells Fargo analyst Jonathan Bock wrote in a research note.

FSIC’s board initially approved a measure allowing the BDC to take on additional leverage, which is now capped at a 2:1 debt-to-equity ratio rather than its previous 1:1 limit.

After Standard & Poor’s released unfavourable guidance on the issue, FSIC rescinded its board decision. The firm hopes to keep an investment-grade label from the ratings agency, allowing it to optimise the liability side of its balance sheet.

“An entity with a potentially larger capital base will have access to some more different forms of capital, potentially even simplifying some of the facilities that are out there,” KKR’s Dan Pietrzak said.

FSIC had investments in 94 portfolio companies, as of 31 March. Of those positions, 65 percent were first lien senior secured loans; 4 percent in second lien senior secured loans; 4 percent in senior secured bonds; 1 percent in collateralized securities; and 13 percent in equity investments or other securities. The combined FS KKR joint venture will contain six funds, 150 sponsor relationships, and 325 portfolio companies.